Has it really changed?
In March 2014, we published an article about the beleaguered UK Co-operative Group. This organisation, founded in 1844, had been brought to its knees by the near collapse of its banking division following ten years of rapid expansion. In August 2018, the relatively new CEO set out his goals in a interview with the Financial Times. Here we examine the approach he is taking to rebuild the fortunes of the Co-operative Group and ask whether his approach to corporate governance is holistic, and whether his goals are realistic.
A short history
Briefly, the co-operative had been established in Rochdale in northern England as a relationship between a group of poor but respectable citizens and a shop which undertook to supply goods of reliable quality at fair prices. In return for their flat-rate membership fee of £1, the members of this co-operative society would receive a “dividend” relating to the value of purchases they made from the shop. This wasn’t the first co-operative, but it was the most successful, and it spawned several related service functions which also operated as co-operatives, most notably purchasing, farming, insurance, banking, funerals and pharmaceuticals. The most important of these, purchasing, grew until by the 1920s, as the Co-operative Wholesale Society (CWS), it was one of the biggest organisations in the country.
Note that the original purpose was not “do-gooding” but ethical trading. And the purpose, or goal, was to provide decent quality food and other goods at a reasonable price for the members of this consumer co-operative society. It is also worth noting that around the time of our last article, the Rochdale Observer printed an article from its edition of 100 years previously about a meeting of the Cooperative Men’s’ Guild. At this meeting, apparently, one speaker said the Co-operative movement (it was always known as the Movement) “laid too much emphasis on ideal” and urged recruitment of the “best brains in business” to drive the movement forward. Perhaps as a result of these pressures, in the 1920s, a new retail society was formed, the Co-operative Retail Society (CRS), to embrace the best practice in retail, and the CRS itself grew until it became the largest of the retail co-operative societies.
Sadly, a strength of the co-operative movement – its widely spread, large number of locally trusted societies, supported and serviced by big societies comprising organisations providing key services, fostering great loyalty among its members – also contained the seeds for growing obsolescence and stultification. The problem lay in its governance.
The voting structure allowed one vote per member, which sounds fine, except that what evolved was a pyramiding of control in which meetings of local societies voted to elect the members of their governing body. Since only a minority of members bothered to attend these meetings, the controlling bodies became progressively dominated by the “activists”. This situation was compounded by the growth in the size of the societies and amalgamation between societies which resulted in the growth of tiers: local, regional, national.
Two things made this structure dangerous. Firstly, as the societies had grown, it became necessary to employ professional managers, but the stress on membership control meant that the boards of directors consisted of “amateurs”, activists drawn from the membership, often with little business experience. Secondly, the Movement sponsored its own members of Parliament, and had a close association with the Labour Party, having participated in its creation. Hence the board members tended to have an approach to business which reflected that of the Labour Party, which was inherently suspicious of business.
These governance problems became progressively more complex as the twentieth century progressed and weaker societies were taken over by stronger ones, all the time without central control of the whole co-operative movement. The acquiring societies then had both direct members and society members, each being controlled in turn by its own direct members. Moreover, the CWS found itself rescuing societies and thus became a significant retailer as well as the major wholesaler to the movement.
The consequence was that, despite being the first into self-service supermarkets, and having giant purchasing power, the Movement as a whole was unable to keep pace with the changes in society resulting from the expansion of the welfare state (reducing the dependence on and hence loyalty to the Movement) and the growth in the new supermarkets led by Sainsbury’s and Tesco.
A disastrous dash for growth
By the late 1990s CWS was trying to achieve scale and power by taking over CRS, which it ultimately did in 1999. From then on, the executive leadership of CWS, with the support of its amateur “co-operator” directors, went on a growth spree, acquiring the Somerfield supermarket chain and building its financial services business by merging its bank with the Britannia Building Society to create what it called a “super mutual”. By then, its amateur directors were being paid quite significant directors’ fees, not out of line with those paid in listed companies, despite being, well, amateurs.
However, not only had the governance problem not gone away, in terms of the executive not being held to account by a board of suitably experienced directors, but two other issues loomed large and rapidly brought progress to a halt. The first problem was that the management issues arising from the need to absorb major new businesses stretched the existing team well beyond their ability to cope. And the second problem was that the group simply didn’t have adequate financial resources to take the necessary actions to achieve long term success. Somerfield was a tired chain of second rate supermarkets and needed major investment, which wasn’t available, but the killer was the bank, which progressively revealed huge write downs in their commercial loan portfolio.
At the time of writing our last article, the Co-operative Group had lost its recently appointed chief executive who resigned suddenly after his salary was leaked by a board member angry about his recovery plans. And Lord Myners, a Labour peer, was about to present his controversial report recommending major changes to the constitution which would put the Executive in charge, create a majority of non-executive directors on the board and eliminate the tiered membership voting structure.
Not long after our article, Lord Myners in turn decided to resign and another board member, incensed by his confidential report, triumphantly leaked the fact that they had forced him out.
Away from the brink
The subsequent history is of the reluctant adoption of Lord Myners’ report by the membership over strong opposition from one of the big societies, and the recapitalising of the bank, resulting in the Co-operative Group progressively losing control and then selling its stake completely. In the process, to pay off its debt obligations, the Co-operative Group had to sell its farms and its chemist chain. Its chief executive during this time presided over the stabilisation of the Group, outlining his three phase programme: rescue, renewal, rebuild. He handed over to his successor in late 2017 indicating that the Group was now entering the third phase.
So what is the Group’s strategy? Well, Steve Murrells, the new CEO, talks about helping the health of local communities and reinvesting in local causes. He refers proudly to its high ethical standards, mentioning Fair Trade and cutting use of plastics, and says the younger generation love the co-op model and are sceptical of public companies. He has also invested in education, through an Academies programme, and is exploring going into healthcare. He doesn’t mention the other existing services, insurance and funerals, but these, like the banking, chemists and farms which had to be abandoned, were originally designed and introduced in a different era. The only one which has any claim to be a market leader is funerals. All the other are in markets dominated by much larger players.
So his declared approach is to build a convenience chain, while spending scarce resources on “good works” which foster the ethical differentiation of the Group.
Steve Murrells, was interviewed by the Financial Times in August 2018, and we thought it would be interesting to see how his assessment of the Co-operative Group’s situation compared with our own assessment, based to an extent on our earlier personal knowledge of the Co-operative Movement and of some of the people involved.
Taking our holistic approach to corporate governance, we look at the key stakeholders and the topics which they should be considering. Then we look at how the Group’s current approach matches up to the expectations of these major stakeholders under the key topic headings. Note, this is not about compliance with corporate governance codes per se, though it assumes compliance. We remember that the whole purpose of our holistic approach to corporate governance is to arrive at, or to confirm, a realistic goal for the business which all the key stakeholders have signed up to.
How do we assess the new strategy?
The three questions to be asked about Steve Murrells’ strategy are:
- Is that what his stakeholders want, and is this a realistic goal?
- Does his strategy provide the means of achieving the goal?
- Do they have the people and financial resources to achieve it?
If the answers to all three question are not YES, then the Co-operative Group is doomed to a slow demise. Sadly, these are the same questions that we asked four years ago.
For the purposes of this article, regarding stakeholders, we will limit ourselves to considering the customers, members and employees. And regarding topics, we will consider the ethical reputation, the goods and services provided in the business model, and the adequacy of the organisational resources. So the first thing to note is that, as a consumer co-operative, the customers and members should be one and the same. And there will undoubtedly be encouragement for employees to be members too. Thus all the interests should be aligned regarding the retail services provided by the Group to its three key stakeholder groups.
However, if we consider the Group as a co-operative, whose competitive advantage is the fact that it is a co-operative, and one professing to operate ethically on behalf of its members, how powerfully does that stack up as a competitive advantage?
Our research showed that, all things being equal, people will shop at the nearest supermarket which provides all the things that they regularly buy. Traditionally, the major shop is supplemented by top-up shops, and though that model is being called into question, both by the growth of internet shopping and local convenience stores, this is still largely the case. In any event, quality expectations are so high nowadays that the original raison d’être of the Rochdale Pioneers is now irrelevant. Similarly, the superior buying power of the major supermarkets eliminates any possibility of the Co-operative Group using pricing strategy as a competitive weapon unless it is prepared to cut prices to a level which would do major damage to what are already very small margins.
So if the Group doesn’t provide more or less everything that its competitors provide, it will ultimately go out of business. But in this industry, scale is everything in terms of buying power, and as we have argued before, the size of the Co-operative Group leaves it at a relative disadvantage compared with its bigger competitors. Moreover, by discarding a number of its bigger stores to allow it to focus on convenience stores, it is losing scale and has now been overtaken by newcomer to the UK market, Aldi. The focus on convenience stores is natural, given Steve Murrells’ earlier background running Tesco’s own chain of convenience stores, but it doesn’t address the volume problem.
And there is always the threat of online shopping, hybrid models such as “click and collect” or “clicks meet bricks” and the move by online retailers to use their technology and efficient systems to transform the physical shopping experience. It must only a be matter of time before the UK market is disrupted by the likes of Amazon with their cashier-less convenience stores or China’s Alibaba (who have spent more than $8bn in 2 years on bricks and mortar investments) with their hi-tech, smart-phone oriented Hema supermarkets.
Conventionally, in any particular market, there will be a few dominant players, with a cost leader and the other major participants differentiating themselves in some way. Below that level, life will be very difficult and only survivable as specialist niche players. So, as number six in the UK, logically the Co-operative Group is going to be squeezed mercilessly by the much bigger Sainsbury/ASDA and Tesco, and mortally threatened by low price competitors Aldi and Lidl. And they are addressing precisely the Co-operative Group’s target market of the more price conscious and less well-off.
Our assessment of the stakeholder customers/members’ objectives in shopping at the Co-op is that they are looking for a slight price advantage over what they would otherwise buy at Tesco, and the related activities are no compelling reason for the majority to shop at the Co-op. The ethical aspect is commendable, but the recent history of the Group has tarnished that image and, anyway, it really isn’t much of a competitive defence against the Aldis of this world, whom no-one has yet accused of being unethical.
So a strategy which results in reduced volume and gets the Group into unfamiliar territories like education, is only going to hurt profits and distract management, without fulfilling the goals of stakeholders.
Is this good governance?
Considering our three questions:
To the question, are convenience stores what the Co-operative Group’s customer/members want, the answer would seem to be YES, but not to the exclusion of most of their other shopping. This would seem to call into question the whole consumer co-operative model, and leave the Co-operative Group looking like just another retailer.
If the Co-operative Group is just another retailer, and the ethical dimension is a fairly weak source of competitive advantage, the size disadvantage will be an overwhelming long-term problem. Hence the strategy of building the biggest chain of convenience stores is not sustainable.
Are the resources adequate?
Retrenching from the biggest stores to focus on smaller stores may release management resources, or it may generate a problem of insufficient management experienced in this field. But regarding financial resources, the old problem of co-operatives not being able to raise share capital and hence being dependent on bank finance remains.
Steve Murrells’ predecessor’s philosophy in 2016 was: do the right thing by getting into markets which are not working, like childcare, energy, mobile phones, elderly care – creating platforms for people to cooperate. But spending scarce resource on “ethical” diversions is not the answer. If the Co-operative Group wants to go back to its roots it should provide something that the people they are targeting need but can’t get, and that’s no longer simply good quality food at affordable prices.
So, despite the success of Lord Myners in changing the constitution and achieving a more professional board, sadly, we remain convinced that the steady decline of the last seventy years is not going to be halted, let alone reversed. A cynical conclusion is that Steve Murrell is driving this strategy forward because it’s what he knows. And for all the emphasis on ethics, this is not holistic good corporate governance.