The Merits of Long-term Value Creation for All Stakeholders
Our future is shaped at an accelerated pace by the ongoing effects of globalization, climate change, and the growing power of digital transformation. Our lives are transformed by the adoption of smarter, cheaper, and faster ways to communicate, connect, work, access knowledge, educate, shop, get healthcare and be entertained.
A new reality is emerging in the business world, that of “value-creating capitalism”, which is prompting organizations to revisit and reaffirm their values, recalibrate their priorities and set new long-term performance criteria. It's about linking profit to purpose.
"Once a choice, soon a necessity, social consciousness is here to stay," says Alan Murray, CEO of Fortune Media, and seasoned journalist. He continues: "We need to pay more attention to the positive impact on society, because if we don't, we could have an existential problem down the road."
The evolution of capitalism
In the decades following World War II, a form of socially responsible capitalism, based on the long-term and referred to as the "stakeholder model", gained widespread popularity in the United States and Western Europe.
This stakeholder-based view of capitalism emphasizes long-term value creation by considering the needs and interests of all stakeholders in the economy and society at large, as opposed to short-term profit maximization for shareholders. As a result, the links between companies and their communities became stronger. In Western Europe, for example, employee representation on corporate boards emerged, a trend that continues to this day. The same applies to ties with suppliers and customers, with procurement, production and sales being primarily local or regional.
But in the early 1970s, under the pressure of an emerging recession and the influence of economist Milton Friedman, who advocated "shareholder primacy" as the guiding principle of corporate management, the United States reversed course and returned to short-termism and the pursuit of profit. Friedman's idea that "the only responsibility of a business is to make money for its shareholders" was adopted and the stakeholder approach was abandoned. This gave rise to a new form of capitalism, known as Neo-American Capitalism or Quarterly Capitalism, which became the norm in the United States.
The globalization of the economy further amplified the trend toward the resurgence of shareholder capitalism, as companies began to operate internationally and trade across borders in a fiercely competitive environment. As a result, they loosened their ties to local communities and national governments to focus on short-term profit maximization.
Income inequality as a result of shareholder capitalism
Shareholder capitalism led to huge income inequality, particularly in the aftermath of the 2008 global financial crisis, which eroded the middle class and resulted in a decline in competitiveness and innovation.
Ever since World War II, most people who grew up in advanced economies could expect to be better off than their parents. This assumption has proven correct in most cases: over the past 70 years, sustained global economic growth resulted in rising incomes for all households (except for a brief interruption in the 1970s due to the oil crisis). However, this upward trend has come to an end. Between 2005 and 2014, about 2/3 of households in 25 advanced economies saw their real incomes stagnate or decline, according to a McKinsey Global Institute report.
In Europe, unlike the United States, the stakeholder movement survived and even grew, particularly in the Nordic countries, which were able to sustain higher levels of competitiveness and equality than their American counterparts. It is worth noting that Europe's comprehensive welfare system includes universal health care and education, which contributes to economic efficiency and equity.
A shareholder-centric approach often leads to value destruction rather than value creation.
There is a profound dichotomy between companies that continually ask the self-serving question, “what’s in it for us” and those that start by considering the needs of all stakeholders and ask, “what’s in it for all our stakeholders"? These are two radically different ways of looking at the world and operating in it.
For decades, companies have operated in cycles of earnings forecasts and quarterly press releases focused on internalizing profits and externalizing costs, with little regard for the social and environmental consequences of their actions. To boost short-term profits, some groups resorted to a variety of accounting and financial gimmicks, including financial engineering, share buybacks, tax loopholes, ruthless cost-cutting, hastily executed acquisitions and innovation activities, ... sometimes to the detriment of the long-term interests of the company, employees and even shareholders.
Today's big 5 technology companies (GAFAMs), that generated trillions of dollars in shareholder value, did so by instilling a company-wide passion and unwavering commitment to delivering value to their customers. In contrast, yesterday's giants, such as IBM and GE, that persisted in their shareholder-centric thinking, struggled, and delivered little value to their shareholders, despite massive digital investments.
When companies focus primarily on replenishing their coffers with profits for their shareholders, they often find that they cannot generate the commitment and agility needed for innovation. As former GE CEO Jeff Immelt notes in his new book, Hot Seat (2021), "Since leaving GE, I have grown more aware of the link between innovation and value creation inside companies."
Value-creating capitalism – is inclusive
The strategy for long-term value creation is inclusive. It involves caring about the interests and needs of all stakeholders, not just investors. To create long-term value, you cannot ignore the needs of your customers, employees, and suppliers.
As early as 1954, Peter Drucker asserted that "there is only one valid purpose for a business: to create value for its customers in a sustainable way". This revolutionary idea, at odds with the dominant thinking of the time, is perfectly clear in 2022: the consumer dictates the rules of the marketplace. Thanks to globalization, deregulation, and new technologies, especially the Internet, consumers have choices, access to reliable data about those choices and the ability to interact with other customers. They now expect value that is instant, frictionless, interconnected and preferably free.
To succeed in today's ever-changing, customer-centric digital marketplace, companies must obsessively focus on meeting changing customer expectations, while also paying attention to the broader social issues they care about, such as climate change and equality.
Furthermore, to be competitive in today's economic environment, organizations must develop strong relationships with their employees and suppliers. Building a multi-stakeholder community, connected by a common purpose and trust, provides organizations with a source of support in good times and bad. This principle is analogous to how palm trees withstand major tropical storms. Picture palm trees facing a severe tropical storm. They bend but do not break. Part of their secret is their extensive rooting system - not one anchor point, but many points that can resist severe stress. This is also the best strategy for building resilience in a new economic reality.
Companies with a long-term vision outperform their peers
McKinsey developed a systematic measurement tool - the 5-Factor "Corporate Horizon Index*" to better understand long-term capitalism - it measures the long- and the short-termism at the corporate level. This index provides consistent evidence that a long-term approach produces superior results across a range of economic and financial metrics.
Over the past 15 years (2001-2015), companies that focus on the long term generated 47% more revenue, 36% more profit, and $7 billion more in market capitalization than their short-term counterparts, according to McKinsey's Global Institute. They also created 12,000 more jobs over that period. And, if all these companies had generated the same number of jobs, the U.S. economy could have added more than 5 million jobs in that time frame.
*: Their 5-factor Corporate Horizon Index uses a data set of 615 large and mid-cap US publicly listed companies from 2001 to 2015 and is based on patterns of investment, growth, earnings quality, and earnings management. It enables to separate long-term companies from others and to compare their relative performance, after controlling for industry characteristics and company size.
At least since Adam Smith it was assumed that the only purpose of a business was to make money for its shareholders. This was as obvious as the "fact" that the sun revolves around the earth, until we discovered that this was not the case.
In fact, making money is the result, a by-product, not the goal!
In conclusion, value-creating capitalism with a long-term focus is the catalyst for progress. It drives innovation, raises living standards, increases life expectancy and quality of life. It energizes economies and expands opportunities for individuals. It is also the best way to increase shareholders' income in the long term.