Reshaping Business and Capitalism for the 21st Century

Last month I participated in a panel on business-government relations at a conference sponsored by the International Academy of Management, a global forum dedicated to the advancement of the science and art of management.  Despite pressures to decrease the size of government, its influence on business continues to increase around the world.  So does government’s dependence on business to help address society’s most complex and important problems, including job creation and the development of healthy, sustainable environments.  

In capitalist, democratic economies, the private and public sectors have different objectives, one focusing primarily on profits and customer relationship, and the other on improving the quality of life of individuals and societies.  The pursuit of these seemingly different objectives have often led to contentious relations.  But, given the complex societal challenges we all face in the 21st century, business and government must learn to better collaborate and understand each other.  They must realize that we’re all in this together.  The implications, I believe, are profound, not only to business and government, but to the very nature of capitalism.

For much of the past century, the essence of capitalism has been embodied in the quote: The Business of Business is Business.  The quote is variously attributed to long time GM chairman and CEO Alfred P. Sloan and to University of Chicago economist and Nobel Prize recipient Milton Friedman.  In a 1970 NY Times Magazine article, The Social Responsibility of Business is to Increase its Profits, Professor Friedman wrote: 

“In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business.  He has direct responsibility to his employers.  That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.” 

Friedman and other neoclassical economists believed that given all relevant information, people and companies will make rational decisions to maximize their utility and profits, and that markets on their own will just about always achieve the right results.  They thus advocated a very limited, circumscribed role for government, which was succinctly captured in president Ronald Reagan’s famous phrase from his first inaugural address:  “Government is not the solution to our problem; government is the problem.”  Over the next thirty years, this phrase became ingrained in a large segment of our country. 

Many believe that the 2008 financial crisis, the worst since the Great Depression, was the direct result of such narrow views of business and government.  As a result, we are now asking important questions: How should the private and public sectors work with each other so together they can better address society’s pressing needs?  Beyond obeying the law, what societal responsibilities should companies have in a well-functioning, 21st century capitalist economy? 

Noteworthy among the efforts addressing these questions is the Creating Shared Value business concept developed by Michael Porter and Mark Kramer in two Harvard Business Review articles: Strategy & Society: The Link between Competitive Advantage and Corporate Social Responsibility, and Creating Shared Value: Redefining Capitalism and the Role of the Corporation in Society, published in 2006 and 2011 respectively. 

“The capitalist system is under siege,” notes the latter article in its opening paragraph.  “In recent years business increasingly has been viewed as a major cause of social, environmental, and economic problems.  Companies are widely perceived to be prospering at the expense of the broader community.”

“Even worse, the more business has begun to embrace corporate responsibility, the more it has been blamed for society’s failures.  The legitimacy of business has fallen to levels not seen in recent history.  This diminished trust in business leads political leaders to set policies that undermine competitiveness and sap economic growth.  Business is caught in a vicious circle.”

“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.”

Over the years, companies have developed a number of programs aimed at societal benefits beyond their financial interests and legal responsibilities.  Such corporate social responsibility programs include community, philanthropic and sustainability activities, generally aimed at enhancing the company’s brand and its reputation as a good social citizen.  But, such social activities have been separate from the company’s overriding business objective of creating economic value.

The basic premise behind the principle of shared value is that a company’s profitability and competitive position require the creation of both economic and social value, because the interests of the company and the health of the communities around it are mutually dependent on each other.  It says that you cannot view business value creation as being primarily about optimizing the short-term financial performance of the company and its shareholders, while ignoring the interests of customers and communities.

Porter and Kramer propose three distinct ways for companies to embrace shared value creation:

• by reconceiving products and markets: “Too many companies have lost sight of that most basic of questions: Is our product good for our customers?  Or for our customers’ customers?”
• by redefining productivity in the value chain: “A company’s value chain inevitably affects - and is affected by - numerous societal issues, such as natural resource and water use, health and safety, working conditions, and equal treatment in the workplace.”
• and by enabling local cluster development: “No company is self-contained.  The success of every company is affected by the supporting companies and infrastructure around it.”

Is the principle of shared economic and societal value in conflict with free market capitalism?  This question has also been long debated, ever since Adam Smith - the 18th century Scottish philosopher and father of free-market, free-trade capitalism - laid down the foundations of capitalism and modern economics in The Wealth of Nations.

Smith believed that wealth creation in a competitive commercial economy should be guided by the market’s invisible hand.  He used this metaphor to indicate that, “in a free market, an individual pursuing his own self-interests tends to also promote the good of his community as a whole,”  and that “the free market, while appearing chaotic and unrestrained, is actually guided to produce the right results by this so-called invisible hand.”

For years, many thought that Smith was thus advocating a laissez faire style of capitalism in which corporations and individuals should be encouraged to focus on wealth creation with very few controls, checks and balances.  But, as I learned more about his life and works, I discovered that nothing could be further from the truth.  

While The Wealth of Nations is his opus magnum, he wrote a number of other books, including The Theory of Moral Sentiments, in which he argued that sympathy, the human ability to have a strong feeling of concern for another person, is required in an economic system in order to achieve socially beneficial results.  In an excellent 2009 Financial Times opinion piece, Harvard economics professors and 1998 Nobel Prize winner Amartya Sen wrote:

“It is often overlooked that Smith did not take the pure market mechanism to be a free-standing performer of excellence, nor did he take the profit motive to be all that is needed . . . People seek trade because of self-interest – nothing more is needed, as Smith discussed in a statement that has been quoted again and again explaining why bakers, brewers, butchers and consumers seek trade.  However an economy needs other values and commitments such as mutual trust and confidence to work efficiently.”

Mutual trust and confidence are more important than ever in our increasingly integrated world.  In April of 2006, IBM’s then CEO Sam Palmisano outlined his vision for the 21st century global corporation in an article published in Foreign Affairs, - The Globally Integrated Enterprise.  He identified some of the key challenges faced by companies as they seek to become globally integrated enterprises.  Foremost among them “will be to figure out how to maintain trust in enterprises based on increasingly distributed business models,” he wrote.

“Global corporate integration will involve significant changes in organizational culture, new forms of partnership among multiple enterprises and segments of society, and many new standards for managing a much more complex marketplace. . .  A company’s standards of governance, transparency, privacy, security, and quality need to be maintained even when its products and operations are handled by a dozen organizations in as many countries.  A reliance on hierarchies contained within one function, enterprise, or nation must be supplemented by new ways of establishing trust, based on shared values that cross borders and formal organizations.”

Companies must learn to view shared value as the way to achieve economic success in our global, interconnected and highly complex economy.  To help bring this about, earlier this year Palmisano launched the Center for Global Enterprise, a private, nonprofit research institution devoted to the study of the contemporary corporation, globalization, economic trends, and their impact on society.

“Not all societal problems can be solved through shared value solutions,” write Porter and Kramer in their 2011 HBR article.  “But shared value offers corporations the opportunity to utilize their skills, resources, and management capability to lead social progress in ways that even the best-intentioned governmental and social sector organizations can rarely match.  In the process, businesses can earn the respect of society again.”

Comments

[Gregorio Martin]

Irving:
Might you consider the following study:
http://www.futuretech.ox.ac.uk/sites/futuretech.ox.ac.uk/files/The_Future_of_Employment_OMS_Working_Paper_1.pdf
Some reflexion could be interesting.
Thanks again

[Henry Bennett]

IMHO Milton Friedman is the greatest embarrassment the Chicago School of Economics and the Nobel Prize Committee have ever had!