January 16, 2011

Revisiting the rights and responsibilities of business

“Businessmen that take seriously their responsibilities for providing employment, eliminating discrimination, avoiding pollution . . . are preaching pure and unadulterated socialism.”
Milton Friedman, 1970

Nobel prize-winning economist Milton Friedman penned those fiery words back in 1970 in his influential article “The Social Responsibility of Business Is to Increase its Profits.” He continued to defend them until his death in 2006.

Friedman has had a monumental influence on economists and CEOs who have followed his philosophy. Although we cannot attribute the global economic meltdown of 2008 to him, his ideas certainly influenced its root causes.

A short-term focus on shareholder gains has substantially increased the velocity of stock market trading. In the past 25 years, holding periods for stocks have fallen from eight years to six months. CEOs focusing on meeting the demands of short-term investors have led to the destruction of many once-great companies, including General
Motors, Sears and Enron. This culminated in the 2008 global financial meltdown, when over-leveraged financial institutions collapsed as they tried to maximize short-term value.

The havoc caused by the short-term shareholder value ideology has led to a narrow focus on shareholders, the loss of America’s innovative edge and the hollowing of communities. As a result, employees have lost their jobs, customers lost their suppliers, communities lost valued supporters and, ironically, shareholders lost a fortune. Collectively, these factors have contributed to the loss of trust in free enterprise companies.

In a sharp rebuke to the Friedman philosophy, my Harvard colleague, Michael Porter, and his co-author Mark Kramer have written a seminal piece in this month’s Harvard Business Review: “The Big Idea: Creating Shared Value.” They advocate that creating shared value between companies and society “holds the key to unlocking the next wave of business innovation and growth [and] reconnecting company success and community success.”

The time is ripe to reassess the true purpose of business. In a free-enterprise system corporations are chartered by society and endowed with certain rights and responsibilities. Those that fail to contribute to society may find their charters withdrawn or their freedom to operate restricted.

The French experience
I had this experience in 1982 while serving on the board of Bull SA, the French computer company. When the Socialists under Francois Mitterrand swept into office, Bull and 10 other large French companies were nationalized, thereby losing their status as capitalist enterprises. In the 2008 collapse, AIG, General Motors, Fannie Mae and others were effectively taken over by the U.S. government.

The public outcry subsequently led to financial services reform legislation restricting the freedom of financial services firms. Across cultures and legal systems, there’s an unalterable truth: Business is a social institution that must satisfy society’s needs.

Today there’s a growing consensus among opinion leaders and many CEOs that it’s time to reassess the purpose of business. I propose that, “The role of business is to
increase value for all its stakeholders — customers, employees, shareholders and communities — while safeguarding the societal ecosystems in which it operates.”

Economists find this definition imprecise, as they prefer a single yardstick for measuring corporate performance. However, elegant theory rarely captures the messy complexities of reality.

The new generation of business leaders recognizes that sustainable value for shareholders, employees and communities can only be achieved by creating superior value for customers. Employees are far more motivated to serve customers with innovative products and better service than they are in trying to get stock prices up. This more-expansive view of creating shared value results in a growing business that can increase its profits, reinvest in the business and reward shareholders while simultaneously fulfilling society’s needs. That’s the only way to achieve long-term success.

Here in Minnesota this course is being pursued by companies such as 3M, General Mills, Target, U.S. Bancorp, Medtronic, Cargill and others. These companies have grown and prospered for decades — relying on the community while also contributing to it.

In contrast, recall the case of my former company, Honeywell. Its former CEO sold this global leader to Allied Signal for a modest premium and moved its headquarters to New Jersey. As a result, 21,000 well-paid Minnesotans lost their jobs and the state lost a generous community citizen.

As employment stagnates and the public remains exasperated with business, leaders who don’t adopt this broader view of the corporation’s role in society are likely to see their free-enterprise prerogatives sharply curtailed. As a fervent capitalist, I believe this would be a disaster. Instead, we need corporate leaders who align their missions with the interests of society in order to innovate, grow and create jobs. Minnesota businesses can provide the proving grounds for this renewal.


(Note: This article was originally published in the Minneapolis StarTribune on January 15, 2011.)