Business Breakdowns
· Matt Reustle, Asif Jeevanjee
[00:00:00] S0: It's a good opportunity to talk about what contracts look like in this space. Whether it's the term of the contract, how they're priced and structured. Anything that you can share on that for standard contracts, to the extent that there are standard contracts in food services. [00:00:00] S1: Contracts are typically three to five years. But there are exceptions where they can be longer. In particular in the sports and leisure area, and in education where contracts can run up to eight years. And there are some historical B&I contracts. B&I is business and industry, where contracts have been longer still. There are three types of contracts. There's something known as fixed price contracts where the client will agree with Compass a fixed price per meal, and then it's up to Compass to figure out how to manage their costs to make sure they make a profit. There's another contract type which is Cost plus, where Compass will simply pass on whatever costs are incurred in making the food, plus a small management fee. And then there are P&L contracts where Compass and the client will agree to share the profits earned on the operation. [00:00:00] S0: From an investor perspective, even from the business's perspective, is there a contract type of those three that is most preferred? What results in the highest margins, or something that you see a transition towards more and more?
· Matt Reustle, Asif Jeevanjee
[00:00:00] S0: From an investor perspective, even from the business's perspective, is there a contract type of those three that is most preferred? What results in the highest margins, or something that you see a transition towards more and more? [00:00:00] S1: Contracts are evenly split across the business by those three types. And that hasn't changed very much over time. We don't have enough information to discern different levels of profitability by contract type. And the contract structure that's adopted is largely down to the circumstances of the client. Some clients prefer a fixed price contract because it gives them certainty about what the outlay is each month in a subsidized cafeteria. Other clients may want to share in the upside potential and elect a P&L contract. Whichever structure is written into the RFP, Compass will factor that into their bid terms to ensure that the structure is commercially attractive to them. And that's from a margin point of view, but also from a risk point of view. [00:00:00] S0: On that point, in terms of retention, I'm trying to get some appreciation for how sticky these contracts might be. Because you are on the corporation's premises, their facilities, I imagine there is some ability to switch and it's not going to be a complete overhaul. What does retention tend to look like for the industry and are there things that can make them more sticky? Good service and steady performance is certainly going to be one of those. But are there hidden things that maybe impact the retention rate and stickiness of any of these contracts?
· Matt Reustle, Asif Jeevanjee
[00:00:00] S0: On that point, in terms of retention, I'm trying to get some appreciation for how sticky these contracts might be. Because you are on the corporation's premises, their facilities, I imagine there is some ability to switch and it's not going to be a complete overhaul. What does retention tend to look like for the industry and are there things that can make them more sticky? Good service and steady performance is certainly going to be one of those. But are there hidden things that maybe impact the retention rate and stickiness of any of these contracts? [00:00:00] S1: There are switching costs involved. The retention rate for Compass is 96%, which is industry leading. That is very, very high. And when you think about the scale of the business, $42 billion of revenue, if you're hitting a 96% retention rate, that means you're losing 4% every year, which is a lot of business which they have to then replace. So to tread water, they've got to win, let's call it $1.5 billion a year. To grow as they have, they've got to do that again. Retention is really important. I like to think of it as... in investing, Warren Buffett's rule is don't lose money. I think in contract catering, it's do not lose a contract that you've won. This is really the secret sauce to Compass's ability to grow. They've excelled not only at winning business, but on hanging on to business that they've won.
· Asif Jeevanjee, Matt Reustle
[00:00:00] S1: There are switching costs involved. The retention rate for Compass is 96%, which is industry leading. That is very, very high. And when you think about the scale of the business, $42 billion of revenue, if you're hitting a 96% retention rate, that means you're losing 4% every year, which is a lot of business which they have to then replace. So to tread water, they've got to win, let's call it $1.5 billion a year. To grow as they have, they've got to do that again. Retention is really important. I like to think of it as... in investing, Warren Buffett's rule is don't lose money. I think in contract catering, it's do not lose a contract that you've won. This is really the secret sauce to Compass's ability to grow. They've excelled not only at winning business, but on hanging on to business that they've won. [00:00:00] S0: That 96% tells me that there's something very sticky about their business. And I appreciate that you mentioned it still requires them to replace a billion and a half of revenue each year just to tread water. What would you point to in terms of competitive advantage that they might have versus their peers? And anything else on the switching costs that would be associated with it? If I can comprehend what that would look like, it would be helpful. As an example, what would it entail to move from one provider to the next? Beyond we have this crew that's shown up and served the food out of here on Friday, on Monday, it's going to be this group. What else goes into it that makes it more complex?
· Asif Jeevanjee
[00:00:00] S1: Contracts do move around every time you win a contract from another provider. There are bid costs involved and there are mobilization costs involved, which can be quite high. So those are the switching costs, but also the incumbent operator is going to know how the operation works and what the needs of the client are. So there is an advantage to the incumbent. But I think Compass's industry leading retention is really down to making a science out of sales and retention. They keep a very close eye on what it is that the customer wants. And when I say the customer, one of the things that makes this industry quite unusual is there are two customer groups. There's the client and there's the consumer. Whether it's through surveys or through technology and data, Compass has a very, very good idea of if the client or the consumer is not happy. They will work very hard to fix that, long before the contract comes up for renewal. So by the time it's coming to the renewal point, they're in a really good position to hang onto it. It's also important to point out that it's going to be very difficult to achieve 100% retention. Because, for example, a client might change its factory footprint and close a factory or consolidate offices and therefore a site will disappear, which is out of Compass's control. So there'll always be some contract loss.
· Matt Reustle
[00:00:00] S0: Yeah, I can imagine scenarios. To your earlier point, the incumbent understands the operation very well. They can probably price the contract to that specific setup. While new bidders might not appreciate it, might come in with a lower price, and it might not be bad business to lose in that sense if what is required is going to undercut you on pricing, to the extent that that happens, I could certainly see it. What else goes into their model in terms of, as you mentioned, being the 800 pound gorilla? Maybe we should go back in time and cover some of the history and build up to it. That might be a good place to start because I want to work towards how they've gotten to this place. What is the origin story of Compass? Can you bring us back to the beginning and the formation of this company? How far it goes back and then we can work our way forward.