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Morning Briefing Strap Line
Fri 23rd Nov 2012 - Friday Opinion
Subjects: Deeper meaning, time away from the business, the tie and Enterprise challenges
Authors: Paul Charity, Ann Elliott, Charlie McVeigh and Ted Tuppen

Standing for something By Paul Charity

There seems to be a mood of change in the air. As you look around the foodservice landscape, more and more operators are using words like natural, organic, authentic, local in their descriptors of food. On the drink front, operators are moving to create points-of-difference by sourcing local or artisan beer – or brewing on the premises. It feels like operators have recognised that their customers will reward them if they connect with their locality, dig deeper, source better quality ingredients and strive to be more authentic – and believe in something.

And there may be broader tends afoot. Panera Bread is the most successful quoted restaurant operator in the US of the past decade. Founder Ron Shaich believes the company’s success is the result of an adherence to “conscious capitalism” – create a deeper bond with consumers, staff and suppliers for standing for something. Those companies that do this, “Firms of Endearment”, outperform their peers, he believes. He told the European Foodservice Summit in Zurich that his company is “driven by building a deeper connection with consumers through “purpose””. He argued that operators will out-perform dramatically if they combine operational excellence with innovation and then layer this will a deeper connection with all stakeholders by “standing for something”, by creating a deeper ethical meaning for their company.

Ron Shaich describes “Firms of Endearment,” written in 2007 by Raj Sisodia, Jag Sheth and David B. Wolfe, as his seminal business philosophy textbook. In the book, the authors convincingly argue that businesses outperform when they win a share of heart. The authors argue: “The title of this book testifies to a deep-seated changes in how people see things in mainstream business culture. Consider the words affection, love, authenticity, empathy, compassion and other terms of endearment. Until recently, such terms had no place in business. However, that is changing. Today, a growing number of companies comfortably embrace such terms. That is why we have coined the phrase firms of endearment. Firms of Endearment strive for share of heart. Earn a share of the customer’s heart and they will gladly offer you a bigger share of their wallet. Do the same for an employee, and the employee will give back a quantum leap in productivity and work quality. Emotionally bond with your suppliers and reap the benefits of superior offerings and responsiveness. Give communities in which you operate reasons to feel pride in your presence and enjoy a fertile source of customers and employees.”

The book lists 12 characteristics for Firms of Endearment. They are:

1 Their executive salaries are relatively modest

2 They operate at the executive level with an open-door policy

3 Their employee compensation and benefits are significantly greater than the standard for the company’s category

4 They devote considerably more time than their competitor to employee training

5 Their employee turnover is far lower than the industry average

6 They empower employees to make sure customers leave a transaction fully satisfied

7 They make a conscious effort to hire people who are passionate about the company and its products

8 They consciously humanise the customer experience for customers and employees, as well as the working environment

9 Their marketing costs are much lower than those of their industry peers, while customer satisfaction and retention are much higher

10 They view suppliers as true partners and encourage suppliers to collaborate with them in moving both companies forward

11 They consider their corporate culture to be their greatest asset and primary source of competitive advantage

12 Their cultures are resistant to short-term, incidental pressures, but also prove able to quickly adapt when needed. As a result, they are typically the innovators and breaker of conventional rules within their industries.

Panera Bread has been the best-performing restaurant company in the past decade – its stock is up 60-fold since 1999. And Shaish issues the following challenge to competitors: “Conscious capitalism works better. The challenge I would issue is: how are you going to make your company an instrument of service to society to fulfil your obligation to build shareholder wealth?” It’s food for thought, isn’t it?
Paul Charity is managing director of Propel Info

A Grimm’s Fairy Tale of the Tie by Charlie McVeigh

One sunny morning, John, a naturally optimistic, thrusting entrepreneur-type, wakes up. Over the past three years, through hard work and ingenuity, he has built up a small group of five bookshops, Books Anonymous, in cosmopolitan areas of UK cities.

The USP of his shops is they offer a very large and unusual – some would say quirky – range of English and foreign language books. In a declining market, with strong competition from the internet and supermarkets selling half-price Harry Potter books, our entrepreneur has created a type of bookshop which can survive and even thrive by giving customers lots of reasons to come. Books Anonymous staff are knowledgeable and enthusiastic and love nothing more than discussing arcane literary matters with browsing intellectuals. The atmosphere is calm and friendly. Frequent events are held on the premises, including book launches and readings. Books are not discounted. In each micro-neighbourhood where they trade, Books Anonymous are regarded as heroes.

Not everything has gone to plan, but, by and large, he is pleased and proud of his achievement and his operation is profitable and cash generative. Being an entrepreneur, however, he regards this as only the beginning and is keen to keep rolling the dice by opening more sites.

So on the aforementioned sunny morning, and risking his wife’s disapproval, our man surreptitiously checks his emails at the breakfast table. PRIME KENSINGTON BOOKSHOP LEASE FOR SALE – LOW PREMIUM, he reads, attempting to ride a sudden jolt of adrenalin. Ever since frittering his days away behind the counter at Waterstone’s, where he learnt the book trade and dreamt up the idea for Books Anonymous, he has fantasised about having a site in Kensington. His initial impression of the address is positive and the small picture on the screen reveals an attractive, even ideal building.

Feigning total focus on family matters, his mind starts to churn, fear and excitement fighting for dominance. This could be the next one.

At last the kids are packed off to school and he is in the car, calling the agent, from whom he had bought one of his existing sites. They have a relationship of sorts. The agent sounds a little unenthusiastic. “You do realise it’s tied,” he explains. “The building is in shocking condition and has a Delapidations Schedule as long as your arm. Yes, the rent is not too bad, but this site has changed hands more times than I can remember. And you will have to buy all of your books from the landlord at double the price you normally pay. I don’t see how it can work for your model. Previous tenants have not been able to compete with the WH Smiths down the road, which sells books cheaper than you will be able to buy them. What’s more, the landlord doesn’t have a great selection of books. Should I go on?”

Now, unlike in the pub trade, tied bookshops are relatively rare and this is the first time John has come across one. His mind is boggling at the bizarre, arcane nature of the proposed commercial arrangement. So he decides to contact the landlord to understand more, as he remains convinced that – given a level playing field – he could make this site work.

The landlord’s rep, sounds excited when he calls. “Oh yes, we’ve heard about Books Anonymous. Very much the coming thing. We’d love to have you in as a tenant.” John explains his conundrum, which boils down to the fact that his business model, which he regards as the future of book retailing in neighbourhoods such as this, cannot function without a wide range of specialist suppliers competing on price to sell Books Anonymous the large range of interesting publications which underpin the brand offering.

“You’re in luck,” says the landlord’s rep. “We just launched a new type of lease, which we can issue to you. It’s called the Freedom Plus Agreement.”

John’s heart leapt.

“Under the terms of this new and exciting lease, we the landlord will permit you to buy 50 per cent of your non-fiction books from anyone you like. All other books will continue to have to be bought from us of course. But this will allow you to have a really exciting range of non-fiction books which you can sell at your usual prices and margin.”

From time to time, John drove past the Kensington site in later years. It remained closed, the chip-board window hoarding gaining new bill posters for circuses and UK Garage nights. Each time his heart would sink.

Then one evening, coming back from a particularly stimulating reading at a Books Anonymous, he approached the location. The shop was alive again! Brightly lit, with a new modern frontage and people inside. The bookshop of his dreams had become… an estate agents.
Charlie McVeigh is chief executive of Draft House

The lessons of time away from the business by Ann Elliott

I really struggled at times last week when I was trekking around the Torres Del Paine Circuit in Patagonia in aid of Bowel Cancer UK. At one point, when I was almost up to my armpits in snow, trudging up hill on the side of a mountain and freezing cold, the guide pointed out our mid point destination - the windiest and coldest pass in the area which was far away in the distance. When I fell for the umpteenth time I just so wanted to turn around and head back to the last refugio. But I couldn’t. There was no turning back.

As I tried to step into the footprints of those in front of me to avoid sliding down the mountain, I took my mind off my aching legs by thinking about my business and how far we had come in the last 12 months and our plans for the year ahead. What struck me (apart from the tree I banged into when I fell again) was the similarities between what I needed to make the most of the trek (and to enjoy it) and what I needed to make a success of the agency in 2013.

At the time the words ‘ grim determination’ came into my mind first. I knew I had to get through the John Garner pass to enjoy the staggering views of the Southern Patagonian ice fields and the Grey Glacier ahead - I had a vision and I was determined to see it alongside, not behind, the others. It’s been imperative to have a vision running the business and it’s also been critical to have the determination to achieve that vision and to try and do so whilst being better than our competitors.

Focus and concentration were both critical at key points in the trek particularly when there was a real risk of falling, no possibility of rescue and only my fellow trekkers to get me down if I broke anything. I have needed those two attributes in spades at times over the years when being distracted would have had disastrous results.

Our porters would only carry 7.5 kilos of our stuff. If we wanted more we had to carry it ourselves – I didn’t want to carry any baggage so I had to really think very carefully about what was vital and what wasn’t. To be honest there have been times in the past when I could have had a lighter business and not carried baggage of any kind around with me. Paring down to the minimum needed for survival would have been a productive exercise at some points over the years.

Fear overwhelmed me when I had to climb down a long, metal ladder tied precariously to the side of a gorge as I am petrified of heights. But the team helped me get onto the ladder backwards and take one step at a time down to the rocks at the side of the river at the bottom of the gorge. I had to ask the team to help, trust them implicitly, recognise my fear and do it anyway. One of the questions I ask myself from time to time is: “What would you do if you weren’t afraid?” These brief but terrifying few minutes reminded me of what can be achieved when fears are conquered. They also reminded me of the power of being humble and asking for help when you need it.

What’s been more important than most of these things though has been the ability to laugh. When it’s snowing and you need a pee at 3.48am. it’s vital to laugh when you trip over the guy ropes and drop your head torch. Laugh and the world laughs with you, cry and you cry alone - particularly at 3.48am.
Ann Elliott is chief executive of Elliott Marketing and PR

Progress on the key challenges by Ted Tuppen

We put our challenges into three categories - trading, debt and property. As far as trading goes, we have invested in our estate and we’ve positioned ourselves now for real like-for-like growth. We are getting improvement across all geographies with the south, which represents 42 per cent of our income, firmly in growth. We targeted flat like-for likes in the second half of our financial year and missed it by a couple of million pounds, despite a poor summer and the negative impact of the Olympics. Two million pounds is about 12,000 barrels of beer and with sales close to mid-January levels during the two weeks of the Olympics - the £2 million of sales were lost in those two weeks alone. So we think that the 1.2 per cent like-for-like downward shift across the estate for the year is very acceptable in the circumstances that we were facing. 

We made real progress on the debt front – a £266 million overall reduction, with Tranche B repaid, floating rate notes all repaid, fixed rate notes purchased in advance and the banks financing completed with a flight-path to zero of bank debt or thereabouts. We have restored confidence in the debt markets with our bonds trading up by an average of 21 per cent. Okay, we’ve lost some of the discount arbitrage. But I would rather recognise the refinancing confidence that we get from seeing the 2018 notes trading close to par value with a yield of around 7.2 per cent. 

On the property front we have reorganised our property function to enhance our investment efficiency and recognise that £4.3 billion of freehold assets should be a profit opportunity. We have delivered a £208 million disposal programme, 102 exceptional trading pubs have been sold at 14 times income, probably about 16 times EBITDA and a 28 per cent profit over book value. 199 non-viable pubs have been sold at an average of £336,000 compared to £227,000 last year. Our annual re-valution has addressed the tail but of course takes no account of the upside opportunities.

Where to next in 2013 and beyond? In many ways it’s the same story moving on to the next stage. The same headings are relevant - trading, debt and property – and, not before time, shareholders.

In respect of trading, the business model works. We provide the platform and the support for great entrepreneurs to run their own pubs. Like-for-like value of our beer sales is up nearly seven per cent during the year - the sort of like-for-like sales increases that managed house operators would find very acceptable. We have invested in our people, we know where to look (to invest) – improving curb appeal and providing great ranges of beers, food, plus entertainment, technology and accommodation. We have to buy smarter, we have to sell more, but we are well placed to do that.

On the debt front, we have solved the major issues and now we have some choices. Our debt is secure, manageable, tax efficient and predominantly at fixed interest rates. It’s worth noting that £35 million of debt repurchased at a ten per cent discount creates equivalent value to a one per cent growth in like-for-like EBITDA. Debt is no longer just a risk, it represents an opportunity for us to create value for shareholders.

On the property front, and I say this with no particular pleasure, we have about 700 pubs where we rate the external condition as not good enough - poor. In 12 months, we won’t have any pubs in that condition, we won’t have any poor condition pubs. Discipline, enforcement, investment and disposal are the key. And we will continue with our disposal programme, improving the quality of the estate by tail-end disposals and maximising the value of every sale whether it’s through high prices for exceptional trading assets or alternative use where applicable. 

In respect of shareholders, this has been quite a journey back from the dark days of 2008 when dividends ceased and the share price collapsed by 95 per cent. On the positive side, net asset value has been kept intact during the past four years, somewhere just shy of £3-a-share although Earnings Per Share (EPS) has pretty much halved. Now is the time to deliver like-for-like income growth and EPS growth and to rebuild confidence in our business model and our asset value.

In terms of delivering shareholder value, I just want to deal with a couple of fairly obvious points. Firstly, our net asset value is £1.4 billion or around £2.85 per share. We trade at 65p, a discount 75 per cent to net asset value. On a total assets basis, the market believes that our pub estate is overvalued by about 27 per cent. Clearly, there is something for us to address there.

Secondly, looking at our cash generation chart, excluding disposals and capex, which, in steady state, would pretty much offset each other, we generated net cash of around £100 million last year. On an entirely hypothetical basis, let’s now look at value creation over the next three years. Let’s ignore disposals or assume that they will generate cash proceeds broadly in line with net book value. Let’s ignore dividends. If we pay dividends, the money goes to shareholders anyway. Let’s ignore the immaterial cash impact of like-for-like growth and decline or the purchase of debt at a discount. This is not a forecast or a financial model, it’s a theoretical representation of the future. If we use our £100 million of cash generation to pay down debt, all things being equal, and our enterprise value remains the same, the mathematics demonstrates that the value of our equity will double over the next three years, an Internal Rate of Return of just under 30 per cent. If confidence in our balance sheet improves, if debt ratios are deemed to be less of a risk, if we can deliver growth in EBITDA or earnings per share, then a re-rating might help to push the total enterprise value towards our true balance sheet value. For management and for shareholders, this is certainly a prize worth working for.

As far as the outlook goes, we have a great pub estate and some great publicans - and through investment, training and support they are getting better all the time. We have strengthened the team significantly and I have great confidence that we can perform well whatever the market throws at us. 

But let us be clear, the market isn’t great and it’s not suddenly going to become great. We are looking for like-for-like net income stability in 2013 but the First Quarter of this financial year will be difficult as our like-for-like sales will take the hit of losing £1-2 million on the WaverlyTBS collapse and we face very strong comparables from last October, in particular, when the weather was glorious. First Quarter like-for-likes probably won’t look that good but for the full year we believe we won’t be far off achieving flat like-for-likes, plus or minus a bit. In the face of rising costs for our publicans, the last five years have seen us reduce like-for-like rents by 12 per cent and increase discounts on beer by £28 per barrel. I just want to dwell for a moment on that transfer of value, which together has cost us in the region of £54 million this year alone – an equivalent value transfer from us to our publicans of £9,000 per pub per year. Despite this, our business remains robust, the vast majority of publicans are working with us for mutual success and most under-performers have left the business. We are close to stability in like-for-like income per pub, our balance sheet is fairly valued and strong, our debts are manageable, our cash generation is strong and we believe that we can generate real value for our shareholders.
Ted Tuppen is chief executive of Enterprise Inns and his remarks were addressed to City analysts this week

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