Firms of Endearment

The Attack of the Capitalist Fundamentalists

In case you missed it, Fortune’s annual list of most admired companies appeared in the March 19th issue. The list is compiled from the results of a survey of the Fortune 1,000 conducted by the Hay Group. Hay survey asked executives, directors and analysts to rate companies in their industries on eight criteria, from investment value to social responsibility.

Not surprising (at least to us) FoEs took five of the top 10 slots, starting with Starbucks who came in second after GE. Interestingly (again, at least to us) GE appears to be moving toward FoE status. We also have seen signs of FoE-ness emerging at Proctor & Gamble, which place in the 10^th spot of most respected companies.

Thus with two near-FoEs and five confirmed FoEs, it seems that FoE-ness is catching on in a big way.

Despite this, those whom we have dubbed “capitalist fundamentalists” are still alive and well, often fighting with mean spiritedness against any notion that proactive social responsibility has a place in corporate purpose.

One such is the Free Enterprise Action Fund. It looks upon companies that have bought into the corporate social responsibility movement with contempt. But rather than attack the executive leadership of those companies, FEAC goes after faceless “left wing activists” who would turn capitalism against itself. From FEAC’s home page:

Why invest in the Free Enterprise Action Fund? Left-wing social and political activists are harnessing the power, resources and influence of publicly-owned corporations to advance their social and political agendas. (1) Frustrated by their failure to advance their agendas in the public political process, these activists use capitalism against capitalism under the guise of “corporate social responsibility” and “socially responsible investing.” (2) Their movement threatens shareholder value and the American system of free enterprise.

Leveraging its status as an institutional shareholder in hundreds of America’s largest companies, the Fund aims to defend free enterprise from the Left’s use of capitalism against capitalism.

Our Core Principle. “The social responsibility of a business is to increase its profits.” [Milton Friedman Winner of the 1976 Nobel Prize in Economics]

Interestingly, FEAC doesn’t eschew companies that proudly maintain a social agenda. Five of their investments are cited in our book as FoEs. How pure are these chaps, anyway? One of their larger investments is Johnson & Johnson (an FoE) whose widely applauded Credo – drafted long before corporate activists were anyone's worry – lists shareholders last in its enumerated list of beliefs and dedicated efforts.

These guys ought to fund the development of a time machine and take a one-way trip to the 19th century. They are wildly out of touch with business realities in the 21st century.

Take a look at the Johnson & Johnson Credo:

Our Credo

We believe our first responsibility is to the doctors, nurses and patients,
to mothers and fathers and all others who use our products and services.
In meeting their needs everything we do must be of high quality.
We must constantly strive to reduce our costs
in order to maintain reasonable prices.
Customers' orders must be serviced promptly and accurately.
Our suppliers and distributors must have an opportunity
to make a fair profit.
We are responsible to our employees,
the men and women who work with us throughout the world.
Everyone must be considered as an individual.
We must respect their dignity and recognize their merit.
They must have a sense of security in their jobs.
Compensation must be fair and adequate,
and working conditions clean, orderly and safe.
We must be mindful of ways to help our employees fulfill
their family responsibilities.
Employees must feel free to make suggestions and complaints.
There must be equal opportunity for employment, development
and advancement for those qualified.
We must provide competent management,
and their actions must be just and ethical.

We are responsible to the communities in which we live and work
and to the world community as well.
We must be good citizens – support good works and charities
and bear our fair share of taxes.
We must encourage civic improvements and better health and education.
We must maintain in good order
the property we are privileged to use,
protecting the environment and natural resources.

Our final responsibility is to our stockholders.
Business must make a sound profit.
We must experiment with new ideas.
Research must be carried on, innovative programs developed
and mistakes paid for.
New equipment must be purchased, new facilities provided
and new products launched.
Reserves must be created to provide for adverse times.
When we operate according to these principles,
the stockholders should realize a fair return.

If these guys were authentic, they would dump J&J immediately, for its Credo runs solidly against the Friedman dictum that the only social responsibility of a company is to create profits for its owners. The J&J Credo was drafted 60 years ago, about 25 years before Friedman made his celebrated remarks about the only social responsibility of companies.

DBW

How FoEs Leverage the Second Law of Thermodynamics (2)

An architect friend of mine, Wayne Smith, told me one day that communities must have something of value to export to remain vital. Years later, after reading about Ilya Prigogine’s proposition that living systems remain far-from-equilibrium because they discharge entropy to permit the inflow of restorative energy, I had a better understanding of what Wayne meant: the process of freely and openly interacting with the external world facilitates a community’s export of entropy.

Take blighted neighborhoods. They suffer a paucity of things of value to export. Entropy builds up like streetside detritus. Everyone sees the accumulating rubbish, but ignores it because they know trash removed today will be replaced by new trash; so why bother? The slum desperately needs revitalizing energy, but it cannot efficiently absorb it because of the efficiency-robbing effects of ever-mounting entropy. Its inner-directed perspective, focused on raw survival, consumes the community.

Many companies suffer from an inner-directed perspective that impedes the exporting of entropy. They operate as “closed systems.” Closed systems are incapable of self-renewal. Only by entering the bidirectional stream of exporting (entropy) and importing (energy) can a system remain in a far-from-equilibrium state.

A closed system company typically sees operations through a shareholder lens. This restricts the exportation of entropy. (Remember Milton Friedman’s famous take on corporate social responsibility: The only social responsibility a company has is to lawfully make profits for its owners. He was in essence championing the closed system approach to company organization. )

The structure of closed system companies promotes information constipation. Employees are strewn along channels of information with the power to block the free flow of information. Employees at all levels use information as a strategic tool for their own survival. Wanting credit for newly found information, an employee may keep it from upper management as he or she waits for the most propitious time to release the information.

With similar self-interest at play, an employee may withhold bad-news information to protect his or her position. This happens with daily regularity in hierarchical organizations. The result? Entropy builds and compromises the well being of the company.

Hierarchically organized companies also experience mighty, mindless defense of the status quo at all levels regardless of changing conditions that call for change. Mindless defense of the status quo contributes to entropy build-up and blocks the flow of self-renewing energy.

Firms of endearment are outer-directed systems. Their commitment to addressing the needs of all stakeholders gives them continuous access to catalysts that trigger continuous exportation of entropy.

Southwest 93-member culture committee fights against status-quoism that impedes the export of entropy. Honda’s waigaya ensures the outward flow of entropy and influx of self-renewing energy. The car company also helps suppliers export entropy, thus making them healthier participants in Honda’s economic ecosystem, thus making the ecosystem healthier for all.

Operating with a transparency not customary with closed-system companies, FoEs are immune to information constipation. They are able to get early indications about problems from every stakeholder group.

For example, when a Wisconsin Whole Foods store voted for union certification, John Mackey personally investigated the situation to find out where management had failed employees. He corrected the alleged deficiencies, after which employees voted to decertify. A more typical C&C approach would have been to send a swat team into the region (which Wal-Mart does) to figure out how they could pull the teeth of the union or at least minimize its influence on employees.

The open-system structure of FoEs permits more rapid responses to situational change that require quick responses than closed system structures. In the latter, people’s first responses tend to be along the lines of “How will this affect me?” FoE employees are likelier to ask, “How will this affect the company? Or the customer? Or the supplier? Or the community? Therein lies the existential difference between the open-system SRM business model and the closed system C&C business model.

DBW

The New Business Imperative

According to a newly released survey from Institutional Shareholder Services, nearly all investment advisors interviewed in a global study agree that corporate governance is no longer a compliance obligation for companies, but an imperative business responsibility.

What does this mean? From our perspective it means that the day when the signature traits of firms of endearment will traits in mainstream corporate communities could be not all that far in the future. The interesting question here is what happens to a FoE’s competitive advantages when competitors acquire many of the same competition-beating characteristics? We will explore that question in a future post.

And what do the findings of the ISS survey mean from an investor's perspective? They mean greater transparency, for one thing. While a spate of high profile corporate scandals has made compliance a bigger issue than ever before, of the 63% of investors predicting corporate governance to increase in importance over the next three years, only 37% listed compliance as a driving factor. Enhanced investment returns (33%), client demands (32%) and risk management (21%) were seen as bigger issues than scandals.

Institutional Shareholder Services interviewed 322 investment analysts from 18 nations. Total assets managed by their firms add up to $10.5 trillion, about one-third of the estimated total global equity assets. The full 100-page study can be accesses here.

DBW