35: Freely employed
Privatization by employee buyout
The problem: privatizing small firms
There are many companies which could benefit from the injection of new capital and management that comes from privatization, but which are too small for a stockmarket floatation, or in which the real asset of the company is its own workforce. So how best to privatize these companies?
The idea: turn workers into owners
Where companies depend to a major extent on the performance of their employees, as most service companies do, why not let the workers themselves take the company private by becoming its owners?
In Chile in the early 1970s, one such company was CESMEC - Centro de Estudios Medicion y Certificacion de Calidad. Its role was measurements and quality certification. There were other state enterprises doing some of the same things, but the military government decided to close all but three (which included CESMEC), and sell those three into the private sector.
Then, at the last moment, CESMEC was told it would not be privatized; but nevertheless, it it would lose its operating subsidies from the government.
This news left CESMEC with a big problem. It was incurring major operating loses: in 1973 these amounted to 409 million pesos, and losses, or very slim profits, occurred in the subsequent years. Without subsidies, it could survive only by becoming profit-making, and for that it would need the increased autonomy and flexibility that only private-sector operation could give it. So a plan was drawn up by CESMEC's leadership, to achieve this privatization by convincing employees to purchases the enterprise themselves.
On 6 October 1977 the government reluctantly agreed to allow CESMEC to proceed with this privatization scheme - the first case in Chile when an entire state company would be sold to its employees.
The management team made 100,000 shares of stock available for employees of CESMEC to purchase, with preference based on the employee's current salary, years with the company, and level of responsibility. Out of the 87 employees offered first preference to buy stock in the company, 83 did so.
CESMEC employees knew the risk to be high. But it was the only way of saving their jobs. The managers were more confident, boosted by what they saw as recent positive trends. By 1978, six principal managers owned 36 percent of the equity.
The privatization had a clear effect on performance and motivation. Operating efficiency increased, as well as the income and profits of the company. By 1985 sales in CESMEC had tripled. And the government was saving money because it no longer had to pay out subsidies to CESMEC.
Example: road freight system
National Freight was one of only two companies earmarked for privatization by Mrs Thatcher's 1979 election manifesto in the United Kingdom. However, the government's advisers believed it would take perhaps three years or more to bring this under-performing haulage company to the stock market, so the search began for other methods of privatising it.
The company itself suggested the alternative: that it should be privatized into the ownership of the employees themselves. Under the proposal, all 23,500 employees would be given equal opportunities to buy shares in the new privatized company. The new company would not be run as a co-operative, but the employee-shareholders would appoint experienced and professional managers to run it, just as any other owners would do. To reassure the government that the firm would not be sold on for quick profit, the workforce signalled their long-term commitment to the enterprise by agreeing not to sell it within five years.
The management team had to convince not just the government, but the banks - whose support they needed to raise the capital to buy the company from the government and set about restructuring it. The banks gave them credit, but only in return for the managers agreeing to expose themselves fully to the business risk by taking sizeable stakes in the new enterprise. Communications with the workforce had to improve too: managers had to explain to individual truck-drivers what it meant to become a worker-shareholder, and to secure their agreement to the changes.
In all, the employee buy-out raised £7.5 million - some bank finance, but mostly from employees. Some 45% of the employees invested at that initial stage. There were no free shares or deals: everybody who wanted a £1 share had to pay £1 to get it. And at the first AGM of the new company, some 1,800 worker-investors turned up.
In 1981, National Freight had a bottom-line profit of around £1 million. By 1986 that had soared to £37 million, and turnover increased at the same rate. Before much longer, the company was able to point to its first millionaire - a truck driver whose investment had grown so much in value that he now ranked among the super-rich!
But National Freight was not unique.Austin Rover - a state-owned carmaker that was being sold to the already-privatized British Aerospace - wanted to dispose of its parts business, Unipart. So it allowed Unipart to be bought by its staff and institutional backers.
Assessment: a positive privatization tool
Employee buy-outs are a good way of privatising some companies. It may not be appropriate for large utilities or manufacturing companies, where the main asset is the capital infrastructure, and where very large amounts of money are needed to realize the value of the company. For them, a stockmarket floatation is preferable.
However, for smaller companies whose success of failure depends largely on its workforce and the efficiency of service they offer - the diligence, for example, of the ordinary truck driver in a haulage business like National Freight, it can work spectacularly well. Once empowered by ownership, the individual workers in such companies can identify where management and systems are poor and make sure they are corrected so that the performance of the company is turned round.
To manage the transition from state- to employee-ownership needs considerable skill from the lead managers, who have to learn new ways of communicating with the employees - the people who are now their bosses. Best results seem to come if the newly privatized company is run on normal commercial lines, rather than as some sort of political co-operative. And there are benefits in having rules to ensure that the employee-investors are committed to the enterprise for the long term, and not just out to make a quick return.
For further information:
- See Cesmec's website at www.cesmec.cl and also see www.poptel.org.uk/aries/buyouts/archive/msg00003.html.
- Thomson, Peter (1998) 'The Buyout at national Freight' in Butler, Eamonn (ed) The Mechanics of Privatization: Adam Smith Institute (London) www.adamsmith.org.
- For more general information on employee buy-out plans, see Young, Peter (1990) A Social Charter for Ownership: Adam Smith Institute (London) www.adamsmith.org.
- See also Bell, Michael G (1989) Incentive Through Ownership: Adam Smith Institute (London) www.adamsmith.org.
- For general information on privatization strategies, see Pirie, Madsen, Blueprint for a Revolution (download PDF 167kb): Adam Smith Institute (London) www.adamsmith.org.
- Brennan, Laurie (1990) 'The Mechanics of the Buy-Out' in Butler, Eamonn (ed.) Privatization Now! Adam Smith Institute (London) www.adamsmith.org.
Copyright 2002: Adam Smith Institute
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