Category Archives: sustainability

Adding Coherence to Capitalism

This post is inspired by my two favorite business readings of 2010: (1) “Creating Shared Value” by Michael Porter and Mark Kramer (Harvard Business School), and (2) “The Essential Advantage: How to Win with a Capabilities-Driven Strategy” by Paul Leinwand and Cesare Mainardi (Booz and Company).

I’ll risk doing a huge injustice to both of these contributions to the literature on business strategy and development and attempt to boil down the crux of each as follows.  The essence of “Creating Shared Value” is that “Companies can create economic value by creating societal value” in three key ways: reconceiving their products and services, redefining productivity along the value chain, and building supportive industry clusters at each of the company’s locations.  In other words, we need to move beyond giving lip service to calls for corporate social responsibility, adopt a long-term perspective, and pursue the real returns on investment in the community.

The essence of “The Essential Advantage” is that companies succeed, “not because of what they own or how big they are or because they are positioned in the right industries.  Their advantage lies in what they do and how everything fits together to create value. They succeed because they are coherent.” High relative coherence is what gives a firm the “right to win” in a given market, and coherence refers specifically to the “resolute, clear-minded focus in a company on three critical elements”, i.e. its unique value proposition, its system of distinctive capabilities, and its lineup of products and services.

The arguments articulated in “Creating Shared Value” and “The Essential Advantage” overlap and complement one another in several key respects.  First, both are about building virtuous circles of value creation whereby improving value in one area gives rise to opportunities in the others.  Second, both posit that a firm can create the most value, for both shareholders and society, by doing what it does best, that is leverage its most distinctive capabilities. Charitable monetary donations, for example, are a weak contribution to social welfare in comparison to the deployment of a firm’s core competences for the same purpose.  Third, Porter, Kramer, Leinwand and Mainardi have composed complementary pieces in that the former two authors offer an inspiring new sense of purpose for businesses, and the latter two authors offer a practical framework for setting priorities and coherently reflecting that purpose in a firm’s capabilities, product and service portfolio, and day-to-day operations.

Now to the point of this post: after these two readings, I was left wondering how, more generally, any firm’s value proposition might reflect both its contribution to social welfare as well as its distinctive capabilities. I wondered how, specifically, a firm might position itself vis-a-vis other firms or institutions as the champion of one discrete approach to shared value creation or another or as the champion of some combination of approaches. Porter and Kramer offer some examples of paths toward shared value creation — i.e. improving water and electricity efficiency, enhancing employee skills, health and safety, and promoting supplier access and viability — but I see these and other stated examples as less than fully representative of the full array of paths.  Reconceiving products and services, redefining productivity, and building supportive industry clusters are three, but they are among others, and “building supportive industry clusters” is awfully broad as it encompasses everything from public-private partnerships to shared infrastructure. Likewise, after reading “The Essential Advantage”, I was left wondering what is the list of most commonly used approaches for creating shared value that would supplement what Leinwand and Mainardi identify as 15 mutually exclusive value propositions that they see companies combining most frequently to compete and win (in the traditional sense of turning a profit).

An hour and three cups of coffee later, I came up with a list of seven mutually exclusive “shared value propositions” — or what Leinwand and Mainardi would call “puretone ways to play” (and I would be delighted to highlight others that anyone might suggest).  I phrase each in terms of the basic approach to creating shared value in a particular market, in a way that differentiates the company.

(1) Human capital developer. These companies invest in and advocate for local education, health services and social diversity (e.g. gender equality) to enhance labor market conditions, for their own benefit and for all.  3M, for example, actively contributes to the University of Minnesota’s highly competitive chemistry program.

(2) Resource steward. These companies maximize the productivity of their resources, ensuring minimum environmental impact and maximum health of their employees and their families, thereby minimizing resource costs and employee absences and lost productivity.  They also advocate for the protection and enhancement of these resources in general for the sake of national economic competitiveness and well-being.  Paperless companies save trees and money.

(3) Infrastructure provider.  These companies invest in infrastructure (I mean this in the broadest sense to include networking platforms, electricity and water utilities, transport infrastructure, etc.) that unlocks growth in their supportive industry cluster and the local economy in general.  De Beers has made significant contributions to utilities and transport infrastructure in some parts of Africa where both the firm requires that infrastructure for diamond mining and the community requires infrastructure in general.

(4) Alliance coordinator. These companies orchestrate partnerships between firms and institutions of government and civil society for the sake of correcting “coordination failures” (in the market failure sense). Specifically, these firms improve their own coherence through sharing of market, technology and resource access among strategic allies (i.e., other organizations in their supportive industry cluster). The strategic alliance between General Motors (GM) and Shanghai Automotive Industry Corp (SAIC) in 1997 involved substantial knowledge transfer to local Chinese employees and market access for GM.

(5) Policy influencer.  These companies know how to navigate regulations and transparently advocate for policy changes that create value for both the firm and for society.  A good example is Google’s success in influencing ICT sector deregulation in North Africa by drawing attention to implications for poverty reduction and development. These firms are essentially capable of “changing the game” by affecting change in the business climate itself.

(6) Consumer educator.  These companies view their current and potential customers as partners in collaborative product and service improvement.  Open-source software development (i.e. crowdsourcing) is one great example of the way in which these companies succeed.

(7) Social value player.  These companies motivate customers to embrace products and services that create societal benefits, like healthier food or environmentally friendly products.  These companies also serve disadvantaged communities and developing countries — customers at the bottom of the pyramid — that have not been recognized as viable markets; to do so, they redesign their products, services or distribution methods, offering them at very low or even zero cost.  Also, by learning-by-doing these companies thereby trigger capability improvements that often have application in traditional markets.

After producing this list, I realized that several could be captured under the large umbrella of “building supportive industry clusters”, but I find it more helpful to disaggregate the notions of alliance coordinator and infrastructure provider, for example, as they tend to reflect very different capabilities.  I also include areas concerning factor conditions (human capital developer), government (policy influencer), and demand conditions (consumer educator) because they help to reflect the ways in which a firm can strengthen what Professor Porter himself coined as the “Diamond of National Advantage”, and because they, again, reflect very different capabilities.

With due consideration and incorporation of the above seven Shared Value Propositions, and while guided by the roadmap articulated in “The Essential Advantage”, a firm can learn to build and leverage its unique system of distinctive capabilities to achieve a sustainable edge over the competition and simultaneously serve the basic needs of society.  As firms increasingly do so, we will see the emergence of a more coherent form of capitalism, in which the basic aim of businesses is to mobilize people around solving our shared social, environmental, and economic problems, and to do so as productively as possible.

The new ROE?

Lately I’ve been giving a lot of thought to topics of environmental systems and sustainability policy for consulting work and somehow this idea from Corporate Finance class with Professor Jacque resurfaced.  (For additional context, I was reading an interesting guide on “Decoupling Indicators” published by OECD, OECD_Decoupling.)

A useful technique for better understanding the underlying drivers of a firm’s past performance is to decompose Return on Equity (Income / Equity or “ROE”) into three components: Profit, Asset Utilization, and Leverage. The decomposition is insightful as the components reflect three basic functions in a firm: marketing, operations and finance, respectively.  As a formula, it looks like this:

Income / Equity = (Income / Sales) * (Sales / Assets) * (Assets / Equity)

Okay, so why the heck did this occur to me, besides that I might be a huge nerd and/or one of the few paying attention in lecture?  Well, what if we think of Net Exports as our flow variable (replacing Income) and Cumulative Environmental Impact as our stock (replacing Equity)?  Decomposing Net Exports / Cum Env Impact could involve some of the central elements of sustainability strategy, namely: (1) global markets, (2) productive people, (3) frugal behavior and (4) clean technology.  It could look something like this:

Net Exports / Cum Env Impact = (Net Exports / GDP) * (GDP / Population) * (Population / Consumption) * (Consumption / Cum Env Impact)

This could be one way of quantifying and decomposing a measure of Sustainable Environmental Economic Development (SEED?).  When I look at this formula (that I sketched on a napkin) my immediate reaction is that the best way to maximize the left-hand-side is to invest in knowledge-based, clean technology sectors in order to serve international markets, while promoting social responsibility and educating the next generation about the risks facing our planet and the opportunities for entrepreneurship.  That sounds about right, but maybe there’s a better formula out there(?)