A personal stake: Why employee-owned businesses return more than a profit

Employee-owned businesses remain an oft-overlooked option for companies as a means toward ramping up productivity, profit and morale. But a new study shows that the overwhelming success of companies like UK-based John Lewis is due to innovative mechanisms to encourage employee participation and cultivate a culture of ownership. Andrew Bibby explores how this company model of a fully or majority employee-owned business is not only self-sustaining and successful, but is in fact widely applicable.

LONDON - Oxford Street is home to London's premier shopping area, a magnet for locals and tourists alike, where British and international retailers have their flagship stores. Yet one store on Oxford distinguishes itself in a surprising way - it is owned by 63,000 people.

John Lewis, which has traded in the United Kingdom for almost 150 years, is the largest fully employee-owned company in the UK, with 27 department stores and almost 170 supermarkets. All 63,000 permanent staff are known as "partners", and together they ultimately control the business. There are no external shareholders; rather, all company shares are held in a specially created employee benefit trust.

John Lewis has operated as a fully worker co-ownership business since 1950 when the son of the founder transferred ownership of the firm to the employee trust at far below the market value. Today, John Lewis' constitution states that the company's ultimate purpose is "the happiness of all its members, through their worthwhile and satisfying employment in a successful business". Partners "share the responsibilities of ownership as well as its rewards of profit, knowledge and power".

The John Lewis Partnership, as the company is officially known, also has innovative mechanisms in place to encourage employee participation in the business. Parallel to normal management structures is a separate system of democratic partnership bodies, one for each main operating unit. All partners are represented through the group-wide Partnership Council which appoints five non-executive employee directors to the main board and has the power to dismiss the chairman. At the day-to-day level, staff can also demand responses by management to anonymous criticisms and comments via the in-house magazine.

Giving employees a piece of the pie

Although the John Lewis Partnership is well known in the United Kingdom for its innovative structure, it has often been disregarded as a relevant model for other businesses because it was originally created as a philanthropic endeavour by its former owner. But a new report entitled Shared Company, issued by the UK association of employee-owned businesses Job Ownership Ltd (JOL), suggests that this form of company structure is both successful in business terms and more widely applicable than most suspect. The report quotes British, US and Japanese academic research which claims to demonstrate that employee ownership and participation improves productivity and company performance. What is needed to achieve this, the report says, is a "culture of ownership".

JOL is particularly keen to encourage the idea of employee buy-outs for smaller, privately owned businesses whose owners are looking to withdraw, typically at the time when they come to retire. Philanthropy, JOL stresses, doesn't need to apply. In fact, selling a business to the current management and workforce may be the most advantageous way of extricating capital while ensuring that a business is able to continue trading. Patrick Burns, JOL's executive director, says a huge number of businesses fail because of botched succession when a former owner withdraws. He criticises business advisors and accountants for not necessarily understanding that worker buy-outs are a potential alternative to management buy-outs or commercial sales.

For the claimed benefits of employee ownership to be applicable, however, a company must be genuinely in the hands of its workforce. JOL makes it clear that it is not talking of the common international practice of rewarding staff, especially senior staff, with company shares as a management or HR incentive. Rather, its focus is on employee-owned businesses, or in other words companies which are either wholly or majority-owned by their employees. Ownership may be through individual shareholdings, collectively held holdings (as used by John Lewis) or some combination of the two.

This key point is the crucial one, according to David Erdal, head of Baxi Partnership, a UK capital fund for employee co-ownerships. "Control is very important;" he said. "If it's less than 50 per cent, then it's not control." He adds that, in his opinion, majority or fully employee-owned businesses tend to have healthier corporate governance. "Compared with a shareholder-owned company where shareholders are sometimes ignorant of what's going on, employees know it backwards, who's good and who isn't. Directors have to play straight," he said.

Employee-owned businesses such as John Lewis where the share capital is held for the benefit of the workforce are not synonymous with worker cooperatives, which tend to have more rigorous democratic structures and which commit themselves to following the seven agreed principles established by the International Co-operative Alliance. However, even when adding in cooperative businesses, the number of companies which are broadly employee-controlled remains relatively small. One difficulty is that these businesses cannot always access the full range of equity capital available to other businesses, and are therefore limited to using loan capital or retained profits for financing growth.

All for one, and one for all

The question of whether employees should be encouraged to become part-owners of their businesses, and particularly whether they should be encouraged to provide themselves some of the capital needs of a business, has been on the agenda recently at the European level, particularly in relation to the EU's declared Lisbon strategy for economic competitiveness. A European Commission communication three years ago called for financial participation by employees in their own companies to be encouraged as a political priority within EU Member States.

The EU call is a broad one, covering a multitude of situations, from JOL-style employee co-ownerships to mainstream corporations with share-ownership schemes. Perhaps because of this, the issue of employee financial participation can be a controversial one. Observers point out that it can be highly imprudent to encourage employees to be reliant on a single business not only for their employment and pension but also as a place for their investment money.

As Dr Antonio Fici of the law faculty of the University of Rome points out, trade unions have also often been cautious of schemes to encourage workers to invest financially in their firms. "They fear that direct involvement of employees will change the system of industrial relations in terms of individualism and contrary to conflict, thereby diminishing the protective role they play," he says. But Dr Fici, who has studied employee participation particularly in relation to cooperatives and social enterprises, says that it is quite possible to develop forms of employee participation which the social partners can embrace. It helps, he says, to appreciate the distinction between profit-sharing and real forms of employee ownership. Certainly, JOL sees no difficulty here. As its Shared Company report puts it, "There's nothing about employee ownership that rules out a strong, positive role for unions."

Ways to create employee ownership:

  • By selling shares to employees
  • Through schemes that allow employees to buy or own shares when key targets or a fixed date are reached
  • Through governing rules, such as for companies limited by guarantee where all members have equal voting rights

Employee-owned businesses can assume one and sometimes more of the following structures:

  • Company limited by shares
  • Industrial and provident society (IPS)
  • Company limited by guarantee
  • Partnership
  • Cooperative
  • Employee share ownership plan (ESOP)

Key advantages of employee-owned businesses:

  • Start-up businesses can raise cash by selling shares to employees
  • Employee ownership helps a growing business recruit and retain key employees
  • Improved employee motivation leads to better performance