What is the business of business?
By building social issues into strategy, big companies can recast the debate about their role in society.
Ian Davis
The McKinsey Quarterly, 2005 Number 3
The great, long-running debate about
business's role in society is currently caught between two contrasting,
and tired, ideological positions. On one side of the current debate are
those who argue that, to borrow Milton Friedman's phrase, "the business
of business is business." This belief, most established in Anglo-Saxon
economies, implies that social issues are peripheral to the challenges
of corporate management. The sole legitimate purpose of business is to
create shareholder value. On the other side are the proponents of
corporate social responsibility, a rapidly growing, rather fuzzy
movement encompassing companies that claim that they already practice
the principles of CSR and skeptical advocacy groups arguing that they
must go further in mitigating their social impact. As other regions of
the world—parts of continental Europe, for example—move toward the
Anglo-Saxon shareholder value model, the debate between these points of
view has increasingly taken on global significance.
Both perspectives obscure, in different ways, the significance of
social issues to business success. They also unhelpfully caricature the
contribution of business to social welfare. It is time for CEOs of big
companies to recast this debate and recapture the intellectual and
moral high ground from their critics.
Large companies must build social issues into strategy in a way that
reflects their actual business importance. Such companies need to
articulate their social contribution and to define their ultimate
purpose in a way that is more subtle than "the business of business is
business" and less defensive than most current CSR approaches. It can
help to view the relationship between big business and society as an
implicit social contract—Rousseau adapted to the corporate world, you
might say. This contract has obligations, opportunities, and advantages
for both sides.
To explain the basis for such an approach, it may help first to
pinpoint the limitations of the two current ideological poles. Start
with "the business of business is business." The issue here is not
primarily legal: in many countries, such as Germany, companies have a
legal obligation to stakeholders, and even in the United States the
legal primacy of shareholders is open to very broad interpretation.
The problem with the "business of business is business" mind-set is
rather that it can obscure two important realities. The first is that
social issues are not so much tangential to the business of business as
fundamental to it. From a defensive point of view, companies that
ignore public sentiment make themselves vulnerable to attack. Social
pressures can also serve as early indicators of factors essential to
corporate profitability: for example, the regulations and public-policy
environment in which companies must operate, the appetite of consumers
for certain goods above others, and the motivation of employees—and
their willingness to be hired in the first place.
Companies that treat social issues as either irritating distractions or
simply unjustified vehicles for attacks on business are turning a blind
eye to impending forces that have the potential to alter the strategic
future in fundamental ways. Although the effects of social pressures on
these forces may not be immediate, that is not a reason for companies
to delay preparing for or tackling them. Even from a strict shareholder
perspective, most stock market value—typically, more than 80 percent in
US and Western European public markets—depends on expectations of
corporate cash flows beyond the next three years.
Examples abound of the long-term business impact of social issues. That
impact is growing fast. In the pharmaceutical sector, the past decade's
storm of social pressures—stemming from issues such as public
perceptions of excessive prices charged for HIV/AIDS drugs in
developing countries—are now translating into a general (and sometimes
seemingly indiscriminate) toughening of the regulatory environment. In
the food and restaurant sector, meanwhile, the long-escalating debate
about obesity is now resulting in calls for further controls on the
marketing of unhealthy foods. In the case of big financial
institutions, concerns about conflicts of interest and the mis-selling
of products have recently led to changes in core business practices and
industry structure. For some big retailers, public and planning
resistance to new stores is constraining growth opportunities. And all
this is to say nothing of the way social and political pressures have
reshaped and redefined the tobacco and the oil and mining industries,
among others, over the decades.
In all such cases, billions of dollars of shareholder value have been
put at stake as a result of social issues that ultimately feed into the
fundamental drivers of corporate performance. In many instances, a
"business of business is business" outlook has blinded companies to
outcomes, or to shifts in the implicit social contract, that often
could have been anticipated.
Just as important, these outcomes have not just posed risks to
companies but also generated value creation opportunities: in the case
of the pharmaceutical sector, for example, the growing market for
generic drugs; in the case of fast-food restaurants, providing
healthier meals; and in the case of the energy industry, meeting
fast-growing demand (as well as regulatory pressure) for cleaner fuels
such as natural gas. Social pressures often indicate the existence of
unmet social needs or consumer preferences. Businesses can gain
advantage by spotting and supplying these before their competitors do.
Paradoxically, therefore, the language of shareholder value may in this
respect hinder companies from maximizing their shareholder value.
Practiced as an unthinking mantra, "the business of business is
business" can lead managers to focus excessively on improving the
short-term performance of their businesses, thus neglecting important
longer-term opportunities and issues, including societal pressures, the
trust of customers, and investments in innovation and other growth
prospects.
The second point that the "business of business is business" outlook
obscures for many companies—the need to address questions about their
ethics and legitimacy—is related to the first. For reasons of integrity
and enlightened self-interest, big companies need to tackle such
issues, with both words and actions. It is neither sufficient nor wise
to say that it is for governments to set laws and for companies simply
to operate within them. Nor is it enough simply to point out that many
criticisms of businesses are unmerited or that those throwing the mud
ought also to examine their own practices and social responsibility.
Irrespective of whether the criticisms are valid, their cumulative
effect can shape the strategic context for companies. It is imperative
that businesses seek to lead rather than merely react to these debates.
Moreover, in certain parts of the world—particularly some poor
developing countries—the rule of law and basic public services are
notable by their absence. This reality can render the "business of
business is business" mind-set positively unhelpful as a guide for
corporate action. If companies operating in such an environment focus
too narrowly on ill-defined local legislation or shy away from broad
debates about their alleged behavior, they are likely to face mounting
criticism over their activities as well as a greater risk of becoming
embroiled in local political tensions.
Is CSR the answer? If only it were. The point is not to criticize the
many laudable CSR initiatives undertaken by individual companies or to
dispute the obvious need for businesses (as for any other social
entity) to act responsibly. It is rather to examine the broad
prescriptions proposed by groups and activists involved with CSR. These
prescriptions commonly include stakeholder dialogue, social and
environmental reports, and corporate policies on ethical issues. This
approach is too limited, too defensive, and too disconnected from
corporate strategy.
The defensive posture of CSR springs from its origins. Its popularity
as a set of corporate tactics was driven, in large part, by a series of
anticorporate campaigns in the late 1990s. These campaigns were in turn
given impetus by the antiglobalization protests mounted around the same
time. Since then, companies have been drawn to CSR by nice-sounding if
vague notions such as the "triple bottom line": the idea that companies
can simultaneously serve social and environmental goals as well as earn
profits. Companies have seen CSR as a way to avoid
nongovernmental-organization (NGO) and reputational flak and to
mitigate the rougher edges and consequences of capitalism.
This defensiveness starts the argument on the wrong foot—certainly as
far as business leaders should be concerned. Big business provides huge
and critical contributions to modern society. These are insufficiently
articulated, acknowledged, or understood. Among them are productivity
gains, innovation and research, employment, large-scale investments,
human-capital development, and organization. All of them are, and will
be, essential for future national and global economic welfare. Big
business also supplies investment vehicles that are likely to be
central to the provision of pensions in the aging countries of the
Organisation for Economic Co-operation and Development (OECD). In
developing countries, meanwhile, the entry of multinational companies
through foreign direct investment has often contributed critical
capital, technology, skills, and other poverty-reducing economic
spillovers. It is no coincidence that developing countries place such
emphasis on attracting big business and the investment it can bring to
their economies.
CSR is limited as an agenda for corporate action because it fails to
capture the potential importance of social issues for corporate
strategy. Admittedly, companies undertaking a stakeholder dialogue with
NGOs will be more aware, in advance, of potential issues. But tracking
NGO opinion is only part of the process of understanding the range of
social pressures that can ultimately affect core business drivers such
as regulations and consumption patterns.
An obvious next step for companies, having understood the possible
evolution of these broad social pressures, is to map long-term options
and responses. This process clearly needs to be rooted in the
development of strategy. Yet typical CSR initiatives—a new ethical
policy here, for example, or a glossy sustainability report there—are
often tangential to it. It is perfectly possible for a company to
follow many prescriptions of CSR and still be caught short by seismic
shifts in the socially driven business environment. One of the
compounding problems is the fact that many companies have chosen to
root their CSR functions too narrowly, within their public- or
corporate-affairs departments. Although such departments play an
important tactical role, they are often geared toward rebutting
criticism and tend to operate at a distance from strategic decision
making within the company.
A contract has two sides, and business must acknowledge that in return for the ability to function, it is subject to rules and constraints
In the limitations of both CSR and of the "business of business is
business" thinking lie the outlines of a new approach—as relevant for
Chinese, German, and Indian companies as for US and British ones. Three
main strands stand out. The first is a helpfully simple prescription:
businesses should introduce explicit processes to make sure that social
issues and emerging social forces are discussed at the highest levels
as part of overall strategic planning. This point means that executives
must educate and engage their boards of directors. It also means that
they need to develop broad metrics or summaries that usefully describe
the relevant issues, in much the same way that most companies analyze
customer trends today. The risk that stakeholders—including
governments, consumer groups, lawyers, and the media—will mobilize
around particular issues can be roughly estimated by studying the known
agendas and interests of these parties. For example, the likelihood
that the obesity debate would rebound on food companies was partly
predictable from the growing expenditures of governments on
obesity-related health problems, the inevitable media focus on the
issue, plus the interest of some lawyers in finding fresh corporate
targets for litigation. By the time businesses seriously engaged with
the question, they were in a defensive posture, merely struggling to
catch up with the public debate. In the future, companies will need to
be much better at understanding and anticipating such issues.
Both the second and third strands of the new approach reflect the idea
that there is an implicit contract between big business and society or
indeed between whole economic sectors and society—the contract that is
the subject of this article. Detractors have often successfully
portrayed the contract as a one-way bargain that benefits business at
society's expense. The reality is much more complex. The activities
undertaken by business have clearly brought social benefits as well as
costs. Similarly, however, there are two sides to a contract, and
business must acknowledge that in return for the ability to function,
it is subject to rules and constraints. At times, the contract can come
under obvious strain. The recent backlash against big business in the
United States can be seen as society seeking to shift the terms of the
contract as a result of popular perceptions that business has abused
its power. Similarly, in Germany at present, business is struggling to
defend itself against charges that its contract with society is
fundamentally unbalanced.
The second strand requires companies not just to understand their
individual contracts but also to manage those contracts actively. To do
so, companies can choose from a range of potential tactics, such as
more transparent reporting, shifts in R&D or asset reorganization
to capture expected future opportunities or to shed perceived
liabilities, changes in approaches to regulation, and, at an industry
level, the development and deployment of voluntary standards of
behavior.
Some companies and sectors are already experimenting with such
approaches. Nonetheless, there is scope for much more activity,
provided it is aligned with corporate strategic goals. Reshaping
conduct on an industry-wide and increasingly global basis may be
particularly important, given that the perceived misdeeds of one
company can rebound on its sector as a whole.
An important point to remember is that companies, depending on their
circumstances, will have quite different tactical responses, so
off-the-shelf or simply nice-sounding solutions may not always be
appropriate. Transparency offers a good example. It is easy, but wrong,
to say that there can never be enough of it. What might be good for a
pharmaceutical company trying to restore the consumers' trust could be
damaging for a hedge fund manager. A voluntary code of practice for a
retailer naturally would be very different from that of a copper-mining
company.
This observation leads me to the third strand of the new approach for
business leaders: they need to shape the debate on social issues much
more consciously by establishing ever higher (but appropriate)
standards of integrity and transparency within their own companies and
by becoming much more actively involved in external debates (such as
those in the media) on issues that shape the social context of business.
A starting point may be for CEOs to articulate publicly the purpose of
business in terms less dry than shareholder value, although that should
continue to be seen as the critical measure of business success.
However, it may be more accurate, more motivating—and indeed more
beneficial to shareholder value over the long term—to describe the
ultimate purpose of business as the efficient provision of goods and
services that society wants.
This is a hugely valuable, even noble, purpose. It is the basis of the
contract between business and society and the basis of most people's
real interactions with business. CEOs could point out that profits are
not an end in themselves but a signal from society that a company is
succeeding in its mission of providing something people want—and doing
so in a way that uses resources efficiently relative to other possible
uses. From this perspective, the creation of shareholder value or
profits is the measure, and the reward, of success in delivering to
society the goods and services we desire, which is the more fundamental
business objective. The measures and rewards reflect the predominant
values of the relevant society.
CEOs could point out that profits are not an end in themselves but a signal from society that a company is providing things people want
By moving away from a rigid focus on the term shareholder value, big
business can also make clear to broad audiences that it understands the
trade-offs inherent in its social contract. The debate between business
and society is essentially one about how to manage (and reach agreement
on) those trade-offs. What might this point mean specifically? There is
no shortage of big social issues today that directly affect many big
businesses and require new debate. These issues include ensuring that
aid organizations and trade regimes successfully promote the
development of Africa and other poor regions, whose economic liftoff
would present a major potential boon to global markets as well as to
international security; promoting a more sophisticated and sensitive
approach, by both companies and governments, to balancing the societal
risks and rewards from new technologies; spearheading dialogue on the
health care and pension challenges in many developed countries; and
supporting efforts to resolve regional conflicts.
Obviously, the relevant issue must be matched to the specific business.
Some companies and business organizations have taken strong public
stances on these and similar issues. But in general, high-level,
concerted corporate activism is more notable by its absence. Business
leaders shouldn't fear taking a more forward role advocating the idea
of a contract between business and society. Public receptiveness to
active business leadership on issues such as these may be a lot greater
than some might be inclined to think. Despite the poor image and bad
press of big business in recent times, polls suggest that people retain
a belief in its ability to provide a positive contribution to society.
More than two centuries ago, Rousseau's social contract helped to seed
the idea among political leaders that they must serve the public good,
lest their own legitimacy be threatened. The CEOs of today's big
corporations should take the opportunity to restate and reinforce their
own social contracts in order to help secure, for the long term, the
invested billions of their shareholders. 
About the Authors
Ian Davis is the worldwide managing director of
McKinsey & Company. This article was originally published as "The
biggest contract" in the May 26, 2005, issue of the Economist. Copyright © The Economist Newspaper Limited, London, 2005. All rights reserved. Reprinted by permission.
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