How to Fix Capitalism

Featured Guest: Michael E. Porter, Bishop William Lawrence University Professor and coauthor of the HBR articleCreating Shared Value.

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ADI IGNATIUS: Welcome to the HBR IdeaCast. I’m Adi Ignatius, Editor in Chief of Harvard Business Review. Today with me is Professor Michael Porter, of Harvard Business School, who’s going to be talking with us today about an important new article in HBR, about the next evolution of capitalism. Professor Porter, thanks very much for being with us.

MICHAEL PORTER: Adi, my pleasure.

ADI IGNATIUS: Now, your article is meant to fix a problem. What is the problem?

MICHAEL PORTER: Well, the problem is I think we’ve gotten into a very vicious cycle in thinking about the relationship between business and society. And really, the purpose of capitalism, and the benefits of the capitalist system to society, and to meeting society’s needs– needs like improving people’s lives, and improving the health of communities. We’ve gotten into a cycle where, I think, business has evolved and thinking about business management has evolved, in a direction that we’ve narrowed the scope of how you create economic value. And increasingly, companies are being perceived as creating profit at the expense of the community, not creating profit that actually ultimately benefits the communities.

As a result of this, I think government has increasingly seen business as a problem, as a source of bad things in society. And the mindset is becoming increasingly to regulate, to control, to tax. And ultimately, now often political leaders are unable to pursue business-friendly public policies, because the political environment almost forces them to be tough on business. Despite the fact that we know at some deep level, business and society need each other. But we’ve kind of gotten ourselves into a bad place.

ADI IGNATIUS: But, I think a lot of business people would argue, what we do is run businesses, and we make profits. And when we’re successful we hire people. And that’s all we can do. To have an agenda beyond that is really outside of our scope.

MICHAEL PORTER: Yup. Well, that has been the increasingly well-articulated view about the relationship between business and society over the last 20 or 30 years. Milton Friedman famously argued that the social responsibility of business was to maximize its profits. And this simple act of profit maximization was good, in and of itself. That was enough. That was sufficient. So what was good for business was axiomatically good for society.

But I think– as we’ve seen the effect of business practices on things like health and nutrition and the mortgage crisis– there’s example after example where, actually it’s much more complicated than that. And yes, profit is not inconsistent with society’s needs. But if you think about creating economic value in a narrow way, if you don’t understand the broader and more subtle and longer-term influences on the ultimate sustainability of affirmed success, you can get into a situation where that profit really does come at the expense of society.

And I think there’s a backlash of society saying, wait a minute. We don’t like this profit. All these companies right now, as you know, are reporting increasing profits, but there’s no jobs. The communities are saying, gee, it’s great that XYZ Corporation is making more money, but what’s in that for us? We can see the layoffs. And we can see our local suppliers who have been cut off and have to go out of business. We can see all this development and pollution and strain on resources. And we understand the profits are good, and somehow that we need capitalism. But yet there’s this increasing tension between these, ultimately, partners who actually are mutually dependent on each other.

ADI IGNATIUS: Now, the term you use is creating shared value, so talk a little about how that would work, if it were.

MICHAEL PORTER: Yes. The basic premise of this article is that we once thought if business just increases its profit, what’s good for business is then good for society. I think what this article tries to say is, we need to kind of think differently. What’s good for society is actually good for business. And that sounds like a play on words, but it’s really quite a profound difference in perspective.

The concept of shared value says that, actually, creating societal benefit is really a powerful way to create economic value for the firm. And that we’ve missed, by and large, many of these opportunities to create profit– let’s call it, the right way– profit that actually comes from meeting fundamental, human, societal needs. The most obvious example of that would be the environment. We used to think that being environmentally friendly was a good thing to do, that if you were a good person, in a good company, and you were being responsible, that you’d worry about the environment. Well, we have companies now that are understanding that if they think about the environment, they actually save gobs of money– by reducing energy cost, and minimizing unnecessary logistics that they somehow convinced themselves was a good idea in some theoretical view of how to globalize.

We’re seeing all kinds of examples that, by creating products that are actually dealing– not just with contrived needs or trying to force products onto the customer– but if we create products that are actually good for the customer– nutritionally good, environmentally good, help them save, help them raise their family in a better way– that actually that’s the right way to make economic profit. And so the concept of shared value tries to focus on the tremendous opportunity to create economic value through creating social benefit. And one of the underlying premises is that we’ve maxed out on meeting the conventional needs that we’ve taught ourselves to meet, over the last decades. But we have vast needs in the world– not just in the developing world, but even in the advanced world. We have all kinds of people that are having issues of health and housing, and let’s get busy mobilizing capitalism to meet those needs. And by the way, we can make a lot of money doing that.

But that kind of profit creates shared value. It’s not just profit at the expense of society, or at the expense of the consumer. It’s really profit by benefiting the society and the consumer. That’s the basic idea. This article makes the somewhat controversial case that all profits are not created equally. And that profits that accompany improving nutrition are better than the profits that accompany forcing people to eat too much and getting fat.

ADI IGNATIUS: It’s a pretty dramatic rethink about capitalism. Given your past and your history, are you surprised that Michael Porter has ended up here?

MICHAEL PORTER: All my past work, actually, has sort of equipped me to now examine this issue. And of course, as you know, I’m both an economist– so I’ve been steeped in externalities and all that kind of stuff, and social welfare theory, and all that. But I’m also a business school professor, so I know a lot about firms, and how they actually operate. I did a whole body of work on the role of location– how where the company is matters. And I think that work was a critical piece of seeing the, if you will, the synergies between business and society. And I think it’s, in a sense, the next chapter of thinking about strategy, and about configuring value change, and about creating competitive advantage.

We make the case in the article– Mark Kramer and I– that these shared value dimensions of a company’s strategy that involve these societal impacts on important societal needs, these are going to be some of the greatest differentiators that companies are going to be able to mobilize in the coming years. We tapped out the more conventional model of how to compete, and everybody imitates. But when you look at a company like Whole Foods, that’s created an enormous economic success by building a share value perspective into everything they do. I think that the great strategy of the future are going to have this dimension. And the companies that are going to have the more sustainable advantages are not just going to be making these minor cost and quality differences, they’re going to be engaging communities they’ve never served before. They’re going to be thinking much more deeply about the underlying human needs that are related to their product.

ADI IGNATIUS: But you can’t always have it both ways, can you? At a certain point, companies are going to have to choose between community and profit, aren’t they?

MICHAEL PORTER: We would argue that there are many, many, many things that companies can do, that don’t involve the trade-off. And that’s where the company should focus. I would say that every company is going to have to be compliant. It’s going to have to obey the law. It’s going to have to meet all legal, explicit, and community standards, in terms of how it behaves.

But shared value says that if we’re going to go beyond that, don’t just come up with a volunteer program to have people build houses. Don’t just have your petroleum engineers out raking the beach on weekends to clean up the beach. Don’t give money to 72 random social causes, because you’re trying to build your reputation. Figure out what your product is, what your value chain is. Understand where those things touch important social needs and problems.

If you’re a food company, boy, let’s think about nutrition. If you’re a company that makes an energy-using product, let’s think about the energy use of the product. If you’re a company that’s in the financial services industry, let’s think about saving and sustainable financing or buying a home, but in a way that actually works for the consumer, and is not a cynical effort to force them to take out a mortgage they’re not going to really be able to pay back. So I think that there’s going to be copious opportunities, in the product, in the value chain, and in the cluster of supporting industries, within the communities. There’s going to be copious opportunities to create shared value, I think, for many years to come.

ADI IGNATIUS: Give me a concrete example.

MICHAEL PORTER: Well, in the article, Adi, we used the concept of fair trade purchasing. The idea of fair trade is that the farmer or the small vendor is not getting enough of a price for their product or their crop, and the distribution channels and the marketing companies are getting too big a share. So the idea of fair trade is, we’ve got to give better prices to the farmers, so that they can have a living wage. That’s a classic CSR idea. It’s really about, there’s a fixed pie. There’s a fixed amount of wealth. And we just have to share more of that wealth with the farmer. And if we do that, we’re being good guys, and we’re being fair.

Now, shared value thinking says, no, that’s not the right way to think about it. The real opportunity is to expand the pie. The real opportunity is to figure out how we can create more value, and therefore the farmer will actually get rewarded for the reality of participating in creating more value. And everybody can benefit. And now the smart companies are understanding that if you train farmers better in how to grow crops, if you help them get access to appropriate fertilizer, and seeds, and seedlings to plant, if you assist them in improving, again, the logistical systems by which they’re getting their products to market, you can make farmers dramatically more productive per hectare. You can raise the quality. Therefore, you can afford– and in fact want to– pay a higher price for a higher quality product.

And all of a sudden, you can go from improving a farmer’s income by 20%, to improving a farmer’s income by 200% or 300%. But not through charity, not by being the good guy, but by actually expanding the pie. By creating economic value, but also creating social value at the same time.

So that example, I think, is a pretty vivid framing of this difference of perspective, but also the tremendous size of the opportunity. And yet, one of the big objections to corporate social responsibility has been, why should your personal values about what you want to give to, and what charities– why should you be spending the shareholders’ money deciding that you want to support breast cancer, verses Habitat for Humanity? The shared value concept is very much about self-interest. It says it’s in the self-interest of the company to think about purchasing coffee a different way. And in a sense, then, it’s still the invisible hand of Adam Smith. It’s not the corporation wasting the shareholder’s money. So I think the fair trade example really brings this point– hopefully quite clearly– to the fore, and will give companies opportunities to see how they can apply it to their business.

ADI IGNATIUS: It’s an idea that has the potential to really change things. I’m very glad that you and your co-author have brought it to us. What’s next? How do we change the world?

MICHAEL PORTER: Well, I think the first step is to provide a vocabulary and a framework for thinking about it. And, of course, hopefully we’ll do that. I think there are some excellent companies that are leading the way here. I’ve presented this thinking a number of times to the Chief CSR Officers of some of the biggest companies in the world that gather in various forms. Certainly, the sophisticated [? committee ?] is kind of understanding that the CSR is kind of a dead end. It was a phase, but I think we’re ready to move on. I think that the folks in the CSR world now understand that the real impact that can be had is really, not by the CSR department, or by the charitable giving. The real impact is by actually mobilizing the business itself.

So I think the time is right, and we have to now provide some of the tool kits that will allow companies to do this better. But I’m confident over the next few years that there’ll hopefully be a literature that will be developed on this. But I think the good news is that this is not something that is not yet being practiced in the real world. There are Nestle’s. There are Unilever’s. There are Cargills. There are GEs. There are enough examples.

And also, I think that there’s going to be a fascinating period ahead of us. And again, I think we’re not only going to do good for society, but we’re going to end up reinventing a lot of how we can figure value chains. We’re going to rethink the whole notion of location, where we locate stuff. We’re going to transform the way we deal with suppliers. We’re going to learn how to redesign products in ways that are going to have, I think, benefits that will go way, way beyond what we can imagine today. I’m really quite optimistic, because I’ve seen how powerful this can be in enough cases that I think it’s absolutely real.

ADI IGNATIUS: Thank you for this fascinating idea. It will be very interesting to see how this all evolves.

MICHAEL PORTER: My pleasure. It will be a great journey,

ADI IGNATIUS: The article is about creating shared value. For more on the topic, go to hbr.org.