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How will the UK's VAT rise impact companies and customers?

10th Jan 2011
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How will the UK's VAT increase impact the British consumer - and how will businesses respond?

With the British VAT rate having been hiked up to 20%, UK businesses will be left wondering how consumers will ultimately respond to another economic blow. From price rises on supermarket shelves to another increase at the petrol pumps, the government’s 2.5% sales tax increase is a further blow on top of energy price increases and a generally sluggish economic recovery.

People seem confused about how much this will affect them. A recent survey by customer experience specialist Retail Eyes found 52% of people won’t change their spending habits, although the same poll discovered that a quarter are anxious about the increased cost of grocery shopping, and nearly two-thirds worried about petrol prices.
But new research from marketing services firm Acxiom - 'VAT increase to 20% - the effect on UK households', which can be read in full here - indicates how the UK as a whole and, perhaps more crucially for marketers, individual households in England, Scotland and Wales will be hit. The report states that consumers will suffer a collective drop in discretionary income – the amount of money people have left to spend after legal outgoings such as mortgage and Council Tax have been paid – of £2.3bn. The average UK household will be £225 a year out of pocket, with this figure rising to £448 for some groups.
According to the report, compiled using Acxiom’s Affordability data insight products, while low-income groups will continue to struggle and higher earners should be cushioned from the increase, it is the ‘comfortable’ groups of consumers that will have their spending power most impacted by the rise. The groups that will feel the greatest pressure include: married pensioners; married couples living with grown-up children; and childless couples aged 25 to 34. Clearly, people are going to face some tough choices to prevent slipping into debt or, alternatively, must cut out some of their discretionary purchases and concede they can no longer live the lives they’ve become accustomed to.
Business implications
But what will the UK’s highest-ever sales tax mean for business? According to research by business services network Baker Tilly, one in five firms remain unsure how to respond to the VAT increase in terms of new pricing structures. Not all sectors will be directly affected by the increase - energy use is not currently subject to VAT rises above the statutory 5 per cent charge, for example - but the fact is that if people’s finances are squeezed, the more likely they are to build credit or default on payments. The report outlines key findings in the credit, telecoms and energy industries, all of which will need to determine strategies for customer management, to prevent wasting budget by targeting households that are unlikely to meet payments.
Taking a closer look at these sectors, credit cards holders who rarely or never pay in full are most likely to be stretched elsewhere and are at risk of falling into arrears. Meanwhile, the other now more overstretched households - those currently struggling to keep on top of weekly budgets - will find it difficult to continue to pay their balances in full. Consumers with lower monthly balances who predominantly use cash at present may rely more heavily on credit cards as the effects of the VAT rise kick in. Credit providers need to be aware of the groups who are most likely to build credit and fail to pay it off; caution is urged with high-balance households as they may already be overstretched with other debt.
As for telecoms providers, they should keep an eye on lower- and mid-level salary households. Those consumers with the least to spend even before 20% VAT will see the greatest reduction in discretionary income, and are most likely to be at risk of arrears and default. Households in the £10,000 to £15,000 band will fare worst, but pockets of people earning around £30,000 will also struggle.
Energy issues
Finally, there will be a marked effect on some households’ ability to pay energy bills, even though as stated domestic fuel is subject to a rate of only 5% VAT. Households earning between £10,000 and £15,000 will be ten times less likely to be able to pay their energy bills because of the pressures on other outgoings they must pay for that will be caused by the VAT rise. Those earning up to £25,000 are also deemed high risk and may need more flexible payment options.
Households spending the least on energy (between £4.60 and £12.55 per week) run the biggest risk of running into arrears or defaulting. Middle earners will have reduced discretionary income, impacting their payment options. The key for utility companies is to recognise that any additional price rises they choose to pass on to customers is likely to tip these groups further into trouble and they will struggle to meet their bills.
As for battle-hardened retailers, they were warning of the dire effects the VAT increase might have even before it was officially announced last summer. A survey for retail consultancy more2 found that 7% of store owners would likely shed staff after the new level kicked it, with the vast majority also admitting that they would have no choice but to pass the cost on to their shoppers. A similar poll for ecommerce group Venda concluded two-thirds of retail experts believe the increase will dent consumer confidence.
Business response
In light of these findings, it has been suggested that a large number of organisations may decide to adopt the strategy of not adding the extra 2.5% VAT to their ticket prices. According to Baker Tilly, as many as 30% plan to absorb the VAT rise within the business. Meanwhile, a further 10% plan to gradually increase prices over a period of time leading up to January and 4% have already increased their prices.
Baker Tilly’s head of VAT, Steve Hodgetts, warns: "Businesses need to be looking at VAT efficiencies. They need to be ensuring that they are maximising their VAT recovery, recovering it at the earliest opportunity they can. They need to apply all of the reliefs correctly and, importantly, must ensure that they are not making careless mistakes because the penalty regime for non-compliance is severe."
Tony Wright, restructuring and recovery partner at Baker Tilly, adds: "In areas where a business can’t recover VAT, it will effectively mean margins are reduced if it is unable to pass the increase on to customers. If companies attempt to absorb the VAT increase where they are only marginally profitable, it will only add to their financial pressures.
"Time To Pay arrangements made in respect of VAT charged post 4 January 2011 will, in real terms, be at a 14% higher level than those agreements made in respect of pre-2011 debts. This will pose further working capital pressures on those businesses whose viability is already questionable."
Alternatively, other organisations will focus on improved customer experience and service as a way of protecting business. Simon Boydell, marketing manager for Retail Eyes says: "While the jury remains out on the exact impact the VAT rise will have on consumer spending, one thing is pretty certain - the competition on the high street will remain high. Delivering excellent service by improving your customer’s experience is a simple and cost effective way to boost sales, distinguish yourself from the competition and most importantly, create customer retention. Make sure all staff are briefed on the expected high standard of service and they recognise opportunities to cross and up-sell.  Also, seek regular feedback from customers about their experiences and share this with your staff."
While the consumer will initially feel the pinch, they are in charge of the household purse strings and ultimately decide which brands and retailers deserve their hard-earned income.
Regardless of which sector a company operates in and where in the country the bulk of their business takes place, their marketing campaigns and efforts to drive revenue will need extra thought and precision in the coming months.
Stephen Whyte is CEO Europe at Acxiom.

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