Outsourcing and employee ownership - growth versus equity?

John Lewis's outsourced cleaners are striking for a livingwage. You might be inclined to file that under obvious - where in the world are cleaners not outsourced and underpaid? With John Lewis, though, it points to an important general problem with the viability of employee ownership of businesses (for readers outside Britain, the John Lewis Partnership is owned by its 81,000 employees; it is a successful operator of department stores and supermarkets, and its annual profit-sharing bonus for employees is widely reported in the media).

Since the 1950s, economists have speculated that a profitable employee-owned business would not grow as much as the same business would if it were owned by capitalists, because the incumbent workers would not want to dilute their individual shares of profits by adding new worker-owners. This argument is known as the Illyrian Model, for reasons to do with the name of a province of the Roman Empire and the practice of worker-self management in Communist Yugoslavia, but that's a story for another time. Within a capitalist economy, workers who happen to own their business can try to have the best of both worlds. By hiring non-owner employees whenever an opportunity for growth presents itself a two-tier system is produced - owners and non-owners - and this has been widely seen as leading to the degeneration of the worker-owned company, marking its gradual descent into capitalist ownership. Notice that the Illyrian model is both a prediction about the fate that will befall worker-owned enterprises (they will either stay small, or stop being worker-owned), and an explanation for why worker ownership is not more widespread.

John Lewis has long been seen as an important counter-example to the Illyrian model, a case which casts doubt on the economists' gloomy prediction. It operates under a constitution which ensures that all permanent employees are "partners", each entitled both to a share in the annual bonus pool and to a voice in the company's democratic process, and it has pursued growth successfully for many decades. Thus, it seems to have hit on a solution which solves the Illyrian problem. Yet, if large groups of employees (cleaners, for instance) can be outsourced into non-partnership, the guarantee that all employees will be partners becomes more a legal technicality than a principle of governance.

This is not a problem peculiar to John Lewis. Consider another leading worker-owned company, the Mondragon Corporation. This group of companies, based in the Basque Country of Spain, has about 84,000 employees. It is best known as a manufacturer - its companies make a wide variety of consumer and producer goods, from sleeping bags to materials handling equipment. It was set up with a constitution which promised the opportunity of membership for all employees, and a structure which promoted entrepreneurship and growth. Even more than John Lewis (perhaps because the Mondragon Corporation grew from scratch, rather than being bequeathed to the workers by their former employer), it has been seen a as case which demonstrates the viability of employee ownership and a model for how to do it.

For Mondragon's first few decades it was a local group of manufacturers selling largely within a protected Spanish market. Today it is a multinational corporation and has many operations staffed by non-members. It also owns both retail stores and factories in Spain but outside the Basque country, many of whose employees are not members. In fact, for the group overall, non-member employees outnumber members. You could argue that becoming multinational was a mistake for Mondragon, but I am inclined to believe that it was a business necessity given both the increased pace of technological change and the requirements the company faced as a supplier to other multinational manufacturers. For reasons of language, national identity, distance, finance, and differing legal systems, it is not easy to extend shared ownership to those working in these far-flung subsidiaries. According to the Illyrian model, it's not even in the incumbent worker-members' financial interest to solve this problem - they could just continue treating the employees in their distant subsidiaries and joint ventures the way that John Lewis's outsourced cleaners are treated, and keep sharing the profits among the smaller group of members. This has been a matter of concern within the Mondragon Corporation for years; it's not something they're indifferent to (check out the FAQs on the company website) but not something that has been solved either.

A basic strategic planning step in businesses anywhere today is to identify a core competence - an area in which your company has what Michael Porter calls sustainable competitive advantage, or, in the old fashioned terms of industrial economics, market power. The next step is to outsource as many non-core functions as feasible. We could have an argument about whether the outside suppliers are cheaper because, as specialists, they are more efficient, or because they are paid less - though I'm pretty sure I know what the John Lewis cleaners would say about that. The Illyrian model was articulated in a different time, when businesses kept more functions in-house because the costs of outsourcing were higher. The Illyrian model predicted that worker-owned business would either stay small, or take on non-owner employees. Today, the same logic suggests that successful worker-owned businesses can also keep the number of owners small - and the bonus cheques large - by outsourcing low-wage functions. This presents a challenge for those who want to see employee ownership as a more widespread ownership model, or who see it as an ownership model that promotes greater social solidarity and economic equality. Not all workers are 'employees'.

(A longer version of this post, with references, can be found at frederickguy.com.)

This piece is part of the Democratic Wealth series, hosted by OurKingdom in partnership with Politics in Spires.