Sustainability and Profit: From Trade-Off to Essence

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Economic paradigms come and go. The seemingly endless debate between neo-liberals and –Keynesians in the past century provides a fascinating account of this. It shows that there must be words in economic debate other than last words – that no matter how certain an insight might seem in a particular instance, it will likely be proved wrong in the myriad combinations of circumstances that history inevitably yields.

The essence of capitalism evolves around the centrality of profit, which in many ways is the very reason it has outcompeted its economic alternatives. Few would disagree with the central claim of University of Chicago’s Milton Friedman’s controversial essay on social responsibility (New York Times Magazine) that the paramount social objective of any business is to achieve profits within its legal constraints. The disagreement about whether this is the only responsibility of a business in many ways comes down to our understanding of profit itself, which has undergone a remarkable development since capitalism’s rise in the 18th century. A 19th century capitalist’s focus on net-profits was overridden by a 20th century shareholder’s emphasis on ‘Earnings Per Share’. A 21st century stakeholder in turn might not even be able to fully quantify the positive as well as negative returns from the consumption of a product, yet be fully aware of their presence.

One misconception is to think of profit and sustainability in terms of trade-offs and sometimes even as mutually exclusive objectives.  The willingness to sacrifice a fraction of earnings to become more sustainable is ubiquitous, but publicly displayed concerns for sustainability are more often about CSR reports than about meaningful impact. As even the least sustainable companies are claiming to be sustainably conscious, sustainability is becoming more of a buzzword than a credible course of action. As a consequence, companies find it increasingly hard to convince the general public that they are doing more than paying lip service to an abstract ideal of goodness.

This conception of profit and sustainability is likely to change within the next decade as the link between profitability and sustainability is established through the absence of alternatives. As a report by MIT Sloan argued in 2012, there is no scenario in which a firm can afford to ignore considerations for sustainability in the near future. Changes in customer preferences, regulations, political pressure, resource scarcity and competition will make it increasingly difficult to generate profits unsustainably (MIT Sloan Management Review). This development puts substantial pressure on companies to adapt decisively and fast.

An important source of pressure in this direction is the widely recognized rise of consumer power as well as social and environmental activism. Just as the rise of shareholder influence has led firms to accept EPS as one measure of performance in the 20th century, the rise of stakeholders including customers, NGOs and public-private partnerships is likely to lead them to accept another class of indicators, adding quality as a second dimension next to the quantity of profit.

Perhaps more importantly is the rise of an internal source of pressure from within firms, whose shareholders see their profit margins shrinking ever faster, threatening the very existence of their work and investment. In a world, where access to information is almost ubiquitously available and where globalization has led to a fierce competition in virtually all economic sectors, what sets companies apart is not an ability to minimize costs for an existing operation or to market a potentially harmful product more convincingly than others. What does matter is a company’s will and ability to create a product or service that authentically enhances the well-being of its customers (The New Capitalist Manifesto).

Friedman argued that a businesses may “generate goodwill as a by-product of expenditures that are entirely justified on its own self-interest” (New York Times Magazine), but he wrote for a different economic paradigm – a paradigm in which it was at a firm’s discretion to choose whether or not to be sustainable. This time is now gone.

Today, firms will have to invest heavily into mitigating the risks that result from shifts in economic paradigms. Resource scarcity has led the carpet manufacturer Interface to develop Clean Blue, a technology system that enables Interface to use renewable resources like old carpets and even trash to manufacture new products. Changes in consumer preferences and environmental activism have led Coca-Cola Company to introduce the PlantBottle in 2009 to decrease the environmental footprint of its global plastic. So far 30% of the bottle is made out of plants, but the company has a declared goal to produce it exclusively from plant waste by 2015.

The rise of impact capital, which according to the Monitor Institute will amount to $500 billion dollars by 2020, makes accessibility to some substantial sources of funding conditional upon compliance with strict sustainability standards. Nature, the world’s most prominent academic journal in the natural sciences, estimates the gross output of the world’s ecological systems and natural capital at a minimum of $18 trillion a year, giving governments all over the world a huge incentive to enact legislation for its protection. One example of this is the EU’s introduction of its emissions trading scheme (ETS) at the beginning of 2012 that is meant to force airlines worldwide to pay their share for the environmental pollution created through aviation (DG CLIMA).

In the future, business leaders will have to consider a myriad of potential shocks to the development of their business. Resilience to these shocks is thus a vital imperative for success. Yet in the face of change, firms must remain dynamic and first-movers who adapt to more stringent sustainability standards on their own initiative will enjoy a substantial advantage over peers that are forced to do so. As recent studies have shown, genuinely sustainable business practices yield lower costs, increased revenues, more innovation and stronger political leverage (HBR). Resilient Dynamism thus legitimately occupies its central place on the World Economic Forum’s agenda for 2013.

Sustainability is neither a sacrifice nor a trade-off. As public opinion, regulations and competition advance, it is becoming the essence of profit-making itself and the only competitive advantage that provides a solid foundation for a long run sustainable development. The race for this advantage has already begun, as ever more global players such as Nike, Coca Cola, Walmart and others are realizing its vitality. As long as markets are allowed to work more or less freely, companies that are desperately trying to protect the status quo, are bound to fail. Our economic paradigm is shifting. All business leaders, economists and politicians are invited to adapt.

Featured image source: business-ethics.com

3 thoughts on “Sustainability and Profit: From Trade-Off to Essence

  1. Excellent article, very informative and a good read after all! Congrats. There is just one thing I was wondering about when reading your article: You describe how “international civil society” basically is “adding quality as a second dimension next to the quantity of profit”. But aren’t these mechanism you are mentioning (Scarcity of resources, consumer awareness, regulation etc.) rather factors that will contribute to internalize the externality, i.e. adding the “quality of profits” if you will as a component of the quantity of profits, rather than an independent indicator by itself? This probably looks trivial, but if prices set incentives, then there rather be a mechanism how prices and thus profits contain that information in a quantitative way. Now, if that is the case, I don’t see much disagreement with Friedman anymore, as the company’s self-interest is actively being pursued, while equilibrium profits are determined as the interaction between the companies’ cost structure and effective consumer demand (which reflects its evolving preferences). Economically speaking, aren’t environmental concerns just a relatively new set of constraints to be considered in a firm’s optimization problem, where its bindingness is endogenously determined by dynamic consumer preferences?

    • Johannes, thanks for highlighting this – I agree that as far as the operations of markets are concerned prices alone are able to quantify our qualitative considerations for sustainability. After all, prices are formed on the basis of supply and demand, which in turn are now ever more influenced by sustainability issues. In this sense, what we see is not a rise of a different indicator but, as you say, an increasing internalization of externalities. Also, I think there is much more agreement with Friedman than disagreement: If business profits reflect sustainability constraints they should be legitimately the sole focus of firms. The disagreement with Friedman is thus not conceptual but rather one in emphasis. It is based on the fact that he underestimated the role that ‘public goodwill’ would eventually play in today’s profit-making. He viewed it as an optional extra that may or may not contribute to business performance – a view that is still commonly held by many business leaders. The result is that the number of CSR initiatives has increased significantly, but firms’ business models, many of which are fundamentally unsustainable, are left untouched.

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