Week ending 22nd March 2013

The budget dominated the business, economic and political news last week.  You will be pretty fed up with reading about it by the time this week’s TWb4TW is published.  So apart from a small mention at the end this is a budget free zone.

Cunning Foxtons

One positive sign that maybe an economic recovery could be stirring is a revival of interest from investors in Initial Public Offerings (IPO) or “floating a company on the stock market” to you and me.  Investors are encouraged that both Esures and estate agents Countrywide’s IPOs got away smoothly last week and have even begun trading above their float price, which is a first for some time.

This has prompted reports that another high profile firm of estate agents, Foxtons, are considering a potential £780m IPO.  You may remember Foxtons prospered during the London property boom and became famous for the brightly painted Minis it provided to its staff which promoted its brand as they hurtled round the streets of London.  Foxtons expanded rapidly on the back of the London property boom.  However, whilst it was high profile it was not very highly thought of by people who had bought or sold property with them.  Over optimistic valuations and putting sold signs on properties that were not yet sold to boost their apparent sales success were just two examples of practices their clients complained of.

In 2007 BC Partners (BCP) paid £375m for the business of which £300m went to Jon Hunt the founder.  Then the London residential property collapsed and so did Foxton’s profits.  The deal had loaded the company with debt and initially the banks involved took control with a debt for equity swap and BCP writing off a significant proportion of their investment.  However, surprisingly BCP then decided to buy back both the debt and the equity.

Perhaps not so surprisingly.  The buy backs were achieved at an advantageous price as the banks were happy to get rid of the problem.  The timing was good as the London residential property market recovered and Foxton’s high market share enabled them to deliver record sales and profits.  So it would not be surprising if the next stage of BCP’s cunning plan for Foxtons is an IPO.  If they were to achieve £780m this would be a pretty good return despite the earlier problems.  But what would investors be getting?

Now even my dog knew that the first property market to recover would be London.  So, on the face of it you would be investing in the dominant player in a resurgent London property market which sounds pretty good.  However Buzzel and Gale in their book “The PIMS Principles” demonstrated that whilst high market share is indeed highly beneficial to profitability, it depended on “how” that market share had been achieved as to whether that profitability could be sustained.  Market share achieved through delivering “superior relative quality” of product and service to the customer would sustain high profitability.  Market share achieved through other means, such as opening lots of estate agent offices, contains inherent weaknesses which eventually become detrimental to profits.

This was backed up by Zook and Allen in their examination of the long term performance of over 2,000 companies in 2001 and then repeated in 2011.  They concluded that:

“A common misconception is that rapid, sustainable growth can only occur in “hot” markets—markets that are growing rapidly—and that being in a hot market is the best way to generate high profit levels. Our data refutes that. A variance analysis of our database demonstrated that relative competitive position within an industry is more than four times more significant than the choice of industry in determining the economic returns of companies. In other words, it’s how you play the game that matters, not which game you play”.

All the commentary around the possibility of a Foxtons IPO centres on the “hot” London residential property market as the key to success.  If Foxtons have also upped their game on the quality of service they provide their clients, the acid test being would most of their clients definitely recommend them to others, then you would have the best of both worlds, a quality company dominating a currently hot market.  However if not much has changed at Foxtons then an IPO would be no more than an opportunity to have a punt on the London residential property market.  Each is a valid proposition provided it is clear which one you are being offered.  Is it real "competitive strength" or just high and possibly temporary market share advantage?  So beware the cunning Foxtons and look carefully at the other IPOs being lined up for launch this year.

ARM – keeping cool in a hot market

In case anyone has not heard of ARM they are a Cambridge based company that designs microchips and generates its revenues from licensing these designs to those that wish to incorporate them in their products.  Its chip designs are used in nearly all the world’s mobile phones and you won’t find a hotter market than that.

ARM was created from a spin off from Acorn computers, a company that prospered for a while but just could not keep up with the big boys in PCs.  However what they did know was that could design better micro chips than Intel and others.  Because they did not have experience or facilities for manufacturing they came up with the licensing model.  This has proved to be spot on and so resilient that ARM safely worked its way through the dotcom boom and volatility in semi-conductor markets.  In 2012 they achieved £577m of sales and £221m of profit.

ARM is an outstanding example of how "competitive strength" creates the "changeability" that delivers even more "competitive strength".  They demonstrated this again last week when their CEO Warren East announced he would be leaving after 12 years in charge, handing over to Simon Segars who has been with ARM even longer than East.  Given that the opportunities for ARM to go for another major phase of growth have never been better it is perhaps surprising that East has decided to go now.  His reasoning is that as it will take 6 years for ARM’s next design blueprints to be in products and with the company being in a strong financial and market position now is the right time to make this change.

This is a superb example of clear thinking and the understanding that it is not the “hot” market that really matters but the company’s ability to successfully exploit the opportunities.  East has ensured ARM can do this in every respect, right down to deciding that a change of leadership was required.  We don’t have enough people like him in top positions in UK businesses.

Italian Job

The financial crisis in Cyprus was a big economic and political story last week.  The Cypriot government is trying to raise the €6bn it needs to secure an EU bailout and proposed to do this by taking a slice out of citizens and exp-pats’ bank accounts.  Tactically actually having a government is where the Cypriots may have put themselves at a disadvantage in their negotiations with the EU.  Let me explain.

By contrast it is now more than a month since the Italian elections and they still haven’t actually got a government.  In fact as 25% of the vote went to a party that said it would not be part of any government Italian voters in effect voted not to have government and that’s what they got, or didn’t get.  This confirms the observation of a previous UK ambassador to Italy that “it is not difficult to govern the Italians, it is simply unnecessary”.

So Italy is probably a country that can get by perfectly well without a government. When it comes to negotiating with the EU (or Germany to be more accurate) this puts them at an advantage as the Italians have contrived a situation where there is no one for the EU to talk to.  This leaves the EU with little choice but to carry on as before which suits the Italians, both voters and politicians perfectly.  Cyprus and maybe Spain take note!

Rhyming slang

Briefly on the budget I was struck by George Osborne’s little catch phrase, “aspiration nation”.  This sounded like a trial run for the Tory election slogan in 2015.  Ed Milliband countered with “a degraded budget from a degraded chancellor”.  However without the little rhyme it isn’t memorable enough to be an election slogan.

However the overall reception from UK business to the budget was that we are an “anticipation nation”.  In other words we are still waiting for George Osborne to redress the balance between just making announcements and actually doing something.  Even some of the things that sounded like they might be about to doing something are not planned to happen for 12 months or more.  A bit less of the politics and a bit more focus on the day job of getting the UK economy moving is what business is still looking for.

So that was some of the week before this week. We hope you found some of the above thought provoking and useful for you and your business. We trust you had a good weekend and hope you have a great week this week.

Week ending 15th March 2013

TWb4TW is back.  Sorry for the gap, have had a very busy two months (good)  plus some health problems with immediate family (not so good) that took up a lot of time.  So here we go with some of last week's news.

Is there a nasty side to John Lewis?

Last week John Lewis Partnership (JLP) was accused by the Forum of Private Business (FPB) of bullying its suppliers when it was revealed it was demanding a “growth rebate” of up to 5.25% from its suppliers.  JLP’s argument is that its exceptional sales performance is due to its investments in new stores, refurbishments and its growing e-commerce operations.  Therefore it is only reasonable that suppliers who benefited from increased profits through efficiencies provided from the increase in volumes should make a contribution towards the investment that brought this about.

On the face of it this does look as though JLP, who are often praised by government as a model British business, love their customers and love their staff, but are just as capable of putting the boot into their suppliers as any of those nasty supermarket people.  I am not going to try to resolve the argument between JLP and FPB in this article as this is a case of “they would say that wouldn’t they” on both sides.  What it has made me think about though is the relationship between suppliers and retailers.

Manufacturers and suppliers of consumer goods have one fundamental challenge. Their expertise and assets are in developing and producing the products.  However even if you have invented and can produce the best mousetrap in the world if you do not have the means to put in front of customers in a way that enables them to buy it, then you don’t have a business.  Retailers provide the space to stock and display product, the footfall of customers who might buy the product and the means of making the transaction.  If a consumer goods supplier cannot find an alternative way of doing all this themselves then they have to work with a retailer, otherwise no sales!

These suppliers need to think hard about what this means for the balance of power in the relationship.  Apart from a few “must have” products and brands (a costly position to achieve and often temporary) this generally means the balance of power is always going to be with the retailer, so don’t be surprised if the retailers use it.

James Dyson had to face up to this some years ago.  Even though he had invented the best vacuum cleaner on the market, the expectations of customers for household electrical goods were that prices did not increase and over time they reduced.  Dyson’s retailers had to respond to this if they were to compete and so did Dyson.  This is why he closed his UK manufacturing facilities (much criticised at the time) and moved to Malaysia to lower his costs.  Because Dyson faced up to the reality of the market in which they operated and adjusted their business model to compete effectively they are now a global brand and business and employ more people in the UK than they did when they manufactured here.

So if you are a JLP supplier and feel they are now showing their nasty side, which you didn’t see coming, then ask yourself this question.  Would you rather have them as a customer who, with their “competitive strength” can invest and change to meet the new challenges in the market or would you rather have been a supplier to HMV and Jessops whose lack of “competitive strength” meant they couldn’t and didn’t?

Zara – another way

Talking of retailers the world’s largest clothing retailer is the Spanish company Inditex, best known in the UK for its Zara fashion shops.  In spite of the global financial crisis and economic chaos in Spain the company’s value has grown from €37bn in 2007 to €65bn now.  Profits increased by 22pc in 2012 alone.

Inditex is not only the world’s largest clothing retailer but also one of the largest clothing designers and manufacturers.  The company produces more than half of its products itself and every item of clothing passes through its Spanish manufacturing and logistics facilities.  All this started when Inditex’s founder and owner Amancio Ortega opened a shop in La Coruna to sell products from his nearby factory.

So it’s another business model but in Inditex‘s case it’s a fast fashion model, capable of taking a design from catwalk to shopfloor in two weeks.  What’s more if a design does not sell it can be withdrawn, the lessons learned and then replaced in the same time frame.

Contrast this with the situation at M&S where the only change they have made to their clothing business model was to move their British based supply chain offshore.  M&S are desperate to get their clothing business right but the next opportunity they will have is not till they launch their Autumn Winter ranges later this year.

This is not to say that the answer for M&S is to move into manufacturing.  What this and the Dyson example illustrates is the crucial importance of getting your business model right, taking full account of all the challenges involved, including the possibility of your customers demanding retrospective discounts.  I so often hear about business ideas and business plans, but not so often about how a business is supposed to work.  Successful businesses have robust business models and you can see why they work.

Morrisons – why are we waiting!

Another retail struggler is Morrisons who last week reported sales down by 2.1pc and profits by 7.2pc.  CE Dalton Phillips blamed this on lack of an online business, limited presence in the fast growing convenience store market and failure to promote the points of difference.  All very well and “bleedin' obvious” Mr. Phillips but when are you actually going to do something about it?

He has had a bit of luck with the convenience stores as other retail failures have enabled Morrisons to acquire 62 sites to expand the “M Local” stores.  On the points of difference they have hired that irritating Geordie pair Ant and Dec (not all Geordies are irritating, just Ant and Dec) to front an advertising campaign to promote the fact that Morrisons are the second biggest manufacturer of fresh food.  This has been reported on repeatedly in the business and trade media but no actual sign of the campaign itself yet.  Morrisons also failed to capitalise on the horse meat scandal, with only a few press adverts and the odd interview with Mr. Phillips being the sum total of their efforts.

On the internet he has stated “ we have a specific plan on the proposition and how we will be different” but no more details as these are apparently “commercially sensitive”.  This appears to be still stuck somewhere between the idea and the planning stage.

All this points to a lack of “changeability” in Morrisons’ culture and business processes.  This was evident in spades when they bought Safeway and the integration of the two businesses took forever.  They don’t seem to have shaken this off and until they do I don’t see them overcoming the challenges they are creating for themselves.  If Morrisons start demanding rebates from their suppliers before they have delivered sales growth then this won’t be a sign of smart business, just one of desperation.

Merve swerves but Heseltine on the money

In an interview last week Mervyn King, the soon to retire governor of the Bank for England actually said that economic recovery is now “in sight”.  Coming from the biggest misery guts in the whole economy I take this as the strongest signal yet that we can actually look forward to better times and that they are not too far off.

However far more significant for me was a radio interview with Michael Heseltine earlier in the week, as part of the usual “what do think will/ought to be in the budget” run up to the actual budget.  Heseltine replied that “what government, the public and private sector, in fact everyone in this country has got to realise is that we have got to do everything much better than we have ever done in the past”.  The big theme for the budget is “growth” but whether we get anything that is really about growth is another matter.  However I am pleased to find that Lord Heseltine agrees with me (note agrees with me) that growth is about “getting better” not about “getting bigger”.  Take note Morrissons, M&S and any of you JLP suppliers feeling hard done by.

Quote of the week

In a party political broadcast last week David Cameron stated that he had not gone into politics to be “the popular guy”.  My first thought was “that explains a lot” but my second was could this signal a new direction in political campaigning?  After years of politicians trying and failing to make themselves popular has Cameron spotted a truly left of field strategy for electoral success?  If so he will have sidestepped Ed Milliband who is desperate to make himself popular (or even for people to know who he is) and Nick Clegg who thinks he must be popular because what’s not to like about a fair minded Lib Dem like him.  Perhaps the killer ticket to capture the "unpopular vote" at the next election could be David Cameron and Ed Balls?

So that was some of the week before this week. We hope you found some of the above thought provoking and useful for you and your business. We trust you had a good weekend and hope you have a great week this week.