November 7, 2018
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. In this second article we look at the evidence that businesses that do embrace responsibility and sustainability outperform competitors.
The Business Case
Business leaders, seduced by the lure of shareholder value maximisation, often proffer multiple excuses for not taking more positive action on ESGissues, that they can’t afford it. Costs will go up. We are too small. Yes, we understand the triple bottom line – but for now it needs to be profit first, people and planet can come later, when we can afford it.
Yet, the evidence reveals these to be false arguments. Businesses that are embedding responsible and sustainable business practices show, lower costs, higher employee engagement and productivity and improved returns.
It may seem strange to have to set out a business case for being responsible and sustainable. Keith Weed, Unilever’s Chief Marketing Officer, has said “I’d love to see the business case for being unsustainable!”
The evidence is now conclusive. As the late Ray Anderson said – it is a better business model.
In 2010 Britain’s Business in the Community recognized a divide between those that “embrace sustainability-driven strategy and management, and those that don’t. These ‘embracers’ are the businesses that will survive and thrive”. BITC commissioned the Cranfield School of Managementto compile the business benefits for being a responsible business, “to help those currently at an earlier stage of the journey”. The studydemonstrated seven ways in which business benefits:
- Brand value and reputation
- Employees and future workforce
- Operational effectiveness
- Risk reduction and management
- Direct financial impact
- Organisational growth
- Business opportunity.
Since that study, several further research papers have highlighted the benefits. In 2011 a Harvard studyprovided “evidence that High Sustainability companies significantly outperform their counterparts over the long-term, both in terms of stock market as well as accounting performance.”
In 2014 a study by the Smith School at Oxford Universityand Arabesque Asset Managementshowed that Companies with strong sustainability scores show better operational performance and are less riskyand that Investment strategies that incorporate ESG issues outperform comparable non-ESG strategies.
In 2015 Project ROIbuilt on the 2010 BITC findings cited above and provided detailed economic analyses on business benefits:
- Share price and market value
- Sales and revenue
- Reputation and brand
- Human resources
- Risk and license to operate.
The report concluded that a “more productive approach will be to develop business-aligned and integrated CR strategies.”
In January 2016 the Financial Times highlighted a reportby HBR Analytica and EY’s Beacon Institute that found “companies with a purpose beyond profit tend to make more money.”
In 2017 in a HBS Whiteboard session Andrew Winstonneatly summarises the arguments in “The Business Case for Sustainability.” No wonder then that so many leading global businesses are not just dabbling with ESG issues but going “All In”.
When Larry Fink, the CEO of the world’s largest investor, Blackrock, writes to the CEOs of companies he invests in and urges them to find their purpose and that the “board is essential to helping a company articulate and pursue its purpose” purpose – it is time for NZ Boards to sit up and take action.
Environmental, Social, and Governance issues.
The Business Case for being a responsible business” 2011 available on www.bitc.org.uk
The Impact of Corporate Sustainability on Organizational Processes and Performance by Robert G. Eccles, Ioannis Ioannou, and George Serafeim HBR Working Paper 2011
From the stockholder to the stakeholder:How sustainability can drive financial outperformance”by Smith School, Oxford Universityand Arabesque Asset Management 2014
Project ROI Defining the Competitive and Financial Advantages of Corporate Responsibility and Sustainability by IO Sustainability and Babson College 2015
“All In: The Future of Business Leadership” by David Grayson, Chris Coulter, Mark Lee Greenfield Publishing 2018
Tagged Business Case, ESG Risks, Purpose, Sustainability
November 6, 2018
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.
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.
Tagged ESG Risks, Purpose, Responsibility, Role of Profit, Shareholder Value, Stakeholder Value, Sustainability