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(originally published by Booz & Company)


More Than Words

The success of these schemes provoked their demise. Many schemes had a surplus of assets over liabilities. Successive governments were therefore keen to limit the tax relief the schemes enjoyed, so they placed restrictions on the amount of surplus a scheme could have. This meant—bizarrely—that it became more tax-efficient to reduce contributions to limit the surplus.

Then, just at the height of the schemes’ popularity in the mid-1990s, when companies and members had stopped contributing to the schemes, a number of problems began to emerge. People were living longer—which meant the funds would have to pay out more to members than the actuaries had estimated. (When the Tesco scheme began in the 1970s members lived 11 years into retirement: today it is more than 20 years.) Low inflation meant pension schemes’ liabilities—the pensions that the scheme would have to pay out in years to come—cost more to fund. This happened at the same time as stock markets underperformed their long-term average for nearly a decade, depressing investment returns for pension funds. Adding to the schemes’ woes, the Government changed the tax regime, making them much less tax-efficient. They also introduced a raft of legislation to protect people’s pensions (after a number of pension scandals), which made pensions much more costly to provide. Any one of these developments would have posed a significant challenge to a pension scheme. Taken all together they brought into question the viability of pensions as a company benefit.

What I expected would happen—and what was needed—was a debate about long-term savings. Instead, the defined benefit company pension scheme, which had been so lauded, was suddenly friendless. A trickle of companies announced the closure of defined benefit schemes, replacing them with defined contribution schemes or, in some cases, no scheme at all. And that trickle soon became a flood.

A defined contribution scheme shifts the liability from the company (usually an experienced investor and administrator) to an individual who generally has little experience of investment or administrating a pension. If managed by the individual who is paying into their own pension, advisers’ fees can eat up 30 to 50 per cent of an uncertain return. So one consequence of the move to this type of scheme was a decline in the value of a pension. Another was a decline in employee loyalty, as people came to feel that the company they worked for no longer cared about their retirement.

Tesco, the largest private employer in the UK, was affected by these challenges like everyone else. Our advisers said that we should follow the herd and join the stampede for the exit. The board did not agree. We decided instead to modify our defined benefit scheme from one based on an employee’s final salary to one based on the salary earned over the employee’s career. The scheme member would still have a defined benefit at retirement, but the cost to the employer would be both more predictable and, in some cases, slightly lower.

We took a different path from most other companies, for several reasons. All Tesco’s staff had always automatically enrolled into our pension scheme, so the vast majority of staff were members. Our pensions, therefore, were not a perk for a few senior employees, but something in which everyone had a stake and an interest. Furthermore, on our board sat both long-serving executives (who had grown up in the company and readily identified with the employees) and independent directors: they all understood that the Tesco pension benefit was one of a number of long-term benefits that allowed relatively low-paid staff to share in the company’s success. Consequently, the board always recognised pensions as part of a wider culture which rewarded staff loyalty, and contributed to high staff morale and commitment—all vital to the success of the Tesco brand.

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The Reviewer

  1. George S. Yip is a management professor and codirector of the Centre on China Innovation at the China Europe International Business School in Shanghai. His books include Strategic Transformation: Changing While Winning (with Manuel Hensmans and Gerry Johnson, Palgrave Macmillan, 2013) and Managing Global Customers: An Integrated Approach (with Audrey J.M. Bink, Oxford University Press, 2007).

This Book

  1. Management in 10 Words: Practical Advice from the Man Who Created One of the World’s Largest Retailers (Crown Business, 2012), by Terry Leahy
  2. Terry Leahy was the CEO of Tesco PLC for 14 years, during which sales and profits quadrupled. He was knighted in 2002 for his services to food retailing and named the Sunday Times Business Person of the Year in 2010. Since stepping down as CEO of Tesco in February 2011, he has served as a senior advisor to Clayton, Dubilier & Rice, a private equity firm, and chairman of B&M Stores, a discount retailer.
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