Burgess COMMENTARY

Peter Burgess

Creating Shared Value

The capitalist system is under siege. In recent years business increasingly has been viewed as a major cause of social, environmental, and economic problems. Companies are widely perceived to be prospering at the expense of the broader community.

Even worse, the more business has begun to embrace corporate responsibility, the more it has been blamed for society’s failures. The legitimacy of business has fallen to levels not seen in recent history. This diminished trust in business leads political leaders to set policies that undermine competitiveness and sap economic growth. Business is caught in a vicious circle.

A big part of the problem lies with companies themselves, which remain trapped in an outdated approach to value creation that has emerged over the past few decades. They continue to view value creation narrowly, optimizing short-term financial performance in a bubble while missing the most important customer needs and ignoring the broader influences that determine their longer-term success. How else could companies overlook the well-being of their customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell? How else could companies think that simply shifting activities to locations with ever lower wages was a sustainable “solution” to competitive challenges? Government and civil society have often exacerbated the problem by attempting to address social weaknesses at the expense of business. The presumed trade-offs between economic efficiency and social progress have been institutionalized in decades of policy choices.

Companies must take the lead in bringing business and society back together. The recognition is there among sophisticated business and thought leaders, and promising elements of a new model are emerging. Yet we still lack an overall framework for guiding these efforts, and most companies remain stuck in a “social responsibility” mind-set in which societal issues are at the periphery, not the core.

The solution lies in the principle of shared value, which involves creating economic value in a way that also creates value for society by addressing its needs and challenges. Businesses must reconnect company success with social progress. Shared value is not social responsibility, philanthropy, or even sustainability, but a new way to achieve economic success. It is not on the margin of what companies do but at the center. We believe that it can give rise to the next major transformation of business thinking.

What Is “Shared Value”?

A growing number of companies known for their hard-nosed approach to business—such as GE, Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart—have already embarked on important efforts to create shared value by reconceiving the intersection between society and corporate performance. Yet our recognition of the transformative power of shared value is still in its genesis. Realizing it will require leaders and managers to develop new skills and knowledge—such as a far deeper appreciation of societal needs, a greater understanding of the true bases of company productivity, and the ability to collaborate across profit/nonprofit boundaries. And government must learn how to regulate in ways that enable shared value rather than work against it.

Capitalism is an unparalleled vehicle for meeting human needs, improving efficiency, creating jobs, and building wealth. But a narrow conception of capitalism has prevented business from harnessing its full potential to meet society’s broader challenges. The opportunities have been there all along but have been overlooked. Businesses acting as businesses, not as charitable donors, are the most powerful force for addressing the pressing issues we face. The moment for a new conception of capitalism is now; society’s needs are large and growing, while customers, employees, and a new generation of young people are asking business to step up.

The purpose of the corporation must be redefined as creating shared value, not just profit per se. This will drive the next wave of innovation and productivity growth in the global economy. It will also reshape capitalism and its relationship to society. Perhaps most important of all, learning how to create shared value is our best chance to legitimize business again.

Moving Beyond Trade-Offs

Business and society have been pitted against each other for too long. That is in part because economists have legitimized the idea that to provide societal benefits, companies must temper their economic success. In neoclassical thinking, a requirement for social improvement—such as safety or hiring the disabled—imposes a constraint on the corporation. Adding a constraint to a firm that is already maximizing profits, says the theory, will inevitably raise costs and reduce those profits.

A related concept, with the same conclusion, is the notion of externalities. Externalities arise when firms create social costs that they do not have to bear, such as pollution. Thus, society must impose taxes, regulations, and penalties so that firms “internalize” these externalities—a belief influencing many government policy decisions.

This perspective has also shaped the strategies of firms themselves, which have largely excluded social and environmental considerations from their economic thinking. Firms have taken the broader context in which they do business as a given and resisted regulatory standards as invariably contrary to their interests. Solving social problems has been ceded to governments and to NGOs. Corporate responsibility programs—a reaction to external pressure—have emerged largely to improve firms’ reputations and are treated as a necessary expense. Anything more is seen by many as an irresponsible use of shareholders’ money. Governments, for their part, have often regulated in a way that makes shared value more difficult to achieve. Implicitly, each side has assumed that the other is an obstacle to pursuing its goals and acted accordingly.

Blurring the Profit/Nonprofit Boundary

The concept of shared value, in contrast, recognizes that societal needs, not just conventional economic needs, define markets. It also recognizes that social harms or weaknesses frequently create internal costs for firms—such as wasted energy or raw materials, costly accidents, and the need for remedial training to compensate for inadequacies in education. And addressing societal harms and constraints does not necessarily raise costs for firms, because they can innovate through using new technologies, operating methods, and management approaches—and as a result, increase their productivity and expand their markets.

Mark R. Kramer cofounded FSG, a global social impact consulting firm, with Professor Porter and is its managing director. He is also a senior fellow of the CSR initiative at Harvard’s Kennedy School of Government.

This move is being driven by the failure of Asset Allocation using Modern Portfolio Theory to deliver on its promise of better investment returns. Think, underfunded pension liabilities.However, this movement is important as an enabling technology for Prof. Porter's vision of Shared Value.Consider this.In the Securitized Economy that is the primary architecture for investment that dominates so much of our thinking about Economics today, enterprise and investment can come together around only one, single point of shared value. That is the market-clearing price for securitized assets traded as commodities over an Exchange. Think, optimizing shareholder value. The price has to always go up, because that is what enables the Markets to deliver on their foundational value proposition: a certain sale at an uncertain price. An expectation of rising price -- or other potentially profitable movement in price - is what delivers the certainty of sale. So, profits have to always go up, even if driving profits up now effectively undermines financial security later. This gives us the classic problem of short-termism, and its many corollary complications: lack of transparency; misalignment of incentives; and a herky-jerky pattern of booms that always, eventually, go bust.

In the Real Economy, we have more to work with. Enterprise and investment coming together directly can reach agreement around multiple points of shared value. Some of these must be financial. Others can be societal.

It takes scale to invest directly into the Real Economy. Individuals do not have that scale. Institutions do. This is unprecedented.

Back in the mid-19th Century, when securitization was first being adapted to finance large-scale industrial expansion into a vast and open Western Frontier, pensions did not yet exist, life insurance was only just getting started as an industry itself, and endowments/foundations were still thought of largely as extensions of the family trust. At that time, the best choice for aggregating large amounts of personal wealth to form capital in amounts large enough to invest in large-scale industrial enterprise, was to break up enterprise into bite-sized pieces that individual investors could afford to buy, through the process of securitization. Individuals won't buy in, unless they are sure that they can always get out, whenever they need or want to. Thus the popularity of the Exchange and its value proposition of a certain sale, even though it comes at the cost of an uncertain price.

Today, there is another option. Vast amounts of personal wealth are being entrusted to various institutions as stewards of a chartered trust in exchange for providing programmatic benefits to their respective program beneficiaries, now and later, pretty much in perpetuity.These institutions don't need investment to be broken up into small pieces, They have the scale and the longevity required to invest in giant chunks, alone, or with a manageable number of their peers, using the club model. As large investors -- true financial partners -- in enterprise, these institutions do not need to sell out, in order to get their money out. Instead, they can stay in, recovering invested capital and realizing investment returns by taking an agreed split in the cash flows being generated through the productive use of productive assets by the enterprises they are invested in.

Without the need for a certain sale, these institutional investors no longer need to accept uncertainty in price, or any of the complications of short-termism.There is also this. By getting their invested capital back directly from the enterprise, they can retain control over the decision if, how and when to re-invest. So, they can evolve their portfolio over time, as the economy evolves, rather than getting locked in to pre-defined sets of asset classes that are effectively silos for containing the received wisdom of a past time, and that always end up getting over-banked, which only exacerbates the dysfunctional paradigm for prosperity as a recurring cycle of booms that always, eventually go bust that has become the hallmark of our times.

Think, 2008. Thought-leading institutions like CalPERS, CalSTRS, TIAA-CREF and others are waking up to the realization that they have the power to make this choice: that they can invest directly into the Real Economy. They are moving to use this power as a better choice for building a more satisfying blend of both financial and societal values into their investment portfolios, for both now and later, pretty much in perpetuity. They are beginning cautiously, because they also realize that they do not yet have the skills, experience or access to opportunities they need in order to use this power wisely, and well.What Prof. Porter is advocating here can become an important part of a new curriculum for institutional investors and their investment professionals to become properly adept at identifying and qualifying well-structured investment directly into the productive use of productive assets, that pay good returns, and otherwise fit within their stewardship agendas, to build a portfolio of investments that evolves as the economy evolves, riding the ebb and flow of change, and adaptation to change.For institutions, this agenda will always include the same set of financial values.

These will include: principal protection, programmed performance, threshold returns, constancy, transparency and alignment of incentives.Societal values can be custom-crafted to the opportunity and the institutions doing the investing, and may include any or all of these most pressing issues of our time: climate stability, resource stewardship, social mobility, financial integrity, global community and economic adaptability.Think of it as a marriage of stewardship investing and values-driven entrepreneurship.Stewardship investing is new.

It is an innovation that is evolving right now, in real time, in the trenches of institutional investment in real new value creation. Accordingly, it does not really have a name, and few people are really talking about it. It is, however, the ally Prof. Porter, and others who think like him, need to embrace in order to drive the change they are advocating here. show less