Complexity will strain warm and cuddly business model

[TrueBlueTerrier]

http://www.ft.com/cms/s/0/8da34f24-e50d ... abdc0.html" onclick="window.open(this.href);return false;

In recent weeks, members of the government have talked a good deal about the John Lewis model. It is to be applied, they say, to Royal Mail on privatisation, and even to some Whitehall departments.

I should explain for non-UK readers that John Lewis is the favourite department store chain of the British middle classes. It is also a large and flourishing workers’ co-operative, in which the employees own all the assets and enjoy all the proceeds.

Needless to say, the government has no such intentions in reality. All it has in mind is the more conventional model employed – for instance – in stockbroking, whereby the controlling shareholder hands out stock to employees as incentives.

Using the stockbroker comparison would not be a great selling point right now. So instead, the John Lewis name is invoked for its warm and cuddly associations.

John Lewis’s ultimate purpose, says its constitution, is “the happiness of all its members, through their worthwhile and satisfying employment in a successful business”. In this model, people come first – indeed, labour has explicit primacy over capital.

This might seem a very attractive and promising way to run a business. But John Lewis is one of relatively few co-operatives to have achieved durable success. Plainly, this stuff is harder than it looks.

Why? One reason is complexity. In conventional corporations, capital takes primacy over labour. The company’s main purpose is to maximise the return to its owners. That sounds rather bleak, but it has the virtue of being both simple and reproducible.

Many co-operatives, by contrast, end up squabbling over the rules. The workers may distrust the bosses, and the bosses may be reluctant to loosen their grip on power.

We should note that when Spedan Lewis turned his family company over to the workers, he was careful to do it in two stages. Profits were shared with employees from 1929, but outright ownership was not transferred until 1950.

Second, the model puts a considerable strain on human nature. It is worth comparing John Lewis here with its nearest quoted competitor, Marks and Spencer.

Over the past five years John Lewis has produced rather faster sales growth than M&S and much better growth in earnings. The base salary of the directors, meanwhile, is roughly comparable.

But the John Lewis directors get the same annual bonus as everyone else – 15 per cent last year. The M&S executive directors got 100 per cent on average last year, with share options on top.

Third, the model is inflexible in terms of capital. Take the case of Baxi, a UK maker of domestic boilers that was handed to its workers for a nominal sum by the controlling family in 1983.

By the 1990s the European market for domestic heating was consolidating and Baxi was exposed. So in 1999 it took the fatal step of paying £480m cash for a rival, Potterton. Crippled by debt, it collapsed very quickly into the arms of private equity.

This kind of business risk, of course, is precisely what equity capital is for. But company employees generally do not have personal savings equal to the task. And if outside capital is called in, the co-operative principle is at once compromised.

It should be noted that ambitious claims are made for companies which, while quoted, have some employee share ownership. That is rather a different thing. And while some such companies may outperform, let us recall that Lehman and Bear Stearns had very high levels of employee ownership when they blew up.

One further argument advanced for the co-operative is that since it is not burdened with outside capital, it has a competitive edge in its pricing. A good test of that is the grand original of the movement, and another retailer – the UK’s Co-operative Group.

In 1913 the US jurist Louis Brandeis wrote of this organisation in glowing terms. Its revenues of $150m – £31m at the then exchange rate – was greater, he remarked, than all but a very few US industrial corporations.

As a share of UK domestic product, £31m then equals £17.9bn today. Last year the Co-operative Group, despite enjoying a renaissance of late, had revenues of just £12.5bn.

Six years after Brandeis wrote, an eastern European immigrant named Jack Cohen set up a grocery stall in London’s East End. The resulting quoted company, Tesco, built its reputation on low prices. Its sales last year were £56.9bn.

It is not necessarily contrary to the spirit of capitalism to say that if there were more companies like John Lewis, the world would be a better place. If only it were that easy.