R. Edward Freeman is a professor of strategy, ethics, and entrepreneurship at the Darden School of Business at the University of Virginia. He tweets @re_freeman. Heather Elms is an associate professor of international business at the Kogod School of Business at American University in Washington, D.C.
On Sept. 13, 1970, economist Milton Friedman suggested that, as the headline to his essay in The New York Times Magazine put it, “The Social Responsibility of Business Is to Increase Its Profits.” While we hear from many executives about additional social responsibilities, all too often those executives will revert back to arguing, “...but our first social responsibility is to maximize shareholder profits.”
Businesses that want to be successful in the 21st century need to be saying and doing something else.
Here’s what we argue: The social responsibility of business is to create value for stakeholders. That means its customers, suppliers, employees, and communities, as well as its shareholders.
The stakeholder approach aims to create a new narrative about business — a new story — that enables great companies to make our communities and our lives better through the creation of stakeholder value, rather than simply profit to shareholders. The story includes a recognition that if we want the outcome of business to be a more responsible capitalism, it requires stakeholders to value business responsibility.
Why We Need a New Story
The Great Recession of the late 2000s should have made one thing abundantly clear: The way we have been encouraged to think about business is no longer appropriate — if it ever was. In the 21st century, there is too much complexity and too much uncertainty for a focus on “maximizing profits this quarter” to work very well. The landscape is littered with companies that tried this, and they simply did not understand — either because they could not understand or refused to understand — the complex consequences of their actions. This led to the demise of investment banking company Lehman Brothers, the bankruptcy of automotive company General Motors Corp., and the crash of countless smaller businesses. It cost U.S. citizens trillions of dollars.
If you add to these debacles a whole series of high-profile, far-reaching scandals (Enron, Madoff, Wells Fargo, Volkswagen), where unscrupulous companies and their executives acted for themselves while pretending to do what was in the shareholder’s interest, the old story simply collapses. We can no longer afford to accept that businesspeople will be only self- and shareholder-interested, greedy little bastards divorced from the societal context in which they are embedded.
And to be clear: Cobbling together ideas like “corporate social responsibility” is ineffective. Friedman was wrong nearly 50 years ago when he argued that the only business of business is to make profits for shareholders, but he was right when he urged businesspeople to stick to business. Notable executives like former General Electric CEO Jack Welch have agreed. “On the face of it, shareholder value is the dumbest idea in the world,” Welch told the Financial Times in 2009. “Shareholder value is a result, not a strategy. ... Your main constituencies are your employees, your customers, and your products.”
The New Story Spotlights Stakeholders, Not Just Shareholders
In reality, the only way to make profits is to have great products and services that customers want because those offerings make their lives better. Profits follow from having suppliers who are committed to making a company better, and employees who are inspired to work together to create something of value. And if a business is not a good citizen in its community, at least in a free society, people will use the political process to regulate the business closely and even prevent it from operating within community borders. Stakeholders are interdependent, and everyone who runs a great business knows that.
The new story of business is about creating as much value for all these stakeholders as possible, and this of course includes creating profits for shareholders. In the global economy, customers, suppliers, employees, communities, and financiers — shareholders plus bondholders plus banks and other sources of capital — are all intertwined. The winning business models of the 21st century figure out how to get these interests going in the same direction, with as few trade-offs as possible.
Organizations that compromise the interests of one stakeholder with the interests of another quickly find that, in today’s world, there is simply no place to hide. Someone will figure out how to do the business better without the trade-offs.
Today’s business world yields “continuous creation,” not the old story’s “creative destruction.” Many resources may be limited, but human ingenuity and imagination are not, especially when inspired by a sense of purpose. Think about Amazon (and its recent acquisition, Whole Foods Market), Genentech, Apple, Facebook, and Google — all are high-purpose, stakeholder-oriented companies, based on creating value for multiple stakeholders. No business is perfect, and every business can improve, but it is time to end the myth that Wall Street is disconnected from Main Street. Get executives focused on value creation for real people, and products, services, and jobs will appear.
We know that one immediate reaction of many executives of public companies will be, “Oh, but my fiduciary duty is to shareholders.” Not so. Legal precedent suggests that courts have granted companies a great deal of flexibility in how they balance their stakeholders, including shareholders, in the interests of the business. We see similar flexibility worldwide. Capitalism works because entrepreneurs and managers figure out how to get the interests of many going in the same direction.
The stakeholder approach sets forth a new conceptualization of business, in which business is understood as a set of relationships and management’s job is to help shape these relationships. Business is about how customers, suppliers, employees, financiers, communities, and managers interact to create value, and there is no single formula for balancing or prioritizing stakeholders. Creating that balance is part of what management is all about, and it will be different for different companies at different times.
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The New Story and Stakeholder Responsibility
Business is designed to meet demand. The danger of both the old story (shareholder profit maximization) and the new story (stakeholder value maximization) is that there are some activities in which business should not engage. If, for instance, consumers value only the cheapest product or service, and it is enabled only by depriving employees of any value (and perhaps much worse), then businesspeople must engage their ingenuity and imagination. They need to be inspired to create competitive products and services that create value across the board — for employees as well as consumers, and other stakeholders as well.
This can be done — business is certainly capable of motivating the interests of consumers, employees, investors, and other stakeholders toward one option over another. Business drives demand for technological innovation: You probably didn’t know that your smartphone would be able to do as much as it does, but now that you do, would you ever go back to a flip phone? In the same way, business can drive demand for responsible capitalism by offering responsible options for all stakeholders.
Stakeholders need to respond to these options. Consumers need to purchase responsible products and services. Employees need to choose to work for responsible employers. Suppliers need to provide for responsible buyers. Investors need to finance responsible opportunities. And communities need to welcome responsible entrants and help to sustain responsible incumbents. Responsible capitalism depends on responsible behavior from both business and its stakeholders.
The New Story and the Future of Business and Capitalism
Capitalism is simply the greatest system of social cooperation that we have yet invented. It allows free people to cooperate together and create value for each other in a way that no individual can do alone. Business can be a part of solutions to societal problems, rather than a cause — witness Tesla and renewable energy, IBM and smart cities, and recent startups like Milk Stork Inc., based in Palo Alto, California, which provides an option for mothers who travel for business to get breast milk home to their children.
Let us aspire to these kinds of businesses, and others that create value across stakeholders, rather than settling for value only to shareholders. Let us benefit from the implications of a better way to think about business.