Going from chasing profits to creating value

values

In 1970, the eminent economist and Nobel Prize winner Milton Friedman wrote that “there is one, and only one, social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”.

More than four decades later, no one will argue with him that one of the main objectives of businesses is to make profits for shareholders, but profits alone are no longer enough. Societal expectations of roles of businesses, as well as views of business leaders, have undergone a sea change.

Businesses in the second decade of the 21st century are expected to create value concurrently for their shareholders, consumers, employees and communities in the areas they operate, as well as for society as a whole. This is what a major multinational like Nestlé calls creating shared value, a term that it coined and is now used extensively by many businesses. Another major multinational, Unilever, has declared that its “clear purposes are to make sustainable living commonplace”, which is the best long-term way to grow its businesses.

A quick analysis of the current views of major multinational companies (MNCs) indicate that a good majority of forward-looking and “enlightened” companies currently hold similar views as Nestlé and Unilever, rather than what Friedman had stated in 1970. Equally, a significant percentage of their shareholders and stakeholders are quite comfortable with the paradigm shift.

This, of course, does not mean that every MNC has embraced this philosophy completely. For example, most companies still compensate their senior executives handsomely, and almost exclusively, on the basis of shareholder returns. Very seldom are their societal contributions considered when the remuneration packages are decided.

But there are signs that mindsets of business executives are changing. For example, Nestlé has not listed its shares on the New York Stock Exchange because one of its requirements is quarterly projections. The view is that it leads to short-termism, rather than a focus on long-term investments.

Unilever has gone a step further. Its chief executive Paul Polman has said candidly that the company would like long-term investors. If investors do not like its long-term business view, which emphasises a value-creation model, he would respect their opinions, but they “should not put their money into our company”.

In spite of, or because of, taking this high road, according to the latest figures from Financial Times, Unilever’s returns on assets is 9.88 per cent, on equity 33.16 per cent, and on investments, 16.62 per cent – a very creditable performance.

Nestlé returns are as good: on assets 6.59 per cent, equity 14.68 per cent, and on investments, 9.41 per cent. This shows that well-run companies with a social conscience can at the same time create value for their shareholders and for society as a whole.

Taking a long-term view is essential. Take some major MNCs. Procter & Gamble started life in 1837, Nestlé in 1857, Coca Cola in 1886 and Unilever in the 1880s. All these companies older than 130 years old plan to stay around for the next century and longer. To do so, they must continue to create value for their investors and society as a whole. There are no short cuts or options.

With changing mindsets, business models and societal expectations, most major MNCs are now producing annual sustainability reports. In our view, good and reliable sustainability reports will help investors, regulators and non-government organisations (NGOs), and should also increase these companies’ transparency, credibility and reputation. We have analysed such reports for major companies and harbour no doubts that they are a step in the right direction. But they still have a long way to go.

There are many problems such reports have to overcome. First is the target audience. They seem to be written for everybody and nobody at the same time! Very few people, except probably for those who rank sustainability of companies and perhaps some regulators, read these reports. These reports are basically failing to connect with, or inform, an ever-growing group of shareholders, most of whom have very specific interests. They are often heavy on pictures (weight too!) and graphics, but short on specifics. If they are to be read and made use of, information needs to be targeted to specific interest groups and disseminated accordingly. This will require a determined effort, but the results will have a perceptible impact.

THE WATER SECTOR

Take for example, water. If one analyses the sustainability reports in this sector, unquestionably, companies like Nestlé, Unilever, Procter & Gamble and Coca Cola have in the last decade made significant reductions in water use per unit of product manufactured and waste water generated. They treat their waste water and then reuse it. They have made their staff conscious of the value of water, and use the latest technology and best practices in management to make water use more efficient. These are undoubtedly very positive developments.

However, at best, current sustainability reports give information on the company’s performance on a national basis, not by locations from where water is being extracted and used and waste water is discharged. Water is always managed locally. Thus, nation-wide data are of limited use to local stakeholders or water managers.

Equally, the reports rarely consider risks posed to local communities whose water demands for various uses are going up. The companies and local communities use the same water sources. During years of severe droughts, communities often resent seeing industries using their sources of water while they themselves do not have enough. Several MNCs have had to cease operations during droughts in India and California. This is a growing risk.

Companies also need to explain how they calculate water risks. Mere mention of it in general is meaningless. How they are measuring, estimating and reporting water risks, since the methods available for this are rudimentary? Also, very few companies report how they integrate water in their operation and management practices.

A major user of water is the supply chain of companies, especially for products that are water-intensive to produce. There is very little collaboration at present with suppliers in terms of water use, extent of waste water treatment and various other water-related factors. Most sustainability reports treat these issues only anecdotally.

Equally, details of stakeholders’ engagement in water-related issues are basically unreported or under-reported. In fact, some business leaders have become greatly involved in water-related issues, a prime example being Peter Brabeck, chairman of Nestlé. He, more than any academic or individual from the public sector, is surely one of the world’s most effective, dynamic water ambassadors.

One key area of our studies of MNCs and sustainability looked at the extent to which companies are now also playing the traditional roles of NGOs and governments. We now see several major MNCs engaged in problems related with social and environmental issues such as human rights violations, child and indentured labour and biodiversity losses in their supply chains; they are also doing development work traditionally in the domain of governments, such as building schools and toilets for girls, supplying clean water, establish libraries in schools, providing veterinary services for farmers, providing health and nutrition information to consumers, and contributing to women’s empowerment.

Enlightened companies like Nestlé, Coca Cola, Unilever and Proctor & Gamble are steadily enlarging their societal footprints by complementing the activities which have erstwhile been led by NGOs and/or governments.

We expect to see more involvement of businesses in such areas.

If Friedman were alive today, he would probably agree with the current paradigm where businesses not only make profits for their shareholders but also concurrently play increasingly important roles in terms of value creation for the entire society.


The piece first appeared in Business Times here.

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