Business Stripped Bare

We are now a ‘branded venture capital’ company, and — given the importance of the word ‘brand’ in that definition — I think now is a good moment to say something about how we arrived at this way of doing things.

In 1989, I asked Will Whitehorn, our former director of communications (now head of Virgin Galactic), to take a look at how companies similar to ours operated. We began to look at different types of business organisation, to see what suited a company such as Virgin. Will’s report crystallised our options very neatly, identifying three models of corporate governance we should study further.

America was home to the equity investment option. Big equity investors like Berkshire Hathaway (owned by Warren Buffett, the world’s richest man), Blackstone and the Texas Pacific Group took a large share of traditional businesses that had good cash flows, and this proved to be an excellent way of making money for investors, including mutual funds and pensions. The Texas Pacific Group, for example, had stakes in Continental Airlines, Burger King, MGM and the Carlyle Group, one of the world’s leading private equity groups.

As a sure-fire way of turning a healthy profit, the equity investment option left us curiously unmoved. It certainly didn’t sit easily with the energetic Virgin brand. These groups tend to sit back and simply provide capital. That’s not the Virgin way of doing things. We like to get our hands dirty. There were aspects of its organisation that we liked — it could respond quickly to changes in the market, and bail itself out of trouble fast. But it seemed a bit anonymous for our taste, and altogether too concerned for its own well-being.

The second business model Will identified came from South Korea. There, big business is conducted through ‘chaebols’, which are chiefly responsible for the nation’s remarkable economic progress. The chaebol is usually controlled by a founding family, and its ownership is centralised. It is, at its heart, an old-fashioned family business — probably a manufacturing company — with subsidiary companies providing it with components. Companies such as Samsung, Hyundai and LG operate a range of businesses, from computer-chip manufacture to laptops, phones, PCs and motor cars. This makes the chaebol powerful in certain key industries — computers in particular. However, we saw that its ‘family’ structure made it difficult for it to raise vital funds at short notice. These companies tended to look after their own; and capital didn’t flow so easily between them (an image with which we are all painfully familiar, as we cope with the 2008 global ‘credit crunch’).

Will’s third business model came from Japan. I have admired the Japanese technological revolution ever since I was running Virgin Records shops. In 1971, Japan was one of the first countries we exported records to, and I went out and launched a joint venture business there. Our Virgin Megastores were first into computer games and consoles with SEGA Nintendo, Atari and Sony PlayStation, all keen supporters of Virgin. And what I learned about the Japanese way of doing business has had a strong impact on us.

Before the Second World War, Japan was controlled by a few major conglomerates under the system of zaibatsu. The zaibatsu were disbanded by the Allies because they wielded excessive political power, and their machine tools for making armaments and munitions were converted to the manufacture of items such as sewing machines, cameras and motorbikes. From these ploughshared industries, and excellent loans from Japanese banks, the keiretsu emerged, and they have since taken world leadership positions in a surprising number of industries.

In 1984, in a Fortune listing of the largest 500 non-US industrial corporations, 146 were Japanese. Twenty-eight of the 100 largest commercial banks outside of the US were Japanese — with Japanese banks filling the top four spots. Toyota and Nissan became the third and fourth largest car manufacturers behind General Motors and Ford. Nippon Steel was larger than US Steel. Hitachi and Mitsushita Electric were second and third behind General Electric, and bigger than Philips and Siemens.

When I started in business there were around half a dozen major keiretsu in Japan, and I have had business dealings with almost all of them in some way over the last thirty-five years. Where chaebols have a centralised ownership, keiretsu are held together by cross-shareholdings, and governed by a strong group of professional managers. So, for example, we have a company like Mitsubishi, set up around the Mitsubishi Bank, and working in a host of industries from cars through to brewing, oil, real estate and heavy industry. All of its companies are woven together, yet each is self- contained.

I liked the fact that the keiretsu employed a lot of different corporate structures. Indeed, both chaebols and keiretsu were tempting models to adopt — were it not for the fact that they were so impossibly complicated for us to implement. On the one hand it was hard to see how Virgin could behave as a chaebol-like extended family network, given — well — we weren’t really a family. As people, we certainly tried to behave well and responsibly to each other, but past that point the family metaphor began to break down. It suited neither our flexible way of working, nor the freedom each company enjoyed to pursue its own projects, nor the dizzying rate at which our top people joined, left, rang us up, worked with us again for a bit, vanished again, rang us up…

Keiretsu presented us with a different problem. All these cross-shareholdings meant that everyone was working out of each other’s back pockets, whether they wanted to or not. It meant we couldn’t shed businesses without a lot of pain and, by the same token, our businesses couldn’t build up their own head of steam without a lot of interference. Turn us into a keiretsu, and I could imagine all 300 companies in the group advising and cautioning each other to death. We’d disappear up our own internal politics in seconds.

We wanted to do something that was like a hands-off keiretsu — something with venture capital corporate governance. This is where the American private equity model came in. We realised that, rather than tie ourselves in knots with cross-shareholdings like a keiretsu, we could emulate the best of American private equity companies, investing in all our companies like classic Western venture capitalists.

So we were back to the venture capital model again.

For a little while there, it felt as though we were going round in circles — but then it began to dawn on us. What would separate us from all the other venture capitalists and private equity houses out there? Our brand. Our worldwide brand name both advantaged our businesses, and bound them together. The solution had been staring us in the face all the time. Indeed, it was already in place and working well. We didn’t need cross-holdings, or strong family structures: we had a flag.

The bonding power of the Virgin brand has permitted us to take the bold decision to give everyone the opportunity to be entrepreneurs in their own right. It is a flag to which all members of our extended family pay due respect. They enjoy the advantages of doing business under the Virgin umbrella, and in return they agree to protect the integrity of the brand. If they don’t, then we can legally withdraw the name. Everybody fights for their own particular Virgin company — and shares in the upside when things go well.

The story of Virgin Active’s growth is, in many ways, one of the best examples of Virgin’s branded venture capitalism at work.

In 1997, I was approached by Frank Reed and Matthew Bucknall with an idea to set up Virgin health clubs. The pair had just sold their company, LivingWell, to Hilton hotels and they wanted to have another crack at building a health club business with a difference. They felt that together with Virgin they could bring a sense of fun, value for money and quality to a market that was disappointing the customer.

Some of the existing UK health clubs were a little tired, the membership fees too restrictive and the service unfriendly. In a way it was not so dissimilar to the airline industry that we had launched against in 1984.

Frank and Matthew spent two years researching and developing a Virgin product that would stand out from the crowd. The market seemed overcrowded to many and Virgin Active (as the business was called) would have to pass the test with our team.

To their credit they managed it — the large family-friendly clubs hit the spot. In August 1999 we opened the first one in Preston. It was much bigger than the average UK health club and had that sense of fun and value for money which is core to so much of what we do.

The combination of strong and independent management, the brand, great delivery and ambitious staff has been a real recipe for success. In an industry which has had its difficulties, we have continued to grow both in the UK and internationally.

Our big break, for example, was the acquisition of South Africa’s Health and Racquet chain, which catapulted the business from a small UK operator to the leading player in South Africa.

Many of our successful businesses have been built from the ground up — employing new people rather than