Grow the Pie: How Great Companies Deliver Both Purpose and Profit (Summary)

Introduction

Professor Edmans discussed the concept of purposeful business, highlighting how great companies can achieve both purpose and profit. He provided examples to illustrate a different perspective on definition of purposeful business, contrasting it with the typical definition, which is to avoid doing harm, pay fair taxes, avoid pollution, and treat workers fairly in your business.

Power of purposeful business

The Great Rift Valley, stretching from Lebanon to Mozambique, is home to some of the world’s highest mountains and deepest lakes. One such lake is Lake Magadi, located in Kenya. Only fewer than 1,000 people live there, including Emmanuel Saronga, a goat seller. He faced challenges in his life, including checking cash, storing it, and walking for a day to bank it. He couldn’t graze his goats in the greenest pastures and had to be one day from a bank. Emmanuel’s life was tough, as he had to rely on his livelihood.

Vodafone, a UK telecoms company, launched m-pesa in Kenya in 2007, allowing people to transfer money from phone to phone as easily as sending a text message. This revolutionized banking without access to a bank, transforming lives like Emmanuel’s. In the first seven years, m-pesa lifted 200,000 households out of poverty, many of which were women, and allowed them to move from agriculture to business and retail, significantly contributed to both security of transactions and gender equality. This story is not just about one person but also about hundreds of thousands of people.

Also, in 2012, Vodafone became the first global telecoms company to release a tax transparency report, detailing their global tax payments to governments. This transparency is crucial in telecoms, as licenses can be located in low-tax jurisdictions, promoting transparency and accountability.

Vodafone took two important decisions of launching m-pesa and releasing tax transparency reports. Not taking the first decision would not have had any negative consequences, with no media boycott or backlash by customers, but it created the most value for society through its accomplishments. Not taking the second decision of releasing tax transparency reports would have led to public outrage and worsened Vodafone’s ESG rating or reputation. The consequence of not being transparent on tax could be significant, and Vodafone itself had experienced a nationwide boycott of stores due to concerns about paying insufficient tax.

“Purpose” is not just about doing no harm, but actively creating value for society and doing good. Purpose should not only be about avoiding scandals but also creating value, even if it is not expected. Such efforts can also lead to financial value, as seen with the successful revenue stream that Vodafone created through m-pesa, by charging a small percentage for every transaction.

To demonstrate the business advantages of actively doing good, the framework of “growing the pie” is useful.

Framework of growing the pie

The pie represents the value a company creates, typically divided between investors who receive company profits and society which receives fair taxes, wages, and prices. “Improving the purpose of companies” that is often presented in the media is seen as splitting the pie differently, paying higher taxes and more to employees. However, this is problematic as investors are not just nameless capitalists, but also part of society, and include pension funds like the Japanese Government Pension Investment Fund and insurance companies which take care of “society.” Therefore, the goal should be to grow the pie instead of repurposing what is already there.

Innovation and excellence are key. Creating value for society, such as Vodafone did with m-pesa or launching banking without a bank, makes people willing to pay for these benefits, resulting in a profit. This approach is not about redistribution but about delivering value.

Despite the fact that car companies should invest in electric vehicles purely based on a profit motive, regardless of whether they are interested in the ancillary benefits that such production may have on the environment, companies like Vodafone face significant tech challenges and a negative net present value, but their innovations turn profitable in time.

Vodafone’s purpose was to create a digital society that enhances socioeconomic progress, which inspired them to launch m-pesa, ultimately turning into profit. However, purpose differs from long-term profit maximization, which often results in good decision-making, but would not allow for the type of innovation that allowed for m-pesa. Therefore, purpose is an essential order to try and achieve success in truly innovative fields where it is necessary to break new ground.

In providing evidence for such an argument, it is important to be cautious of confirmation bias, where people may accept evidence if it confirms their beliefs, which is a particular problem in responsible business.

Forbes, a respected business magazine, claimed in an article that there is a study confirming that companies excelling in sustainability outperform their peers financially. However, the journalist deemed the report accurate based on surveys of people who already support that belief, and not by examining its methodology or scientific accuracy.

How can we actually measure the effectiveness of purpose?

To measure whether purpose is the driver of success, we examined the 100 best companies to work for in the United States, which go above and beyond in their treatment to their employees, providing a healthy and rich work environment. They deliver shareholder returns by beating their peers by 2.3% to 3.8% per year over a 28-year period, resulting in 89% to 184% cumulative growth. By treating their workers well, companies not only increase motivation, productivity, and retention, but also benefit shareholders by increasing the size of the pie.

Much effort was taken to ensure that this was in fact a causative effect of employee conditions and not just a result of tech industry overall success and to eliminate other potential factors. The attention to societal and employee quality of work and life was in fact the cause of the success.

To continue, the term ‘purpose’ is often misunderstood, often referring to a company’s goal to serve customers, workers, suppliers, the environment, communities, and investors. However, this is unrealistic as there are many necessary tradeoffs. For example, closing a polluting plant may benefit the environment but negatively impact employees.

Purpose in English means being focused and deliberate. For our purposes, it is defined as the reasons a company exists, who the company serves, its reason for being, and its role in the world. A purposeful meeting has a clear agenda and should be targeted to achieve these goals. This may seem lofty, but it is essential to understand and address these aspects.

A company’s existence, or reason for being, should be determined by the principle of comparative advantage, focusing on its strengths and unique solutions it can deliver to address world problems. It should not aim to solve all 17 sustainable development goals, but rather focus on the ones that can significantly impact the world.

Considering one’s resources and expertise in a company’s operations is key. Vodafone utilized their telecoms expertise to enable mobile money transfer, while Toyota utilized their manufacturing expertise to create masks and face shields during the pandemic. Eisai Pharmaceuticals utilized their drug manufacturing expertise to create DEC tablets to control lymphatic filariasis, donating them freely to endemic countries. By leveraging these resources and expertise, companies can creatively serve society and contribute to a better future.

Materiality

The concept of materiality is crucial in understanding purpose and problem-solving. It is based on one’s comparative advantage and the importance they serve. By using this advantage, shareholders can create value for stakeholders, which in turn, can turn into shareholder value. This virtuous circle ensures that stakeholders are served and benefit from the company’s efforts.

Yamaha, a Japanese company that produces outboard motors for fishing, goes beyond just producing great motors. They provide a free Fishery Journal to teach methods of capturing, processing, and selling fish, and successful fishing communities lead to increased demand for motors. Yamaha also works on supply chain partners, recruiting and training local mechanics to repair outboard motors, ensuring they maintain a strong supply chain.

To define our purpose, we need to understand our comparative advantage and material value. To put our purpose into practice, we must focus on three things: the first is being innovative, for example generating new business, products, or clients. A purposeful company aims to serve society, and not just create financial value.

As an example of finding new clients driven by a desire to serve society, NatWest, a UK bank, was asked by the UK government to conduct a Rose Review, which found that £250 billion could be added to the UK economy if women could have equal access to financing as men. Small businesses often have a lower record of accomplishment of accounts and so financiers are forced to determine whether to provide financing based on the confidence level portrayed by the entrepreneur who is seeking funds. Women typically are less practiced in displaying confidence, so they are disadvantaged by this type of evaluation. This issue is not limited to women but also affects ethnic minorities, people from different regions, and those without a degree. Alison Rose, CEO of NatWest, decided to create value for society by providing fair access to funds for entrepreneurs. This approach ultimately led to increased profits for NatWest.

The webinar marks the launch of the book Grow the Pie into Japanese, which has been released in nine other countries. Japan has always prioritized long-term thinking, and this webinar aims to highlight the positive impact of this on society and the company’s long-term success.

Comment

IKEDA Yoko:
Japan is currently promoting “New form of capitalism”, which aims to create new markets by solving societal problems. This approach aligns with the book’s idea of economic growth through purpose. In Japan, entrepreneurship is growing, and a survey shows that the top reason for starting a new business is to solve societal issues.

Please let me introduce a leading case here in Japan. Hito-bito, a company founded in Fukushima Prefecture by Miai Kobayashi, distributes substandard fruit and develops a femtech product using Asian persimmon peels. The company supports local farmers and communities, linking urban and rural areas and solving gender gap issues. Kobayashi found new value in Fukushima’s dormant resources, utilizing an underrepresented market. Japan wants to create an ecosystem for increasing the number of such companies in Japan. As a first question for Professor Edmans what are some regulatory and non-regulatory measures that the government can take in its role in order to increase the number of companies like Hito-bito, including any examples you may have of initiatives by foreign governments?

Additionally, how might such an upgraded capitalism affect existing economic and social systems? There is a chance of causing discontinuous changes in company operations and traditional economic models. Even large corporations can benefit from transformation opportunities. What future developments do you foresee after your pie economics becomes more widespread?

Alex EDMANS:
Promoting purposeful entrepreneurship in small businesses is challenging due to low access to finances due to information asymmetry and the fact that most fail. The market solution of leaving it to banks and equity investors may not be effective, as there may be few willing to provide capital. Tax incentives can help, such as the Seed Enterprise Investment Scheme in the UK, where 50% of the investment goes back to the investor as a tax rebate and their investment is exempt from capital gains tax on the investment. Incentives for both investors and companies, such as tax breaks and subsidies for research and development, are also important.

The UK government also offers numerous resources for small businesses, including guidance on business planning and account filing. The government organization, Be the Business, provides education and training to encourage businesses to start, demonstrating the government’s commitment to supporting small businesses beyond taxes.

The education system needs to change to teach financial literacy instead of only somewhat abstract math etc., because such literacy is essential for everyone, regardless of their business goals. This includes understanding stocks, bonds, compound interest, and how companies make money.. Teaching financial literacy earlier can encourage businesses to start, as it will help people to raise funds without being intimidated.

Upgraded capitalism can positively impact existing economic and social systems by addressing societal issues and creating value for society. Business is not a zero-sum game, but if properly run, it can be a positive sum, and create a positive perception of businesses, creating value for shareholders and aiding further in addressing wider societal issues.

Q&A

Q:
Purpose Management in Japan is a popular strategy, but it’s often confused with ESG management. What is the difference between Purpose Management and ESG management?

Alex EDMANS:
Purpose is about taking action for intrinsic reasons, such as growing the pie and creating value for society, leading to profits as a by-product. ESG, on the other hand, is about instrumental motivation, such as hiring new people to improve diversity statistics, even if they don’t provide cognitive diversity or a diversity in thinking. My recent paper, “The end of ESG,” highlights how purpose has become overshadowed by ESG, as companies do things to improve ESG metrics regardless of whether that action has a better or worse outcome for society than a purposeful action would have. For example, Vodafone’s m-pesa initiative would not have improved their ESG metrics despite providing massive societal value, because it didn’t necessarily improve their carbon footprint, reduce the gender pay gap, or increase the number of women on the board.

Q:
Purpose Management is widespread in the UK, which is the birthplace of the Purpose Management. What is the indicator and the reason of the image of the spread of Purpose Management in the UK?

Alex EDMANS:
I think Japan has been practicing purpose for decades, focusing on long-term thinking and treating employees well. This is reflected in their systems, such as lifetime employment and long-termism. In general, businesses that generate high long-term returns are often linked to purpose, as it leads to long-term success, but there aren’t any easily defined indicators otherwise. The U.S. is strangely an example of many purposeful companies, with many startups in the country having significant valuations, indicating that investors look beyond quarterly earnings.

Q:
Would Purpose Management make society richer, or would it make companies more competitive and profitable? What do you envision in the world where Purpose Management has spread further? If a company takes a grow-the-pie approach, which is related to Purpose Management, what type potential unintended consequences do you see from implementing pie growth or purpose management, and how can some of these potential unintended consequences be mitigated or ameliorated?

Alex EDMANS:
The idea of growing the pie rather than splitting the pie is a win-win approach for both society and companies. Companies run with the purpose of creating value for society will ultimately lead to higher profits. However, the unintended consequences of this approach are that the benefits are only seen in the long term, as it is costly in the short term to invest in innovative projects and employees. In fact, with ESG, firing men and putting women on the board, regardless of who is more qualified would immediately improve ESG metrics despite potentially harming the company long-term, but creating purpose would improve both ESG and financial metrics over the long term.

Q:
Will capitalism change as Purpose Management expands? Will Purpose Management correct disparities or not? What is the relation between the spread of Purpose Management and the disparity issues?

Alex EDMANS:
Capitalism should evolve into a long-term form that serves society. Purpose Management may not correct disparity, but perhaps that is not necessary, if the size of the pie is increased and everyone gets more.

It is not really the role of companies to address disparity. Rather, governments must take the lead in that regard as they reflect the preferences of the electorate. Companies are responsible for creating value for society. Different people have different views on disparity, so the government which is elected should address disparity as part of their purview and be elected out if their decision do not bear fruit.

Q:
The compensation level of Japanese big businesses is still low compared to the U.S. and the UK, and considering on the pie growing economy in Japan, do you recommend using high-powered incentives in Japan. If so, do you have any input on effectively introducing this system?

Alex EDMANS:
Chapter 5 of Grow the Pie discusses compensation, and argues that a purposeful company should pay its executives a lot, as it allows them to grow the pie and create more value for others. This perspective challenges the pie splitting mentality and encourages a more balanced approach to compensation.

Bart Becht, a UK CEO who created shareholder value for 10 years, improved Reckitt Benckiser’s environmental record, and created 10s of thousands of jobs and resigned after protests for being paid £92 million in compensation that year. The day after he resigned, Reckitt Benckiser’s market value dropped by £1.8 billion, which is clearly disastrous. Hiring a good CEO is expensive but hiring a bad one can lead to worse performance.

Q:
The Japanese audience is very interested in Purpose Management, with Toyota and Yamaha being typical examples. What are other examples of Purpose Management outside Japan, in addition to Vodafone.

Alex EDMANS:
Outside Japan, there are lots of examples, and in the book, there are lots of purposeful examples other than Vodafone around the world. Vodafone only appears in Chapter 8 of the book. Japanese companies, including Toyota and Yamaha, have a long-term success history, with success in companies like Sony, Toshiba, and Hitachi likely driven by a purpose, demonstrating the importance of purpose in the Japanese market.