Bad timing at Morrisons

Morrisons’ managers were told that they’d face a stark choice: redundancy or a lower-level role, such as working on its counters as butchers, bakers or fishmongers. Not exactly a morale booster.

History already

At this time, most people expected Covid-19 to be contained beyond Europe’s borders. The first crisis point (Lombardy) only became apparent in the middle of February. After that, supermarket sales in Britain began increasing, as customers began stocking up on hand sanitisers and liquid soaps.

By early March, there was a run on medicines, cleaning supplies, pet care items, pasta, rice (and bizarrely, toilet rolls). On 12 March, Tesco felt obliged to reassure everyone that there would be no food shortages, and on the same day Boris Johnson advised anyone showing mild symptoms to self-isolate for at least seven days. This was meant to slow the spread of the virus so that herd immunity would build up. His words triggered a further rush to buy.

The middle of the month brought appeals for calm. Then, on 19 March, competition laws were relaxed to enable supermarkets to improve their supply chains by sharing resources. In that week, according to market research firm Nielsen, frozen food sales increased by 84 per cent compared with the same week in 2019. When the government closed pubs and restaurants, sales of beer, wine and spirits went up by 67 per cent. During March, Britons made a staggering 79m extra grocery shopping trips, driving up supermarket sales by 20.5 per cent and online sales by 14 per cent. The total increase at Morrisons was 19.3 per cent. 

Morrisons, with about 110,000 employees, set about recruiting 3,500 more to expand its home delivery operations. Its chief executive, David Potts, said: “We haven’t had the time to plan [for the 'panic' buying], nor do we know when it will end. It is relentless and demand is still rising.” Unlike other supermarkets, Morrisons produces much of the food it sells. In fact, it’s also Britain’s biggest food producer. “We will play our full part in feeding the nation during this important period,” Mr Potts added grandly. On 24 March, a sunny weekend enticed out the crowds, all doing their thing for herd immunity. A day later, the government changed tack and announced the national lockdown.

Store managers will have been vital in organising the staff to cope with the onslaught of customers. On 2 April, Morrisons doubled managers’ bonuses. They were tripled for other frontline staff. Morrisons claimed that their thank-you bonuses were more generous than those of other supermarkets. Presumably, the managers’ redundancy programme had been put on ice. 

Trouble at the top

In the midst of all this, on 26 March, Morrisons made another, less effusive announcement. Two non-executive directors, Tony van Kralingen and Neil Davidson, would each be “stepping down to pursue other interests”. It’s customary to thank departing directors for their service. The phrase was conspicuous by its absence.

The departure was a far cry from the announcement on Mr van Kralingen’s appointment three years ago. Then, Andrew Higginson, Morrisons’ non-executive chairman, said: “I am delighted to welcome Tony. He brings a very broad experience in the drinks industry across a number of disciplines including human resources, marketing, supply chain and manufacturing. He will be an important addition to our board.” 

Mr van Kralingen seemed the perfect fit. He’d worked for SAB and then, after the merger, SAB Miller for 33 years.  Since 2008, he’d been its director for group procurement, technical research and development of human resources. He immediately took over chairing Morrisons’ remuneration committee.  

The Tesco three

Before joining Morrisons in 2015, Mr Higginson had been Tesco’s chief financial officer and chief executive of its retailing services business. One of his first achievements as its new chairman was to recruit Mr Potts to (as the tabloids put it) “stop the rot”. The previous chief executive had been heavily criticised by Morrisons’ founder Sir Ken Morrison, and dismal Christmas trading sales had sealed his fate. Mr Potts had resigned from Tesco a few years earlier, and Trevor Strain, Morrisons’ chief financial officer, had also had a senior role in Tesco before being head-hunted in 2009. 

These three have been widely credited with Morrisons’ recovery. Mr Potts’ success includes extracting Morrisons from its poorly performing convenience stores, and negotiating more favourable agreements with Ocado, Amazon and McColls. The two executives were set ambitious three-year targets for their Long Term Investment Plan (LTIP). They managed to exceed them. Their reward was to receive almost all the shares originally awarded – and for investors to claim that their performance targets must have been too easy. At the 2017 AGM, shortly before Mr van Kralingen joined, the company narrowly escaped seeing its remuneration policy voted down. 

Covid-19 strikes

Mr van Kralingen took pains to respond to investor criticisms. He has gradually been tightening the LTIP.  Executives now can’t sell LTIP shares until five years after the award date. The LTIP targets (of cumulative adjusted free cash flow, growth in total sales growth, and growth in earnings per share) have been tweaked. These can be calibrated from the published accounts, but what if the outcomes have been distorted by external events? 

That’s where discretion comes in. The remuneration committee says that to “ensure the vesting of the LTIP is an accurate and fair reflection of performance”, it reserves the right to “adjust these calculations for material exceptional events…which were not in the contemplation of the committee at the time that the targets are set and which otherwise materially distort the outcome”. But discretion is subjective, and consistency can prove elusive.  It can lead to lively committee discussions.

Some external events are easily managed. IFRS16, for example, which is an accounting change that applies to all companies, changes the way leases are charged. So for like-for-like comparatives, either the reported figures or the previous year’s have to be restated. At Morrisons, a view had to be taken on the sales figure target, after new agreements involving its wholesale business (especially with McColl’s) were front-loaded. And arriving at a realistic earnings per share comparison after so many structural changes has proved to be no easy matter either.

Morrisons’ performance conditions are absolute, rather than being relative to competitors. That’s fair enough if you assume that the only way for supermarkets to increase sales and earnings is by taking market share from others in the sector – and if you factor in Mr Potts’ skill at finding and securing new outlets. 

But what about the impact of Covid-19 and other events beyond his control? With the forced closure of pubs and restaurants, supermarkets have all sold significantly more products, especially food and drink. The government’s holiday on business rates has also boosted free cash (worth over £300m to Morrisons). Against that, cash has been reduced by accelerated payments to small suppliers, and by higher pay costs, especially for sick leave and self-isolation. The sales target assumed that sales of property would continue, but these are now likely to dry up. Should the performance outcomes be adjusted for such gusts of fortune? And if so, how? The free cash flow used to fund a special dividend, but that has been suspended: shareholders’ returns have been docked. Should the top pay be too?

Unbalanced pay

Whoever chairs the remuneration committee can be expected to explain the thinking of its members to employees and shareholders. The members at Morrisons were six non-executive directors (now four), plus Mr Higginson. Including the company chairman is unusual, but by no means unheard of, probably because it helps to avoid misunderstandings. Excluded company chairmen have been known to overrule their remuneration committees. 

Inclusion seems not to have worked at Morrisons. Mr Higginson’s interpretation of discretion might have differed from those of Mr van Kralingen and Mr Davidson (and possibly other non-executives) due to what the Financial Times delicately described as a “perceived closeness” of the Tesco three. Or a revised remuneration policy might have proved contentious. It’s due to be put to shareholders at the 2020 AGM in June.

Mr Higginson would no doubt argue that Morrisons needs Mr Potts. For particularly in times of crisis, strong, capable leaders can save companies far more than whatever they’re paid. But as the country slips from recession into depression, high pay – and high pay differentials – will become political targets. Mr Potts is on a salary of £850,000 a year. Those frontline staff, who bore the brunt of the customer surge, are on earnings of £17,500. He received £3,519,000 for his performance in 2018-19. That special thank-you bonus for staff will pay them each £1,050.

Admittedly, invidious pay differentials are common across the supermarket sector. Mr Potts, though, received the most in 2018-19 (see the table below). His £4.6m just pipped Dave Lewis, the outgoing chief executive of Tesco. Both have faced mammoth challenges in turning their companies around. But Tesco is four times larger.  

Reining back pay from these dizzy heights will not be easy. To misquote Oscar Wilde: for Morrisons to lose one independently minded non-executive director in the midst of a crisis may be regarded as misfortune, but to lose both looks like carelessness. Whether or not this was due to bad judgement or just bad timing, only time will tell.