Reimagining capitalism

Contrary to expectations of wealth destruction and reduction of income inequality associated with a pandemic like Covid 19, the exact opposite trend is happening. Amidst the raging pandemic, the larger companies from US to India have been announcing record profits and cash surpluses, due in no small measure to wage cuts and furloughs, among other things. These corporates have used the opportunity to become more "efficient" by maximising labour productivity and thereby exacerbating an already disturbing trend of business concentration. 

Worse still, public policy too has tended to amplify these trends. With equity markets dictating policy making, governments have been forced into intervening aggressive with liquidity support and other measures, most of which have an inherent bias towards the bigger companies. Bailouts have been designed to primarily protect the interests of capital and financial market investors, while leaving workers to fend for themselves. This was a feature of the GFC too, when TARP focused on backstopping Wall Street and investors, largely ignoring the suffering of households facing foreclosures. 

This naturally resurfaces the issue of reimagining capitalism. 

In this context, I have blogged here and here, and here about the hypocrisy of the business groups advocating stakeholder capitalism like the Business Roundtable and their apologist ideologues. 

There are two articles that have come to notice in recent times in this regard.

The Times has an article about how co-operatives in Spain's Basque region have helped smoothen capitalism's rough edges and tide over the pandemic by being considerate with their workers. These co-operatives adopted flexible approaches like agreeing to small wage cuts and lesser working hours to keep workers from being laid off. 

The article describes the cooperative enterprises centred in the town of Mondragon, who have managed to reconcile the often-conflicting aims of profitability and protection of stakeholder interests,

Most of its workers are partners, meaning they own the company. Though the 96 cooperatives of the Mondragón Corporation must produce profits to stay in business — as any company does — these businesses have been engineered not to lavish dividends on shareholders or shower stock options on executives, but to preserve paychecks... Its cooperatives employ more than 70,000 people in Spain, making it one of the nation’s largest sources of paychecks. They have annual revenues of more than 12 billion euros ($14.5 billion). The group includes one of the country’s largest grocery chains, Eroski, along with a credit union and manufacturers that export their wares around the planet... In a world grappling with the consequences of widening economic inequality, cooperatives are gaining attention as an intriguing potential alternative to the established mode of global capitalism. They emphasize one defining purpose: protecting workers... Cooperatives... typically require that managers plow the bulk of their profits back into the company to prevent layoffs in times of duress... 

At Mondragón, salaries for executives are capped at six times the lowest wage... The lowest tier is now €16,000 a year (about $19,400), which is higher than Spain’s minimum wage. Most people earn at least double that, plus they receive private health care benefits, annual profit-sharing and pensions. Every cooperative pays into a collective pool of money that covers unemployment benefits and aid to member cooperatives that are struggling. When a crisis requires limiting production, workers continue to get paid as normal, while accruing balances of working time owed that management can assign later.

Its results have been very impressive,

The system proved robust during the global financial crisis of 2008, followed by the so-called sovereign debt crisis across Europe. Joblessness soared beyond 26 percent in Spain. But in Mondragón, the cooperatives apportioned the pain through wage cuts and advance payments on future hours. Unemployment barely budged. 

This about the history of Mondragon is fascinating,

In Mondragón, the cooperatives trace their origins to the wreckage of the Spanish Civil War in the early 1940s, when a priest, José M. Arizmendiarrieta, arrived in the area bearing unorthodox ideas about economic betterment... When the priest approached the owner of a private vocational school to see about opening it to everyone, he was rebuffed. So he started his own, today known as Mondragon University. The priest viewed cooperative principles as the key to lifting living standards. In 1955, he persuaded five of the first graduates of the local engineering program to buy a company that made heaters and run it as a cooperative. They elevated workers into owners — partners is the term of art — with each gaining a single vote in a democratic process that determines wages, working conditions and the share of profits to be distributed each year. Over the decades, scores of other cooperatives took root, dominating the town’s economy. Each business is autonomous, but they operate under shared principles, especially the understanding that if someone loses a job at one cooperative, he or she has the right to take a position at one of the others. If there is no job, partners are entitled to job training plus unemployment benefits lasting up to two years.

There is a lesson here for impact investors and entrepreneurs looking to create impact. In many respects, one José M. Arizmendiarrieta may have created more enduring impact than perhaps all the conventional impact investors combined. Instead of chasing quick-fix technology solutions to persistent development challenges, how many entrepreneurs and investors are even thinking of creating impact through such simple models that present an alternative to capitalism?

Another article, in the WSJ (HT: The Gold Standard) looks at how private equity investors and their practices are corroding franchisee relationships that power small businesses. As they pursue the profits at all cost approach, PE owners of franchised businesses are coercing franchises to accept tough and unreasonable terms. Franchising has been a successful part of the economy in recent years in businesses ranging from hairstyling shops to hotels, eateries, and tax-preparation outlets

Franchisees run 55% of American hotels, according to industry tracker STR. They operated 84% of U.S. chain restaurants last year, according to data from restaurant strategy firm Aaron Allen & Associates. The roughly 774,000 franchised establishments in the U.S. employed about 8.4 million people last year, according to the International Franchise Association, a trade group.

The pandemic may have exacerbated tensions and surfaced them. 

Modern franchising dates back to the use of outside sellers in the late 19th century by the company then behind Singer sewing machines. The contemporary model—in which head offices grant the right to sell, using brand-specific methods, under a company name in exchange for royalties or other revenue—took off after World War II... Franchisees pay brand owners tens of thousands of dollars, and spend significant additional amounts in some cases, for the right to open a franchised business. They sign multiyear contracts that spell out royalties or other money owed to the franchiser, such as a percentage of gross revenue, and agree to maintain the brand’s standards. Franchisees also agree to pay various fees and typically contribute to marketing funds the brand uses to buy national ads. In return, franchisees gain access to customers who trust the brand, plus training in how to operate profitably. The brand owner often sells the franchisees supplies and services at prices it sets. These sales and franchisers’ fees have both become points of contention in some franchise deals.

As profit maximising capitalism took over, the relationship between franchisors and franchisees have changed, often for the worse. Instead of acknowledging the deeply inter-dependent and mutually beneficial nature of their relationship, franchisors like PE funds, with their shorter time horizons, have tended to squeeze out as much as possible from their franchisee partners. Illustrating the point is the story of the Meineke car repair chain, 

Sam Meineke, the 89-year-old founder of his namesake car-repair chain, was part of a generation of entrepreneurs who helped transform the U.S. economy through legions of franchisees... Janet Cummings’s family opened the first muffler shop Mr. Meineke franchised, in Houston in 1972. As her family’s Meineke outlets grew, to a total of 18, so did her connection to the founder, who she said sent her a wedding gift and attended her parents’ funerals. “It was really like family,” she said.

Mr. Meineke sold the business in 1983. A private-equity firm that became its owner stopped sending franchisees reminder notices when it was time to renew contracts, Ms. Cummings said. That was a disadvantage because renewing early allowed owners to roll over contracts, on terms that might be better than those available if they had to negotiate a fresh one. Operators pushed to get the reminders back. “The further the owners are from the franchisees, the harder it is for them to understand what is good for the franchisee is good for the franchiser in the long run,” Ms. Cummings said. A different private-equity firm, Roark Capital Group, now controls Meineke, through a Roark-owned firm called Driven Brands. Ms. Cummings said she wasn’t sent a renewal reminder for a long-held Meineke location.

Reseting the relationship between franchisors and their franchisees to one which is a mutually beneficial partnership is a good example of an alternative form of capitalism. Given that across industries, a few franchisors dominate the market, it would be sufficient if they come together and endorse a code of conduct for them which takes the interests of their partners into account instead of the single-minded pursuit of profits.