That seems pretty simple until you start to unpick what it takes to make sustainable profits. For one, it requires an engaged, properly skilled workforce willing to supply the discretionary effort the best performing companies enjoy.
"Stakeholders are pushing companies to wade into sensitive social and political issues.” - Fink
And according to the latest Edelman Trust Barometer “despite a high lack of faith in the system, there is one relationship that remains strong: ‘my employer’”.
Fifty-eight per cent of general population employees say they look to their employer to be a trustworthy source of information about contentious societal issues, Edelman found.
Successful companies also require long term, competitive sources of funding, whether from financial institutions or investors.
And the world’s biggest investor BlackRock has, for the second year running, been unequivocal about what it expects if it is to supply that capital: the companies in which it invests to have a sense of purpose and be able to articulate that.
BlackRock’s chief executive Larry Fink, who fanned controversy last year when he raised the concept, doubled down this year in his annual letter to the CEOs of companies in which BlackRock invests.
"Stakeholders are pushing companies to wade into sensitive social and political issues - especially as they see governments failing to do so effectively," Fink wrote - speaking for BlackRock’s $US6 trillion of funds under management.
“I wrote last year that every company needs a framework to navigate this difficult landscape, and that it must begin with a clear embodiment of your company’s purpose in your business model and corporate strategy,” he wrote.
“Purpose is not a mere tagline or marketing campaign; it is a company’s fundamental reason for being – what it does every day to create value for its stakeholders. Purpose is not the sole pursuit of profits but the animating force for achieving them.”
More than money
Sophisticated investors have long looked for intangible or unappreciated sources of value in companies. How a company interacts with society is one such factor.
And now investors are quite explicit about looking at this, currently under the rubric of environmental, social and governance issues (ESG).
According to Katie Hudson, portfolio manager and head of Australian equities research at Yarra Capital Management, “incorporation of ESG analysis into investment processes represents arguably the largest advance in investor thinking of the past 20 years”.
“As intangible assets – including brands, R&D and even corporate culture – grow to an increasingly high proportion of company value, an investment process that identifies and values social-risk factors will enhance the ability to deliver long-term outperformance,” she wrote in the Australian Financial Review.
Fink’s letter is a rational, tightly argued demolition of those who still think a business can somehow isolate itself or ignore the environment in which it operates or claim it is has some amoral indemnity against social licence.
“Profits are in no way inconsistent with purpose – in fact, profits and purpose are inextricably linked,” he wrote. “Profits are essential if a company is to effectively serve all of its stakeholders over time – not only shareholders, but also employees, customers, and communities.
“Similarly, when a company truly understands and expresses its purpose, it functions with the focus and strategic discipline that drive long-term profitability. Purpose unifies management, employees, and communities. It drives ethical behaviour and creates an essential check on actions that go against the best interests of stakeholders. Purpose guides culture, provides a framework for consistent decision-making, and, ultimately, helps sustain long-term financial returns for the shareholders of your company.”
Providers of capital are focusing on factors like purpose and ESG not because they are philanthropists but because they recognise the link between such focus and profitability. Milton Friedman wouldn’t be diametrically opposed to this argument. He 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.
Understood more broadly, the “rules of the game” are not just black letter law but those principles which govern behaviour – they are set by society, by providers of capital, by staff, by customers.
Fink wrote “as a fiduciary to these clients (investors in BlackRock funds), who are the owners of your company, we advocate for practices that we believe will drive sustainable, long-term growth and profitability”.
The Edelman Trust Barometer found employees are ready and willing to trust their employers but the trust must be earned through more than “business as usual”.
“Employees’ expectation that prospective employers will join them in taking action on societal issues (67 per cent) is nearly as high as their expectations of personal empowerment (74 per cent) and job opportunity (80 per cent),” according to Edelman.
Moreover, “the rewards of meeting these expectations and building trust are great”. Employees who have trust in their employer are far more likely to engage in beneficial actions on their behalf:
- they will advocate for the organisation (a 39-point trust advantage)
- are more engaged (33 points)
- remain far more loyal (38 points) and committed (31 points) than their more sceptical counterparts.
The key point is companies should not think of purpose or profits. Purpose - an understanding of what a company stands for, its values, where it sees itself contributing to society – sustains profits.
Of course business leaders who speak about social, even political, issues will continue to be criticised – by those who vested interests are challenged. Political parties cajole business to speak up in favour of their policies but pillory them when they disagree.
That’s not going to change. But business leaders would be better served paying attention to insights like those in the latest Edelman Trust Barometer:
- 71 percent of employees believe it’s critically important for “my CEO” to respond to challenging times
- More than three-quarters (76 per cent) of the general population concur—they say they want CEOs to take the lead on change instead of waiting for government to impose it.
Even if it is not articulated specifically, society expects business to have “purpose”. So do shareholders.
Andrew Cornell is managing editor of bluenotes