How can companies prioritize purpose while balancing their responsibility to shareholders? This dilemma is heightened considering some of the world’s most serious challenges exist in developing countries where solutions are unlikely to be profitable in the short term. Is the trade-off between purpose and profit necessary, or is it possible for companies to achieve both?
To discuss these issues, Alex Edmans, Professor of Finance at London Business School and author of “Grow the Pie: How Great Companies Deliver Both Purpose and Profit”, which was included in the FT’s list of best business books of 2020, spoke with Andrew Hill, Associate Editor and Management Editor of the Financial Times, in a conversation hosted by Olenka Kacperczyk, Associate Professor of Strategy and Entrepreneurship at London Business School.
- To increase value, firms should take responsible actions that benefits all stakeholders, growing the overall ‘pie’ rather than focussing only on returns to shareholders;
- Firms can create long-term profits while honouring stakeholders’ best interests, even if those stakeholders are unable to afford the firms’ products or services;
- While government regulation can be effective in ensuring a fair split of the pie (e.g. through minimum wages and corporation taxes), companies play the largest role in growing the pie through innovation;
- We as individual citizens, employees, and investors have a role to play in encouraging firms to prioritize purpose, and we can do so through putting our money behind companies that reflect our values, through our investment positions and our customer decisions.
Merck proved its commitment to its mission to save and improve lives around the world
Edmans began his definition of ‘purposeful business’ through an anecdote about the pharmaceutical company, Merck. In 1978, a Merck scientist realized that the company’s antiparasitic livestock drug, Ivermectin (later renamed Mectizan), could be effective to treat onchocerciasis, or river blindness, in humans. Nearly 300 million people in some of the poorest countries in Africa and Latin America were at risk of contracting this painful and life-altering disease.
After Merck was approved to use Ivermectin for humans, the problem turned to funding the treatment. Neither the affected individuals nor their countries’ governments could afford the drug. However, Merck’s stated purpose was to save and improve lives around the world. So, in 1987, after attempting and failing to secure international aid or philanthropic funding, Merck’s CEO decided to launch the Mectizan Donation Program, in which Merck entirely funded the distribution of the drug at zero-cost to the end users.
The Mectizan Donation Program still exists, having given out 2.7 billion treatments to date. While the program has had a hugely positive impact on the world, it may seem like an impossibility to fund such an effort while maximizing shareholder value. However, this has not been the case for Merck. Shortly after launching this Mectizan Donation Program, the company was awarded for being the most admired company by Business Week and Fortune. The positive effect on Merck’s reputation has endured over the last three decades. Top employees chose Merck over other companies, even forgoing higher compensation, because they were inspired and motivated by Merck’s commitment to its purpose.
Since the start of the Mectizan research in 1978, Merck’s average annual shareholder return has been 13%, about 50% higher than that of the S&P 500. Whether correlation or causation, this statistic is certainly not at odds with the fact that prioritizing purpose can be consistent with, rather than contradictory to, long-term shareholder returns.
Why aren’t there more examples like Merck?
Edmans continued by explaining that he sees two ways in which companies can serve society. One is by offering concessionary pricing to make products, especially necessities, accessible for low-income populations. For example, Merck’s Donation Program or Unilever’s current campaign to give €100 million of food and sanitizer to communities in need. But the second way to serve society is through innovation, and there are far more examples of this. By developing a novel product or service that can improve health or wellbeing, a company can serve society even if they don’t give away the product at or below cost.
An example of this from the book is Vodafone’s M-Pesa, a mobile money service, which was developed using the company’s core expertise in telecommunications. Vodafone identified their expertise and recognized that financial inclusion was a major challenge to economic development in Kenya, so they utilized their engineers to develop a scalable solution, M-Pesa, which allowed people to save and send money through mobile phones. In less than a decade after launch, 200,000 households (2% of Kenya’s population) were lifted out of poverty. The positive impact was more pronounced for female-headed households, driven by increased saving patterns and entrepreneurship. Clearly, this innovation was beneficial to these communities’ wellbeing, even though the users had to pay a small fee to participate in the service.
So, what exactly is a purposeful business?
Giving insight into his book, Edmans explained that people often think about the value that a company creates as a pie, and that a responsible company is one that splits the pie fairly between shareholders’ profits and stakeholders’ interests, by giving money to charity or paying workers a living wage, etc. Instead, Edmans wants to change the thinking about responsible business, to focus on growing the pie, rather than dividing it. The way to create more value for society is not by giving them a greater share of the status quo, but through creativity and innovation. He also highlighted how traditional companies focus on ‘problem solving’ – satisfying a known need – but responsible business involves ‘problem finding’ – using its expertise to create a product or service that customers never previously asked for yet end up finding valuable, such as M-Pesa.
He defines ‘purposeful business’ as one that creates profits only through creating value for society. Rather than donating to causes at the expense of profits, purposeful companies use their expertise to solve social problems, which can ultimately lead to higher profitability. This ‘growing the pie’ mentality resolves the trade-off between profit and purpose and asserts that profit can be a by-product of solving social problems.
How does purposeful business compare to ESG and CSR efforts?
Environmental, Social, and Corporate Governance (ESG) has become an enormously important investment strategy over the last few years, particularly in the US. ESG will continue to be important, but Edmans’s concern is that these ESG metrics may not truly capture the efforts that companies go through to be purposeful or responsible actors. Many of the ESG metrics are on the ‘do no harm’ end of the impact spectrum, which tends to align with the ‘split the pie fairly’ mentality. Examples include efforts to limit carbon emissions or water waste. The main responsible action that a company can undertake is to grow the pie is to actively innovate, and those efforts cannot be captured in standard ESG metrics. Assessment of a company’s value to society must be specific to its own purpose and industry.
As an example, Edmans described the MSCI Warming Potential tool, which evaluates portfolios to flag which stocks are contributing most towards global warming. The worst stocks flagged by this tool were semiconductors because manufacturing semiconductors releases perfluorocarbons, a more harmful emission than carbon dioxide. However, semiconductors can have a hugely positive impact on the world by powering the solutions to global warming or making technology more effective in developing countries. So ESG metrics might pressure investors to divest from semiconductor companies despite their positive potential. For reasons like this, Edmans suggests that investors take a holistic perspective of not only the harm caused, but also the value generated by a company.
On the CSR side, in Edmans opinion, the two main issues are the scale and integrity of the efforts. The average FTSE 100 company’s CSR spend is £10 million, compared to an average procurement budget of £4 billion. So, a company can make 400 times the impact through responsible procurement than through CSR spend. Initiatives such as the Buy Social Corporate Challenge, which support small, purpose-driven businesses. One example Edmans gave was PwC buying toiletries for their employee bathrooms from The Soap Co., which makes vegan, cruelty free, natural and certified plastic free products and employs visually impaired or otherwise disabled workers in the UK.
CSR has traditionally been seen as non-core rather integral to the business strategy. A tobacco company can donate some of its profits to improve its reputation. Whereas purpose is inextricably linked to the core business, using their expertise in more creative ways to solve societal problems.
Are companies in developing economies poor investments because they’re less purposeful?
When determining if a business is purposeful, it should be compared to peers, rather than global leaders. For example, an inexpensive fast-food restaurant could be valuable in a developing country where citizens might otherwise not be able to afford taking their family out for a meal, while the same restaurant would not be additive to a developed country where other healthier options are prevalent. In developing countries, there are many companies that are far less advanced in some areas of governance and environmental action, but that are providing a valuable service to their community. So, investors must recognize the challenges that other countries face are different from challenges faced in the developed world.
In terms of governance, Edmans underlined the importance of linking pay to long-term performance. But many developing countries lack the culture of equity ownership among management, instead cash salaries and intrinsic incentives are more prevalent. Therefore, it would be unreasonable to compare governance across companies who have not adopted the western executive pay model. Rather than comparing compensation directly, investors can request that companies in developing countries disclose whatever policies they do have, because transparency is still a helpful step toward accountability.
How has the COVID-19 pandemic impacted businesses’ efforts to be purposeful?
Pharmaceutical companies have a huge opportunity to solve the societal issue of COVID-19 through vaccine development, but this opportunity differs greatly from the Merck example because Merck did not have public pressure on them to eradicate river blindness. In today’s heightened anticipation, pharmaceutical companies will need to act very carefully to be seen as purposeful rather than exploitative in pricing and distributing their vaccines. Because the pandemic has affected both developed and developing countries, pharmaceutical companies could sell vaccines at a reasonable profit to developed countries, which would allow them to sell at or below cost to developing countries. This two-tiered strategy would have the reputational benefits for companies who assert that their goal is to improve human health rather than to make a profit.
Even outside of the pharmaceutical industry, the economic slowdown related to the pandemic could pressure companies to stop spending scarce resources on social efforts and to just focus on their own survival. But with the idea of growing the pie, companies can embrace the mindset of problem finding and redeploying your expertise. The solution is not always to throw money at an issue, which indeed becomes more challenging when money is tight, but to redeploy the company’s existing, non-financial resources to creatively address social problems.
For example, Mercedes typically uses their expertise in precision engineering to make Formula One engines and pistons, but they chose to redeploy that expertise to make CPAP breathing machines, a less invasive alternative to ventilators. Because they utilized their existing expertise and human capital, it did not cost them much to reverse-engineer the design, and they were able to meet an urgent need and generate profit from a new revenue stream. This effort had the added benefit of improved employee motivation because these precision engineers were able to use their talents to solve problems rather than sitting idle.
How can government help encourage purposeful business?
While it’s businesses that have the greatest power to create social value, governments can also play a role in supporting purposeful business practices through regulatory frameworks and policy decisions. Edmans asserts that governments’ role is to ensure that markets work better, by protecting property rights, ensuring competition, and addressing externalities. Strong property rights are strongly correlated with economic development, because they protect outside investors from companies losing out through related party transactions and tunnelling, etc.
Competition can force companies towards being responsible through pressure from employees and customers walking away. Therefore, anything governments can do to promote competition, such as limiting monopolistic power and funding small businesses, is very beneficial.
Finally, to address externalities, there are some value-destroying business practices, like using child labour or modern slavery, that should be regulated out of existence, rather than left to the market. There are certain minimum standards that governments must uphold to protect against a race to the bottom in which some companies cut corners to make outsized short-term profits, driving purposeful companies out of business.
What can we as individuals do to influence companies to be more purposeful?
We as individuals have the power to put our money behind the purposes that we believe in through customer decisions and investments. Edmans argues that we as citizens have more power now than ever before to affect companies. If a company is a bad actor, we can publicize on Twitter and force improvement through customer boycotts can spread hugely. We can also encourage companies to be more purposeful by paying more for products we believe in, like organic or locally-sourced food, and we can use apps like Buycott and Good on You to help make sustainable buying decisions. For more information on this topic, Edmans suggested listening to his and Tom Gosling’s podcast – Can Citizens Make a Difference?
Liz Wolohan (MBA2022) is passionate about expanding London Business School’s reputation as a global leader in impact-focussed business education. In Autumn 2020, Liz led a London Business School Impact Consulting Club engagement with an Australian NGO and will chair Social Impact Week in March 2021. She is a Social Representative for her class and a member of the Women’s Touch Rugby Team. Liz is an intern for the Wheeler Institute, contributing to the creation of content that amplifies the role of business in improving lives.
Andrew Hill’s conversation with Alex Edmans was co-hosted by London Business School’s Wheeler Institute for Business and Development and the Centre for Corporate Governance. To learn more about Edmans’ views on purpose and profit in the context of COVID-19, check out his appearance in the Wheeler Institute COVID-19 series here.
Andrew Hill is an associate editor and the management editor of the FT. He is a former City editor, financial editor and comment and analysis editor. He is the author of ‘Leadership in the Headlines’ (2016), a collection of his columns, and ‘Ruskinland’ (2019), about the enduring influence of Victorian thinker John Ruskin. He joined the FT in 1988 and has also worked as New York bureau chief, foreign news editor and correspondent in Brussels and Milan. Andrew was named Business Commentator of the Year at the 2016 Comment Awards and Commentator of the Year at the 2009 Business Journalist of the Year Awards, where he also received a Decade of Excellence award.
Alex Edmans is Professor of Finance at London Business School and Academic Director of the Centre for Corporate Governance. He is Managing Editor of the Review of Finance, Associate Editor of the Journal of Financial Economics, and serves on Royal London Asset Management’s Responsible Investment Advisory Committee. He has spoken at the World Economic Forum in Davos, testified in the UK Parliament, and given the TED talk ‘What to Trust in a Post-Truth World’ and the TEDx talk ‘The Social Responsibility of Business’.