SMEs & Risk In 2020Business & risk implications of a shifting landscape

insights

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Contents

Introduction 3

The SME Workforce & Workplace of the Future 5

The SME Business Model of the Future 7

SME Trading in the Future 9

The SME Production, Product & Services of the Future 11

Final considerations 13

www.zurich.co.uk

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SMEs & Risk in 2020

Introduction

Predicting what the future holds has never been easy but even less so in these turbulent times. However, one thing is for sure, this is a time of enormous change and with this change being incredibly rapid too.

As a leading business insurer, we need to understand not only the risks that our customers are currently facing, but also in the future, so that we can work together with brokers to help SMEs build greater resilience against the challenges they will face.

Zurich has a unique focus on risk and thought leadership. For the SME sector it entails following the long-term shifts in the UK SME landscape, whilst also tracking the practical, day to day business risk environment for small businesses whether a start-up, small manufacturer, beauty salon or an expanding retailer.

This is why we have researched the future of SMEs and risk. Our research focused not only on the long-term future of the SME sector in 2062 – but, perhaps even more interestingly, what will be the shape and challenges of the sector in the near-term, by 2020.

Many of the 2020 findings are significant; of the 1,000 SMEs polled1:

• 45% categorized their firm as a ‘web firm’ – where the business conducts at least some of its operations, sales or marketing online

• 27% believe that over 50% of their employees will work from home / telecommute

• 10% believe that the home, mobile and teleworking trends will change the very nature of their business

• 38% stated that the number of sub-contractors working for SMEs will increase; 33% that the number of permanent, long-term employees will reduce

• 65% that the ageing workforce will be an opportunity for their business to retain talent & experience; and 52% that the ageing workforce will present new customer and service opportunities for their business

• 70% that traditional high street SMEs will have to radically change their customer experience in order to compete with online purchasing

• 42% that SMEs will work together to achieve back-office business savings; 44% believe that the majority of SMEs will outsource back office work (eg. finance, HR) in the future

• 44% believe there will be more local business partnerships based on sustainability

• 26% that employee ownership schemes will be an important part of the UK SME economy

• 69% stated that Intellectual Property will be very important for SME businesses in the future

More importantly, 38% of SMEs even agreed that ‘artificial intelligence’ software programmes and services will play a critical role for the small business in the future; and 41% agreed that Artificial Intelligence (AI)such as Siri (Apple’s Iphone capability to provide verbal ‘real-time’ answers to verbal questions) will become our trusted workplace advisors by 2020. 36% also stated that robotics will play an important role in different types of SME businesses and services in the next eight years.

In this report, we have tried to give you a flavour of what lies ahead for small businesses and medium size enterprises, the challenges they will meet and the risk implications.

We have segmented the SME business of 2020 into four perspectives:

• The workforce & workplace – what will be the future shape of the SME?

• The business model – how will the future SME structure change?

• Trading – where and how will SME trading take place in the future?

• Production, Product & Services – what might SMEs manufacture and how will they deliver goods & services in 2020?

Each area has emerging risk implications – both insurable and non-insurable. The pace of change within the sector is accelerating; as technology develops, there are enormous opportunities open for even the smallest businesses.

We hope that this research will help provide some useful insights when talking to your clients and thinking about the future of SME risk.

1 Zurich research, 1064 randomly selected British SME Business owners and managers polled by Vision Critical, October 31 – November 7 2012

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We believe the role of the broker will be more important than ever in the coming years as SMEs face an increasingly complex business environment and changing risk profile. There is a real opportunity to embrace this change, and that is why we have chosen to work only with brokers in small commercial.

It is most encouraging that in our research 45% of SMEs stated that the importance and number of SMEs will increase in the UK economy in the future. Whilst the sector is entering another period of transformation – and the challenges and risks that entails – the future is perhaps even brighter for the small business, the entrepreneur and the future of the high street, in whatever form it takes.

Richard Coleman

Director of SME

Zurich Insurance

SMEs & Risk in 2020

Q34. Do you believe that adopting new advanced technologies, processes and services will be a significant business challenge for your company in the next several years (by 2020)?

Yes - this will be a very significant challenge 14% for the business

Yes - we do not have the requisite skilled workforce 12%

Yes - it will require significant investment 24% and business change

No - we are already integrating and using new technology 22%

Not applicable - we do not manufacture anything 22%

I don’t know 6%

14%

12%

24%22%

22%

6%

50% state that new advanced technologies and services will be a significant

business challenge

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SMEs & Risk in 2020

The SME Workforce & Workplace of the FutureFlexibility of the workforce and workplace is already a key priority for many SME businesses and this is a trend likely to only increase towards 2020.

An increasing number of SMEs are offering employees the opportunity to work from home, along with irregular days/hours of employment. As recent changes in Employment law take effect, the shape and culture of SME teams is changing. More men and women are more frequently requesting ‘flexible hours’ as they struggle to balance the needs of young children. The demand for greater flexibility is set to continue into the foreseeable future as employees continue to work into older age.

This flexibility is assisted by ever-improving technology making telecommuting, mobile and home-working a realistic option for many. By 2015, the government promises superfast broadband will be serving at least 90% of UK premises, with universal access to standard broadband. By 2020, ‘super-connected cities’ may be the norm2.

Many small businesses also see increasing benefits in part-time staff, job sharing or shift work - instead of the expense and inflexibility of employing full-time staff. This includes an increasing move towards using sub-contractors who can be employed on an ‘as and when basis’, reducing fixed costs for the employer – but with the increased risk around loyalty. For the future, SMEs are likely to have to deal with increasing “out of hours” and even ‘24/7’ delivery of products and services/queries to match consumer demands.

Working patterns are also changing to accommodate this 24/7 service expectation. We may even see a return to the shift-work patterns of previous decades. Indeed the number of men doing traditional shift work has fallen from 16.0% in 1999 to 14.8% in 2009, according to the Health & Safety Executive3.

Finally, the population is ageing and working longer. The Office of National Statistics (ONS) states that the age people retire rose from 63.8 years to 64.6 years for men and from 61.2 years to 62.3 years for women between 2004 and 20104. The retirement age for younger people is already set to potentially rise to roughly 70 years. An ageing workforce will bring both risks and opportunities, for instance retention of talent and expertise, for small businesses.

“Organisations are under constant pressure to produce goods and services. . . as and when customers want them. This pressure can often mean that new ways of working have to be found. .,” Advisory, Conciliation and Arbitration Service (ACAS)

Key market trends

• 90% access to superfast broadband by 2015 – ‘SMB and Infrastructure’, 2012

• 5G to be rolled out nationwide by 2020 - ‘SMB and Infrastructure’, 2012

• Approximately 367,000 unemployed individuals projected to be securing work in SMEs each year and 85,000 to become self-employed – Federation of Small Businesses (FSB)

• 84% of small firms agree or strongly agree that their reliance on the internet will increase - FSB

• The market for freelancers had grown by 12% in 2012 - Institute of Consulting (IoC)

SMEs & Risk in 2020

2 Source –Department of Culture, Media & Sport (www. Culture.gov.uk)

3 Source – Changes in work shift patterns over the last ten years, HSE

4 Source – The labour market and retirement, ONS, 2012

Yes - this will be a very significant challenge 14% for the business

Yes - we do not have the requisite skilled workforce 12%

Yes - it will require significant investment 24% and business change

No - we are already integrating and using new technology 22%

Not applicable - we do not manufacture anything 22%

I don’t know 6%

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SME business challenges

• Managing the greater freedom of employees working as sub-contractors or as closer partners of the business

• Maintaining flexible business operations (eg flexible staffing levels) in order to respond quickly to a rapidly evolving market

• Developing staff loyalty in the future - the days of ‘a job for life’ are over, but responding to staff demands may be the loyalty “currency” of the future

• Managing new business costs, for instance shift work can reduce fixed unit costs but increase staff wages

• Ensuring information security of confidential business management information (MI) and patents despite a more fluid workforce and associated risks (eg increased risk of IP theft)

• Keeping abreast of technology changes and maintaining up to date equipment

• Monitoring the home and remote environments to maintain Health & Safety standards

Risk considerations & questions

• How are SMEs responsibilities changing with the increased blurring of the line between ‘personal’ and ‘commercial’ risks? What happens when an employee’s home become their primary workplace?

• The growing use of employees’ personal devices for work (the “Bring Your Own Device” trend) may lead to increased data security risk and potential for fraudulent activity

• Remote working may bring about a lack of leadership and direction, potentially leading to abnormal (or unhealthy) work patterns – and new potential employee sickness and stress exposures

• A potential shift in the employment legal environment – moving from Employers liability to a more Public / Contractual liability environment

• A more transitory workforce may result in more exposure to fidelity risk

• ‘Live / work’ lifestyle offices may reduce theft and crime risk (due to 24 hour occupancy) Business Interruption (BI) impact and BCP requirements

• Potential increasing importance and costs of rehabilitation & medical services due to an ageing workforce

SMEs & Risk in 2020

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The SME Business Model of the FutureFor many small businesses, the source of finance in the future is likely to be different than today. Peer-to-peer investing, or crowd sourcing, is becoming more mainstream. Zopa, RateSetter and Funding Circle have already lent £218m, £29m and £41m respectively, reports Moneywise5. Other new forms of factoring (eg ‘invoice factoring’) may continue to grow as SMEs look away from traditional banks for funding.

Many ‘baby boomer’ SME owners of family-owned businesses, who provide more than nine million jobs and a quarter of GDP6, will reach retirement by 2020. The financial dynamics of their businesses are also set to change as they look to position the business for divestment, inter-generational transfer or MBOs.

In addition to these changes in finance, more flexible business structures are likewise on the future horizon. More employers are using ‘employee ownership share plans’ to attract and retain talent while increasingly offering equity to third party investors to help grow the business. Research by the Employee Share Ownership Centre shows that “having an employee share scheme increases productivity and innovation levels.” These business ownership structures enabling SMEs to scale up their workforce, operate on lower fixed costs and protect their short-term cash flow.

Moreover, as globalisation becomes a business reality, growing numbers of SMEs are increasingly reliant on overseas imports and exports, bringing different supply chain challenges to the fore. According to the Manufacturing Advisory Service’s latest business barometer7, 77% of manufacturing SMEs in England recognise the need to improve supply chain processes and 44% of the firms’ surveyed admitted inadequate control of processes, leading to hidden problems and worsening performance.

Not all small businesses recognise the risk as yet though. According to a new government BIS report8, “while some businesses implemented a deliberate policy to spread risk and avoid being too heavily reliant on a single customer relationship, others did not despite acknowledging the inevitable risk.” Supply chain diversity and complexity is set to increase for the foreseeable future for SMEs.

“Entirely new business models are appearing, where the ability to build flexible alliances at speed is a critical management skill”, Manchester Metropolitan University

Key market trends

• “The professional, scientific and technical sector had the largest growth between 2011 and 2012, an increase of 22,000 businesses.” ONS Statistical Bulletin, 2012

• Evidence suggests the smallest firms are the most nimble, with interval or seasonal operations as well as virtual firms – EU SMEs in 2012, European Commission (09/12)

• Firms in the “hi-tech” and knowledge intensive industry often show a strong performance in terms of productivity and employment. The UK is the home of the largest number of knowledge intensive services – EU SMEs in 2012, European Commission (09/12)

• With two thirds of UK SMEs are family owned and run, the Forum of Private Business (FPB) stated the country’s economic future is hugely reliant on the success of such firms (SMEWeb 29/02/12)

SMEs & Risk in 2020

5 Source – www.moneywise.co.uk

6 Source - Why the government can’t afford to ignore family businesses, Independent, Oct 10, 2012

7 Source – www.mymas.org

8 Source – Boosting Finance Options for Business, Dept Business Innovation & Skills (BIS), 2012

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SMEs & Risk in 2020

SMEs & Risk in 2020

SME Business challenges

• Balancing the short-term return demands from investors vs the long-term success of the family business

• Gaining additional skills to manage new and complex key contracts and supplier relationships (eg outsourcing, contract employees, global exports/imports, etc)

• New global risks, such as the current Eurozone instability, will impact the local risk landscape for small firms - a heightened environment of uncertainty

• Management structures for ‘employee ownership’ may be challenging to put in place and manage effectively

• Business innovation - managing the risk of failure versus potential greater rewards from significant short-term innovation investments

• SMEs will need to rely increasingly on technology innovation to create competitive business models

• Managing talent and employee expectations, as increasingly well-qualified workers will want ‘better’ jobs and higher rewards, whilst being ‘in-demand’

• Successfully navigating the challenges of changing owners / leadership teams

Risk considerations & questions

• What impact will the increased pressure on short-term returns have (as required by some finance providers) on risk management and decisions on retained/transferred risks?

• Access to legal expertise (including Legal Expenses cover) is likely to be increasingly required for SMEs in managing procurement & contracts with larger corporate customers

• The complexity of supply chains for SMEs can introduce higher working capital risk and third party reputational risk exposure. ‘Plan B’ back-up suppliers will also be increasingly critical for redundancy

• Complex product recall exposures and costs associated with either outsourcing production or exports expansion into some international markets

• Potential greater risk to security of capital flows accessed through less secure or unconventional sources. Higher risk lending arrangements must be balanced by reduced risk in other areas of the business

• Potential exposure for Directors and Officers to minority shareholder & employee stock ownership plan claims against decisions made in the interest of ‘the family’, and not the new shareholders

• Increasing importance of succession planning & development to maintain long-term viability of the business

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SMEs & Risk in 2020

SMEs & Risk in 2020

SME Trading in the Future

For Retailers, the future of the High Street is about ‘reinvention’, as many of Britain’s town centres are already struggling with the combined forces of out-of-town shopping centres, the internet and recession.

The successful future high street retailer will become more personalised and interactive, moving to delivering a high-street shopping ‘experience’. New uses of technology will add to the experience of physical shopping. RFID (radio frequency identification) tags on clothes and in changing rooms, for example, can turn on the right music for the outfit or change the lighting.

Many SMEs are already embracing the internet as a virtual store-front, either with their own website or adopting platforms, such as Amazon. Moreover, by 2020 the majority of actual small business sales and service may be done online with technologies such as Skype in the Workplace and Apple’s FaceTime. Even new virtual worlds, such as Second Life, may allow potential customers to discuss points with online assistants and review products and services – such as kitchen designs, clothes, new hairstyles and even holiday destinations – before they buy.

eBay and Amazon platforms offer even the smallest business the opportunity to extend their customer reach across the country and beyond. Amazon’s merchant program enables the SME to ship and store in the online giant’s fulfilment centres. eBay expects one in 10 businesses to achieve turnover of at least £3m9.

The explosion of UK businesses trading via the Web economy has started to open up the boundaries for SMEs who can now look abroad for new markets (with the breadth of customers that are accessible online). The Global market does however introduce more complexity and new issues and challenges for SMEs to master.

Q Finance sums up many of the risks: “International trade activities can be risky for all firms due to regional and global political instability, exchange rate fluctuations, climatic and other environmental uncertainties, the pace of change in telecommunications and transportation, shifting markets, and new entrants (competition) in those markets10.”

“SMEs will only be successful if they are able to manage the multitude of dimensions associated with globalisation” Q Finance

Key market trends

• 36% of FSB small business members were trading online in 2012 - FSB11

• Almost 50% of shoppers now make use of mobile devices in-store to inform their buying decisions - GroupM

• The internet contributes to 8.3% of the UK economy, a bigger share than for any of the other G20 major countries - bbc.co.uk, 12/03/12

• Over £446m in overseas sales were achieved by eBay’s UK-based small businesses during the whole of 2010 - BusinessZone.co.uk, 26/08/11

• Nearly one-quarter of UK SMEs are already exporting, and nearly half of them are considering entering new overseas markets - DBIS

• The UK government wants to have another 100,000 UK businesses exporting by 202012

9 Source - Exports driving million pound small businesses on eBay, BusinessZone.co.uk, 26/08/11

10 Source - What Entreprenuers and Small Business Owners Can Do To Increase Their Chances of Success in the Global Economy, Q Finance

11 Source – The Voice of Small Business, FSB Survey, 2012

12 Source - UK Trade and Investment Minister – Lord Green, BIS (www.bis.gov.uk)

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SME Business challenges

• Technology management - running a successful online and offline High Street business will require investment in technology and staff training

• Managing the brand and business online - SMEs will need to be very nimble, sometimes even reinventing brand identity, as well as managing inventories and staff skills to stay up to date with trends

• The business continuity implications of web services and platforms, given small business have limited IT disaster recovery budgets. Service suppliers will have to manage resilience

• New areas of reputational risk - social media and peer review sites can make – or break – a brand overnight

• Understanding and transparency of credit risk – across potential web suppliers and business customers

• Increased business management challenges, associated with going global

• Managing higher customer expectations - customers increasingly expect to get what they want. They want it personalised and they want it quickly.

Risk considerations & questions

• Potential new retail showroom formats may increase public liability exposure, dependent upon activity and footfall

• Bespoke or luxury innovations to the high-street shop experience and services may reflect a more complex risk and liability profile, dependent upon activity

• Potential increased threat of online / cyber fraud in the future; for example, the use of “fraudulent identities or businesses” in online marketplaces

• Increased risk to data privacy and security; ‘social marketplaces’ may give rise to increased libel threats in the future

• International export-focused businesses likely lead to a change in the traditional SME travel profile (ie more long distance travel) with implications for Personal Accident / Business Travel

• Increased risk to SMEs trading in legal environments which they do not understand, for instance understanding US products liability law

• Accidental violation of political regulations, such as a trading with sanctioned states, governments or individuals

• Potential unknown weather-related and climate change risks associated with physical assets or suppliers located abroad

SMEs & Risk in 2020

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The SME Production, Product and Services of the future In the next decade, advanced manufacturing will have wide repercussions for the SME sector. One of the biggest potential growth areas is additive manufacturing or ‘3D printing’ due to its almost unlimited design possibilities and lack of waste. The technology involves making three dimensional objects by laying down successive thin layers of powdered material, such as a polymer, according to the instructions provided by a digital model.

‘3D printing’ is already in commercial use today and widely expected to become mainstream within a few years. For SMEs, the price of 3D printers is projected to fall to a level that even very small businesses will be able to provide completely customisable production items, like jewellery and household objects.

Advances in ‘automated (artificial) intelligence’ will also allow SMEs to use smart systems to manage stock, maintenance programmes, heating and lighting, and accounts. Manufacturing systems already include self-monitoring capabilities and in 2020 will start to self-correct. Small robotic tools will feature increasingly in many sectors: medical and dental treatments, construction and demolition, machinery inspection and maintenance, and underwater industrial operations.

SME international product trade is also growing strongly – with potential future implications for SME Intellectual Property (IP) protection in less regulated markets. Half of UK exports by value now come from SMEs. Cheaper technology, better communications, lower trade barriers, financial deregulation and opening of new markets have helped smaller businesses go global.

Advances in motor vehicles also promise to impact UK small businesses. More vehicle movements with smaller loads are likely by 2020, as businesses move to shorter delivery times (with 24/7 customer demands), cut stocks and order supplies as needed. Vehicles will become more intelligent with better journey and fleet management. Mapping tools will allow businesses to group collections and deliveries more efficiently.

Finally, among the emerging developments for 2020 are driverless/driver-assisted trucks and cars that use energy and road space more intelligently and reduce accidents and deaths. The first public test of such vehicles took place in May 2012, whilst Google has now successfully trialled single driverless cars on challenging routes using information gathered from Google Street View.

“People think that autonomous driving is science fiction, but the fact is that the technology is already here.” Linda Wahlstroem, project manager for the Sartre project at Volvo Car Corporation” 13

Key market trends

• There are at least 10,000 SMEs in the advanced manufacturing sector alone today - UK Trade and Investment 14

• Only 6% of SMEs obtain patent protection for their innovations, as opposed to 13% of large firms - Intellectual Property Office 15

• Robot sales to the United Kingdom surged by 72% in 2011 compared to 2010 to 1,514 units - World Robotics 2012 Yearbook

• “The next generation of factories will have to be adaptable not only to the needs of the market but also the growing requirements for economic and ecological efficiency” Loughborough University 16

SMEs & Risk in 2020

13 Source – www.volvocars.com

14 Source – Lord Green speech: “SME Exporting: The National Challenge”, www.ukti.gov.uk

15 Source – IPO Report: From Ideas to Growth, Intellectual Property Office

16 Source – www.lboro.ac.uk

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SME Business challenges

• More intelligent vehicles may present opportunities for SMEs to reduce the costs of transport and delivery, but involve new operational challenges

• With rapid advances in advanced manufacturing, small manufacturers will need to be flexible, continuously utilising available technologies to remain competitive

• Value for many businesses will lie in reputation, ‘IP’ and expertise, not property, plant or machinery. SMEs must learn how to protect and defend their intellectual assets

• Sustainability of manufacturing and traceability of components is growing in importance

• Artificial Intelligence software and web services is likely to improve business efficiency; SMEs who use it well may gain competitive advantage and cost efficiencies

• Wider use of robotics may start to add new areas of service and operational potential whilst reducing the risk to employees of high-hazard activities

Risk considerations & questions

• Potential increase in product liability exposure as SMEs are able to manufacture sophisticated, high-tech products on a small scale

• What impact will there be on the ‘traditional’ perils associated with SME’s? (as more informal and unlicensed manufacturing may take place in domestic environments, such as home manufacturing utilising 3D printers)

• Increased continuity planning (BCP) requirements associated with more advanced manufacturing production factories and even small-scale production environments

• Growing intellectual Property (IP) risk associated with advanced manufacturing, science and technology-based businesses

• Driverless fleets may potentially lead to a reduction in claims and motor accident trends; however service fees and breakdown could increase over time

• What are the potential future litigation trends associated with the application of robotics? (given ‘human error’ is more tolerated by society than system error)

SMEs & Risk in 2020

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Final considerations

Today our world is changing faster than ever. In particular, this rings true for the SME sector. New technologies, demographic shifts and globalisation will have a profound impact on the future of UK small businesses.

That is why we have researched the challenges and opportunities for SMEs both in the near future (2020) and the much longer term (2062). No one can exactly predict the future for today’s small businesses, but these changes are happening today.

SME risk is also changing and, in many ways, becoming more complex. As a leading business insurer, we need to understand not only the risks that our customers are currently facing, but also those emerging on the longer-term horizon, so that we can work together with brokers to help to future-proof SMEs against the challenges they will face.

The need for trusted advice, foresight and expert guidance will become increasingly important over the next decade. We believe the role of the professional independent broker and the insurance industry will be even more important and valuable than ever in the coming years; particularly, as SMEs face an increasingly complex business environment and changing risk profile.

Zurich has chosen to work only with brokers in small commercial - we believe there is a real opportunity for Zurich and brokers to embrace this change and the emerging opportunity together.

SMEs & Risk in 2020

www.zurich.co.uk

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