Return on investment was eight times greater for firms of endearment after ten years compared to the S&P 500
Over recent years, a major problem has emerged in the myopic way we think about capitalism – we prioritise shareholders whilst ignoring other stakeholders and focus on competition whilst forgetting cooperation. So, is there another way to think about how to do business?
An alternate view, ‘conscious capitalism’, recognises that no company can survive without a full complement of stakeholders: from employees, suppliers and partners, who create products and services; to customers, who must be satisfied; to society and the environment; and to investors, who are paid out of profits (note 1).
While adopting such an approach may sound like a distraction to hard-nosed business strategists, the numbers do stack up. In the book Firms of endearment: how world-class companies profit from passion and purpose (note 2), the authors looked first for passion, not profitability. Even though profit was not the prime motivation, the shortlist of 28 ‘endearing’ companies achieved returns on investment of 1,026% between 1996–2006 a ratio of 8:1 compared to Standard & Poor’s (S&P) 500 stocks (figure 1).
To understand how ROIs of this magnitude can be achieved, we must consider the role of each stakeholder as part of an overall business cycle, which runs from visionary leadership to satisfying the investors’ needs.
Return on investment was eight times greater for firms of endearment after ten years compared to the S&P 500
As figure 2 shows, until other stakeholders have performed their roles, companies have no revenue for investors. We can decree that shareholders deserve the rewards of success, but other stakeholders must each excel in turn. The remainder of this article examines each of the stakeholder groups in the cycle to understand the part they have to play.
One characteristic that defines conscious leaders is an appeal to their businesses to serve and strive for a higher purpose. This active policy elicits commitment from all stakeholders, catalyses innovation and engages customers. For example, during Bill George’s time as CEO at Medtronic, the company grew from USD 1.1 billion to USD 60 billion (note 3). This financial growth was never its prime purpose, however. The company’s pacemaker products gave ten million people many extra years of life. Patients would give positive testimonials at every company conference, as would relatives and clinicians.
Successful leaders lead with the heart, not just the head. They possess qualities like empathy, compassion and courage. They also have the ability to establish deep, long-term and genuine relationships where others trust them (note 4).
BILL GEORGE, CEO, MEDTRONICS, 1991–2001
A second ‘higher’ objective is stakeholder integration, aimed at win–win relationships rather than a zero-sum game where if one party gains, another must lose. For example, if you pay your employees a better salary, you will recruit a higher calibre of person who stays longer and develops their skills further. Jordan’s Furniture pays 15–20% above the industry norm, but sales per square foot are six times above the average of their competitors (note 5).
A third characteristic is fostering a workplace culture that confirms and upholds corporate values. Culture and values guide all staff in being accountable for their promises and actions, in being loyal to the company’s purposes and in treating people with respect. A culture where people trust each other is demonstrably superior to one where they do not, and incredibly less costly.
A worldwide Gallup poll found the chief determinant of human happiness was employment in a meaningful job working alongside colleagues that were cared about (note 6). This is unsurprising, as we spend one-third of our waking hours at work. However, a Conference Board survey found only 50% of Americans were satisfied with their jobs.
Work can be treated as a ‘job’, a ‘career’ or a ‘calling’; companies found on the firms of endearment shortlist insist upon the latter, therefore training their people assiduously. For example, The Container Store, repeatedly voted as among the top 100 companies to work for in FORTUNE magazine, spends more than thirty times as much on training as the industry average.
Johnson & Johnson decided it was cheaper to keep people healthy than pay the costs of sickness. Their wellness programme actually made money by reducing medical premiums and staff absences from work. Every dollar spent earned an extra USD 1.71 in reduced costs (note 7).
The estimated amount Johnson & Johnson saved on healthcare costs through their employee wellness programme between 2002–08
While supplier performance is crucial to product and service delivery, organisations frequently assume that suppliers should be paid as little as possible, as late as possible. Lack of cash flow has wiped out more small businesses than any other cause (note 9).
A salutary example is General Motors, which gouged USD 4 billion from suppliers in 1992–93. Wall Street applauded the strategy, but GM’s suppliers began to cut quality, reduce service levels, cut back on R&D and pressurize their own suppliers. Some of GM’s suppliers even reduced their exposure by switching customers, no longer supplying GM with goods and services. For GM, bankruptcy was merely a matter of time.
Conscious companies behave quite differently. Whole Foods’ tens of thousands of suppliers are partners in every sense of the word. Nurturing small companies is vital to inspiring original thinking and to encouraging better land use and sustainability. The company sponsors pilot projects to be undertaken by suppliers, providing data from stores to guide strategy (note 10).
The partnership concept also spreads to trade unions. Southwest Airlines, whose success despite the troubles within the industry is legendary, is among the most unionised airlines in the USA. However it agreed a ten-year contract with the Southwest Airline Pilots' Association in 1995, freezing pilots’ wages for five years in exchange for stock options (note 11).
If you serve your community, your employees will be enthused, your customers grateful and your business will prosper
Many customers just want the product at low cost, but an increasing number choose to shop with companies whose values and wares mean something beyond price. While a trillion dollars a year is spent on advertising in the USA, a surprising aspect of conscious companies is how relatively little they spend – a higher purpose needs no jingles.
Conscious companies often support legal contracts with suppliers and buyers with often-unspoken emotional contracts that are based on trust. For example, a supplier of pizza ovens to restaurants had the idea of replacing ovens at any time during the first two years. Lawyers warned that restaurants would turn in old ovens, however well they worked, and demand new ones. The lawyers were correct, but less than 1% of customers did this, whereas the offer inspired trust and confidence for the remaining restaurants.
The most credible advertising of all is word of mouth from grateful customers, which is worth a hundred intrusive commercials. Social media amplifies word of mouth, further deepening emotional relations between companies and customers.
Growth of companies with cultures including all stakeholders, compared to 166% for others
The opposition to corporate social responsibility (CSR) is that the money belongs to shareholders rather than businesses. As a result many CSR programmes function as appendices to the main purpose of making money. This is myopic rather than wrong. If you serve your community, your employees will be enthused, your customers grateful and your business will prosper. Most CSR practices cost little and gain much.
The essence of conscious capitalism is that serving the community should be part of corporate strategy, for shared benefit. For example, IBM has created a Corporate Service Corps in which volunteers use their skills to help emerging economies. The initiative is designed not just to help the poor but develop IBM’s future leaders (note 12).
Conscious companies differ significantly in their attitude to tax. In 1943, US corporations paid 39.8% of their profits in corporate taxes (note 13). In 2002, the General Accounting Office revealed that 61% of US corporations paid no corporate tax at all in the period 1996–2000 (note 14). In the period 1996–2004 however, average payment for firms of endearment was 33% (note 15).
There are serious costs in shareholders asking for profits to rise quarter by quarter. Nearly everything that pays off in the long term has costs in the short-term. The reverse is also true. Most things that pay off short-term have long-term costs. As a result, corporate lifespans are getting shorter. We work our companies to death and discard the people inside them.
This explains the extraordinary mortality among companies classed by commentators as ‘good to great’ (note 16). Picked for their profitability, their ‘good’ or ‘great’ results were gained at the expense of other stakeholders. For example, Kroger, the retail chain was designated ‘great’ in 2001, but had lost over half its stock price six years later (note 17).
It is easy to manage short-term rises in share price to hit a quarterly goal. Off-shoring of labour, stealthy cuts in quality, and small price rises all release equity. A study by the US National Bureau for Economic Research found 80% of executives would cut R&D and marketing expenses to hit quarterly targets, even if this would hurt the company (note 18).
So how do conscious companies fare? As we saw, firms of endearment beat S&P 500 averages by a ratio of 8:1 over a ten-year period. This isn’t a one-off study: a research project at Harvard Business School selected 207 large US companies, focusing upon ‘strong and flexible business cultures that included all stakeholders’ (note 19). These hugely outperformed a sample of companies that lacked these features, for example by a revenue growth of 682% as against 166% (note 20).
Whilst financial analysts may assume that shareholder value must be captured from other participants, profitability targets or the attempt by shareholders to wrest money from other stakeholders, this can prove counter-productive. All stakeholders create wealth: win–win relationships can create abundance for all parties.
We have a metaphor for maximising profits for just one stakeholder. If any part of a cybernetic system insists on growing at the expense of other parts, the system will atrophy then collapse. In this sense shareholders act like aggressive cancer cells, killing the host body on which they rely. In business terms, this strategy is not only foolish, it is suicidal.
Has traditional capitalism gone as far as it can go? Western businesses are driven by shareholders who will quickly back another horse if their investments do not deliver, which drives organisations towards reductionist strategies that sacrifice longer-term gain on the altar of quarterly profits.
The good news is that all is not lost. Organisations can learn from sources as wide ranging as Eastern philosophy and business practices, US stakeholder cooperation models, and European, family-run businesses. All these examples show that significant longer-term gains can be made to the benefit of all parties, not just a small group of disinterested financiers.
In this carefully researched book, authors Charles Hampden-Turner and Fons Trompenaars set out a future that is both inclusive and profitable, balancing immediate needs with more sustainable growth. As the business landscape becomes increasingly diverse and interdependent, it will favour companies that engage best with customers, partners and other stakeholders.
Capitalism with a conscience will be published in May 2014. See more details here: http://inst.be/ext-SHE
Charles Hampden-Turner is a leading thinker and author on the paradoxical nature of value creation and the creator of Dilemma Theory. For the last few years, Charles has been the Director of Research and Development for Trompenaars Hampden-Turner. He is also a Senior Research Associate at the Judge Institute of Management Studies at Cambridge University and a Fellow of the Cybernetics Society.
Fons Trompenaars is recognised around the globe for his work as a consultant, trainer, motivational speaker and author of various books on all subjects of culture and business. As Founder and Director of Trompenaars Hampden-Turner, he has spent over 20 years helping Fortune 500 leaders manage and solve their business and cultural dilemmas to increase global effectiveness and performance and is regularly listed as one of the world’s most influential management thinkers.