It’s easy to see why big business is in disrepute. Whether it’s the oil companies’ systematic promotion of fossil fuels at the expense of climate change, big tech playing fast and loose with our privacy and our democracy, large pharma growing rich from selling high-priced drugs, manufacturers transferring whole industries along with their jobs to China or Mexico, big banks creating a mammoth financial crisis without being held accountable, executives’ self-dealing through share buybacks and exorbitant compensation, or the growing concentration of market power in many sectors, it’s no wonder that Americans’ once-sunny view of big business has shifted towards disapproval.
Jamie Dimon, chair of the Business Round Table.
Jamie Dimon, Chairman and CEO of JPMorgan Chase, speaks at the Bloomberg Global Business Forum, ... [+]
While in 1950 a poll found 60% of Americans had a favorable opinion of large firms, by 2017, that number had declined to 21% in a Gallup poll. Today, politician after politician promises remedial or even punitive action, and in August, big business itself signaled a shift: the Business Round Table, the influential US business group, amended its two decade-old declaration that “corporations exist principally to serve their shareholders,” yet without really clarifying what businesses do exist for.
Some reformers cry that firms must put “purpose before profit” and declare lofty social purposes. Take for instance the recent series of articles in the Financial Times on the theme of “purpose and profit.” It illustrates how the addition of wider social purposes risk getting us out of the frying pan of corporate greed and into the fire of corporate confusion. In the articles, Royal Dutch Shell, Novo Nordisk, Hitachi, Levi Strauss, Mars Inc, and Danone are mentioned as possible exemplars of firms that are trying to “combine profit with a wider purpose.”
Yet while it’s welcome that maximizing shareholder value is increasingly being recognized as—in the words of Jack Welch—"the world’s dumbest idea”— imagining that corporations might get out of their self-constructed moral doghouse by grafting a preachy social purpose on top of their profit motive may well be the second dumbest idea in the world.
Why Preachy Social Purposes Don’t Cut It
After several decades in which maximizing shareholder value has been the corporate orthodoxy, shareholder value is now embedded in the mindset, habits, practices, processes, systems of big business. It is enforced by Wall Street and its preoccupation with short-term profits, particularly in the case of firms that have no clear long-term growth strategy. Merely declaring a “wider social purpose” on top of these existing mindsets, habits, practices, processes, and systems is unlikely to achieve more than to create a façade behind which corporations will continue operating as before.
Indeed, the group of companies that Financial Times has assembled to illustrate the “firm with a broader social purpose” illustrate the issue.
Royal Dutch Shell is obviously one of the firms making money from the very fossil fuels that are causing climate change. Anjli Raval writes: “How should a company that generates most of its profits by meeting the world’s still-robust demand for oil and gas navigate the future as the political tide turns increasingly against fossil fuels?” The recent book, Kochland: The Secret History of Koch Industries and Corporate Power in America by Christopher Leonard gives a blow-by-blow account of how viable policy actions to deal with climate change were systematically thwarted by the petroleum industry over several decades. “Inspired by confectionery giant Mars,” Raval writes, “Shell has pledged to halve the emissions intensity of its products by 2050 and will link its short-term targets to remuneration for executives. Despite this raft of changes, Shell’s oil and gas business will account for the bulk of its capital investment and generate most of its profits for years to come.” As the FT article itself points outs, cleaner energy is now declared to be a more important part of Shell’s agenda, but it is hard to see any real change.
And if Mars Inc is to be the inspiration of “a firm with a wider purpose” as a result of its concern for nutrition, it would be good to know how this wider purpose relates to its actual business of making and selling products of such dubious nutritional value as Mars bars, Milky Way bars, M&M's, Skittles, Snickers, Twix, non-confectionery snacks, Combos, and pet foods, such as Pedigree, Whiskas, Nutro and Royal Canin brands. It is one thing to talk about nutrition. It is another to be doing something meaningful about it. (The Washington Post also reports that Mars Inc’s decade-long campaign to reverse deforestation has failed.)
Nor does the Japanese multi-year effort to improve governance at the sprawling Japanese conglomerate Hitachi seem like a convincing example of wider social purpose.
In another article, Levi Strauss is cited as an example of a private company that recently went public with an unusual pitch to investors, telling them that it would manage its business for the long term and not provide quarterly earnings forecasts. The IPO was over-subscribed. Levi’s CEO Bergh says: “I wanted Levi Strauss and Company to be and be seen as the world’s best apparel company, and among the best companies in any industry. That was the noble cause.” Yet it is hard to see how being the world’s best apparel company offers any clarity as to what Levi’s real goal is.
Danone is cited in an article by Andrew Hill as an example where the CEO proposed shifting about half Danone’s products — representing some $1bn of yoghurt sales — to non-GMO ingredients. The CEO argues that this is an important change that would improve soil health and biodiversity. Hill cites Jefferies’ sector analyst Martin Deboo summed up the doubts about Danone in a note about the French company published last year: “We worry that a too-obsessive pursuit of purpose-driven benefits and brand-as-social-advocate might blind Danone to the value of more mundane, but potentially broader, consumer appeals.” Indeed, if Danone believes that GMO ingredients are harmful, why is Danone selling them at all?
The insulin maker Novo Nordisk is a more plausible example of a firm with a social purpose, but it is hardy typical, given its philanthropic ownership. Sarah Neville explains that Novo Nordisk’s mission was formalized in 1989 when the Novo Nordisk Foundation was established: it owns all the company’s A shares, and controls 76.2 per cent of the votes, granting it an ironclad majority at annual general meetings. It distributes funds to support scientific, humanitarian and social causes.
Given this list of firms, one can almost sympathize with Jennifer Burns, an associate history professor at Stanford University, who is working on a biography of Milton Friedman and who contributes an article in the series attempting to re-argue the case that companies should concentrate on maximizing their profits. Grafting preachy social purposes on to a business is likely to cause confusion of purpose.
The Only Valid Purpose Of A Corporation
More fundamentally, adding preachy social purposes doesn’t address, let alone resolve, the underlying issue: what is the purpose of a firm? Most firms today are not focused sharply enough on what Peter Drucker considered as the real purpose of a firm. “There is only one valid purpose of a corporation,” he wrote. “to create a customer.”
Only one.
His foundational insight was formulated in 1954 in his book, The Practice of Management. “It is the customer who determines what a business is,” he wrote. “It is the customer alone whose willingness to pay for a good or for a service converts economic resources into wealth, things into goods… The customer is the foundation of a business and keeps it in existence.”
Drucker repeated the dictum in his 1973 magnum opus, Management, once again with the reasoning behind it. In his 1985 book, Innovation and Entrepreneurship, Drucker was equally adamant on the centrality of the customer. At the same time, the customer isn’t the only stakeholder. Making great workplaces is a secondary goal and avoiding social harm is a tertiary goal, but the only valid primary goal of a corporation is creating customers through continuous innovation.
Drucker's books
In 1954, Drucker presented his radical idea essentially without evidence. Indeed, it would have been a stretch of the imagination to accept that a firm like General Motors (GM) was in business for anything other than to make money itself. GM didn’t totally ignore the customer, and sometimes even recited phrases like “Our Customer Is Number One.” But when push came shove, the customer only figured in their thinking to the extent that it fitted the internal preoccupations, processes, systems and plans of the firm itself.
In fact, firms went in the opposite direction by espousing the maximization of shareholder value.
Then customers struck back. In the 21st century, power in the market-place shifted from seller to buyer. Through the Internet, globalization and deregulation, customers suddenly had choices, reliable information about those choices and an ability to communicate with other customers. The firm-centric marketplace turned into a customer-driven marketplace.
In this current customer-driven world, the customer experience is everything. Now a phone is no longer just a phone: it’s a multi-functional meeting every conceivable personal customer need. Now a car is no longer no longer just a metal transportation device: it has become a computer that delivers a unique customer experience. Now retail is no longer just a store: it’s an app on your phone that can deliver any one of hundreds of millions of products within a day. In this emerging new world, firms that were primarily focused on delivering continuous new value for customers are making huge amounts of money. Those that aren’t have struggled.
Social Purpose: The Risk Of Loss Of Direction
The sad truth is that we have been down the path of purpose diversification before, with disastrous results. In the period 1932-1970, managerial capitalism was understood to mean exactly that: meeting and balancing the needs of all the stakeholders. As expounded in the 1932 management classic, The Modern Corporation, and Private Property by Adolf A. Berle and Gardiner C. Means, the idea was that public firms should have professional managers who would balance the claims of different stakeholders, taking into account public policy.
The result? What management theorists came to call "garbage can organizations." These were organizations that couldn't make up their minds. Goals wandered in and out meetings and decisions happened randomly, depending on who was present. The organization often had no clear preferences or guidelines. It frequently operated on the basis of inconsistent and ill-defined preferences, goals, and identities.
This is a principal reason why shareholder value theory emerged in the first place. In 1970, Friedman took the logical step and said that if organizations are confused, let them focus on one goal: shareholders. (It made eminent sense to focus on a single goal since mathematically you can only maximize one variable. The trouble is: Friedman chose the wrong single variable: shareholders.)
The Real Challenge For Management
By 2019, the shift in power in the marketplace has taken effect and the Fourth Industrial Revolution is well under way. Firms that focused on continuous innovation for customers and are organized to be nimble, adaptable, and able to adjust on the fly to meet the shifting whims of a marketplace driven by end-users were flourishing, and have become the largest firms in the world. The examples are striking: Alibaba, Airbnb, Amazon, Etsy, Lyft, Menlo Innovations, Microsoft, Saab, Samsung, Spotify, Tencent, Tesla, Uber and Warby Parker.
The principal challenge of management today is not to pursue preachy social purposes but rather to create the capability of business agility to enable continuous new value to mercurial customers, while the public sector takes steps to rein any abuses of monopolistic power that may emerge from the very success of delivering value to customers.
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