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Operating the Co-op

The Strategist suggests alternative ways to save the Co-op

 

Lord Myners’ damning report into the Co-operative Group’s failures contains sound strategic logic, but omits some key elements: its happy customers. Chris Middleton and Stuart Lauchlan report.

LEADERSHIPStories of drug-taking ‘crystal Methodist’ Paul Flowers, former chair of the Co-operative Bank, may have grabbed the tabloid headlines, but the real cause of the Co-operative Group’s near collapse was a board of dyed-in-the-wool traditionalists, some of whom didn’t know the difference between debit and credit.

That was the scathing conclusion from former Labour City minister, Lord Myners, whose 186-page report into the Co-op’s problems called for a radical change of strategic direction.

The imperative for strategic change was clear from figures published in the report: 150 years of the Co-op’s accumulated net worth – as much as £3.5 billion – was wiped out in a little over four years, because of what Myners called “deplorable governance failures”. These left the group with debts that accumulate £100 million in annual interest payments, according to CEO Richard Pennycook.

On 17 May, eligible Co-op members voted unanimously to accept Myners’ recommendation to reform the group’s governance structure by appointing an independent Chair, six or seven non-executive directors and two executives, all drawn from professional backgrounds.

But are all of Myners’ remedies the right ones and is the group abandoning the co-operative spirit that served the organisation well for a century and a half? On the day of the vote, one member was reported in The Guardian as suggesting that there would be “civil war” if the remainder of Myners’ recommendations were pushed through.

One hundred and fifty years of failure?

Old Co-operative store

The Co-op’s heritage on the high street

Much of the damage to the Co-op’s reputation and finances occurred during fiscal 2012-13, for which the Co-op reported a £2.5 billion loss, the worst in its history. In April 2014, Pennycook admitted that the group’s performance had been “disastrous”.

Myners’ recommendation to oust the board that presided over that failure was based on what he called their “culture of entitlement” and their “strong vested interests and a reluctance to rethink existing ways of doing things.”

Ironically, his report was published on the same day that the public face of that entitlement culture, the Reverend Paul Flowers, escaped being jailed on drugs-related offences with a fine. Flowers had been appointed Chair of the Co-op’s banking arm despite having no previous banking experience.

In his coruscating analysis, Lord Myners – himself a former Co-op board member who resigned over colleagues’ resistance to change – suggested that corruption and denial were rife within the organisation, citing “repeated instances” where there had been “denial of responsibility, corrosive suspicion, deliberate delay and a practice of hiding behind ‘values’ in order to deflect or stifle criticism and protect self interest.”

What Myners ignores

Co-operative food

The Co-op is attracting customers that support ethical business.

Corruption needs to be excised from any organisation, but the Co-op’s structure and core values present a complex set of challenges. Those can’t all be met by just ‘sweeping away the old’ and replacing it with a management culture borrowed from a corporation.

Customers appreciate community values, and those organisations that stand by them, if for no other reason than those values are scarce in many sectors of the economy.

That the Co-operative Group made strategic errors is beyond doubt. For example, it allowed its banking arm to spiral into a crisis that, in 2013, forced it to restructure its debts in an attempt to fill the £1.5 billion hole that had appeared in its balance sheet. The move saw the Co-operative Group hand 70 per cent of its stake to bondholders.

In May, it was announced that Richard Pym, who became Chair of the bank in June 2013, will step down at the end of the year. A further 10 per cent of the group’s holding in the bank is to be sold, meaning that the lender may be one step closer to either a sale or being rebranded and moved out from under the Co-operative umbrella.

However, Myners’ report into the group’s failings omits some intriguing facts.

In the four years during which the group’s net worth was decimated, customer satisfaction with its banking arm soared across all channels – in particular for its in-branch service. The Co-operative Bank was rarely outside the top three performers in most customer satisfaction studies, while rivals such as Santander, Royal Bank of Scotland and Barclays often received appalling ratings from users.

The ramifications of that are uncomfortable for banking customers. At a time when some high street banks have become little more than shopfronts for a ruthless technology-led operation that keeps human beings at arm’s length, the bank that got customer service right on the high street – while banks such as Smile and First Direct proved equally popular online – became mired in debt.

Of course, the bank’s management was financially inept, but it did something that few other banks have managed since the recession: it kept its customers happy. The same ‘customer satisfaction versus profitability’ problem applies to other areas of the Co-op’s business, which also do something right: they attract the rising numbers of customers who want to support ethical and community-based organisations.

It goes without saying, therefore, that the Co-operative Group needs to rebuild its reputation as an ethical business, but it also needs to start spreading the news about its history, culture, aims and mission to make a stronger connection with new or wavering customers. Beyond that, it needs a new message that says ‘quality’ to people, because any business that is owned or run by its members or employees ought to take greater pride in itself and its products.

Paul Flowers

Disgraced former chair of the Co-operative Bank, Paul Flowers.

However, while Flowers may have come to personify the board’s management failures, Myners belief is that the problems undermining the Co-op date back nearly 60 years, with previous boards being equally unwilling to contemplate reforms to operating strategy and corporate structure.

In his view, the Co-op has reaped the reward of decades of neglect. That may or may not be true, but Myners was hardly a dispassionate observer while writing his report; he was a man with an axe to grind.

Strategic sense

Key to Myners’ strategic recommendations is the new board structure, which members have voted to accept. The current board has 21 members, including 15 ‘lay directors’ from regional Co-op boards, including an engineer, a plasterer and a retired deputy head teacher. That board will be replaced by people with more business experience, while a 50-strong membership council will hold the board to account.

A lack of basic business experience has proved near-fatal to the Co-op, said Myners in his report: “The Co-op board tends not to ask the right questions, because the people around the board table don’t know the difference, in some cases, between a debit and a credit.

“Effective organisations, undoubtedly, tend to have a strong managerial presence, but it’s never down to one woman or one man; it’s down to an accountable and experienced board who hold that executive to an agreed strategy and have the right knowledge to ask the right questions.”

Before the 17 May vote, Myners slammed Co-op members’ suggestion that some lay directors should be retained. “To insist on at least a token presence is akin to insisting that Manchester United should field a side which includes a least three players from Rochdale FC,” he said – perhaps ignoring Manchester United’s own managerial and performance problems of late.

A lack of respect

Many of Myners’ recommendations make sound strategic sense, but what is lacking in his report is a sufficient appreciation of what co-operatives – along with other mutuals and employee-centric organisations – offer the customer as well as their stakeholders. The point is that the Co-op is not a corporation, even if it needs to be run with the professionalism of one.

Lord Myners

Lord Myners: His report offers strategic sense, but omits the customer angle.

In the 21st century, the mantra of shareholder/investor value has become so dominant that, at an extreme, customer (or taxpayer) value risks being relegated to an afterthought. Some banks, for example, have thrived by pushing the consumer further away from the organisation and by lending less and less to small businesses. Such banks have become self-serving entities, often propped up by government aid.

However, the Co-operative and organisations like it are self-serving in a different sense, in that they strive to extend the community spirit that exists within the organisation outward to the customer and, thereby, to benefit from increased customer support.

The real challenge for the Co-op, therefore, is how to embrace reform, root out corruption, and help its members and customers thrive, while at the same time hanging onto the core principles that are worth preserving.

One answer is for the Co-op to become even more ‘local’ and community focused, supporting local makers and local businesses, and to start telling its story more confidently and consistently.

Its member-owned message sits well with an age in which many consumers are tiring of the lack of diversity on the high street and are exerting pressure on businesses to give something back to the communities in which they are based. It is unfortunate, then, that the Co-op is –rightly – seen in a light of strategic mismanagement and financial incompetence. That needs to change.

Board-level overhaul is essential if the Co-op is to stand any chance of recovery, agrees Professor John Thanassoulis of Warwick Business School, but there are caveats. “Lord Myners is right that a board needs talented individuals who are not corrupt,” he says, “but the challenge surely is to create a governance structure whereby this is achieved.

“If members do not have a seat at the top table, then the independent directors will be almost unassailable. Independent directors are liable to be chosen from those experienced in running supermarkets/banks/pharmacies from the private sector. Those who have made a career [out of] successfully defending shareholder interests are liable to behave in a similar way on the Co-operative board.”

Thanassoulis approves of Myners’ other recommendations, which include:

• An investigation by the City regulator into a report that the Co-op commissioned into leaks from the boardroom.
• A review by the Financial Conduct Authority into a new regulatory regime for co-operatives and other large non-financial mutuals.
• A review of the £1 membership fee – one and half week’s salary when the Co-op was set up in the 19th Century, which would now be equivalent to £675.
• A vote on any future payments for “loss of office”. This follows the row over a £6.6 million, two-year deal for former CEO Euan Sutherland (described by Myners as “the right man, and forced out by some people who should lower their heads in shame”.)

Myners has “succinctly identified the problem at the Co-operative Group,” says Thanassoulis. “The Co-operative Group had poor strategic direction and made bad decisions.”

The Co-op’s challenge

“The challenge is to find a governance structure which can deliver services that customers want to buy, at prices they are willing to pay, while representing the long-term interests of current and future co-operative members,” Thanassoulis continues. “These members are the customers themselves, the workers and the suppliers.

“There are several models that Lord Myners can look to for inspiration. PLCs have governance geared to maximising returns for shareholders; universities have governance that seeks to marry the pressures of academic rigour and excellence with profitable nous; charities have to be true to their purpose while delivering services under very tight cost control; and John Lewis has perfected an employee ownership model.” TS

The Strategist says

While Myners presented a strong set of strategic recommendations in his report, some of the Co-op’s problems are more subtle than he acknowledged. Whatever the Co-op does next, it should beware of shifting too far towards an arm’s-length customer approach externally in order to address its own internal governance problems. While Myners slammed the group for its adherence to a century and a half of co-operative values, customers and members alike cherish those values because they themselves feel valued by them. That the Co-op needs internal reform is in no doubt, but it should beware of abandoning its community and member focus in an attempt to behave more like a corporation. The answer must lie in combining the commercial viability of organisations such as John Lewis with the emerging social structures of the digital age.
 Stuart Lauchlan is co-founding editor of Diginomica.com, a Strategist media partner. Chris Middleton is founder and editor in chief of Strategist magazine.

 

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