13 January 2020
Sustainability and profit are not mutually exclusive, but are two sides of the same coin for a large company. Alessandro Profumo explains why today's businesses must bring individuals back to the heart of their projects, with a view to sustainable development that once again considers the long-term horizon. Inclusiveness and innovation are essential in meeting the challenge of a capitalist model that needs to be rethought.
In 1970, economist Milton Friedman argued that a company's only social responsibility was to increase profits while abiding by the "rules of the game" on the market. Is this idea of a company still valid today?
Personally, I don't think it was valid even then, let alone today. Milton Friedman and the Chicago School made important contributions to economic theory, but there are other legitimate schools of thought. In a market logic, if I am the owner of a company, listed on the stock exchange or not, that company is expected to continue to produce wealth over time. But to do this, the business model on which the company is based must be sustainable.
How can a company's sustainability be measured?
A company is sustainable if it has the ability to correctly interpret and predict the needs and expectations of the range of subjects and groups with which it does business, its stakeholders. For example, if a company fails to anticipate the needs of its customers, it will become difficult over time to respond to their demand with a coherent supply of goods and services. Sooner or later its ability to earn revenue, bear costs and generate income in a broader sense will decline.
Investing in suitable people, technology and innovation is essential to support a sustainability strategy. If people aren't happy to work with me, they won’t provide customers with good service and if there is no common sense of belonging and purpose, the company will fall apart. If I take advantage of my suppliers and pay them badly, or I don't allow them visibility, they won't invest in our partnership, weakening my value chain. If the area in which I work, and I use the word "area" in a broad sense, from the small village community to a nation, does not consider me a good citizen, because of unacceptable behaviour or because I am not interested in community development, it will try to hold me back with adverse regulations, fining me and putting in place laws that are against my interests. All this will make it more difficult for me to make money for my shareholders.
To return to the initial question, I believe that social responsibility and profit are not mutually exclusive, but represent two sides of the same coin. It is no coincidence that I used the term sustainability, because the term corporate social responsibility is now outdated.
Corporate Social Responsibility was born from the awareness that there are ethical and social relationships that the company has outside its perimeter. But today, you prefer to talk about sustainability. Why did this change happen?
It was an interesting and very positive change that allowed us to get closer to the heart of the problem. It was a change in the way of thinking that focussed on the relationship between stakeholders and business, where the boundary between good management and sustainability is objectively very blurred.
The idea of sustainability has a double meaning, on one hand, the concept of "corporate sustainability" is essential and understood as the ability to guarantee sources of wealth over time. On the other hand, we gradually began to talk about "sustainable business". The United Nations' sustainable development goals (SDGs) created a connection between companies and the world in which we live. The SDGs are relevant for all parties, not only individuals and governments, but also business owners. Companies must therefore be sustainable, but at the same time support sustainable development by widening their perimeter. Therefore, the sustainability of the economic model in general becomes central.
Talking about sustainability also means looking again at a company's timeline. The pace of the contemporary economy often forces companies to focus on how to generate profit in the short term, sacrificing long-term issues. How can we overcome this obstacle?
There is an excellent piece by Mark Carney, governor of the Bank of England and president of the Financial Stability Board (FSB) in Basel. It is entitled "Breaking the Tragedy of the Horizon" and deals with his activities with the Lloyds of London insurance market. In his role as regulator, Carney underlines how the theme of the time horizon is of fundamental importance. In particular, if it is too short, the company risks being crushed by contingent market pressures. In England the central bank is supervisor of both the banking and insurance systems. For example, all environmental issues potentially have a very strong impact on the insurance world in the long run. Therefore, it is necessary to lengthen the time horizon to fully take them into account. It was from here that the FSB guidelines relating to transparency in all non-financial corporate communication came. The definition of corporate sustainability introduces a long-term concept.
There is also a purely financial issue. If I am the shareholder of a company, one of the fundamental things to consider is that a large part of my total shareholder return comes from the performance of the shares on the stock exchange, much more than from distributed dividends. The stock market value is linked to the product of the company profit by a multiple or to the sum of expected cash flows and the terminal value. Both the multiple and terminal value in many cases represent a very high part of a company's total value and are closely linked to sustainability, because they discount growth prospects and the flow of future income. Therefore, there is also financial reasoning making this a coherent strategy. I firmly believe that sustainability should be pursued because it is in the interest of the company, not simply because it is politically correct.
In the immediate post-war period, some large companies, and I'm thinking of Olivetti among others, had already adopted a production model centred on respect for their employees and the area where they operated. That was then lost in the heavy restructuring of the Italian industrial system. Is it possible today to look back to that time for ways to value new skills?
That model has been partially lost in large enterprises, but to a much lesser extent in medium-sized enterprises where there are many entrepreneurs today who make it part of their daily operations. I'm thinking of Enrico Loccioni, who owns a very advanced technological business in a small village in the Marche region, or Andrea Pontremoli and Dallara, in the motor valley of Emilia-Romagna. These companies focus on their employees and the local area and are doing very well.
We talk a lot about Adriano Olivetti in the post-Second World War period because he was highly visible, but there were many other entrepreneurs worth remembering. For example, there was an interesting exchange of ideas between Alberto Pirelli and his son Giovanni, there is the legacy of the Marzotto family in Valdagno and people like Aristide Merloni. Each of them contributed intuitively and effectively to the creation of a people-based business model.
If we talk about the structure of Italian capitalism, especially at the level of small and medium-sized enterprises, it is dominated by ownership and business management systems which are strongly rooted in the family. What kind of effects does this model have in terms of sustainability?
Economic history teaches us that companies led by professional managers generally have higher growth rates and, after the initial phases of the company's life, a greater risk appetite. The entrepreneurial family, on the other hand, is exposed to higher risks in the start-up phase of the business, when it invests most of its resources, after which it continues along an asymptote, with a lower propensity for growth.
Let’s take a step back, though. We often make a value judgement about the ownership of a company. However, if we compare the United States and Italy, we see that the percentage of family owned companies is the same. The big difference is in the management system. In some European countries, such as Germany, companies are led by external managers much more often than in Italy, and even the average size is different, a family owner who relies on a manager has less problems with growth because they reason in purely economic terms. Therefore the issue is managerial rather than ownership structure.
In ownership terms, the main issue is not so much the difference between family and non-family businesses, but the controlling shareholder, a family, foundation or other entity. The stock market exerts strong pressure in the short term on listed companies. Cash flows move from one company to another, Leonardo today, other companies tomorrow. But there are also long-term investors. It is therefore essential that the structure of a company's board of directors is strongly focussed on sustainability issues, making the interests of long-term shareholders coherent with those of short-term shareholders.
Then there is a further factor, relating to the relationship between the company and management. Bengt Holmström was awarded a Nobel Prize a few years ago for his research into the "principal-agent" model, investigating how management must be assessed and remunerated to give optimal results, and having shared long-term goals is an essential part of this model.
Let's focus on the relationship between business and the individual. Inequality is a central theme of the current debate, income inequality, as well as gender and educational gaps are a serious problem. Do you believe that the company should also take on the challenge of inclusiveness?
I strongly believe that diversity is always a factor which provides wealth and value. There are numerous studies which have assessed the performance difference of so-called "groups of equals" and "diverse groups". Diverse groups generally perform better because there is more creativity with a variety of ideas and the ability to innovate and motivate. In relation to sustainability, when we talk about people management, inclusiveness must encompass gender, nationality and age.
The responsibility of a large company does not end with the relationship with people, but also relates to its role within a country's economic system. You are at the helm of Leonardo, a business that drives national technological development. Do you think that innovation is part of the company's social function?
I don't think it is innovation itself, more the fact that innovation allows a company to respond to customer needs in a more coherent way. Innovation is not pursued because it is considered ethically or socially good. A company like Leonardo must innovate to remain in the market. And innovation is being carried out more and more openly, investing in small businesses, working with research centres and cooperating with universities, this is the open innovation model, which has a positive impact outside a company's perimeter. A company that innovates like Leonardo contributes to the creation of the cognitive capital of the country. We work with many universities and open our supply chain up to innovation, our products can have a dual use, with a knock-on effect in many production sectors. These are what economic theory calls positive spillovers. In essence, I believe that innovation is one of the key factors in sustainability, especially for companies operating in the world of cutting-edge technology, such as ours. If we stopped the technological development machinery, maybe we would make more profit in the short term, but we in a few years we would be doomed to disappear. This is why Leonardo today invests one and a half billion euros every year in research and development.
We have talked about corporate responsibilities, let's try to take another perspective. What do other parties, the state and civil society, need for a company to be able to act as an agent of social development?
The important thing is to always try to align the interests and paths of all those involved in entrepreneurial initiatives. And this becomes fundamental, for example, when we talk about technology. Innovation can be disruptive because it makes old skills obsolete and forces people to learn new things. We must be open to change and regeneration. Aligning interests means making it clear that change is also in people's interest. This is often difficult. When I meet the leaders of local communities, they ask me what I need to improve Leonardo's business. My answer is always the same, well-trained people, because the individual is at the heart of a company's existence. The most crucial system alignment must be education and training.
Leonardo is an industry that works closely with the institutional world, also from a commercial point of view and we need to share our long-term needs. In recent months we have talked a lot about the Tempest project, a next generation aircraft that will become operational around 2035. It is a very long term horizon. To make the decision to invest in such a significant project, the interests of the political system, the cooperative defence system and industry all have to be aligned.
In September 2019, the American Business Roundtable association, the very top of the American corporate system, also approved a declaration of new principles, admitting that the purpose of a company can no longer only be to generate profit. What is your take on these overseas developments?
Well, it's a positive step that they are addressing these issues. However, I would say better late than never. It was 2003 when I published “Plus Valori. La responsabilità sociale d’impresa” (Social Responsibility of Business) together with Giovanni Moro. Frankly, I wonder how it has taken them so long to reach that conclusion, given that the United States was one of the epicentres of the 2007 crisis. Evidently they too have now realised that the capitalist model needs to be rethought.