What is the purpose of business?

Why are so many firms insisting on telling us what their ‘purpose’ is? David Jevons, Oxera Partner, has been looking at the role of business in today’s society and discusses the purpose of a corporate purpose.

Since the 1970s, introductory economics and finance classes have taught that the purpose of a firm is to maximise shareholder wealth; yet today, some of the most successful and high-profile firms are keen to communicate a different purpose.

Google says it wants to ‘Organize the world’s information and make it universally accessible and useful’, while Facebook says it will ‘give people the power to build community and bring the world closer together’. Neither mentions shareholders or profit, yet these are currently two of the world’s most successful firms.

Evolution or revolution?

Purpose isn’t a new concept, but the way we are talking about it is. Milton Friedman set out what he believed the purpose of a firm to be in his influential article ‘The Social Responsibility of Business is to Increase its Profits’ for The New York Times Magazine in 1970.

There are good reasons why Friedman concluded that the purpose of firms is to increase shareholder wealth. He argued that boards and management (corporate executives) are the agents of the shareholders, and their primary responsibility is to their shareholders.

If corporate executives start pursuing broader social interests, they are imposing a tax on their shareholders and also decreeing how that tax should be spent. Some shareholders may want to give their profits to particular charities, while others may want to spend it on expensive yachts or fine wines. The corporate executives can never hope to proxy these different interests. Instead, Friedman argued, it is more efficient for shareholders to incentivise the executives to maximise profit, which can be more easily measured, and allow shareholders to distribute that profit as they see fit. Friedman argued that it was virtually impossible for management to accurately make trade-offs in line with their shareholders’ preferences.

If Friedman was right, why are so many firms eager to state their purpose without mentioning profits or shareholders?

Shareholders and stakeholders

Recently, social and political pressure has been increasing on business leaders to go beyond simply creating value for shareholders. Across sectors, firms are recognising that the decisions of management have a profound effect on employees, partners and suppliers, the communities they operate in, and the natural world. Scrutiny is increasing and governance codes are changing to compel them to act.

As well as the stick of enforcement, firms are also understanding the opportunity to be drivers of the change they want to see on major issues, such as workforce equality and climate change. However, as Friedman highlighted, making these trade-offs across stakeholders is really hard. Firms need a way to communicate their priorities, and the trade-offs they are going to make, to all of their stakeholders. This is why many corporates are deciding to define and share their corporate purpose.

Purposeful purposes

Corporate purpose should clearly state why an organisation exists and what benefit it aims to provide to the world at large. Purpose can, and should, be the cornerstone of successful modern enterprise. It can be used to set direction, guide management through making difficult trade-offs and enable difficult conversations within organisations. It drives a better employee experience by uniting and exciting people, and provides a transparent statement of intent to the outside world, establishing stronger connections with customers and communities.

Unlocking change

Firms are the space in society where financial capital, labour, natural capital, and physical and social infrastructure all meet. To tackle some of the biggest challenges in society around the environment, fairness and growth, we need firms to actively look at the returns that they generate to all these different forms of capital, as well as the trade-offs between them.

In order to unlock this change in society, firms need not only financial capital but also buy-in from their stakeholders. Sometimes this buy-in is in the form of explicit contracts, such as licences to operate, environmental consents or planning permissions. However, contracts are not perfect—they cannot account for every eventuality, so we often have to rely on implicit contracts.

Bike-share schemes that don’t get acceptance about where their bikes can and cannot be left from the communities in which they operate find it hard to succeed. Customers who are loyal to a service provider don’t expect to be charged an excessive premium for that loyalty.

We have seen that firms who don’t get these contracts right across their stakeholders find themselves on the receiving end of negative media campaigns or regulatory scrutiny—all of which reduce trust across the firm’s stakeholders.

If firms want to achieve progress—through which we might all benefit—there needs to be trust across stakeholders. Without trust, stakeholders are likely to block attempts at change that don’t immediately benefit them. This trust is built by firms upholding explicit and implicit social contracts across different stakeholders and ensuring the trade-offs they make are consistent with their purpose. If firms want to maintain legitimacy and have impact, they need to articulate their purpose to the stakeholders who enable them.