Edward Freeman: Businesses Should Be Driven By Purpose

R Edward Freeman
The Man: Originated the Stakeholder Theory that challenged managers to look beyond profits. The Elis and Signe Olsson Professor of Business Administration, Darden School of Business, teaches a popular course Leadership and Theatre, where students enact scenes from plays and learn lessons in innovation, ethics and creativity. He tells us that the essence of real capitalism lies in creating value for all stakeholders and not just shareholders.

The Oeuvre: In a global economy it is becoming very important for businesses to build their strategies around relationships with key stakeholders. His book Managing for Stakeholder: Survival, Reputation and Success lays out the essentials of doing business in the modern world.

X-Factor: He draws out students and gives them practical real life ethical challenges.  Go beyond the classroom!

The Message: Capitalism is in trouble. We can be the generation that makes it better.

The Hypothesis
Business has to be a good citizen in the community and society. The old way of business presupposes the purpose of business is to make profits. This is akin to believing that making red blood cells or breathing is the purpose of life. Yes, we must have red blood cells, just as businesses must make profits. But the purpose of business is usually determined by a passionate entrepreneur chasing a dream to change the world.

So What?
Executives need to ask, “What are the four or five questions my people should ask to be sure we focus on our purpose, do business the right way, and create value for our stakeholders?” By engaging the entire organisation in these critical questions, executives can create a living culture that will continuously produce value for customers, suppliers, employees, financiers, communities and society.

In 1970, economist Milton Friedman articulated the view that the only responsibility of the executive was to maximise profits for shareholders. The influence of Friedman’s view during the next 40 years has been legion. The dominance of economics/finance based thinking has swept the business world from Wall Street to Delhi. And, the public trust in business is at an all time low. It’s time for a change.

We can no longer afford to see business as a purely economic phenomena unconnected to society and disconnected from a sense of doing the right thing. Ironically, Friedman himself recognised that the shareholder value rule would work only if businesses obeyed the law and ethical custom, but many of his followers assumed that business and ethics were disconnected, hence the joke about business ethics being an oxymoron. Today, we need a deeper connection. We need a new story about business that is appropriate for the 21st century and the global business environment that we all face. It goes like this.

Businesses in the 21st century will be successful and sustainable if and only if they seek to create value for customers, suppliers, employees, communities (and society), and financiers (shareholders, bondholders, banks, etc). Every business model is built on this principle, and it is past time to recognise that it forms the essence of real capitalism. Any successful business must have products and services that customers want.

In today’s world, a business is far better off when it has suppliers who are committed to making it better and more effective. It needs employees who are committed to the business and bring their expertise and creativity. Business has to be a good citizen in the community and society. The ground is littered with companies that have ignored this stakeholder. Executives and shareholders have lost billions of dollars of value because society has been ignored. And, if a company does all of these things, the outcome will be profits. Yes, that’s right. Profits are very important and they are an outcome of executing a business model that is oriented around creating as much value for stakeholders as possible.

Image: Alex Masi / Corbis

Some thinkers have rejected the stakeholder model because they believe that stakeholder interests are always in conflict, but it is the very conflict of interests that leads to the possibility of creating even more value. When the interests of customers and suppliers seem to conflict, we redesign products and supply chains so that both win. When community interests around clean environment seem to conflict with customers, we focus on innovations that allow companies to be green and profitable. The power of ‘and’ is substantial. Capitalism works because enterprising entrepreneurs and professional managers figure out how to create value for multiple stakeholders at the same time.

What does this have to do with ethics? First of all we need to see stakeholders as human beings, not just economic agents. The remarkable rise of the Indian business community has made the lives of the citizens in the world’s largest democracy, substantially better.  From large enterprises like the Tata Group and Infosys, to start ups like Husk Power, Indian companies have improved the fabric of society in India and around the world. Once we come to see business in the more humane terms of stakeholders, then we can more easily integrate ideas about ethics and morality.

Second, the old story of business, exemplified by economic/finance thinking supposes that the purpose of a business is to make a profit. This is akin to believing that making red blood cells or breathing is the purpose of life. Yes, we must have red blood cells, just as businesses must make profits, but the purpose of a business is usually determined by an entrepreneur who is trying to change the world, chase a dream, and who is passionate about a particular business idea. The great Indian companies were started to make the world and Indian society a better place. Profits are important, but they are an outcome of business models oriented around creating value for stakeholders.

Of course, there is no panacea here. Some businesses and their executives make mistakes. Some of these mistakes are very costly in economic and humane terms. We need to look no further than the Bhopal disaster to remember the consequences of failing to see business in essentially moral terms.

This is a substantial challenge for corporate leaders. Executives need to create a culture of innovation and value creation, which consists of several interconnected tasks. First, they need to be sure that they have processes in place in their companies that ensure that all employees understand and stay focussed on the corporate purpose.

Second, executives need to encourage people to be constantly looking for ways to create value for multiple stakeholders. Third, leaders need to articulate a set of values that defines the way the company wants to conduct its business. More importantly, they must embody those values and be role models for their top team. Employees know whether or not corporate values are real, by watching the behaviour of the top team.

Fourth, corporate leaders need to encourage people to speak up when they see their company not living up to its values and purposes. Speaking up is important in purpose driven organisations. If the purpose drives us to act, then we all should want to know when we are falling short, so that we can correct our behaviour or find innovative ways to create values that are consistent with our main purpose. Finally, executives need to ask, “What are the four or five questions that my people should ask to be sure that we focus on our purpose, doing business the right way, and creating value for our stakeholders?”

By engaging the entire organisation in these critical questions, executives can create a living culture that will continuously produce value for customers, suppliers, employees, financiers, communities and society.

Capitalism is in trouble. But we can be the generation that makes it better. We need to come to expect our businesses to be driven by purpose, other than short term profits, and we need executives to hold themselves to a set of values. We need to integrate business and ethics at the deep level of the business model. The only legitimate role of the executive is to create as much value as possible for stakeholders.
 
Reading List
1. Built to Last — Jim Collins
2. Thriving on Chaos — Tom Peters
3. Authentic Leadership — Bill George
4. Managing for Stakeholders — R Edward Freeman, Jeffrey Harrison, Andrew Wicks