Corporate Social Responsibility Stakeholder Theory, Ethics, Trust and the Return on

Customer

By: Eva Kanovich World Mediterranean MBA Student

Date: September 12th, 2007 Submitted to: Mr. Andrew Roberts

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Table of Contents Abstract…………………………………………………………………………………… p.2 Introduction ……………………………………………………………………………… p.3 Defining Corporate Social Responsibility……………………………………………….p.3, 4 Andrew Carnegie………………………………………………………………………….p.4 Key Developments………………………………………………………………………..p.5, 6 Micro vs. Macro Approaches…………………………………………………………….p.7 Anything for Profit –An Economic View of the Firm……………………………………p.7 Milton Friedman, Albert Carr and Robert Reich………………………………………..p. 8 Stakeholder View; Edward Freeman…………………………………………………….p.9 Instrumental Stakeholder Theory…………………………………………………………p.9 Evolution of the Consumer: People, Planet, Profit……………………………………..p.9, 10 Acknowledging Stakeholder Power: Cooperation and Collaboration………………..p. 11, 12 FORTUNE Accountability: Beyond the Bottom Line…………………………………...p.13, 14, 15 Corporate Social Responsibility, Business Profitability and Increased Customer Satisfaction…………………………..p.15, 16 Increased Customer Interest and CSR…………………………………………………..p.17, 18 Return on Customer and Total Shareholder Return……………………………………p.18, 19, 20 Conclusion…………………………………………………………………………………..p.21 Bibliography…………………………………………………………………………………p.22, 23

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Abstract

There are countless writings on Corporate Social Responsibility (“CSR”), but little correlative examination of the Return on Customer, CSR and overall value maximization. This paper offers a qualitative look at the key developments of CSR, the evolution of needs of the modern day consumer and the tenable value consumers bring in generating future cash flow for a company. Pivoting on the writings of both micro and macro schools of thought, I set out to show the limitations of shareholder theory and contend that businesses, much like consumers, espouse similar value systems; mirrored respectively in Maslow’s hierarchy of needs. Highlighting a consumer centric approach to business, I show that companies can be both ethical and profitable if they incorporate key stakeholder interests and CSR into their ongoing business strategies.

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Introduction Much like the businesses they operate, business managers live under continuous pressure and scrutiny to excel or to achieve; to be profitable or to be virtuous. But is there a way that they can be both? Companies and individuals alike are being held increasingly accountable for their actions as demand grows for higher standards of Corporate Social Responsibility. Stakeholders: including shareholders, analysts, regulators, activist, labour unions, employees, community organizations and the news media are asking companies to be accountable not only for their own performance but for the performance of their entire supply chain and for an ever changing set of Corporate Social Responsibility issues. These societal demands and consumer pressures have ultimately led to an economic paradigm shift; wherein corporate social responsibility needs to drive corporations beyond the bottom line. Companies must now go over and above the once prescribed altruistic do-gooderist- philanthropic contributions they made; rather align both ethical and business strategies so as to quell all stakeholder expectations. ‘The invisible hand,’ as once described by Adam Smith, has failed to ensure business morality and has contributed to the shaping of modern day CSR implementations. This paper will address the humanitarian side of capitalism whilst entertaining a myriad of Corporate Social Responsibility theories. It will explore the long standing competing shareholder vs. stakeholder debate and the link between profit, consumer and Corporate Social Responsibility. The objectives will be threefold: Firstly, to show that modern consumers exact Corporate Social Responsibility strategies from the companies they endorse. Secondly, to show that Corporate Social Responsibility is competitively advantageous. Lastly, to demonstrate how Corporate Social Responsibility is a means of redefining profit maximization and increasing a return on customer. Defining Corporate Social Responsibility There have been breathless writings on CSR yet no single definition to date. Generally, CSR is regarded as the economic, legal, ethical and philanthropic expectations placed on corporations by society.1 In this regard companies are required to meet their economic and legal requirements and at the same time are expected to operate in ethical ways and avoid social injuries even if the corporation may not benefit in the short term. The concept in and of itself has become synonymous with organizations, especially but not limited to commercial business, having the duty to take care of all their stakeholders’ interests and is often used to describe businesses’ integration of social and environmental issues into decisions, goals, and operations. A widely quoted definition by the World Business Council for Sustainable Development states that “Corporate Social Responsibility is the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large.”2 This holistic and symbiotic approach to business holds organizations as being fully integrated partners in their communities, rather than seeing them more narrowly as being primarily in business to make profits and serve the needs of their shareholders. This duty of care is seen to go beyond the statutory obligation to comply with legislation. As corporations operate in many communities and across various social segments, and they frequently have to respond to the different needs of these groups, let us further the aforementioned definitions as follows: corporate social actions whose purpose is to satisfy social needs. Here the fundamental idea is harnessed on the notion that a business should have obligations to work for social betterment and should act as the consistent function of the company’s operations.

1 Mattten, Crane, Chapple. ‘Behind the Mask: Revealing the True Face of Corporate Citizenship

2 www.wbcsd.org

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The vantage point of the consumer is equally important in identifying the most crucial tenets of Corporate Social Responsibility. In a 2007 Fleishman-Hillard survey, consumers responded to the “what is Social Responsibility” question with more than a dozen unprompted response categories, including the most frequently offered responses: “Corporations need to be committed to the public and communities and overall to society” (23%) - No.1, “Corporations need to be committed to employees” (17%) - No.2. 3 Such feedback suggests consumers’ proclivity to identify corporate function as being just with various stakeholders.

Andrew Carnegie The idea of Corporate Social Responsibility finds its roots in the writings of Andrew Carnegie, founder of U.S. Steel, who articulated two principles he believed were necessary for capitalism to function. First, the charity principle which requires more fortunate members of society to assist its less fortunate members, including the unemployed, the disabled, the sick, and the elderly. He maintains that these "have nots" could be assisted either directly or indirectly, through such institutions as churches, settlement houses, and other community groups.4 Second, he puts forward the stewardship principle, which requires businesses and wealthy individuals to see themselves as the stewards, or caretakers, of their property.5 This idea assumes that wealth maximization benefits all stakeholders. Carnegie views the rich as holding their money "in trust" for the rest of society as a whole. In turn, they could use it for any purpose society deemed legitimate. However, he maintains that it is also a function of business to multiply society's wealth by increasing its own through prudent investments of the resources that it was caretaking.6

3 Rethinking Corporate Social Responsibility: A Fleish-Hillard Study

4 Freeman, E.,Liedtka, J. ‘Corporate social responsibility: a critical approach - corporate social responsibility’ 5 Ibid 4 6 Freeman, E.,Liedtka, J. ‘Corporate social responsibility: a critical approach - corporate social responsibility’

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Key Developments

When compared to developments in previous centuries, the two most striking features of twentieth century economic growth are its staggering size and acceleration. It has witnessed the awakening and expansion of globalization, the transformation of the capitalist system, the ascension of capital markets and the deepening competition in business. Now, in an era of permeable boundaries, cross flow of information and greater mobility of human capital, corporations have been confronted with the evolving eco-friendly, ethically conscious, socially minded post-modern consumer. Such commitment and awareness has provoked an irreversible trend in business: to progressively, innovatively and steadfastly integrate CSR into corporate vision and strategic planning.

But how did we get to this point? Although the past is never a perfect template for the present we must look at CSR having its seminal roots in three correlative movements: 1) Community relations and contributions response to local pressures/needs and CEO/Senior Management-1960’s and 1970’s, 2) Corporate Citizenship model based on ethical issues including the new corporate or strategic philanthropy-1980’s-1990’s, and 3) Strategic Alliances closely aligned with corporate objectives-1999 and beyond.7

Traditionally businesses operated exclusively on the classical economic model of maximizing profits. As long as the firm could sell its good(s) or service(s) at prices high enough to make a profit and survive, then its social obligation was fulfilled.8 However, shortly after large companies first emerged in the 1870s, debate quickly arose as to the appropriateness of their conduct.9 This debate would later arise with many multinationals in the 1990’s as their unethical behaviour would be publicly rebuked.

Upon the heels of the Great Depression, the 1930’s signaled a transition from a primarily laissez-faire economy with industrial power and might in control to a more mixed economy with a more activist role by organized labor and the government.10 Eventually, the government's creation of various socially oriented programs to ease the country's economic woes resulted in more socially minded Americans.11 Thus, more socially minded persons demanded more socially minded businesses. Under the auspices of change, and in a flurry of enlightened self-interest, businessman and politicians alike wanted to rebuild the post World War II economy. Protracted debates over the appropriate role of business in society continued and business leaders seemed to (more than ever) come to espouse a belief of the equitable distribution of wealth. Little by little, the pillars of corporate philanthropy were being established with the creation of public interest watchdogs and regulatory agencies such as the American Civil Liberties Union. The Federal Trade Commission stimulated new interest in business ethics, the standards by which to judge corporate and individual behavior within the moral framework of business and society.12

7 Jafar, Alamgir. ‘Global Scenario and Context’ 8 Ibid 7 9 Jafar, Alamgir. ‘Global Scenario and Context’ 10 Ibid 9 11 Jafar, Alamgir. ‘Global Scenario and Context’ 12 Ibid 11

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The 1950’s ushered in an era of Social Responsibility. It was Howard Bowen's Social Responsibilities of the Businessman (1953) that expanded social responsibility into the corporate realm. According to Bowen, the social responsibilities of a businessman consisted of obligations to pursue those policies, make those decisions or to follow those lines of action which would be desirable in terms of objectives and values to society.13 Soon afterwards, all three levels of government started enacting increasingly detailed legislation conducive to socially responsible behavior by businesses. Further, the four key regulatory agencies – the Equal Employment Opportunity Commission, the Occupational Safety and Health Administration, the Environmental Protection Agency and the Consumer Product Safety Commission – were established from 1969 to 1972.14 These developments created an entirely new framework for managers: hit all of a sudden with four enormous regulatory agencies making many demands for information and corrective action.15 A combination of factors propelled the subject of socially responsible business to the frontlines during the 1980s.The ‘ME’ decade of popular culture was symbolic in many ways. It bore the largest population growth the world had ever seen, witnessed the introduction of compact discs, the first Macintosh, the first available hand held phones and presented a time wherein social issues were becoming more visible and registering on the corporate radar. After the decline and then eventual collapse of socialist economies, the world saw the rise of the technological revolution and the globalization of economics – the creation of a worldwide market that championed capitalism and democracy as twinned values. More transparency was demanded of companies and coupled with the consumer rights movement heightened scrutiny of corporate practices. In 1937, Adam Smith wrote that “consumption is the able end and purpose of all production, whereby the basic measure of an economy's worth should be the health, safety and economic well-being of its consumers.”16 Here, consumer sovereignty governs supply and demand. Moving from a work-based to consumer-based society, the Reagan-Bush era, in which government restrictions on businesses were loosened, caused some business leaders to contrast what appeared to be an alarming array of crumbling institutions – including weakened federal and local government agencies once charged with protecting those institutions – with the wealth they and their shareholders had amassed over roughly the same period, and to recognize an inherent imbalance.17 The 1990’s present a time of environmentalism and entrepreneurship. With the Royal Dutch/Shell crisis thrust upon the world in 1995, the general public had put morality to centre stage. It called attention to the dubious corporate policies and practices that lay behind consumer goods offered for sale in the Western World.18 Transnational corporations were now seen as having to be moral actors with moral and ethical obligations. In lieu of the crisis, consumers increasingly began demanding that corporations pursue socially responsible goals rather than ones purely motivated by bottom line profit maximization. Companies could no longer employ the antiquated charitable giving method to offset the damage they were doing both to communities and the environment. Being both reactionary and visionary to this moral consumer activism, corporations such as Starbucks responded through ethically branded strategies; for example, ensuring that farmers would receive an equitable price for their coffee and receive help in strengthening their farms in the future.

Within an evolutionary landscape, CSR needs to be looked at as more than a cost constraint or charitable deed. Strategic CSR needs to directly align key stakeholder interests, business strategy and financial long term profitability. In modern light, when identifying both the social and

13 Ibid 12 14 Jafar, Alamgir. ‘Global Scenario and Context’ 15 Ibid 14 16 Smith, Adam. The Wealth of Nations, 1937, p 625 17 Jafar, Alamgir. ‘Global Scenario and Context’ 18 Holzer. Boris, ‘Framing the Corporation: Royal Dutch/Shell and Human Rights Woes in Nigeria,’ Journal of Consumer Policy

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business aspects of CSR it is highly important to distinguish strategic CSR from charitable donations and good works. Corporations have often spent money on community projects, scholarship endowments, and the establishment of various foundations such as Habitat for Humanity and Ronald McDonald House. In addition, they have also often encouraged employees to volunteer in community work thereby creating goodwill in the community which in turn directly enhances the reputation of the company and strengthens its brand.

Listening and incorporating consumer demands has now become a type of brand insurance for corporations. According to a survey conducted by Cone Communications and the Roper Group, 76% of consumers would switch brands to further worthy causes (holding price and quality constant with other goods). Results of another extensive study conducted by the same groups reveal that 40% of (25,000) respondents would consider punishing a business deemed not to be socially responsible; 20% of respondents avoided products of offending businesses or expressed their dissatisfaction to others, and one in five consumers were likely to use their purchasing power "to reward a company perceived as socially responsible.”19 Micro vs. Macro Approaches There are two basic approaches to the concept of Corporate Social Responsibility. One school of thought focuses on micro level analysis which deals specifically with how individual companies could be made more responsible towards society.20 Robert Ackerman, a micro-level theorist espouses that responsiveness should be the goal of corporate social endeavour. Archie B.Carroll’s well known four-part CSR pyramid model plays on the latter and suggests that the total Corporate Social Responsibility of business entails the fulfillment of the firm’s legal, economic, ethical, and discretionary responsibilities.21 It must produce the goods and/or services that society wants and in a lawful manner and must sell them at a profit.22 Nevertheless, business here should also be a good corporate citizen, whereby it should contribute financial and human resource to the community and improve overall quality of life. Conversely, researchers belonging to the macro level school of thought favour government, not individual companies, as the entity that establishes and achieves a country's social goals. Anything for Profit –An Economic View of the Firm Within the economic view shareholder value consists of maximizing share value and wielding short term profit .Those against CSR have anchored their arguments in the economic view of the firm which suggest that the primary task of the corporation is to fulfil its economic purpose. For this approach social problems and social services are relegated to the role of the government since businesses are set up as economic institutions, not welfare agencies. The economic view supports the same values as the Pareto Optimality theory which maintains that free-market forces ensure that maximum social benefits will be achieved at minimum social costs.23 The alleged problem within CSR in a capitalistic scenario is primarily a Pareto Optimization problem whereby there exist too many conflicting objectives, namely, minimizing costs, maximizing profits and satisfying all stakeholders.

19 Cone press release 2005 20 Pater. Alberic, ‘Corporate Social Responsibility Theories: Mapping the Territory’ Journal of Business Ethics, Volume 53, Numbers 1-2 / August, 2004 21 ‘Caroll. A.’ Thee Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders.’ Business Horizons, July-August 1991 22 Freeman, E.,Liedtka, J. ‘Corporate social responsibility: a critical approach - corporate social responsibility’ 23 Lantos, G. ‘The boundaries of strategic corporate social responsibility,” 2001 Volume: 18 Issue: 7 Page: 595 – 632, MCB UP Ltd

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Milton Friedman, Albert Carr and Robert Reich According to Milton Friedman, a company’s mandate is to make money. A fervent proponent of the economic view, Friedman fundamentally bases his arguments on two principal contentions: one economic and the other, legal. From the economic perspective, he asserts that if managers spend corporate funds on projects not intended to maximize profits, the efficiency of the market mechanism will be undermined and resources will be misallocated within the economy.24 On the legal side, Friedman contends that because managers are legal agents of stockholders, their sole duty is to maximize their financial return. Hence, if they spend corporate funds for social purposes, they are essentially stealing from the stockholders.25 What Friedman fails to address is a scenario wherein there could be a profitable return on social projects and said return on such action could actually maximize shareholder return not only in the short but in the long term. Rather, Friedman champions the idea that society determines and meets its needs and wants through the marketplace He determines the needs of society to be singular rather than pluralistic; neglecting to take into account spiritual and self actualization needs. Through his agency perspective, Friedman maintains that ‘the business of business is business,’26 and that corporations’ main players should be those that invest their wealth: the shareholders. Investment here does not take into account the investments made by other parties, namely, consumers. Friedman’s perspective is rooted in the idea that the corporation’s priority should be to satisfy the shareholder and to make profits. For him, the relationship between the corporations and groups such as employees, suppliers and customers is maintained as primarily economic. In ‘Is Business Bluffing Ethical?’ Albert Carr posits that “we can learn a good deal about the nature of business by comparing it with poker. While both have a large element of chance, in the long run the winner is the man who plays with steady skill. In both games ultimate victory requires intimate knowledge of the rules, insight into the psychology of the other players, a bold front, a considerable amount of self-discipline, and the ability to respond swiftly and effectively to opportunities provided by chance. Focused solely on profits and legality he continues, “Poker's own brand of ethics is different from the ethical ideals of civilized human relationships. The game calls for distrust of the other fellow. It ignores the claim of friendship. Cunning deception and concealment of one's strength and intentions, not kindness and openheartedness, are vital in poker. No one thinks any the worse of poker on that account. And no one should think any the worse of the game of business because its standards of right and wrong differ from the prevailing traditions of morality in our society.”27 Much like his follower, Friedman undersells the humanitarian dimension of capitalism. Although never overtly dismissing philanthropy, he pointedly questions its merits in terms of engendering profitability. Rather, he suggests that a business’ social responsibility should be to increase its profits in a free enterprise system where there is no coercion and deception. He denies the importance of networks linked to the corporations such as communities, media and the natural environment which now, in the 21st century are inextricably linked to the crucial long term viability, profitability and sustainability of a firm. Notable liberal economist Robert Reich agrees with Friedman, contending that “if a certain action improves the corporation's bottom line, there's no point in labeling it socially responsible. It's just good business.” What Reich neglects here is to realize that CSR is not about generous deeds, volunteerism or virtue, but about social impact and competitive advantage. In his controversial new book, Supercapitalism: The Transformation of Business, Democracy, and Everyday Life, Reich goes as far as suggesting that “if consumers were willing to sacrifice good deals for the sake of some social goal they believed in – for example, paying more for a garment with a label

24 Friedman, M. ‘The Social Responsibility of Business is to increase its profits’ New York Times Magazine, pp. 87-91 25 Ibid 23 26 Friedman, M (1970) ‘The Social Responsibility of Business is to increase its profits’ New York Times Magazine 27 Carr, A. ‘Is Business Bluffing Ethical?’ Harvard Business Review 46, January-February, 1968, pp. 143-53

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guaranteeing it's not made by children in a poor country or for a book that's made with recycled paper – then you're right: Supercapitalism, as I've called it, would serve the interests of us both as consumers and as citizens. But the overwhelming evidence shows that consumers are not willing to make such sacrifices. If items are priced the same, consumers will choose the one that better matches their personal ethics, but they won't pay more for one that does.’28 The Natural and Ethical Report of 2005 challenges this assertion and presents findings that suggest that (for example) 67% of Dutch and 60% French consumers are wiling to pay a premium for ethical products. Stakeholder View Edward Freeman Business should not be separate from ethics and society. From an investor’s perspective, the purpose of business should be to maximize profits, but what is the purpose for other stakeholders? An enlightened corporation should try to create value for all of its constituencies. The stakeholder theory challenges the conventional market capitalist views of the firm. Rather it views the corporation as an entity through which a variety of participants who may be interdependently related accomplish multiple and at times divergent goals. Stakeholder theory describes the firm as a nexus of co-operative and competitive interests possessing intrinsic value.29 Stakeholder theory, often thought not to take account of the interests of shareholders, in fact does so by seeking to ensure the long-term sustainability of the company. It is imperative to note that businesses rely on the contribution of a much wider set of constituents, not just shareholders, for its success and they have a duty to take into account the interests of these stakeholders as well as the shareholders. Rather than looking solely at wealth maximization through classic business models, stakeholder view, offers an enlightened self–interest approach; taking into account other issues that could impact the sustainability and long term profits of the firm-namely consumers. “It’s tempting to consider value simply as a matter of maximizing the short term financial performance of the organization,” 30 says Michael Jensen. Contending with that value maximization approach is stakeholder theory which says that managers should make decisions so as to take into account all of the interests of all stakeholders in the firm. He further writes that “a firm cannot maximize value if it ignores the interests of its stakeholders. But a melding of new interpretations of both value maximization and stakeholder theory is necessary so as to make possible the long run maximization of the value of the firm.”31 CSR should be viewed as more than an add-on solution. Rather, it should be strategically integrated as a direct response to stakeholder demands for ethical business and be fully integrated into core business practices.

Instrumental Stakeholder Theory How do we get beyond the theoretical problem of reconciling corporate social responsibility and shareholder value? Instrumental stakeholder theory suggests a positive relationship between corporate social profitability and corporate financial profitability. According to this theory, the satisfaction of key stakeholder groups is instrumental for organizational financial performance. By addressing and balancing the claims of multiple stakeholders’ managers can increase the efficiency of their organization’s adaptation to external demands. The assumption here is that instrumental strategic ethics generally equates or engenders wealth maximization. Additionally, according to Freeman, high corporate performance results not only from the separate satisfaction

28 Wooseley, M. Forbes Q&A ‘Supercapitalism: Transforming Business, Democracy and Everyday Life’ Sept 6, 2007 29 Freeman, E (1984) Strategic management: A Stakeholder Approach 30 Jensen, Michael.HBS working paper "Value Maximization, Stakeholder Theory, and the Corporate Objective Function," 31 Ibid 30

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of bilateral relationships 32 but also from the simultaneous coordination and prioritization of multilateral stakeholder interests. These strategic and tactical steps may be necessary to reduce the likelihood of the organizations becoming stuck in a high-density network which can reduce corporate financial profitability in a number of ways.33 For example, in a high-density network, firms may become stuck in the role of compromiser or subordinate, depending on the degree of the firm’s network centrality.34 Either of these roles may lead to further consumption of valuable firm resources such as time, labour, and capital. Evolution of the Consumer: People, Planet, Profit Over the course of this century, the affordability and availability of consumer goods have greatly increased and given rise to new behaviors and new consumer attitudes. But are price, quality and end benefit the only purchase determinants or are there other drivers? In their book, Brand Spirit, How Cause Related Marketing Builds Brands, Hamish Pringle and Marjorie Thompson contend that consumers are going beyond the practical issues of functional product performance or rational product benefit and further than the emotional and psychological aspect of brand personality and image.35 Consumers are moving towards the top of the Maslow Hierarchy of Needs and seeking self-actualization. Instead of just looking for product benefit, they are now asking for and are compelled by demonstrations of good and ethical behaviour. They are questing to identify, relate and be challenged by the brands they endorse. They want to share the same values and work towards self-perfection.36 We can look towards NIKE who pioneered the focus on self-actualization with their famous "Just Do It" tag line. Home Depot followed suit with "You can do it. We can help." 37 Starbucks also engaged it’s consumer with its mantra ‘Rewarding Everyday Moments.’ These companies have transcended the product only relationship with customers. The aforementioned brand names have unequivocally demonstrated a belief in their customers' abilities to reach higher, accomplish more and become the best person they can be.

32 Orlitzky, Frank L. Schmidt, Sara L. Rynes. ‘Corporate social and financial performance: A meta-analysis Organization Studies’ 33 Rowley, T.J. 1997. ‘Moving beyond dyadic ties: A network theory of stakeholder influences’. Academy of Management Review 34 Freeman, E (1984) Strategic management: A Stakeholder Approach 35 Pringle, Hamish & Thomspon, Marjorie, Brand Spirit, How Cause Related Marketing Builds Brands, 2001 36 Ibid 35 37 Hamish, Pringle, Thomspon. Brand Spirit, How Cause Related Marketing Builds Brands, 2001

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So if consumers are moving towards the top of Maslow’s hierarchy, are corporations doing the same? Frank Tuzzolino and Barry R. Armandi, provide a motivational theory of organizational social response based on Maslow's hierarchy of needs in their work A Need-Hierarchy Framework for Assessing Corporate Social Responsibility.38 They suggest that a parallel exists between individual and organizational needs. This organizational-need hierarchy consists of: (a) physiological needs which are fulfilled by corporate profits; (b) safety needs which focus on criteria such as dividend policy, payout ratio, integration, conglomeration, and competitive position; (c) affiliative needs which are manifested by the willingness to participate in trade association, lobby groups, industry publications; and (d) internal and external self-actualization needs. The former pertains to employee relations and addresses such areas as job enrichment, compensation policy, and pension plans. External self-actualizations refers to community and government relations as demonstrated by corporate philanthropy, affirmative action, pollution abatement, and product reliability.39 Acknowledging Stakeholder Power: Cooperation and Collaboration Should corporations be concerned with their social performance as much as their economic results? And if so, why? According to an ASQ poll, 96% of business leaders think their company's CSR behavior will greatly impact the nation’s economic future, but more than 40% still do not have any policy in place to guide their company's actions. These ASQ findings hyphenated with the McKinsey Quarterly Global Survey of Business Executives, which polled more than 4,000 executives from 116 countries in December 2005,40 shed new light on the importance of social strategic interest. While the January 2006 edition of the McKinsey Quarterly published the results of the global survey, the latest edition of the publication includes an in-depth analysis of the survey findings, entitled "When social issues become strategic". The McKinsey analysis maps out the social contract businesses must honor, extending it well beyond the traditional understanding of abiding by formal laws to encompass less formal stakeholder expectations and, increasingly, "frontier" expectations that are still developing.41 The authors cite obesity as an example, where responsibility has shifted from individuals who choose what to eat to companies that make or sell unhealthy foods, just as the debate around tobacco shifted from individual smokers to companies' marketing of addictive products. Companies such as McDonald’s are now adding healthier menu options so as to combat the societal and ethical pressure bestowed on fast food companies. Should McDonalds want to maintain its number one perennial ‘global brand’ standing, it will have to rigorously provide a conscientious product offering. 42 “Business leaders must become involved in socio-political debate not only because their companies have so much to add but also because they have a strategic interest in doing so," stated McKinsey analysts Sheila Bonini, Lenny Mendonca, and Jeremy Oppenheim. Subsequently they assert that “Social and political forces, after all, can alter an industry's strategic landscape fundamentally; they can torpedo the reputations of businesses that have been caught unaware and are seen as being culpable; and they can create valuable market opportunities by highlighting unmet social needs and new consumer preferences." 43

38 Tuzzolino, Frank & Armandi, Barry R., A Need-Hierarchy Framework for Assessing Corporate Social Responsibility’ 39 Ibid 38 40 Baue. B, ‘Social Funds, April 4th 2006, Analysis Advocates Strategic Approach to Corporate Social Responsibility’ 41 Ibid 40 42 Baue. B, ‘Social Funds, April 4th 2006, Analysis Advocates Strategic Approach to Corporate Social Responsibility’ 43 Ibid 42

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The McKinsey analysis takes a practical approach of acknowledging the reality of stakeholder power instead of fighting it. Rather than denying it, Mckinsey analysts recommend acknowledging it and working with it. They believe that it is beneficial to all parties to endeavour towards creating shared value. The analysts assert”…we believe that the case for adopting a wholeheartedly strategic approach to the socio-political agenda is threefold.” They continue to say, “First, these forces can alter an industry's landscape in fundamental ways. Second, the immediate financial and longer-term reputational impact of social issues that backfire can be enormous,” citing the Monsanto genetically modified organism debacle and the Exxon Valdez oil spill. They finally remark that “new product or market strategies can emerge from changing social and political forces." Think Toyota Prius.44 Toyata’s success speaks for itself; hybrid sales in 2006 doubling to capture 3% of all the company's sales in Canada-which is nearly 6,000 vehicles.45 Furthermore, Toyota towers as a key example of a company which responded early to public concern about auto emissions. In turn they created the hybrid-engine Prius that significantly reduced pollutants and gave Toyota and enviable lead over its rivals in hybrid technology. The McKinsey analysis also recommends something that may seem antithetical to competitive capitalism: namely, collaboration and cooperation. It notes that Coca-Cola and PepsiCo have experienced success through a common approach of implementing policy prohibiting the marketing of their core carbonated soft drinks to children under 12.46 The analysts state that "as a rule, companies should consider responding on their own if they think they can capture the first-mover advantage (as British Petroleum did in acknowledging the dangers of global warming), if they are a target, or if a collective approach is too difficult or costly. Collaboration can be attractive if the stakeholders regard all companies as equally culpable, if regulation is imposed on an entire industry, or if isolated, individual action would clearly destroy value." 47

44 Baue. B, ‘Social Funds, April 4th 2006, Analysis Advocates Strategic Approach to Corporate Social Responsibility’ 45 CSR automotive, February 22, 2007, Report on Business 46 Baue. B, ‘Social Funds, April 4th 2006, Analysis Advocates Strategic Approach to Corporate Social Responsibility’ 47 Ibid 46

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FORTUNE Accountability: Beyond the Bottom Line Ranking of the world's largest companies by how well they conform to socially responsible business practices

From the July 23, 2007 issue(Accountability ratings for 2007 will be published in November 2007)

Fortune Global 500

2006 Rank

2005 Rank Company

Accountability score* Industry

Global 500 Rank

1 3 Vodafone 72 Computers and electronics

66

2 1 BP 71 Petroleum refining 4

3 2 Royal Dutch Shell 69 Petroleum refining 3

4 8 Électricité de France 61 Energy and utilities 68

5 15 Suez 58 Energy and utilities 96

10 5 Carrefour 50 Trading and merchandise

25

11 9 Peugeot 50 Automotive 60

14 28 General Electric 48 Computers and Electronics

11

17 18 Total 46 Petroleum refining 12

18 24 International Business Machines

46 Computers and electronics

29

19 56 Volkswagen 46 Automotive 17

Rank 2007 Company Revenues ($ millions)

Profits ($ millions)

1 Wal-Mart Stores 351,139.0 11,284.0

3 Royal Dutch Shell 318,845.0 25,442.0

4 BP 274,316.0 22,000.0

10 Total 168,356.7 14,764.7

11 General Electric 168,307.0 20,829.0

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Business survival and profitability depends on changing socio-economic norms and the new moral marketplace. Within this framework, different CSR activities are aimed at different audiences, but about one in every ten dollars of assets under management in the U.S-an estimated $2.3 trillion out of $24 trillion48 is being invested in companies that rate highly on some measure of social responsibility. This is a $2.3 trillion wager that socially responsible companies will outperform companies that don't engage a wide array of stakeholders, from shareholders and customers to employees and activists, in an ongoing conversation about what can be done better.49

Taken from the 2007 issue of Fortune: Accountability :Beyond the Bottom Line, the world's largest companies were ranked according to how well they conform to socially responsible business practices. The survey conducted by AccountAbility (a London think tank on corporate accountability) and CSR network (a British for-profit consultancy), measured 6 criteria, ranging from stakeholder engagement to performance management, at the top 50 companies on Fortune's Global 500 list. Fourteen other large companies were included so that there were at least ten in each of five industry sectors. 50

Many of the highest-ranking companies were not conventionally considered do-gooders or philanthropic corporations, but ultimately showed progressive CSR tactics to reinvent their business strategies. Oil giants BP and Shell assumed the No. 2 and No. 3 ranks respectively, however, the rankings did not measure performance outcomes such as CO2 emissions. It is important to note that four of the top ten on the list were utilities.51 The rankings’ barometer focused on management practices: Does a company have procedures for listening to critics? Are its executives and board members accountable? Has it hired an external verifier? This is where the triple bottom line comes into play-where CSR measures align both corporate and public expectation and ultimately correlate both socially responsible practice and year end profitability margins.52

Much to the chagrin of those that espouse shareholder theory, the key motivation here is for businesses to look beyond economic performance for indicators of success. Corporate Social Responsibility proponents define a company as socially responsible if it maximizes its “triple bottom line.” It encourages companies to maximize their economic, social and environmental impacts-something which shareholder fundamentalists would maintain deviates from the essential role of business. CEO’s are coming to the realization that CSR counts. This year the top-ranked company was Britain's Vodafone, the world's largest mobile-phone operator, edging out last year's leader, BP. "What we've tried to do is embed CSR," 53 said Charlotte Grezo, the company's director for corporate responsibility.54 There were four newcomers in the top ten this year - French water companies Suez (No. 5) and Veolia (No. 8), Italian utility Enel (No. 6), and British banking and insurance company HBOS (No. 9). Both newcomers and those that fared well in the 2005 rankings were those that progressively embraced strategic management systems and/or engaged with a broader array of stakeholders.55 The 2006 ratings penalized companies that failed to address non-financial issues at the core of their business. Conversely, Volkswagen climbed the rankings from No. 56 to No. 19 after releasing its first comprehensive CSR report. This clearly demonstrates that Corporate Social Responsibility may be used as a means of differentiation in otherwise competitive environments.

48 Demos, Telis, Beyond the Bottom Line. www.money.cnn.com, October 23,2006 49 Fortune Accountability Beyond the Bottom Line. www.money.cnn.com, July 23, 2007 50 Demos, Telis, Beyond the Bottom Line. www.money.cnn.com, October 23,2006 51 Ibid 50

52 Demos, Telis, Beyond the Bottom Line. www.money.cnn.com, October 23,2006 53 Ibid 52 54 Ibid 53

55 Demos, Telis, Beyond the Bottom Line. www.money.cnn.com, October 23,2006

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At No. 52, Home Depot also made strong gains; doubling its score, in part due to the company’s publication of a Web report on the non-financial impacts of its business, such as how the wood it sells affects forests in North America and the Amazon.56 General Electric (GE) is a prime example of a company that has effectively managed key stakeholder relationships and boasted significant financial gains as evidenced in the company’s No. 11 ranking in Fortune 500 (2007), No. 14 in Socially Responsible Ranking and No. 4 among Most Valuable Global Brands of 2006.57 GE’s success can be attributed to the socially and environmentally conscious business stratagems the company has embarked on. Most notably, its ‘Ecomagination’ technology has offered a new approach to solving customers’ toughest environmental challenges. Put into practice, GE’s belief that financial and environmental performance can work together to drive company growth.

Criticized by CSR campaigners in the past for unethical business practices, McDonald’s now seems to tower as example of a corporation that has integrated social demand into its business objectives and been rewarded with a healthy return on shareholder equity. ”The most important thing is to listen to our customers,” stated spokesperson Walt Riker. 58 The turnaround plan, which from 2003, focused on customers demand in-turn lead to the company’s stock soaring to an all time high above $55 since it announced its largest-ever dividend increase. McDonald’s promised to return $15 billion to $17 billion to shareholders through dividends and share buyback by the end of 2009.

Corporate Social Responsibility, Business Profitability and Increased Customer Satisfaction Corporate Social Responsibility is contingent on various factors, namely: cost of social response relative to the firm's resources, firm's culture, values of management, and rewards a firm expects to receive from the social segment it serves. Business and investment communities have long debated whether there is a real connection between socially responsible business practices and positive financial rewards. There is a growing body of data, both quantitative and qualitative, that demonstrate the bottom line benefits of socially responsible corporate performance. In the last decade an increasing number of studies have been conducted to examine this link. These studies generally fall into two camps: those analyses that argue companies should pursue CSR initiatives because they are the moral thing to do and those that argue companies should pursue CSR initiatives because they will enhance profits. The former, upheld by stakeholder theorists, are founded on the premise that without proper pressure companies will not act in a socially responsible manner. The claim here is that managers overemphasize the pursuit of profits while overlooking the benefits of Corporate Social Responsibility. Onside with those that maintain that CSR will enhance profitability is Janet Blake, Head of Global CSR at British Telecom (BT). Recently interviewed in Green Business News, Blake explains “that there is a strong financial return on CSR (BT estimates that about £2.2bn revenue per year is tied to CSR), not to mention an improvement in customer satisfaction - BT estimates that for every 10% rise in customer awareness of CSR, there is a related 1% increase in customer satisfaction.59 Deductively, there in turn must be a correlation between customer satisfaction, return on customer and profitability. A study by the Centre for Social Markets found that “there was a CSR premium (i.e. an addition benefit because of Corporate Social Responsibility earned by firms or appreciated by consumers and other stakeholders) that could be earned by firms on such items as product quality, employee

56 Demos, Telis, Beyond the Bottom Line. www.money.cnn.com, October 23,2006 57

Business Week 2006 ‘Innovation Metrics The top 100 Brands’ 58 Carpenter, David. ‘How McDonald’s Got Cooking’, Associated Press September 21st, 2007 59 www.green.itweek.co.uk/2006

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productivity, consumer satisfaction.”60 Therein the additional CSR costs could well be cancelled out by consumers accepting to pay for this additional premium or through prices being positively affected by the additional efficiency that CSR was likely to bring about. The Centre maintained that “evidence for this positive CSR premium is growing. How big this premium is likely to be is a matter for further research although visionary CSR companies can have a premium of at least 5% over non visionary companies”61 Furthermore, over 100 empirical studies published between 1972 and 2000 have examined the relationship between companies’ socially responsible conduct and financial performance. In these studies, the majority of results (68%) point to a positive relationship between corporate social performance and financial performance. The London Business School confirms these findings and has identified 80 studies on CSR, of which 42 demonstrated a positive impact, 19 found no link, and 15 produced mixed results and only 4 showed a negative impact.62

To give some examples of the studies:

• Companies with a public commitment to ethics performed better on 3 out 4 financial measures than those without. These companies also had 18% higher profits on average. (Source: Institute of Business Ethics, 2003)

• A study of “stakeholder superstars” (including Coca Cola, Procter and Gamble, Johnson & Johnson) showed that companies who consistently tried to take into account its stakeholders opinions outperformed the S&P 500 by more than twice the average over the past 15 years. Total shareholder return was 43% over the past 15 years, while the total shareholder return from the S&P 500 was 19%

• This result was confirmed by Harvard University, who that found stakeholder-balanced companies’ showed four times the growth rate and eight times the employment growth when compared to companies that are shareholder-only focused (Harvard University, 2000).

• Other research show that corporations with a public commitment to relying on their ethics code outperformed firms that did not by two to three times (Business and Society Review, 1999)63

Overall wealth maximization is achieved through strategic stakeholder relationships. Many experts even argue that a company’s commitment to social responsibility improves its financial performance by attracting more investment. For examples, 9 of the 15 largest social funds are in the top quartile of investment categories based on a three-year performance.64 In addition, a study by the University of Southwestern Louisiana titled, "The Effect of Published Reports of Unethical Conduct on Stock Prices,” showed that publicity about unethical corporate behavior lowered stock prices for a minimum of six months.65 The latter findings highlight the relationship between stock, share market performance and corporate reputation rankings. Said results confirmed that based on total equity return, firms of higher reputation outperform lowly ranked firms. .

60 Laffer, A. ‘Does CSR enhance business profitability?’ November 19th, 2004 61 Ibid 58 62 www.crseurope.org 63 Ibid 60 64 www.csreurope.org 65

Journal of Business Ethics Volume 15, Number 12 / December, 1996

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Increased Customer Interest and CSR In 1960, Theodore Levitt, wrote "Marketing Myopia," one of the most widely-quoted and reprinted Harvard Business Review articles. The article warned of the dangers from firms shortsightedly focusing on their products and, in doing so, overlooking the needs of their customers.66 Levitt insisted that the organization must learn to think of itself not as producing goods or services, but as buying customers; as doing the things that will make people want to do business with it. Although a functional fundamentalist that viewed CSR as immaterial, Levitt’s article seems to call into play customer needs which now, forty years later, are entrenched in ethically minded purchasing. While businesses must first satisfy customer’s key buying criteria-such as price, quality, availability, safety and convenience, studies have shown a growing desire to buy or not buy because of other values-based criteria such as ‘sweatshop-free‘ and ‘child-labour free’ clothing, lower environmental impact and absence of genetically modified materials or ingredients. (i.e. Body Shop). I draw attention to a body of evidence that suggests that the ethical conduct of companies exerts a growing influence on the purchasing decisions of customers. On December 5, 2006 GolinHarris revealed results of its fourth national survey, ‘Corporate Citizenship Gets Down to Business: Doing Well by Doing Good 2006.’ The survey found that Americans were sending a clear message to Corporate America: ‘Do more, be authentic and the business rewards will follow.’67 An overwhelming two-thirds of Americans interviewed said:

• “Doing well by doing good” is a savvy business strategy. Good corporate citizenship should be approached as an investment, asset and competitive advantage for business that contributes to the company's success.” (67%)

• “Business should invest significantly more money, time, attention and resources in corporate citizenship than it does today.” (68%)

• “Corporate citizenship should be considered an essential, high priority compared to other priorities companies face and manage in running a profitable, competitive and successful business.”68 (68%)

A loyal customer is the equivalent of repeat business and the possibility of increased profit margins. The strength of the business-consumer relationship is only as good as the level of satisfaction it generates. In a recent study by Cone Inc. and AMP Insights, (2007) more than one in five consumers reported having either rewarded or punished companies based on their perceived social performance.69 The following, outlines the repercussions of both responses towards companies. While support of social issues improved trust in a company, Cone’s research also showed that Americans stood ready to act against companies that behaved illegally or unethically. Although the effects of such actions may have not hurt the company in the short term, the consequences for business could be devastating in the long-term.70Those surveyed responded that they would react in a variety of ways if they were to find out about a company’s negative practices:71

• Consider switching to another company’s products or services (90%) • Speak out against that company among my family and friends (81%) • Consider selling my investment in that company’s stock (80%) • Refuse to invest in that company’s stock (80%) • Refuse to work at that company (75%)

66 Levitt,T. ‘Marketing Myopia.’Harvard Business Review, 2006 67 GolinHarris News Release December 5, ,2006 68 Ibid 46 69 Cone press Release 2004 70 Ibid 69 71 Cone Press Release 2004

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• Boycott that company’s products or services (73%) • Be less loyal to my job at that company (67%)72

So, responsible business can make for loyal customers, improved morale and higher productivity among employees. In turn, companies should have an interest in strengthening their social responsibility with associations and consumers. Companies need to be cognizant that any actions that violate societal expectations could very well damage, even destroy, brand image among networked stakeholders. Precariously balancing the interests of various groups is paramount to safeguarding a company’s image.

A recent study by the Reputation Institute found that companies which demonstrated: innovation, vision, social responsibility and appealed to emotions while simultaneously posting strong financial results, had the best corporate reputations. For its eighth annual rankings, Reputation Institute surveyed more than 60,000 people online in 29 countries – participants could only vote on companies based in the country where they live – and used the result to determine a company's reputation. Consumers were polled on seven factors that contribute to a firm's reputation: products and services, innovation, workplace, governance, citizenship, leadership and performance.73 The results ultimately proved that good deeds, lead to good reputations. Charles Fombrun, Executive Director of the Reputation Institute said that “companies that gave to social causes did well in the survey.” 74 According to Fombrun, Ikea and Lego were “two companies that (had) taken responsibility for the development of their region and country and (were) seen as national icons. They have earned their trust, respect and admiration from behaving in ways that are relevant to their key stakeholders and that’s why they’re rated tops by the public.”75 Integrating CSR in business strategy has not only had a social impact, but, as reported in 2007, led Lego to report a 3% rise in pretax profit.76

72 Ibid 71 73 www.forbes.com/leadership/2007/05/22/reputation-institute-rankings 74 Ibid 73 75 http://reputationinstitute.com (Press Release May 2007) 76 Reuters August 29th, 2007

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Return on Customer and Total Shareholder Return Ultimately, both short term and long term company profit are generated from the one business asset that matters most: customers. So it’s imperative that companies’ align their business objectives with the increasing social consciousness demands that consumers place on them. Peppers and Rogers, who defined and launched the global CRM movement, have devised Return on Customer (ROC) formula for measuring the rate at which overall enterprise value is created by customers. This formula is consumer centric-defining the customer as the primary profit and value driver of the business. According to Don Peppers and Martha Rogers, a customer can create value for a business in two very important ways: by increasing the company’s current-period cash flows and by increasing its future cash flows. 77 For instance, as stated previously in the section on reputation, if a customer has a bad experience with a company and becomes less inclined to do business with it in the future, the firm loses value at that very instant with the customer’s change of mind. This company would lose real value-in the same way as share price would lose current value when future profits are threatened.

In their work, Return on Customer: Creating Maximum Value From your Scarcest Resource, Rogers and Peppers explode the notion that “maximizing the value created from a given customer over time, most likely occurs when the company’s value to that customer is maximized and the customers who get the most value are those who have come to trust the firm. So to maximize Return on Customer (ROC) a firm must earn trust.”78 The two authors maintain that most customer relationship management ROI-oriented business cases focus too much on the near term, counting only direct "hard" benefits and ignoring the more important "soft" benefits that relate to customer satisfaction, retention and lifetime value optimization. Their ROC model focuses on the softer benefits especially maximizing customer lifetime value.79 Peppers and Rogers believe that "Customers are the only reason you build factories, hire employees, schedule meetings, lay fiber-optic lines, or engage in any business activity. Without customers, you don't have a business."80 Therefore attracting and retaining customers should both be regarded as critical processes. To model a very simple example of unintended value destruction Rogers and Peppers consider a company that has a million customers, each with a 1% likelihood of responding to a direct mail sales offer.81 Let us assume that each solicitation costs $1 to send out and each positive

77 Peppers, Don & Rogers, Martha, Return on Customer: Creating Maximum Value From your Scarcest Resource 78 Ibid 77 79 Peppers &Rogers, Martha, Return on Customer: Creating Maximum Value From your Scarcest Resource 80 Ibid 79 81 Peppers, Don &,Rogers, Martha(2005), Return on Customer: Creating Maximum Value From your Scarcest Resource,

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response generates $125 in cash flow.82 Thus, with the first campaign the company spends $1 million on solicitations and generates $1.25 million in cash flow for a $250,000 profit.83 The firm can effect up to six solicitations a year and each campaign pulls a 1% response from the customer base. As Table 1 illustrates below, these customers represent $6 million for the firm. The firm’s Return on Customer remains constant in subsequent years because it continues to generate a steady 1% productivity rate on its customers year to year.84

This begs the question, what if after six unsuccessful solicitations each year; the customers were to become less likely to take the company’s offer during the next year?85 The company builds into the model a .05% annual decline in response rate, accounted for by increased speculation about the brand and its corporate affiliation. If the decline were actually .05% annually then the firm would be destroying about a quarter of its customer equity-more customer equity than it was reaping profit.86 The result: a negative ROC in the first year as shown in Table 2 which then accelerated downwards as the company continues to decrease the value of its customer base.

82 Ibid 81 83 Peppers & Rogers.Return on Customer: Creating Maximum Value From your Scarcest Resource 84 Ibid 83 85 Peppers & Rogers, Return on Customer: Creating Maximum Value From your Scarcest Resource 86 Ibid 85

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An examination of Table 2 reveals a direct relationship between the decreasing rates of profitability and the declining customer response rates. While the company may assume it is creating value, in actuality customer equity is declining each year by an amount exceeding the year’s profit; with an end result of total value created each year being negative. As a result, the company’s return on customer is negative and while it might think it has a profit to report, it is actually eating its own customer base. Year 4 is the very last year that the company will generate any current-period profit as it will have completely destroyed the productivity of its customer base.

To compliment the Rogers and Peppers theory, research conducted by Bain Consulting Group and Harvard Business School in August of 2005, showed that the longer a customer is a with a company, the greater the annual profit generated from that customer. These increased profits came from a combination of increased purchases, cost savings, referrals and a price premium.87

This research implies that companies should not be near-sighted and simply look at market share or short term profitability as would people such as Friedman. Rather they should base their marketing programs on the following basic tenets: Firstly, to quickly assess which new customers have the greatest potential to become high-value, long-term customers. Secondly, to reward existing high-value, loyal customers with preferential treatment in order to retain a higher percentage of said customers.88

Conclusion In the end, what benefit does return on customer bring to overall shareholder return? When we talk about Total Shareholder return, we define it as an investment term that refers to the overall return a shareholder earns from owning a company’s stock over some period of time. It is the economic value of a business broken down into customer specific units.89 This definition is based on what a shareholder’s actual cash flow would be if he were to buy the stocks at the beginning of the period and sell it at the end. All value is created by any company’s business operation must come from its customers at some point. 90 Therefore, if the discounted cash flow value of an operating business is created entirely by customers, the result is that its discounted cash flow is composed of a whole of individual lifetime values. All the firm’s current and future customer lifetime values added together (its customer equity) will equal its total discounted cash flow. Beyond the bottom line, businesses need to balance economic, legal, and social responsibilities in order to achieve long term success. Firms that are seen as acting illegitimately are likely to

87 Cutler, Andy.(2005) ‘The need for Customer Centric Marketing’ 88 Ibid 87 89 Peppers & Rogers,Return on Customer: Creating Maximum Value From your Scarcest Resource 90 Ibid 89

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face difficult relations with employees, governments, communities, and consumers – which all have direct impacts on the top and bottom lines. When examining whether or not business could prosper from strategic Corporate Social Responsibility it is pivotal to see it’s overall business benefits – lowering and limiting litigation, sizably reducing taxes, protecting and enhancing brand image, improving customer satisfaction and retention, reducing employee turnover, reducing operating cost, increasing both reputation and sales and increasing customer loyalty. By integrating a stakeholder perspective which accounts for various consumer needs (i.e. ones of self actualization), management is best placed to optimize shareholder returns over the longer term and create overall value maximization-both for the consumer and the corporation.

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