Finding balance in the post-Brexit era

Den Howlett Profile picture for user gonzodaddy June 30, 2016
Summary:
As a tumultuous week in Europe concludes, Den pores over some of the numbers to see if he can find an answer to the threatened recessionary winter and its impact for technology.

 

via Corbettreport

Grab a cup/glass of your favorite brew - this is a long one.

Over the last week I've been reading everything I can find on the anticipated economic consequences of Brexit. It should be no surprise that commentators of nearly every stripe are forecasting their version of doom. This from Mike Butcher MBE of TechCrunch sums the situation very well:

I wonder how real this depression is. I contend that the more commenters forecast doom, the more likely it is that people will take fright, triggering a recession. It doesn't have to be that way.

I've been trawling the accounts of some of the largest technology companies who supply into the enterprise to figure out their likely UK exposure because this will in turn impact investment both in and around technology. I've also looked at the latest available statistics on the UK tech sector. Finally, and perhaps most importantly, I've engaged in online conversations around the broader topic of expected impact on the technology services sector.

Let's go through them one at a time on the assumption that some sort of break will happen.

Most tech companies report their earnings in USD and often denominate their deals in that currency. The one major exception is SAP, which reports in Euros but which I know largely operates local currency pricing arrangements. I have said before that the currency impact is the most obvious immediate impact from the buyer's (and seller's) perspective, but the amount of business done as it relates to the whole determines the kinds of strategy that a vendor can adopt.

Vendors could offer favorable and flexible deferred settlement terms over the next few quarters so that the impact of currency volatility is mitigated on both sides.

A number of vendors shovel large amounts of their 'real' revenue through a combination of entities that frequently involve billing in Eurozone countries. This is done for tax mitigation purposes but given that the USD/GBP/Euro don't move in lockstep, the currency impact may turn out to be much smaller than the initial and sudden decline in GBP's value might have suggested. On to the figures.

The big players

The numbers I've extracted are mostly a year out of date but they are readily accessible for free from public records.  They provide some clues about the levels of business and numbers of people involved. Taken together, the aggregate revenue for all the companies I mention for accounting periods ending the end of 2014 or into 2015 was: £16.6 billion. As a side note, the TechPartnership states (PDF) that the tech industry contributed £91.1 bn to the UK economy in roughly the same period. However, it is when you look at the impact on the whole at a more granular level that things get more interesting.

SAP for example posted £737.5 million in the year to 31st December, 2014. That was equivalent to about 5.4% of SAP's total recorded revenue for 2014. The exchange rate at the close of 2014 between GBP/Euro was €1.28 compared to today where is is around €1.21, a decline of 5.5%.

Oracle recorded £765.4 for the year ended 31st May 2015 or 3.1% of total revenue. Looking at currency, GBP has declined about 7.75%.

Salesforce posted £232 million for the year ended 31st January, 2015 but of that figure only £56 million was attributable to UK business. £166.9 million was for the rest of Europe and £9.5 million was for the rest of the world. Once again, the total number recorded in the British entity was the equivalent of a rounding error.

Only Cisco, which recorded £9.8 billion in the UK or 31% of the total for year ended 25th July 2015, shoveled a significant level of revenue through its UK business. However, we have to be careful because again, based upon the geographical analysis, only £2.8 billion or 8.9% of total worldwide income related to the UK. For Cisco, the relative decline from a GBP standpoint was 8.5%.

Overall therefore, and making allowance for the way technology companies have a habit of schlepping non-US revenue in inventive ways for tax purposes, we can tentatively conclude that the overall exposure for business technology providers is relatively small.

The big services companies, and here I am primarily thinking about IBM, Infosys, Wipro and the like will all have long standing arrangements with their clients. Their clients might be distressed on currency and, in some cases may even be thinking about decamping to Europe. Vodafone is the most high profile company spoken about in this context While that sort of thing grabs the headlines, does anyone seriously think Vodafone would simply shut down its entire UK franchise Of course not. The banking sector might be different where the threat of the UK losing a chunk of its services is real. It is unclear the technology impact in this sector although we know that the UK is at the forefront of investment in fintech startups.

The smaller players

Where Brexit does have a more important impact, is on those US companies that want to aggressively grow their UK and european footprints. Workday, Tableau, Qlik and NetSuite for example collectively recorded £118 million during the period under review, ranging from £19 to £43 million.

These are very small numbers on the top line but then all these vendors are working hard to expand their customer footprints. That means investment at a time when the market is uncertain and the currency is relatively weak. It is likely that all these companies - and many more - could not have anticipated the current uncertainty or volatility. As Stuart Lauchlan reported on recent comments by Marc Benioff, CEO Salesforce:

There’s been so much discussion about what happened last week with Brexit. Specifically what I would say, is that in Davos, the discussions were not forceful around Brexit. In fact, they were somewhat ambiguous, I would say even tentative.

Even the leaders of the United Kingdom who were there, including David Cameron, in their specific comments to CEOs, which I personally attended, were kind of, I would say, unremarkable in their content.

Because of that, I believe it was a little bit too little, too late when finally they realised that there was a real situation and it could really turn in the wrong direction. A group of CEOs placed an advertisement in a London newspaper only a few days before the vote. Unfortunately it’s just not enough.

Right now, our advice to cloud vendors coming to the UK is simple: double down on explaining the value you deliver to buyers. Anything that can be said which demonstrates value should serve well in both quelling fears while at the same time providing opportunity for buyers to both grow efficiently and profitably. That's the only message that will matter for those who are in the market to buy.

Services - a reset?

via Horses for Sources

Attempting to get a firm handle on the UK technology services sector was rather more difficult than for the software vendors. Accenture offshored its structure to Gibraltar some years ago so getting any sense there was nigh on impossible. Infosys reports out of Bangalore, India but doesn't provide enough insight upon which to draw conclusions. IBM, which has had a presence in  the UK since 1962 reported £3.7bn for the year to 31st December, 2014 of which £2,9bn was attributed directly to the UK with a total staff complement of 15,819.

The best we can say is that services are a sizable component of the UK technology industry but for as long as there is significant local presence, the immediate Brexit impact as it relates to currency is likely to be immaterial. Instead, we think there are much broader issues at stake.

Phil Fersht offered an eloquent explanation as to what Brexit means:

The vote for Brexit wasn't really about debating the finer points of EU membership - it was a big thumbs down for the establishment from over half the UK voters who feel disenfranchised.  This is a reflection of the ever-widening gap between the wealthy and the working classes, the educated and the uneducated, the socially-connected ambitious younger generation and the disconnected older generations, who've lost interest in the direction of the modern world that no longer represents their interests.

Moreover, this rebellion against the establishment can be clearly mirrored in many of our enterprises, where similar issues of disenfranchisement are rapidly permeating...

...when 30% of services jobs are likely to be phased out over the next five years, we need to ensure these people can orient themselves into new jobs. Politicians need to forge closer ties with business leaders to ensure this happens, otherwise we'll have more Brexits and more fascist lunatics creating frightening futures for us.

When you have 52% of your voting public sticking it to the establishment, there is a serious situation emerging that could change the game forever:  if we can't have leadership that can get back in touch with the people doing these rote jobs, we will end up with governments that force even more draconian measures on businesses to protect jobs. And this will likely mean less competitive businesses and less jobs to go around in any case.  This is a journey to the bottom if we give in to archaic government measures and an avoidance of investment in work creation through re-education and training.

In the UK, you can take this assessment further. Compared to the concentrated tech centers of London and its environs, cities like Edinburgh, Manchester and Cambridge frequently struggle to attract enough of the right talent and money needed to grow tech businesses, let alone service existing. It is a frequent cause for complaint with no obvious answer in sight. One colleague for example told me that despite government incentives, attempts to establish branches in the north have often failed. The business isn't there in sufficient quantity to make the required investments worthwhile. It is concentrated among a small number of locations, mostly in the London area.

In that sense, this anomaly is a near perfect mirroring of the concentrations of wealth, which as we know, eventually leads to a reduction in demand. How does this work? When wealth becomes highly concentrated into the hands of a few, demand has to fall because there are not enough people who are not super rich to make up the demand for continuing growth. In stark terms, how many iPhones can a bajillonaire own?

Paradoxically, while the offshoring of rote jobs has served to alleviate poverty in far flung lands, the labor arbitrage race to the bottom has had the reverse impact onshore. This is most dramatically illustrated by this graph, taken from economist Branko Milanovic's review of global inequality (PDF.)

via Branko Milanovic

Here, you can see that between the 55th and 80th percentile, real income increase has fallen dramatically. These are exactly the target group most impacted by globalization. The burning question today is whether the current crisis triggered by Brexit will lead to a broadening of that collapse in real earnings growth back to the 25th percentile. If so then we really are in trouble.

The 4th Industrial Revolution

Historians argue that in times like this, things have a tendency to work out. Indeed, some have gone so far as to dub the current period as the 4th Industrial Revolution. Sounds great doesn't it? Maybe so, but ominously, events like this have often been accompanied by civil strife or outright war. This time it is different. Allegedly. According to a WEF article posted at the time Benioff et al were in Davos:

We stand on the brink of a technological revolution that will fundamentally alter the way we live, work, and relate to one another. In its scale, scope, and complexity, the transformation will be unlike anything humankind has experienced before. We do not yet know just how it will unfold, but one thing is clear: the response to it must be integrated and comprehensive, involving all stakeholders of the global polity, from the public and private sectors to academia and civil society.

In short - hey, look how awesome things will be...oh heck, how do we get there? Exactly.

We already see some of the consequences anticipated by Fersht but Brexit has brought the potential social impact into sharp relief. WEF anticipates this with:

At the same time, as the economists Erik Brynjolfsson and Andrew McAfee have pointed out, the revolution could yield greater inequality, particularly in its potential to disrupt labor markets. As automation substitutes for labor across the entire economy, the net displacement of workers by machines might exacerbate the gap between returns to capital and returns to labor. On the other hand, it is also possible that the displacement of workers by technology will, in aggregate, result in a net increase in safe and rewarding jobs.

We cannot foresee at this point which scenario is likely to emerge, and history suggests that the outcome is likely to be some combination of the two. However, I am convinced of one thing—that in the future, talent, more than capital, will represent the critical factor of production. This will give rise to a job market increasingly segregated into “low-skill/low-pay” and “high-skill/high-pay” segments, which in turn will lead to an increase in social tensions.

Brother, it is already happening...

The next steps

Winding back to what Benioff said, you have to wonder what the politicians and super rich were thinking at Davos in that the conversations yielded nothing of substance to address this issue. I suspect that everyone collectively decided to pretend that all is well. It isn't.

Right now, much of the discussion appears to be centered on argument around the twin political poles of capital and labor. I, along with others believe that is wrong because those arguments merely perpetuate the systems of the past and to which we can objectively point as ultimately failing. The trouble is that none of us, myself included, can find an answer that makes sense without significant political input. Given the current vexed state of affairs in both the UK and Europe, it is hard to see how a consensus approach is possible.

It may well be that as the Brexit dust begins to settle and the UK finds itself with a new government leader, a pragmatic deal will be struck behind closed doors that goes some way towards re-aligning economic interests while at the same time acting upon the urgent need to prepare for workforce displacement. That will inevitably mean capital handing back some of the wealth concentration I referred to above. Capital won't do so without exacting a price on capital markets. Should anyone care? I don't think so. Stock markets are but one part of the economy. They do not create recessions. Recessions happen when people stop spending.

It seems to me that the mood among citizens across Europe is ripe for the kind of social change that can provide the breathing space for enlightened governments to act in just fashion while at the same time allowing technology to proceed in improving all our lives. Whether they will is the open question. As Fersht concludes:

This is serious stuff, and we can't afford to keep brushing these issues under the carpet in a democratic society.

Amen to that.

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