Last week, The Business Roundtable, an organization of 200 CEOs of Fortune 500 companies, released an updated statement on the purpose of business. The priorities that came out of the roundtable may seem like firms are departing from standard business theory, but when examined more closely, it actually appears that the “new” business priorities do affect profit margins. If businesses implement these priorities, they will make more profit. If they don’t, they will lose profit.
Standard business theory suggests that businesses exist to make a profit, i.e. to increase the value of its shares for shareholders. Critics of this theory suggest that businesses ought to take other interests’ into account such as employees, contractors, communities, environment, anyone and everyone who may be affected by a business’ actions and decisions.
The Roundtable veered from the standard theory and added stakeholder aspects to their statement on what a business should be. The new priorities included:
- Delivering value to customers by meeting customer expectations and desires
- Investing in our employees by providing appropriate compensation, benefits packages, and training and development to acquire the necessary skills for changing economy
- Dealing fairly and ethically with our suppliers by being good partners
- Supporting the communities in which we work by respecting the people in our area and protecting our environment through sustainable practices
- Generating long-term value for shareholders by increasing profits and maintaining transparency
However, all of the priorities actually affect profit margins. Businesses are pursuing profit; the only update is that they are revealing how they will continue to make a profit. If a business does all of these effectively, it will make more profit. But if a business does them poorly, it will lose profit.
Take “Investing in our employees” for example. Businesses attach skilled, qualified, hard-working employees by offering a competitive salary, health benefits, good PTO, and maybe a ping-pong table and free snacks. Employees are more likely to work for companies that value them as expressed by compensation and benefits. In today’s tight labor market, businesses must offer these if they want to continue to make a profit because employees are the ones providing the service and making the good. This is actually referred to as the efficiency wage hypothesis in labor economics. The hypothesis argues that wages are not always at equilibrium and there are incentives for employers to pay their employees more than the equilibrium price to increase their productivity and efficiency or reduce turnover costs. When wages are high, employees are more likely to work harder and better for the business, increasing profits! At the end of the day, the better employees a business has, the better the product will be. Therefore, by businesses seeking profit, employees will receive compensation and benefits that motivate them to work well creating a better end product for the company and the customer.
Even protecting the environment and maintaining good relationships within the community can affect stock prices and overall growth of a business. In a sense, the environment is capital. If the environment changes so that a business can no longer provide the goods and services it sells in that area, the business will lose profits. The same goes for good relationships with the community. Both of these contribute to more profits for the business.
To be clear, not everyone will always end up better off when businesses seek profit; there will still be people who lose the economic game. However, these businesses are making incremental improvements towards long-term mutual benefit with practices that benefit both their employees, partners, and communities and bottom line.
ReasonablEconomics 