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09

Mar

2020

The Business Case for Purposeful Business

Written by: Alex Edmans

 
 

Capitalism is in crisis.

The consensus among politicians, citizens, and even executives themselves is that business just isn’t working for ordinary people. It serves to enrich the elites – fat-cat CEOs and hedge fund investors – by exploiting workers, price-gouging customers and polluting the environment.

Citizens, and the politicians that represent them, are fighting back. The precise reaction varies – Extinction Rebellion, trade wars, and revolts against CEO pay. But the sentiment’s the same. “They” are benefiting at the expense of “us”.

But anti-capitalist reforms risk throwing out the baby with the bathwater and ignore the positive role that businesses can play in society. Merck’s drug Mectizan has substantially reduced river blindness worldwide; Vodafone’s mobile money service M-Pesa has lifted 200,000 Kenyans out of poverty; and Google’s maps, search engines, and shared documents make millions of lives easier each day.

Viewing business as “them” and society as “us” is an example of the pie-splitting mentality. It sees the value that capitalism creates as a fixed pie that investors and society fight over. So CEOs seek to make profit by exploiting society; citizens seek to straightjacket business with heavy regulation.

But business and society need not be enemies. The pie-growing mentality stresses that the pie is not fixed. By investing in stakeholders, a company doesn’t reduce investors’ slice – it grows the pie, ultimately benefiting investors. A company may improve working conditions out of genuine concern for its employees, yet these employees become more motivated and productive. A company may develop a new drug to solve a public health crisis, without considering whether those affected are able to pay for it, yet end up successfully commercialising it. A company may reduce its emissions far beyond the level that would lead to a fine, yet benefit because customers, employees, and investors are attracted to a firm with such values.

The idea that the pie can be grown – that both investors and society can benefit – seems a too-good-to-be-true pipedream. However, rigorous evidence suggests that companies that do good for stakeholders also do well for shareholders. One of my own studies shows that companies with high employee satisfaction outperformed their peers by 2.3-3.8% per year over a 28-year period. That’s 89-184% compounded. I do further tests suggest that it’s employee satisfaction that leads to good performance, rather than the reverse. Other studies find that customer satisfaction, environmental stewardship, and sustainability policies are also associated with higher stock returns. So creating value for stakeholders isn’t just a worthy ideal – it’s good business sense.

The implications are profound. A social mission isn’t just a “nice-to-have” extra that can be delegated to a Corporate Social Responsibility department, but should be front and centre. All investors – not just Socially Responsible Investors – should consider a company’s social impact when deciding whether to invest, since it ultimately affects financial returns.

So how does a company actually put this into practice and “grow the pie”? The starting point is to define its purpose – why it exists, its reason for being, and the role that it plays in the world. Purpose answers the question “How is the world a better place by your company being here?” A purpose might be to develop medicines that transform citizens’ health; to provide an efficient rail network that connects people with their jobs, family and friends; or to manufacture toys that entertain and educate children.

Importantly, a company’s purpose cannot be to earn profits – instead, profits are a by-product of serving a purpose. A purpose should also be focused. Many companies have broad purpose statements, such as “to serve customers, workers, and the environment 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 because it ignores the harsh reality of trade-offs. Closing a polluting plant helps the environment but hurts employees. A focused purpose statement highlights which stakeholders are first among equals to guide these tough decisions. And evidence highlights the criticality of focus. Companies that do well on social dimensions across the board don’t beat the market. But those that do well on only dimensions material to their business – and scale back on others – do outperform.

So it’s not business or society – it’s and. This observation gives us great hope, but also great responsibility. Not only can all stakeholders benefit from a growing pie, but it’s also their duty to work together to grow the pie. When they do so, bound by a common purpose, they create shared value in a way that enlarges the slices of everyone.

Importantly, an approach to business driven by purpose typically ends up more profitable in the long-term than an attempt to maximise shareholder value. So it’s one that leaders should voluntarily embrace, even in the absence of regulation or public unrest. Creating social value is neither defensive nor simply “worthy” – it’s good business. The highest-quality evidence, not wishful thinking, reaches this conclusion: To reach the land of profit, follow the road of purpose.

Grow the Pie by Alex Edmans

Grow the Pie by Alex Edmans

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About the Author: Alex Edmans

Alex Edmans is Professor of Finance at London Business School and a leading authority on reforming business to serve the common good – but using solutions based on rigorous evidence and recognising the importance of both investors and stakeholders. He has spoken at the World Economic Forum in Davos, testified in the UK Parliament, and given the T...

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