The Business Case for Purpose
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Originally published in MISC Magazine, 2018
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9 MINUTE READ
It has become very fashionable for consultants and business professors to encourage companies to ask “why” they are in business. What is their raison d’être, beyond just making money? Or is that all there is?
After almost 40 years of neoliberal economics, the prevailing and very entrenched answer to this question is that a corporation’s sole purpose is to maximize shareholder value. And the primary metric of that value is stock price. This has become orthodoxy in both business and the academy to the point where, as pointed out by Miguel Padró in a 2014 publication for the Aspen Institute, MBAs leave school “believing that they are legally and morally obligated to maximize stock price for their investors.”
In other words, it has become religion.
There is no law that obligates corporations to maximize shareholder value. As the above-mentioned study asserts, even Delaware corporate law – the most shareholder-friendly in the United States – remains “fundamentally ambivalent about defining the purpose of corporations.” It may not be a legal requirement to put shareholders first, but to oppose that notion has in the last few decades been considered blasphemous.
Why did this particular definition of corporate purpose catch fire in the first place? From the time the corporation as we know it emerged in the mid-19th century until the Reagan administration, the debate about corporate purpose was unresolved. But since it was “fundamentally ambivalent,” and since business abhors ambivalence, the simplicity and irreducibility of shareholder value was eagerly embraced. Here was one data point, one simple metric, the ultimate reduction of all the value chain’s inputs and outputs into a single, tidy little number. It was as if we had finally reached the apotheosis of modern business thinking, the ultimate “less is more” moment. Henceforth, all of the messy contexts and complexities of corporate reality would answer to one call: the one the CEO made to analysts every quarter, in which the most important question was, “Will the stock price match, exceed, or miss our expectations?”
Corporate Taxes: Expectation vs. Reality
To those against the primacy of shareholder value, this quarterly trial by fire automatically prioritizes short-term decision making and encourages all kinds of gaming designed to keep the stock price up, from spreading false rumors to executing share buybacks. It is also seen by non-believers to deprioritize the creation of long-term strategic value for both the enterprise and the communities in which it operates. If the corporation is primarily focused on keeping analysts and shareholders happy in the short term, all other constituents – from employees to customers to communities – lose in the long term.
We can see this in the context of taxation. Neoliberal orthodoxy dictates that reducing corporate taxes is a necessity for remaining competitive in the global marketplace. In the US, everyone complains about the statutory corporate tax rate of 35%. But due to the complexity of the tax code and its many loopholes, incentives, and subsidies, corporations actually are more likely to pay an average of 13-19%. According to SEC data, 15 of the largest Fortune 100 companies, with combined revenues of over a trillion dollars, paid almost zero (0.059%) in federal income taxes in 2016. Between 2008 and 2015, US utility companies paid an effective rate of 3.1%, telecoms paid 11.5%, and internet services paid 15.6%. Sounds like 35% was just a suggestion.
Tax incentives and subsidies are meant to encourage job creation and economy building. But that’s not what’s happened. Instead of investing in growth and innovation, corporations are hoarding their cash. US firms are sitting on cash reserves of $1.9T at home and $2.5T abroad. They are awash in capital. Without corporate paying its fair share of income taxes, communities suffer. Corporations not only get access to public infrastructure – they also escape the responsibility of building, maintaining, and upgrading it. The communities that share that infrastructure, on the other hand, bear the burden. As Matthew Gardner, Senior Fellow at Washington’s Institute on Taxation and Economic Policy, said in a recent New York Times article, “When the biggest companies aren’t paying their fair share, that means the rest of us are left to pick up the slack. It means small business and middle-income families are paying more.”
Unfortunately, the middle class is shrinking just as its tax burden, along with the cost of living, is climbing. According to a March 2016 paper by Stanford’s Sean F. Reardon and Cornell’s Kendra Bischoff, middle wage earners shrank from 65% to 41% of the population between 1970 and 2012. Over the same period, middle class wages have stagnated. In 1973, the median hourly wage was $4.14. In 2014 dollars, that would be $22.07. Meanwhile, the median hourly wage in 2014 was $20.74. In 2014 terms, that’s actually over $2000 a year less than it was 44 years ago.
Tax avoidance (or “tax efficiency,” as it’s euphemistically referred to) is only one of the tools employed by corporations to prioritize shareholders. Globalization, privatization, and financial deregulation have contributed significantly to the bottom line, even as they have hastened the deterioration of the middle class through job shrinkage and wage stagnation. The middle class, once the engine of consumption and the bulwark of North American prosperity, is in a state of growing precarity. And when that engine sputters, the market will not be far behind.
The Business Case for Purpose
In a 2006 Harvard Business Review article entitled “Strategy & Society: The Link between Competitive Advantage and Corporate Social Responsibility” by Porter and Kramer, and again in the January 2011 follow-up piece by Porter entitled “Creating Shared Value: Redefining Capitalism and the Role of the Corporation in Society,” Porter came to the conclusion that shareholder primacy was unsustainable. But his motivation wasn’t entirely altruistic; it was based on the belief that by considering the corporation’s broader impact on society and the environment, companies could actually develop greater competitive advantage.
Here was an argument for taking a balanced approach to sustainable prosperity that was framed within a set of business principles as opposed to moral ones. By leveraging “innovation in new technologies, operating methods, and management approaches,” Porter suggested, “a firm can improve society while increasing their productivity and profitability.”
He provided three ways in which to achieve this balance:
Re-conceive products and markets to provide appropriate services and cater to unmet needs. For example, the provision of low-cost cellphones developed new market opportunities as well as new services for the poor.
Redefine productivity in the value chain to mitigate risks and boost productivity. For example, by reducing excess packing in product distribution, a business could also reduce both cost and environmental degradation.
Enable local cluster development by improving the external framework that supports the company’s operations. For example, this could be achieved by developing the skills of suppliers.
This was an attempt to apply business logic to the challenge of shared prosperity. It was never, in Porter’s own words, about “being a good corporate citizen, but being a better capitalist – it’s a win-win.”
Being a “better capitalist” sounds like it would be more motivating to a businessperson than being a “good corporate citizen.” But the idea that you can be profitable by being considerate of people and the environment has not exactly caught fire, due in part to the fact that rigorous analysis of the impact of shared value mechanisms has been lacking.
Despite these shortcomings, there are some examples of Fortune 100 companies and leading consulting firms that have adopted these principles. Unilever CEO Paul Polman has become the poster boy for fusing social purpose with business success. Unilever can lay authentic claims on the link between business and society, as it was founded in the 1880s by creating the world’s first branded bar of soap (Sunlight) to combat disease and infant death in the abject poverty of Victorian England.
More than 130 years later, Polman sees the world through a very similar lens, pointing out that over 160 million children in the world are stunted from malnutrition, 8 million people die prematurely each year from pollution, and the world’s richest 1 billion people consume 75% of its natural resources. In a February 2017 Fortune magazine article, Polman remarks, “We’re wasting 30-40% of the food in this world, whilst millions go to bed hungry. Why do we not have the moral courage to attack that?”
Could it be that the allure of short-term gains makes it impossible for some investors to summon the patience required for a long-term strategy? In response to this attitude, Polman has famously limited profitability guidance for investors and analysts to once every six months. He sides with those who argue that “the tyranny of the quarterly report traps public companies into continually trying to drive up share prices for investors, while downgrading more long-term, complicated missions, like improving working conditions and the environment.” It was a bold move for the CEO of one of the world’s largest food producers to make. Time will tell if the rest of the market has the sense – or the patience – to embrace it.
Learning to Look Beyond Shareholder Primacy
“Leadership is about who the leader is, not what the leader does… the most successful leaders are strong characters, and have a strong purpose – they do not just focus on shareholder value which is too narrow, and too short term.” These are the words of Dominic Barton, Global Managing Director of consulting firm McKinsey & Company. He notes that there will be 2.2 billion new middle-class consumers by 2030, most of them in Asia and Africa. At the same time, there will be increasing challenges to the availability of natural resources. “This is why climate change and sustainability are business issues,” he says.
This focus on the middle class – shrinking in the west while growing in the east – is a reflection of the role it has historically played as the engine of shared economic prosperity. As Robert Reich has so often said, if you keep taking money out of the pockets of the middle class, there will be no one to buy your products and services. So it may come as no surprise that, after years of austerity and slow-to-no growth, people are looking for something more from corporations and business in general. If you are keeping wages stagnant for decades and not creating jobs, and if you enjoy corporate tax reductions paid for by cuts to public services to the point where schools, hospitals, and social programs are in a state of steady deterioration, then you better have something else to offer.
In a recent EY paper entitled “Winning with Purpose,” research revealed that 89% of customers believe that purpose-driven companies deliver higher quality products and services. In an Edelman study, 72% of respondents said that they would recommend a company with a purpose – a 39% increase from 2008. The Havas Meaningful Brands Index claims that between 1996 and 2011, purpose-led companies performed 10 times better than the S&P 500 in terms of revenue growth. In the same study 75% of people reported expecting brands to improve wellbeing and quality of life, but only 40% believe they are doing so.
It’s no surprise that people wouldn’t care if 74% of the brands existing today were to disappear. If these stats are to be believed, purpose is looking more like a source of competitive advantage than ever. As an indicator of how much this concept has taken hold, the September/October 2017 issue of Harvard Business Review ran an article that, in HBR tradition, codifies the approach to competing on social purpose.
The fact that the article was co-written by a Coca-Cola executive and a business professor for the benefit of large multinational corporations like IBM, Google, Fedex, and VISA is a signal that some of the giants are paying attention to the stats listed above. One would love to believe that this is the result of a shifting moral perspective. But in the perverse logic of neoliberal economics, the market’s only moral compass is shareholder primacy. For purpose to replace that would require a profound paradigmatic shift – or a socioeconomic catastrophe even broader and deeper than the Great Recession. Let’s hope for the former.