Just as a personal purpose allows a citizen to focus on what he’s truly passionate about and skilled in, corporate purpose allows an enterprise to focus on the activities that impact the most material stakeholders and in which it has greatest comparative advantage, says Alex Edmans
There is growing consensus that companies have a responsibility not only to shareholders, but also to wider society – customers, employees, suppliers, communities, and the environment. Indeed, last August, the US Business Roundtable signed a commitment to serve these stakeholders.
That sounds inspiring, but how do companies actually put it into practice? Skeptics are doubtful whether the Business Roundtable signatories will actually do what they say. Companies know how to make decisions when they have a single responsibility to shareholders. There’s a well-established framework – Net Present Value analysis – that Business Schools like mine have been teaching for decades. But it’s much harder to make a decision if a company has multiple objectives.
If a business aims to serve not only investors, but also society, how does it know whether to take an action that helps one but hurts the other? Making your packaging recyclable is costly, but helps the environment. But those benefits are very difficult to quantify in financial terms, so you can’t weigh them up against the cost to profits and decide whether to make the investment.
Advocates of responsible business sweep these complexities under the carpet, arguing that companies should simply serve society and eat up any hit to profits. Indeed, profits are seen as ill-gotten-gains that go only to rich investors, so any calls to prioritize society over profits win votes, grab headlines, and earn Retweets. But profits serve a crucial role in society – providing returns to parents saving for their children’s education, pension schemes investing for their retirees, or insurance companies funding future claims. Any serious proposal to reform business needs to ensure that profits are delivered alongside social value.
Moreover, even if we ignored profits, trade-offs would still exist. Many decisions help some stakeholders but hurt others. Shutting down a polluting plant helps the environment, but helps employees. If a company has a responsibility to both workers and the environment, how can it decide whether to take such an action?
My new book, Grow the Pie: How Great Companies Deliver Both Purpose and Profit, aims to answer these uncomfortable questions – in turn providing a framework for companies to implement responsibility in practice. The starting point is for a company to define its purpose. But ‘purpose’ is an overused buzzword nowadays – so what does it actually mean? Purpose is why a company exists, its reason for being, and the role that it plays in the world. It’s the answer to the question ‘how is the world a better place by your company being here?’
Importantly, a company’s purpose cannot be to earn profits – instead, profits are a by-product of serving a purpose. This is similar to how a citizen’s vocation is not to earn a salary; instead, he earns a salary by choosing a career he enjoys and thus flourishes in. Equally importantly, a purpose should be focused. Many companies have broad purpose statements, such as ‘to serve customers, colleagues, suppliers, the environment, and communities while generating returns to investors,’ because they sound aspirational. But a purpose that tries to be all things to all people offers little practical guidance in taking tough decisions that help some stakeholders but hurt others.
Let’s go back to the decision to shut down a polluting plant. That’s not a hypothetical dilemma, but a real one. The French electricity company Engie owned Hazelwood, the most polluting power station in Australia – but also one that 750 employees relied on for their jobs.
How did Engie decide what to do?
In 2016 it announced a transformation plan to prioritise the environment. As new CEO Isabelle Kocher said: ‘We want to focus our investments solely on generating low carbon energy … we are redesigning our entire portfolio.’
Even though Engie views employees (as well as customers, suppliers, and communities) as important, this statement made it clear that the environment was first among equals. So, it took the difficult decision to close Hazelwood in November 2016 – and then participated in a worker transfer scheme to help the displaced employees find jobs.
It’s useful to revisit the analogy with a citizen’s vocation, or personal purpose. A purpose is what a citizen would like to achieve in life – Oprah Winfrey’s is ‘To be a teacher. And to be known for inspiring my students to be more than they thought they could be.’ One of the benefits of clarifying your personal purpose is to help with time management. In Stephen Covey’s bestselling book, 7 Habits of Highly Effective People, time management is Habit #3, which Covey calls ‘First Things First’. However, before Habit #3 becomes Habit #2, ‘Begin with the End in Mind’ – defining a personal purpose. You can’t decide how to allocate your time if you don’t know what your goals are – what you want to achieve with your time. And these goals must be focused, otherwise you won’t know what commitments to turn down. That’s why Winfrey’s purpose is exclusively to be a teacher – not to also be a doctor and run a homeless shelter, even though those are worthy causes. Similarly, a company can’t decide how to resolve trade-offs without unless it has a clear priority structure for the activities it wishes to undertake and the stakeholders it wishes to serve.
How does a company come up with a purpose statement? The book introduces two principles to offer guidance. The first is the principle of materiality – which stakeholders are most material to a business? For example, local communities and the environment are critical to the Singaporean-headquartered agribusiness Olam, which grows cocoa, coffee, nuts, spices, and rice. Communities provide workers and customers, and land and water are vital inputs into production.
So Olam’s core purpose of ‘Growing Responsibly’ aims to preserve the environment and regenerate the communities in which it operates. In contrast, communities and the environment are less material to an online services company, such as the flight aggregator Skyscanner. It can hire employees from all over the world, sell all over the world, and uses few natural resources.
Evidence highlights the importance of materiality. Companies that deliver value to all stakeholders, across the board, don’t actually beat the market. They’re probably making investments in an undisciplined way, and forgetting about their responsibilities to investors. But those that deliver strong performance only to stakeholders material to their business – and scale back on others – do significantly outperform.
The second is the principle of comparative advantage – what activities can a company do better than its competitors? Importantly, a company should focus on solving the social problems that it’s most equipped to tackle, not necessary the ones that are most pressing. For example, telecoms company Vodafone’s purpose isn’t to tackle climate change, even though it’s a major problem and telecoms use substantial electricity. Instead, its purpose is ‘to connect everybody to live a better today and build a better tomorrow.’ Due to this purpose, it launched M-Pesa, a mobile money service in Kenya that provided financial inclusion to the unbanked and lifted 200,000 households out of poverty.
Leaders of today’s companies are in a privileged position, as technology and their global reach give them more power to create social value than arguably ever before. But they are also in a challenging position, because the world’s social problems are more serious than ever before. Climate change, income inequality, population growth, resource usage, the displacement of workers through automation – the list is endless. A leader wishing to serve a purpose beyond profit may feel powerless to solve all of these problems.
But she doesn’t have to. Purpose should not be exhausting but freeing. Just as a personal purpose allows a citizen to focus on what he’s truly passionate about and skilled in, corporate purpose allows an enterprise to focus on the activities that impact the most material stakeholders and in which it has greatest comparative advantage.
Alex Edmans is Professor of Finance at London Business School and author of Grow the Pie: How Great Companies Deliver Both Purpose and Profit, published by Cambridge University Press, out 26 March 2020.