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Searching for Dignity

Dignity is so deep in a mess largely of its own making that it will be a business-school case study for decades to come – how to wreck the perfect business model by remembering to be greedy but forgetting to be efficient.

And I barely exaggerate. The number-two provider of funerals in the UK with easy access to capital markets for expansion appeared to have it all – a market that could never disappear, where demand was assured and price elasticity was wonderfully stretchy.

Yet Dignity’s bosses stretched it too far. Throughout the 2010s, revenues and profits rose smoothly even as productivity – measured by funerals per outlet – faltered badly and Dignity’s furious acquisition strategy ushered in capable competitors to a market where the barriers to entry are almost as low as estate agency.

Maybe that didn’t seem to matter since buying a funeral is “the ultimate distress purchase, made infrequently by inexpert, emotionally vulnerable clients”, according to one funeral director. So if Dignity’s funerals per outlet kept falling, no problem – just crank up the price, the customers will be too upset to notice. Eventually, consumer watchdogs noticed for them and the phrase, “funeral poverty” entered the lexicon. That description seemed appropriate since the average cost of a funeral, including a cremation, was over £3,700 in 2018 and spend per funeral differed little between households whether rich or poor.

In response, enter the UK’s top competition watchdog, the Competition and Markets Authority (CMA), looking and acting like Dignity’s nemesis. However, rather than being the hound from hell, the competition regulator may end up being the group’s slobbering Labrador. As to why the CMA will be so friendly, it’s because, when it finally draws its investigation into the UK’s funerals market to a close, it may do what all regulators do – introduce more regulations. That would suit Dignity nicely.

“I share the board’s vision for stronger regulation of our industry in which high-quality providers like Dignity can thrive,” says the group’s new chairman, Clive Whiley. Of course he does. That would be an industry in which new players – often set up by experienced people that Dignity has bought out but lacking Dignity’s economies of scale – would struggle with the extra costs that more regulation brings.

It is possible we will get an idea of what a re-shaped UK funerals industry will look like later this summer. Whatever the outcome of the CMA’s investigation, Dignity will have its work cut out to get its financial act together.

Even before Covid-19 hammered this year’s revenue, Dignity was beginning to suffer from its own inefficiency. Its long-term strategy has been to grow by acquisitions; so much so that, for example, in the eight years 2012-19 it spent £237m on buying smaller funerals operators but only £170m on internal capital spending. Yet over that same period, the number of funerals it performed grew by only 1.3 per cent a year. Stinging customers compensated for this – revenue per funeral grew by 6.1 per cent a year. For the most part this generated enticingly fat margins – 30 per cent-plus in the years 2012 to 2017 and still 13.3 per cent in 2019. As further evidence of bloat in the group, central overheads grew by 11.6 per cent a year from 2012 to 2019 and finished sucking up approaching 10 per cent of the group’s £340m revenue.

That will have to change partly because, at least in the short term, Covid-19 is exacting a toll. Dignity performed 4 per cent more funerals in the first quarter of 2020 compared with a year earlier. Since then, revenue per funeral has plummeted and, in May, the figure was running at about £2,200 compared with £2,648 in the first quarter. Project that lower average over a year and – all else being equal – Dignity’s funerals side would make losses. Meanwhile, its smaller – though more profitable – crematoria operation (23 per cent of revenue but 41 per cent of profit in 2019) is also seeing lower-than-expected revenue.

Quite likely it won’t be that bad. Besides, in the longer term Dignity has a commanding presence in an industry that won’t go away. Yet it clearly needs to reshape its business model, which, presumably, is what its ‘Transformation Plan’ is all about. Do that and, as the table indicates, there may be lots of value on offer. The table’s figures are extracted from a simple model based on Dignity’s costs where all inputs stay the same except operating profit margins. They indicate the wonder – and the danger – of leverage. But Dignity can cut itself some slack by attacking those overheads and its interest costs – a £340m group running on operating profit margins of, say, 11 per cent or so can’t afford to pay £25m a year in interest. Do that and, even if Dignity does not find dignity, it will make its shareholders happy again.

Leverage on Dignity
Profit marginOp profit (£m)Per share value (p)
15%50.8766
12%40.7395
11%37.3272
10%33.9152
Source: S&P Capital IQ