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Toying with the Future: Brexit and the Risk Facing the Games Industry

The UK's decision to sever its ties with the EU after 40 years as a member of the trading bloc will have repercussions across the political and economic spheres, with even the toy industry sent reeling by this unexpected development.

Photo: Risk: Does the UK have a strategy for surviving post-EU economic meltdown?
Risk: Does the UK have a strategy for surviving post-EU economic meltdown?
Photo: Risk: Does the UK have a strategy for surviving post-EU economic meltdown?
Risk: Does the UK have a strategy for surviving post-EU economic meltdown?

Less than two weeks ago, the UK went to the polls in an historic referendum, with the electorate faced with the choice as to whether or not to remain a member of the European Union (EU). Despite widespread reservations about certain aspects of the EU's structure and remit, it was generally felt that the majority would support continued membership. The final decision, however, confounded all such expectations.

With the Leave camp proving surprisingly victorious, this will have clear ramifications for the UK and the EU across both the economic and political spheres. Pretty much caught in the crossfire, it also has direct consequences for the UK and European toy markets, both in the short-and long-term.

Now, some 11 days after the electorate announced its verdict, continuing uncertainty seems to be the only certainty on offer, a state of play that will prove anathema to any business. Every day throws up fresh confusion – both of the major political parties are in turmoil, the Prime Minister has resigned, while a series of aftershocks has sent the British economy reeling. Prior to the vote, such a scenario had been widely predicted as the consequence of any Leave vote, although this was greeted in certain quarters as pure scaremongering.

Scaremongering or not, the pound has fallen to its lowest level against the dollar in more than three decades, while the stock market also fell sharply. In total, this has seen billions of pounds – hopefully temporarily – wiped off the shares of British companies.

More recently, there are signs that economic shocks have begun to subside, a belated acknowledgment that any real change is at least two years off, maybe more. Although the leaving process could be painful – and inevitably involve protracted discussion – there is still a hope that the UK could negotiate a settlement that would entail, in practice, little change on a day-to-day basis, especially with regard to access to the European single market.

In the short term, the weakness of the pound remains of primary concern. On the night of the referendum, I was sitting in Las Vegas airport with two directors of a British PLC, along with hundreds of British toy and licensing executives, all of whom were flying back from a licensing trade show. Conversation was dominated by just how much currency the directors would be forward buying when they landed back in the UK, with the pound having briefly risen to US$1.50 on the back of the exit polls, at the point still predicting a Remain victory.

Photo: Lego of Europe: The people have spoken.
Lego of Europe: The people have spoken.
Photo: Lego of Europe: The people have spoken.
Lego of Europe: The people have spoken.

When we landed at Gatwick 10 hours later, the situation had been turned on its head. Leave had clearly won, sending the pound tumbling to $1.32, its lowest level for 30 years. For once, the ashen faces around the baggage carousel weren't just down to exhaustion and jetlag after an overnight transatlantic flight.

Currency swings of this magnitude will inevitably have a major impact on the UK toy market. Last year, toy pricing was based on an exchange rate of around $1.50 to £1, giving toy suppliers and retailers a little additional margin to work with. Post-referendum, the exchange rate has seen a 12% swing against sterling. Coming at the time when prices are being quoted for spring/summer 2017, it is clear that calculating the trade prices – as well as the subsequent retail negotiations – will be a much harder process this time round.

For many UK toy companies, an erosion of margin is the last thing they need. Retailers, of course, still have a default setting of refusing to accept price increases. It is not difficult to see why they adopt such a stance. If prices increase, the inevitable corollary is that sales volumes may well fall, something that is in no one's best interest.

It is tough to get the balance right, especially with wages continuing to rise in Asia, driving factories to seek price increases wherever possible. When currency fluctuations go slightly in your favour – as indeed they did for UK suppliers and retailers last year – it provides something of a buffer. When they go against you – especially to the extent they have over the past week – it leaves little room for manoeuvre.

It could be argued that toy companies should have been prepared for such an eventuality and could have forward bought currency as a protective measure. In fairness, some almost certainly did, but not all of them by any means. Even in the case of those that did, they are only likely to have stowed away sufficient funds for six months at best, certainly not enough to ride out the two years or more of the Brexit negotiation period.

The situation could be further compounded by a drop in consumer confidence, an inevitable consequence of the events of the past two weeks. With the current Chancellor warning of potential tax hikes in the wake of the prevailing economic conditions, many consumers may feel a little less inclined to spend than they have in recent years. In fact, the UK toy sector has enjoyed two-and-a-half years of extremely positive sales. The 6% rise in both 2014 and 2015 was followed by a similar level of growth in the first half of 2016, making the UK Europe's largest toy market. Last year the UK toy industry was valued at £3.2 billion, a year-on-year increase of £150 million. Whether it will still be the number one market in Europe by the end of the year is anyone's guess.

Photo: Baulch: “Pure scaremongering.”
Baulch: “Pure scaremongering.”
Photo: Baulch: “Pure scaremongering.”
Baulch: “Pure scaremongering.”

Of course, it is not just sales volumes that could potentially be affected by the events of the past few weeks. There are a multitude of business-related areas that could be subject to change. Safety legislation, import tariffs and Pan-European licensing agreements have all been raised as areas of concern by toy companies over the past week.

There are, of course, many possible different outcomes. Indeed, change could be as straightforward as a lawyer simply amending the wording of a contract from 'European' to 'UK and European'. On the other hand, depending on the ongoing discussions between the UK and the remaining members of the EU, there may be far more hurdles to overcome.

If the relationship between the UK and Europe does – as some suspect – become fraught, there are those who believe that this could push the UK towards establishing closer ties with the rest of the world, in particular the US and Asia. In the case of the latter, through the UK's long-term involvement with Hong Kong, there are already robust structures in place that could facilitate just such a development.

There is an adage oft repeated in senior circles within the toy industry – the toy market is effectively recession-proof or, at the very least, recession-resistant. Although the UK is not yet technically in a recession, many of the factors that normally affect toy companies during such a period are almost certainly coming into play. It could be that this particular adage is going to be tested as never before.

John Baulch, Publisher, Toy World

Content provided by Picture: HKTDC Research
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