4. Impact on SMEs
- Scotland’s economy comprises predominantly small and medium sized enterprises (SMEs) which are likely to find it more difficult to prepare for Brexit due to resource constraints and uncertainty over what to prepare for. This was a theme raised in most dynamic consultation workshops with particularly clear risks identified in chemicals, construction and financial services.
- Larger companies are more likely to have capacity to prepare for Brexit and put in place relevant contingency plans. As a consequence, there is a risk that SMEs may be at a disadvantage in undertaking Brexit preparations more slowly than larger firms; for example, earlier contingency actions taken by larger companies to secure warehousing or mitigate logistic issues could limit the scope for SMEs to do same.
4.1 Brexit risks
A survey conducted by the Federation of Small Businesses Scotland indicated that 1 in 7 small businesses has yet to make any preparations for a no deal Brexit. This theme emerged in a number of the dynamic consultation workshops including food and drink, life sciences, high value manufacturing, construction and the creative industries. This is a particular risk for the Scottish economy given the relatively high proportion of SMEs.
Scottish industries tend to consist of a few large companies, relatively few medium sized firms, and then a significant number of smaller businesses. This is illustrated in Figure 3 below, that shows over 98% of Scottish businesses are classified as small (employing less than 50 people), accounting for over two-fifths (42.4%) of total employment. In contrast, less than one percent of Scottish businesses are considered to be large, accounting for a similar level of employment (45.1%).
Figure 3: Share of enterprises, employment and turnover by size of enterprise, Scotland, 2018
Source: Businesses in Scotland, Scottish Government
4.2.1 Capacity constraints
The larger firms consulted as part of the dynamic consultation exercise indicated that they had undertaken preparations for Brexit and had developed an understanding of the potential impacts of a no deal Brexit on their business. Although this was more evident in foreign-owned firms in manufacturing, larger companies had also taken practical steps to assess the readiness of their supply chains, e.g. supplier surveys, moving annual maintenance periods into April 2019, and stockpiling supplies and finished products. Common examples of Brexit preparation activities in Scotland, and across the UK include:
- Supplier engagement – surveys, contract reviews, switching to more local or less exposed suppliers.
- Entity review – subject to review of regulatory requirements, moving to or setting up EU-27 entities for regulatory approvals or distribution, setting up new UK entities.
- Adjusting trade flows – for example servicing customers in Northern Ireland directly from Scotland rather than via the Republic of Ireland (or mitigating via bonded warehouses).
- Border delay hedges – including Authorised Economic Operator (AEO), increasing inventory stock-holdings or changing service lead-time guarantees.
- Customs readiness and up-scaling – including UK Tariff Codes/integrated Tariff of the European Union (TARIC) classifications, HMRC’s new Customs Declarations Service, systems configuration, hiring additional customs compliance staff, assessing broker readiness.
The shared perception from the dynamic consultation process was that SMEs were far less likely to have assessed the extent of their Brexit risk or undertaken any contingency planning. In particular, while large organisations were able to establish governance structures dedicated to Brexit and assign a number of staff for reviewing risks and preparing contingency plans, SMEs were consistently reported to be unlikely to have the capacity to make similar investments.
The dynamic consultation demonstrated higher levels of self-assessed Brexit readiness in sectors dominated by foreign owned enterprises or in highly regulated industries (e.g. financial services, life sciences, chemicals, energy and high value manufacturing). Only 1 in 10 of businesses asked in these sectors reported they were not ready at all for Brexit, with 4 out of every five saying they were only partly ready.
Further, two-thirds of business were not confident that the UK would secure a Brexit deal prior to March 2019, and while the majority of firms responded that they had made preparations for such an outcome, a greater proportion of foreign-owned firms, and those that operate in heavily regulated industries, had done so.
For example, in the chemicals and high value manufacturing sectors, larger companies engaged in dynamic consultation had sought to establish if their suppliers had processes in place for Brexit. It was their view, made on the basis of responses they had received from their supply chains, that many SMEs have not yet started this process. In some sectors (high value manufacturing and chemicals) larger firms have been further pursuing SMEs for reassurances, while in others (construction) there was an explicit acknowledgement that the complexity of supply chains made this a more challenging task. In the chemicals sector, a trade association indicated that large companies are likely to have sought to establish if their hauliers had processes in place for Brexit. It was their belief that SMEs would not have started this process yet.
Smaller companies may be at a disadvantage in undertaking Brexit preparations more slowly than large companies. For example, larger companies are likely to implement logistical solutions first, like warehousing and transportation mitigations, and as a result there may be limited capacity for small businesses to do the same.
Dynamic consultation evidence indicated that small businesses are more likely to find dealing with regulatory changes and changes in the visas system to employ EU workers difficult. According to a trade association, a challenge for the many smaller firms in the Scottish financial services industry is that they will find it more difficult than larger companies to deal with Brexit without transitional arrangements and with a loss of passporting. Further research is required by SG to understand how to mitigate the impact of a loss of passporting.
Smaller firms in the chemicals sector will face a particular challenge in respect of REACH registration (Insight 12).
Insight 12: Scotland’s chemicals sector and regulatory alignment
The Scottish chemicals sector has a large degree of intra-industry trade with the EU; this is facilitated by regulatory equivalence. Companies in this sector are registered with the ECHA and REACH. Companies in this sector that are already registered will have to transfer their registration to a EU27 address. This may be more difficult for smaller companies which do not have European arms. The process is likely to be longer for firms which do not yet import or export with the EU as they will have to register for the first time.
Source: EY dynamic consultation
Some of the mitigations that larger businesses indicated they had been undertaking may not be possible for smaller firms. For example, a larger company in the food and drink sector reported hedging against currency risks of Brexit. This company noted that smaller companies would be unlikely to be able to do the same.
Likewise, some larger companies in the construction industry had begun to stockpile materials. This would be challenging for the significant proportion of small construction firms in Scotland, as they lack the resources to evaluate their exposure to what can be very complex supply chains. They would also struggle to stockpile materials due to cash flow constraints, and would have challenges in forecasting future work due to the bespoke nature of individual contracts. Consequently, border delays could lead to business failure for small businesses through delays to contracts and customer complaints. Some large companies have also noted they are stockpiling contracts in their project pipeline.
There is also likely to be a significant cash flow risk to SMEs (and indeed larger firms) in the event of a no deal Brexit. In particular, disruptions to supply chains from border delays could result in increased demands on working capital. Financial institutions in particular may need to extend additional credit, or relax normal lending conditions to prevent increased levels of financial distress. While this is a risk particularly for SMEs, it also extends across the wider Scottish economy, and potentially calls for a coordinated response by SG, the Enterprise Agencies and the financial services sector.
4.2.2 Opportunities for SMEs in preparing for Brexit
A number of businesses in the dynamic consultation mentioned that there may be some advantages in Scotland’s small scale in terms of opportunities for better coordination in response to Brexit. For example, there was a common complaint by those who had undertaken significant preparations as to the extent to which it has taken up resources and senior management time that would have otherwise been best directed at growing the business. SG could facilitate sharing best practice between businesses. There was evidence from the dynamic consultation that this might be more realistic in the Scottish context than across the UK. For example, in the financial services sector in Scotland, the extent to which firms shared best practices was anecdotally remarked upon as being more collaborative than for the sector across the UK as a whole.
This is more possible in sectors like financial services and life sciences that are more geographically focused and can take advantage of their closer-knit professional communities. Indeed, almost all businesses which participated in the dynamic consultations reported that the workshops were either useful or very useful. This level of goodwill could be something the sectors themselves and Government can build on.
There was also the more general question as to whether Scottish businesses are getting relevant support from their trade associations on general and Scotland specific Brexit issues. Businesses that EY spoke to in some sectors, for example the creative industries, indicated that they felt there was less support in Scotland because most of the activity in this sector is London-centric where their trade associations are also largely based. This is an important consideration for business in Scotland because, if the support and activities by industry trade bodies on Brexit are London/UK centric, it may not reflect the views and issues of Scottish businesses, or it might leave business in Scotland slightly isolated from trade body and wider discussions. This was felt to be a particular issue for SMEs in the creative industries which do not have representation or the resource to travel to London.
There was some awareness – which was also promoted in the dynamic consultation – that SG are delivering a number of initiatives to support business through Brexit, for example, the multi-partner, pan Scotland Prepare for Brexit campaign and website. This initiative aims to equip businesses of all sizes, sectors and locations with the know-how and confidence to actively plan for Brexit. That said, there was evidence from the dynamic consultation that this may not be reaching all businesses across Scotland. Further targeting may be warranted especially amongst SMEs in Scotland’s key industries in order to raise awareness of the support already available.
4.3 Implications and policy response
The evidence from dynamic consultation suggests that SMEs are unlikely to have made preparations for Brexit. SG should consider how it could further support these enterprises ahead of and during Brexit.
4.3.1 Support SMEs in key Scottish sectors through Brexit
- SG Enterprise Agencies should build on the Prepare for Brexit campaign, and in particular, explore how it can provide more targeted support to SMEs. This could include calling on larger business to provide support to SMEs in their supply chains.
- SMEs should also recognise the opportunities they can take advantage of as smaller and more nimble organisations, for example, pivoting to become part of domestic supply chains. Indeed, this applies to Scotland more generally: there are likely to be advantages of scale. For example, it may be easier to coordinate activity and share best practice that the Scottish economy could take advantage of: examples include closer alignment between the life sciences sector, Scottish universities and NHS Scotland to fast track the commercialisation of new products.
- SG and businesses should encourage UK-wide trade associations to consider the specific need of Scottish members. Perhaps through existing or new Brexit-specific industry groups to facilitate knowledge sharing across sub-sectors.
- Businesses should review their financing and cash positions in the context of the potential challenges that Brexit represents (e.g. border delays) to cash flows and working capital.
- SG should engage with Scottish retail banks about relaxing credit requirements through Brexit to assist SMEs if activity is disrupted and cash flow and working capital are hit.
Email: Central Enquiries Unit