Better than Brundtland Introduction Sustainable entrepreneurship has gained greatly in significance in recent years. This is reflected in e.g. the heightened media attention for the subject. Triple Value has contributed to that public debate with articles and opinions, principally in het Financieele Dagblad. The present collection brings together 26 of these articles. They provide a survey of our viewpoints and the evolution of our thinking. Even more important than the stimulation of a public debate is the substantial progress that many companies have already made in the field of sustainable entrepreneurship. Measured by market capitalisation, about 80% of the 25 AEX-listed companies are now regarded as ‘sustainability leader’ by the Dow Jones Sustainability Index1. But there is no reason for complacency. Notwithstanding the progress made, sustainable entrepreneurship has yet to secure a solid position on the agenda of many boards of management and, above all, business unit managers. This is mainly because the subject is viewed too much from the need to ‘do something good for the world’. The contribution of companies towards sustainable development will remain sub-optimal unless value creation is given more central prominence. We think that sustainable entrepreneurship needs a new impulse. This is briefly discussed in the final section of this introduction. First, however, we must defuse six myths that currently impede the development of sustainable entrepreneurship:: 1. Sustainable entrepreneurship calls for a different focus from the creation of shareholder value; 2. Corporate governance, compliance and sustainable entrepreneurship are separate issues; 3. Non-financial value is of little significance; 4. The core of sustainable entrepreneurship is sustainability; 5. Companies must be active in developing countries to help poor people; 6. The government is a director and driver of sustainable entrepreneurship. The following six sections each centre on one of these myths. The subsequent chapters of this book contain articles we have written in relation to the respective myths.
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Own research of Triple Value, October 2005
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Where the Brundtland2 definition of sustainable development states that we must meet our present needs without compromising the ability of future generations to meet their own needs, we believe that the bar must be raised higher. As you will be able to read at greater length in the final section, we think that companies focussing on actual progress will not only help their shareholders and the world population to meet their needs, but will also enrich the ability of future generations to better meet their needs. For there is no substitute for technological and innovative power and result-driven entrepreneurship. The active harnessing of this power to achieve genuine progress is what sustainable entrepreneurship adds to ’straightforward entrepreneuring’. In the dynamics in which companies operate, this is not a choice but a necessity to survive in a hypercompetitive environment. ‘Survival of the best fitting’ is the challenge facing companies. Value creation remains the basis for survival; access to resources, efficient allocation of resources, and agility (i.e. the ability to respond to the external context) translate, in our view, into competitive advantages. Only those companies that master these competencies will remain successful in the long term.
Myth 1: Sustainable entrepreneurship calls for a different focus from the creation of shareholder value A common assumption is that shareholder value is achieved at the expense of other stakeholders. Shareholders, however, have no contractual relationship with the company and only receive a return for contributing capital after the company has met its responsibilities towards other stakeholders. By contrast, the relationships with many of these other stakeholders are contractually-based. Our own research among AEX-listed companies shows that in 2004 these paid about seven times as much in salary costs to employees than in dividend to shareholders. And the government received more than twice as much in taxes. So shareholders are not the privileged group that many perceive them to be. The pursuit of shareholder value involves maximising the value of the company as a whole. Any attempt to realise ‘stakeholder value’ – if indeed it is at all possible to find a method that does justice to the diverse needs of this heterogeneous group – deprives a company of the incentives to deliver a better performance than is contractually required. Maximisation of shareholder value therefore offers the best guarantee for the protection of the future interests of stakeholders, while optimisation of stakeholder value may leave the shareholder empty-handed. That is not desirable: without shareholders companies simply cannot survive. It is important to understand that a focus on shareholder value is not exclusively about promoting the interests of the shareholder. But it is precisely through this focus that the interests of other stakeholders are also best-served. This is obviously
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In 1987 the World Commission on Environment and Development (WCED) published the report ‘Our common future’. This document is also known as the Brundtland report, named after Gro Harlem Brundtland, the chairman to the commission. The definition of sustainable development, which has been launched in this report, is still regarded as the most authoritative.
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not to say that no problems exist in the current organisation of economic interests. We will return to some of these in the final section. An attempt to resolve these imbalances by altering the company objective in favour of stakeholder value would, in our viewpoint, be putting the cart before the horse. The objective pursuit of maximum effectiveness and efficiency would then be replaced by a subjective quest for the ‘optimal’ distribution of income. Shareholder value is an objective measure for controlling and directing a company. No mixed bag of conflicting objectives can ever match that. The reality therefore is: sustainable companies must remain focused on creating shareholder value. This is the best guarantee for meeting the long-term interests of other stakeholders.
Myth 2: Corporate governance, compliance and sustainable entrepreneurship are separate issues Old habits die hard. Perhaps this explains the outdated but persistent perception that companies operate in two arenas: one of the shareholders and one of the other stakeholders. Even companies that are seen as the trailblazers of sustainable entrepreneurship are at best building shaky bridges between these arenas. Consequently, there is strikingly little contact between the departments that are responsible for these areas. That is a risk. By assuming that it can thus best serve both arenas, the company turns itself into a two-headed beast. What the people at the top fail to realise is that a beast with two heads is by definition a monster. The one head is ignorant of what the other says and promises, and that leads to inconsistencies and contradictions. This puts the credibility and predictability of the business in jeopardy. In the past years this could be seen most starkly in CEOs with a disproportionate and one-dimensional dedication to sustainable entrepreneurship. Often things went badly wrong precisely at these companies. This phenomenon was so striking that the market became very wary of companies whose CEOs championed sustainable entrepreneurship. Phil Watts of Shell and Cees van der Hoeven at Ahold became exponents of how it should not be done. In our view the governance of these companies – and sometimes also their compliance – actually came under pressure because they divided the world into two arenas. By maintaining a semblance of sustainability and good intentions, the top sought to conceal their appetite for shortterm results. Both the interests of shareholders and the credibility of sustainable entrepreneurship were thus damaged. The view on sustainable entrepreneurship that we advocate therefore assumes a single arena: integration of corporate governance, compliance and sustainable entrepreneurship. That is in the interests of both the shareholders and the other stakeholders. The reality therefore is: it is a superseded misconception that the world of capital providers is a different one from that of the other stakeholders in a company. This is why corporate
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governance, compliance and sustainable entrepreneurship must be managed as an integrated whole.
Myth 3: Non-financial value is of little significance In efficient markets there is no difference between pursuing short- and long-term shareholder value. For in such a market, there are no arbitrage opportunities for shifting value from the long to the short term. But it is evident that some companies have allowed the share price to rise at the expense of long-term enterprise value. Incentives for this are often encapsulated in the top executives’ reward structure. Particularly in these days of hedge funds it is vital that companies focus on the long term and do not confuse shareholder value with the share price. For at least two thirds of a company’s value lies in cash flows to be generated over a term longer than five years3. These cash flows largely come about through the sale of products and services that still need to be developed, purchased by customers who still have to be acquired, produced and sold by staff who still have to be recruited and under legislation in which current externalities constitute a tangible cost item. Making financial projections over such a long term, which by definition entails many uncertainties, is largely crystal ball gazing. So it is therefore crucially important to obtain insight into non-financial matters such as access to the labour market, the development of employees and management skills, customer retention by responding to (changing) wishes of customers and the ability to comply with future regulations by anticipating social developments. Companies are beginning to wake up to this. But the way in which they currently supply non-financial information is often more reminiscent of uncoordinated carpet bombing than of a few well-aimed shots. The pursuit of transparency only makes sense when it concerns matters that are genuinely of material significance to the company. Making an inventory of the types of non-financial information that are relevant for the long-term financial value of a company and quantifying this information will be crucial for companies in the coming period. The afore-mentioned factors, namely access to the various markets in which the company is active – capital, raw materials, labour and sales markets – and the allocation of resources, must be central in this connection. More is less. Or in the words of Gordon Gekko, the investment banker in the movie Wall Street: “It’s all about the bucks, kid. The rest is conversation.” The reality therefore is: it is precisely non-financial aspects that principally determine the value of companies.
Myth 4: The core of sustainable entrepreneurship is sustainability
3 Assuming capital costs of 8%. In the case of company growth this is higher and because capital markets grow faster than the economy it is plausible that the weight will shift even further to the future due to the declining risk premium for equity.
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We realise that this myth may appear rather provocative. Many readers might respond with a comment along the lines of ’the world is facing enormous problems, so shouldn’t sustainability be the central issue?’ Certainly, it is in no way our intention to detract from the importance of sustainable development. The point we wish to make here concerns the role of the diverse players in the socio-economic field. In that field companies have a monopoly on entrepreneurship. Their business is to interest customers in their products. Not only now, but also in the future. Governments set frameworks (see also myth 6). Non-governmental organisations act either as the thorn in the side of companies or as their partners. Everyone thus has their own role in making our living patterns more sustainable. But the most effective and efficient contribution that companies can make is determined by their success in entrepreneurship. This means that they must create and seize opportunities in markets by operating in a smarter and more appealing manner than their competitors. Competition has led to the standard of life that we enjoy in free markets. And competition remains crucial to finding solutions for many existing problems. The art for the other players in the field is to make sure that companies are constantly stimulated to develop and sell relevant solutions or sustainable products and services. But market demand is a key prerequisite: this is where the customers are in the driver’s seat. But legislation can also be an effective tool for influencing companies, just as NGO actions can also make a valuable contribution. The positions of customers, legislators and NGOs pose companies with the challenge of continuing to come up with smarter and better entrepreneurial solutions. Some companies also take their own initiatives to cultivate sustainable market opportunities through smarter entrepreneurship. It was, after all, not the legislator who forced Toyota to make the Prius. The company came up with that idea itself and is now reaping the fruits. Note also the ambitious actions of General Electric. The vigour with which this company has embraced sustainability springs from the profit-making potential that the management sees in sustainable products. Sometimes a sector as a whole agrees to raise the bar. The Equator Principles to which over 40 of the largest banks in the world have committed themselves were born from rightly understood self-interest. This contributes towards higher corporate earnings and also to sustainability. In other words: esteemed stakeholders, let each of you do what you are good at! And make sure companies remain entrepreneurial. For that’s how this group can make a maximum contribution towards sustainability. The reality therefore is: without successful entrepreneurship, a company immediately goes under. Without attention for sustainable development, it does not (immediately) go under. This proves that entrepreneurship is the most relevant aspect.
Myth 5: Companies must be active in markets of developing countries to help poor people To our mind the poverty gap between ‘North and South’ is the biggest disgrace in our present-day world. Many hundreds of millions of people are cut off from
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primary necessities and the prosperity we often take for granted. It is saddening to have to conclude that so much well-meant aid yields so little. Development aid can evidently provide relief in acute emergencies, such as in the wake of natural disasters. But in other situations it appears to be much less effective. There is a growing body of evidence that poverty is not caused by too little aid but rather by an absence of fundamental liberties, including a free market. First and foremost: business cannot provide the ultimate solution for eradicating poverty. Good government and institutional structures are indispensable to resolve this massive issue. But the poorest stand to gain more from the presence of companies than is often believed. Vice versa, the poor have more to offer companies. That is the central idea behind the ‘base of the pyramid’ (BOP) concept. When companies manage to satisfy the real needs of the poorest, development is stimulated. Companies who succeed in doing this in a profitable manner unlock a vast potential. The 80% of the world population living in developing countries represents a purchasing power equal to that of the combined populations of Japan, Germany, France, Italy and the United Kingdom. In addition, (economic) growth in emerging markets is of a greater magnitude. Even more important perhaps than this economic potential is the innovation that is necessary to be able to serve the poorest people. In the words of C.K. Prahalad4: “Learn how to serve the poor; the rich will come”. Products for the poorest may only cost a fraction of what we are used to in the West. Otherwise they will be unsellable. Capital-intensive business models have no role to play here. So it is no coincidence that some of the most innovative developments, even in ‘high-tech' sectors like mobile telephony and health care, are taking place in countries like India. The lack of existing infrastructure in many developing countries means they can apply new technologies faster. The West may be ahead on the learning curve, it is behind on the forgetting curve. Micro-credits were invented in developing countries but are now also applied in the United States and Spain. And a laptop of 100 dollars currently seems set to capture a large slice of the existing laptop market. But the potential of the BOP markets simultaneously poses a threat to companies in developed markets. If they are not able to meet the needs of the poorest in a profitable manner, companies from developing countries who can do this will eventually come to the West. The first signals of the strength of companies from developing countries are already visible in Mittal Steel’s bid for Arcelor and the acquisition by the Chinese company Lenovo of the hardware activities of IBM. The reality therefore is: companies are wise not to treat developing countries as an object of charity or a source of cheap labour but as a source of profitable growth and innovation.
Myth 6: The government is a director and driver of sustainable entrepreneurship Let there be no misunderstanding; the government has a crucial role to play in sustainable development. Good legislation is of great importance and its 4
See for example: C,K, Prahalad ‘The fortune at the bottom of the pyramid’, Wharton School Publishing 2005
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enforcement is even more important. A sub-standard legal infrastructure is a major contributor towards the miserable conditions in many developing countries. In the Netherlands we are blessed with a government which, on the whole, works reasonably well. Nevertheless we conclude that it cannot be seen as an important director or driver of sustainable entrepreneurship. The lack of overall direction is principally due to the fact that the various ministries are too involved in looking after their own affairs and have no eye for a coordinated and consistent approach to the wider world community. This leads to a substandard performance, that no business could get away with for long. The government cannot be seen as a driver because it lacks a ‘can do, will do’ spirit and because it is not in touch with reality. National government has no hesitation in proclaiming the importance of sustainability, but at the same time is happy to wait until 2010 before enforcing one obvious and simple way of pursuing that aim, namely sustainable procurement. Clearly, the government is long on words but short on deeds. In addition, the government has become too detached from day-to-day practice to be seen as a credible driver. Projects such as Clean, Clever and Competitive are announced and launched amidst great fanfare in a bid to communicate a shared standpoint with business about the competitive advantage of sustainability. But the lead time is so long and the consultation with business so meagre that ultimately all that remains is a toothless paper tiger cub. Time and again the government fails to live up to the expectations that it builds, which is not only extremely disappointing but also undermines its credibility. In the light of these modest results of the Dutch government it is encouraging to see that the authorities at European level are unable to take even the most inconsequential of decisions. Europe is wrestling with conflicting national interests and is totally lacking in leadership. The main object of the exercise appears to be to keep up appearances with superfluous ambition statements. This has an unintended positive effect: rudderless government leaves business free to steer its own course in the field of sustainable entrepreneurship and that leads to more tangible progress than the government can lay claim to. It’s unlikely that the European policy can ever become more effective than that. The reality therefore is: the government still has a lot to learn from business when it comes to achieving targeted results in the field of sustainability.
A new impulse We live in challenging times. The world is confronted with the real and sometimes negative consequences of international developments such as globalisation, population growth, industrialisation of emerging markets, growing demand for raw materials and environmental impairment. The biggest global problem, however, is the poverty gap between ’North and South’. The meagre progress made in that field is staggering. In addition, it is abundantly clear that the business community is also guilty of mistakes and malpractices; the accounting scandals are a telling example of this.
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But let it be clear: we believe in the power of the business community and the effective contribution that sustainable entrepreneurship makes towards improving the living environment. This, however, does not happen by itself and not every company is equally successful in this respect. Stakeholders are becoming more critical and, more than ever, have the means (of communication) to hold companies to account for their behaviour. We think there are three decisive elements that define success in this playing field, and thus determine which companies continue to create value in the long term: access, allocation and agility. First of all: access. By this we mean retaining access to resources that are crucial to the operations of the company. In the light of the intensifying competition, access can no longer be taken for granted. Companies from emerging markets, which produce more cheaply, influence the access of ‘Western’ companies to the customers in these markets. It is also a challenge to anticipate future markets to which you, as a business, wish to gain access; ‘base of the pyramid’ strategies can make an important contribution to this. But in the labour market, too, competition is severe and it is difficult to retain access to the most qualified people. To be successful, companies need good partners. In other words: they must continue to form part of ’winning chains’. You do not retain access simply by paying more and more. You only keep it if you remain an interesting party. Attractive for customers, challenging for employees, reliable for partners and accepted, at the very least, by society. Short-term self-interest impedes survival in a hypercompetitive environment. The second driver of long-term value is allocation. Companies add value through enhancement of products and services before offering them to their customers. Effective and efficient companies are more productive and add more value. Efficient and effective utilisation of skills and resources is the result of their correct allocation. An organisation which mis-allocates typically has wasteful processes or wastes its human capital and is uneconomical. Companies increase their productivity by allocating capital to the most promising projects. In times of ever-scarcer nonrenewable resources, investing in the development of renewable substitutes is one example. But developing employees and staffing them so that their skills are put to best use is another way of enhancing productivity. Markets are better at allocating resources effectively and efficiently than governments and productivity is thus an imperative that follows from a company’s role in society. Productivity is therefore also a measure of a company’s societal responsibility. And with the growing scarcity of natural resources, human talent, environmental quality and even quality of life, markets will prefer companies that do better and more with less. The third crucial element is agility. By this we mean the flexibility and versatility that companies must have to anticipate the accelerating dynamics in the world. Dynamics arise at macro-level through internationalisation, blurring borders, cultural crosspollination and the confusion resulting from this.
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At their own micro level companies are also facing more intense dynamics. The most competitive companies derive their competitive power more from how quickly and effectively they respond to changing circumstances than to their ability to predict the future better than their competitors. Anyone who wishes to respond alertly to changes must first of all be able to accurately pick up external signals. It is precisely because shareholders – barring the odd visible exception – exercise little influence over companies that companies must avoid complacency by being open and receptive to other stakeholders. Stakeholders are becoming increasingly critical, are demanding more transparency and can assert their opinions evermore forcefully in this dynamic world. Agility does not mean ’going any way the wind blows’. It is a third element in the ability to adapt to and function in a challenging environment. The three elements are obviously interrelated: access to the various markets demands agility, agility requires an organisation in which resources are efficiently utilised and an efficient organisation needs access to resources. The challenges are enormous, both for companies and for society. But instead of doom and gloom scenarios, we believe in opportunities. We are optimistic. Companies which – stimulated by the carrot and stick of their stakeholders – are able to cope with the dynamics of access, allocation and agility, continue to create value and make a positive contribution to society. That contribution goes beyond what the Brundtland definition understands by sustainable entrepreneurship. We think that sustainable development should mean that the current world population can meet its needs, while enriching the ability of future generations to meet their needs. While Brundtland says that we must not compromise the opportunities of future generations, we are convinced that the technological and innovative power of business and industry can actually offer them more. That way companies take up the challenge of ‘survival of the best fitting’. We obviously do not have all the answers. But with this vision in mind, we will intend to continue moulding and shaping the activities of Triple Value Strategy Consulting.
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