Profit by Purpose

I hope that I'm wrong but I suspect that those responsible for the corporate governance which establishes executive targets and associated remuneration will fail to heed the warning from this report of MPs. 

This isn't a case of MPs in an ivory tower pursuing some kind of socialist agenda. Larry Fink, the CEO of Blackrock, wrote in his 2019 letter to the CEOs of the businesses they are invested in, on behalf of his clients: "Market uncertainty is pervasive, and confidence is deteriorating. Many see increased risk of a cyclical downturn. Around the world, frustration with years of stagnant wages, the effect of technology on jobs, and uncertainty about the future have fueled popular anger, nationalism, and xenophobia. In response, some of the world’s leading democracies have descended into wrenching political dysfunction, which has exacerbated, rather than quelled, this public frustration. Trust in multilateralism and official institutions is crumbling."

This prompted us at Outwith to do some further reading in this area and found some stats which helped us to better understand what has brought us here e.g. the way in which the proceeds from the success and growth of businesses have been shared between stakeholders has changed significantly in our lifetimes from c10% of profits in 1970 to >60% by 2015; share buybacks have increased from c5% of profits in the early 80's to 20-25% by the the mid 90's. Thereby, we can see some contributory factors to how it is that 0.7% of the world's population now own 41% of its assets and how in a country like ours, 60% of the people in poverty live in a household with at least one person working.

We couldn't agree more with what Larry Fink's letter continues to say: "every company needs a framework to navigate this difficult landscape, and that it must begin with a clear embodiment of your company’s purpose in your business model and corporate strategy. Purpose is not a mere tagline or marketing campaign; it is a company’s fundamental reason for being – what it does every day to create value for its stakeholders. Purpose is not the sole pursuit of profits but the animating force for achieving them." This is a clear rebuttal of the Friedman thesis dating back to 1970 that has driven so much of our capitalist thinking for the last 50 years i.e. the only responsibility of business is to increase its profits and thus that the only responsibility for managers is to maximise profits within legal constraints. We can see that, unfettered, this is leading to a self-defeating cycle whereby public frustration is threatening the stable environment which businesses need to thrive.

We also believe that what is alluded to in the section underlined above is that many businesses fail to translate their stated purpose into execution. In many cases, not because of a lack of will but a lack of skill or know how - it just isn't the way in which operating models that people have grown up with have worked. We call this the 'hard wiring' of a business and has to be tackled in order to affect meaningful change. We advocate doing this by breaking down a broad purpose statement into its constituent parts in a way which can connect to the day to day work of all employees, together with the right articulation of desired outcomes and associated measures of success.

Final point on these measures of success. Total Shareholder Return (TSR) has been instrumental in ensuring that Friedman's thesis has been writ large into the long term incentive plans (LTIPs) that have often become the focal point of the headlines on executive pay. This is a powerful lever to represent the valid interests of one group of stakeholders, but we can see how there needs to be checks and balances to this in the long term interests of business - equally powerful levers to represent the needs of employees; customers and society. For example, we perceive that Customer Lifetime Value (CLV) or similar should become a far more prevalent measure of the performance of executive teams, given that it depends on the cost effective, acquisition, retention and growth of customers and can't be manipulated by share buybacks.

The last word on this theme should always belong to Theodore Levitt “The purpose of a business is to get and keep a customer. Without customers, no amount of engineering wizardry, clever financing, or operations expertise can keep a company going.”

Tim Sefton