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November 6, 2018

§1. Profit Is not the purpose of business!

In this series of three brief articles, Ron Ainsbury, Visiting Fellow at the Cranfield School of Management and Senior Fellow at the Research Centre Business Innovation at the Rotterdam University of Applied Sciences, sets out why and how New Zealand directors should be directing efforts to ensure that their businesses have a clear purpose and have the governance systems in place to ensure that the purpose is followed.

Perhaps, by focusing on purpose and embedding the culture and values to support that purpose, much of the unethical behaviour of corporations could be reduced and so much of the focus on the plethora of compliance rules, regulations and procedures minimised.

The Purpose of Business

The IOD’s Four Pillars of Governance Best Practice, states that ‘Corporate governance exists to help organisations achieve their fundamental purpose … typically to maximise shareholder value.’ Why?

This focus on short-term profit and maximising quarterly shareholder value has grown since the US Economist Milton Friedman first stated “there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

As a result, since then, most business schools, business commentators and analysts have developed and used various profitability measures such as quarterly earnings per share, to gauge the success of businesses, and stock market investors narrow their focus even further, sometimes to daily profit expectations.

But shareholder value is not a legal requirement. The NZ Companies Act 1993, 131 (1) states that ‘A director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.’ Australian, US, and UK laws reiterate this, using ‘best interests of the shareholders’ as the guideline for a director’s decision-making.

In recent years the wisdom of focusing a businesses’ purpose on shareholder value has come into question. Martin Wolf writing in the Financial Times wrote: “Almost nothing in economics is more important than thinking through how companies should be managed and for what ends. Unfortunately, we have made a mess of this. That mess has a name: it is “shareholder value maximisation”. Operating companies in line with this belief not only leads to misbehaviour but may also militate against their true social aim, which is to generate greater prosperity.”

This view has been repeated in several articles, for example, James Montier of the global investment firm GMO wrote a well-researched article in which he demonstrated that
shareholder value maximization is “The World’s Dumbest Idea”.

It is time business went back to basics. With a few exceptions, businesses start when an entrepreneur sees a situation where a group of people can have a problem solved. As Peter Drucker once put it, “The purpose of business is to create and keep a customer.”

Creating and keeping customers could mean offering a new product or service that is cheaper, or of higher quality, longer-lasting, is disposable, offers superior performance, offers faster performance, and so on. In each case there is a group of people who are willing to pay for this innovation. If we look at the successful companies of today and trace back to how they first started, we see this clearly:

  • Nike, founded by an athletics coach, who wanted his athletes to have better performing running shoes
  • Google founded by students who wanted to be able to find academic papers on the internet more easily
  • Facebook founder Mark Zuckerberg wanted to help individuals share experiences with friends
  • Henri Nestlé wanted to help mothers who couldn’t breastfeed
  • Steve Jobs wanted everyone to be able to have computer power in their hands
  • Quakers offered to provide safe custody of gold for 17th century London goldsmiths and founded Barclays!

Each of these companies ventured into unethical behaviour, I assert because as they grew their governance focus shifted from purpose, values, and culture to short-term profitability, most probably as a result of stock market pressures.

Of course, there are many people who start a business simply dreaming they will become rich, but unless they find a market and provide an innovative solution, they won’t. If the entrepreneur manages the new businesses efficiently, then she or he earns a profit on the investment.

Drucker sets out three purposes of profit:

  • validation of the soundness of an enterprise’s efforts (the right purpose)
  • compensation for the risks that the business is incurring (dividends for investors
  • the generation of resources needed to fund future growth (sustainability).

The way to ensure the sustainability of the enterprise is to reinvest in innovation and meeting consumer needs.

Some continually argued against this profit-centred approach. Charles Handy, in the Michael Shanks Memorial Lecture in 1990 argued “To say that profit is a means to other ends and is not an end in itself is not a semantic quibble, it is a serious moral point.” And went on to address the purpose of business.

In recent years there has been a move away from Friedman’s profit-centred focus as business leaders have rediscovered the power of purpose. While John Elkington’s “People Planet Profit” may have started a trend towards businesses taking a lead in being socially responsible (CSR ) this new focus on purpose is not CSR it is central to the business. As David Grayson and others argue in their recently-published book, it is about companies going All In” (“All In: The Future of Business Leadership” by David Grayson, Chris Coulter and Mark Lee. Routledge 2018).

In October 2014 Coca-Cola Enterprise sponsored a “Future for Sustainability” Summit and commissioned a Cranfield School of Management and the Financial Times study, entitled ‘Combining Profit and Purpose’.

In a recent article, the strategy guru, Michael Porter wrote: “A big part of the problem lies with companies themselves, which remain trapped in an outdated approach to value creation that has emerged over the past few decades. They continue to view value creation narrowly, optimizing short-term financial performance in a bubble while missing the most important customer needs and ignoring the broader influences that determine their longer-term success. How else could companies overlook the wellbeing of their customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell? How else could companies think that simply shifting activities to locations with ever lower wages was a sustainable “solution” to competitive challenges?

The role of Purpose is thoroughly set out in a seminal book “The Power of Purpose” by John O’Brien and Andrew Cave, required reading for every CEO and Director, indeed, for anyone interested in starting or running a successful enterprise, whether for profit or not.

Even in the world of investment finance, where the purpose of investing is purely for profit, we see a realisation of the importance of Purpose. Earlier this year Blackrock’s Larry Fink encouraged CEOs to reconsider their purpose writing “Without a sense of purpose, no company, either public or private, can achieve its full potential.”

“The bottom line result is that purpose-driven, people-centric, values-driven companies outperform. Not just because they do better sustainably over time, but because they avoid the risk. They avoid the Volkswagen and the Tesco problems, and they avoid the thing that wipes 30% off their share prices.” Ann Francke, CEO, CMI

Instead of criticising those who have signed up to the New Zealand Climate Leaders’ Coalition we should all be encouraging all business leaders to go further and focus on the wide range of ESG risks and ensure that their individual businesses have a clear purpose. NZ directors may find that they will need to spend less time on compliance.

Next

In the second article in the series Ron will present the evidence that businesses that focus on purpose and manage responsibly and sustainably, taking into account their potential impact on a wide range of stakeholders, generate superior returns for their investors.

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October 22, 2018

Is the current focus on Climate Change misguided?

Is the current focus on Climate Change misguided?

I was listening to the BBC Friday night comedy when the subject turned to the recent IPCC Climate Change report. “I don’t see the politicians doing anything about it, so I’m not” said one comedienne. She went on to say she had explored the UK government website to find out what she could do – and there was nothing, she claimed.

Reducing CO2 emissions is something quite difficult for individuals to tackle – seemingly it needs disruptive changes to lifestyle: stop flying, stop driving a car, turn off the heating and wear warm clothes in winter and so on. All the luxuries of modern life for which generations have strived – to be denied.

In some parts of the world the response is ‘bring it on’. How many Scottish comedians have used that line since ‘Global Warming’ (what we used to call Climate Change) became the catch cry?

To my way of thinking, the fundamental causes of Climate Change is the result of waste; wasteful use of resources, such as oil, gas and coal. But it is also the non-use of abundant solar energy, which to me is another kind of waste.

Should we be focusing on eliminating waste?

A Dutch brewer once gave me a rather colourful explanation of fermentation. Yeast cells are floating in a sugary solution. They eat the sugar, make love producing babies (more yeast) and excrete alcohol and CO2. I hasten to add he used more colourful verbs!

After a while the alcohol level in the sugary soup becomes toxic, the yeast cells die in their own waste. Thus, there is an upper level to the alcohol strength that can be produced by natural fermentation.

The metaphor is clear. When people say we are killing the planet – is it the CO2 levels we should tackle – or waste?

A few years ago an environmental documentary, ‘Trashed’, featuring Jeremy Irons as presenter, was published. The message about how pollution is harming people and the planet is as stark as Al Gore’s ‘Inconvenient Truth’. But, whereas Al Gore (and the IPCC) paint a future disaster based on predictions – ‘Trashed’ shows video footage of real damage.

The effects of waste are evident. We don’t need predictions of what might be and how our lives might be affected by waste . The effects of waste are before our eyes: polluted rivers and beaches, polluted air, city streets pock-marked with chewing gum, cigarette butts on street corners, litter alongside country roads, skeletons of birds showing a gut full of plastic.

Could a focus on eliminating waste be more productive?

Tackling waste first, by being less wasteful of energy in our homes and vehicles, by focusing on the household savings that will result, becomes individual action that tackles excess CO2. Let’s not forget it is excess CO2 that is the problem – without any CO2 at all – no plants, no trees, no vegetables – no life!

With Asian countries like China and Thailand refusing waste from western nations – it is time we stopped producing waste.

The circular economy movement offers dozens of practical tips for individuals, small businesses and community groups to take action. We don’t need to wait for government.

And whereas proposed Climate Change solutions appear to add significant costs to the economy, reducing and eliminating waste via Circular Economy principles offers value – measured by some in billions.

The Circular Economy opens up opportunities, for social and for-profit entrepreneurs taking advantage of new technologies (‘green chemistry, biochemistry, Nanotechnology and whole system design) in what Australia’s Natural Edge project called the 6th wave of innovation.

Shall we focus on eliminating waste?

© Ron Ainsbury 2018
www.GoJacaranda.com

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October 5, 2017

Trust and Business Leadership

Can much of the current political unrest be explained by the decline in trust of our leading institutions by the majority of citizens? A brief read of Edelman’s Trust Barometer might cause one to agree.

https://www.edelman.com/trust2017/

In answer to the question: ‘How much do you trust?’ in a survey of 33,000 respondents aged 18 and over in 25 markets 53% said they trusted NGOs, 52% trusted business, 43% trusted the media, and 41% trusted government. The level of distrust varies across countries but in almost every country there has been a steady decline in trust over the past the past few years.

Table: Distrust figures for selected countries

Reading behind these global figures are some interesting details.

In a crisis government official are only rated as very or extremely credible by 29% of the population, CEOs fared a little better at 37%. Most people are skeptical about what they are told by leader in a crisis.

Edelman sets out the path of a downward spiral as concerns turn into fears. Edelman focuses on five major concerns: corruption, globalization, eroding social values, immigration, and the pace of innovation. As concerns among the population grow to fears their belief in the system is eroded. Trust declines. The risk of population action rises.

Figure: Edelman’s Downward Spiral

    Implications for Business

If CEOs, NGOs. And government are not credible – then who are credible?

A person like me 60%

Technical expert 60%

Academic expert 60%.

Even these figures are not encouraging, 2 out of 5 people do NOT find these people credible!

‘Business plays a role in stoking societal fears’ says Edelman as people worry about losing their jobs because of lack of training ,or to foreign competitors, or to immigrants willing to work for lower wages, or because jobs are moved to offshore. Little surprise then that protectionism is on the rise.

The advice for business is clearly set out. Citizens expect that businesses should stop:

a. Paying bribes
b. Paying senior executives hundreds of times more than workers
c. Moving profits offshore
d. Overcharge for products that are necessities of life
e. Reducing costs by lowering quality …

and instead:

a. Adopt ethical business practices
b. Treat employees well
c. Pay fair share of taxes
d. Listen to customers
e. Offer high quality products / services.

There is a wealth of detail behind these statistics and while details vary from country to country what seems to be clear from Edelman’s report (which has been conducted annually since 2001) is that across the world people are crying out for leadership. And business leaders have the opportunity to provide responsible leadership. But they need to put the interests of consumers and their employees above their own personal desires.

This message is amplified by Simon Sinek in his talk “Why leaders eat last”.

https://www.youtube.com/watch?v=ReRcHdeUG9Y