Proven, Profitable, and Sustainable
For the past fifty years, leaders in the business world have believed that their sole responsibility is to maximize profit for shareholders. But this obsessive focus was a major cause of the abuses that nearly sunk the global economy in 2008. In this analytically rigorous and eminently practical book, Bruno Roche and Jay Jakub offer a more complete form of capitalism, one that delivers superior financial performance precisely because it mobilizes and generates human, social, and natural capital along with financial capital. They describe how the model has been implemented in live business pilots in Africa, Asia, and elsewhere. Recent high-profile books like Capital in the Twenty-First Century have exposed financial capitalism’s shortcomings, but this book goes far beyond by describing a well-developed, field-tested alternative.
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About the Author
Bruno Roche has been the chief economist of Mars, Inc., since 2006 and leads Catalyst, a global thought leadership capability and internal think tank for Mars, Inc., where the ideas in this book were first proposed. Roche also is part of the World Economic Forum.
Jay Jakub is the senior director of external research at Mars, Inc./Catalyst. He joined the Catalyst corporate think tank in 2007 and coleads with Roche this pioneering new business model initiative. He is also the author of Spies and Saboteurs.
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Heal Business to Heal the World
By Bruno Roche Jay Jakub
Berrett-Koehler Publishers, Inc.Copyright © 2017 Bruno Roche and Jay Jakub
All rights reserved.
The Expanded Meaning of Capital
All truth passes through three stages. First it is ridiculed. Second it is violently opposed. Third it is accepted as being self-evident.
— Arthur Schopenhauer, German philosopher
We can't solve problems by using the same kind of thinking we used when we created them.
— Albert Einstein
When we started our new business model research in 2007, more than a year before the 2008 global economic crisis, our intuition was that the financial capitalism approach of Milton Friedman would soon reach its limits and needed to be reformed and made more complete in order for the economy and business to continue to create value.
The 2008 crisis wake-up call and a growing sense of urgency
In the years since the 2008 crisis, what began as intuition on our part has been dramatically confirmed as fact. The long-accepted (by business) Friedmanic assumption that the sole social responsibility of business is to maximize profit to maximize shareholder value — combined with the pressure of financial capital on business operations and the primacy of short-term financial capital creation over other forms of capital — is viewed by a growing number of stakeholders as being obsolete or no longer fitting for today's economic, social, and environmental context.
Perhaps those who enacted Friedman's views on a wide scale in ways that may have gone beyond his intent were more responsible than the man himself for the distorted form of incomplete capitalism bearing his name that we have today. Friedman's writings, after all, do reflect a recognition that some form of social expenditures are necessary to maximize the long-term profitability of a company. Yet, this seems to have been largely ignored by most who adopted Friedman's model, and the focus — short or long — remains fixed upon maximizing just one form of capital: money. And that is the point that truly matters — acknowledging what Friedman's adherents have done through their single-minded focus on that one form of capital, and what they and others must now accept if capitalism is to become functional and not create even greater dysfunction or be discarded completely for any number of inferior alternatives that could inflict their own dysfunctions on the world.
We are pleased to observe that partly as a result of the wakeup call of the 2008 crisis, there is now a growing and active movement — though still largely disparate and chaotic, made up of a relatively small number of businesses, NGOs, and a handful of academics — that challenges the hypothesis of Chicago. Some of these go by various monikers like conscious capitalism, inclusive capitalism, the triple bottom line, creating shared value, and the B Corp movement. In some instances they even predate the 2008 crisis, like the Social Venture Network, though the magnitude and continuing effects of 2008 helped make the world more open to discussing the current system's shortcomings.
We have no doubt that something good will emerge from this rising awareness. But at the same time, we wonder whether it will be enough — and come quickly enough — to mitigate the most destructive aspects of the pain associated with the economic transition that will come when the current system goes from being dysfunctional to nonfunctioning, as nearly happened in 2008. We don't know the answer to these questions of timing and acceptance, but we feel a strong and growing sense of urgency to share what we have learned about what a more complete form of capitalism could look like, despite the fact that we are still very much on a journey with this work.
Contrary to what happened in 1989 when the Berlin Wall collapsed almost overnight, where the alternative to the Marxist model (the market economy) was already in place in the Western world and ready to take over, the next model that will succeed financial capitalism is not yet in place. Hence, if Wall Street "collapses" in its own way, suddenly like the Berlin Wall did, we don't yet have an accepted alternative to embrace.
The role of global corporations in the development and enactment of a new model
Since business has historically been the driving force that has brought prosperity and taken millions of people out of poverty, and major corporations today have more power than some governments, we asked ourselves, "What would or should be the role and responsibility of large multinational firms in the coming transition from one system to the next?" And we asked how large multinational firms could help give birth to a new, more balanced approach to value creation and value sharing in terms of deploying a new model on a large scale.
Our intuition has been that a model based on the fair sharing of benefits among all stakeholders would create greater, more holistic, measurable value. Such a model, in turn, will necessarily lead to a superior approach for business than the model currently in place most everywhere. But we had to prove it.
Implicit principle needing to be explicit
The business principle that the sharing of benefits across stakeholders could lead to superior business performance over that of maximizing benefits to shareholders has only been implicitly enacted in some successful businesses over the last century or so. But it has not yet been translated into an explicit management theory. It is still more of a selective management philosophy than a scientifically rigorous management methodology that can be more widely deployed. Part of the explanation for this is that prior to the latest crisis, which exposed major underlying weaknesses in the financial capitalism model, most business managers and MBA educators were still too deeply rooted in their belief in the superiority of Friedman's approach to think much beyond it, other than perhaps in relatively narrow, ideological ways. Of course, there are always some exceptions, but none have as yet been simple, scalable, and compelling enough to be transformational.
In 2007, we sensed it was not only possible but also critically important to make this implicit management philosophy more explicit; to translate it into a true management theory. This was because we saw the global economic system as being on the brink of a systemic shift, with most businesses woefully unprepared. Making the implicit more explicit was not going to be easy, as it required developing new metrics for the different forms of nonfinancial capital, along with new management practices, and verifying through rigorous business experiments whether and how this approach can indeed create superior value for all — more than a profit maximization approach. The 2008 crisis brought a welcome new atmosphere of open-mindedness among some business managers and business educators that enabled us to proceed in earnest.
No relationship between profit and growth: a natural law or a worrying outcome of ideology?
To our surprise, our initial research into the management literature highlighted that the questions of "the right level of profit," or whether business should just be about shareholder profit, or whether greater sharing among stakeholders can deliver superior performance over time, have not been addressed rigorously or systematically. With the exception of a handful of papers and case studies, some of which have been only recently published, we found no truly rigorous approach or framework to address this question in a meaningful way.
This space today, again with very few exceptions, essentially constitutes a green field in the literature. This gap in the literature is in and of itself a remarkable circumstance, suggesting a vacuum in economic thinking that underscores the overwhelming influence of the Chicago school, even with all its now obvious dysfunctions becoming more visible to those who look for them. But it is sometimes difficult to see the forest for the trees, especially when our business schools and corporations are nearly all in lockstep in focusing only on trees.
Consequently, we conducted extensive empirical research into the actual performance of more than 3,500 companies (public and private, across different geographies) over roughly a three-decade span (1978–2006) leading up to the kickoff of our business model research program in early 2007. Our purpose was simply to study the causal relationship between profit and growth, i.e., between past profit and future growth, between past growth and future profit, between past growth and future growth, and between past profit and future profit, all over different time scales. The results highlighted a surprising pattern. We found no causal relationship between profit and growth, and no causal relationship between past growth and future growth — regardless of the time scale. The only strong causal relationship we found, in fact, was between past profit and future profit, implying that the only long-lasting pattern in business is its ability to generate profit — irrespective of its top line. A striking and surprising result.
Looking further into a subset of the sample data we examined — focusing on FMCG (fast-moving consumer goods) players (see figure 1) — we highlighted that while growth has been volatile (with ups and downs) over time, profitability during the same time span has steadily and consistently increased. In other words, consistently rising profits have been achieved by thousands of companies over the past few decades in both high-and low-growth scenarios. High profits did not inhibit or promote growth. High-profit businesses, in fact, apparently can live together with sluggish growth. Low growth is sustainable. Low profit, however, is not sustainable. It is remarkable that this pattern held during the 2008 global economic crisis, during which many corporate top lines plummeted while profit continued to increase (though only slightly), hence, securing the continuing remuneration of shareholders whatever the underlying economic context.
These facts appear to validate Friedman's assertion that the only worthwhile goal is to maximize profits, and the role of management, therefore, has implicitly been focused on driving up bottom line net earnings (extracting increasingly more value over time) rather than on managing top line gross revenue, which is more prone to external economic fluctuations. One could argue of course that the increased profitability observed across firms over roughly the last thirty years has actually been driven by rising productivity and accelerating technological change. However, the steadily falling labor share in large economies since the 1980s, as pointed out in a recent paper by the Organisation for Economic Co-Operation and Development (OECD) and the International Labour Organization (ILO), suggests the opposite. Over the last three decades, in a majority of large economies, including the United States, Germany, and Japan, wage growth has actually been lagging behind productivity growth, and labor productivity has outpaced real average wage growth.
Furthermore, the steady increase of the so-called "ecological footprint" of human activities reveals that the world now uses the equivalent of at least 1.6 planets to provide the natural resources it needs to operate versus 1.0 planets in 1970, around the time Friedman's model was invented and began to gain more widespread acceptance in business. The productivity gains have not translated into higher remuneration of the planet and the people, but rather have provided greater benefits to shareholders who own the financial capital.
This rather new phenomenon — the lower pre-1970s ecological footprint and the fact that income flowing to labor and financial capital was more or less fixed for decades prior to the dramatic tilt toward the latter in the 1980s — raises a bigger question about whether profit maximization is a natural law or an ideology. And it also begs the question of whether this increase in profitability over time sustains or undermines Friedman's approach, as earlier noted. Being able to outsource jobs to cheaper and cheaper labor markets to help drive the bottom line (net earnings) regardless of top line (gross sales) performance, after all, cannot continue indefinitely. One day there will be no cheaper labor market to which jobs can be outsourced, and the laws of supply and demand will drive up the cost to business of natural resources as the planet becomes more and more depleted. Such is the way of new forms of scarcity that were not present at the birth of Friedman's model.
Figure 1 illustrates that on average, the profitability (bottom line) of the top FMCG companies doubled over the thirtyyear period we examined, while revenue growth (top line) was highly cyclical, hence, there is little evidence of any meaningful relationship between the top and bottom lines, only between past and future profit. Thus, it is the Friedmanic ideology, underpinned by management practices and metrics that only drive the bottom line, acting as the profit engine for business — but only for as long as labor and natural resources remain roughly in status quo, which is no longer the case.
Going beyond traditional boundaries and financial capital to measure performance
The need to extend the firm's responsibility beyond its traditional legal boundaries is driven by the fact that most businesses increasingly operate within complex value chains, made of business players of different sizes, operating in different geographies. Metaphorically, one could therefore argue that nowadays each business value chain is only as strong as its weakest link. And responsible, more mutually beneficial business practice is about ensuring that the weakest links of the value chain do not become weaker, but rather are strengthened because the financial cost incurred by a disruption of a value chain is frequently much higher than the cost of maintaining the strength of the weakest players in the value chain. Hence, it is important to embrace the entire business ecosystem in which a business operates, beyond the traditional legal boundaries of the firm. This includes identifying the weakest links and the most acute pain points across all forms of capital, setting up methodologies and metrics to account for them, fostering an environment that is conducive to investing in strengthening those weakest links, and giving them the means to invest and grow (by offering higher margins, as one example among others).
In the same way that economics essentially is the management of scarcity, management is predominantly about measurement. Hence, there is a need to translate the concept of changing various forms of scarcity into the managerial area and to develop new performance metrics for the other forms of capital we discuss in detail in this book (social, human, natural). The idea is to manage the new forms of scarcity and to account for the nonfinancial riches (in nonfinancial ways) that have heretofore been "hidden in plain sight" because of their prior overabundance, yet they have always been critically important for the sustainable performance of any business.
Because the metrics for nonfinancial forms of capital (social, human, natural) have in the context of business application been comparatively weak, confusing, or even nonexistent in some instances, the easiest and most obvious form of capital to measure has been money. This, in turn, has convinced many who are moving into this multi-capital space of research — especially those engaged in management consulting — to simply monetize the other forms of capital in order to deal, eventually, with one metric. This is despite the (obvious to us) fact that monetizing everything may be counterproductive and will certainly be inaccurate, as how can one put a dollar figure on community trust, for example? Or on managers walking the talk of the values they espouse? As we know from history, human nature often follows a path of least resistance, following the logic of Occam's razor, where the simplest explanation or solution is usually superior. In this case, monetizing may seem relatively simple on the surface, but it will be distorting in ways we will later discuss in the chapters on each nonfinancial form of capital.
From the perspective of what constitutes "value" in a business context, the planet provides the resources with which business makes products. The people transform those resources into the actual products and services. The money provides the liquidity to enable people to affect the transformation. This is consistent with the core principles of economic history we noted in the introduction.
The overabundance of money in the system
As stated previously, our argument is that if economics essentially is the management of scarcity, then there is no need to overly focus on financial capital alone because, while money was scarce in the postwar period, this is no longer the case. In fact, if anything, the amount of financial capital that is allegedly currently in existence — we say allegedly because it is inconceivable that much of this financial capital exists as more than a bookkeeping exercise, especially in the case of derivatives valuation4 — is almost unimaginable.
Excerpted from Completing Capitalism by Bruno Roche Jay Jakub. Copyright © 2017 Bruno Roche and Jay Jakub. Excerpted by permission of Berrett-Koehler Publishers, Inc..
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Table of Contents
Foreword Colin Mayer, Former Dean, Oxford University's Saïd Business School Martin Radvan, President, Mars Wrigley Confectionery ix
Introduction: Uprooting the Dysfunctions of Financial Capitalism 1
Chapter 1 The Expanded Meaning of Capital 25
Chapter 2 Five Indicators for Measuring Human Capital and Well-Being at Work 57
Chapter 3 Measuring Social Capital-How Communities Affect Growth 69
Chapter 4 Measuring Natural Capital-Making More from Less 87
Chapter 5 Recalibrating Financial Capital-How Mutuality Drives Profits 99
Chapter 6 Maua-Social and Human Capital: A Case Study 107
Chapter 7 Coffee-Natural Capital: A Case Study 127
Chapter 8 Remunerating the New Forms of Capital 131
Conclusion: Repositioning Business as a Restorative Healing Power 145
Afterword Lim Siong Guan, former Group President, Singapore Sovereign Wealth Fund (GIC) 165
About the Authors 183