Businesses’ social purpose is as a part of an interdependent society, not as exploiters of it

From Davos to the Australian financial sector, businesses and investors are having conversations ‘regaining the community’s trust’ and ‘social licence to operate’ in a manner that suggests business exists in a parallel universe to society.

That somehow a ‘social purpose’ gives companies an entry ticket to exploit communities for their commercial gain, and that this approach is acceptable.

Here’s a thought, when businesses recognise they are part of an interdependent society, then they would realise they already have a ‘social purpose’. A few actually.

  1. Businesses provide useful goods and services to customers and in return they get paid for these goods and services. Without customers the business doesn’t exist, so that is quite a good reason to look after your customers.
  2. Businesses provide jobs for people and in return those people provide skills, experience and commitment to help a business thrive. Without employees they don’t exist, so that is quite a good reason not to screw your employees over.
  3. Businesses pay (or should pay) tax based on their earnings to the government of the jurisdiction and in return they get access to decent infrastructure (power, water, telecommunications, roads etc) and educated people who can get medical help when they are sick (and healthy people are better for the economy). They may also get government agency support in establishing export pathways overseas, they may benefit from the research paid for by taxpayers at universities in developing their product and they may receive subsidies to develop those products. These are very good reasons to pay your taxes and contribute to the society in which you operate.
  4. Businesses need a supply chain to operate. Without suppliers it is difficult for businesses to operate in our highly specialised world. For example, it does not make economic sense for every business to make its own paper, have a power plant to generate its own electricity or maintain a team of tradespeople to fix the air-conditioning, do the plumbing and the like. So that is a good reason to have a good relationship with suppliers and have reasonable payment terms.
  5. Businesses may also contribute to their communities through:
    1. supporting education institutions and in return they help create their future employees and product lines;
    2. Support local sporting and other community clubs and in return that may generate custom and goodwill, which means revenue;
    3. They may invest in developing employees in remote and regional destinations where they work and in return they also get a cheaper workforce that doesn’t need to be flown in, are likely to stick in the job longer and they contribute to a stronger and economically stable community; and/or
    4. Not pollute the environment from which they earn their income.

Businesses are part of the community, they are members of the society they live in, and like all members, they have interdependent relationships in those communities. Their survival, or social licence to operate if you must, depends on it.

Of course, this all goes to custard with businesses, and the investors that provide their capital, start to think that they belong at the top of the tree of power and that they should benefit at the expense of their customers, employees, suppliers, host governments and communities.

They can sustain this for a while by taking advantage of the significant power imbalance, but after a time, people understand that this behaviour has done profound damage environmentally, culturally and socially and they start demanding something better.

Surely the social purpose of business is to contribute to the community by creating wealth through buying and selling of useful goods and services that do not destroy the environment and people’s lives, providing employment and contributing to creating a community that we all want to live in.

The finance sector, like all addicts, must want to change

Getting rich, having access to powerful people, controlling people’s financial destiny and having tangible expensive signs of status easily available to you is intoxicating. It can, like any drug, become hard to live without and encourages a muddle-headed notion that you are entitled to it, you deserve it.

The trail of destruction of this type of myopically selfish behaviour of the many in the Australian financial sector was revealed over the year-long  Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

Ken Henry, Chair of the National Australia Bank, spelled it out in his testimony to the Royal Commission, that somewhere in the neoliberal takeover of the world’s markets of the last 40 years, the PURPOSE, or ends, for a business to exist was to make as much money as possible for those with access to other peoples’ capital. This became more important than providing a suitable, useful or valuable good or service that people wanted to buy.

And unsurprisingly, the Australian financial sector lost its way as it prioritised getting another hit of ‘more’. More money for themselves. More power. More privilege. More stuff.

When a business’s primary purpose or ‘end’ is to provide a good or service that is valuable to and valued by its customer, there is a clear destination. A business can measure how many times it achieves it, how it can improve on it or adapt itself to meet customer requirements. There is a clear compass.

When a business’s ‘end’ turns inward exclusively prioritise its own enrichment, then it has no external reference point, no definitive destination to be reached. More and more is better, greed is good. The end justifies any means to get there, because there is no such thing as enough.

The financial institutions preyed on people’s lack of understanding of their essentially intangible product and, in a display of breathtaking hubris and arrogance, converted the concept of caveat emptor (buyer beware) into ‘we are going to fleece the dumb suckers’ because they felt entitled to do it and it gave them another hit.

The financial institutions also gave a privileged seat to the professional investment teams that provide them the capital they need to exist. These investors, at an arm’s length away from the customers and the employees, focused solely on their investment returns, driving short-term profits to meet their own targets for personal enrichment.

In order to avoid repeating this process over and over, the people with the power to change the destination must want it to change. They must accept that their short-term binge for self-enrichment will ultimately weaken the financial system. They need to accept that they are not inherently entitled to create wealth for themselves at the expense of customers and employees.

A sustained shift to a customer-focused, ethical approach to providing access to capital for businesses and people to thrive is required. Banks and other service providers must understand that there are limits on what they deserve in payment for providing that service.

And we all must accept that the drug of ‘more and more’ is not good for any of us.

Facebook’s ‘smartest in the room’ guilty of a failure of governance

The events of the past few weeks show us that somewhere, somehow Facebook’s management, board and institutional investors lost sight of the company’s most valuable asset, its users.

Or more correctly, only saw the value in how the users and their data could be mined and sold for profit, not as valuable customers. Valuable customers who may walk away or change their usage habits if their trust was lost, as happens with every other retail business. What was the users’ privacy worth?

And while the mainstream media flagellates Mark Zuckerberg, the obvious target, for the Cambridge Analytica breach, there is a marked absence of focus on the broader board’s role in this gross failure of governance.

The Facebook Board of Directors is made up of Mark Zuckerberg, COO Sheryl Sandberg, four venture capitalists, the CEO of The Gates Foundation, the CEO of Netflix and the CEO of WhatsApp. And all, as outlined in the company’s own corporate governance guidelines are “encouraged” to speak to any member of the management team about any concerns at any time.

One has to wonder how much time and energy the board spent considering the risk associated with Facebook’s known, cavalier approach to users’ personal privacy and their openness about mining their own data for revenue gain. Or were they all in the thrall of Mr Zuckerberg, perhaps the emperor with new clothes on this issue and could not manage their CEO?

When did they start to express their concerns about Facebook’s fast and loose approach on privacy? Did they consider it, or was the revenue raising possibility of its customers the only consideration? What type of culture was the board being allowed to breed and what sort of risk was it opening the company up to when its customers said enough?

It is well documented that Facebook was among the first serious wave of internet-based social media platforms that struggled early on to find a way to create reliable revenue stream that could be turned into profit. But has the hunt for revenue, and then the astounding success of their advertising algorithms been at the cost of understanding what the company’s purpose is, and who keeps them in business.

Governance is not just about ensuring and maximising cash flow. It is also about understanding the full range of risks that may threaten the viability of a company. It is worth remembering that while the number of users outside of North America and Europe are growing the fastest, the revenue stream from these regions is low. It is the more stable user groups of North America and Europe that provide the vast majority of advertising revenue. It can also be argued that the customers in these markets are the most likely to change their user behaviour if they perceive their privacy has been invaded  beyond their comfort threshold.

And what is more the institutional investment community seem blithely unaware of how they may have encouraged a culture that led to this outcome, but are quick to ‘raise concerns’ when it is already too late. Fund managers, who invest on behalf of us, are only now beginning to review their investments in Facebook due to ethical concerns, after this widely-reported breach of privacy and the harvesting of information of 50 million users. Concerns about how Facebook guarded their users’ privacy is not new. Cambridge Analytica’s particular use of the data is deeply disturbing but is not a solo event for Facebook.

AMP Capital says it has been monitoring the ‘data and privacy issues in the realm of social media’ for some time, but has it done serious risk analysis of a known issue with Facebook? From a pure business perspective, besides the actual platform, Facebook’s most valuable asset is its users and the company has had to be dragged into dealing with a myriad of privacy issues over years.

Australian Ethical said “if they formed a view they disregarded privacy, we won’t invest in them.” It doesn’t take much of a search to find Mr Zuckerberg’s view that privacy is dead.

None of what has happened to Facebook is really that surprising. All of the landmarks of this particular road to hell were well signposted – the disregard of the value of people’s privacy, the primacy of using data (known to users or otherwise) to generate advertising revenue and the lax control over who else was using that data. And if these signs were so obvious, how and why did the management team, the board and the professional investment community ignore them?

A sinking feeling tells me, that the reaping as much profit as possible, and a belief that they were the smartest people in the room, clouded all other risks and any respect and consideration for their users.

And if they want to understand how the hubris of believing themselves to be the smartest people in the room plays out, they only need to Google the hedge fund name ‘Long Term Capital Management’.

ESG issues are a sleeper risk that remain on investors’ blind side, despite what history teaches us

Casting my eye at the scattering wrecks of companies brought low by poor decision-making in the last 20 years, it can be said that there was a common theme is the prioritisation of profit-making and personal enrichment that fuelled the road to hell. Little thought was given to values that would contribute to the long-term sustainability of the company and benefit the broader community group.

BP’s Gulf disaster revealed a history of shaving the safety margins to maximise profit, a multitude of banks with their trading scandals which revealed a blatant disregard for the law and belief that self-enrichment trumped all things, the many multi-national companies that shuffle money to avoid paying a reasonable tax in countries where they enjoy the benefits of stability and certainty that a decent tax base funding infrastructure, education and health provides.

It is heartening to see that a recent survey by the CFA Institute of more than 1,500 investment portfolio managers around the world are taking more interest in environment, social and governance (ESG) issues but the underlying value set remains the same. It is telling that 61% of respondents would only be willing to pay 50% or less of what they spend in independent verification of financial statements on independent verification of ESG reporting by companies. Just 11% would spend as much in ESG verification as they would on financial verification.

It is also heartening that, according to Management Today, Mark Hafaele, the Chief Investment Officer at UBS has had a change of heart and recognises that companies that take ESG seriously can deliver share price growth and profitability. According to an interview in Management Today, Mr Hafaele noted that the consideration of ESG issues can de-risk investment returns.

It is fascinating, however, despite the rich lessons history has to offer, the professional investment industry still places far more value in reviewing the financials of a company – which can be a very creative story, rather than the reporting on environment, social and governance matters which can reveal much better a company’s approach to a broader stakeholder group and genuine understanding of a risk wider than ‘will this affect my share price this quarter’.

It is myopic also that most conversations about risk are associated with some sort of mathematical modelling and an analysis of numbers. Unfortunately, the impact of human decision making, driven by their underlying values is very difficult to create a data set around, except if you learn from history and consider philosophy. Ignoring what cannot be inputted into a mathematical model and measured means you increase your risk of being blind-sided by the inevitability of human fallibility driven by a set of values that promote fear and greed.

Milking the dairy industry dry leaves us all poorer

Once upon a time, two large milk wholesaling companies faced public backlash about their decision to unexpectedly pay dairy farmers less for milk than it cost to produce and apply it retrospectively.

The good consumers of Australia, frothing with outrage, supported the local farmers by buying the named brands milks at the local supermarkets and took photos of the sold out sections of milk fridges and plastered them all over social media. The supermarket brand milk remained on the shelves and the consumers conveniently ignored the fact they had propped up this unsustainable system by buying $1 a litre milk for the preceding two years.

Meanwhile, in a spectacular display of cynical cause-related marketing, Coles, one of the originators of the $1 a litre milk in 2011, launched a special brand of milk that was more expensive with 20c from every sale going to a fund for the farmers.

This is the same supermarket chain that signed a 10-year milk supply deal with Murray Goulbourn, that according to their public statements at the time it would be ‘a major win for farmers because we cut out the middle man and farmers get a bigger share of the retail price’. Three years in, that doesn’t appear to be working.

The real bottom line in this ethical conundrum that we all need to consider, how much do we value our dairy industry? How important is it for Australian to be able to produce its own milk and dairy products and, if that is important, what is a viable price to pay the farmers who make it?

For the investment managers investing in Woolworths and Wesfarmers (the owner of Coles), an important question is when the stand over tactics of the supermarkets’ on their suppliers actually starts destroying the economic value of an entire industry, is it time to look more broadly than just what creates profit margin for the two powerful distributors?

Beyond the marketing, the real story is, in 2011 the supermarkets, started offering $1 a litre milk, purportedly to make milk ‘affordable’ for more people, even though it has been bought by the majority as a valued staple food for decades. Cheap milk was the enticement to get customers in the door and then get them spend up on other higher margin products. It was part of a vicious price war between the two major supermarket chains in an attempt to defend and grow their market share.

It was never going to be the supermarkets that bore the brunt of the price cut, they can choke the distribution channels, so held the power to pass financial pain onto their suppliers. And the institutional investors who bought shares in Woolworths and Wesfarmers (the owners of Coles) approved of this margin clawback because it delivered on the profit line.

And the customers bought the $1 milk, telling themselves that is what they could afford. Until now.

This week’s debate about the value of the Australian dairy industry, what is reasonable for the farmers to earn and what we are prepared to pay for milk the perfect parable to demonstrate the cause and effect of valuing the profitability of the dominant and powerful groups in a production chain, over the value of the product and industry itself to a society.

Murray Goulbourn and Fonterra are not blameless either. MG were briefing shareholders this month that there was no concern with their financial stability, with a strong balance sheet and a growing business, but in the same breath talking about a Support Package for farmers to spread the impact of the cost cuts over the next three years. So, they won’t absorb any of the price pain, but are happy to pummel the farmers, without whom, they wouldn’t have a product to sell.

We, as members of superannuation funds and other investment vehicles, provide the capital to the likes of Woolworths, Coles and Murray Goulbourn and we can use our collective power to be more thoughtful about the impact of their profit seeking on entire industries. Pushing the pain down to the most powerless group in a supply chain makes us all poorer.

Tax avoidance is rewarded by the financial markets

This weekend the leaders of the G20 nations met in Brisbane and corporate tax avoidance, or ‘minimisation’ was on the agenda. There has been outrage in recent months as it was revealed that large companies have routed money through complex structures in countries such as Luxembourg in order to minimise the tax. The objective is to maximise profits for shareholders and minimise a company’s contribution to the community benefits derived from tax payments.

Some of the companies are global household names such as Ikea, Pepsi, Deutsche Bank and use these methods. Apple and Amazon have been at centre of similar controversies in the recent past. While many commentators are focused on the impact on the public purse of those countries where revenue is generated, very few are asking why the dominant value of profit maximisation is allowed to continue to reign. It is just assumed that is what companies will do and markets will accept it.

Why is profit maximisation more important than paying reasonable tax to help develop the countries from which corporations derive their revenue? Why does short-term earnings results designed for the investment markets get more senior management attention than long-term investment in the future of societies for hospitals and health care, schools, roads, public transport and the like? This community investment through tax payments also benefits the very same companies which use the infrastructure networks such as roads, rail, airlines and ports, and whose employees and their families go to the schools and use the hospitals.

It is because those in senior management at these companies and those that control the investment decisions at large institutional investment groups, prioritise a very narrow set of short-term profit-driven values over the longer term goals of a rise in living standards for all. We know that they share the same values because investment funds participate in the same tax minimisation schemes. Public investment funds from Canada, Australia, as well as investment giants like Citigroup, Credit Suisse, ABN Amro, AIG, Dexia, Fidelity, Schroders, State Street and UBS were also on the list of tax offenders released by the International Consortium of Investigative Journalists.

These investment houses manage billions of dollars of citizen’s retirement and other savings through a variety of mutual funds. And because they have the power to make the investment decision, they impose a narrow set of profit-driven values on their decision. They do very little to gather the views of the citizen investors or reflect them in the investment decisions.

As those who provide the money for these funds to invest, we have a responsibility to make it clear that we are not only the ultimate shareholders of these funds who want a long-term return from our savings but we are also the people who use the infrastructure, the schools and the hospitals that improve our societies’ standards of living, as opposed to wanting our investments to produce a short-term return to boost the bonus payments of our professional money managers.

A virtuous approach to investing could benefit us all

Laura D’Olimpio argued in her recent article on The Conversation, that the ancient Greek philosopher Aristotle claimed that being virtuous was rational and good for everyone. Humans, he wrote, are political and moral creatures because we live in a society and our behaviour affects one another. Virtue is the mid-point between excessive or deficient behaviours and finding the mid-point was crucial for everyone to flourish. For instance, we may have to pay $5 more for a T-shirt, and a large Western organisation may need to take a small cut to its profit margin in order for garment workers in Bangladesh to have a safe working environment and enough money to support the family. But everyone still wins because we still get cheap t-shirts, the business still makes money and people in Bangladesh improve their quality of life through economic growth.

But the spectre of renowned free marketeer economist Milton Friedman still looms over the financial markets and listed companies. Friedman believed in the view that the only social responsibility of business was to make profits’ is still a dominant belief among large investment houses and the companies they invest in. Therefore, maximising profits is a seen as a virtue in this world.

Indeed, Max Weber, as cited in Dyck and Schroeder’s 2005* article, wrote that materialism and individualism are the twin hallmarks of the moral point of view that underpins management thought. A focus on work and emphasis on material success has become normalised in western management and is the ‘uncontestable, objective, morally neutral ‘reality’’ adopted as the natural facts of life, rather than a particular version of the ‘moral’ facts of life. This translates into modern management’s focus on efficiency, productivity, profitability, measured by performance relative to other comparable companies and the expectations of the market.

Materialism is used as a tool to measure human progress, a method of attaining ‘success’ and social acceptance. In 2010, Decktop, Jurkiewicz and Giacalone** argued that financial success and material possessions are the core elements of western corporate cultures and financial rewards at work are used as a form of motivation and control. Materialistic values are rewarded in employees because they are aligned to those in senior management. In this view, money and the desire for money equal competence and the acquisition of more of it (particularly more than someone else) equals greater competence. People with these values gravitate to jobs that can be measured by material accumulation. In corporate finance books this belief is reinforced. According to the Principles of Corporate Finance, ‘the goal of maximising shareholder value is widely accepted in both theory and practice’ because, the authors argued that shareholders’ priority is ‘to be as rich as possible’ (Brealey, Myers and Allen 2011). The question of ‘why is this important?’ is not considered.

Companies are held captive by the tyranny of a quarterly earnings reporting cycle that focuses on short-term profit making rather than long-term sustainable business development. This benefits the privileged class of institutional investors who make their money by managing trillions of dollars of other citizens’ money. They market their competence as investors to attract more money, based on these short-term returns. When the reality is most of their investors have a very long-term investment timeframe and quarterly results are not particularly relevant.

This mismatch in expectations between the average citizen whose retirement funds are managed by institutional investors, and the investors and senior managements of companies themselves is demonstrated in the recent research by Harvard Business School and Chulalongkorn University. The research showed that the average citizen around the world believes that CEOs earn far more than what is a fair amount, when compared to an unskilled workers. What was worse is that the estimate was completely out of kilter with the astronomical pay packets that actually get paid, which is supported by most fund managers.

Surely this is an example of one group, the powerful elite who manage and influence the management of large listed companies, who’s values are at the extreme end of a spectrum, and the virtuous mid-point which allows everyone to flourish is a long way, away.

*Dyck, B. and D. Schroeder. 2005. “Management, theology and moral points of view: Towards an alternative to the conventional materialist-individualist ideal type management.” Journal of Management Studies 42(4): 705-735.

** Decktop, J., C. Jurkiewicz, and R Giacalone. 2010. “Effects of materialism on work-related personal wellbeing.” Human Relations 63(7): 1007-1030.