The word “purpose” has been tossed around in business a lot recently. I’ve been guilty of it myself—the description of this very newsletter has the word in the first sentence:
Win-Win-Win is a community for purpose-driven leaders in the sports and entertainment industry.
So what do we mean by purpose in business? What does it mean to be a purpose-driven business leader? How do you lead teams and companies with purpose? Why should we build purposeful companies?
To answer these questions, let’s look back at how the purpose of business has evolved in the United States. We’ll see that there was a prevailing theory that dominated how we thought about the purpose of business over the past several decades. However, we will also see that there was an alternative theory about the purpose of business that has been bubbling up since the 1980’s, which has now started to take hold in the hearts and minds of business leaders.
Along the way, we’ll see that our initial beliefs about the purpose of business led to two massive problems that made society pretty pissed off about business. Those two big problems have forced us to rethink the way we run our companies, and explain why purpose has become such an important idea and mindset for leaders today, and for the coming decades.
Friedman’s Shareholder Theory
For a long time, the corporate world has acted with a shared understanding that the purpose of business is to deliver a return on investment to shareholders. Milton Friedman, the 1976 Nobel Prize winner in Economic Sciences, called this “shareholder theory.”
Friedman was an influential economist and professor at the University of Chicago. His shareholder theory set the tone for business for the next 50 years. In September 1970, Friedman published an article in The New York Times Magazine titled, “The Social Responsibility of Business is to Increase Profits.”
Friedman believed that the only purpose of business was to make money and increase value for shareholders of the company. Here’s one of the key lines from his column:
“In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom.”
-Milton Friedman
Shareholder theory has been the prevailing mindset in the business community since the 1970s, and as a result, the past fifty years have been incredibly prosperous for American businesses. On September 1, 1970, the S&P 500 Index—which tracks the value of the 500 largest companies in the United States—was listed at 82.58. At the time of writing, the S&P 500 stands at 3375.75—a 4,087% increase in value.
There’s little doubt that business leaders driven by increased shareholder value were able to increase the wealth of shareholders. Along the way, businesses created high-quality products and services that have enriched our lives, and they provided meaningful jobs that helped generations of Americans raise families comfortably.
One could argue that creating products, jobs, and wealth for shareholders created value for society as a byproduct. That’s not wrong. However, by putting profits at the core of business, by making it the one and only purpose of business, we also created two big problems in society that have forced us to reconsider shareholder theory.
Big Problem #1: The Climate Crisis
Led by the mindset that profits are the only purpose of business, corporate executives failed to consider the effect that their companies have on the environment and on the well-being of our planet.
The overwhelming consensus from the scientific community is that the planet is warming at a rate that is unsustainable for life on Earth. Global warming and climate change has already had harmful effects on ecosystems, wildlife, and people across the planet. Scientists have concluded that “greenhouse gases emitted by human activities are the primary driver.”
While the S&P 500 may have gone up and to the right over the past fifty years, unfortunately, the average rise in temperatures has looked like this:
Via NASA/NOAA
The climate crisis has changed the calculus for business leaders. A warming planet will lead to increased temperatures, longer periods of drought, more frequent and damaging wildfires, and more powerful tropical storms. The Intergovernmental Panel on Climate Change stated in a 2013 report, “Taken as a whole, the range of published evidence indicates that the net damage costs of climate change are likely to be significant and to increase over time." To put it another way, as the graph above continues to go up and to the right, it becomes more likely that businesses bottom lines will be affected. When bottom lines are affected, the S&P 500 starts to go down and to the right.
Big Problem #2: Income & Wealth Inequality
A second big problem that the profit-first mindset created is income inequality. In the United States, there is a growing gap between the have’s and the have-not’s. According to the Pew Research Center, “over the past 50 years, the highest-earning 20% of U.S. households have steadily brought in a larger share of the country’s total income.” Data analyzed by UC Berkeley economist, Emmanuel Saez, shows that “America’s top 10 percent now average more than nine times as much income as the bottom 90 percent.”
Even more mind-blowing than income inequality is wealth inequality. Statistics from the Forbes Institute for Policy Studies show that three men—Bill Gates, Jeff Bezos, and Warren Buffett—own more wealth than the bottom 50% of Americans. Three people own over $100 billion more wealth than the combined wealth of 164 million Americans.
Via inequality.org
So the shareholder theory of business has been great at generating income and wealth over the past fifty years. The problem is, this mindset has only been great at generating wealth for a small percentage of people in the U.S.
While obviously not the only two problems facing the United States and the world, global warming and income inequality are two of the biggest problems that businesses can do something about. They are problems that business leaders must address if they want to continue to do business. Without shifting their mindset away from the “profit at all costs” attitude that Friedman articulated in the 70s, businesses will fail.
Think about it. What good is the continued growth of profits if the planet continues on its warming trajectory, and more people, wildlife, and ecosystems have to suffer the consequences? What good is the continued growth of shareholder value if only a select few people get to reap the benefits?
The music will stop in the business world if we continue to be driven by profits. Fortunately, there is alternative path for business leaders, one that was laid out by another influential professor during the 1980’s.
Freeman’s Stakeholder Theory
In 1984, Professor R. Edward Freeman from the University of Virginia Darden School of Business published the book, Strategic Management: A Stakeholder Approach. In his book, Freeman outlined an alternative to shareholder theory, which he called “stakeholder theory.”
To Freeman, the idea that business was only about increasing profits was outdated and incomplete. Instead, he believed that a business exists to create value for all stakeholders that are affected by that business, including employees, customers, suppliers, shareholders, local community members, governmental bodies, and the environment.
What shareholder theory failed to do was consider that every business has an effect on more people than those who own shares in the company. Professor Freeman’s ideas on the purpose of business are more considerate of humanity. A stakeholder approach to managing a company is a more human approach to managing a company.
“It’s important to think about stakeholders as having names and faces and families because they’re human beings just like you and I. If we treat them as faceless entities, as roles, as assets, as receivers of products and services, we miss the fundamentally human connection that capitalism allows us to provide.”
-Ed Freeman
Even though Freeman started writing about and educating business leaders about stakeholder theory in the 1980s, I don’t think it would be too much of a stretch to say that shareholder theory has won out. Looking at the incredible growth in shareholder value over the past 40-50 years combined with the problems of climate change and income inequality highlighted above, it’s hard to argue that business leaders have been focused on all of the stakeholders affected by their companies. However, we are finally starting to see this attitude change.
The New Purpose of Business
In August last year, The Business Roundtable—an organization whose members include the CEOs of some of America’s largest companies—announced that they had created “a new purpose statement for business.” For decades, Business Roundtable had been staunch supporters of shareholder theory, but with their new purpose statement, it appeared that these business leaders realized that stakeholder theory was the right way to run their companies.
“The American dream is alive, but fraying. Major employers are investing in their workers and communities because they know it is the only way to be successful over the long-term. These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.”
-Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co. and Chairman of Business Roundtable
The new purpose statement was signed by 181 chief executives of major U.S. business, and made a fundamental commitment to:
Delivering value to our customers,
Investing in our employees,
Dealing fairly and ethically with our suppliers,
Supporting the communities in which we work, and
Generating long-term value for shareholders.
Business Roundtable closed the announcement by stating, “Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.”
To Address Our Big Problems, We Must Be Driven By Purpose
Without a sense of purpose, no company, either public or private, can achieve its full potential.”
Larry Fink, CEO of BlackRock
At last, we seem to realize that a profit-driven mindset in business is not the best way to build companies. It’s not the most human way to build companies.
Having a purpose-driven mindset, focusing on all stakeholders—who are human beings—is the way we need to build companies. Consumers demand this mindset. Employees demand this mindset. And now, investors are increasingly demanding this mindset.
The message has come through loud and clear: there is no point in building businesses with only profit in mind. If we continue to do so, the planet may be so damaged by the climate crisis that businesses will lose profits anyway. If we are only focused on profits, we will continue to build an economy where only a small number of people receive the majority of income and wealth.
Business leaders must commit to a purpose-driven mindset if they want to succeed going forward. I believe that not only will leaders find that building purposeful businesses will be more profitable going forward, but they will also find that it is a more fulfilling for their personal lives.
If you come into work every day thinking about how your company can serve others, how your company can make a positive impact on other people and on the planet, isn’t that more exciting and empowering than thinking only about how to increase the bottom line?
Each of us needs to shift our mindset about business. Our planet needs it. Our communities need it. Our customers and shareholders demand it. There’s no better day than today to commit to purpose.
Win-Win-Win is a community for purpose-driven leaders in the sports and entertainment industry. Once a week, on Thursdays, I’ll send you a thoughtful essay/blog post about how we might leverage the influence of our industry for good. Please reach out to me on Twitter or LinkedIn if you’d like to connect and discuss my work or find ways that we might collaborate.