Northern Rock split a poor policy decision for the future

Today the EU approved the UK government plan to split nationalised bank Northern Rock into two. One half will become a so called 'good bank', to be flogged off to a private company while the other half will become a 'bad bank' and remain in the state sector. The bad bank will keep all of the Rock's 'toxic assets', such as the 100% plus mortgages which the bank was left holding after the US financial sector suddenly lost interest in 'repacking' them as AAA securities (which weren't) in 2007.

The government apparently intends to return the 'good bank' to the private sector by the 2010 General Election. Given that that will be in May or before, the privatisation will happen almost straight away in business terms - a very quick privatisation. Although no doubt there will be a competitive process to buy the good bank, bidders, who could include Tesco Bank, Virgin Money, or the National Australia Bank, will be buying a business which would almost need rebuilding from scratch as a credible savings and mortgage bank. Meanwhile taxpayers will be left holding the toxic assets in the bad bank, and could possibly be paying for them as generations. Surely it would be wiser to rebuild Northern Rock in the public sector, but with private sector style management for a ten or twenty year period to restore it to profit, before releasing it back on the market for a much larger sum? Its not as if there are not precedents. Even the privatisation hungry Conservative government of the 1980s knew this; British Steel was a basket case nationalised industry suffering serious losses when the Conservatives came to power in 1979. By 1988 it had been turned around by new management who closed unprofitable plans, improved the company's marketing strategy and made it a world productivity leader in the industry. In the car industry the basket case British Leyland, nationalised by Labour in 1975, was also returned to the market successfully by Mrs Thatcher's government in 1986, again with unprofitable parts of the company closed and the company's trade union problems resolved. If we must have government intervention in industry, why can't we turn it around and make it a good investment for the taxpayer?

Iceland to go

Much has been made of the US-based fast food chain McDonald's apparent decision to leave the Icelandic market. The media have seized on this as a cheap example of how the once proud Icelandic economy has deflated further due to the collapse of its banking system in 2008. What is often forgotten is that Iceland is a very small country in population terms, with a national population of just 300,000, roughly the size of one of the larger UK provincial cities. Just as the effects of economic growth per capita in such a small economy are very pronounced because the earnings per head are higher, then a crash will also be felt more acutely, and the country is presently attracting far more attention from the international media than it typically has done because of this.

In reality this situation will not affect the McDonald's Corporation or indeed Iceland to any great extent. For a start McDonald's only had three branches in Iceland, a number that might be considered sufficient to serve a population of 300,000. However, the company was not even exposed to much of the risk related to these three branches. As with most McDonald's restaurants, McDonald's did not own and operate them directly, instead franchising its format to a local operator, in this case a company called Lyst. The franchising system is an important part of the fast food business, often ignored by campaigners against it, who fail to realise the opportunities it allows for local entrepreneurs to establish a business creating local growth while supported by national or, in this case international marketing generated by the parent company. Companies such as McDonald's have used franchising to establish large brand name based business networks rapidly, requiring less start-up capital and sharing risk with local operators. The benefit of having a widely known business name is obvious for the franchisee; goodwill can be shared with the other members of the network, meaning that people not familiar with the locality will patronise the business expecting certain service standards. Additionally product innovation is often carried out by the franchisor.

Lyst has decided to discard the McDonald's franchise and to start trading under its own identity instead. Patronage has increased due to recession suffering Icelanders seeking cheap fast food but the cost of supplies from McDonald's approved suppliers in Germany has doubled due to the collapse of Iceland's currency. Lyst will no doubt be able to operate its three restaurants more cheaply while McDonald's are unlikely to notice the loss of franchise fees from the outlets. Indeed, they are now free to re-enter Iceland on more favourable terms at a later date. The beauty of franchising is that the deal can be flexible enough to be operated by both parties to be operated for as long as necessary, but discarded if no longer viable, often with fewer ill effects than if the franchisor had owned the franchisee directly.

Rangers F.C. partly nationalised?

A quick Sunday post. The team manager of the Scottish football club Rangers, Walter Smith, has revealed that the club is unable to enter the transfer market because the club is now being run by its bank, the Lloyds Banking Group, which is 44.4% owned by the UK government via its vehicle UK Financial Investments Ltd. Rangers have, despite having a vast support, successive championships, and their own chain of sportswear shops in Scotland and Northern Ireland been overspending on players for years. While the bank has not taken a stake in the club, if the bank is forced to bail the club out (they could let, say Albion Rovers fail, but to let Rangers fail would be political suicide) it is possible the bank could end up with a stake in the club. Just as with the DSB Bank owner Dirk Scheringa and his club AZ Alkmaar, football has once again proved that it is incapable of being run as a business, now to the extent to which the state may have to intervene by proxy.

UK Postal strike - can the workers win?

More on the UK postal dispute, which I mentioned on October 8. Today the UK's Communication Workers Union (CWU) announced that planned national strikes by postal staff will go ahead on Thursday and Friday, with further strike dates to be announced on Thursday. The strike will be split over two days with mail centre staff and drivers striking on Thursday, while delivery and collection staff will strike on Friday. Postal workers in the UK have already been holding localised strikes for several months. The CWU's members are striking over the 2007 Pay and Modernisation Agreement, signed following a round of strikes, in which the union agreed that modernisation would be necessary, but that Royal Mail would consult with them over modernisation which would replace workers. The union claims that Royal Mail has failed to do this, leading to a bitter dispute by modern British standards.

The present dispute is probably the worst industrial dispute in the postal industry since that of 20 January - 8 March 1971. In 1971 200,000 postal workers spent seven weeks flat out on strike. The strike completely paralysed the system, with post offices, then part of Royal Mail, also mostly closed. Postal workers went without wages throughout the strike, many being supported by 'hardship payments' from the union. Like many industrial disputes of the 1970s the dispute centred around pay rather than allegedly poor management decisions and the threat of redundancy. While inflation in 1970 ran at 6.4%, rising to 9% in 1971, in January 1971 the Royal Mail offered workers an 8% rise. The union had asked in late 1970 for a somewhat inflatory £3 a week, or 15-20% rise, which not surprisingly, management refused as it would cost the firm an extra £50m a year. As the strike wore on the union reduced its demand to a still somewhat high 13%, while management increased their offer to 9%, but mostly stood their ground despite the lack of postal deliveries, and £25m's worth of lost revenue. By early March the union was running out of funds and encouraged workers to return to work, without even the 8% rise originally offered, making General Secretary Tom Jackson unpopular among the membership. Instead the union was forced by the Department of Employment to accept an independent enquiry into efficiency in the post office which would then set a pay award.

While today's postal workers are not striking for the entire week, it remains to be seen how long their resolve will hold as they still stand to lose one day a week's pay from the strike. With Royal Mail again looking unlikely to climb down, the CWU might do well to consider the humiliating climb-down forced upon their predecessors. Strikes in the modern era rarely do workers much good in the long run, with the employer affected often loosing business and being weakened financially. If people are forced to find alternatives to Royal Mail for the time being, they may just find they prefer them even when the service returns to normal.

DSB Bank allowed to fail

Yesterday something very unusual in banking politics happened - a bank was allowed to fail. The DSB Bank, a small savings bank was allowed to collapse by the Dutch government. The bank entered administration last week after savers co-ordinated a bank run to threaten the bank's solvency. The run was organised by DSB's mortgage customers who were disgruntled with the bank's policy of linking expensive, and often unnecessary insurance policies with its mortgages, which were forced onto customers, making a €1.6bn profit. A US company, Lone Star Funds, were interested in buying the remains of DSB but failed to reach agreement with the bank's Chief Executive Dirk Scheringa. Scheringa also approached the Dutch government for €100m's worth of aid, but finance minister Wouter Bos refused, arguing that DSB's proposed business model would lead to the loss of these funds in addition to the funds already lost. The main Dutch clearing banks are responsible for guaranteeing deposits up to €100,000 in the Netherlands, and will pay the remaining savers €3,000 each, but did not want to buy DSB as its loan losses and potential legal claims were considered too great.

Bos also noted that the collapse was not related to the credit crunch, and that an independent investigation into the collapse of DSB was set up. Little is clear about DSB and its practices, as it was privately owned by Dirk Scheringa. Scheringa established the bank in 1975, originally as a financial consultancy known as Buro Frisia. The company expanded aggressively through aquisitions, gradually building up a portfolio of financial businesses. Controversially, in 1999 a planned IPO was aborted by Scheringa just hours before the start of trading due to a disagreement with the banks over the proposed share price. Scheringa chose instead to keep the company private, raising finance via subordinated loans instead. In 2005 the company was granted a banking license by the Netherlandsche Bank, which operates as the Dutch central bank. Scheringa also owns the football club AZ Alkmaar, the reigning Dutch champions, and an art museum, the Scheringa Museum for Realism, in Spanbroek, North Holland. It seems likely that Scheringa's financing of these assets, among others, came from DSB Bank funds. No doubt the inquiry into the bank will shed some light on the business model used by Scheringa to run the bank, which appears to have been controlled too closely by him. This blog will return to this story when more is known - it will be interesting to see if any interesting conclusions regarding the ownership of banks and whether it should be dispersed will be reached by the inquiry.

Recent Business History on BBC Four/iplayer

BBC Four occasionally gives us some excellent documentaries that, while often concentrating on the products, also feature business history topics, often in an accessible (and entertaining) fashion for a wide audience. The channel has long ran excellent music documentaries which often talk about the business side to some extent too; also a few months ago the Crude Britannia series gave an excellent overview of the British oil industry.

The present 'Electric Revolution' season, focusing on how electrical devices have changed our lives, has also brought some excellent material to our screens. Last night I watched Podfather, a biographical documentary of the inventor of the silicon chip and Intel founder Robert Noyce. As well as telling us about the science behind Noyce's invention the programme also told us about Noyce's role in establishing Silicon Valley's corporate culture. Silicon Valley business historian and Noyce biographer Leslie Berlin was even drafted in as one of the programme's talking heads. The story of how Noyce and his colleagues broke away from their original employer, William Shockley, to gain the patronage of the Fairchild Coporation, and then broke away from Fairchild to form Intel was well told. Noyce's style of management was also noted; that he was uncomfortable with large hierarchical organisations, and formed Intel as a company without a hierachy where senior management would work on the same floor as their underlings. The family tree aspect of Silicon Valley was also noted; the existence of many firms that split away from Noyce, and also Noyce's role as mentor to Apple's founder Steve Jobs, and Jobs' own role as mentor to the founders of Google.

Also part of the 'Electric Revolution' season was Micro Men, a rare drama about a business topic, set in Cambridge's 'Silicon Fen' against the backdrop of the British home/micro computing boom of the early 1980s. Micro Men is a slightly tongue-in-cheek dramatization of the competition between the eccentric inventor Clive Sinclair and his former employee Chris Curry, who breaks out Silicon Valley style to start up his own firm after Sinclair fails to be persuaded about the potential market for computers. Sinclair is played by the British comedy actor Alexander Armstrong with great comedy value, but the programme is no mere comedy biopic. Serious business topics are dealt with; the drama shows Sinclair's annoyance with the interference of the late 1970s Labour government's National Enterprise Board, before going on to show how government intervention shaped Curry's new company Acorn. Acorn won a major contract with the BBC to create a new machine for a computer literacy TV programme, the BBC Micro, which the Thatcher government then funded the purchase of for schools, much to Sinclair's annoyance. Consequently the first computer used by many people that were at school in the UK in the 1980s or early 1990s was the BBC Micro. The programme then showed how Sinclair's company accidentally found success in the games market with its cheaper and smaller Spectrum model, while Sinclair ironically coveted the BBC Micro's more worthy market. Both firms directed investment into competing with each other rather than concentrating on their strengths, with Sinclair bringing out the QL, a failed business/educational machine, while Acorn developed the Electron, a games machine which launched only after the gaming boom was over. The programme even deals with Acorn's descent into financial difficulty as the bank happily gives the company bigger loans for expansion, and it carries out an ill-advised stock exchange flotation. The programme deals with these topics in an entertaining way, although naturally some of the events that are depicted are probably exaggerated. But its well worth watching to understand the fate of Britian's long forgotten domestically owned computer industry, and particularly to understand why entrepreneurs are often good at starting businesses but poor at running mature businesses.

Both programmes are still on iplayer until Monday 19th October.

Royal Mail - managed decline?

Today postal workers in the UK voted to strike nationally, following a series of local disputes regarding a range of issues affecting the organisation, which mostly stem from the gradual decline of post on paper. Royal Mail, which remains a state owned enterprise whose role is to provide a letter and parcel delivery service to every UK address, says that letter and parcel traffic is falling by 10% per annum, meaning a reduction in income of around £170m per annum. Despite this the company did manage to make an operating profit of £321m in the year to March 31 due to efficiency savings. Naturally however such efficiency savings are unpopular with the unions.

The decline of the Royal Mail does have true historical significance - it is one of the world's oldest surviving businesses, and particularly unusual in this sense that it still fulfils the same function. Its roots can be traced back to the 16th century at least, when it was literally the 'Royal Mail', carrying mail for royalty and government business. In this sense its roots parallel the internet somewhat, which was originally established by the US government for internal purposes. Members of the public were able to use the system from 1635 onwards, when Charles I opened up the service. It was granted a monopoly as the 'office of postage' by the dictator Oliver Cromwell in 1654, a monopoly only removed by government in 2006. A network of horse drawn carriages conveyed mail on contract for the post office, although originally the recipient paid for postage. This system was changed in 1840 with the innovation of the postage stamp, which meant that the sender paid the postage, which was reduced to 1d., or old penny (about 30p today). This, and the introduction of rail transport for letters led to a real boom in post office business, and about half of Prime Minister Gladstone's civil servants were postmen. The mail remained a government department, the 'General Post Office' until 1969, a period in which it had control over all communications in the UK (such as telgraph, telephony, radio and tv). Since that time it has been administered as a separate business, but still remained in the state sector, and still employs over 120,000 people today. With postal volumes declining so rapidly it seems unlikely to be a viable candidate for privatisation anytime soon - but at the same time it seems likely that unions may have to concede that with postmen having less to deliver, it may eventually become economically inefficient for society to continue to pay them to walk round everybody's front door every day. But how long will this take?

Tesco - making a lot from little things

Today the UK retail multinational Tesco announced half year results which exceeded the expectations of the City. The company's Chief Executive, Sir Terry Leahy proclaimed that the British economy was over the worst of the recession, perhaps missing the point that people are likely to turn to a low cost retailer such as Tesco during a recession. Tesco made a profit of £1.41bn on a turnover of £30.4bn; sales in the UK grew by 2.8%. The company has also created 6,500 jobs this year so far. The company has also successfully expanded globally from its UK base, firstly in emerging economies in central and eastern Europe, then in Asian countries; attempts to enter more developed economies such as the US have as yet been less successful.

Tesco's present record may be very impressive, but it is easy to forget that in the 1970s the company was the sick man of the British high street. Tesco's founder Sir Jack Cohen had expanded the company from its origins as a market stall in 1919 (all good retail stories start with a market stall) into a bulk-buying chain of grocers, and then after post-war rationing was abolished in 1954 into supermarkets. At this point supermarkets were new and exciting to consumers; Cohen became famous for a 'pile it high, sell it cheap' philosophy, expanding the company rapidly via new store openings and frequent acquisitions. The low margins on basic goods could easily be recouped by selling them on a mass scale; a chain of 900 stores, all in the UK was established. By the late 1970s however the company was struggling; more sophisticated retailers such as Sainsbury's and Marks and Spencer were attracting increasingly affluent consumers who had begun to shop on quality rather than price. Tesco found that many of its stores, inherited from a mixed bag of owners, were too small and poorly designed, while the company was not even using its market power fully to institute central buying with the benefits in pushing supplier prices down.

The company bounced back under Managing Director Ian MacLaurin, whose initiative 'Operation Checkout' in 1977 saw Tesco institute central purchasing and introduce new price cuts, forcing Sainsburys to cut its prices in retaliation. This was followed by an aggressive modernisation campaign to reduce the company's downmarket image, with 500 stores being closed and others expanded, with lighting improved and isles widened. Own brand products were also introduced for the first time, gradually being adjusted into a range of their own to appeal to customers of all income levels. By the mid-1990s Tesco had become the UK's largest supermarket chain, successfully expanding into Scotland and Northern Ireland ahead of rivals Sainsbury's. Now the company is aiming to purchase one of the UK's nationalised banks, perhaps Northern Rock or the Royal Bank of Scotland (a once unthinkable possibility - Tesco Personal Finance was originally a joint venture with RBS), to add to its rapidly growing banking arm. As Tesco diversifies further, both geographically and in range of products offered, in order to satisfy stock market expectations of growth, will it again reach a stage where it over-expands based around a narrow business model and becomes unmanageable?

The BAE Bribery case - a chance for the SFO to redeem itself?

Today the UK's Serious Fraud Office, which has powers to investigate and prosecute serious frauds involving over £1m announced that it would ask the SFO to prosecute BAE Systems, the UK's leading defence equipment manufacturer, which is accused of bribing government officials in Tanzania, the Czech Republic, Romania and South Africa to secure contracts. These allegations run over a long time period, and follow an earlier case dropped by the SFO into alleged bribery by BAE over a deal with Saudi Arabia.

The SFO has generally struggled to secure prosecutions since its creation as a specialist agency to deal with corporate fraud in 1988. The SFO was created following a string of high profile frauds that the Police and the Crown Prosecution Service were unable to successfully bring prosecutions over. It was thought that a specialist agency employing lawyers and forensic accountants would be better placed to deal with the complexity of fraud cases, which often involve a high degree of specialist financial knowledge. However, the agency has proved so unsuccessful in this aim that last year its role was openly challenged by lawyers representing a group of drug companies accused of fixing prices against the National Health Service. The case was thrown out of court after the SFO failed to prove its case despite carrying out an 8 year long investigation, costing taxpayers £25m. Such actions are never cheap, but one can only hope that in this instance the SFO is more successful than it has been in the past if the body is to prove its worth at dealing with corporate fraud.