The prof­itabil­ity of trust

Financial Mirror (Cyprus) - - FRONT PAGE - By Klaus Sch­wab

The ef­fects of the most dev­as­tat­ing fi­nan­cial cri­sis in decades have be­gun to fade. But de­bate about the fun­da­men­tals of the global econ­omy is far from over. In­deed, there has been a new wave of heated dis­cus­sion about whether com­pa­nies should put prof­its or the common good first.

Mil­ton Friedman, a lead­ing pro­po­nent of the profit-ori­ented ap­proach to cor­po­rate man­age­ment, fa­mously de­clared that “the business of business is business.” In­deed, from this stand­point, there is no con­tra­dic­tion be­tween profit max­imi­sa­tion and the common good. The pur­suit of profit it­self is a so­cially ben­e­fi­cial goal.

A con­cep­tual ba­sis for the op­pos­ing per­spec­tive, to which I ad­here, lies in the Har­vard economist Michael Porter’s the­ory of shared value cre­ation. In fact, my own pub­li­ca­tions pro­mote the stake­holder con­cept as the frame­work for a mod­ern un­der­stand­ing of so­cially re­spon­si­ble cor­po­rate man­age­ment.

The the­o­ret­i­cal de­bate could con­tinue in­def­i­nitely. But, in terms of prac­ti­cal company man­age­ment, such ide­o­log­i­cal po­lar­i­sa­tion is not par­tic­u­larly use­ful. If man­agers had to choose be­tween ful­fill­ing the ex­pec­ta­tions of share­hold­ers and meet­ing their so­cial and eth­i­cal re­spon­si­bil­i­ties, their com­pa­nies would prob­a­bly col­lapse.

In­stead, suc­cess­ful man­agers recog­nise that any company is both an eco­nomic and so­cial en­tity, and thus that no stake­holder can be ne­glected. As I wrote more than four decades ago, a company, “like an or­gan­ism…de­pends on sev­eral ar­ter­ies,” all of which it must nur­ture if it hopes to sur­vive and grow.

That sounds straight­for­ward. But it can be very dif­fi­cult when the de­mands of, say, the company’s share­hold­ers con­flict with the in­ter­ests of its em­ploy­ees, cus­tomers, or lo­cal com­mu­ni­ties. The good news is that, in any such con­flict, there is one clear, uni­fy­ing goal: en­sur­ing the company’s long-term suc­cess.

This re­quires, first and fore­most, that the company is prof­itable. But prof­itabil­ity should not be an end in it­self; it is a tool to help man­agers de­ter­mine the most ef­fec­tive use of their re­sources and gauge the company’s com­pet­i­tive­ness and vi­tal­ity. So in­stead of just pay­ing out div­i­dends, com­pa­nies should use their prof­its to bol­ster their long-term vi­a­bil­ity.

Prof­itabil­ity, growth, and safe­guards against ex­is­ten­tial risks are cru­cial to strength­en­ing a company’s long-term prospects. But if th­ese three fac­tors con­sti­tute a company’s “hard power,” firms also need “soft power”: pub­lic trust and ac­cep­tance, won by ful­fill­ing a company’s so­cial re­spon­si­bil­ity. Only when a company has gained the pub­lic’s con­fi­dence – its “li­cense to op­er­ate” – can its man­age­ment cre­ate longterm value for all stake­hold­ers, in­clud­ing share­hold­ers.

In short, the real con­flict is not be­tween profit max­imi­sa­tion and so­cial re­spon­si­bil­ity, but rather be­tween short- and long-term think­ing. This, in a sense, is an eas­ier con­flict to re­solve. After all, a short-sighted ap­proach not only un­der­mines com­pa­nies’ prospects; it also threat­ens the en­tire econ­omy. In­deed, man­agers’ ir­re­spon­si­ble fo­cus on ad­vanc­ing share­hold­ers’ im­me­di­ate in­ter­ests, thereby max­imis­ing their own bonuses, con­trib­uted sig­nif­i­cantly to bring­ing the global fi­nan­cial sys­tem to the brink of col­lapse in 2008.

In or­der to en­able a company’s man­age­ment to ac­com­mo­date the long-term in­ter­ests of all stake­hold­ers, cor­po­rate decision-mak­ing must ac­count for the four pre­req­ui­sites of a company’s sur­vival: prof­itabil­ity, growth, risk pro­tec­tion, and pub­lic trust. Given that sat­is­fy­ing one of th­ese pre­req­ui­sites of­ten comes at the cost of the oth­ers, such a sys­tem would en­tail con­tin­u­ous adjustment and com­pro­mise.

We are emerg­ing from a pe­riod when com­pa­nies, un­der pres­sure to meet share­holder ex­pec­ta­tions, fa­vored prof­itabil­ity and growth, even if it meant tak­ing un­due risks and los­ing pub­lic con­fi­dence. Com­pa­nies now need to work on min­imis­ing risk and build­ing trust by meet­ing the le­git­i­mate ex­pec­ta­tions of all their stake­hold­ers, in­clud­ing re­duc­ing their ac­tiv­i­ties’ ad­verse im­pact on the en­vi­ron­ment and cre­at­ing high-qual­ity em­ploy­ment op­por­tu­ni­ties.

But cor­po­rate so­cial re­spon­si­bil­ity is not limited to how a company does business. Firms should use their core com­pe­ten­cies to help find so­lu­tions to to­day’s most press­ing so­cial prob­lems. In other words, beyond serv­ing its own stake­hold­ers, a company should ac­cept its own role as a stake­holder in our col­lec­tive fu­ture – a sort of quid pro quo for its li­cense to op­er­ate.

For­tu­nately, com­pa­nies are in­creas­ingly act­ing with a sense of so­cial re­spon­si­bil­ity. By work­ing with gov­ern­ments, in­ter­na­tional or­gan­i­sa­tions, and civil so­ci­ety, com­pa­nies are ad­dress­ing ma­jor chal­lenges like so­cial in­te­gra­tion, and cre­at­ing the nec­es­sary sys­tems to pro­vide ed­u­ca­tion and health care to those who need it most. Th­ese com­pa­nies are im­ple­ment­ing the stake­holder con­cept on a mi­cro and macro level, an­swer­ing to the de­mands of their em­ploy­ees, cus­tomers, and com­mu­ni­ties, and thus strength­en­ing their brands.

In do­ing so, such com­pa­nies of­fer a pow­er­ful re­sponse to the ques­tion of what their role in so­ci­ety should be. More im­por­tant, they are show­ing the rest of the cor­po­rate sec­tor that the business of ad­vanc­ing the common good is a wor­thy one.

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