Companies move past Friedman’s theory of business
Milton Friedman Was Wrong: Great Companies are Increasingly Focused on Social Impact
In April 2021, the CEOs of over 100 corporations signed a letter expressing their disapproval and disappointment on the recent voting changes enacted by the State of Georgia. Their action is the latest indication of an emerging pattern wherein corporations advocate for the political, societal, and environmental issues they deem important.
This relatively new phenomenon of corporations acting as important members of local, national, and global communities has the potential to be incredibly impactful on multiple levels. Their care and involvement stand in stark contrast to the views promoted over fifty years ago by libertarian icon Milton Friedman, who published an essay that would come to be known as the “essay heard around the world” for a generation of free-market capitalists. Friedman, who won a Nobel prize in economics in 1976, eschewed the idea that businesses had any obligation to better society. The title of his essay says it all.
The Social Responsibility of Business Is to Increase Its Profits was blunt in its conclusions. Friedman made the case that businesses shouldn’t need to go against their best (financial) interests to improve society because they aren’t people with real beliefs or morals. Any action taken to support “social” causes, he argues, only diverts resources away from the company’s primary business efforts and supports initiatives that may or may not run counter to the company’s best interests.
“There is one and only one social responsibility of business,” Friedman declares. “To use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
Amid the fiftieth anniversary of Friedman’s essay, much reflection and commentary have been leveled. Five decades on, this perspective sounds harsh and even a little gauche — an out-of-favor defense of cold, calculating capitalism. Friedman’s essay balances its dismissal of social responsibilities with a clear belief in the value that businesses hold in society when allowed to grow freely. But a retrospective look into history leads us to doubt whether the value of pursuing profit above all else stands true now if it ever did at all.
Interestingly, there are simple logical examples that retrospectively refute Friedman’s principle. Specifically, treating employees favorably and creating a company and culture they want to be part of generally costs money. Some companies make the investment in the hopes of receiving long-term benefit, while others dismiss these expenditures as totally unnecessary.
There are no better examples than two iconic companies in my hometown Seattle community when thinking about this conundrum: Starbucks and Costco. Both treat their employees differently from their earliest days; they pay them well, provide health insurance and even give them ownership — what Starbucks refers to as “Bean Stock.” Their forward-thinking leaders — Howard Schultz and Jim Sinegal — believe these measures are not only the right thing to do but, equally important, the smart thing to do for their business.
Creating an environment where employees of all pay grades are considered partners and treated more than fairly can dramatically improve retention and morale. Frequent employee turnover is expensive to deal with and reduces profits. In other words, paying employees a little more today — in cash and benefits — will reduce short-term profits for shareholders and generate long-term material benefits that will ultimately positively impact profits.
But this strategy is directly contradictory to Friedman’s view.
On September 13th, the 50th anniversary of Friedman’s manifesto, the New York Times published a retrospective that asked some of the greatest CEOs and corporate leaders alive today to share their perspectives. By and large, their comments came to a similar conclusion: Friedman was wrong.
“The headline said it all. Our sole responsibility to society? Make money. The communities beyond the corporate campus? Not our problem. I didn’t agree with Friedman then, and the decades since have only exposed his myopia,” Marc Benioff, chief executive of Salesforce, shared.
“Just look where the obsession with maximizing profits for shareholders has brought us: terrible economic, racial, and health inequalities; the catastrophe of climate change. It’s no wonder that so many young people now believe that capitalism can’t deliver the equal, inclusive, sustainable future they want.”
Many of the most prominent CEOs make the point that businesses undermine themselves by adhering to a profit-above-all-else philosophy — but Darren Walker, the chief executive of the Ford Foundation, goes further than disagreement, arguing that the world in which Friedman’s lessons might have sufficed no longer exist.
“Friedman’s thinking became theology — the intellectual scaffolding that allowed its disciples to justify decades of greed-is-good excess. Gone were the days when someone like my semiliterate grandfather, with only a third-grade education, could work as a porter and benefit from a profit-sharing plan provided by a company that dignified his work.” Walker explained.
“In their place were new conditions in which our social contract frayed and our economy tilted out of balance — fomenting the unsustainable inequalities that plague America today. Friedman ignored that in a democratic-capitalist society, democracy must come first. ‘We, the people’ grant businesses their license to operate — which they, in turn, must earn and renew.”
Today’s corporate employees — especially Millennials — yearn to be part of an organization that shares their values and supports both their people and their communities. This sense of shared purpose unquestionably improves employee morale, pride, and participation, all of which bolster longevity and, I would argue, commitment to do the right thing for the company.
Referring again back to Seattle, two prominent tech companies — Microsoft and Amazon — have stepped in to combat the housing crisis in Seattle. Do they need to do so? No. Is the cost of giving such aid expensive and a direct hit to short-term profits? Yes. But both companies understand that businesses are just as much a community member as any person — and equipped with far more power and influence than the average person. That power comes, in turn, with a commensurate responsibility to support the community from which they draw talent, resources, and support.
However, corporate responsibility projects aren’t always limited to a given geographical area or professional sector. As part of its One Million Black Women initiative, Goldman Sachs recently committed $10 billion in direct investment capital to “address the dual-disproportionate gender and racial biases that Black women have faced for generations.” Specifically, the initiative aims to invest in key moments within Black women’s lives with the broader purpose of forging stronger, fairer professional outcomes and bettering communities at large. Goldman Sachs has built its plan atop a culture of listening and learning, soliciting input from across the country on the investments, resources, and programs with the most impact in serving Black women and their respective communities.
Similarly, in October of 2020, JP Morgan Chase announced that it would be allocating $30 billion to solving inequalities driven by systemic racism. These funds will be used to promote and expand affordable housing and homeownership for underserved communities, grow Black and Latinx-owned businesses, improve access to banking and financial health in Black and Latinx communities, and boost JP Morgan’s investment in employee diversity.
“Systemic racism is a tragic part of America’s history,” CEO Jamie Dimon shared in a press release. “We can do more and do better to break down systems that have propagated racism and widespread economic inequality, especially for Black and Latinx people. It’s long past time that society addresses racial inequities in a more tangible, meaningful way.” I want to invest in companies with this belief and I know that many other far more substantial investors share this view, too.
Now, one of Friedman’s points stands true — the money allocated to measures like JP Morgan’s isn’t going directly into shareholders’ pockets, at least in the short-term. Friedman never considered the positive impacts that “Stakeholder Capitalism” — taking care of employees, customers, communities, and investors — might have on customers and, ultimately, investors.
Recently, a new stakeholder has been incorporated into that list: our planet. In an age when everything a company or its leaders do is transparent, immediately available, and determinant of their brand, it’s easier than ever for customers, employees, and investors to learn what companies stand for and “vote” their approval or disapproval via their actions.
As an investor, I find this especially poignant. It is smart to invest in a company with high employee morale and low turnover that customers are consciously choosing to support instead of one that maximizes quarterly profits at all costs. It makes complete sense to understand the DNA of a company before making an investment, as the long-term implications — both positive and negative — can be enormous.
More and more companies are embracing “stakeholder capitalism,” often with investor support. In fact, top investors are moving from accepting or seeking out such practices to proactively encouraging them. It’s hard for a company not to pay attention when the world’s largest asset manager takes an antithetical position to Friedman by encouraging these types of capital expenditures. BlackRock — the world’s largest investment manager with $7 trillion under management — has made it clear that a company’s sustainability efforts will factor meaningfully into its investment decision process.
Investors clinging to Friedman’s philosophy are increasingly likely to receive a rebuke from corporate leadership similar to what Howard Schultz articulated in the New York Times compendium about Friedman:
If Friedman had balked, asserting that Starbucks could have performed even better without these ‘socially responsible’ activities, I would have told him what I told an institutional investor who wanted me to slash health care costs during the Great Recession, or what I said to a shareholder in 2013 who falsely claimed that Starbucks’s support of gay rights hurt profits: If you feel you can get a better return elsewhere, you are free to sell your shares.
We all have the power — as investors and customers — to encourage and embrace the companies that share our values. I would assert that a company that practices stakeholder capitalism will do better over a long time horizon than those focused on maximizing short-term profits. However, a company can’t divorce itself from generating a profit to concentrate on supporting stakeholder initiatives; without profit, a company is destined for failure. Thankfully, as demonstrated by the companies mentioned herein, following this principle does not mean a diminution in fantastic upside for investors or employees.
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