Feb 26, 2019

Fortune: Responsible Capitalism Will Be The U.S.’s Saving Grace

Last Thursday, Kraft Heinz announced a $15.4 billion write down of its mega-brands and disclosed an investigation by the U.S. Securities and Exchange Commission of its accounting practices. Consequently, its stock dropped 27% the next day and is down 62% from its peak two years ago. One more short-term cost cutter bites the dust.

Kraft Heinz is getting criticism from all directions for its cost-cutting methodsand deservedly so. Far-left Democrats and far-right Republicans will likely use Kraft Heinz as an example of capitalism run amok—that the actions of 3G Capital (its Brazilian owners) and Kraft Heinz executives left thousands of employees without jobs and potentially harmed the legacy of household brands Heinz and Kraft.

And did all this cost-cutting benefit its shareholders? Hardly. The biggest losers are shareholders who bought into Kraft Heinz’s myth of making draconian cost cuts and using the cash generated to buy more companies. Two years ago, Kraft Heinz reached a peak valuation of $110 billion, emboldening 3G to make a sudden offer to acquire Unilever for $143 billion. Although it withdrew the offer two days after Unilever’s firm objection, the writing was on the wall: Kraft Heinz could not sustain its business without major acquisitions. As Kraft Heinz’s cost-cutting methods ran out, and its sales declined, its stock price plummeted and large acquisitions became impossible. Its stock value has now shrunk to $43 billion, a 62% loss for shareholders.

The Kraft Heinz debacle illustrates the flaws in strategy of maximizing short-term value by excessive cost-cutting. As I wrote two years ago when Kraft Heinz launched its bid for Unilever, this was a battle for the soul of capitalism.

Has capitalism run amok? Kraft Heinz is not alone in this short-termism approach. Mike Pearson of the pharmaceutical company Valeant used a similar approach that drove its stock value to $91 billion before its accounting maneuvers became public, and Pearson was fired. As a result, its value sunk to $8 billion, a 91% loss for investors as it changed its name to Bausch Health. And Elizabeth Holmes created Theranos, a sham blood testing company based on an unproven premise, that reached a $9 billion valuation before collapsing and going out of business.

Yet in spite of these fiascos, many investors still pressure companies to pursue the short-term model, figuring they can enjoy the ride on the way up and get out before it collapses. As a result, long-term shareholders get left holding the bag. Small wonder that these disasters give capitalism a bad name and encourage attacks from politicians on both sides of the aisle.

Could they doom capitalism? That would be a disaster because responsible capitalism offers the greatest vehicle for being an integral part of addressing society’s myriad problems. Companies have the resources and the talent to contribute to solving tough problems like climate change, income inequality, health care, and education.

Responsible capitalism provides well-paying jobs for its employees, complete with health care and retirement benefits; offers customers high quality products with great value; bolsters communities by supporting local education, health care, and infrastructure; and ensures steady returns to its shareholders.

As a result of problems created by capitalism’s extremes, most notably the meltdown of the financial system 10 years ago, responsible CEOs and their boards have shifted to the multi-stakeholder model of responsible capitalism as purpose-driven, values-centered organizations. They have recognized the pitfalls in the stock market’s unceasing pressure for maximizing short-term earnings and cash returns to shareholders, rather than investing in building sustainable businesses. These CEOs understand that serving a greater purpose and meeting customers’ needs with innovative products and service is the best way to develop talented organizations with highly motivated employees. By creating greater value for their customers, they increase their revenues and profits while earning sustainable value for their shareholders. This model works as long as companies continue to invest for the future in difficult times as well as boom times.

As CEO of the world’s largest investment fund, BlackRock’s Larry Fink has led the way with his annual public letter, insisting that CEOs have strategic plans integral to their business models to use their resources to address societal problems. Other prominent CEOs, like General Motors’ Mary Barra and PepsiCo’s former CEO Indra Nooyi, have been passionate advocates for the purpose-driven approach to address societal problems.

As a result of their leadership, coupled with the evident pitfalls of maximizing shareholder value, most CEOs that I know are shifting their companies to become purpose-driven, values-centered organizations. While they have the resources and the talent to contribute to solving tough societal problems, they cannot do it alone, of course. With the federal government paralyzed by gridlock, responsible business leaders have collaborated with state and local government officials, non-profits, academics, and educators to devise local and national solutions to these seemingly intractable problems. Business leaders like these offer the best hope of creating responsible capitalism that serves the needs of society.

Bill George is a senior fellow at Harvard Business School, former chairman and CEO of Medtronic, and the author of Discover Your True North. Follow him on Twitter or read more at BillGeorge.org.

This content was originally published on Fortune.com on 2/26/2019.