Introduction
In today's rapidly changing business landscape, companies are facing increasing pressure to not only generate profits but also contribute positively to society. The traditional view of business as solely profit-driven is being challenged, and a new paradigm is emerging. Alex Edmans' book "Grow the Pie" offers a fresh perspective on how businesses can thrive while simultaneously benefiting society and ensuring long-term success.
This book introduces the concept of the "pie-growing mentality," a revolutionary approach that encourages businesses to focus on expanding their overall value rather than merely redistributing existing value. By prioritizing the well-being of all stakeholders – including customers, employees, communities, and the environment – companies can achieve sustainable success that benefits everyone involved.
The Pie-Growing Mentality: A New Approach to Business
Understanding the Pie-Splitting Mentality
To fully appreciate the pie-growing mentality, it's essential to first understand its counterpart: the pie-splitting mentality. This traditional approach views business value as a fixed pie, where increasing one stakeholder's share necessarily means decreasing another's.
A stark example of this mentality is the case of Turing Pharmaceuticals and its CEO, Martin Shkreli. In 2015, Turing acquired the rights to Daraprim, a life-saving drug used to treat toxoplasmosis, a parasitic infection that can be fatal for patients with weakened immune systems. Overnight, Shkreli increased the price of Daraprim from $13.50 to $750 per pill – a staggering 5,500% increase.
This decision exemplifies the pie-splitting mentality at its worst. By dramatically raising the price, Shkreli aimed to maximize returns for investors at the expense of patients who desperately needed the medication. While legally permissible, this action sparked widespread outrage and highlighted the ethical issues inherent in such a narrow focus on profit maximization.
Embracing the Pie-Growing Mentality
In contrast to the pie-splitting approach, the pie-growing mentality focuses on creating value for all stakeholders, effectively expanding the overall "pie" rather than fighting over existing slices. This approach recognizes that businesses can and should play a positive role in society while still maintaining financial success.
A prime example of this mentality in action is the story of Roy Vagelos, former CEO of pharmaceutical company Merck. In the late 1970s, Merck discovered that ivermectin, a drug initially developed for livestock, could cure river blindness in humans. Despite the high costs associated with distributing the drug to impoverished communities in Africa and the lack of profit potential, Vagelos made the bold decision to give the drug away for free.
This decision, driven by a commitment to serve society, had far-reaching positive effects. Not only did it save millions of lives, but it also enhanced Merck's reputation, attracted top talent, and ultimately benefited the company in the long run. By focusing on creating value for society, Merck grew the overall pie, demonstrating that ethical business practices and financial success are not mutually exclusive.
Implementing the Pie-Growing Mentality
Adopting a pie-growing mentality requires a shift in how businesses approach their operations and decision-making processes. Key aspects of this approach include:
- Integrating social responsibility into core operations
- Focusing on continuous innovation that benefits society
- Prioritizing long-term societal benefits alongside profits
- Paying fair wages and investing in employee development
- Reducing environmental impact and promoting sustainability
- Engaging positively with local communities
By embracing these principles, companies can create value across the board, benefiting all stakeholders while ensuring their own long-term success.
The Role of Incentives in Growing the Pie
The Controversy of Executive Pay
Executive compensation is a hot-button issue that often sparks public outrage and debate. The case of Bart Becht, former CEO of Reckitt Benckiser, illustrates the complexities surrounding this topic.
In 2010, Becht earned £92 million, breaking UK records for executive pay and triggering widespread criticism. The backlash was so severe that Becht resigned in 2011, causing Reckitt's market value to drop by £1.8 billion. However, this incident reveals the importance of looking beyond headline figures to understand the full context of executive compensation.
Under Becht's leadership from 1995 to 2011, Reckitt experienced remarkable growth, with significant annual increases in sales, operating income, and net income. Becht's focus on continuous, incremental innovations rather than grand new products earned him industry accolades. During his tenure, Reckitt's share price soared, creating £22 billion in value for investors.
Moreover, Becht's influence extended beyond shareholders to benefit customers and employees. He spearheaded product innovations that simplified daily tasks, fostered an entrepreneurial culture that encouraged employee contributions, and led environmental initiatives that significantly reduced the company's carbon footprint.
The media's portrayal of Becht's pay missed crucial details. Most of his £92 million came from share options accumulated over a decade, reflecting his long-term commitment to the company. Additionally, Becht reinvested a significant portion of his earnings into society, donating £110 million to charity.
Designing Effective Incentive Structures
The Becht case highlights the need for a more nuanced approach to executive compensation. While it's true that the average S&P 500 CEO earns 264 times the average employee's salary, simply reducing pay levels is not an effective solution. Instead, the focus should be on designing incentive structures that promote long-term value creation and align with the pie-growing mentality.
Key principles for effective executive incentives include:
- Linking pay to long-term performance metrics
- Promoting high CEO stock ownership to boost long-term success
- Implementing simple pay structures, such as restricted shares, rather than complex bonus schemes
- Locking shares for several years to ensure CEOs focus on sustainable value creation
By adopting these principles, companies can create incentive systems that drive long-term value creation for both shareholders and stakeholders, effectively growing the pie for all involved.
The Controversial Practice of Share Buybacks
Understanding Share Buybacks
Share buybacks have become a contentious issue in recent years, with critics arguing that they prioritize short-term gains over long-term investments. To illustrate the complexity of this practice, consider the case of Humana's CEO Bruce Broussard in 2014.
When Humana's earnings per share (EPS) dropped from $7.73 to $7.34, threatening Broussard's bonus, which depended on an EPS of $7.50, he initiated a $500 million share repurchase. This action nudged the EPS to $7.51, securing his $1.68 million bonus. While this example might seem to confirm critics' concerns, the reality of share buybacks is more nuanced.
Share buybacks occur when companies use spare cash to repurchase their own shares rather than investing in growth or increasing wages. Between 2003 and 2012, S&P 500 firms spent $2.4 trillion on buybacks, accounting for 91% of their net income. This practice has drawn criticism from politicians across the political spectrum, with proposals to limit or restrict buybacks gaining traction.
The Potential Benefits of Buybacks
Despite the controversy, share buybacks can serve strategic purposes when executed correctly:
- Reducing future dividend obligations
- Signaling a CEO's confidence in the company's long-term prospects
- Reallocating resources to more valuable areas
- Providing flexibility in capital allocation compared to dividends
- Enabling targeted returns for investors
- Leading to more concentrated ownership, which can enhance incentives for value creation
Research shows that buybacks can increase long-term stock returns more effectively than short-term prices. Moreover, surveys indicate that companies typically engage in buybacks only after funding all desirable investments, suggesting that buybacks are a response to low investment opportunities rather than their cause.
Misconceptions About Buybacks
Several common misconceptions about share buybacks need to be addressed:
- Buybacks are not free gifts to investors, as investors can sell shares anytime, with or without buybacks.
- The notion that buybacks come at the expense of wages is flawed, as net income used for buybacks is calculated after deducting wages and other expenses.
- Buybacks do not necessarily crowd out productive investments, as companies often pursue them after exhausting other investment opportunities.
Aligning Buybacks with the Pie-Growing Mentality
When properly executed, share buybacks can contribute to growing the pie by aligning company resources with value-creating investments and a long-term perspective. The key is ensuring that buybacks are part of a broader strategy focused on sustainable growth and societal benefits.
To achieve this, companies should:
- Clearly communicate the rationale behind buyback decisions
- Ensure that buybacks do not come at the expense of necessary investments in research, development, or employee welfare
- Use buybacks strategically to signal confidence in the company's long-term prospects
- Implement buybacks as part of a comprehensive capital allocation strategy that balances short-term returns with long-term value creation
By approaching buybacks with these considerations in mind, companies can leverage this practice to grow the pie for all stakeholders while maintaining financial flexibility and shareholder value.
Purpose-Driven Excellence in Enterprises
The Power of Purpose
Purpose is the reason a company exists, serving society and answering the question of how the world is better with its presence. When businesses align their operations with a clear and meaningful purpose, they can create significant value for both society and shareholders.
Consider the case of M-Pesa, a mobile money service launched by Vodafone in Kenya in 2007. This innovation transformed the lives of people like Emmanuel Sironga, a goat trader in the remote village of Magadi. Before M-Pesa, Emmanuel had to rely on cash for all transactions, facing significant risks and inconveniences. With M-Pesa, he could deposit, withdraw, and transfer money using his phone, dramatically improving his ability to conduct business and manage his finances.
The impact of M-Pesa extends far beyond individual convenience. By 2014, this service had lifted 196,000 Kenyan households out of poverty, demonstrating how businesses can create substantial societal value through excellence in their core activities.
Embedding Purpose in Business Operations
To truly embrace purpose-driven excellence, companies must integrate their mission into every aspect of their operations. This approach involves:
- Clearly defining and communicating the company's purpose throughout the organization
- Using purpose to guide strategic decisions and day-to-day operations
- Focusing on excellence in core business activities to serve society effectively
- Innovating continuously to address societal needs and challenges
Patagonia, the outdoor clothing company, exemplifies this approach with its commitment to environmental renewal. Their "Don't Buy This Jacket" campaign, which urged consumers to reconsider purchases and prioritize sustainability, demonstrates how purpose can drive bold business decisions that prioritize long-term societal impact over short-term gains.
The Universality of Purpose-Driven Excellence
It's important to note that purpose-driven excellence isn't limited to industries typically associated with social impact, such as pharmaceuticals or technology. Even companies producing everyday items can significantly contribute to societal well-being through excellence in their specific roles.
For instance, Unilever's handwashing campaign, launched in 2010, aimed to improve hygiene practices worldwide. This initiative, which aligned with Unilever's core business of producing soap and other personal care products, led to a 23% reduction in pneumonia infections and a 45% reduction in diarrhea cases in targeted areas.
Integrated Reporting and Thinking
To effectively communicate and reinforce their commitment to purpose-driven excellence, companies can adopt integrated reporting practices. This approach involves combining financial and non-financial measures to provide a comprehensive view of performance.
Integrated reporting offers several benefits:
- Enhancing transparency and accountability
- Fostering integrated thinking within the organization
- Ensuring that stakeholder concerns are incorporated into all major decisions
- Highlighting the company's commitment to social responsibility
- Strengthening long-term sustainability and success
By adopting integrated reporting, companies can better align their operations with their stated purpose and demonstrate their commitment to growing the pie for all stakeholders.
Empowering Citizens to Shape Business Practices
The Power of Individual Action
While it's easy to feel powerless in the face of large corporations, individuals have substantial influence in shaping business practices. As stakeholders, policymakers, and influencers, citizens can play a crucial role in promoting the pie-growing mentality.
Investors
As an investor, you can select companies that align with your values, prioritizing those with strong social performance. Organizations like the British charity ShareAction provide resources to help individuals make socially responsible investment decisions, such as ranking mutual funds based on their stewardship practices.
Employees
Employees hold significant sway by choosing employers with ethical practices and avoiding companies with poor social records. The Wells Fargo scandal of the 2010s, where employees felt pressured to open unauthorized accounts to meet sales targets, highlights the importance of working for companies with strong governance and ethical practices.
Customers
Customers can assert their influence by purchasing products from responsible companies. Resources like the Ethical Consumer website help individuals make informed choices and support businesses that align with their values.
Direct Engagement with Companies
Individuals can also directly engage with and influence a company's decision-making processes:
- Investors can propose changes at company meetings
- Employees can suggest improvements within their organizations
- Customers can provide feedback and support shareholder proposals
The case of Lego illustrates the power of customer engagement. In 2004, Lego was nearing bankruptcy. By 2015, it had become the world's largest toy company, driven in part by customer engagement through the Ambassador Programme, which solicited ideas for new products and helped refocus existing ones.
The Role of Policymakers
Policymakers can influence regulation through voting and public consultation, addressing market failures and redistributing gains from pie growth. For example, carbon taxes, supported by over 3,500 US economists, could reduce emissions and promote environmental responsibility on a national scale.
However, regulations need to be carefully crafted to avoid stifling innovation and should be tailored to different enterprise circumstances. "Comply-or-explain" provisions offer a flexible approach, allowing companies to either comply with rules or explain why they do not, ensuring accountability without a one-size-fits-all approach.
The Impact of Influencers
Influencers, including media and think tanks, play a vital role in shaping public opinion about business practices. By naming, celebrating, and shaming, they highlight both positive and negative corporate behaviors. It's essential for influencers to present information with accuracy and balance, using rigorous evidence to provide a comprehensive view of complex issues.
Taking Action as an Individual
Every individual can significantly impact business practices through their choices and actions:
- Make informed investment decisions that align with your values
- Choose employers with strong ethical practices and governance
- Support companies that demonstrate a commitment to social responsibility through your purchasing decisions
- Engage directly with companies through feedback, proposals, and participation in stakeholder initiatives
- Stay informed about policy issues and participate in the democratic process
- Use your voice on social media and other platforms to advocate for responsible business practices
By taking these actions, individuals can contribute to a system where businesses strive to grow the pie for everyone, creating lasting positive impact in the world.
Conclusion: Growing the Pie for a Better Future
The main takeaway from Alex Edmans' "Grow the Pie" is that businesses can achieve sustainable success by adopting a pie-growing mentality, focusing on creating value for all stakeholders rather than just maximizing profits for shareholders. This approach involves:
- Integrating social responsibility into core operations
- Aligning executive incentives with long-term goals
- Using practices like share buybacks strategically to foster growth
- Embracing purpose-driven excellence in all aspects of business
- Empowering citizens to engage with and influence business practices
By working together, individuals and businesses can build a fairer, more sustainable economy. This collaborative approach demonstrates that everyone has a role in growing the pie and achieving lasting positive impact.
As we move forward, it's crucial to recognize that the success of businesses and the well-being of society are deeply interconnected. By embracing the pie-growing mentality, companies can not only ensure their own long-term success but also contribute to solving some of the most pressing challenges facing our world today.
The journey towards a more equitable and sustainable business landscape is ongoing, and it requires commitment from all stakeholders. As individuals, we have the power to influence this change through our choices as consumers, employees, investors, and citizens. By supporting companies that prioritize long-term value creation and societal benefits, we can help shape a future where business success and social progress go hand in hand.
Ultimately, "Grow the Pie" offers a hopeful and practical vision for the future of business – one where companies thrive by creating value for all, rather than extracting value for the few. By embracing this mindset and working collectively towards its implementation, we can build a more prosperous, equitable, and sustainable world for generations to come.