Banks must find the means to support innovation and reap the rewards

Dr Steven McCabe “writes I was involved in a debate which took place as part of Birmingham Made Me Expo on what is an appropriate economic strategy for the Midlands”.

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I was involved in a debate which took place as part of Birmingham Made Me Expo on what is an appropriate economic strategy for the Midlands.

This debate produced some really crucial questions.

Probably the most crucial is, what should such a strategy consist of?’

Another is, how do we facilitate a culture that will ensure growth and jobs in this region?’

Unsurprisingly, much of the debate involved the issue of whether there are structural problems that militate against this region.

Those involved also debated the role of both central and local government level, as well as the other interested agencies, in facilitating a recovery which is sustainable.

The thing that was absolutely agreed by all was that encouraging innovation in all sectors was crucial.

All panellists reinforced the message that in order to compete effectively it is vital for companies to provide goods and services that are perceived by customers as being superior to those offered by competitors and include the latest technology and ideas.

Interestingly, an earlier speaker on concluding his talk about the origins of manufacturing in Birmingham was asked by a member of a school party why the manufacturing industry lost out to other countries.

There’s no easy answer to this question but, for a multitude of reasons, despite this sector being the effective bedrock that created opportunities over the last 200 years, in terms of jobs it has declined rapidly since the late 1970s.

It would be foolish to believe that these jobs lost will ever be replaced, though many argue that more should be done in dedicating effort and funding to ensure that we support the manufacturing and engineering sector.

In answer to the question, we do know that the one aspect of manufacturing and engineering where we still have a competitive advantage is in the expertise and creative ability of those who design products.

The problem is that they are not always made here.

Comparison was made with the likes of Germany where the creative and innovative expertise is harnessed to make the high-value and innovative products which are also made by indigenous workers.

There was common agreement that if we had maintained a culture of placing creativity and innovation in our manufacturing we might potentially have had a sector which has survived as well as Germany’s.

I’ve said before that we should do everything we can to emulate what occurs in Germany where there is a network of small and medium-sized companies dedicated to making high-quality and innovative products; the Mittelstand.

These companies were vital to Germany’s ability to withstand the chaos caused by the global financial crisis so much better than other European economies including ours.

A fascinating debate ensued as to whether we could produce a culture to support a Midland’s version.

And this is where the problems begin.

The renowned quality guru Dr Deming used to say, in response to any solution intended to produce improvement, “by what means?”

Take finance for instance. In Germany the Mittelstand is supported by banks which see the benefit in funding innovation and creativity which will not only create jobs but will contribute to future prosperity and growth. For example, when Germany’s second largest bank, Commerzbank, announced its results in February it was able to report that it made operating profits of 1.6 billion euros for the division dedicated to funding companies in the Mittelstand.

This was far more profit than the rest of Commerzbank’s divisions combined.

Investing in innovation, therefore, should be seen as a ‘no-brainer’. Not in this country it seems.

According to two recently published reports small businesses wanting to invest in innovation find it increasingly difficult to secure funding through bank loans.

The effects of the credit crisis has made banks more reluctant to invest in companies developing schemes which they consider to be risky which, of course is frequently a corollary of attempting to be innovative.

According to Credit and the Crisis: Access to Finance for Innovative Small Firms Since the Recession, which has been jointly published by the Big Innovation Centre, whose director Professor Birgitte Andersen was a speaker at Birmingham Made Me, and the Work Foundation it is becoming increasingly difficult for small enterprises with innovative ideas to attract the funding that will enable them to get beyond the inception stage.

This report shows that the rejection rate for funding has increased from 11.5 per cent in 2007 to a rate now of 22 per cent.

What this tells us is that if companies are being effectively stymied at this stage in their evolutionary development they are less likely to flourish and become the dynamic concerns which will ensure jobs and future economic prosperity.

The main author of Credit and the Crisis: Access to Finance for Innovative Small Firms Since the Recession Dr Neil Lee, asserts that the inability of these firms to obtain finance will act as a ‘long-term drag’ on our economy and undermine recovery.

Dr. Lee argues that it is essential for the government through its policymakers to ensure that money which is supposedly available to business – such as the Bank of England’s ‘Funding for Lending’ – actually gets to where it is needed; stimulating fledgling innovative enterprises.

The second report paints an equally problematic picture of the way in which lending to innovative business occurs in this country.

Two Spheres That Don’t Touch: The Relationship Between British Finance and British Innovation which has been published by NESTA, an independent charity which supports organisations and individuals in bringing new ideas and innovations to fruition, and contends that there is a structural problem in funding for companies that require finance in order to be creative and especially when thinking about attempting something radical or different.

As this report explains, even before the global financial crisis, investment in innovation was falling and is resonant with Credit and the Crisis: Access to Finance for Innovative Small Firms Since the Recession in its view that the trend has exacerbated in recent years.

As many commentators have identified, those controlling funds – mainly banks – saw investment in companies engaged in developing innovative and creative ideas as too long-term and potentially riskier than property development and financial products which were so in favour in the early part of the last decade but ultimately proved so toxic.

Hiba Sameen, the author of Two Spheres That Don’t Touch: The Relationship Between British Finance and British Innovation, has called for urgent action by the government to remedy the situation:

“We would like to see government redoubling their efforts around finance for SMEs, particular those most likely to boost jobs and growth. The British Business Bank is taking steps in the right direction by promoting alternative sources of finance for SMEs, but its current scope and scale are too small to make a big difference in the finance gap for SMEs. The government needs to increase its scale by dedicating more capital to the bank, and also increase its scope by facilitating access to public corporate bond markets for SMEs.”

If we contrast this with what goes on we see the starkness of the difference. In Germany large banks such as the likes of Commerzbank and Deutsche Bank are in competition with 430 local savings banks and over 1200 local cooperatives which are able to finance small innovative businesses at low rates.

The president of the association representing savings banks, Georg Fahrenschon, believes that there is a virtuous relationship between his members and Mittelstand companies.

Crucially the relationship is long-term and explicitly about supporting the development of innovation using low-rate finance.

Many German banks lent abroad in search of higher rates of discovered that high interest rates bring risk.

Rüdiger Filbry, who works for Boston Consulting Group in Munich, explains that many German banks are effectively rediscovering domestic lending to companies in the Mittelstand and as Hans-Dieter Brenner, who is chief executive of Helaba, a Frankfurt-based Landesbank, suggests that the clamour to invest is like a train which will not have sufficient space for everyone.

Of course, crucial though finance is, it must be part of a culture which is conducive to producing the sort of success enjoyed by Mittelstand companies.

Culture, a word which came up in the debate at ‘Birmingham Made Me’ is another problem for us.

Germany has had generations of developing a socially democratic system in which there is a belief in the importance of engineering excellence and creative thinking.

I remember being surprised at seeing the sort of brass plates which are still occasionally located outside solicitors’ and doctors’ practices in this country for engineers in Germany.

Going into a career in engineering and manufacturing is perceived as having equal esteem to other professions.

Equally important is the focus on trust and respect coupled with prudence. This starts at school and continues through either technical or university education and, importantly, all institutions involved are dedicated to working collaboratively.

As many others have identified, the collaborative spirit of Mittestand companies is demonstrated by the works councils which mean that workers are involved in the strategic decision-making which, if successful, will guarantee their jobs.

Workers are stakeholders who have a very definite interest in thinking and working to produce innovative solutions.

Mittelstand companies are almost all family owned ventures. The priority is to ensure long-term stability but the owners understand that they must invest in new ideas which will ensure their products have excellence and distinctive features meaning they are seen to be superior and will attract high prices and be desired by customers in export markets.

One of the other speakers in the ‘Birmingham Made Me’ debate was local businessman Simon Topman, chief executive of Acme Whistles, who entirely endorsed the importance of constantly investing in improving the product.

But this requires money and the belief that the economy is not going to radically improve anytime soon makes attracting investment harder especially from public funds.

According to a paper written by the Institute for Fiscal Studies (IFS) and Institute for Government (IFG) austerity is likely to last until 2020.

Whoever wins the next election will inherit the sort of budgetary problems the coalition government have had to contend with. As George Osborne is discovering, fiscal rebalancing requires savings in public spending combined with an upturn in economic activity.

Though Osborne is achieving the former, the latter is not happening as fast as hoped with the consequential consequence of lower tax revenues which requires even more savings; a sort of vicious circle.

As the IFS/IFG paper explains, “spending as a share of GDP is higher than planned – even if the cash level of spending is as expected – which is why the chancellor is imposing a further round of spending cuts on departments.”

Statistics recently produced by the Office for Budgetary Responsibility (OBR) suggest that whilst the economy is improving we should remember that we are overly dependent on services which constitute three quarters of national output.

We desperately need to encourage the sort of innovation that is so typical in companies operating in the German Mittelstand.

Doing so would not only create the opportunities and apprenticeships which are critical to reducing unemployment among the young, but in producing precisely the sort of goods which has enabled the German economy to weather the economic downturn so much better than ours.

And a recently published report, Making at Home, Owning Abroad, A Strategic Outlook for the UK’s Mid-Sized Manufacturers, which was prepared by Dr Finbarr Livesey from Cambridge University and Julian Thompson, Director of Enterprise at the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) and supported by Lloyds Bank makes the need to alter the way in which innovative companies are encouraged.

This report asserts that companies that the trend for companies to shift production overseas – particularly Asia – may be ending. Wage costs in such countries are not as low as they once were coupled with rapidly increasing fuel costs as well as emerging technology means that so called ‘outsourcing’ is economically less of a consideration.
As a consequence according to this report producing in the UK will become far more attractive and, significantly, could potentially lead to an additional 200,000 jobs with a corresponding £20 billion reduction in the trade deficit.

This most certainly is not ‘small beer’ and the authors of report believe that it is essential that mid-sized manufacturing companies are given every support possible. However, they argue that more needs to be done to ensure that this shift occurs successfully:

“It is imperative that both industry and government begin to discuss the medium term and how investment decisions now will affect the growth trajectory for both companies and the country.”

As was made clear during the ‘Birmingham Made Me’ debate there is considerable support for the development of an innovative culture that would enable local companies to compete with the German Mittelstand.

The conditions for achieving this objective are good but, as always, more can be done by all interested agencies but most especially government.

* Dr Steven McCabe is director of research degrees for Birmingham City Business School