UK: NFC keeps its drive.

UK: NFC keeps its drive. - As more companies stick to their knitting and contract out activities such as distribution, road haulage firms are benefitting. NFC's "hidden plus factor" - a culture dedicated to employee share-ownership - gives it an edge.

by Tom Lloyd.
Last Updated: 31 Aug 2010

As more companies stick to their knitting and contract out activities such as distribution, road haulage firms are benefitting. NFC's "hidden plus factor" - a culture dedicated to employee share-ownership - gives it an edge.

On the face of it, transport is not the sort of industry you would expect to demonstrate a great deal of recession resilience. On the contrary, since its customer base is industry in general, you would expect its own health to be a pretty accurate reflection of the health of the economy as a whole.

Why is it then that Britain's road haulage industry seems to be surviving the recession relatively well, and what is it about NFC, the largest group in the sector, that has enabled it to do even better than its rivals?

NFC's profits reached a peak of around £96 million pre-tax for the year to the end of September 1990 (adjusted for an extra week's trading); fell to a little under £94 million in 1991; and, in the "annus horribilis" of 1992, reported a solid £91-million pre-tax profit for the 12 months to 3 October.

The main reason why the transport industry as a whole seems to be surviving the recession in such a robust fashion is that over the past decade or so large British firms - particularly those in the food and retail sectors - have been taking a long, hard look at their transport and distribution arrangements.

Heeding the new management edict of "stick to your knitting", they have been asking themselves what their core business activities are, and many have come to the conclusion that distribution is not one of them. Accordingly, they have been sub-contracting their "logistics" or their "supply chain management", as the modern management parlance has it, to specialists like NFC's Exel Logistics.

"Britain has the most sophisticated logistics and transport industry in the world," says James Watson, chairman of NFC. "This is partly because we deregulated early" (in 1968, as opposed to the 1980s in the US and more recently still on the Continent, where the process remains incomplete), "and partly because UK retailers have been very supportive, and have demanded high quality service and Just-In-Time (JIT) delivery systems."

The result of this industrial restructuring is that though convoys of container trailers blazoned with the Sainsbury and Tesco logos still ply the country's motorways, a closer inspection reveals that most of the trucks that haul them carry another, smaller logo, such as Exel, indicating that subcontractors are at work. "All the major food retailers contract out now," says Watson. "They often use more than one subcontractor and they still do some themselves, but they have recognised the advantages of contracting out. "

Watson estimates that roughly half of the British logistics systems are contracted out, compared to 10-12% in the US. "There is going to be a big change in the US and Europe," he predicts, "and despite the recession in the UK, contracting out is still increasing here. This has enabled us to grow." The switch from in-house logistic systems to contracted out arrangements has done more than increase the quantity of the transport industry's earnings; it has also increased the quality. A consequence of the up-grading of old-fashioned "commodity" haulage business into higher value-added logistics and supply chain management business, has been a change in the relationship between transport groups and their customers.

At the start of the 1980s, barely a third of NFC's turnover was contract-based. The rest consisted of traditional one-off deals, the volume of which was closely linked to the ups and downs of the economic cycle. Watson estimates that nowadays around 60% of NFC's turnover is contract-based, with three-to-five-year contract periods and clear profitability parameters based on management fees and cost-plus arrangements.

But only part of the 1980s growth in NFC's contract business can be attributed to the general, structural change in the whole industry. The rest is the result of the company's deliberate policy of rebalancing its customer base. "We've moved away from general commodity business to more customer-focused industries, like food and retail," explains Watson. "There is less manufacturing now." The company is also a key operator in express delivery with its Lynx service which was formed in 1987 by bringing together the Roadline and National Carriers divisions of NFC.

In retrospect, the timing of the celebrated National Freight Consortium staff buyout in February 1982, for £53.5 million, was brilliant. The recession of the early 1980s, aggravated by its old-fashioned business mix, had hit profits hard during the closing stages of the group's sojourn in the public sector, so the deal was struck at what was more or less the nadir of the company's fortunes. Today NFC's market value is more than £1.5 billion.

"The 1979-80 recession was rough," Watson recalled. "We were determined we wouldn't go through that again. We made three important strategic decisions. We had been totally dependent on the UK market and we realised we had to grow the business internationally.

We wanted longer-term commitments from our customers and we needed a better customer mix."

As discussed above, considerable progress towards the last two objectives has been achieved.

At the same time profits from overseas activities have risen from practically nothing in 1979 to around 30% of the total, thanks mostly to several overseas acquisitions.

But although NFC has bought four companies in the US, three in France, two in Spain and two in Germany, since the buyout, its strategy is not "acquisition-led" in the classical sense.

"Acquisitions are expensive," Watson says. "The plan has been to plant flags, learn about markets, develop an ability to expand and then to grow organically. We're in Canada now and we are following customers: for instance, Marks and Spencer to France and Spain, Sainsbury to north-east America and Procter and Gamble to Mexico." It would be wrong, however, to attribute all NFC's recession resilience to well-conceived plans, skilfully implemented.

There is also the group's "hidden plus factor", as its chief architect and former chairman, Sir Peter Thompson, described it. This is its culture of employee share ownership and the employee enthusiasm it has created. Watson and his fellow directors remain convinced that the decision to opt for an employee buyout in 1982, rather than the more conventional management buyout (which could have made Thompson and his colleagues, including Watson and the former chief executive Jack Mather, rich beyond the dreams of avarice) has been an enormous competitive advantage for the company.

"Our relative success has been due to strategic decisions, and to employee share-ownership," Watson asserts. "That was a dramatic change. Employees, their families and pensioners still own 45% of the business, and 90% of employees own shares." At the last count, employees owned about 17.5% of the total equity and their families and pensioners owned another 21%. Bearing in mind the double-voting rights granted to employee shareholders (enshrined in a notorious clause in NFC's articles of association), that indicates employees, and shareholders loyal to them, account for some 56% of total votes.

Leaving aside, for the moment, the key question of how "bid proof" that makes NFC, it is worth noting the benefits other shareholders have earned from the profit-sharing arrangement that finances employee share purchases. As the table (see p46) shows, NFC's taxable profits would have been hit much harder by the recession, without profit-sharing.

The fall in net operating profits from their peak in 1989 to the 1992 level was 11%, but because of the sharp fall in profit-sharing during the period, pre-tax profits last year were actually a touch higher in 1992 than they were in 1989.

Profit-sharing, therefore, quite apart from possibly increasing employee commitment, motivation and enthusiasm, has, by making employee costs flexible in a downward direction, acted as a powerful recession shock-absorber, thus, in City parlance, enhancing the "quality" (ie, durability) of NFC's earnings.

Notwithstanding the controversy aroused in the City by NFC's double-voting rights clause when the company came to market in 1989, the virtues of employee ownership, and the culture associated with it, have not been lost on the City. A number of institutions who swore they would never back a group that favoured employee-shareholders at the expense of others, are now very satisfied NFC investors. They soon recognised that by being picky about the dilution of their voting rights, they were denying themselves a good investment opportunity in a key sector.

But how durable is NFC's culture? If the recession is reducing the profit-sharing available for share purchases, is it not inevitable that redundancies, retirements and other kinds of reductions in numbers will progressively erode employee share-ownership, to the point when NFC becomes an "ordinary" company in which employees have a stake that is significant, but is no longer significant enough to guarantee continued independence?

And if and when that happens, what effect might that have on Sir Peter's "hidden plus factor"?

During the seven years between the buyout in 1982 and the flotation in 1989, the percentage of the equity owned by the employees held steady at 80%. Following a rights issue at the time of flotation, the percentage fell to 30% and in the past three years it has been declining at a rate of between 4-5 percentage points a year to the current level of 17.5%.

As the double-voting rights lapse when the proportion of equity held by employees falls below 10%, the rights would be lost within two years under existing arrangements. However, steps are being taken to boost employee shareholdings to help avoid this.

The Inland Revenue allows the company to match the amount employees save for tax-free share purchases. Part A of the existing NFC scheme awards bonus shares to employees who save to buy shares, and part B awards bonus shares to all employees. In both cases, the shares have to be held in trust for five years to be tax free. "We don't much like Part B because it's a give away," company secretary Jeremy Letchford explains, "so we are switching the emphasis to part A, by increasing the existing bonus of two free shares for every five bought, to buy one and get one free. BOGOF is a 50% discount so there is a very strong incentive to save."

In addition, a share option scheme has been approved similar to the executive share option schemes for which tax breaks were granted in the 1981 budget, but in NFC's case they will be available to all employees. Here again, there is a link to savings. For instance, an employee who saves £100 to buy shares gets, in addition to his or her £100-worth of free shares, options to buy another £100-worth at the current price, in five years time (just at the period when his or her £200-worth of shares are emerging, tax free, from trust).

By favouring those ready to save for tax free shares, both the adjustments to the existing scheme and the new option scheme should increase the proportion of equity owned by NFC employees above what it would otherwise be. However, it is very hard to predict whether the stimulus will be enough to arrest the decline in employee share-ownership. It depends on how much profit-sharing there is, and that depends on how fast profits grow. It is certain though that, if nothing else, the revised arrangements will defer the point at which employees share-holding falls below the 10% at which double-voting rights lapse.

Letchford says that employee-shareholding should not be seen as a defence against a takeover bid and that, anyway, the flotation in 1989 resulted in a much bigger change in attitude by employees on how they regarded the company than anything faced now. Watson elaborates. "We faced the problem of a reducing employee shareholding when we floated," he says, "and the percentage of employees who are shareholders is more important than the percentage of shares they hold.

"What matters is the way you treat people when they are shareholders - we see employees as part-owners. We have very good communications; they feel they have a say. We don't treat the institutions any differently, and they believe in employee shareholding. They have approved the new arrangements. What is important is whether we're managing the company well."

All the same, it is hard to escape the impression that Sir Peter Thompson's NFC is undergoing a certain amount of change. A new chief executive, Peter Sherlock, has just been appointed, who was not part of the buyout team. It is not clear whether Sir Peter would have approved of the sale of NFC's travel interests which has taken place over the last two years, and Sir Peter had strong views about options. He did not like them.

Nevertheless, certain things remain the same. The new chief executive has expressed his belief in, and commitment to, NFC's six "core values" - employee ownership, quality, internationalism, people development, social responsibility and premium performance - and in view of the pressures resulting from the recession, it is an impressive demonstration of the strength of the commitment to the company that so many shares are still in the hands of employees, their families and pensioners. There is no other UK company with a market value anywhere approaching NFC's, where 45% of the equity is still in private hands.

The leadership is still passionate and evangelical about the principles which were espoused at the time of the buyout. "Our philosophy and values are exportable," Watson insists. "Ninety per cent of our US employees are shareholders and we're expecting 100 agents from our American company, Allied Van Lines, at the annual general meeting in Nottingham this year." (NFC's annual general meetings are famous. They are always packed, always huge and always lively. They symbolise the culture of the organisation.). "We're not seen as so special in the US and on the Continent as we are here, and profit-sharing schemes can't be as tax-efficient in all countries, but we involve everybody and, as far as we can we are extending all the profit-sharing schemes to our foreign subsidiaries."

The participative and generally "nice" culture of the company does not seem to have been too bruised by the harsh realities of the economic climate. "Recession brings home to you how some things need changing," Watson muses. "BRS (the core of the transport division) was a regional operation. We made it national and saved £10 million of overheads. Recession makes you see things more clearly. We have had to cut costs, but we have also continued to invest in growth areas and we have maintained training budgets.

"We've had to make 1,500 people redundant but you can carry employees with you if you communicate and explain. We don't link shareholding with redundancy. Most people go quietly if it is done reasonably and they are kept informed. We have an employment agency to help them find new jobs. We try to deal with people decently - to explain and go through things as much as possible."

NFC's commitment to being a socially responsible company also remains undimmed. It is still giving 1% of profits to charity each year; the NFC Foundation (set up in 1988) is still giving away over £1 million a year; and the company continues to be wholly committed to furthering the cause of business education in the communities around the country where its subsidiaries operate.

"Having a role in the community is on the management agenda," Watson says. "We have a menu of educational responsibilities, such as being a school governor, that we encourage our executives to undertake."

Some say friendly, communicative and participative cultures, like NFC's, will be key components of competitive advantage in the future, as relationships between companies and their suppliers become progressively more intimate.

As Watson puts it, "If you're an integral part of your customer's business - involved in warehousing, IT systems, vehicles and people you need a relationship of trust. If a customer is planning a fundamental change in its distribution arrangements, we'll do it together, starting from square one."

PROFIT-SHARING: THE RECESSION SHOCK ABSORBER

1987 1988 1989 1990* 1991 1992

Operating profit 64.5 90.4 114.4 106.6 102.1 102.7

Interest 13.9 11.5 8.3 5.8 5.0 8.4

Net operating

profit 50.6 78.9 106.1 100.8 97.1 94.3

Profit-sharing 3.2 11.8 15.9 5.0 3.4 3.3

Pre-tax profit 47.4 67.1 90.2 95.8 93.7 91.0

(*) adjusted to eliminate effect of an extra week's trading,

Source: Annual Reports.

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