The Harvard Business Review began 2011 with Michael Porter and Mark Kramer inventing jargon and claiming they were reinventing capitalism. This month the Global Managing Director of McKinsey & Co. offers an executive summary course on the same topic. Read my views below and add yours in the comments.
I. Creating Shared Value: A Ripple Not a Wave
In the lead article of the January-February 2011 edition of the Harvard Business Review Harvard
[i] strategy guru Michael Porter and his business partner at their consulting firm FSG Social Impact Consultants claim to have reinvented capitalism in a manner that will restore the diminished trust in business which is now viewed by many as a cause of many social, environmental and social problems. Even better, this new recipe will unleash a
wave of innovation and growth. Porter and Kramer label their new approach
Creating Shared Value (CSV). As the name implies, they call for a refocusing of companies away from short term financial performance and towards community-wide value creation. They write
The concept of shared value can be defined as policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which it operates. Shared value creation focuses on identifying and expanding the connections between societal and economic progress.
The concept rests on the premise that both economic and social progress must be addressed using value principles. Value is defined as benefits relative to costs, not just benefits alone. Value creation is an idea that has long been recognized in business, where profit is revenues earned from customers minus the costs incurred. However, businesses have rarely approached societal issues from a value perspective but have treated them as peripheral matters. This has obscured the connections between economic and social concerns.
Porter and Kramer are right to remind businesses, nonprofits and communities of the benefits that they derive from mutual understanding and closer collaboration. They provide numerous vivid examples of how companies are benefiting from such relationships. But their thesis is not original. Adam Smith recognized the same symbiosis 235 years ago. Such situations have been well known for decades to the business and civic leaders in many places including Houston (oil and gas), San Jose (information technology), Bangalore (software development, call centers), Shenzhen (electronics assembly) and Raleigh Durham (research).
The application of CSV is unlikely to have the transformative benefits claimed. It does not address many of the problems that have created the distrust of business. Furthermore, it does not offer a way for businesses to measure the shared value that their activities may generate nor offer new ways that such value can be incorporated in business decision making.
The diminished trust attributed to the 2007-08 housing crisis and financial meltdown was ultimately caused by agency problems in loan originators, investment banks and rating agencies as well as regulatory capture and old fashioned fraud. The call for CSV does not address any of these issues. Instead, the authors ignore the unglamorous business practices that reinforce ethical conduct and compliance with the law and that reduce or offset externalities. In a blog post on the FSG web site co-author Mark Kramer dismisses the “more traditional CSR activities such as GRI reporting that responsible companies accept as a cost of doing business.” In fact GRI reporting provides valuable nonfinancial information to company directors, to investors (e.g. more than 870 UNEP PRI members who manage ~$25 trillion in assets) and to other stakeholders and improves the reporting companies’ standing in the capital markets. Surely that is shared value.
Businesses seldom respond to exhortations in the Harvard Business Review. Instead they pay attention to signals or information such as customer preferences, prices (of goods, services including labor and capital), taxes and subsidies (negative subsidies), laws, technology and customs and traditions. Each company responds to these signals in its own way, but collectively these responses produce an emergent order that we recognize as a market. The order will not change because someone, even Michael Porter, calls for it to. CSV does not provide a new way for a company to capture more of the shared value. Neither does it produce a new set of information or signals to influence business decisions and thus modify the emergent order. Until then CSV will unleash only a ripple rather than the predicted wave of innovation and growth.
II. Capitalism for the Long Term—The Cliff Notes Version
In the following issue of the HBR[ii] Dominic Barton, Global Managing Director of McKinsey & Company tackles a similar problem: how to restore the weakening social contract between capitalism and the public. Mr. Barton gets neither the cover-page treatment nor the fancy charts and graphics that jazz up the Porter-Kramer article. But his diagnosis of the causes of the crisis of confidence in business is more clear-eyed and his recommended remedies are likely to be more effective than the January recipe.
Mr. Barton calls on business and finance (1) to abandon their short-term orientation and reengineer incentives and structures to focus their companies on the long term, (2) to focus on serving the interests of all major stakeholders rather than just shareholders and (3) to offset the risks of dispersed and disengaged ownership by strengthening boards’ authority and capability to act like owners. All of these recommendations are on target but the article suffers from its brevity; the recommendations are too general and deserve a more elaborate treatment. Furthermore, the author seems unaware of some of the important work already underway to solve some of the problems he identifies. And in a couple of cases he points his finger at groups that may not be responsible for the problems.
For instance, he scolds institutional investors which hold “roughly 35% of the world’s financial assets” for taking the short-term view and thereby leading “capitalism as a whole” down the same path. He seems oblivious to the progress that has been made over the last half decade in propagating as ESG perspective among institutional investors. Refer to the work of the UNEP Principles for Responsible Investment mentioned above. He also is too quick to accuse high frequency traders “who now account for 70% of all U.S. equities trading” of contributing to short-termism. Where is the evidence that these traders’ activities, largely based on arbitrage, influence the business plans of the companies whose stocks they trade?
The problems that Mr. Barton cites do indeed pose existential threats to capitalism and the brief sketches of solutions that he offers point the right direction. His large audience deserves a more complete roadmap. Perhaps he and his McKinsey colleagues are already printing those maps for their fee-paying clients.
[i] ”Creating Shared Value: How to Reinvent Capitalism—and Unleash a Wave of Innovation and Growth” by Michael E. Porter and Mark R. Kramer, Harvard Business Review, January-February 2011. A copy of the article is available at fsg.org. Registration is required.
