The evolution of Corporate Ethics: a strategic case for profit maximization through responsible behavior
Palladium's Robert Matus and Ben Ersing explore how ethical business leads to long-term profit maximization.
To survive in tomorrow's global economy, corporate leaders must take what they were taught in business school about enterprise value creation and sustainable competitive advantage and adapt it to the changing world…or risk struggling to compete. They must evolve to the new global economic reality, and adopt a new way of thinking and problem solving, one that approaches profits and social impact as inextricably intertwined. This evolution of corporate ethics can be thought of as a fundamental shift in the factors which drive corporate governance and strategic decision-making. We are now transitioning from a world where philanthropic social contributions, i.e., Corporate Social Responsibility (CSR), influenced behavior, to one where authentic Positive Impact drives behavior. Natural psychological biases make this change extremely difficult for many corporate leaders, and even more so for entire enterprises, that must seek to undergo dramatic shifts in the way they think about and conduct business. There are, however, a handful of visionary leaders who are helping to pave the way, and whom we can learn from and emulate. We hope that through this brief article, we can spur increased contemplation and dialogue on this important topic, and help readers to begin assessing what it could mean for them as individual consumers and leaders within their own organizations.
Corporate Ethics is Dead. Long Live Corporate Ethics
In the 1960s, big business began to dominate the United States and the global economy: Many corporations were merging into conglomerates, consumers were shifting from local sole proprietor stores to discount chains stores, and small family farms were giving way to corporate industrialized farms. It was at this time that the locus of corporate governance began to shift from a focus on the company, to a focus on society, and the concept of CSR began to emerge as a response to public backlash against the perceived negative social impact of big business. Under CSR programs, multi-national corporations largely maintained their existing business operations, and added an additional practice area focused on designing and implementing community programs which they could use to demonstrate their social impact and mitigate any negative public perceptions. At that time it was simply a reactive public relations strategy, something viewed by most corporate leaders as a cost of doing business, not a strategic differentiator and source of competitive advantage.
The global economy has changed significantly since the 1960s, as have consumer tastes, expectations, and bargaining power. Certainly, this structural change was further catalyzed by the 2008 global economic crisis, but indicators of it emerged prior to the Great Recession. Tom's Shoes (2006)—a prime example of a company that integrated social impact and values into the core of its business model and value proposition—went on to demonstrate the commercial viability of the business model when Bain Capital purchased a controlling stake for $300M in 2014. The events of 2008 to 2010 gave this structural economic and social shift the push it needed to become a true sustainable force for change. Today, innovative first-movers are successfully structuring social values deep into the fiber of their global enterprise strategies, and more and more use cases are emerging to demonstrate the strategic competitive advantage and increased shareholder value it can create.
In today's increasingly networked, transparent world, consumers are hungry for meaning, authenticity and purpose. As such, business ethics, or corporate social responsibility, are no longer sufficient. In fact, they are dead. Today, ethical business, as traditionally understood, is just smart, long-term-profit-maximization oriented business. Period.
Global Mega-Trends Driving the Change in Enterprise Value Creation Strategy
The customer is always right, and millennial customers have spoken loudly and clearly. At 92 million, the millennial generation is the largest in U.S. history, and generation Z is close behind. In the U.S. alone, companies are battling for $200B in annual purchasing power amongst this consumer class. Recent studies have found that over 75 percent of millennial consumers say it's either 'fairly' or 'very important' that a company contributes positively to society. However, it is no longer sufficient for companies to put on a superficial facade of creating positive social impact through CSR programs. Millennials are known for intense brand loyalty to those companies who truly and authentically stand for more than their bottom line, and for punishing those who are deemed to be inauthentic or out of touch. The only way for corporations to win and maintain millennials' trust is to be, or to become, authentically focused on creating value for society in addition to value for shareholders. This intentional, authentic approach to competitive strategic differentiation through simultaneous social and economic value creation is what we, the authors, refer to as a Positive Impact Strategy.
While many discussions are focused on millennial consumers in developed markets, those markets are stagnating in their growth potential; it is emerging-market consumers who are expected to drive future corporate earnings. In fact, emerging markets represent a disproportionate share of future global economic growth - estimated by some to reach $30 trillion by 2025, and referred to by McKinsey & Co. as "the biggest growth opportunity in the history of capitalism." The emerging 4.2 billion consumers behind this economic growth are, you guessed it, millennials; and many experts anticipate that with this demographic dividend and enormous purchasing power we will see a shift towards emerging-markets consumers in defining innovation, product design, and strategy. It is not only developed-country consumers who are demanding increased authentic and positive social engagement and consumer experiences from their brands. Emerging markets consumers are increasingly influenced in their buying behavior by the sustainability of a corporation's products and approaches For example, a 2014 National Geographic Society survey of 18,000 people in 18 countries found that consumers in India, China, South Korea, and Brazil scored the highest in terms of increasing their environmentally friendly behavior. To successfully compete in "the biggest growth opportunity in the history of capitalism" companies should consider embracing and 'leaning in' to the potential competitive advantage which a Positive Impact strategy provides.
Use Cases & Innovative First-Movers
A successful business case for this shift in strategic thinking is increasingly being built by innovative first-movers. Take Unilever for example. The company is a global food and consumer products giant with €52.7 billion in revenue per year, 169,000 employees worldwide, and operations in over 100 countries, making it second only to Proctor & Gamble in the packaged consumer goods category, and on par with Nestle and Kraft Heinz in the food and beverage industry. Though not without its critics, Unilever, under the leadership of CEO Paul Polman, has responded to the changing market dynamics (i.e., consumer demands, emerging market growth, purpose-seeking stakeholders, etc.) by completely shifting the company's strategy from being socially-neutral to Positive Impact-focused. Their transition has not been without challenges, but illustrates a potentially powerful competitive differentiator for consumer brands.
When Paul Polman took the reins of the company in 2009 and launched the bold Unilever Sustainable Living Plan (USLP) which aimed to double the size of the business whilst halving its environmental footprint by 2020, the move was nearly unanimously recognised as a bold and ambitious step for the company. Intended to re-think the way the company approached value creation and its competitive position, the USLP disbanded the company's sustainability department, integrating its components into the entire enterprise and fostering a strong 'brand with a purpose.' Polman's sweeping incorporation of what we would call a radically innovative Positive Impact Strategy, won him widespread recognition within the international community, including United Nations accolades as a "Champions of the Earth Award" in their Entrepreneurial Vision category.
Like any major organizational transformation, the process has not been an easy one. The lynchpin to Polman's success to date was gaining buy-in to an innovative new approach to thinking about corporate value creation and competitive advantage, and then injecting these business practices into the DNA of the entire company and its partners. To accomplish this, Unilever started by developing a core purpose, "Making Sustainable Living Commonplace," which it places at the center of its financial and economic decisions, as exemplified by its prominence within discussions of shareholder returns in its Annual Report. As of 2015 and 2016, Unilever had also acquired or developed 12 "Sustainable Living Brands" which grew 30 and 40 percent faster than the rest of the business in the respective years.3 Beyond the products and brands they develop, Unilever has taken an intentional approach to reducing their manufacturing operating costs through reducing their environmental impact. Since 2008, they have cut CO2 emissions from energy by 43 percent, from water abstraction by 37 percent and from total waste by 96 percent per ton of production.4 Though some analysts on Wall Street have been outspoken in their criticism and scepticism of Polman's strategy, Unilever has able to grow revenues, maintain margins, and make progress on its sustainability goals. Overall, during Mr. Polman's tenure, Unilever NV (ADR)'s shareholder value increased from $25.16 (Jan 2, 2009) to $58.82 (Aug 21, 2017).
The CJ Group is another example. This South Korean conglomerate with over $18Bn in revenue and operations in consumer packaged goods, pharmaceuticals, and media and entertainment, amongst other industries, has built its entire mission around "contributing to the nation and to society by creating the best value with ONLYONE products and services." This core mission is then exemplified throughout its daily operations and strategic initiatives. Most recently, it has been recognized for its intentional efforts to provide employment for South Korea's elderly population through a delivery agent's workforce scheme. While this might not seem like a "big deal" to some readers, in South Korea, more than half of the country's workforce is expected to be over the age of 50 by 2050, and today, almost half of those over 65 years old live in poverty. By intentionally designing a corporate strategic initiative that provides employment to elderly South Koreans, CJ Corporation is able to simultaneously drive progress towards the social impact aspect of its mission by working to reduce the level of poverty throughout the country, while simultaneously increasing domestic consumer purchasing power and likely, domestic market share.
These are but two abbreviated examples of how industry leaders are taking concrete steps to tackle significant social challenges, while simultaneously making a profit. Rather than a short article like this, an entire book could be written on the detailed strategies of how corporate leaders have achieved these feats, and how others can follow suit. The following section presents a short introduction to how one might think about designing and implementing such a Positive Impact Strategy.
So What Can Corporate Leaders Do Tomorrow?
It's not easy to shift a leadership team's thinking, organizational processes, or profit centers, even if it provides a long-term competitive advantage. It can often be difficult to even know where to start. However, there are a number of key strategic levers that corporate leaders can pull in order to begin this change process; and each one of these levers derives its own independent value creation, apart from the entire enterprise shift.
One place to start is to remove the notion of a Sustainability or Corporate Social Responsibility Department by integrating it into another key business function (such as the Strategy Office). In doing so, sustainability-oriented thinking is promoted and incorporated across the entire enterprise. Successful companies often focus on aligning the organizational culture, including hiring and promotion strategies, to this new enterprise value proposition. Through implementing values-based hiring programs which are aligned with the overall enterprise strategy and vision, leadership can begin to 'get the right people on the bus, in the right seats' to begin fostering a culture focused on generating both financial and social value for the enterprise, and for society. By prioritizing the hiring and promotion of individuals who have a deep grasp of the social challenges encountered by the business, as well as of the commercial opportunities, challenges, and approaches to value creation, leaders can begin widening the broader team's focus to think laterally across these lines. In broad terms, leaders could consider at least three additional areas to innovate and develop a Positive Impact Strategy:
- Marketing and Product Development - Using values-based customer segmentation and identifying product-market fit based on a specific social issue rooted in the target customers' values, while also crafting authentic brand narratives around the social issues and products in a way that drives brand loyalty. An example of product development is the Unilever Blue Brand and Rama Product Line, which has integrated additional supplements such as vitamins into consumer staples targeting lower-middle-class emerging markets consumers, to provide health benefits in addition to the direct value sought by customers.
- Corporate Development - Leveraging opportunities for strategic alliances, acquisitions, and partnerships with companies and organizations that fit its dual financial/social mission and which can provide access to valuable markets, resources and insights, particularly within emerging markets. For instance, companies such as global chocolate manufacturer Barry Callebaut are joining strategic alliances with large international donors and public-sector actors to address a specific social issue such as income inequality and poverty amongst small-holder farmers, while simultaneously providing increased access to local markets, strategic local market intelligence, and sustainable raw materials.
- Pricing Strategy - When targeting emerging markets low-income consumers (or the 'Base of the Pyramid'), leaders could consider partnering with international donors or multilateral agencies to develop innovative financial products and pricing structures to facilitate access to essential goods at more cost-effective price-points. For instance, with its Wheel detergent which is priced profitably at a sale price 30 percent less than other detergents, Unilever is able to provide a valuable product with a direct social benefit to a customer segment traditionally overlooked by companies in India.
The few use-cases we have discussed are hardly meant to be exhaustive, nor do they dive into the more nuanced elements of what drove their success, or what challenges and hurdles they faced along the way. However a full-fledged analysis of the opportunities was never our intention for this article. Rather, our hope is that through it, we will contribute to the burgeoning dialogue and spur further conversation.
The Coming Decade
While some skeptics may point to this as a passing fad, we see it as part of a much larger global mega-trend which, while still in the nascent stages, is fast becoming 'business-as-usual.' As in any significant period of structural economic change, there are those who will identify and adopt trends early, and will be better positioned to thrive in the new landscape. Similarly, there are those who will reject or hesitate to buy into the changing market environment, and they will find themselves increasingly struggling to compete. The challenge will be to find individuals who have deep insights and understanding of both the corporate world as well as of deeply entrenched social interests, and the actors who have traditionally focused on addressing them (i.e., international donors, international organizations, multilateral organizations, International NGOs, social enterprises, etc.). Finding and developing the talent that can successfully work in this type of environment requires identifying individuals who have a vast, diverse, non-linear global perspective—people who can think creatively across cultures and geographies, sectors and industries to develop innovative solutions, and gain buy-in from the multiple potential stakeholders in order to create value. We believe that these fundamental differences—both in how business is done and our perspectives on enterprise value creation—will be primary tenets of this next wave of global innovation.
This article was originally published in the Carnegie Council for Ethics in International Affairs.