UK: GOOD VALUE AT BOOTS. - From grand strategy to minor product changes the group has a clear objective: to add value for shareholders.

by Martin Vander Weyer.
Last Updated: 31 Aug 2010

From grand strategy to minor product changes the group has a clear objective: to add value for shareholders.

'We are are not university professors,' David Thompson, group finance director of Boots, remarks while explaining the analytical purity of his company's decision-making processes. But the newcomer to Boots' spacious 300-acre campus headquarters at Beeston on the edge of Nottingham, with its striking collection of 20th century architectural styles, could be forgiven for thinking that he had strayed into an exclusive business-school-cum-science park funded by some benign but publicity-shy religious cult. Conversations with senior executives tend to reinforce rather than dispel that impression.

Boots is in fact a very unusual organisation. It is the largest British public company to keep its head office in the provinces rather than in London - a factor which has clearly helped to shape its distinctive self-image, and injects a certain distance into relations with stock-market analysts and City journalists. It is a rare combination of long-established traditions and state-of-the-art management techniques. It is both a finely-tuned cash-generating machine and, by all accounts (the two being not often compatible), a congenial place to work. Boots ranks with Marks & Spencer and Sainsbury as one of Britain's most respected and enduring stores groups, with sales of £4.5 billion for the year to March 1995, and pre-tax profits of £526 million. The engine of its business is Boots the Chemist (BTC), started in 1877 by Jesse Boot, who was the great benefactor of Nottingham and indeed the founder of its university. As Britain's largest chain of retail chemists BTC is a market leader in healthcare, cosmetics, toiletries, baby products and film processing. Its cursive logotype, refined only slightly since the 1880s, is an instantly recognised icon of the British high street.

Perhaps because BTC is so ubiquitous, many people assume Boots to be nothing but chemists shops - which in fact account for about two-thirds of group turnover and operating profit. The rest of the group includes a portfolio of other retailing activities - the car-and-cycle accessories chain Halfords, Childrens World, Boots Opticians, Fads home-decorating shops and a 50% interest in Do It All, the DIY superstores - plus manufacturing of over-the-counter healthcare products and own-label toiletries. There is also a substantial property division, developing and owning retail sites to make best advantage of the group's own space requirements - and returning an operating profit last year of £67 million, the second largest contributor in the group.

These activities are governed by a simple but powerful set of ideas. At all levels, from grand strategy down to small changes in BTC's product range, the group adheres fervently to the principle of 'value-based management', which decrees that a project is only worth pursuing if it creates additional value for shareholders - that is, if it generates a long-term return in excess of the cost of capital. Value is measured ultimately not by simple earnings per share but by the accumulation of gross dividends and growth in share price. And the key to extracting value, according to Thompson, is the maximisation of long-term cash flow. It is an approach not designed to hold the attention of City analysts, who prefer rapid results on which to write headlines which stimulate market turnover.

'Out timescales are a lot longer than the stock market's,' says Thompson. 'I think the serious institutional shareholders understand our approach now, even if some of the brokers don't. Earnings can be misleading, but there's no kidding with cash flow at the end of the day. It's a philosophy that makes decision-making extremely easy.' Easy or not, the results of the value-based approach are plain to see in Boots' annual report for the year to March 1995: a five-year return to shareholders of 104%, placing the company second only to Marks & Spencer (with 113%) in a selected league of retailers and pharmaceuticals businesses well ahead of Kingfisher (78%), W H Smith (67%) and Tesco (47%).

As for cash flow, the group has been steadily improving its position since the turn of the decade, when the £980 million Ward White group acquisition (which brought in Halfords, Fads and Do It All) boosted debt to an uncharacteristically high gearing level of 48%. Over the past five years that debt has been eradicated, leaving an almost embarrassing cash pile of over half a billion pounds.

These results are, in one sense, traceable to the two biggest decisions in Boots' recent history: the appointment of Sir James (now Lord) Blyth as chief executive in October 1987, and the purchase of Ward White in l989. But the results are also the collective achievement of Boots' management corps - notably homogeneous in its personal style and background, and imbued with a set of values which owe more than a little to the cost-conscious, philanthropically inclined Jesse Boot, who died in 1931. Those values - in areas such as staff welfare, product quality and relations with suppliers - are understood so intuitively throughout the firm that, until very recently, no one has ever thought it necessary to write them down.

Within a framework of clear investment guidelines and highly developed analytical tools - and the kind of collegiate trust which comes from having spent their entire working lives with the company - the heads of the group's nine major business divisions enjoy considerable freedom. This in itself represents something of a break from Boots' traditional, highly centralised, decision-making structure. But it seems to be working. 'We prefer the word "independence" to "autonomy",' says Thompson, making a distinction which indicates intensive thinking about the precise nature of the relationship between divisional management and head office. But Steve Russell, newly appointed managing director of BTC, confirms that, 'If you've got the ideas and can articulate them convincingly, nothing stands in your way. It's a highly effective way of unlocking the ideas of the people in the business.' Russell also talks about 'modernisation born out of the realisation of the core values of the business'. Essential to the process is the accuracy of the data on which small decisions are based, and large ones built up. Boots has perfected over many years a sophisticated system of 'retail engineering' - that is, of continuous management of its product ranges and store lay-outs to maximise margins, combined with exhaustive monitoring of competitors and consumer preferences. 'Direct product profitability' is a technique which allocates 90% of total group costs to individual products, taking precise account of the costs of labour, distribution, stock investments, shelf and warehouse space to give a comparable measure of the profit contribution of every item on sale.

The impact of all this can be readily observed in any of BTC's 1,167 stores. The visitor senses immediately a collective scientific mind at work. The style is clinical and bright - masculine, perhaps, but non-aggressive, reinforcing the Boots' image of the reliable pharmacist in a white coat as the central pillar of the business. The limited ranges of merchandise reveal acute attention to stock control, while the lay-out - uncluttered, impulse-buy items closest to the tills - suggests careful analysis of customer behaviour.

But the creative - perhaps feminine - side of Boots' nature can be seen in many points of detail: the successful relaunch of the 60-year-old Number Seven cosmetics brand, the style of which over the years presents a microcosm of the history of packaging design; the Shapers range of low-calorie convenience foods; and the development of a range of 'natural' and 'global' personal-care products to compete with Anita Roddick's powerfully marketed Body Shop brand. ('We're really very grateful to the Body Shop,' Russell observes. 'They've created a market that's worth £50 million a year to us.') When Russell reports all these elements of his business plan to his boss, Lord Blyth, he goes armed with a complex set of statistics and market analysis diagrams to back up his investment case. Blyth, a quiet, tennis-playing Scotsman with mid-Atlantic undertones, is clearly the dominant figure in the group. Unusually, he is not a lifelong Boots man: he has added his own special ingredients to the company's traditional formula. He joined Boots from Plessey, the electronics group, having previously been head of defence sales for the Ministry of Defence - a most unlikely background for a top retailer. But Blyth's earlier career took in stints with Mars and General Foods, and although he discourages personal publicity he is recognised as one of Britain's most disciplined, hands-on managers - recognition reflected in his appointment by the Prime Minister to head up the Citizen's Charter initiative, which seeks to bring best customer-service practice to the interface between state bureaucracy and the public, and by his peerage in this year's Queen's Birthday honours.

It is Blyth who introduced the value-based management principle to Boots, but his approach is not such a radical departure from past practice: unlike many established retailers, the company has long prided itself on analytical, marketing-led decision-making. Blyth's contribution has been to set this in the context of total returns to shareholders.

Blyth, incidentally, is now one of Britain's highest-paid retailers, having collected £888,000 in salary and bonuses last year. 'I'm paid sensibly for what I do', was his only comment, and objective observers would probably agree that a man like Blyth clearly has a market value - as it happens, he falls midway on the store bosses' pay scale between Sir Ian MacLaurin of Tesco and Sir Richard Greenbury of M&S. Underlining the social awareness which is part of Boots' culture, however, group chairman Sir Michael Angus (formerly of Unilever) has been quick to acknowledge adverse public sentiment on top people's pay. In June he announced that the company would issue no more share options to executives and would cut directors' service contracts to no more than two years.

Thus far, perhaps, Boots sounds almost too good to be true, both in commerce and in corporate citizenship. But just as the most respectable public figures sometimes have embarrassing shadows in their past, so Boots has the Ward White acquisition. This was a boom-time 1980s decision if ever there was one, and an investment which has so far shown a paltry return on a price of almost a billion pounds. According to one Boots executive, 'Ward White brought us the gem of Halfords,' which now accounts for 9% of group turnover. But, well-recognised high-street name though Halfords may be, it was in reality very much a flawed gem, in need of much cutting and polishing.

Halfords, and the whole of Ward White had been managed in a style which was almost diametrically opposite to that of Boots: with a sharp eye on the share price for eventual sale and an appetite for rapid expansion, but a very loose eye on margins, product range, quality and shop design. Post-acquisition scrutiny of the accounts of some of its subsidiaries found them to have been optimistic - to say the least. 'We learned the hard way what you can let yourself in for when you make an aggressive acquisition,' says Brian Whalan, former marketing director of BTC and creator of the Childrens World chain, who now has the task of turning Halfords around by the application of proven Boots methodology.

This has been a lengthy project but is beginning to pay off at last: profit last year was up by 41%, at £20.5 million, on £378 million turnover. Halfords outlets, particularly the out-of-town superstores where growth is focused, now demonstrate precisely the same business psychology as BTC - with the same clean, uncluttered look, carefully selected lines of stock, and what Whalan calls 'the intellectual approach to true profitability'. The effectiveness of this strategy can be seen in Halfords' substantial market-share increase for bicycles, achieved by better display and service, despite reductions in product range and allocated store space. More problematical is a loss-making chain of service garages but improvement may show through by careful targeting of the right kind of customer - boosted by an innovative deal to service all Daewoo cars in Britain and to sell the Korean car through the adjacent Halfords superstores.

Also part of Ward White were Fads and the Payless DIY stores, subsequently merged into the Do It All joint venture with W H Smith. DIY was very much a 1980s story, linked to the property boom, and remains in desperate straits, with supply vastly exceeding demand and margins destroyed by a long, price-cutting war. Most DIY superstores are echoingly empty for much of the time, and the moribund state of the housing market means that they are likely to show a more feeble recovery than the rest of the retail economy.

Fads, meanwhile, has been completely reformulated (it is now called 'Homestyle by Fads') to sell co-ordinated ranges of curtains and bedding matching the wallpapers and paints, but it, too, is far from busy. Both these elements of Boots continue to make losses, dragging the contribution from the Ward White purchase down to an operating profit of little more than £5 million for 1994/95.

Many analysts would be thrilled if Blyth took a swift decision to get out of DIY altogether. But that is not the Boots way: operating losses of £15 million last year are no reason to cut and run if long-term forecasting suggests that cash flow can eventually be made positive by relentless application of the Boots treatment. Russell, who ran Do It All for three years before taking up his present post at BTC, believes that this can be made to happen: he claims to have already put 'a much better engine' in the business, and that the application of the Boots ethic of customer service will eventually win through. In the case of Do It All, that result may have to be achieved by buying in W H Smith's stake to gain full control, rather than selling out.

Self-belief in the power of the Boots treatment makes reluctance to withdraw from troubled business areas a potential weakness in the armour of the group's strategic thinking - and it is accompanied by a distinctly cautious approach to new acquisitions, the legacy of Ward White. Both factors play a part in the story of Boots pharmaceutical and over-the-counter healthcare activities.

Ethical drugs is an industrial sector dominated by giant manufacturers with very deep pockets to fund the necessary R&D - often now undertaken in multinational joint ventures - and to sustain pay-back periods on new products of 10 years or more. Boots enjoyed the long-term fruits of one highly successful product, the pain-killer Ibuprofen. But it struck disaster with its heart drug, Manoplax, which tests indicated might be shortening the lives of congestive heart disease patients, much though it eased their suffering. The product was immediately withdrawn, with a substantial write-off, in July 1993. An 18-month review of the future of Boots Pharmaceuticals ensued, resulting in its sale, at the end of the last financial year, to BASF of Germany. Thompson says that it was 'a wrench to sell' - but the resulting profit of £273 million has added a new dimension to Boots' growing pile of cash.

Where some of that cash may come to be spent is in the over-the-counter healthcare market, in which Boots foresees considerable growth prospects, both at home and in Europe, building on the success of established products such as Neurofen and Strepsils. The trend in healthcare throughout the developed world is towards self-medication and self-management of health - which means a growing demand for non-prescription medications with the hallmark of reliability of a name like Boots attached to them. Even if a Labour government takes power in Britain, little change is expected in that growth trend in the domestic market which plays to all of Boots' core strengths.

Boots' retailing formula cannot yet cross the Channel because of restrictions in Continental Europe on multiple ownership of pharmacies. But Boots' manufacturing skills can certainly travel, and the company has recently announced that it is actively seeking acquisitions (both in own-label healthcare and in beauty products) to build up its contract manufacturing division. Greater distribution in Continental Europe is a key objective and will provide a partial answer to critics who say that, whatever its strengths, Boots is too dependent on a British retailing market which is already overpopulated.

Contract manufacturing provides a second part of the answer to that criticism. The giant supermarket chains are now Boots' major retail competitors at home, but many of the own-label toiletry and personal-care products they sell are in fact supplied by Boots.

Retailing is a business in which success goes to operators such as Boots, which are clever at squeezing higher margins out of their merchandise and which manage their store portfolio, as Boots does, to achieve the right size of outlet in the right location. Shopkeeping in Britain has been developed to a level of sophistication which is the envy of the world, but it's no longer a high-growth business.

In the end, that must be a frustration for many retail managers. But it does not seem to trouble the men of Boots, who relish the intellectual challenge of maximising returns by the application of a set of proven management precepts. Their over-arching objective, it must be remembered, is not market share or banner headlines: it is value for shareholders. They have already demonstrated, earlier this year, that they are prepared to take that concept to its logical extreme, by simply returning capital to the shareholders. In November 1994, Boots went into the stock market to buy back 9% of its outstanding shares, which were subsequently cancelled - having the effect of raising the value of the remaining shares more tax efficiently than a large special dividend would have done.

Boots is a clever business, managed with a cool head and a strong sense of the enduring values on which it was founded. Its managers may not wish to be depicted as university professors, but a study of its methods would provide a very practical MBA course for many UK businesses.

THE BOOTS COMPANY: Financial Facts.

Turnover/Profit Before Tax*(£m)

Turnover Profit

Boots the Chemist 2,943.8 349.7

Halfords 377.9 20.5

Boots Opticians 119.1 8.3

Childrens World 104.8 0.5

AG Stanley (inc. Fads) 114.6 (8.5)

Do It All (50% ownership) 185.3 (6.3)

Boots Healthcare Int. 203.5 9.8

Boots Contract Manufacturing 216.0 17.8

Boots Properties 98.0 66.8

Pharmaceuticals (discontinued) 441.8 86.4

Group costs (24.8)

Interest - 5.4

Inter-group trading (299.0) -

Total 4,505.8 525.6

Shareholders' funds (£m) 2,006.9

Number of employees 80,866

* for year to 31March 1995

Martin Vander Weyer is an associate editor of the Spectator.

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