Business Breakdowns
· Matt Reustle
[00:00:00] S0: On the point of market penetration, the adoption of food services, whether it's versus the alternative of providing in-house services or just not having any services at all. Do you have any sense of where that stands today in terms of market penetration and however that might be measured?
· Asif Jeevanjee
[00:00:00] S1: If we focus firstly on the North American market. As I said, one of the things that drove Compass to really launch in North America was recognizing that the market was outsourcing, but that was really focused on B&I. So you can imagine companies in the 80s and 90s saying, why are we doing this in house? We should really outsource this. We'll save money and it's really not core to our business. That sort of wave of outsourcing has pretty much happened and today almost 100% of B&I, the marketplace is fully outsourced. It has yet to happen within two very important markets, which is healthcare and education. There, probably in North America, about half the market is outsourced. That's what's continuing to drive Compass's quite high rate of new business wins is increasingly and particularly after the pandemic, those clients are saying we really need to outsource this. And one of the things that's driving that decision is, first of all it's cost. Compass's scale in procurement is so big that they're always going to be able to deliver food more cheaply than an in-house operation. But the other is just rising complexity. Consumers are getting more demanding. They want to know more about the food they're putting in their bodies. They have nutritional demands, whether it's around vegan or gluten free. They want to see labeling around allergens, and that's particularly important in the healthcare and education space. And it's quite hard to deliver on that. You need to have a very good eye on your supply chain. You need to have a lot of data that requires a lot of technology and it's becoming more and more difficult for a single site operator or even a small regional player to really compete. So that's driving a second wave of outsourcing now, in healthcare and education in North America. What's really interesting though at the moment, is that for many many years continental Europe was quite reluctant to outsource. It did happen to quite an extent within B&I, but certainly not the other sectors so much. And that is now changing. Compass recognized that. They've been investing very heavily in Europe in acquisitions in particular, replicating the successful strategy that they executed in the 90s and 2000s in the US. What you're starting to see is really an acceleration in organic growth to levels that we've almost never seen in Europe.
· Asif Jeevanjee, Matt Reustle
I think that's really a repeat of the strategy that's already played out in the US. [00:00:00] S0: It's interesting when you talk about acquisitive DNA to go from a period where that seemed to be a theme in the 90s. I'm sure there was some M&A over the years in between now and then, but to go back to that time period and have a precedent like that, it's a little bit further back in time than most companies would point to in terms of executing a strategy. But it seems like a lot of the DNA is still in place. I want to get into the M&A point a little bit more. But before we move on, in terms of the market size and growth, is there a way to measure how much the market is growing organically each year? I can understand there's going to be contracts that are moving from one provider to the next, but is there some sense in terms of what organic growth is for the market as a whole, whether you break that down geographically or at the world level?
· Asif Jeevanjee
[00:00:00] S1: It's tricky to do that because you've got to assess what is the market. But if I look at Compass specifically, we can tease out what are the elements of growth. There are several elements to their organic growth. One is volume growth. It's pretty hard to eke out more than a few basis points, really, a year from that, because the biggest way you can grow there is to convince people who maybe aren't using their cafeteria every day of the week to use it more often. So that's a very small contributor to growth, but it has been a positive one. The second one is pricing. Compass generally is passing on pricing to the consumer that's broadly in line with inflation. They're certainly not trying to use pricing as an important lever because actually what they really want to do is to try and reduce costs so that they don't have to do that, but they're able to pass on inflationary costs to the consumer. And you've seen that particularly in the last few years when you had quite high food inflation and high labor inflation. They were able to pass that on. Over time, that's been sort of around the 2% type level. The really big driver of organic growth has been what they call net new business wins. I mentioned earlier that retention is around 96%. Compass has been growing net new business at around 4%. So that requires a gross win rate of about 8%, which is on that sales base, absolutely enormous. And they've been doing that to end up at a net new of about 4%. Mid to high single digit organic growth is certainly possible for a very long time for Compass.
· Matt Reustle
[00:00:00] S0: I want to get into the financial dynamics because I think that will instruct some of the M&A conversation as well. You gave a good sense of the top line growth there. One of the benefits of a large player in this market should be the cost structure being more efficient. What does it actually look like in terms of the margin profile of this business and however you might categorize how Compass performs, how the industry performs and the most important metrics associated with the margin profile?
· Asif Jeevanjee
[00:00:00] S1: So the typical margin in the food service sector is around 6%. Aramark makes about 6%. Sodexo a little bit under that. But that's partly because of the dilutive effect of its facilities management business. Compass outside North America also makes about a 6% margin. But in North America they make a more than 8% margin. And what explains this 200 basis point spread? There are several contributing factors. The key one is scale. We've got a fixed managerial cost and technological infrastructure cost. And the more revenue you layer on top of that, the higher your margin is going to go. In addition, Compass has embedded within it an economies-scale-share type of model within the procurement side of the business. And I think that partly also explains the margin differential, although it mainly explains the ability to grow the business. And that drives scale and that drives margin. Just to delve into that, in the early 2000s, Compass acquired a small food procurement technology business called Foodbuy. And that has formed the bedrock of Compass's GPO or general purchasing organization. And the way this works is that most of the ingredients purchased by the Compass chefs are bought through Foodbuy via approved vendors. And as you can imagine, that by itself is a lot of volume. But in addition, Compass invited third parties, these could be cafes, restaurants, hotels, et cetera, to also procure through Foodbuy. Today in total, Foodbuy does about $40 billion volume, 60% of that coming from third parties. And that enables Compass to secure better prices and better payment terms from their suppliers. As an aside, Compass charges third parties a very small fee for using Foodbuy, which I like to think is a slightly Costco-esque touch. And it's a really compelling win-win for everyone involved. Compass attains lower procurement costs which help them win more business, further driving up scale. Third parties can access Compass's buying power and reduce their cost of goods sold in a way they couldn't have done otherwise. The consumer enjoys a lower priced meal and if they're happy, then all else equal, the client will be happy. Even the supplier is content with this arrangement because although they might sell at lower prices, they also have certainty about demand, which is particularly important when you're dealing with perishables.