Success Stories for the 21st Century: Firms of Endearment

A colleague who is organizing a hedge fund based on FoEs asked me to try and capture the essence of Firms of Endearment (Due out in April under the Wharton Business School imprint) in two pages. Here is what I came up with:

Firms of endearment is a metaphor for companies whose operations are guided by a stakeholder relationship management business model. The core premise of SRM business models is that shareholders can benefit significantly when a company endears itself to other stakeholders by giving more than just pro forma attention to their needs and circumstances. Other stakeholders include customers, employees, suppliers and community.

R. Edward Freeman, head of the Olsson Center for Applied Ethics at University of Virginia’s Darden School advanced the stakeholder business model in his book, Strategic Management: A Stakeholder Approach (1984). Since then, stakeholders in every category have demanded greater attention to their needs and circumstances by business corporations. This has unleashed a flood of arguments about the defining purpose of a corporation: Is it maximization of shareholder gain? Or is it service to other stakeholders and society at-large?

Recent history indicates that viewing corporate purpose in such either/or propositions is a flawed approach. The financial performance of firms of endearment shows that increased attention to the all stakeholders can increase shareholder gains. Consider for instance the gains shareholders have derived from FoE Southwest Airlines’ 33 consecutive years of profits. No other major airline comes close to that record. Southwest’s market cap in 2005 exceeded the market cap of all other Big Eight airlines combined.

Shareholders also benefit from Southwest’s ability to ride out economic downturns with minimal negative effects. This is typical of FoEs. And, the same as true of other FoEs, Southwest can adapt quickly to rapid changes in marketing conditions without adversely affecting customers and employees. It was the only major airline that did not lay off workers and cut back flights after 9/11.

Defenders of traditional business models may view FoE concern for all stakeholders as having little value in the “real world.” But the “real world” is where FoEs do dwell. It is a new “real world” in which FoE executives are as focused on Darwinian battles for business survival and growth as any executive operating under a traditional business model.

The SRM business model is better suited to today’s business environment than the traditional shareholder-biased business model is. Two recent events have combined to make this so. The first was the Internet’s entry into the cultural mainstream. This shifted the balance of information power towards the masses. The second event was people 40 and older becoming the adult majority for the first time in history. Age and experience tends to ratchet up expectations people have of companies they deal with.

These two events provide much of the impetus for rising insistence on greater moral integrity, transparency, and empathetic concern for all stakeholders in company operations.

Fortified by wisdom that greater experience and maturity customarily brings and by the bottomless well of information available on the Internet, stakeholder behavior is radically changing. Stakeholders are abandoning their traditional passive stance toward companies they supply, invest in, buy from, work for and permit to operate through public license.

They know that the view that companies create value by how they manage resources and marketing is a distortion of reality. Stakeholders now realize that value creation flows from interaction between all stakeholders, whether or not a company encourages such interaction. Knowing this, stakeholders in every category are demanding more say in corporate purpose, policies and operations. This is transforming corporate monologues (think press releases and advertising) to stakeholder dialogues (think Internet forums, instant messaging and email). Companies that ignore the rising voices of stakeholders have poor prospects for survival.

FoE Whole Foods has reaped outsized gains for its stockholders by tapping into today’s more activist stakeholder constituency. For example, by including representatives of all stakeholder groups in its upstream planning the company sends a signal to all that it wants their help in creating a company that benefits everyone. On the walls of every Whole Foods is a Declaration of Interdependence that acknowledges this position, which has contributed to a nearly unprecedented run-up of shareholder value in an industry noted for razor thin profits.

Starbucks is another FoE that understands how to foster stakeholder collaboration in value creation. This understanding helped turn Starbucks into an international brand in less than 15 years – with virtually no advertising.

Both Whole Foods and Starbucks, as true of all FoEs, subscribe to the idea of corporate social responsibility (CSR). However, their CSR status is less an objective fulfilled than the natural outcome of a stakeholder-biased business model.

Costco’s decision to pay frontline employees 60 percent more that Wal-Mart pays may be socially responsible, but the decision did not flow from a moral code. Rather, it was based on the fact that highly satisfied employees lead to lower employee-related costs, more highly satisfied customers, and lower marketing costs.

FoEs want to make the world a better place. But that doesn’t mean wooly-headed do-gooders run them. FoE leaders practice the art of ironic management – management that achieves results different from what traditional management theory would indicate. A sampling:

• FoEs decentralize decision-making, but in ways that actually increase top executive influence at all levels of a company.
• FoEs pay frontline staff above norms in their category. Rather than increasing the cost of sales, this often reduces the percentage of a revenue dollar that goes to wages.
• FoEs typically depend little or not at all on conventional marketing practices, yet often experience explosive growth.
• FoEs tend to be less influenced by expectations of Wall Street analysts but typically achieve higher price/earnings ratios.
• FoEs operate with greater transparency than most companies but experience less litigation.

We might also aptly deem as ironic the FoE premise that dedicating company resources to making the world a better place is an effective wealth-building strategy. Of course there still are many antagonists to the idea of CSR. But in any event, the future of business enterprise increasingly appears to point toward the stakeholder business model that R. Edward Freemen introduced to the business world two decades ago..