Strategic marketing concepts and best practices

Strategic Marketing

Compass began a new era when they merged with Granada. That transaction heralded several years of restructuring, from which Compass is just now emerging. The period of 2001-2005 was essentially defined by this restructuring, and the its impacts are evidenced all across Compass' strategy and its financial statements.

The acquisition spree of 2001 had two major affects on Compass' performance. The first was to increase the size of the company, and the second was to set about a string of several years' worth of declining results. In 2002, Compass' sales grew 21.8% over 2001, and their operating profits grew 19.1%. More impressive was their after-tax profit growth that year, which was 50.6%. Through a string of minor acquisitions and divestitures, Compass has been able to maintain revenue growth over the period of 2003-2005.

What they were not able to do, however, was maintain profit growth. Over that same period, they recorded declines in operating profit of 0.9%, 2.7% and 8.2% respectively. This is directly attributable to a steady decline in margins. Operating margins were 7.75% in 2001, and declined every year to a level of 5.59% in 2005. These slow, steady declines were accompanied by wild fluctuations in after tax profit. Following 2002's robust growth, after-tax profit declined 11.9% in 2003, remained essentially flat in 2004, but then collapsed 83% in 2005. The company's tax burden has steadily increased over this period. In line with the variance in profit, the share price has also fluctuated significantly.

The end result of this is that while revenues have increased 45.75% over this period, net profit has declined 77.16%. The share price has been reduced 56.1%. Even when factoring in the dividends paid, shareholder value has been eroded significantly over the past five years, 47.5%.

This is indicative of poor performance.

The performance lag is a direct result of strategy. There is no evidence that economic factors have deteriorated to an extent to where Compass can attribute its struggles to them. To some extent, such a massive restructuring will inevitably have a negative impact on performance. Even setting aside the direct acquisition costs, the cost of integrating the different operations is expensive. Moreover, it can take years to see the results of operating synergies gained from the acquisitions.

Geographically, there are some clear points of success and points of struggle. The UK represents the latter. Between 2004 and 2005, that market's share of Compass' total turnover held steady, dropping just 0.2%. Profits however, were eroded significantly, going from 37.9% to 28.8%. This hints at margin squeezes, possibly brought about by intensity of competition in the mature market.

North America represents a success story. This marketplace is also relatively mature, and competitive. Just prior to the evaluation period, major competitor Sodexho merged with Marriott (King, 1997), making them a key competitor in that segment. Despite increasing competitive pressures, Compass was able to grow revenue slightly from 2004 to 2005, but grew profits over the same period from 24.5% to 29.1%. While profit levels are not as high as revenue levels in terms of percentage of Compass' operations, this strong improvement in the area points to sound strategy.

On the surface, their group-wide strategy of developing profit through margins is sound. The argument that economies of scale are key to maintaining those margins and therefore profitability is a reasonable one. However, if this is the strategy then the execution of it has in recent years been poor in the UK. The core business is mature, and management has rightfully targeted areas such as health care and education for future growth. However, the cost of this growth appears to be a reduction in margins. Management maintains that maintenance of these margins is a key priority. However, in the UK market, margins have deteriorated significantly, in particular in 2005. This is consistent with the steady deterioration of margins for Compass as a whole during the period.

Significantly, the margin issues are not congruent with the firm's plans for expansion in the UK. Management has stated that they hope to improve their competitiveness by building economies of scale. This will in turn help them win contracts from smaller competitors. The way in which they would be able to do this seems largely based on price, which naturally will cut into margins. They hope to pressure suppliers, as a result of their economies of scale, in order to counteract their price competition strategy. This plan is if nothing else hopeful, given Compass' size. They are already one of the largest firms in the industry in the world. The number of suppliers who can service Compass' needs is limited. Compass is already getting great prices from these suppliers, so it seems unlikely that they will be able to squeeze much more from them.

In North America, they have had more success, but again are facing a mature market with limited opportunity for growth. The core Business and Industry segment is mature, yet Compass management still believes there is room for growth. With only 25% of the market remaining uncontracted, it is optimistic to think they can make much headway yet their strategy in North America seems to rely on this.

They do, however, still have strong opportunities in the Health and Education segments. Those markets are highly institutional, yet are not as saturated by large contractors like Compass. Management feels that purchasing opportunities can allow them to continue to increase their margins. The size and homogeneity of the U.S. market means that there are more suppliers capable of meeting Compass' needs than in the UK. However, the contract sizes are larger, which puts downward pressure on margins. The presence of two similarly-sized competitors in Aramark and Sodexho in the North American market will make for tough competition.

In the rest of the world, Compass seems to be without any strong sense of direction, aside from in China. The "rest of world" represents 42.8% of their turnover and 41.7% of their profit, yet is lumped together, as though opportunities and operations in these 90-odd countries are analogous. Management talks of China as a major source of opportunity in the same vague sense that many other companies do - they've read the demographics enough to understand the potential but they have little sense of how to accomplish market penetration.

Compass has struggled over the past five years. Part of this is due to issues and costs stemming from their massive restructuring, but part of the problem is internal. Faced with maturing markets, they have slashed margins to win new market share, but that share has come at the expense of profits and shareholder value. Their strategy seems to place significant emphasis on improving their core competencies, but this has seemingly pushed them past the point of diminishing returns and they have little in the way of fresh ideas to turn things around.

Q2. There are several threats to the UK business. The first is the maturation of the Business and Industry market. This market is Compass' largest, but is mature and in a consolidation phase. This increases the intensity of competition and drives down margins. Moreover, it forces companies to compete differently as price and margin start to find their floors. Compass is a low-cost provider, and their leverage with their suppliers is a core competency. However, this leverage is showing signs of erosion, given their diminished margins.

These margins represent a distinct threat in the UK. Margins in the UK are significantly higher than they are in the U.S. The firm appears to view this as a source of opportunity in the U.S., but in the UK it is a threat. The margins in the UK are being squeezed. Price competition is intensifying, but the UK does not have the depth of suppliers that the U.S. has. Moreover it does not have the massive contracts available. Both of these factors have helped to sustain the U.S. market. Without them, the UK will continue to face decreasing margins.

Another threat to the UK business is the threat of external events. The Jamie Oliver expose on the poor nutritional options in British schools was a prime example of such a threat (Bower, 2006). Since Compass competes on price, they inevitably will lean heavily on cheap, processed food, which typically lacks basic nutrition. The outcome of the Oliver situation is that Compass blamed the habits of schoolchildren for their inability to move to a healthier menu; and the nutrition watchdogs turned their attention elsewhere. It would be naive to think that they will not be back. That Compass failed to anticipate the attack, failed to learn from it, and that such criticisms are entirely incongruent with their business model does not bode well for their ability to avoid or manage such public relations crises in the future. The door is open for providers to enter markets based on something other than price, given the relatively narrow focus of the major institutional food providers.

There are opportunities in the UK, however. Markets such as health care and education are still largely untapped by contractors in the UK. Compass has the experience in the U.S. with these markets to exploit this opportunity. The military and offshore markets have also been identified by management as strong potential sources of growth in the UK.

Another opportunity is with new markets, which include arenas, zoos and other public facilities. This emerging market is relatively untapped, and its size somewhat undetermined, pending the creativity of the catering industry. There appears to be good opportunity for growth that involves the maintenance of traditional margins, if Compass can win first-mover advantages at each facility.

One other source of opportunity is in existing markets, even the mature ones. The industry in the UK still has many smaller competitors. Compass can compete with these firms on price, and also on the provision of ancillary services, which many of the smaller firms simply do not have the expertise, equipment or manpower to provide. This gives Compass the opportunity to win market share by simply outcompeting the smaller firms, or by acquiring them to gain their customers.

In the U.S., there are several key threats. The first is the stagnation in the core businesses of Business & Industry and Vending. These businesses amount to almost half of Compass' revenues but the markets have reached maturity. Margins are already tight, and 75% of the industry is contracted. The remaining non-contracting segment is viewed optimistically by management, but those customers who have not switched to a major institutional food provider may have good reasons for not doing so. It may be difficult to improve revenues in this sector going forward.

The U.S. market, for most businesses, has always been subject to intense competition. The three largest providers of institutional food service are all heavily active in North America. Sodexho has a dominant position in the education sector through the Marriott acquisition and Aramark is the dominant company in the market (Weinbeger, 2005). Those three companies, however, account for less than half of the total market. That share is growing, but there are also a number of smaller competitors who ultimately will be forced to compete on bases other than price. With price pressures from the two major competitors, a host of smaller competitors driving the service side, the U.S. market's competition level will test Compass in the years to come.

Another threat is that of oil prices. In the UK, the cost of transportation is not high, given the small size of the country. In the U.S., transport costs represent a significant threat, given the distances goods must travel between their place of production and end destination. Goods must be mass-produced and then distributed nationally, but this model requires low transport costs. A significant rise in fuel prices will cut into, or erode entirely, Compass' margins.

There are a couple of key opportunities. Health care is pre-eminent among them. The U.S. was subject to one of the world's largest baby booms, and those boomers are entering their senior years. An extrapolation of demographic trends indicates the demand for nursing homes will continue to increase for years to come. This is the strongest growth sector available in North America, representing significant opportunity for Compass.

The other opportunity is margin increase. The U.S. still has room for growth in many key markets. The U.S. has many more potential suppliers than does the UK. Compass is growing. Put together, this creates a climate where Compass has stronger power relative to its suppliers than it enjoys in the UK. Yet, there remains a gap between the margins in the two countries. There appears to be opportunity, and management agrees, to increase margins in the U.S. And help close that gap.

Q3. The UK is the most troublesome market for Compass. It is the second-largest for the company, but suffers from major structural problems - stagnant revenues, declining margins and limited opportunity. For the time being, Compass can consider their B&I business to be going nowhere and leave it be. For management's plans and optimism, the ever-declining margins in the UK, led by this sector, are a burden on shareholder value. In lieu of finding a way to staunch the bleeding, Compass should look at avenues to divest itself of this business. They should instead focus their resources on areas with opportunity, in particular health care. This market still has growth potential, and the UK still generates better margins than does the U.S. For the time being. The major risk to this strategy is that it undermines management's view that economies of scale can help to restore profitability. This view is optimistic rather than grounded in facts, so this risk is not as great as management believes it to be. They seem to have an emotional attachment to the B&I business in the UK, and are starting to throw good money after bad at it.

In the U.S., Compass should continue to focus on the health care market, and should also put money into education. Though the nutritional value of their food is no better in the U.S., the culture seems more forgiving of this, so the threat to this market is not as substantial as in the UK. The health care market will continue to grow in light of the aging baby boom generation. Moreover, this market requires additional competencies besides low-cost operation. This provides for greater opportunities for differentiation. The more Compass develops these competencies in the U.S., the better they can translate these to the UK market. This makes the strategies in the two markets complementary.

Compass also needs to shift its purchasing requirements slightly, to hedge against rising fuel prices. They need to take advantage of the depth of potential suppliers in the U.S., to ensure that the suppliers are well-situated in each area of the country. The benefit will be that they reduce the risk of high fuel prices, while maintaining supplier diversity. Corresponding to this shift to more local suppliers will be a greater ability to offer organic foods and fresh produce. These products offer higher margins, and the baby boomers not only have the wealth to pay for them, but the desire to consume them. This will ultimately help to improve margins in the U.S., as well as give them a competitive edge when attempting to secure nursing home contracts. At present, nursing homes have strong power over their suppliers, but the baby boom is spurring growth in that industry to meet escalating demand. This will force nursing homes to compete - something they do not have to do now - and will weaken their power over suppliers.