Harvard Business School representatives, led by Michael Porter, were in Chicago Monday, to talk about their U.S. Competitiveness Project. On the whole, it was a thoughtful series of presentations by both professors and local Chicago business people. I consider three aspects they introduced here:
1. Inadequacy of current financial tools: Off-shoring was discussed at length. Professor Porter had some observations about the limitations of traditional financial analyses, which often seemed to support off-shoring due to the large wage differentials, but don’t take into adequate account the other considerable costs and risks:
– distance from markets and less predictable transit times with the corresponding lengthening of response times, a competitive disadvantage in dynamic markets
– inventory costs in transit
– quality and inspection issues
– differences in workforce skills and communication challenges
– local inflation trends affecting wages
– lack of supporting infrastructure, and so on.
Basically, Porter seemed to suggest that traditional financial analyses are not been sufficiently broad in their scope to capture the full cost/benefit/risk picture, resulting in decisions that have a very short shelf life, quickly becoming uneconomic.
I agree. The financial metrics taught in most business programs are insufficient for today’s world. I think Peter Soyka, author of Creating a Sustainable Organization, would emphatically say that business financial practices are even more inadequate when it comes to capturing the full economic benefits of sustainable business practices. I will talk about that in a later post.
2. Business need to understand the U.S. industrial eco-system – or “industrial commons.” Professor Jan Rivkin noted that companies historically invested in their locales, as every business draws on the resources of those locales, such as an educated workforce, vibrant transportation and supplier networks, and an astute legal system providing a level playing field and protecting IP. With globalization, and the capability to do business from anywhere to anywhere, many executives concluded they no longer needed to “put down roots.” In Rivkin’s words, “The problem is when you do that, the commons gets run down. You start to not have the skilled workforce you need. You don’t have capable suppliers.” That happens wherever a business is, over time, unless there is some compensating force.
There are strong parallels to our planet’s Natural Capital….. the real commons of clean air, clean water, artificial-toxin-free and robust soils, their supportive biodiversity and a protective atmosphere. If we don’t all take care of these life-critical factors, they may disappear, as will we. Sad to say, the environmental commons were only indirectly alluded to as “resources.”
3. Recognize that business has created the monster – the regulatory environment and overcomplicated taxation systems. Kudos to Mike Porter for stating this, albeit tentatively. He continued that we businesses need to tackle the issues… we need to use our influence to make the whole system work better. “We cannot grouse – we must take on the issues.”
Porter then reiterated an earlier theme: that businesses must recognize that it is facing a challenge of legitimacy in the minds of the public. He challenged business to do three things:
a. Run the business well. Be innovative and productive. Be mindful of all your stakeholders.
b. Strengthen the commons in the U.S. communities (and here I would also include the environmental commons)
c. Shift the business-government relationship away from narrow self-interests toward general business environment improvement (here too, the natural environment plays an important part).
For only two hours, a lot was put on the table.
“Corporation, n. An ingenious device for obtaining individual profit without individual responsibility.”
— Ambrose Bierce (1842 – @ 1913)
The Wall Street Journal had a front page article today (Tuesday, 4/16/2011) about the government’s threat to exclude a company – with a history of marketing violations and fines – from doing business with the government unless the company’s chief executive stepped down. Part of the government’s effort to hold business executives accountable, and recognition that corporate fines had little impact on management or management behavior, this move was seen as game-changing. Some called it an expansion of government interference in business; others thought it logical, with the potential to expand beyond health care. Before there is a rush to judgement in either direction, it may be helpful to review the history of the corporation. Please note, this isn’t about business in general, but it is about the particular legal entity called “the corporation.”
The corporation has had a checkered existence from its first emergence in the late sixteenth century. Contemporary businessmen and politicians had been suspicious of it. Rather than the mutual accountability of a partnership – small groups of men, connected via personal loyalties and trust who pooled their resources to both own and run a business, corporations separated ownership from management.
Many believed it a foolproof recipe for scandal and corruption, including Adam Smith. At one time, the corporation was banned in England for over 100 years (1720 to 1825) due to scams. Railroads helped bring it back. Railways were huge initiatives requiring mammoth amount of capital investment, more than most partnerships could muster. Corporations made their way back as a way of raising enough capital to carry out such infrastructure investments. One of the arguments for bringing it back was that it would encourage the “common man” to invest and to thereby understand more about the trials and tribulations of owning a business. This was made possible with the concept of limited liability….. that a stockholder could be held accountable for no more than what he had invested in the company. In England, the understanding was that the corporation owed the State a “duty of care,” the grant theory of incorporation. That is, incorporation was a special privilege granted by the proper level of government (the “State”) for the pursuit of public purposes. Under that theory, the corporation was an artificial entity, created by the State, with powers strictly limited by its articles of incorporation.
In the United States there were initially significant regulations, too. Initially, there were tight state controls, but this too was abused, this time by politicians: the “special charter” process was thought to encourage bribery, political favoritism and monopoly. The concept of “free incorporation” – accessible to all – gained momentum, and incorporation came to be considered as the normal way of conducting business, rather than a privilege granted by the State. This weakened the connection between incorporation and public obligation. Beginning in the 1890s, regulatory protections began their “race to the bottom” when states, notably Delaware and New Jersey, decided to attract the incorporation business to their areas by eliminating or relaxing many restrictions to corporations, among them:
o The rules requiring businesses to incorporate only for narrowly defined purposes, limited durations, and only in particular locations;
o Relaxed controls on mergers and acquisitions;
o Elimination of the rule that one company could not own the stock of another company.
This started a race among other states, strangely reminiscent of today’s special tax incentives, as other states sought to offer equally attractive regulations to corporations.
So began a wave of consolidations….. some 1,800 corporations were consolidated into 157 in the six years prior to 1904. In 1912 due to a perceived corporate abuse of power, a congressional committee was empowered to investigate the financial control that a small group of Wall Street bankers had over the nation’s finances. One ancillary conclusion of that effort was that a corporation’s stockholders were relatively powerless, none had been able to overthrow an existing management or even to have an existing management investigated to determine if it were honestly managed. The committee’s report led to a finding that a group of financial leaders had abused the public trust, and created a climate of public option that lead to the Clayton Antitrust Act of 1914, and to the Federal Reserve Act of 1913. In essence, stockholders and board members were incapable forcing management to operate in ways aligned to the public interest, and the national government had to step in.
Just a little earlier, courts – through convoluted chains of logic – had endowed corporations with “entity status,” even granting it protection under the 4th amendment in 2005. Another tendency was clear: the shifting of power away from the shareholders and directors to the professional managers.
That is a very brief history, but it should help readers see the complexity of the issues. The State, meaning national – and in the U.S., state governments used to have much more influence over corporations than they do now. Corporations have often earned additional governmental scrutiny through scandals, and have repeatedly demonstrated that they are not capable of regulating themselves consistently in a way that is aligned to the public interest.
The corporation is a powerful legal and economic entity. Our nation’s government was founded on the idea of checks and balances. Corporations were not so designed, and depend on governments to regulate and to appropriately assign costs to protect the public interest. This latest initiative – to hold corporate leadership individuals responsible for the pattern of corporate violations – is the latest evolution of strategies to protect the public.
Is it an inappropriate expansion of governmental powers? Do you want your tax dollars supporting a corporation that repeatedly violates the rules, and puts other companies at a disadvantage as well as the public? Food for thought.
When Michael Hammer, author of Reengineering the Corporation, died in 2008, the NYT reported that he once wrote: “I’m saddened and offended by the idea that companies exist to enrich their owners…. That is the very least of their roles; they are far more worthy, more honorable, and more important than that. Without the vital creative force of business, our world would be impoverished beyond reckoning.” (NYT, Sept. 4, 2008)
He and his co-author were reportedly deeply concerned about the misuse of their premise, as “reengineering” became instead “synonymous with less elegant forms of reorganization, notably downsizing, in which C.E.O.’s fire workers wholesale to make a company more ‘efficient’.” (Ibid.)
This was part of a process in which all aspects of a business were analyzed and objectified. With a focus on transaction costs, relationships were often reduced to deal of the day; resources considered only inputs, with a focus on reducing financial outlays to secure them; and people were mostly seen as costs, not resources or investments. Jack Welch of GE was a leading cheerleader. As reported in The Week (March 25, 2011), Welch “argued that public corporations owe their primary allegiance to stockholders, not employees. Therefore…companies should seek to lower costs and maximize profits by moving operations wherever is cheapest.” Welch’s GE even held “supplier migration seminars” encouraging them to “migrate or be out of business.” Welch even advocated the ideal of having plants on barges “to move with currencies and changes in the economy.” (Ibid.)
In 2009, Bloomberg Businessweek (March 16, 2009) reported that Welch had changed his tune, telling the Financial Times that the business emphasis on shareholder value – a.k.a earnings and stock price – was “misplaced.” “On the face of it shareholder value [as strategy] is the dumbest idea in the world.” Welch went on to say, “Any fool can just deliver in the short term by squeezing, squeezing, squeezing.”
Welch went on to explain that “shareholder value is a result, not a strategy…..Your main constituencies are your employees, your customers and your products….” (Ibid)
Still, there are a considerable number of world corporations that believe shareholder value is still the grail, and have the compensation schemas to reinforce its value in their version of the world. Wall Street reinforces their conclusions, with institutions comprising the largest percentage of equity ownership. Institutions often have performance goals to meet that encourages more frequent trades. Institutions include mutual funds and pensions, as well as insurance companies, banks and investment funds responding to competitive pressures to deliver returns….. often driven by folks like you and me who invest funds for retirement. Conclusion: Our society has created rewarding feedback loops for short term thinking which makes meaningful change challenging.
At this past World Economic Forum, there was conversation about developing two kinds of equity, similar to short and long term bonds rates. One suggestion was that certain economic benefits, as an example, dividends, would not accrue to any but long term, such as five years, investors.
Socially responsible investing – defined as an investment strategy that seeks to maximize both financial return and social good such as environmental stewardship, social justice and corporate governance – also has strengthened, especially in the last 25 years.
Indra Nooyi of Pepsico talks about Profit with a Purpose, which incorporates the concept of corporations exercising a “duty of care” to the societies in which they operate – this in exchange for the privilege of limited liability. There is growing recognition that “no corporation is an island,” a la Welch’s corporate barge. In the words of Porter and Kramer, “Any business that pursues its ends at the expense of the society in which it operates will find its success to be illusory and ultimately temporary.” (HBR, Dec. 2006, Strategy and Society)
Getting from where we are to where we might like to be is no cakewalk. Strategy as a management tool becomes more important in the CEO toolkit, as leadership determines priorities and opportunities. Bottom line, managing for long term, generating sustainable shareholder and social value is darned difficult. It also means developing better peripheral vision and sensitivity to evolving science findings, black swans and systemic risks. It requires leadership, a strong sense of values and developing high caliber talent.
No wonder so many choose to focus on short term earnings and stock price. It’s a heck of a lot easier, and often transiently lucrative, especially if contributing genuine value is low on the personal priority list.
In the last year, Michael Porter and Mark Kramer have been writing and speaking on the opportunities available to businesses if they would “broaden” their views to include the society they are a part of, and have the longer term in view. Many business practices in recent times have focused narrowly on transaction opportunities without seeming to consider the societies of which they are a part. Globalization has often led to greater commoditization of products. The business objective of creating demand has often led to unneeded and sometimes deleterious though attractive products. Focus on narrowly-defined “lower costs” has led to often complex and counter-productive expansion of supply chains, greater vulnerability to natural and man-made dislocations, and significant levels of disengagement among employees.
It’s about time business leaders speak out. And some are.
Porter and Kramer’s position is that recent definitions of “Value Creation” has been defined too narrowly as “optimizing short term financial performance… while missing most important customer needs and ignoring the broader influences that determine their longer term success” (HBR, Jan-Feb 2011, page 64). “How else,” asks Porter, “could companies overlook the well-being of their customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell?” (Ibid).
How else, indeed. And how could such strategies be considered “state of the art” by leading Schools of Business Administration for decades? Where were the Business Schools? Indra Nooyi of Pepsico asked Porter that question at the 2011 Davos Conference during a panel discussion. Porter’s response was “guilty as charged,” and added that the definition used in constructing value chains had been too narrow in that many real costs had not been appropriately considered in the “cost-benefit” analysis.
Most fascinating was Nooyi’s discussion of her vision for Pepsico, in which the product line would be reframed, with fewer just “fun” foods (those without nutritional benefit, but oh! so tasty), better foods and good foods. She acknowledged being challenged by folks internally and her Board as to whether she would be acting as a responsible steward for Pepsico if she pursued such a strategy, so deep is the current American business culture in its acceptance of Milton Friedman’s mantra on the purpose of business is profits, and that is how it contributes to society. As I have noted before in an earlier post, even Friedman had assumed an effective State, one that would appropriately assess businesses for the “external costs” they were creating for the society in which they acted. That isn’t happening, either in the U.S. (and the prospect is for even less effective State involvement as business interests lobby for less regulation and lower corporate taxes) or in many places abroad. (Another whole discussion can be offered in terms of creating more effective regulation. that achieves its purpose while stimulating innovation.). Nooyi took the issue very seriously, and had legal resources research in law the purposes and origin of business-and society, the social contract. Going back to the joint stock company laws of limited liability granted by the State, it was clearly articulated that businesses owed their society a “duty of care.”
In Porter’s words, that’s “creating economic value in a way that ALSO creates value for society by addressing needs and challenges.” It is also taking external costs into the cost-benefit equation and mandating taking a longer term view for running a viable, valuable business.
If basic research on oil-consuming microbes in the Gulf of Mexico got a nickel for every ad seen – in newspapers, on TV, on live-streaming, on other web-properties, in magazines – on how hard BP is working to clean up the mess from the Deepwater Horizon, we would all be better positioned for the future. Instead the saturation gives citizens the impression that BP has very deep pockets, and chooses to spend its dollars on polishing its image rather than truly addressing the Gulf issues.
For example, BP’s continues to be less than forthcoming on sharing its high quality video feeds on the well leak. Obviously, as a corporation it is seeking to cloud the estimates of gallons leaked which are the basis for penalties. It had rather spend its resources on PR than true resolution.
Contrast BP’s behaviors to that of Chevron’s Kutubu project in New Guinea as described by Jared Diamond in Collapse.
Clear business principles guided Chevron: First, Chevron recognized that “spending each year an extra few million dollars on a project, or even a few tens of millions of dollars, they would save money in the long run by minimizing the risk of losing billions of dollars in such an accident….or losing its whole investment” (pg. 447).
Apparently BP’s strategic planning understates such risks.
Secondly, Chevron managers appear to understand that cleaning up pollution is usually far more expensive than preventing it in the first place. The ounce of prevention is worth a pound of cure philosophy. That assumes there are appropriate regulations in place or that will be in place before the end of the project’s lifespan to ensure thorough clean-up.
BP apparently plays the delay, blame and obfuscate, and political games.
Thirdly, Chevron managers recognize that a good reputation sometimes provides a competitive advantage in obtaining future contracts. Some believe Chevron’s reputation in Kutubu helped it win Norway’s North Sea contract.
It will be interesting to see how BP fares in its contract campaigns in the future. Their Gulf performance is already complicating their Alaskan drilling.
In addition, New Guinea had some local implications that would reward a strong “good neighbor” position (Collapse, pg. 448). The relatively weak central government would not be able to prevent disruptions by local landowners. It was then important to work with local communities, so that they would believe “they are better off with us [Chevron] there than they would be if we were gone” (pg. 448)
BP has been very important to Louisiana’s economy. Do Louisianians still believe they are better off with BP than they would be if BP were gone? Time will tell.
Good corporate citizenship does pay dividends.
In late June, I spent some time in California with friends. One, a Canadian economist, had done some work for BP and knew former CEO Hayward. His observation was that BP has a much better business reputation in Europe than in America. He attributed that to the “original BP” culture infusing the “European BP” characterized by decentralized management and two prime directives: 1. Safety above all, and 2. Do not take risks that jeopardize the environment. My friend believed that the acquisition of Amoco, an American company with detailed policies and procedures and significant bureaucracy, began the change. In his opinion, as BP’s decentralized management structures took over, the detailed policies and procedures were cast aside, and there was no core ethic to safety or to the environment to guide behaviors. As BP lauched on their cost cutting strategies and their orientation to “no dry holes” and “big finds,” the prime directives got lost.
I’m skeptical of that scenario explaining the last 20 years of accidents, short cuts and maintenance “lite.”
Nonetheless, it brings up some observations:
1. In mergers, strategies for combining cultures are every bit as important as combining operations, and should be orchestrated even more carefully.
2. People in companies watch what their leaders do and whom their leaders reward with promotions and bonuses to determine what is really held in esteem. Clearly, safety and protecting the environment were NOT perceived as BP’s current prime directives.
It is harder to do this in large companies. Executives must be crystal clear and consistent in their actions, and many parts (like compensation and recognition) must be aligned.
IF BP wants safety and environmental protection to be be prime directives, they have their work cut out for them. At the very least, given their recent history, their legal and regulatory performance requirements are being raised for them…. and for everyone else in the industry.
We have all learned a lot in the BP classroom.
1. The pressures from the well head in the brittle lithosphere are tremendous. There is widespread incredulity that a major oil company was so totally unprepared for a blow-out, especially given some of the internal communications (see #2).
2. The documentation trail, as reported in the NYT, suggests corners were cut regarding both the casing used and the blow-out preventer, and that a special permission was granted internally because the casing violated BP’s own design standards and safety policies. According to the NYT, the internal reports do not explain why the company allowed the exception.
3. At the Congressional hearings, a string of witnesses recounted cut corners and bad decision in the days and moments before the April 20 explosion.
4. There is distrust and continued skepticism – based on BP actions – that the company is being open and forthright about its knowledge of the well, the flow-rates, and the implications for the environment.
5. While it appears that the PR department has reined in some of CEO’s Hayward’s insensitive comments – or perhaps his own observations of the environmental destruction his company is causing – true partnership falls short.
6. There are still significant discrepancies in the estimates of oil flowing from the break, although all are significantly higher than BP’s initial estimates of 5,000 barrels per day. The technology exists to easily get a more accurate number. Since BP is on the hook for fines, based on the volume, it has been appeared to be in its interest to low ball, and to continue to be uncooperative in the efforts to gain accuracy. I would suggest that behavior could back-fire, giving the Government little reason to mitigate their estimates.
7. BP’s Hayward continues to dispute ANY potential for there to be plumes of oil floating beneath the surface, in spite of the evidence gathered by several universities. Experiments at UNC-Chapel Hill by fluid dynamics researchers show that the oil’s behavior depends on “whether a spill is released in the form of a turbulent jet or is under less pressure…. The mixture from the first more turbulent jet is trapped underwater in a horizontal plume when it reaches the level where the surrounding water density changes; the second less turbulent jet is not trapped, and the oil rises to the surface.” (http://futurity.org/top-stories/gulf-spill-why-oil-plumes-dont-surface/#more-12625)
UNC researchers also analyzed video of the current spill to try to determine how much oil is leaking into the Gulf. Their estimate: 56,000 barrels per day.
8. BP continues to use the more toxic dispersant, in spite of repeated requests by the EPA to move to a less toxic option. Apparently there is no data on the toxic effects of the dispersant in the quantities being used by BP. Clearly, however, BP’s probable case for using it will be its “effectiveness” in less oil rising to the surface. That is relevant only if one conveniently ignores the observations of the research groups in the Gulf on the horizontal oil plumes.
9. The markets are punishing BP severely. From today’s Reuter’s: BP’s shares have lost more than a third of their value – $67 billion – since the leak began. The cost of protecting BP’s debt against default has risen over 71 basis points to 173 basis points.
10. A colleague talking to oil services providers noted they identified BP as one of the worst companies to deal with: nickel and dime-ing every step. Interestingly, one of the best companies to deal with was identified as …… Exxon.
When there are real numbers on the risk equations, it must be amazing as to how many safeguards one can afford.
From a CSR perspective, wouldn’t it be better to truly join in a collaborative and open effort to stop this disaster? and to work transparently in identifying and mitigating the damage? At this point, it would seem that BP has less to lose if it chooses open cooperation, than if it continues its combativeness.