A transitionary period for the leisure industry



After an undoubtedly eventful year in world politics, many of the sectors The MBS Group focuses on have entered a period of uncertainty – and the casual dining, QSR and hospitality industries are no exception. In fact, many would argue that the sector faces a perfect storm as it deals with unprecedented costs and Brexit ramifications.

Therefore, earlier in February, we brought together a group of industry-leading chief executives from the sector to debate the issues – including increasing regulatory costs and business rates, the introduction of the national living wage, the apprenticeship levy, pension auto-enrolment and, of course, the implications of Brexit.

CEOs Steve Richards (Casual Dining Group) and Robin Rowland (Yo! Sushi) led the discussion. They are both active members of the Association of Licensed Multiple Retailers (ALMR) – the largest representative body in UK hospitality, campaigning on behalf of pubs, bars and casual dining restaurants and encouraging the government to recognise the economic, social and charitable value the sector brings to communities and act upon it.

We were also extremely fortunate to have ALMR CEO Kate Nichols with us. With the ear of the politicians and tapped into the issues facing the sector, Kate kept us up to date with the most recent government and technical movements in the sector.

In this paper, we outline some of the key themes explored over the course of the discussion.

An active sector facing new challenges

In the economically buoyant, pre-2008 recessionary years, the hospitality sector enjoyed a growth-fuelled boom. With major expansion piquing investor interest, supported by a backdrop of a vibrant eating-out market, many strong players emerged, demonstrating the resilience of the sector. Eating and drinking out had become so deeply-rooted in the consumer that the negative effects of the recession failed to materialise, with growth in the sector going from strength to strength as consumers funnelled discretionary spend to the leisure sector over others, such as retail.

Economic recovery after the recession combined with strong cash generation and sensible asset disposals to help many operators address their balance sheets. In 2013-2015, M&A activity was at full tilt, giving rise to a burst of activity such as the break-up of Gondola, the transformation of Tragus to Casual Dining Group and the creation of The Azzurri Group. In the corporate world, notable deals included Greene King’s £774m acquisition of Spirit Group in 2015, and even Tesco’s foray into the sector through the acquisition of Giraffe Restaurants and Harris + Hoole coffee shops in 2013.

Retail had moved towards online and cleared space on the high street, enabling the impressive rollout programmes many groups enjoyed. Whilst larger groups were created, a new breed of small eating out companies surfaced to challenge the established giants. Following the rise of premiumisation and social media, and the emergence of a collaborative economy, nimble challenger brands took centre stage. Furthermore, the industry has seen a boost in leisure spending, thanks to those millennials (18-34 year olds) whose consumer confidence is now at a six-year high.

With the post-referendum and festive period trading remaining robust, predictions of sector-wide negative performance have not yet surfaced. However, as the effects of Brexit become more tangible for consumers, with inflation and business rates increases along with rising staffing costs, there are plenty of indications that this optimism is on the wane. As the sector faces new challenges and an uncertain economic environment, industry leaders need new thinking. They need to structure their businesses to be agile in constantly-shifting sands.

Mounting pressures and measures to deal with them

Although the UK’s colourful food and beverage scene contributes to 10% of overall GDP and one in eight of all new jobs, British hospitality groups are being squeezed like never before and the industry is not feeling supported. In the prevailing interlude leading up to the UK’s separation from the EU, hospitality businesses are coming together along with lobbying bodies to ensure that the sector is at the forefront of the government’s thinking. As the invocation of Article 50 draws closer, the window in which to lobby around new trade, tax and immigration policies post-Brexit is rapidly closing.

However, for many executives in the industry, Brexit is a red-herring. While it remains an unknown quantity – and a risk to future growth, particularly when considering the labour force – existing and imminent domestic policy changes are already having a deep impact on the sector.

Last year, the Valuation Office Agency published its drafted rating list, outlining the new Uniform Business Rates for England. Unlike other commercial property, it values pubs and restaurants based on a percentage of their turnover, meaning that trade achieved in the past two years will influence the new assessments. Properties with at least £100,000 rateable value could see liability increases this year of up to 45%, and this, along with increased rent costs due to strong competition in prime locations, is penalising successful employers.

Lobbying bodies such as the ALMR are making the case for a much more flexible, responsive system that accounts for the changing nature of hospitality businesses. This could take the form of an extension to the phasing-in period for business rates rises – similar to the National Living Wage delay, which saved the industry £1bn. Along with spiralling energy prices, national wage increases and a devaluation of sterling, once-healthy margins are being eroded, pushing executives’ backs against the wall and spooking investors.

Balancing cost increases whilst ensuring compliance on tronc arrangements and healthy eating guidelines is a continually tough act to juggle, especially when such headline-grabbing topics can sometimes lead to irreversible financial and reputational repercussions. The danger is greater for larger brands and chains, as smaller brands are favoured by politicians and the press and less susceptible to negative coverage.

One of the themes that emerged over the discussion was the potential for greater collaboration across the industry. How could established and smaller brands unite in a symbiotic relationship to create combined petitioning power?

Perhaps smaller brands, who have a more sympathetic ear, could help pave the way for constructive dialogue with the government and wider media, while larger companies can leverage the huge amounts of data they have access to in order to strengthen their argument. If shared in the right forums, this data and insight, which is consolidated and distributed by bodies such as the ALMR, may be invaluable to the smaller brands looking to grow whilst giving lobbying groups the crucial information needed to back up arguments with strong evidence.

Immigration and employment levels

As a critical issue for the sector, Ian Wright, Director General of the Food and Drink Federation, wrote an open letter to the government late last year advocating that the priorities of the hospitality sector should be at the heart of Brexit negotiations. Since the height of the recession, hospitality has created 50% of the new jobs in the UK, therefore making the sector a core part of our national infrastructure.

Employment across the board is at a record high, but 45% of hospitality staff are foreign nationals (with 24% of those coming from the EU), leaving the food industry scrambling for workers as the supply from the EU faces a very real ceiling. London is most dependent on non-British nationals, with 65% of the workforce made up of migrant labour, of which 46% come from the EU. One CEO at our breakfast stated that 70% of his workforce was from outside the UK – a figure that did not surprise others around the table.

Attracting transient EU workers who currently reside in the UK has been a key driver of the success and growth of the UK’s hospitality sector. The number of migrant workers in the sector increased by 22% between 2011 and 2015. According to the FT, as many as 94% of EU workers currently employed in hotels and restaurants would fail to meet existing visa requirements once new rules come into play in April, presenting a clear challenge to future growth potential.

If there is to be a shift from a migrant labour force to a domestic one, there will need to be a sizeable investment from both the hospitality industry and the government in skills and education. Making hospitality an attractive, long-term career choice for Brits is both costly and time-consuming, but must be a focus in order to limit skill shortages.

The substantial skills shortage in hospitality is well-documented and often discussed. Demand for talented chefs continues to outstrip the number of candidates seeking work as the industry grows and undergoes some fundamental structural shifts. The proliferation of casual dining forced pubs to innovate and create a competitive food offering, and since 2008, the number of chefs working in pubs has increased by 25%. With 42% of chefs in the UK being EU migrants, restricting free movement of labour will likely increase the gap in the market.

Where will the next cohort of hospitality workers come from? To sustain current growth, a predicted 220,000 further workers will be needed between now and 2020. Limitations on labour supply will drive up employment costs, threatening the sustainability of some businesses. According to the British Hospitality Association, for the industry to continue growing and contributing in the same way to the economy (not to mention our quality of life and wellbeing), the government should consider a ten-year timeline to reduce the number of EU migrants in order to ensure the industry is not forced off a cliff. Granting ‘godfather rights’ to EU nationals already working in the sector is essential to ease the transition.

For the sector to continue to thrive going forward, an open channel to the EU for workers coming into the sector may be required, making it easier to import both skilled and unskilled workers from outside the UK. Noting that the desire to reduce inbound immigration to the UK is one of the top priorities outlined in Theresa May’s recent white paper outlining the UK’s exit plans, how can a middle ground be achieved?

One solution could be to introduce a reduced VAT rate in restaurants, as seen in all but two European countries (Denmark and Slovakia). Could a marked increase in discretionary spending offset some of the costs caused by staffing shortages and increased rates?

Making the most of the cheap pound

A drop in sterling has seen the revival of the ‘staycation’ for Britons wishing to spend their disposable income at home. It has also led the increase in foreign visitors, with figures from the Tourism Alliance showing the number of foreign visitors to the UK jumped 18% in the month following the referendum when compared to the prior year.

Although Brexit has perhaps temporarily shifted global investor perspectives, there are still many positive signs. The devaluation of sterling presents a great opportunity for the UK to welcome an increasing number of tourists and foreign investors. Interest in the UK market from overseas buyers is increasing, and it now ranks third after the US and China for inward foreign direct investment.

Recent in-bound investment includes South African Famous Brands’ acquisition of Gourmet Burger Kitchen in late-2016 for £120m – with FX changes saving them £36m (a huge amount of money in rand terms). In London, Chinese investment in the city reached a record US$9.4bn in the 11 months to November 2016 – nearly double the amount invested for the same period in 2015, and included the Asian fund Junson Capital’s buyout of London Doubletree.

Strong leadership is more crucial than ever

The anxieties faced throughout the sector are triggering the need for two new types of leaders: the entrepreneurs who are inventing new formats and innovating in this highly-competitive battleground; and the experienced general managers who can lead their established companies through continued growth and profitability. Economic disorder, powerful innovation and intensifying consumer demand has meant that most smart leaders have come to accept this frenetic pace of disruption as the norm, and should remain alert and open to opportunity and revolution.

In an industry that has typically promoted operators from the ground up and struggled to hire from other sectors and backgrounds, we must question how these businesses will face the strategic challenges on the horizon. The hospitality industry has only just started to flirt with the possibilities of cross-fertilisation of executives from other sectors; for example, the recent hire of former Paddy Power chief executive, Andy McCue as new CEO of The Restaurant Group and Richard Hodgson, the former Morrison’s exec who now leads Pizza Express. Both will undoubtedly bring a fresh perspective to guiding their respective businesses through a new commercial landscape.

There is a clear advantage to applying lessons learnt from adjacent consumer industries that have also been forced to change. As the multichannel world developed, retailers were forced to switch direction and navigate through an unprecedented level of change, most notably on the technology front. Ultimately, those who survived were those who had faced these issues head on and acknowledged the transformational influence of tech and analytics on consumer insights. Furthermore, times like these require additional talent – at The MBS Group, we have seen a rise in new roles designed to tackle specific strategic questions. Recent examples include:

  • Pricing Directors to maximise revenue creation opportunities
  • Directors of Food & Beverage to reduce cost of raw ingredients and preparation time
  • Productivity Directors to mitigate against increased labour costs
  • Transformation Directors to lead a programme of overall efficiency
  • A new breed of Property Director, better equipped to address the property challenges of the sector

Looking forward

It is clear that the hospitality industry needs and deserves the support of government in both economic and policy terms. As the final shape of Brexit becomes clearer, a change agenda is on the menu, and the opportunity is one to embrace, harness and evolve, or at least use as an excuse to get creative. Once independent of the EU, UK hospitality must stand more united and outward-looking than ever before, and come together with a clear voice to make the strongest possible case for the sector.

While the negotiating priorities for the UK’s future relationship with the EU are beginning to crystallise, it is imperative that the strategic importance of food and drink to our nation’s economic and physical wellbeing is recognised and its future secured. As it stands, the increase in regulatory costs is changing the game for operators and is terrifying investors, and the government needs to ensure that the UK is, and is perceived to be, open for business for visitors, hospitality and tourism.

We have yet to grasp the potential ramifications of our EU exit package, but the need for change and restructuring can bring new business and financial opportunities. As the world continues to evolve, business as usual is not an option.

Your feedback is welcome – please email sophia.witherington@thembsgroup.co.uk