1. An economic assessment of skill gaps on firm productivity
Filtered
14th August 2017

2. Acknowledgements
We would like to thank the Department for Education for access to the 2015 wave of the Employer Skills Survey.

3. Outline Descriptive results: Skills gap density
Skills that need improving
Impact of skills gap on firm performance
How do skills gaps manifest themselves in terms of firm performance
Steps taken to overcome skills gaps
Econometric results:
Impact of skill gap severity on outcomes
Impact of specific skills gaps

4. Background and motivation
Skill gaps
Exist where an employee is deemed by their employer to be not fully proficient.
Consequences
Companies may face lower productivity and profitability than if the workforce were appropriately skilled.
Skill gaps could also limit the competitiveness of an enterprise by restricting their ability to innovate, and ultimately grow.
Objective of analysis
Provide comprehensive insight into employer demand for skills driven by skill gaps.
Data
All analysis is based on data from the 2015 wave of the Employer Skills Survey, a UK-wide telephone-administered, bi-annual survey of employers in the private and public sector.

5. Skill gap density
The number of staff reported as not fully proficient as a proportion of all employment

6. Skill gap density by firm size and occupation
Skills gaps exist where an employee is deemed by their employer to be not fully proficient. Firms are asked about total employment levels by occupation – and then asked to identify how many of these workers are not fully proficient.
The analysis suggests that, on average, firms respond that 1 in 30 employees is not fully proficient (3.33%), with a lower skill gap density occurring at managerial and professional level compared to associate professionals (4.12%) skilled trades occupation (4.85%), sales and customer services staff (5.45%).
Interestingly, skills gaps increase as the size of the firm increases. There is a very low likelihood for a firm with 2-4 employees indicating they have skills gaps (clearly because there is a greater proportionate burden and ‘carry cost’).
Approximately 1 in 20 employees in firms with between 100 and 249 employees are considered less than fully proficient, with this increasing to 1 in 16 workers in firms with more than 250 employees.

7. Skill gap density by region and sector
There is some variation in the incidence of skills gaps by geographic region – though not significantly so. There appears to be a balancing mechanism at play – in the sense that in areas where there is a highly competitive labour market (London and the South East), the potential for (higher levels of) skills gaps is choked off by the ability to recruit more readily.
The regions illustrating higher than average skills gaps are the East and West Midlands and Yorkshire and the Humber.
There is a significantly higher degree of variation when considering the sector of firm operation. Firms operating in the hotel/restaurant sector experience skills gaps approaching 5% (potentially reflecting lower than average salaries and a difficulty in recruiting appropriately qualified staff), while firms in the manufacturing sector indicate that approximately 1 in 25 workers is less than fully proficient.

8. Skills that need improving
Thinking about your <occupation> that are not fully proficient, which, if any, of the following skills do you feel need improving?

9. Skills which need improving by occupation/ firm size
When firms are questioned about the specific nature of the skills gaps, there is some association with the type of occupation (for instance, the highest incidence of manual skills deficiencies is amongst elementary occupations and machine operatives, while problem solving skills are more likely to be deficient amongst managers, professionals and associated professionals).
There is a clear lack of specialist skills at all levels – especially amongst professionals (though note again that the incidence of skills gaps in the first instance is lower amongst this group compared to other occupations (Slide 5)).
Amongst administrative/clerical staff, there are IT and knowledge gaps, while there appears to be consistent literacy and numeracy gaps across all occupations.
The skills that need improving are evenly distributed irrespective of firm size, although IT skills are the most important amongst very small and very large firms.

10. Skills which need improving by region/ sector
The analysis indicates that there is reasonable consistency in the skills gaps by region; however there is some variation depending on the industry.
IT skills are considered particularly deficient in transport/distribution, communications and defence industries, whilst much less important in the hotels/restaurant/ hospitality industries.
Again, across all industries, approximately 25% of responses indicate that there is a weakness in either literacy or numeracy that need improvement.
In general, between 15% and 20% of responses – and more in financial services – indicate that current gaps in knowledge need improving, while the same proportion indicate that it is the specialist skills associated with the occupation under consideration that need improvement – which is especially the case in the construction industries.

11. Impact of skill gaps on performance
Does the fact that some of your staff are not fully proficient have an impact on how your establishment performs?

12. Impact on performance by region/sector
For those firms that indicated they had a skills gap, they were subsequently asked whether and to what extent the skills gap impacted on their firm.
There is a general degree of consistency in the results by region with approximately 30%-40% of firms stating the skills gap had no impact on performance (less so in London); 40-50% indicating there was a minor impact; and approximately 20% stating there was a major impact.
By sector, the results are generally comparable. Firms operating in the hotels/restaurants, communications and transport sectors reported a major impact of skills gaps to the greatest extent (with utilities and public admin/defence the least impacted).
In general, the construction, health/social care and utilities sectors sector were most likely to suggest that skills gaps had the least impact (43%, 42% and 38% respectively).

13. Impact on performance by firm size
When considering firms by number of employees, there is in general a non-linear relationship between skills gaps and impact.
68% of the smallest firms indicate that skills gaps have a major (23%) or minor impact (45%). As the number of employees increases (to employees), the proportion responding that skills gaps have a major impact declines to 14% with the proportion indicating that there is a minor impact increasing to 58% (72% overall).
Essentially, the impact of skills gaps for the smallest firms is less prevalent than for medium sized firms; however, when they do arise, they are more critical for the firm.
However, for the largest firms, the analysis indicates that 72% of firms with skills gaps see an impact on firm performance (the same as firms with employees) – but 18% indicating that these skills gaps have a major effect (and 54% a minor effect).

14. Nature of impact on performance
Is the fact that some of your staff are not fully proficient causing this establishment to..?

15. Nature of impact on performance by region/ sector
Considering the nature of the impact – by region and sector – again, there is a high degree of consistency by region – though a little more variation by sector.
For those firms with skills gaps, in terms of the number of responses (i.e. one firm might provide 4 responses), approximately
10% of responses suggest losing business to competitors
10% delay product/service development
15% have difficulties in meeting quality standards
15% have higher operating costs
15% have difficulties introducing new practices
30% increase workload for other staff
5% outsource work
At sectoral level, skills gaps in the financial services sector are most likely to result in increasing workload, while the implementation of new working practices is disproportionately affected in the education/ defence/ social work sectors.
The retail trade is most affected through lost business/orders, with utilities most impacted by increased operating costs.

16. Nature of impact on performance by size
Skills gaps amongst the smallest firms are most likely to impact firms in terms of lost business/orders and the inability to develop new products/services – and these impacts decline in importance as firms increase in size (but continue to remain in some shape).
Firms with more than 25 employees see an increasing impact of skills gaps on higher operating costs and implementing new working practices, with the impact being more prevalent as the size of the firm increases.
The smallest and largest firms report a disproportionately high incidence of outsourcing work as a result of skills gaps (and a lower incidence of increasing workload for other members of staff (as these outcomes are in part substitutes for each other)).

17. Steps taken to overcome skill gaps
Which if any of the following steps is this establishment taking to overcome the fact that some of its staff are not fully proficient in their job?

18. Steps to overcome skill gaps by region/sector
Considering the steps taken to overcome the impact of skills gaps – by region and sector – again, there is a high degree of consistency by region – with more variation by sector.
For those firms with skills gaps, in terms of the number of responses, approximately
20-25% of responses suggest increased training
10% reallocate work
7% increase recruitment activity/spend
15% undertake more staff appraisals
15% implement mentoring schemes
3-6% increase international recruitment, and
10% change working practices
At sectoral level, skills gaps are addressed through increased training to the greatest extent in the construction industries and financial services, with mentoring schemes being most common in agricultural sectors, construction industries, financial services, admin/defence, education and health/social work.

19. Steps to overcome skill gaps by size
Although training remains the most common response amongst all firms to negate the impact of skills gaps, there is a declining relationship between training and firm size: 26% of responses amongst firms with 2-4 employees relate to engaging in training to overcome skills gaps, compared to 20% amongst those firms with more than 250 employees. The largest firms more likely to respond to skills gaps through increased recruitment expenditure domestically and international recruitment.
In other words, smaller firms are more likely to grow their capacity through training, while larger firms will simply buy in the relevant skills.

20. Incidence of training
Over the past 12 months have you arranged any [off-the-job/on-the-job] training or development for employees at this site?

21. Incidence of training by Sector/Size
There is a significant variation in the extent to which firms train their employees: approximately half of all firms in agriculture do not train, with approximately 41% providing some training off-the-job.
In contrast (and unsurprisingly), only 6% of organisations in the education arena do not offer training – with almost 73% offering both on-the-job and off-the-job training and a further 9% offering off-the-job training only.
More generally, approximately 1/3rd of firms do not train their employees, with a further 1/3rd offering either on-the-job or off-the-job training, with the final 1/3rd offering a combination of the two.
There is a clear relationship between firm size and training incidence. Half of the smallest firms do not train (with those that do split relatively evenly between different types of training).
This compares to firms with between 50 and 99 employees, where only 5% do not train. 15% of these firms offer on-the-job training only, compared to 7% engaged in off-the-job training (only) and 74% providing a combination of both on-the-job and off-the-job training.

22. Econometric results

23. Impact of skills gaps on business outcomes
The previous analysis illustrated the relationship between the existence of skills gaps (‘yes’/‘no’) and different possible firm outcomes (no impact/ minor/major).
Here, we control for firm-level characteristics, and estimate the increased probability of different (negative) outcomes associated with increasingly severe skills gaps.
Compared to establishments with a skills gap density of 1-10% (on average):
Establishments with a skills gap density of 11-20% are 4.7 percentage points more likely to have a major business impact, increasing to 12.6 percentage points for firms with a skills gap of 21-30% and 20.4 percentage points for establishments with skills gap densities of more than 31%.
In relation to the impact of different types of skills gaps on firm level outcomes, having a skills gap in basic IT skills is 3.8 percentage points more likely to result in a major business impact than no skills gap in this area (and 2.7 percentage points more likely to result in a minor business impact) on average.

24. Impact of skills gap severity on outcomes
Disaggregating the business outcomes into specific impacts.
Compared to establishments with a skills gap density of 1-10% (on average)
Establishments with a skills gap density of 11-20% are 4.6 percentage points more likely to lose business to competitors, increasing to 12.4 percentage points for firms with skills gaps densities of between 21% and 30%, and 25.8 percentage points for firms with skills gaps densities of more than 31%.
Similar linear relationships are demonstrated in relation to all other outcome variables – with increasing workload appearing to be the ‘release mechanism’ most instantaneously affected by increasingly severe skills gaps.

25. Impact of specific skills gaps on losing business to competitors and developing new products/services
In relation to the impact of different types of skills gaps on firm level outcomes, the analysis indicates that a skills gap in reading and understanding increases the probability that the establishment will lose business to competitors by 6.2 percentage points compared to an establishment with no skills gap in reading and understanding (on average).
Almost all the different types of skills (gaps) are associated with reduced business performance: a skills gap in computer literacy results in a 4.2 percentage point increased likelihood of losing business to competitors, with a lack of advanced IT skills increasing the probability by 4.7 percentage points.
Similarly, the lack of advanced IT skills and writing ability are the biggest drivers of delays in the development of new products/services (by 5.1 and 5.3 percentage points respectively).
All skills gaps have a negative impact on firms’ ability to develop new services or products.

26. Impact of skills gaps on having difficulties meeting quality standards and operating costs
In terms of the ability of firms to deliver to the necessary quality criteria, skills gaps in reading and understanding increase the probability that the establishment will have difficulties meeting requisite standards by 8.1 percentage points compared to an establishment with no skills gap in reading and understanding (on average).
Almost all the different types of skills (gaps) are associated with reduced business performance: a skills gap in computer literacy results in a 3.7 percentage point increased likelihood of having difficulties meeting quality standards, with a lack of problem solving skills increasing the probability by 5.5 percentage points.
Similarly, skills gaps in reading and understanding and complex problem solving are the biggest drivers of higher operating costs (by 7.4 and 6.1 percentage points respectively).
All skills gaps have a negative impact on firms’ operating costs.

27. Impact of skills gaps on introducing new working practices and workload for other staff
In terms of the ability of firms to introduce new working practices, skills gaps in reading and understanding again increase the probability that the establishment will have difficulties by 8.0 percentage points compared to an establishment with no skills gap in this area.
Skills gaps in computer literacy result in a 6.5 percentage point increased likelihood of facing difficulties introducing new working practices, with advanced IT skills gaps increasing the probability by 6.1 percentage points.
Reflecting the previous analysis on how firms cope with the existence of skills gaps, skills gaps in reading and understanding and complex problem solving are the biggest drivers of increased workload for other staff (by 12.5 and 9.4 percentage points respectively).
Gaps in IT/computer literacy, basic numeracy and complex numerical skills also increase the probability of increasing workload for other staff (by 6.4, 5.2 and 4.1 percentage points respectively).

28. Impact of skill gaps on outsourcing work
Finally, respondents in the ESS indicated that the vast majority of the different skills gaps resulted in an increased probability of outsourcing work, though in absolute terms the effects were generally smaller than for other business outcomes.
Skills gaps in reading and understanding and writing increased the probability of outsourcing work by approximately 3.3 and 3.0 percentage points respectively, with skills gaps in complex problem solving increasing the likelihood of outsourcing work by 2.1 percentage points.

29. Summary Descriptive results
Skills gap density increases with firm size.
There is a clear relationship between training and firm size, with smaller firms least likely to train staff either on- or off-the-job.
The most commonly reported impact of skills gaps is the increased workload of other staff.
The most common response to negate the impact of skills gaps is to increase training.
Econometric results
There is a linear relationship between skills gap density and the impact on all firm performance measures.
Reading and understanding consistently appears as one of the strongest drivers of negative firm outcomes – though all types of skills gaps impact firms to some extent.

30. Thank you for your time – any questions?
Dr Gavan Conlon, Partner, London Economics ,
Ms Sophie Hedges, Economic Consultant, London Economics ,
@LE_Education