Controlling Your Destiny

If differentiation is the secret sauce for successful retailers and brands, company culture is the behind-the-scenes bread and butter.

It's also a factor in the long-term success of privately held companies, experts suggest.

Rallying troops to keep up the fight against an onslaught of new competitors comes down to leadership and the strength of the company's raison d'être.

The leaders of successful privately held companies know control and the freedom it provides is what success looks like. It allows their companies to innovate, to respond to customers, and to reward employees and suppliers for their loyalty as they see fit, and not as shareholders demand.

"Private companies have capital constraints that may or may not be present, but you control your ability to press the gas as you see fit," says Tim Hughes, president and CEO of Falcon Realty Advisors in Dallas. "You can move very quickly or very slowly."

Without a requirement to disclose their financial results or risk factors, private companies can keep their growth strategies close to the vest, which can be an advantage, says Jennifer Di Giovanni, partner at BDO. Being privately held can allow for a greater willingness to try new approaches without concern about being held accountable by shareholders if the experiment flops. Private owners often are more patient about the return on their investment, resulting in a longer-term strategy with an emphasis on customer service and workplace best practices.

"I think a lot of people believe if you've made it in business, you've taken your company to the public market. In reality, there's a lot more regulation, it's a lot more costly, and a lot of times when companies go public, they go private again," Di Giovanni says.

MICROSCOPIC MARGINS

Yet maintaining control and market share in a slow growing economic climate requires exceptional management expertise. Grocery margins can be microscopic, and retailers might be here today and gone tomorrow as new entrants threaten an established player's turf. The longer a privately held company remains in business, the less likely its original leadership and vision will be cutting-edge.

Navigating a company's future growth often requires an ironclad succession plan and a willingness to seek assistance outside the family or the founders' inner circle. At the same time, the company's identity and core values can dissipate if it goes public or takes on a private equity partner, and the founder's stake and passion are diluted.

Often, the trouble begins when the third generation of a family-owned business doesn't want to be in the business, says David Marcotte, senior vice president for retail insights at Kantar Retail. The first generation, and sometimes the second, tend to be risk-takers who get the company up and running and then seek ways to keep it growing.

"Risk is seen as part of the business," Marcotte says. But for the third and fourth generations in many family-owned businesses, taking risks becomes more difficult, and family friction often increases.

Without an obligation to report financial results to the masses, a private company has more breathing room than a public firm in it how operates, and it isn't obligated to answer its critics. "A private company is evaluated closer to an overall strategy, where a company is trying to go versus where shareholders want it to go. That's a key difference," Marcotte says.

OVERSIGHT LACKING?

But the lack of oversight also can lead to management issues, and in some cases the decline of the company. Bickering among family owners can distract a company's management, and frequently leads to a sale of all or part of the business, experts say. Cashing out a family member can result in more debt on the books, says Mickey Chadha, vice president, senior credit officer at Moody's Investor Service in New York.

In an industry where margins are slim, the new leverage can affect the company's ability to compete as the market shifts. But overall, Moody's is forecasting 10 percent annual growth in operating profit for supermarkets in 2016 and 6 percent growth in 2017, making the sector a relative bright spot in the retail industry.

To remain competitive in the grocery industry requires continual reinvestments of capital. "If you don't drive a good consumer experience and let your stores slip, your business is going to go away," says Jim Holbrook, CEO of Daymon Worldwide.

"[Many] private companies don't have the capital to withstand a highly promotional marketplace," Chadha says. "The health of the balance sheet becomes all the more important." At Tops Holding II Corp., parent of Tops Market, a highly leveraged balance sheet resulted in a B3 Corporate Family Rating for the company from Moody's in May, despite the company's overall positive performance. "Debt is a pressing theme. They need to make certain interest payments," Chadha says.

The Fresh Market, which was public until it agreed to $1.36 billion buyout from Apollo Global Management in March, offers a case study in a "build it and they will come strategy" that was effective while the company enjoyed its early-mover advantage. The small-format concept was ahead of its time, and its differentiated products provided excitement to consumers tired of the mass-market brands at conventional supermarkets and mass discounters. But its smaller size also provided less of a barrier to copycats, and little defense against the growth of Whole Foods Market, Sprouts, and the myriad independent farmers-market type retailers.

PRIVATELY REFOCUSING

Returning to a private capital structure, often with a private equity partner, can allow a company time to refocus. "It gives them an ability to call a time out and come back out with an incredible story," Hughes says. "Some companies get beat up" in the public equities market, he adds, where a one- or two-percentage-point decline in same-store sales can be enough to rattle investors.

Returning to a private capital structure, restructuring to an ESOP, or just seeking outside advice also comes with costs. It's incumbent on the owners of a private retailer to understand the cost of private equity investors, in board seats and covenants they might require, says Thomas Sullivan Jr., partner in PwC's Private Company Services.

The Fresh Market's third-quarter results included $1.7 million in professional services and leadership change-related costs, which were partly offset by lower incentive compensation expenses. At that time, CEO Rick Anicetti announced a new goal of luring consumers to the stores 2.5 times a week, compared with the 1.5 times a month the company was then experiencing. The Fresh Market also would reinvest in improved pricing, service, merchandising and marketing, while also doing a better job of telling its story, which had become lost in the noise of the marketplace, Anicetti said.

"We need to differentiate differently on service. We need to differentiate and continue of growing the ambience and experience within our store. We need to be able to tell the story of why our products are so unique and different. But it is about creating both frequency of shop and the basket size of that shop," said Anicetti, who was named CEO in September 2015.

TOUGH TURNAROUND

It's a tall order. The Fresh Market's turnaround will be tough and take at least 18 to 24 months to accomplish, Moody's says, but the retailer's focus on a suburban, health-conscious demographic bodes well for its long-term success. It has less than a 2 percent share of the thriving organic, natural and specialty food retail category.

Adding more private-label products, which now represent less than 10 percent of its sales, could propel margins. Moody's expects The Fresh Market will generate an operating margin of 5.0 percent to 5.5 percent in 2016, compared with 3.5 percent to 6.5 percent for similar players. But perhaps most important, the company needs to re-create its identity through stronger messaging, Moody's says.

Overall, large privately held companies with more than $500 million in annual sales outperformed their publicly traded counterparts every year over a five year period from April 2011 to April 2015. They achieved an average net profit margin of 10 percent for the 12 months ended April 27, 2015, compared with 8 percent for public companies, according to research from Sageworks. Private companies' sales grew 12 percent in the same period, compared with 8 percent for public companies. But percentage gains can be easier to attain for smaller companies because they are starting from smaller figures, and they often have less overhead, Sageworks said.

H-E-B GOES ESOP

Another advantage of being private involves ownership structures, such as employee stock ownership plans. San Antonio, Texas-based H-E-B announced an employee ownership plan in 2015, with 55,000 eligible employee partners receiving stock grants in January 2016 valued at 3 percent of their salary plus $100 in stock value for each year of company service completed through the end of 2015.

"That's been met with great receptivity by the H-E-B employees," says Holbrook of Daymon Worldwide, which also is an employee-owned company. "There's probably some competitive advantage when employees have ownership. You would think they'd be more motivated."

Private vs. Public: A sales and profit comparison

Source: Sageworks. Private company data was sourced from Sageworks' proprietary database of privately held company financial statements. Large companies defined as those with annual sales of more than $500 million. Public company information provided by Mergent.

Privately held companies, whether owned by a small group of principals or by employees, often have a stronger identity than public corporations and a more pronounced culture.

Venture-backed BrightFarms' mission of improving the food system guides its operations. It intends to change the way retailers source locally grown produce by constructing local greenhouses to produce a custom assortment of produce for a particular supermarket.

With most major retailers centralized, CEO Paul Lightfoot doubts a major retailer would have attempted to produce locally grown vegetables. "We're going to reverse economies of scale. That's not something for a big organization to do," he says.

By taking on venture partners, Lightfoot is reporting the company's financial performance to his investors quarterly like a public company might. "The pressure is no less strong," he says, though his sights day-to-day are on pleasing customers instead of meeting guidance.

Lightfoot's long-term goal is to improve the food system. "How we finance it is how we finance it," he says. "I like options. It could be a great outcome someday to be a public company."

While consolidation is certain to continue, Holbrook and others forecast increased interest in private equity partnerships. IPOs are not as attractive as they used to be, he says, perhaps because of the regulations and concern about shareholder scrutiny.

"It seems like today, with no growth, the cool thing is to be privately held with private equity, and scale up," Holbrook says. "It's very tough in the grocery industry to survive and thrive."