The trouble with co-ops

Co-ops have been hailed as a model for a fairer capitalism. But they remain unpopular for a reason, says Matthew Lynn.

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Over the last decade, John Lewis Partnership has been the poster child for worker-owned businesses. It is one of the most popular chains in the country and has expanded both its department stores and its Waitrose supermarkets rapidly, while paying bonuses to staff and keeping its customers happy. If motherhood and apple pie went into business it would do so under the John Lewis brand.

The engine stalls

Right now, however, its engine has stalled. Last week, the chain announced that profits for the first half of this year would drop to "close to zero", compared with £26m in the first half of last year. The bonus would be cut, and a few Waitrose stores would close. It is the most significant setback the chain has faced in years.

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Until this month, John Lewis seemed able to rise effortlessly above the existential crisis that has gripped every other major retailer over the last few years. From its origins as a drapery shop on Oxford Street in the 1860s, it remained primarily a London-based business for much of its history. But in the last 20 years it has pushed relentlessly into new markets, opening 50 shops across the country. Its Waitrose unit has expanded even more aggressively and now has 350 supermarkets.

While just about every other retailer has had to cut back and retrench in the face of rising staff costs, punishing business rates, tepid consumer spending and ferocious competition from the internet, John Lewis seemed able to expand with ease. There was certainly an argument that its co-operative ownership model gave it a competitive edge. The trouble is, that may no longer be true. In fact, the collapse in its profits is about to expose the flaws in the model.

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Three challenges for co-ops

There are three big problems that all co-ops or worker-owned businesses face. First, there is no real discipline. It is easy for firms to overexpand and for costs to run out of control. Indeed, that may well be the problem at John Lewis. It kept on opening new stores and revamping old ones even when it was clear that retailing was in decline, and every other department store and supermarket was cutting back on space and retrenching. A limited company might have been a lot more worried about the potential impact on the bottom line, and started trimming the portfolio earlier.

Next, there is no takeover mechanism. If the management starts making the wrong decisions, then it is very difficult to change them. There are no shareholders to put pressure on the board, and there can't be a hostile bid, which is usually the ultimate sanctions for a quoted company. True, the staff can vote the board out of office, so long as a mechanism is in place for doing that. In reality, however, that is hard to do. Who is ever going to want to be the staffer who tries to oust the boss?

Finally, there is the risk that the company ends up being run for the benefit of the staff rather than the customers. Opening hours are limited, prices edge up, and holidays and benefits become more generous. There is no real pressure to perform, and not much incentive to work harder. Of course, partnerships have tremendous loyalty, and that can be a positive, especially in a relatively small business. But once it gets above a certain size, it can just as easily become an excuse for complacency.

For all their supposed virtues, co-ops remain only a tiny part of every major free-market economy. If they were as great as they are sometimes cracked up to be, there would be a lot more of them out there. Most very quickly fall victim to over-expansion, poor management, and staff indifference, and often all three at the same time. John Lewis may be about to teach us that although it can work for a while, ultimately the partnership model is even more flawed than the limited company.

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