Curse of the Rock Star CEO

Dave Lewis's first day at work was an unpleasant one. Having skydived into the top job at UK grocery giant Tesco earlier this year, Lewis was still rolling up his parachute when the company abandoned its previous profit forecast and slashed its dividend by 75 per cent.

It got worse. Three weeks later, on September 19, he had to announce that the company had overstated profits by £250 million ($465 million) in the first half of the year. The share price plummeted to below £2, a level not seen since 2003 and down roughly 60 per cent from its 2008 high.

Company overstates profit, cuts dividend and share price plummets.

There's nothing unheard of about that. But this is Tesco. The same Tesco feted by grocery retailers the world over. The same Tesco that had its every move successfully copied by Australia's Woolworths. The same Tesco on which hundreds of MBA case studies were written and the same Tesco whose long-standing chief executive was knighted by the Queen. How has it come to this?

While there are a number of issues Tesco is facing that are specific to the UK grocery market, there is also an explanation for Tesco's woes that is all too common.

I call it the curse of the rock star CEO. Terry Leahy began his career as a marketing executive at the supermarket chain in 1979. He departed the chief executive's chair more than 30 years later as Sir Terence Leahy, one of the most studied and admired businessmen in UK history.

Many of the accolades were deserved. Most of the successful grocery retailing initiatives of the past 20 years were introduced at Tesco. Its Clubcard and the customer insights that came with it spawned dozens of rewards replicas around the world. Tesco dramatically improved the quality of its home brand products, and grew this high margin category to 38 per cent of total sales in 2012. Woolworths Select range is a direct rip-off of Tesco's finest.

PEAKS AND TROUGHS

Earnings per share grew sevenfold between 1994 and 2012, and Leahy was awarded Britain's Business Leader of the Year in 2003 and Fortune European Businessman of the Year in 2004.

It's here that the problems started. Leahy and the rest of the management team started to read their own press and believe the hype about them.

This manifested itself in two disastrous ways.

First, they thought they could export their unsurpassed management skills to the rest of the world. By the time Leahy departed, Tesco was operating in 13 other countries across Asia, Europe and the United States. None have become as profitable as the UK was, and some proved disastrous. Tesco exited the US last year at a cost to shareholders of £2 billion and there are more country exits on the way.

All the while, new low-cost competitors Aldi and Lidl were entering the UK market and old competitors were catching up while Tesco dealt with its problems elsewhere.

Secondly, rock star CEOs become so obsessed with their reputation that they never want to disappoint. Analysts' expectations have to be met, even if that means pushing the envelope on accounting or underinvesting in the business. Tesco seems to have been guilty of both.

The recent admission of accounting errors suggests the company was booking supplier discounts before they were actually received. And a simple stroll around a Tesco store or a perusal of a few online forums will show you how much the company has underinvested in its stores.

MESS LEFT BEHIND

It should be a pattern familiar to many Australian investors. Whether Wal King's global expansion at Leighton or Terry Davis's underinvestment at Coca-Cola Amatil, long-serving rock-star CEOs often leave a mess behind them.

The reality is that none of these executives are as important as they, the press or we like to think.

There's no doubt Tesco's management did a lot of sensible and sometimes brilliant things. You can read all about them in Leahy's book, Management in 10 Words. But you won't find anything in there about the fact that the UK is rich and densely populated, the grocery business was highly concentrated and Tesco's main competitor, Sainsbury's, was distracted with similarly hubristic expansion plans at the start of Leahy's reign. These external factors contributed at least as much to Tesco's success as management.

Stephen Hester is one former boss who understands this. Hester chaired RBS in the years after its bailout by the UK taxpayer. Interviewed for Iain Martin's biography* of RBS's rock star CEO in the pre-crisis years, Fred Goodwin, Hester reflected on the reign of the much maligned Goodwin and his own impending departure as chairman: “Individuals are never really as important as they are made out to be. Whether in good times or in bad times. I've said to you before, I don't think Fred Goodwin was as bad as he's subsequently made out to be, and he wasn't as good as he was made out to be at the peak of his reputation.

“And the same will be true of me. I think life will go on remarkably quickly. Pages get turned. That's just how the world works.”

Shareholders would be better off if more executives recognised it.

*Making it Happen: Fred Goodwin, RBS and the men who blew up the British Economy.