UK: IN AN IDEAL WORLD ...

UK: IN AN IDEAL WORLD ... - Managers are being urged to look after the interests of all their stakeholders. Paying heed to such demands is a recipe for confusion - and a licence to fudge.

by Martin Vander Weyer.
Last Updated: 31 Aug 2010

Managers are being urged to look after the interests of all their stakeholders. Paying heed to such demands is a recipe for confusion - and a licence to fudge.

A bang-up-to-date dictionary of political correctness would contain, in bold type, a set of key words of the mid-1990s: community, inclusive, stakeholder. Each one has an entire literature of ideological baggage attached to it; the down-to-earth executive may suspect a mix of trans-atlantic hot air and Blairite circumlocution. But the last of this provocative trio carries real, practical implications for the way in which managers run their companies: the concept of stakeholding merits closer examination.

But be warned. It's a slippery creature to put under a microscope.

Like all fashionable ideas, the term stakeholding is used by different people to mean widely different things which happen to suit their arguments.

At the core of all versions of stakeholder theory, however, is the proposition that a company interacts with five separate interest groups: its shareholders, its customers, its employees, its suppliers and the community at large.

That much is obviously true; the debate which follows from it is about how the company should behave in relation to each of those groups, and whether that behaviour is a matter of moral obligation - which ought perhaps to be backed up by law - or whether it is just a matter of good business sense; whether it is a question of transferring slices of cake from owners of the company to other interested parties, or whether it is about baking a bigger, better cake for all to enjoy.

It is a debate which has been around on both sides of the Atlantic for at least two decades; back in the '70s, both the CBI's Watkinson Report on corporate responsibilities and the Bullock Report on industrial democracy touched on some of the issues involved. It draws heavily on comparisons with non-Anglo-Saxon corporate models which seem to have worked better than our own: on Japan, with its interdependency of manufacturers and smaller suppliers and its system of lifetime employment matched by ferocious corporate loyalty; on Germany, with its stable institutional ownership structure and its board-level dialogue between owners and union representatives.

But the key word stakeholder has only come into currency in Britain in the past five years. The motor component distributor Unipart, the UK company most often spotlighted as an example of stakeholder theory in practice, began to develop its own version of the concept long before privatisation in 1987, but chose not to use the magic word until recently, lest the usage be misunderstood.

That was a wise decision since language adapted to accommodate new meaning can be a dangerous thing. The very act of labelling employees, suppliers, customers and the community in general, as stakeholders in a company immediately seems to impute to them some kind of rights. A stake is, after all (according to Chambers' Dictionary) 'an interest or concern, anything to gain or lose'; 'to stake a claim' is 'to intimate one's right to or desire to possess'. And a right is likely to be fiercely defended by its traditional holder against any newcomer who lays a hand on it.

In its most philosophical form, the stakeholding debate concerns itself obsessively with this basic question of shareholders' property. From the new right, Dr Elaine Sternberg, principal of Analytical Solutions (a business consultancy) and research fellow at the Centre for Business and Professional Ethics at Leeds University, defines stakeholder theory as 'the doctrine that businesses should be run not for the financial benefit of their owners but for the benefit of all their stakeholders'. This undermines private property, and is inimical to good corporate governance, she says; it is a theory promulgated chiefly by those who believe they would benefit if profits were diverted from what she sees as the rightful business owners.

On the new left, Will Hutton, editor of the Observer and author of The State We're In, is not so crude in his attack as to present a simple antithesis of Sternberg's defence of property. He says that stakeholding is all about 'treating people properly', and that 'property rights should not be considered to be without any obligation' to do just that. Together with John Kay, chairman of London Economics (who has written extensively about 'good', 'moral' and 'inclusive' markets), Hutton says that he is trying to mark out a 'third territory' which is neither the collectivism and corporatism of the '70s nor the raw capitalism of the '80s. Hutton favours intervention, rather than persuasion, to create the 'competitive structures more aggressively policed' which he has in mind. He also wants to see something approaching a revolution in the City of London, the centre of the short-termist 'gentlemanly capitalism' which he believes has ruined Britain's manufacturing economy.

And he hopes for a significant evolution of human behaviour: what his ideas fundamentally amount to, he says, is that 'people should behave nicely'.

To which Sternberg responds: 'In the spurious expectation of achieving vaguely "nicer" business behaviour, the stakeholder approach would sacrifice not only property rights and accountability, but also the wealth-creating capabilities of business strictly understood.'

This is a battle of big concepts, but neither side provides much useful guidance for hard-pressed managing directors trying to work out where their duty lies in relation to everyday decisions affecting profits and business relationships. Sternberg presents her arguments in philosophical terms: her recent assault on stakeholder theory in the Journal of the Institute of Economic Affairs contains no examples of a real-life corporate dilemma.

Hutton on the other hand is a skilled polemical journalist, well capable of working backwards from his conclusions to practical examples which happen to support them. But he is ultimately a woolly thinker, and it is noticeable that his ideas have been deemed too way-out to carry the endorsement of the newly business-friendly Tony Blair.

To derive useful meaning from the stakeholder debate, therefore, we need to hear about the real world from people who have to address real business decisions, and then re-examine the underlying principles. Some top managers, like John Neill, group chief executive of Unipart, have embraced stakeholding philosophy with quasi-religious fervour. Others, like Sir Stanley Kalms of Dixons, regard it, in short, as bunkum. What is interesting is the extent to which these and other business leaders tend to agree on fundamental best practice in management. What is important is to ask whether the overlay of stakeholder vocabulary on the consensus of best practice simply creates confusion and ultimately excuses for uncommercial decision making.

Everyone from the Duke of Edinburgh to Hutton himself has beaten a path to Neill's door to find out what is special about Unipart. The answer, Neill says, is a belief in 'shared-destiny relationships', particularly with employees and suppliers. These arrangements are 'essentially voluntary and born and nurtured out of a shared conviction that working in this way produces superior results and fair, enduring, long-term returns' for shareholders, many of whom are in fact employees. The use of the word 'fair' is highly significant: it implies balanced in relation to other stakeholders' rewards, but it clearly does not imply maximum. What Neill rejects is a 'conflict model', characterised by adversarial annual pricing rounds with suppliers and periodic head-to-head tussles with trade unions. 'Experience shows that if you work within a set of trusting partnerships then you can get your quality up and your costs down faster than if you proceed by way of arm's-length brutal negotiation,' he says.

More than half of the Unipart workforce are shareholders in the company, and more than 90% of those staff who bought shares in the 1987 management buy-out still own them. All employees, from directors to shop floor, are involved in continuous learning programmes and team problem-solving exercises aimed at improving the company's competitiveness. Most famously, the company has set up its own 'university', a training centre in which workers can voluntarily acquire new skills.

External relationships are approached in a similar spirit. Neill quotes the example of a raw materials supplier who came to him and asked for a 25% increase because his own costs had gone up. Four Unipart managers were sent to work with four of the supplier's people to identify unnecessary costs in the supply chain. The result? A 4% reduction on the supplier's original price and an improvement in his profit margin.

As to the community as a stakeholder, Neill shares the view pithily expressed by Chris Haskins of Northern Foods: 'Poor people make poor customers'.

The company supports many small-scale charitable efforts in which its staff are involved. More pragmatically, it provides 'Active IT Weekends' in Oxford schools, an investment in early training in the company's catchment area for future employees.

The spirit which Unipart's management has engendered is genuinely impressive but, as ever Hutton points out, the company enjoys an unusual degree of stability which has allowed it to indulge in social experimentation. As the principal supplier of parts for Rover cars, it has a steady market franchise. More importantly, it remains private and has no plans for flotation, with a substantial portion of its shares in the safe hands of its own employees and one sympathetic institution, Standard Life. It is not prey to the whims of City share traders whom Neill calls 'capital tourists, who seek to enter and exit relationships with companies on the basis of mathematical models and their own short-term horizons'.

Dixons, the high-street electrical retail chain, is certainly subject to those pressures, but Kalms, its founder and 25-year chairman, has never found them a problem. 'I've never met an institution which makes demands inconsistent with my own strategy. We've had our ups and downs, but "short-term vs long-term" has never been a subject for argument. If you're a retailer, you have to have short-term performance. What happens in the short term creates the cash for the long term.'

Kalms sounds at first like the sort of capitalist Hutton would like to abolish, but as he continues, it becomes apparent that the differences between him and Neill are far more subtle. Kalms is a respected philanthropist and a serious thinker: he has endowed a chair of business ethics at London Business School, currently held by a Jesuit priest, Jack Mahoney. He is deeply interested in the stakeholder debate, but his hackles rise at the use of the term itself. 'You couldn't put a piece of paper between what John Neill does at Unipart and what we do at Dixons; we're both applying pragmatic market principles. It's just a difference of vocabulary. I'm passionately concerned about my employees, about their health and their wealth, of course I am. And my managers out there in the stores are frothing with excitement about the business.That's called "identification with the company", "pride", "enjoyment of work" if you like, but you don't have to give it this fancy new label which carries all these other implications.

'And who says I have a duty of care to my suppliers?' he demands, warming to his theme. 'That's a crucial difference between me and some of the stakeholder theorists. I may feel concern or commitment towards suppliers, I may have 40-year relationships with some of them, but that's not the same thing as a duty of care. The consumer is king, we have to focus the attention on him. It's not up to the people in the supply chain to support each other. That's a collectivist approach, it creates an artificial market.'

Dixons, like Unipart, does its bit for the community, funding a City Technology College in Bradford, for example. Kalms acknowledges a gap between free-market theory and good citizenship in practice. 'It's a fine point of argument whether the company has a community role, but in the real world, you have to be socially responsible. Yes, you could say that the market economy moved too fast in the '80s, and that now we're having to pick up some of the pieces. You can also say that life isn't just about arithmetic, and that everything you do has to have integrity and some kind of greater meaning. But the plain fact is that you can't have half a market economy.'

Another senior industrialist who has grappled with these ideas is Sir Anthony Cleaver, former chairman of IBM (UK) and current chairman of AEA Technology. Cleaver chaired the Royal Society of Arts' Tomorrow's Company enquiry, which produced a set of guidelines for an inclusive approach to business leadership, investment, people and society. Neill took part in the enquiry, and many of its findings are akin to Unipart practices.

The term stakeholder makes an appearance in the report ('Yesterday's company thinks of stakeholders in terms of separate transactions or conflicting priorities. Tomorrow's company expects its relationships to overlap and seeks to reinforce the commonality between them.') but it is not prominently featured. The guidelines draw back from radical versions of stakeholder theory, though they were much discussed in the drafting.

Cleaver would like to see a voluntary evolution of business attitudes, in which the measurement of success gradually comes to take account of performance in relation to all five stakeholder groups. 'Take environmental issues as an analogue,' he says. 'No one would agree on a strict set of environmental rules to be imposed on companies, but nowadays there's a consensus that something should be said on the subject and 77% of FTSE companies make some kind of environmental statement in their annual reports.

Each company has to set its own targets, and measure itself against them.

It's the same with these other management issues. A well-run company gets the best value out of all five stakeholder relationships. They have to learn how to measure that value.'

The anti-stakeholding lobby argues that there is no objective formula for defining stakeholder value, and therefore that performance simply cannot be measured in this way. SCA Management Consultants have attempted to measure it nevertheless, by looking at a combination of corporate reputation, growth in pay levels and employee numbers, charitable giving and payment of tax, comparing the results against measurements of shareholder value (defined as total shareholder returns relative to sector peers) for the same companies.

SCA's conclusion affirms almost everything that Cleaver and Neill say: 'The relationship between shareholders and stakeholders is not mutually exclusive as commonly perceived, but is fundamentally based on interdependence. Top value creators depend on motivated employees, good relations with the community and strong reputations for on-going success.' In the retail sector, for example, Marks & Spencer and Boots - two companies which traditionally pay close attention to relationships with staff and suppliers and to their reputation in the community - outperform Sears and Burton on both shareholder and stakeholder value.

There is little disagreement that companies which emphasise staff training, motivation and continuous improvement are very likely to produce better quality results, and in the long run to develop better franchises than those who keep their costs low by aggressive de-skilling and high staff turnover. The M&S model of working intensively with long-term suppliers to achieve the right product specification at the right cost is clearly more admirable as a business principle than simply placing orders with the cheapest bidder. To nurture a good name with customers for value and service, so that they return time after time, is clearly likely to be better for long-term shareholder value than to run a here-today-gone-tomorrow discount operation. To spend modest sums on community support can be a matter of enlightened self-interest when the community provides both the customers and the workforce, and is probably as useful for the company's long-term franchise as money spent on aggressive advertising.

The question here is one of definition: what the best performers are doing is surely following best business practice rather than inventing a new capitalist philosophy or a new business accountability?

So what, other than confusion, does stakeholding without regulation offer the CEO suddenly faced with the knowledge that if he buys cheap, top quality components from abroad and closes the local factory that currently makes them, he can increase his long-term shareholder returns without detriment to customer satisfaction? Plain principles of good management (and duty to shareholders) would tell him that he had to close the factory as humanely as possible. Stakeholder theory would offer him excuses for not doing it or fudging the decision. Indeed in the world which Hutton would like us to contemplate, the requirement for the manager not to close down the local factory might even be set in regulation, and that is the dangerous direction in which stakeholding rhetoric leads.

Take as another example the question of how the benefit of a productivity gain might be fairly distributed: here Hutton wants to see lower prices and higher wages as well as or instead of extra dividends. The problem is that while the shrewd manager might well decide, for broader reasons, to do just that, to be told to do it by regulation would be a new ball game altogether. As Kalms says: 'Ethical behaviour in business has to be encouraged by influence and example, not by prescription. If a Labour government changed the rules to make us responsible to anyone other than our shareholders, then the whole system would be fundamentally changed.

That would really worry me.'

It would worry most managers, and the theory behind it deserves to be conclusively set aside. Decent, intelligent business behaviour deserves to triumph over greedy, savage short-termism: this we all know. But it's a tough world out there, and in the end, even in its most anodyne version, stakeholder theory is not much of a guide. It sounds nice, but it's a recipe for confusion.

Martin Vander Weyer is an associate editor of the Spectator

Investing in Inclusives - Good returns on ethics and altruism

Small company funds, green company funds, ethically sound company funds; clearly it was only a matter of time before somebody set up a fund for those sympathetic to stakeholding values.

First off the mark is Kleinwort Benson Investment Management which has developed a series of investment funds in which the constituent companies are chosen on the basis of recommendations set out in the RSA's Tomorrow's Company report. Specifically these will be 'inclusive' companies which eschew short-termism, practise global benchmarking and look after their key stakeholders. Companies will be judged on points such as customer retention rate and employee participation in decision-making.

Explains Ben Siddons, KBIM's chairman of investment trusts, 'We developed a model portfolio which looked at the performance of companies meeting these criteria from December 1992 to June 1996. The portfolio would have gone up by 90%, compared to 38% on the FT-All Share Index (and 34% on the FTSE 100 Index). It's a commercial proposition of best returns - it's altruistic and ethical, but altruistic and ethical in the sense that this is the way to enjoy sustainable returns.' As the stock of companies already meeting these requirements tends to be very expensive, KBIM will be looking to identify companies which are about to start out on the inclusive route, rather than those such as M&S and Boots which are already there.

The funds will be launched in October and Siddons expects them to be 'sizeable' by the end of the year. If the Tomorrow's Company's findings really are the key to sustainability and the return on real funds can match the model, there are far worse places to put your money: 90% over 31/2 years equals 24,500% over 30.

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