October 2016


A game theory

By Richard Cooke
James Lovatt
James Lovatt, supplied
Lovatts Crosswords gave its profits to employees. What went wrong?

“The most fundamental fact about the ideas of the political left,” wrote the libertarian conservative economist Thomas Sowell, “is that they do not work.” Before writing this off as a typically abrasive overstatement, we must make a small concession: most of the time the purer egalitarian models of the harder left haven’t worked very well in practice. That failure doesn’t always look like cranes pulling down Lenin statuary, either. Sometimes they are much smaller, basic breakdowns of co-operation. The free-rider problem. The tragedy of the commons. The game-theory player who succumbs to the “screw you, buddy” impulse and defects.

As unions leak away from the workplace and Chavista Venezuela runs out of state-made toilet paper, those invested in equality are again looking within the confines of capitalism itself. Economists are studying employee ownership, profit shares, worker-owned factories and even Wikipedia. There are prominent prototypes: after a bout of depression and a terse conversation with an employee, the CEO of Seattle-based Gravity Payments, Dan Price, raised the company’s minimum wage to $70,000, slashing his own remuneration in the process. He was denounced by political commentator Rush Limbaugh: “This is pure, unadulterated socialism, which has never worked.” The scheme was imperilled when Price’s co-founder (who is also his brother) filed a lawsuit, attempting to force the company’s sale. But the suit failed, and Gravity’s employees combined to buy their boss a Tesla.

There is a curious Australian precedent for this kind of enterprise, though, a blueprint before its time. I found this out by chance during a conversation at a party, and later discovered that the people responsible were keen to explain what had happened, either as a warning, or a lesson, or just because it’s a good story. “Have you ever heard of Lovatts Crosswords?”

I had. If you walk into a newsagency and see a big book of sudoku or other puzzles, that book is likely published by Lovatts Crosswords & Puzzles. The company supplies crosswords to many magazines as well. It is well respected in the publishing world. I did not know that it is a family company, one that used to have a very unusual structure. The man at the party turned out to be Dom Lovatt, son of the founders, and over the years the company’s business model had cost his family a fortune. A large proportion of the profits had been paid back to the staff.

“But here’s the thing,” he said. “It didn’t work. It didn’t make people happy. My parents had to end it. It made people crazy in the end.”

When I finally contacted one of the founders, James Lovatt, he was overseas. But he emailed me back almost straight away: “If you’re willing to wait, it’s a salutary lesson to business on the unintended consequences of what seemed like a splendid idea at the time but turned out to be a complete disaster (rather like communism).”

James Lovatt would meet me in a hotel lobby, and bring along the CEO of three years, Rachael Northey, who had taken over the day-to-day running of the company from him. Usually, an executive presence in this kind of interview isn’t very welcome – it’s there for damage control and spin, to make sure nothing embarrassing is said. Today it was valuable. It had been Northey’s job to clean up the scheme when it had failed, and she understood what had gone wrong. Lovatt and Northey are very different people – en route to our meeting they had joked about just how different they were – and together they represented two distinct eras in the company’s history.

“Whereas James is a socialist, I guess I’m more a benevolent dictator,” Northey says.

Northey is kindly but unmistakably corporate. She has overseen a period of profitability that’s now very rare in offline magazines. Lovatt is avuncular and a little eccentric, a product of the “stack ’em high, watch ’em fly” publishing days before the internet, when more ramshackle organisations could still be immensely profitable.

“So, after everything that happened, are you still a socialist?” I ask Lovatt.

He is, and always has been, although he doesn’t know why. There is a persistent and persuasive family rumour that he may be the biological grandchild of George Bernard Shaw. Something in the blood. When he first came up with an egalitarian vision for his new company, he felt like a revolutionary. “I thought I was the only one in the world,” he says. “And, well, there weren’t many. I thought, This is the way to go. The people will talk about me years from now, as this was the way to do it. You know, a socialist inclusive company running on democratic lines.”

The only trouble with the enterprise, he now says, is that “it was crap”.

Time has made Lovatt bemused by the experience, animated but not agitated, and genuinely curious about what exactly went wrong. Fortunately, Northey has a knack for opening up the black box at the former crash site and interpreting its contents.

“My experience in the past,” she says, “with any kind of discretionary bonus or bonus scheme is this: The first year it’s a wonderful gift and a bonanza. The second year it’s ‘thanks very much, that’s great’. And the third year … the third year it’s anger and sort of irritation. If it’s not what [the staff] expect.”

“I should have met you years ago,” says Lovatt.

People magazine, where Lovatt started work as a journalist in the 1970s, was not a natural incubator of managerial expertise. “We thrived on boobs and shark stories,” he says. “They were the main things.” The Fairfax board had mixed enthusiasm for this thriving. One of the executives, Vic Carroll, was not keen on the shark stories (his son was a professional surfer, after all). And Lady Fairfax “would be getting ribbed at dinner parties about all the boobs. So she actually sent us a message once saying we were allowed ten nipples a month.” The edict was ignored, the nipple count doubled, and copy sales grew to 350,000.

Among the sharks and nipples, People also had a crossword that claimed to be the world’s biggest. It was so popular that many women were also buying the magazine. Lovatt’s wife, Christine Lovatt, had a knack for compiling crosswords (she worked on People’s), and together the couple suggested that Fairfax bring out a dedicated book. It was a huge success, but had to be painstakingly compiled by manual means. A computer programmer changed that, and in 1978, with a business partner, the Lovatts started their own publishing company, then called Puzzle Press.

The hiring for the new firm, like everything else, was unorthodox. Staff were selected from friends, some of whom had previously joined the Lovatts on a transcontinental double-decker bus ride. In an old interview, Lovatt described his role as that of musical conductor: “I couldn’t necessarily play the trombone as well as somebody else could and I couldn’t play the violin, but I could get them to play together.” He now thinks that makes him “sound like David Brent”. But the new employees were encouraged to be creative. Job titles, departments and budgets were an afterthought.

Then came a consequential brainwave. “I was in the pub – all great ideas start in the pub … Well, it wasn’t that great, as it turned out, but we thought it was. The art director at the time, Andrew Drane, he and I thought, What would motivate us to be interested in staying with the company and not moving? And because we’d had enough beers, we didn’t really stop and think. We just said ‘money’. We were wrong. I mean, it’s taken me 30 years to realise that. We were actually wrong.”

“Hiring a lot of friends,” says Northey, “might have played a part in your decision. You felt, Oh well, we shouldn’t be getting rich and all our friends are not.”

Lovatt still seems split on whether it was ultimately a business decision or a moral decision. He’s keen to downplay the altruistic aspect, but is not entirely convincing. The dividend scheme began on the principle that it would motivate employees as well as remunerate them. Lovatt says that it also “just seemed the right thing to do”. At first, the plan was to take the company’s profits and pay them back to the staff in the form of fully franked dividends on top of their salary. The payments would be scaled to salary as well, with more senior employees taking a bigger slice of the pie.

Christine Lovatt was less convinced. She thought the dividends might be a bad idea, and she could see trouble later on. But revolutionary fervour triumphed, and soon spread to the staff. They voted to change the scheme: instead of being proportionate to income, all the employees would instead receive a flat rate. “Socialism gets replaced with communism, if you like.”

“There were some people there who were actually talking themselves out of $13,000 tax-free a year,” says Lovatt. “Now that’s altruism.” In a good year, the fully franked dividend could reach $20,000 on top of their wage – enough for an employee’s spouse to stop working. The Lovatts bought a farm, intended as a kind of communal holiday home for staff and their families. That bucolic touch was partly inspired by the John Lewis department store business in the United Kingdom, which had provided subsidised holiday homes for its shareholding staff, who are known as “partners”.

The company was a success, and the Lovatts and their staff took great satisfaction from the pleasure their books provided. For the old and the lonely in particular, the puzzles were hugely important.

“I love the fact that we get thousands of letters from people saying how much the puzzles mean to them,” says Lovatt.

“It makes what we do a meaningful occupation,” says Northey.

“It was like making aspirin,” says Lovatt. “And you suddenly discover you’re saving people having heart attacks.”

Internally, though, the high sales papered over problems. What Lovatt now calls the “sniffs of anarchy” had begun. “If I look back, it was probably only three or four years before I realised that it was maybe not …” He trails off. “I just felt it was right. That was the only reason then. It was no longer the feeling that it was good for the company, it just felt morally right by that stage.”

“When I came into the business [in 2008 as content and publishing manager],” says Northey, “there was definitely some anarchy going on.”

“Nepotism, anarchy – you name it, we had it,” adds Lovatt. He sounds almost a little proud.

The flat structure and lack of discipline were supposed to let staff self-organise, come up with new ideas and innovate. But instead of competing against other companies, the staff began to compete with one another.

“The effect of unintended consequences, I think it’s broadly known as,” Lovatt says ruefully.

“It becomes the schoolyard,” Northey says. “It becomes more about the values and the agendas of the powerful individuals. But their agendas are not necessarily aligned with the best interests of the business. It’s usually about establishing power and control. They splinter. They don’t pull together, they fall apart and the silos become really entrenched.”

Lovatt blames his own bad management for the fiefdoms. He couldn’t bring himself to fire friends or even tell them that they were underperforming. Instead, he would bring in a replacement but keep the old person in the role as well, and tell neither party what was happening. The compiling department had eight staff who all thought they were in charge. Not surprisingly, former employees remember an atmosphere of “narkiness” and “bitchiness”. Lovatt himself felt under increasing pressure, trying – failing, really – to manage his arguing friends.

At the heart of the uncertainty were the dividends. They had come to be expected, sometimes even pre-spent, regardless of the profit forecast. And they weren’t resulting in innovation but the opposite.

“Instead of making the people working there push, so there were 50 of us pushing for more profits, there were two of us pushing for profits. Christine and myself,” says Lovatt. “Everyone else saying, ‘Oh no, we don’t want to do that. No, no, that’s too risky, oh God no. We’re OK as we are.’ No one wanted to take a risk, no one wanted to invest in a new magazine or a new project, because they were worried about it affecting the bottom line of their dividend.”

One employee even realised that the dividends could be calculated in August, but were only being paid in December, and threatened to take the company to court. The Lovatts’ utopian vision of a modern socialistic company was falling apart, and Lovatt himself felt demoralised and betrayed. His friendship with staff and his gentle touch seemed to be taken for granted, or even looked down on. The dividends were costing him and Christine a potential fortune, and had become a source of languor and division. He was so stressed that it was affecting his health. Finally, he says, he “exploded” and “read the riot act”.

The occasion was the staff Christmas party.

“I was on the point of tears and I did something that was very uncharacteristic,” he says. There’s a pause. “I hope.”

Before addressing his staff, Lovatt searched online and found an advertisement for an island for sale in the Bahamas. It was priced at $8 million, including staff and a motor launch, about the amount of money that had been sunk into the dividends over the years. He copied the ad into a slide show, stood on a milk crate and delivered an angry presentation.

“Christine and I, we could have bought this!” he started. “Instead, over the last few years we have paid this money in dividends because we felt that it was the right, moral, honourable way to go. But quite honestly, from all the S-H-I-T that I’m getting back from people, with a few exceptions, I wish I’d never even started it! We could have bought a desert island in the Bahamas with staff and a boat and everything for the money that we have spent on this! And all it’s done is bring us grief all the time.”

So how did the staff react? I ask.

“They ignored it.” By this time, Lovatt’s emotional outbursts were becoming more frequent, and staff had begun to ignore him when he blew his top. They were his friends, after all. One had even asked why he was standing on the milk crate.

“A very, very close friend said, ‘What are you doing, big-noting yourself?’ I thought, Is that seriously what you think?

“Once the company was being run by others, some of those people did leave. And they still don’t talk to me. If you want to lose your friends, here’s my advice: employ them. Because even if you’re not running the show, afterwards you’re still considered to be the person who could have intervened and changed things around … I’ve got more friends in Russia now than I have here. That sounds pathetic, doesn’t it?” Lovatt smiles.

The scheme was becoming untenable, not only emotionally but also financially. The 2008 global financial crisis took a huge gouge out of Lovatts. Rather than letting staff go, the management team instead asked them to work a four-day week. Anyone who wanted to work the extra day on Friday, to help pull through the tough times, was welcome to do so.

Northey had joined Lovatts not long before the GFC hit, and as a result never benefited firsthand from the dividend scheme. She was surprised to find that she was one of only two employees working the extra day. The other staff member (now the chief financial officer) who volunteered to work the extra time was also new.

“We’d never participated in that bonus scheme at all,” says Northey, “and yet every other person who’d taken all that extra money …

“We sort of said, ‘Look – this is a time when you can choose to come in and muck in and help the company through, or you can have the day off. It’s completely up to you.’ And they all took the day off.

“And I think that’s what’s most telling. And so they just took the day off and felt very angry at James and Christine for doing this to them.”

Lovatt was surprised as well, and by this time too stressed to take any satisfaction from management. “Christine’s mother used to always say how strange it was, that the mothers who really paid attention to their children, in total detail, they tended to get ignored when the children grew up. Whereas the ones who said ‘Oh get away, I’m busy’ had children who adored them.”

Lovatt moved the company offices from Sydney to the NSW Central Coast to reduce costs, and then agonised about the possibility of staff having mid-commute car crashes for which he would somehow be responsible. Finally relinquishing management of the business in 2013 came as a relief.

“I think,” Northey says, summing things up to Lovatt rather than to me, “one of the principles on which you founded this idea of the business, and giving those large dividends, was flawed logic to some extent. Because there was this assumption that all those individuals would actually put their shoulder to the group effort. But they didn’t know what to do, individually, or where to put their effort. Not many of them were commercially astute. Not many of them had come from other publishing companies or had experience in the industry. They’d come from a variety of sources, just neighbours or people you might have met in a bar. Someone who seemed like a good chap.”

“Or from around the world,” says Lovatt.

“Now [the staff] know what their role is. And that doesn’t mean they can’t be innovative and creative, but they’re working together better because they’re not so worried about defending their space in the company.”

“It was bad management,” says Lovatt. “Come on, let’s be honest.”

There aren’t many employees left at Lovatts who experienced the dividends scheme. It is the stuff of legend. But those who did say things are calmer now, that the company is a more relaxed and fulfilling place to work. Their salary reflects their financial worth, and they are more appreciative of additional recognition.

I ask Northey if she thinks the scheme would work today, and am surprised when she says yes.

“We already have the structure and expectation. If I could engage people in feeling personally responsible for their contribution … They know what they need to do. Whereas I think, once upon a time, there was money there but no one had any idea how to change [the company] or improve it.”

“You’re cooking with the same ingredients,” says Lovatt. “You’re just using a different recipe and getting a cake that looks very tasty. Whereas mine was something like … the dog had had a bad night.”

“In fact, we still have a discretionary bonus sometimes,” says Northey. “But I’m very careful about how I go about paying that.”

Richard Cooke

Richard Cooke is The Monthlys contributing editor. 


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