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Why Good Companies Go Bad: Tesco PLC In The Dock

Another day, another piece of bad news from Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US). This week it was a fall in like-for-like sales, last month poor international results. Is it struggling to pull off the turnaround plan?

There are some worrisome pointers in a seminal paper published in the Harvard Business Review in 1999. In ‘Why Good Companies Go Bad’, academic Donald Sull looked at why previously successful companies can fail to respond to changes in circumstances and go into a downward spiral.

He concluded that a main cause is ‘active inertia’: management is pro-active in addressing the problems, but gets stuck in old ways of thinking and so simply repeats past mistakes.

Does this apply to Tesco?

Tesco’s management is insular, and there is little outside recruitment at the top. Sir Terry Leahy’s long reign fixed a strong corporate ethos, but chairman Richard Broadbent recently admitted that during this time “the company lost touch with the outside world”. Sir Terry was replaced by a lifelong Tesco employee, Philip Clarke.

The finance director is a relative newcomer. But Laurie McIlwee, who joined in 2000, has also undertaken operational roles: that perhaps doesn’t make him the dispassionate checker-and-balancer that finance directors often are.

What of the ‘Build a Better Tesco’ turnaround programme? It’s good, sensible stuff, but boils down to doing more of what Tesco should have been doing anyway. Squeezed between the discounters and top-end Waitrose, maybe Tesco need more radical change.

Margins

Management is now being challenged over its policy of maintaining margins at expense of losing sales. Brokers HSBC and Morgan Stanley have led the charge, the latter saying “We continue to believe Tesco is hostage to its 5.2% margin guidance for its UK operations, which translates into weak top-line growth and market share loss.”

It’s a moot point whether starting a price war would work in Tesco’s favour, but this quote from an advisor to Tesco at the time of the January 2012 profit warning is illuminating: “For too long Tesco has obsessed about the numbers. It is deeply embedded in their culture. I am not sure customers are.” Plus ca change?

The company is also under fire for its four corporate jets and Mayfair offices. Corporate opulence often precedes corporate failure, as visitors to Fred Goodwin’s lavish headquarters might have noted prior to RBS‘s demise.

Faith

I still have faith in Tesco. Its dominant market share is a great competitive advantage, and the upturn in the economy will help revive sales. But if its relative performance doesn’t improve soon I wouldn’t be surprised to see the big institutions forcing a change of leadership.

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> Tony has shares in Tesco and HSBC but no other companies mentioned in this article. The Motley Fool owns shares in Tesco.