High street homilies

185

As Marks and Spencer goes “back to basics”, its story is a paradigm of what happened to British business in the last decade. Was the company’s problem that it changed too little – or that it changed too much?

So Marks and Spencer goes back to basics. Its story is a paradigm of what happened to British business in the last decade – and a pointer to what may happen next. The company is widely criticised for not having changed with the times, and there is a sense in which that is right. But in a deeper sense the problem is not that M & S changed too little, but that it changed too much.

A decade ago, Marks and Spencer was one of Britain’s most admired businesses, by its customers and competitors alike. But the company’s market position was essentially mature. All across Britain, there was ready access to an M & S store. The company’s core market for mid range, practical clothing was not likely to expand much. There was more scope for growth in its food products, but it met greater competition there. You could reasonably expect the company’s sales and profits to grow in line with national income. A little faster, if M & S could diversify its activities and extend the scope of its powerful brand. A little more slowly, if its competitors got their act together.

But the 5% or so annual growth in profits which that picture implied was not enough to satisfy the stock markets of the racy nineties. A premium rating demanded double figure earnings increases. Was it possible that a business of the quality of Marks and Spencer could not match that kind of target?

Of course, it could. You can always squeeze a bit more out of any business. Marks and Spencer increased its margins. It cut numbers at headquarters and limited the growth of its sales staff. It spent a bit less than it might have on store enhancements. And above all, it put pressure on the close supplier relationships which had been the traditionally distinctive feature of the Marks and Spencer business system.

And so the company delivered the kind of earnings growth the markets required. For a bit. Eventually, customers started to notice that value for money was not quite as good as it had been. That you had to wait to get the attention of a sales assistant. That the shops were dowdy and so was some of the merchandise. These impressions accumulated. Gradually, the positive Marks and Spencer anecdotes were replaced by negative ones. Suddenly, the company’s reputation fell off a cliff. And so did its profits.

It once puzzled me that in almost every business I encountered, a capable manager told to trim costs or staff numbers by 10% could easily find ways to do so. Could there really have been so much slack across so many areas of the corporate sector?

The answer is that in almost every business there are balances to be struck on the matter of service. How often should Railtrack inspect its rails, and how frequently should it replace them? How large a sales force does a pharmaceutical company need, and how much duplication and freewheeling enquiry should it allow in its research and development activities? How many customer service people do you need in a bank or an insurance company? How much time and effort should you devote to watching what your competitors are doing? Just how competitive does your pricing need to be?

All of these are judgements: there is a wide range within which reasonable people and capable managers can reach different conclusions. It is never possible to be sure you have called these judgements correctly. But you can be sure that if you are pressed to shift the balance a little in one direction you will always be able to do it, and to justify your decision. And there is the further bonus that culling the weakest ten per cent of an organisation will always improve the average. The problem will creep back – you make mistakes in hiring, and some people’s performance deteriorates over time – but for the moment you have a tighter, leaner organisation.

The effect of all these decisions is to enhance current earnings at the expense of future returns. It will always be difficult to assess whether the current gain exceeds the future loss, and even with hindsight it will be hard to tell. But markets have been slow to recognise that businesses have been accelerating recognition of profits. Instead analysts have projected such future earnings growth forward, and created expectations which will become ever harder to satisfy.

And that is why it is not just recession that will lead more companies to produce profit warnings and earnings shocks. Nemesis will not usually come as quickly, or as abruptly, as it has for Railtrack and for Marks and Spencer. But the lesson of these two companies has implications for everyone. It is that growth in earnings won at the cost of long-run competitive advantage – especially when that competitive advantage is your reputation – will add to shareholder value only for the short time that myopia persists in both the product market and the capital market

Marks and Spencer is right to go back to basics. But it will learn that competitive advantage is more easily run down than built up. If it were otherwise, competitive advantage would not be a source of enduring profit for the businesses that achieve it.

887 words

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