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The business of business isn’t just only about creating profits


Comments / {{hitsCtrl.values.hits}} Views / Monday, 19 September 2016 00:01


untitled-3 The renowned economist Milton Friedman (1912-2006) preached that the business of business is to engage in activities designed to increase profits. He certainly in the current context got it horribly wrong. The business of business isn’t just about creating profits for shareholders — it’s also about improving the state of the world and driving stakeholder value. 

As UN Secretary General Ban Ki-moon said recently, “We are the first generation that can end poverty and the last generation that can take steps to avoid the worst impact of climate change. Future generations will judge us harshly if we fail to uphold our moral and historical responsibilities.” 

On the other hand, shareholder value creating is a refreshingly simple construct i.e. companies that grow and earn a return on capital that exceeds their cost of capital, create value. The 2008 financial crisis is the most recent reminder that when executives, Boards and investors forget their guiding principles, the consequence is disastrous – so much so, in fact, that some economists call in to question the very foundation of shareholder-oriented capitalism. 

As a result of the meltdown, governments are now pushing hard for more regulation and fundamental change in corporate governance. Academics and even some business leaders have changed their focus from increasing shareholder value to a broader focus on all stakeholders, including customers, employees, suppliers and local communities.

Many of the companies that are now the world’s most admired put significant effort into engaging their stakeholders (employees, customers, partners) for a wide variety of things: explaining the vision, policies and beliefs of the company, communicating strategy and milestones, and often involving them in seeking solutions and new ideas. 

As companies sought capital in the public markets and listings on international exchanges, they had to communicate their vision for not just the company — but the country as well. Companies making forays overseas had to work at winning the trust of customers and partners doing business with Sri Lanka for the first time. This process demanded strong corporate cultures.

Shareholder value

Creating shareholder value is not the same as maximising the short-term profits, and companies that often confuse the two, often put both shareholder value and stakeholder interest at risk. A system focused on creating only shareholder value, isn’t the real problem; short-termism is. 

Great managers don’t compromise on safety, don’t make value by destroying their existing networks, just because their peers are doing it, and don’t use creative accounting or financial gimmicks to boost their short term profits, because ultimately such moves undermine intrinsic value. 

What we need now more than ever before is a clearer definition of shareholder value creation that can guide managers and board of untitled-4directors rather than blurring their focus with a vague shareholder agenda. Companies are better able to deliver long term value to the shareholders when they consider key stakeholder concerns; the key would be for companies to examine those concerns systematically in one go to create opportunities to deliver on both objectives and thereby build a sustainable business.

Balancing stakeholder interest

There is now a need for companies to focus on a broader set of stakeholders, not just shareholders. Therefore to create long-term shareholder value it is now necessary to satisfy other stakeholders as well. 

A company for example that tries to boost profits by providing shabby working environments relative to competitors, by underpaying employees, or cutting back on benefits will have trouble attracting and retaining high quality employees. Lower quality employees means lower quality products, reducing demand and hurting reputation. 

More injury and illness can invite regulatory interventions and more union pressure. Higher employee turnover would increase recruitment cost, loss of productivity and training cost. With today’s more mobile and more educated workforce, such a company would struggle in the long term to retain good staff against competitors offering more attractive incentives. However, if the company earns more than the cost of its capital, it might afford to pay above market wages and still prosper. Therefore treating employees well is always good for business.

Invest in people

One common trait amongst organisations that have emerged as winners was due to a concerted investment in people — from employees to channel partners. For example, to attract FDI into the garment industry, the industry had to build talent and fight hard to retain them, as new opportunities opened up. The new emerging sectors like tourism and technology services need to do the same thing. 

The winning companies have invested in strong HR systems and continued to invest big in learning and development. The IT companies were the leaders in this process, as much of their growth depended on work from outside, but other well-known groups maintained their strong performance in large measure because of good HR policies. 

Among the family-owned businesses that emerged stronger in Sri Lanka, there was a concerted effort to professionalise management. The hallmark of many of these companies has been creating a tough but meritocratic systems and investing in world-class facilities.

Conclusion

But how well is well enough? A shareholder focus doesn’t provide an answer. Stakeholders’ focus does. Shareholder capitalism has taken a huge beating in recent years, and given the complexity of the issues, it is unlikely that either the shareholder or stakeholder model of governance would be seen to be far superior to each other. 

However, a shareholder model thoughtfully embraced as a collective approach to present and future value creation is the best at bridging the board and varied interest of the shareholder and other stakeholders alike and the best path to broad economic prosperity and to finally make good money. 

In the final analysis this would however requires decisive leadership; to make the “new normal” better than the old one. Sadly, the world is short of decisive leaders!

(The writer is a HR thought leader.)


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