Nick Carr's essay blog
January 30, 2006
by Nicholas G. Carr
What’s the greatest strategic challenge facing Wal-Mart today? It’s not competition from other retailers. Although the world’s biggest merchant certainly keeps a close eye on rivals like Target and Best Buy, its domination of the industry seems secure for the time being. It’s not pressure from suppliers. Wal-Mart has most makers of consumer packaged goods at its beck and call. And it isn’t the whims of buyers. Shoppers show little desire to abandon their favorite store and its dirt-cheap prices.
No, Wal-Mart’s biggest worry today is the public interest. Whether it’s local activists scotching plans for new stores, bands of former employees launching class-action discrimination suits, the press decrying the company’s stingy benefits, or European voters demanding legislation to protect small shops, the exercise of the public’s will has become the greatest single threat to Wal-Mart’s future growth and profitability. The company’s executives have acknowledged that the recent softness in its stock price is tied to its deteriorating image.
Wal-Mart is not alone. Nearly every decent-sized company faces increasing public pressure in one form or other, and responding to that pressure usually takes a financial toll. Either it entails extra costs, or it requires the sacrifice of revenues. Big oil and gas companies invest in money-losing efforts to develop alternative fuels. Agricultural and chemical conglomerates pass up attractive opportunities to market genetically engineered foods. Media powerhouses steer clear of controversial programming. Pharmaceutical firms give away drugs in Third World countries. Computer manufacturers fund costly recycling projects.
All such efforts have an immediate impact on the bottom line. Many of them influence companies’ long-run growth and prosperity. Yet few managers explicitly account for the public interest when they analyze their industries or make strategic plans. They may have programs for “corporate social responsibility,” or CSR, but these are almost always run outside the mainstream business, as public-relations or charitable sidelines. They’re deliberately segregated from management’s primary profit-making responsibility.
As the experiences of Wal-Mart and other companies reveal, this traditional approach ignores the changing nature of the public interest and its expanding influence over companies’ financial results. The public does not want a company’s charity. It wants a chunk of its profits. The public interest, in other words, now expresses itself as an economic interest — the public has become an active competitor in the struggle to seize the bounties of the marketplace. As a result, the way businesses think about strategy needs to change. If a company clings to the old assumptions, it may be putting its future at risk.
Adam Smith’s Legacy
An intellectual battle has long raged between those who believe a company’s sole goal is to enrich its owners and those who think it has philanthropic responsibilities as well. On one side are what might be termed the capitalist fundamentalists. Their messiah is Adam Smith, their scripture his 1776 masterwork The Wealth of Nations. Smith makes an eloquent case that a business’s only responsibility is to maximize its profits, without any thought to the greater good. “It is not,” he writes, “from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest.” Any activity that distracts a company from the singleminded pursuit of profit — no matter how noble its intent — is to be shunned.
Nearly two centuries later, in a 1970 New York Times Magazine article, Milton Friedman gave Smith’s point a Cold War edge. Denouncing the idea that a company should engage in philanthropy as “fundamentally subversive,” the University of Chicago economist wrote that "the businessmen who believe that they are defending free enterprise when they declaim that business is not concerned 'merely' with profit, but also with promoting desirable 'social' ends ... [are] preaching pure and unadulterated socialism." Business’s “one and only” responsibility is “to use its resources and engage in activities designed to increase its profits so long as it ... engages in open and free competition without deception or fraud."
Friedman’s article seems quaint today. Most executives, whatever their personal beliefs, have broken ranks with Adam Smith and embraced philanthropic objectives. They pursue “diversity” in their hiring, donate corporate funds to charitable causes, issue press releases and advertisements promoting their good works, and more often than not maintain formal CSR programs. Yet scratch the surface of a modern corporate do-gooder and you’ll find an old-fashioned capitalist fundamentalist. Both start from the same assumption: that the pursuit of profit and the improvement of society are fundamentally different goals requiring fundamentally different approaches. Today’s CSR projects reflect, as the business professor Rogene Buchholz has written, “the idea that a private corporation has responsibilities that go beyond the production of goods and services at a profit — specifically, a responsibility to help society solve some of its most pressing problems.” Soft-hearted CEOs may throw a little of their shareholders’ money at noble causes, but that doesn’t mean they confuse philanthropy with their real purpose: boosting earnings.
The belief that social responsibility lies outside a business’s primary profit-making agenda is embedded in the tools managers use to chart their strategies. The most influential of those tools is Michael Porter’s famous “five forces” theory of industry structure. In his 1980 book Competitive Strategy and its 1985 follow-up Competitive Advantage, Porter argued that the scope of industry competition — and thus the field of strategy-making — was much broader than previously assumed. A company doesn’t just compete against its immediate rivals. It also competes for profits with potential new rivals as well as with customers, suppliers, and substitute products. “The five forces,” wrote Porter, “determine industry profitability because they influence the prices, costs, and required investment of firms in an industry—the elements of return on investment.” It’s only through a careful analysis of the forces that a company can understand how to position itself within its industry to maximize its profits.
What’s missing from Porter’s framework is any mention of the public interest. Although he makes a passing reference to the role of government in influencing industry structure, he excludes the public as a force of competition. Companies using his framework would never take into account that people act as citizens as well as customers and that as citizens they may also demand a slice of the value created in a market. Porter’s conceptual scaffold, which has come to define the way companies think about strategy, thus pushes the civic interest to the periphery of managers’ vision. Because the public, in this view, does not directly influence profits, it is largely irrelevant to industry structure and business strategy.
The Public Wants Your Profits
Porter was not wrong. When he originally laid out his thinking, the exclusion of the public was understandable. At the time, the public’s interest in business still tended to be filtered through governments and trade unions, and big companies maintained specialized staffs for managing their relationships with those well-defined bodies. From a strategic standpoint, managing the public interest was a circumscribed affair, consisting largely of lobbying regulators and lawmakers and negotiating with union bosses. Run-ins with protesters were at worst passing nuisances.
But the world has changed since then. As governments embraced free-market capitalism and the power of unions waned, the public lost its traditional advocates. A vacuum was created in the marketplace. That vacuum has been filled by the direct application of the public will. Through myriad interest groups, nongovernmental organizations, ad-hoc committees, and individual activists, the public applies ever-increasing pressure on industries and companies, demanding that some portion of market profits be put to the general good rather than delivered to shareholders.
As citizens have assumed direct responsibility for influencing business decisions, they’ve also become, in general, more prosperous. That’s freed them to dedicate more of their attention to social issues, rather than focus solely on ensuring their economic well-being. The public’s interest in business has been further magnified by an activist press intent on revealing the course and consequences of managerial decisions and actions. The Internet, too, has played a role, providing easy access to information and a powerful means of organizing interest groups.
Over the last couple of decades, in sum, the pressure the public applies on industry has become at once stronger and more diffuse. The public interest plays a much larger role in markets, and it has become more difficult for companies to manage. As much as suppliers or customers or rivals, the public today directly influences all three of the factors Porter specifies as determining corporate returns:
Pricing. Public pressure often reduces the prices companies are able to charge in local markets. The European public’s distrust of Microsoft, for instance, has led governments and educational institutions to consider free, open-source alternatives to the Windows operating system and Office applications suite, forcing Microsoft to offer sharp discounts to maintain accounts. In other cases, the intensification of the public interest may actually provide leeway for raising prices. In a study of grocery buyers, Whole Foods Market found that when shoppers buy organic produce, their price sensitivity goes down as their sense of virtue goes up.
Costs. Responding to public concerns often requires companies to spend more money, hire additional workers or operate in inefficient ways. To allay fears that it might be abetting the destruction of rain forests, Home Depot now meticulously tracks the origins of all the wood used in the products it sells. The Barrick Gold Corporation spends millions of dollars a year supplying health care, water, Internet access and cultural programs to communities near its mines. ABC was forced to cancel a completed but as-yet-unaired series, “Welcome to the Neighborhood,” after interest groups called it racially insensitive.
Investment. Corporate responses to civic pressures frequently involve the investment of capital. Many manufacturers and energy firms have had to retrofit their plants to reduce controversial emissions. To satisfy the aesthetic demands of local residents, wireless companies like Cingular routinely have to erect cell towers disguised as trees or silos, edifices that can cost three times as much as standard towers. Public concerns about labor and environmental standards in developing countries have led many companies to shift their sourcing strategies, sometimes abandoning existing operations.
As the public interest becomes an economic interest, it can no longer be segregated from strategic decision-making. Addressing it requires the same rigor and discipline companies employ in making decisions about entering new markets, launching new products, and raising and allocating capital. The time has come to expand Porter’s framework — to view the public interest as a sixth force of competition and to make it an essential concern of directors, CEOs, and other business strategists.
The Early Movers
There are signs that business is beginning to move beyond isolated, soft-focus CSR programs and deal with the public interest as a strategic issue. Writing recently in the Economist, Ian Davis, the worldwide managing director of consultants McKinsey & Company, criticized traditional CSR approaches for failing “to capture the potential importance of social issues for corporate strategy” and urged companies “to introduce explicit processes to make sure that social issues and emerging social forces are discussed at the highest levels as part of overall strategic planning.”
A handful of companies are already taking such steps. It’s no surprise that those leading the way tend to be ones that have been dealt strategic setbacks as a result of ignoring the public interest in the past. General Electric, for example, suffered from a public perception of arrogance during the 1990s, culminating in then-CEO Jack Welch’s dismissal of health dangers related to the company’s dumping of chemicals into rivers. In addition to damaging the firm’s public image, GE’s high-handed attitude toward civic concerns appears to have contributed to the European Commission’s decision to torpedo its proposed acquisition of Honeywell in 2001, a major blow to the company’s growth plans.
Under Welch’s successor, Jeffrey Immelt, GE is taking a very different tack and tone. The company has begun issuing an annual “citizenship report” detailing its performance in such areas as ethical governance, environmental sensitivity, and worker welfare. What’s noteworthy about the report is that it goes beyond the usual boilerplate rhetoric and case studies to provide a series of performance measures on key citizenship criteria, such as greenhouse gas emissions and penalties for health and safety infractions. The company is even imposing similar measurement requirements on its suppliers.
But GE is not just looking to placate the public. It sees the public’s concerns as a business opportunity and is looking to seize competitive advantage by developing related new products and services. It has, for example, created a portfolio of technologies for reducing pollution and improving energy efficiency that it is aggressively marketing under a new brand: Ecomagination. At the same time, the company is pursuing initiatives to shape the public’s perceptions and demands — in a way that serves its own strategic interests. It is lobbying for coherent global regulatory regimes, which would reduce its compliance costs, and for expanded use of nuclear power, which would bring it new revenues. “Green is green,” says Immelt, making explicit the connection between public sensitivity and profit-making.
Chiquita Brands, the big fruit grower, is another example of a company that has changed its ways. In its former guise as the United Fruit Company, Chiquita was largely responsible for the formation of what came to be called “banana republics” in Latin America. In 1975, its chief executive committed suicide after the firm was implicated in a bribery scandal in Honduras. But for the past ten years it has been collaborating with the nonprofit Rainforest Alliance to improve the environmental and working conditions on its farms in Central and South America. The alliance reviews Chiquita’s performance and certifies which farms are meeting its standards. When the alliance identifies problems, Chiquita is required to address them before it receives the nonprofit’s blessing.
Chiquita’s moves have provided some direct paybacks. Reducing its pesticide use and increasing its recycling of materials saves the company a few million dollars a year. But earning back a direct return on the investment is neither the goal nor the point of Chiquita’s program. Chiquita is deliberately sacrificing some of its profits — or, more accurately, sharing some of the overall market profits with the public — in order to reduce its long-term risk and secure its future financial well-being. In explaining the intent of its efforts to the Financial Times, the company’s treasurer, Jeff Zalla, emphasized the link between social responsibility and shareholder returns: “You would think that any investor interested in strong future cash flows would be interested in social responsibility.”
Managing the Tradeoffs
Taking a strategic view of the public interest is not easy. It requires a coordinated effort to understand the economic consequences of civic pressures, to avoid or mitigate costs by appeasing the public, gaining new income by serving the public interest, and influencing or even changing the public’s views. Most difficult of all, it requires making tradeoffs that will inevitably alienate some constituencies.
The public, after all, does not speak with a single voice. Indeed, different groups of citizens often define their interests in direct opposition to one another — to the frequent consternation of managers. When Kraft Foods announced that it was supporting the 2006 Gay Games, for example, it faced a barrage of criticism from the American Family Association, a large evangelical group. Culture clashes become even more pronounced when companies operate internationally, as Walt Disney recently discovered. Last June, it announced that it would allow shark-fin soup, a traditional dish in Chinese feasts, to be served at wedding parties at Hong Kong Disneyland. The decision was immediately and bitterly decried by environmentalists concerned about declines in shark populations. Caught between conflicting expressions of the public will, Disney ultimately sided with the environmentalists and banned shark-fin soup.
Such conflicts are no different, though, from those inherent in managing other competitive forces. Different groups of customers, for instance, often have very different needs and tastes, and companies take great care to strike the right balance between contending consumer interests in formulating their products and services. Resolving conflicts is also an essential part of managing diverse sets of suppliers. Seeing the public interest is economic terms will allow companies to apply analytical rigor in making hard choices — before they blow up into controversies.
Some will be uncomfortable with such a disciplined, numbers-driven approach. They’ll fear that if companies think of themselves as competing with the public, their managers will inevitably assume an adversarial stance. But such a fear is misplaced. As Porter showed, companies compete for profits with their customers and their suppliers, but that certainly doesn’t mean that they view those groups as adversaries. Rather, it means that companies understand that they need to share the profits in a market with their customers and suppliers — that blindly pursuing their own narrow interests would end up destroying their businesses. Only when companies see the public in similar terms will they treat its concerns with equal seriousness.
Milton Friedman was right: the responsibility of business executives is to deliver the greatest possible long-term returns to their shareholders. Fulfilling that goal, however, requires that the public be given its due.
This article originally appeared, in a slightly different form, in Forrester Magazine.