Phi, Friedman and the purpose of business

This week I was at a session discussing journalism awards and the chair asked: what were the major stories of the year?

"The general public has lost trust in the ‘elites’, the ‘experts’ – whomsoever they may be – and… the corporate world."
Andrew Cornell, BlueNotes managing editor

Plenty were offered up but the themes of disenchantment and the sense of exclusion underlying Brexit, Trump, the European far right, anti-globalisation and the Australian election provided the major undercurrent of debate.

The general public has lost trust in the ‘elites’, the ‘experts’ – whomsoever they may be – and, whether as the representatives of those groups or proxies for them, the corporate world (even if some surveys and focus groups suggest this resentment is overstated).

It’s a particular challenge for banks, not the most-popular corporate sector at the best of times, but no businesses or business groups are excluded.

Boards and senior executives are certainly not oblivious to this development, even if its power has grown with more momentum than many realised. So those concepts of trust, responsibility and increasingly ‘purpose’ are entering the business domain.

Purpose – and, in just one example Shayne Elliott at this bank has spoken about the idea, instituting broad discussion (even putting “purpose” on the annual report cover) in just one example – is increasingly recognised as a principle which, when well articulated and communicated, has enduring benefits for organisations.

THE POINT OF IT ALL

In the growing literature around the importance of purpose, several companies are frequently cited as powerful examples. Some are well known, like Google, 3M and Disney. Some are less well known.

Unilever is a particular example. The consumer-goods multinational had been sagging for a decade when Paul Polman was appointed chief executive in 2009. Employee engagement was poor and the company’s appeal to new employees relatively low.

Polman made purpose a focus with sustainability a fundamental pillar. He said Unilever’s purpose was to make sustainable living commonplace.

He set three goals set for 2020: help more than a billion people improve their health; reduce Unilever’s environmental impact by half; and ensure all raw materials were sourced sustainably.

Critically, purpose was linked to financial outcomes: the three goals would be the driving force to in doubling turnover to €80 billion. Moreover, the purpose had an authentic narrative, drawing upon the firm’s philanthropic origins improving hygiene and reducing infant mortality in Victorian England.

Polman linked managerial compensation to sustainability goals but also closed down the more conventional corporate social responsibility function.

CULTURE

In the financial services sector, the Dutch bank Triodos, with a decades-old reputation as an ethical bank, has a purpose baked into its corporate culture.

“Profit is a yardstick. It shows an organisation is working efficiently but says nothing about the content of what it’s doing,” CEO Peter Blom said.

“We, on the other hand, start with the content of an activity and focus on its sustainability. The first thing we consider is ‘how can this contribute to sustainability?’ Then, as bankers, we ask ourselves ‘is it viable?’ If our professional judgment is correct, profit should follow almost automatically.”

These are admirable ambitions. And in the case of such showcase purpose organisations, there is a demonstrable track record of sustainable returns to shareholders as well.

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They are in fact the answer to Milton Friedman’s famous dictum that a company’s purpose is to make profits. Such companies demonstrate sustainable profits actually do require more than capitalism red in tooth and claw.

(Friedman of course wasn’t that simplistic. He did say “there is one and only one social responsibility of business – to use it resources and engage in activities designed to increase its profits”. But he added “so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”. Critically, it is the “rules” of the game which are complex and long term rely on a social licence as well as black-letter regulation.)

Purpose though is still an emerging discipline and concept. It took the investment community more than a decade to be convinced corporate governance, in terms of policy, independent directors and transparency, was actually a driver of shareholder returns and not just a nice to have.

Indeed, it took some very proactive major investors, particularly the Californian pension fund CalPers, to really enforce the need to scrutinise governance.

Where measures which sound reasonable and desirable (such as linking remuneration to factors such as customer satisfaction or staff engagement – which are difficult to measure precisely) have struggled is investors are sceptical about them being gamed.

It is therefore very interesting to see one of the world’s most powerful investors, State Street Corporation, championing the idea of purpose in the investment community.

NEED TO MOVE

In a new report, published by the Center for Applied Research (CAR), the independent think-tank of State Street, together with the CFA Institute, the group argued “to succeed, the investment industry and its professionals need to move from a performance-driven culture to one that is purpose-driven to better ensure clients’ long-term goals are met”.

Almost 7,000 investors, investment providers and government officials in 20 countries were surveyed along with in-depth interviews with 200 executives and officials.

The research identified a factor State Street called “phi” - the alignment of purpose, habit and incentives – and found that it has a statistically significant and positive link to broad performance measures, including client satisfaction and employee engagement.

Phi, according to the research,can sustain the industry and drive client satisfaction for decades to come.

“A one point increase in phi is associated with 28 per cent greater odds of excellent organisational performance, 55 per cent greater odds of excellent client satisfaction and 57 per cent greater odds of excellent employee engagement,” said Suzanne Duncan, global head of CAR.

“Building a culture and environment with aligned purpose, habits and incentives can give organisations a competitive advantage that is sustainable and will benefit clients, the providers themselves and ultimately society as a whole.”

The CFA research in effect interrogated the 'rules' around Friedman’s dictum and, not unsurprisingly, found sustainable profits and returns to shareholders can’t be legislated.

“When investment professionals are asked to deliver against inappropriate metrics on an inappropriate time horizon, their passion for markets eventually becomes divorced from their true purpose – achieving the long-term goals of the investors they serve,” Duncan said.

It would be surprising if what the analysis identified as crucial to investment performance wasn’t equally applicable to shareholder returns in the corporate world.

Speaking at the launch of ANZ’s 2016 Sustainability Review, the bank’s chairman David Gonski echoed the same sentiments.

Gonski spoke of three priorities the board had endorsed, the second of which was “to support sustainable growth in the communities and countries where we do business”.

“This requires understanding the social and environmental impacts of our business decisions,” he said.

As well as the formal purpose work, which Elliott attributes to bottom-up insights from a young research team in the organisation, Gonski announced the bank planned to revamp its governance structure.

“Reflecting our focus on creating an organisation with a longer term, more equitable and sustainable view of company performance, we are broadening the charter and renaming the Board Governance Committee,” he said.

“Our new Environmental, Sustainability and Governance Committee, which I chair, will bring greater focus to and accountability for, achieving our sustainability priorities.”

Gonski is not Robinson Crusoe. Many senior corporate figures now recognise shareholder value requires a social licence. The investment community will no doubt await further evidence but the research from State Street is unlikely to be unique in theme.

Andrew Cornell is managing editor at BlueNotes