Thursday, November 27, 2014

The Business of Business is More Than Business

BERKELEY – Earlier this year, Robert Simons of Harvard Business School fired off a blistering indictment of American businesses and business schools. American companies, he charged, have become softheaded, unfocused, and uncompetitive, in part because business schools are persuading them to embrace a long list of gauzy, feel-good values, such as social responsibility, environmental sustainability, and inclusiveness.

Reviving a famous broadside by Milton Friedman back in 1970, Simons argued that a company’s only mission is to “compete and win.” Friedman, too, maintained that anything except making money is a distraction.

It is difficult to deny the appealing simplicity of this argument. Who would deny that companies have a clear responsibility to earn profits for their shareholders, or that most shareholders invest primarily to make money, not to make the world a better place? Why make things more complicated?

Because they are.

First, most references to Friedman’s argument overlook his recognition of constraints on business behavior. In his words, companies should “make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.” In other words, compliance with the law is not enough. Some ethical constraints, such as basic human rights, reflect universal values; others vary across time, location, and situations.

Second, not all shareholders are alike. As Lynn Stout of Cornell Law School has put it, they are “human beings with differing investment time frames, different interests ex ante and ex post, different degrees of diversification, and different attitudes toward sacrificing personal wealth to follow ethical rules and avoid harming others.” They also differ in their attitudes toward risk.

Maximizing shareholder value over a particular time period may satisfy the interests of some shareholders but violate the interests of others. The simple theory of profit maximization assumes away the conflicting interests of diverse shareholders. In reality, when businesses make decisions, they have to balance these interests.

Third, businesses can also affect shareholders’ interests over time. Individuals gravitate to organizations that are compatible with their personal preferences. So companies can attract like-minded shareholders by espousing distinctive values, missions, and cultures.

A recent study found that patient shareholders account for a larger portion of the shares of companies that espouse a long-term sustainability agenda relative to companies committed to share-price maximization. A growing number of investors are looking for responsible investment or “impact investment” opportunities that promise a mix of both financial and social returns.

Fourth, every company both depends on and affects the societies in which it functions. The larger and more global the company, the larger and more global are its societal effects.

Companies need customers who can afford their products, which means that businesses benefit from social stability and broad prosperity. Companies also need educated, hard-working, ethical employees and reliable, efficient suppliers. And companies need public infrastructure – not only physical infrastructure like highways and airports, but also social infrastructure like good schools, safe neighborhoods, and effective legal systems.

Businesses that ignore the broader social and environmental context in which they operate are likely to pay a price: reputational damage and loss of brand value, falling sales, difficulties in recruiting talent, lower worker productivity, corruption, tougher government regulation, or an increase in climate-change-related costs.

There are now mobile phone apps that assess and grade large multinational companies’ supply chains for customers, investors, and public officials. Companies that score poorly risk losing sales and investors and triggering official regulatory or legal action.

For example, Apple’s brand was recently shaken by revelations about brutal workplace conditions at Foxconn factories in China, where most of its iPhones and iPads are assembled. In response to concerns among customers, employees, and shareholders, Apple has improved working conditions and agreed to regular reviews by an independent observer. Similarly, American and European clothing companies have been struggling to contain the reputational damage caused by lethal working conditions in Bangladeshi garment factories.

The Friedman-Simons view that businesses’ sole social responsibility is to increase profits assumes that competent, non-corrupt governments both provide the public goods necessary for a prosperous economy and contain the negative externalities, like pollution and climate change, that result from private economic activities. But, in the actual societies in which businesses function, governments are often unable or unwilling to provide required public goods or curb negative externalities. In response to “government failures,” companies face pressure from a variety of stakeholders – including incompetent and corrupt governments themselves – to address broad social and environmental problems.

But businesses cannot solve such problems by themselves. Solutions depend on innovative collaboration among private companies, non-profit organizations, and governments. This is already happening. For example, Walmart has teamed up with the Environmental Defense Fund to devise a strategy to eliminate 20 million tons of embedded carbon in the products on its shelves. Likewise, the European Union, the International Labor Organization, and the government of Bangladesh have cooperated with global companies on a pact to improve conditions for Bangladeshi garment workers.

Companies have a responsibility to their shareholders, but they also have a responsibility to the societies that grant them the right to operate. And they can fulfill both responsibilities profitably. There is no evidence for Simon’s assertion that a commitment to social or environmental values is undermining US companies’ competitiveness. In fact, recent evidence suggests the opposite: social and environmental responsibility can be a source of long-term competitive advantage.

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    1. CommentedJohn Shin

      The most ardent follower of the "win at any cost" dogma is Samsung which actually serves the family who owns just one percent of the company.

    2. CommentedNathan Coppedge

      Flawlessly argued, up to a point. I agree, because I feel that the 'new factors' are the techne or technology of future businesses. They have to 'speak the lingo' and the new social media and environmentalist interests are the nature of the service. If nothing else, speaking the language would help these potential innovators to connect with like-minded people who have been fed the same dialectic. There is probably a hidden exception which goes Simon's way, but whether it is an achievable end for everyone is another matter. It seems to me that what Simon is appealing to is an ineffable 'right stuff', which he feels is not equatable inherently with the new mentality. He is undercutting the 'loaded plate' to appeal to the most ambitious individuals.

      As I see, the author of this article has turned it on it's head, which is not such a bad thing to do. Social media and environmentalism could just as easily be the right stuff, and it is afterall more likely that this approach is closer to the minds of the new generations.

      What is the business mentality of the future? I suspect it is growing more scarce and more prolific, and more and more depending on apparatuses of social dictation and government resourcefulness to be realized. I really hope some of the future innovators are not flying by the seat of their pants one way or the other.

    3. CommentedZsolt Hermann

      Thank you for the interesting and informational review article. It is a very complicated issue, and although the example is from the business world, this paradox applies at all levels of our lives. The "Friedman-Simons view" is not evil as many people would paint it, actually that is the only honest view. This view looking at the world through ruthless competition, and sole focus on self-profit is the direct representation of our inherently self-centred, egoistic, greedy human nature. We are all operated by the same nature and how strong this inherent "hunger", "desire to receive for the self" is determines our place in the pyramid of humanity. And up to this point it seemed this inherent nature drove us through our development, expanding, conquering, amassing fortunes. We would not be asking these questions today if humanity did not evolve into a global, integral system where each and every one of us became interconnected and interdependent. In this new integral system the previous attitude, "operating software" suddenly makes us behave like cancer in a single body, our previously successful system has become self-destructive. This is what the deepening, seemingly unsolvable crisis represents. Thus I fully agree with the fourth point of reasoning in the article: "...Fourth, every company both depends on and affects the societies in which it functions. The larger and more global the company, the larger and more global are its societal effects..." The question is how can we motivate people to take on this notion not only in theory, not only in order to adjust to make more profit, simply exploiting the system in a more cunning, modern way as most leading companies like Apple do today, but in order to truly build a completely new, mutually complementing and equal system, where benefiting, sustaining the community, the environment is primary, and profit is secondary? This is only possible by explaining, teaching people both in theory, and more importantly in practice that in our new, global and integral human system, mutual cooperation, mutual responsibility instead of ruthless competition and exploiting for more profit is the only way each of us can prosper, or even survive. We have all the data, scientific studies, and through the crisis the real life experience to start changing people's attitude and our socio-economic system in a way that we adapt to our new circumstances. Such an adaptation would open up possibilities and prosperity in a way we did not even dream about before, simply as mutual, collective cooperation can propel us to unprecedented quality of life above our present subjective, isolated, fragmented, competitive existence.

    4. CommentedProcyon Mukherjee

      The social costs of running a business (externalities included) are seldom borne by those who profit from it and sustainability is just one of the instruments, it isn't all that could make a world of difference to the new business paradigm that Laura Tyson is suggesting. It reminds one of the example of the sharing of the cake, as in the Theory of Justice, where what justice ('veiled ignorance') would demand, the rules of business from its infinite world of negation turn down, by its mere will; more power will prevail. That which augments power, over everything else, is what matters, at the end. Some call it competitive advantage.