BRILLIANT ANSWERS ONLY

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Two and a Half Cheers for Conscious Capitalism

James O’Toole David Vogel

D uring the recent decadus horribilis in which, for various rea- sons, companies such as AIG, Goldman Sachs, Toyota, and BP dominated headlines in the business press, a few companies associated with the “Conscious Capitalism” movement have dis-

tinguished themselves by their commitments to ethical and sustainable business practices (see sidebar, “Characteristics of Conscious Capitalism”).

The roll call of companies associated with Conscious Capitalism includes Whole Foods, Trader Joe’s, Southwest Airlines, Starbucks, Patagonia, The Con- tainer Store, and Google. Other companies frequently cited as having similar characteristics include W.L. Gore, Tata, Stonyfield Farms, Interface, and Nucor. Thanks to their relatively strong financial performance, many observers now conclude that there is a viable alternative to the business practices that have recently placed so many corporations in such bad light. Our purpose here is to critically evaluate this claim.

Why Not Three Cheers?

In 1979, Irving Kristol published a volume of essays entitled Two Cheers for Capitalism.1 Even as fervent a champion of economic freedom as Kristol could not give capitalism a third hip-hooray because, as he admitted, the system is, by nature, imperfect. He thus implicitly acknowledged the obvious: despite all its advantages over a centrally planned economy, an unregulated market is prone to boom and bust cycles, rewards short-termism, does not internalize environ- mental costs nor provide for public goods, and can lead to grossly uneven distri- butions of wealth both between nations and, internally, among the populations of capitalist countries.

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It is claimed that the business practices associated with Conscious Capital- ism promise to address such shortcomings of corporate capitalism as currently practiced. Hence, it is not surprising that Conscious Capitalism has been widely embraced by many business leaders, academics, and MBA students who have become enticed by the prospect of integrating greater social responsibility into mainstream business practices. Unfortunately, however, we only can give Con- scious Capitalism two and a half cheers.

We applaud the pioneering efforts of many business leaders to create a new model for business behavior and admire what their firms have accom- plished; hence our two and a half cheers. Yet, we also are skeptical of their claims that their practices will, or can, be more widely adopted, let alone bring about the kind of social and environmental transformation of American business (and world society) that its advocates and adherents envision. Just because some business firms can survive, and even prosper, by behaving more virtuously does not mean that most, or even many, other firms can or will do likewise. We also

Characteristics of Conscious Capitalism

While companies associated with the Conscious Capitalism movement are found in different industries and manifest a wide diversity of management practices, all seem to have at least the following characteristics in common:

Higher Purpose: Profits are viewed as the means to some greater end, but not as the primary goal of a business. While long-term profitability is seen as both necessary and desirable, short-term profits are not pursued at the expense of ethical and environmental considerations or higher human values, such as respect for individuals.

Stakeholder Orientation: The companies commit to meet the legitimate needs of all their organizations’ multiple constituencies (or stakeholders)—including employees, cus- tomers, shareholders, suppliers, dealers, host communities, and the physical environment. They often have a “Triple Bottom Line” accounting focus, which means they judge their performance by social and environmental as well as financial criteria.

Integrated Strategies: They integrate their ethics, social responsibility, and sustainabil- ity practices into their core business strategies. In so doing, they attempt to make all their organizational systems and structures consistent with ethical and sustainable behaviors, practices, and products.

Healthy Cultures: Internally, their organizational cultures manifest a strong sense of “community” created by high levels of employee participation in decision making and the sharing of ownership and profits.

Values-Based Leaders: The Chief Executives of these companies typically are “servant- leaders” rather than celebrities. They are modestly paid relative to their counterparts at other firms, and their compensation often comes from their long-term ownership posi- tions (instead of from salaries 300 to 500 times that of the average employee). They lead by the pull of shared values rather than by the push of command.

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can’t give the movement three cheers because we are concerned that the Con- scious Capitalism movement is creating unrealistic expectations for corporate performance that could serve to undermine other strategies that are needed to reconcile corporate practices and social needs.

Doing Well by Doing Good

While the term Conscious Capitalism is new, its underlying claim that firms can do well, or even better, by doing good is not. Between 1992 and 2003, Howard Rothman and Mary Scott published three editions of Companies with a Conscience, each of which featured profiles of a dozen profitable companies that exemplified the values of “caring capitalism.”2 A steady stream of recently pub- lished books have advised managers how to: make “doing good an integral part of doing well,” “deliver value with values,” “build value through values,” and “profit from passion and purpose.”3 In 2007, Business Week published a special report entitled “Beyond the Green Corporation” with the sub-head, “Imagine a world in which eco-friendly and socially responsible practices actually help the company’s bottom line. It’s closer than you think.”4 The article listed thirty global firms (including Hewlett-Packard, Sony, Marks & Spencer, Novo Nordisk, Nokia, and Dell) each of which was reported to be “doing well by doing good.”5

The claim that virtue pays has recently been given even wider currency under the rubric of “sustainability.” Many advocates of corporate “greening” claim that, according to the title of a recent article published in the Harvard Busi-

ness Review, “sustainability is now the key driver of innovation.”6 This theme is echoed in a steady stream of recently published books with titles such as The Next Sustain- ability Wave; The Sustainable Revolution: Por- trait of a Paradigm Shift; Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage; Cool Companies: How the Best Busi-

nesses Boost Profits and Productivity by Cutting Greenhouse Gas Emissions; and Strategies for Sustainability: A Business Manifesto. These books extol the imperative for firms to incorporate sustainability into their core business practices and strategies and to demonstrate the business benefits of doing so.7

In a similar vein, an organization established in 2006 called the “B Lab” certifies companies that use “the power of business to solve social and environ- mental problems.” According to their website, “B Corporations are a new type of company which are purpose-driven and create benefit not only for shareholders, but for employees, the community, and the environment.”8 Some 364 compa- nies in 54 industries with collective revenues of $1.79 billion dollars have been certified, and the B Lab predicts that “in a generation B Corporations will reach 5-7% of US GDP.”

James O'Toole is the Daniels Distinguished Professor of Business Ethics at the University of Denver's Daniels College of Business.

David J. Vogel is the Solomon P. Lee Chair in Business Ethics and Editor of the California Management Review at the Haas School of Business at the University of California, Berkeley. <[email protected]>

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The Promises of Conscious Capitalism

The Conscious Capitalism movement goes a step further. For example, a recently published book of essays is titled Be the Solution: How Entrepreneurs and Conscious Capitalists Can Solve All the World’s Problems.9 It contains an essay by John Mackey, the CEO of highly successful Whole Foods Market, who has become the leading business advocate of Conscious Capitalism. Mackey argues that Con- scious Capitalism represents a “new paradigm” for business:

Business needs to become holistic and integral with deeper comprehensives pur- poses. Corporations must rethink why they exist. If business owners/entrepre- neurs begin to view business as a complex and evolving interdependent system and manage their business more consciously for the well-being of all their major stakeholders, while fulfilling their highest business purposes, then I believe that we would begin to see the hostility towards capitalism and business disappear.10

According to two other business proponents of Conscious Capitalism, “the profit motive, not government or charity, will create the kind of socially responsible world we want our kids and grandkids to grow up in.” They add that “creating a win-win business model—with the wins being what benefits the company, its stakeholders, and the environment/society in general—is the only way to optimize value.”[italics added]11

Likewise, Gary Hirshberg, CEO of Stonyfield Farms, argues that firms practicing Conscious Capitalism will invariably profit from their actions. His standard lecture to business students, entrepreneurs, and managers is entitled “How to make money and save the world.”12 Like Mackey, Hirshberg strongly believes that a Conscious Capitalist business model both should and can be widely adopted—precisely because it represents such a sound approach to creating value.

The Challenge of Sustaining Virtue

In fact, there is a long history of business leaders who have attempted to act virtuously. The first “conscious capitalist” may have been British textile mill owner Robert Owen. Between 1800 and 1825—the era of Dickens’s “dark satanic mills”—Owen introduced relatively short working hours, a grievance procedure, guaranteed employment during economic downturns, and contribu- tory health, disability, and retirement plans. Owen provided clean, decent hous- ing for his workers in a subsidized community free of controllable disease, crime, and gin shops. He took young children out of the factory and put them in a school he founded and paid for. He invented preschool, day care, and adult night school for his employees and their families. The bottom-line: Owen’s company in New Lanark, Scotland became the world’s most productive and profitable textile mill.13 Like John Mackey and Gary Hirshberg today, Owen then began a public crusade to try to convince other business leaders to adopt his responsible and successful business model.

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However, just when Owen succeeded in winning his worker’s trust, and productivity in the mill started to soar, his co-owners began to question his prac- tices, expressing “disapproval of the mixture of philanthropy and business.”14

Their complaint wasn’t that the mill was unprofitable—it clearly was—but that it could be made more profitable still if only Owen ceased treating his employee so well and, instead, increased dividends to it’s investors. Significantly, no other British business firm adopted Owen’s business model. By 1825, the New Lanark mills were shut down, and a dejected Owen emigrated to America. The lesson we draw from this story is not that social responsibly doesn’t pay; it clearly did at New Lanark. It is rather that virtuous capitalism is difficult to sustain.

In this regard, it is instructive to review what happened to the companies on a list of two dozen firms widely recognized for their social commitments and ethical practices published in 1985.15 Subsequently, six of them were acquired by companies with different philosophies, including environmentalist-oriented Atlantic-Richfield, which was acquired by BP. Two went bankrupt, including Control Data Corporation, which had been the first major American company to publicly commit to seeking profits from “doing good.” Only six of these com- panies—Dayton-Hudson (now Target), Cummins, Xerox, W.L. Gore, and Her- man Miller—still exist, are still financially successful, and still practice something like their original virtuous behaviors. However, (with the notable exception of Gore) some of these companies (Johnson & Johnson and Herman Miller) had their commitments to virtue severely tested over the years, or saw those commitments considerably weakened (Cummins and Xerox) when new CEOs entered their respective executive suites.

The case of Johnson & Johnson is sobering. In the 1940s, General Robert Wood Johnson developed the company’s famous “credo,” which emphasized that the firm’s first responsibility was to “the doctors, nurses and patients, the mothers, [fathers were added in 1989] and all others who use our products.”16

Significantly, the interests of shareholders came last. That commitment was put to the test in 1982 when a psychopath placed poison cyanide in packages of the company’s most successful consumer product, Tylenol, leading to the deaths of seven people. At a cost of more than $100 million dollars, the company imme- diately recalled all packages of Tylenol and offered customers full refunds for their previous purchases of the over-the counter product, even if they already had used all but a few capsules. “By acting decisively, the company was able to relaunch Tylenol—in tamper-proof packaging—within three months,” and had “regained most of its market share within a year.”17

J&J’s 300 word “credo” unequivocally declares that its customers come before its shareholders and its response to the Tylenol crisis dramatically demon- strated the firm’s willingness to honor that commitment. The firm protected not just the consumers of its product, but the company’s reputation as well. In 2004, a senior J&J executive told the Financial Times that “the credo is the first thing you learn when you join the company. You learn to ask: ‘What are the credo implications of this decision?’” The Financial Times wrote admiringly that “few big U.S. corporations wear their values on their sleeves like this.”18 On any list

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of firms whose values and practices reflect the principles of Conscious Capital- ism, Johnson & Johnson deserves a prominent place.19

Yet, beginning in 2008, J&J found itself investigated by the FDA and the subject of numerous complaints by customers due to the poor quality of many of its consumer products. Between 2009 and 2010, J&J initiated seventeen product recalls and, as a result, in 2010 sales of its over the counter products declined by $750 million. At a Congressional hearing in May 2010, the chair of the House Committee on Oversight and Government Reform angrily informed a senior J&J executive that “the information I’ve seen during the course of our investigation raises questions about the integrity of the company. It paints a picture of a com- pany that is deceptive, dishonest, and has risked the health of many of our chil- dren.”20 Ironically, among the several products the company was forced to recall because of customer complaints and FDA investigations was Tylenol.

The widely admired response to the Tylenol poisonings by J&J’s CEO at the time, James Burke, became the subject of a Harvard Business School case study and video that were used in thousands of business school classrooms. Burke himself played a critical role in launching the Business Enterprise Trust in order to recognize other examples of responsible corporate behavior.21 How- ever, in October 2010, the Harvard Business School published a case study of the firm’s behavior that offered business students a rather different lesson, namely, how a firm’s reputation and market share can be damaged by a lack of attention to quality control.22

Toyota’s introduction of the hybrid Prius in 1997 was applauded by envi- ronmentalists and became a major commercial success. Toyota quickly gained a reputation as the world’s “greenest” car company. In 2009, however, several of Toyota’s models were discovered to have safety defects—including, ironically, the Prius. Much like the situation at J&J, a wave of recalls—25 in only 30 weeks in 2010—rapidly undermined Toyota’s long-established reputation for quality control, leading to a reduced market share and a decline in shareholder value.

BP (British Petroleum) suffered a similar fall from virtue. In 1997, it became the first global energy firm publicly to acknowledge the risks of global climate change, and prominently featured its commitment to sustainability by changing its name to BP (Beyond Petroleum). The corporation pledged to reduce its greenhouse gas emissions by 10 percent from 1990 levels by 2010— a goal it achieved nine years ahead of schedule—and substantially increased its investment in solar energy. In 2005, BP was named the Financial Times’ “most respected energy company,” and Business Week ranked it in second place on its list of the “greenest companies of the decade.”23 Yet, in 2005, an explosion at the company’s refinery in Texas attributed to inadequate maintenance resulted in 15 deaths and, a year later, inadequate maintenance of its pipelines in Alaska led to several oil spills.24

Then, in the spring of 2010, a drilling platform owned by BP in the Gulf of Mexico exploded, killing eleven workers and producing the largest oil spill in American history. Clean-up costs, fines, and punitive damages (which will be borne by the firm’s shareholders), currently are estimated at billions of dollars.

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The company has also sold off its investments in solar energy. Thus, in little more than a decade, BP went from being seen as the world’s most admired and “greenest” energy company to one widely regarded as one of the most environ- mentally destructive and irresponsible.

Such examples suggest that it is very difficult for companies—particu- larly publicly traded ones—to sustain commitments to virtue over the long run. In reality, the world of business is harsh. Recall that for some fifty years, Levi-Strauss had the reputation for being America’s premier employer of blue- collar workers, yet today it has no manufacturing facilities in the United States. Doubtless, virtue can be sustained: witness Southwest Airlines, Nucor, SRC Holdings, and Gore. However, for the vast majority of socially responsible com- panies, a change in leadership, in technology, or in competitive pressures and, almost always, a takeover will undermine the kinds of behaviors promoted by Conscious Capitalists. This is not to predict that many or even some of the firms identified with Conscious Capitalism will suffer similar fates. However, it does point to the challenges any firm faces in maintaining a responsible business models in the long-run and underlies how difficult it is to make “sustainable” business models truly sustainable.

Competing Business Models

Another source of our skepticism is the limited applicability of the busi- ness model that underlines Conscious Capitalism to many other firms and indus- tries. The problem is not that Conscious Capitalism isn’t a viable business model; it clearly is. Rather, it is not the only viable business model. Scores of business books claim to have discovered the key to business success,25 but none has actu- ally discovered this holy grail for the simple reason that no one business strategy or model is always, or continually, superior to every other one. The same holds true for Conscious Capitalism’s business models. As the experience of American financial institutions demonstrates, firms may prosper by offering highly inflated compensation to their senior managers. Many industrial firms in the United States have delivered high returns to their shareholders precisely by laying off large numbers of employees. Firms may also flourish by marketing highly attrac- tive products or services—for example, Apple, E-Bay, Microsoft, Facebook, Veri- zon, and H&M—without practicing any of the tenets of Conscious Capitalism.

Because the number of successful business strategies and models is infi- nite, no one is, or can always be, superior to all the others. The business world is highly complex and the sources of business success are diverse and constantly changing. Why, then, should we expect all, or even most, firms to follow the Conscious Capitalist route when there are so many others readily available that are at least, if not even more, profitable? The reality is that many firms have and will continue to prosper that do not subscribe to the principles and practices of Conscious Capitalism. That is why we are not convinced that Mackey, Hirshberg, and others will be any more successful than Owen was two hundred years ago in convincing other executives to “get religion” and change the way they con- duct their businesses.

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In this context, it is instructive to examine lists of the most successful newly established companies, most rapidly growing firms, and most successful brands (all of which are periodically published in the business press).26 Certainly, such lists typically include firms identified with the Conscious Capitalism move- ment and others recognized for being among the most sustainable or “green- est.” Yet, the overwhelming majority of companies found on such lists could not by any stretch of the imagination be described as having “doing good” at the core of their business models or strategies. The lesson is not the simple one that Hirshberg claims (to whit, those who do good will do well), but the more complex truth that some firms succeed by doing well, some that do good do not do well, some that don’t do good do well, and some who don’t do good don’t do well!27

The Shortcomings of Stakeholder Management

We also are skeptical of the commitment of Conscious Capitalism firms to treat all their stakeholders equally and fairly. This goal is laudable, but often dif- ficult to realize in practice. Without doubt, there are some—even many—busi- ness decisions that benefit multiple stakeholders, and Conscious Capitalists make an important contribution by developing and implementing those. Nonetheless, it strains credulity to believe that all business decisions fall into this category. At publicly traded corporations, in particular, meeting investor expectations is criti- cal, and mangers have no choice but to put the interests of shareholders first. While Conscious Capitalists are correct in claiming that meeting the interests of other stakeholders is ideally the best strategy for creating profits for owners, it is also the case that the interests of stakeholders can and often do diverge.

For example, when a company lowers its costs by outsourcing production to developing countries, what is good for its customers is not necessarily benefi- cial for its employees, and when sales decline, firms often have no alternative but to lay-off employees to the benefit of shareholders. In the final analysis, the ability of Conscious Capitalist firms to treat all stakeholders equally and fairly is predicated on their ability to maintain a relatively high level of profitability. However, in a highly competitive global economy, firms managed according to the tenets of Conscious Capitalism, like all other firms, suffer periodic financial reverses. Unfortunately, the principles of Conscious Capitalism provides no guide to help managers recognize, let alone manage, the kinds of painful trade-offs all firms must periodically be prepared to make in order to survive. Moreover, absent that guidance, it is realistic to assume that when making such necessary trade-offs, the interests of investors are likely to be paramount, especially if the firm is publically traded.

The Limited Potential of Firms to Do Good

The Conscious Capitalism movement also exaggerates the potential of business firms to “do good.” An important insight and contribution of Conscious

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Capitalism, and the corporate social responsibility and sustainability movements in general, has been to show that firms have more potential to make positive social and environmental contributions than many managers and owners, as well as critics of corporate capitalism, have recognized. Most companies, for example, have found profitable ways to treat their employees better or to reduce their environmental footprints. In addition, some companies have discovered profitable ways to address the needs of the world’s poorest citizens. The list of such activities is large, and growing.

Some critics scoff at such profitable activities, claiming that they are not socially responsible at all but, rather, “just good business.”28 Others claim that most of these activities have been “low-hanging fruit,” and the opportunities for future “win-win” business opportunities have been exhausted, or will be much harder to come by in the future. In our judgment, such criticisms are misguided. Many business opportunities to do both well and good are not like the proverbial ten dollar bill lying on the street, just waiting to be picked up by any far-sighted manager or economist. In fact, discovering such business activities has often required, and will continue to require, a conscious commitment on the part of entrepreneurs and managers to look for them.

Wal-Mart’s recent environmental efforts are an instructive case in point. Many of the firm’s recent, highly publicized environmental initiatives have resulted in substantial cost savings to the company.29 This raises an interesting question: why didn’t the firm’s highly cost-conscious managers discover and adopt them earlier? Why did they only begin to do so after the firm decided to make sustainability an important strategic goal (albeit motivated, in part, as a way of deflecting public criticism from its labor practices)?

Why weren’t these costless and cost-saving activities undertaken until the firm began to work with environmental consultants and non-government orga- nizations? The most likely answer is that its managers had neither the time nor the interest to focus on these particular business opportunities; they had other priorities. In short, the “consciousness” of capitalists, or the values they bring to their business activities, do matter; it can enable them to uncover opportunities for virtuous behavior that more conventional owners or managers whose only focus is on the “bottom-line” are more likely to overlook.

Yet, as we discuss below, the number of such “win-win” business oppor- tunities is also limited. It is unrealistic to suggest that even the most socially conscious and committed business managers can “solve the world’s problems.” Many of those problems are simply beyond the scale, scope, and competencies of business firms to address. Some of those problems may require governmental action, while others are better addressed by non-profits or by social enterprises not required to deliver a market rate of return. Capitalism, as Kristol noted, is a wonderful system whose ability to improve public welfare is indeed extraordi- nary—but there are many laudable goals that the market is simply incapable of accomplishing—however commendable the intentions and actions of Conscious Capitalists.

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Ethics and Profits

A useful way of thinking about the complex relationship between virtue and profits is to view business activities as falling into one of four categories (see Figure 1):

Cell One represents the “zone of opportunity” for Conscious Capitalism, corporate social responsibility, and sustainable business practices. Many of the businesses created by the new, so-called “social entrepreneurs” fall into this cat- egory. These entrepreneurs (profiled regularly in BusinessWeek and Fast Company) have developed business models that make money by doing good—for example, by creating an inexpensive product for sale in the developing world that simply and quickly purifies water, or by marketing healthy, environmentally friendly products domestically. There are, literally, thousands of examples of business activities that fall into this first category. Indeed, almost all of virtuous activities typically associated with the policies and practices heralded by Conscious Capi- talists are found in Cell One. Such activities—running the gamut from recyclable shopping bags to employee stock ownership programs—are desirable economi- cally, socially, environmentally, and ethically.

In the increasingly important arena environmental performance, in par- ticular, many firms are now investing in Cell One green production technolo- gies, developing greener products, becoming more energy efficient, and reducing their waste—all practices that have a positive effect on the bottom line. Envi- ronmentalist Amory Lovins argues that corporate measures designed to increase energy efficiency and encourage the use of renewable resources mostly pay for themselves within a year: “That’s not a free lunch. It’s a lunch you are paid to eat.”30 Hence, numerous startups, as well as established multinationals such as General Electric and Wal-Mart, have learned and demonstrated that “green” can be “green.” These instances of a positive relationship between CSR and prof- its are important. We confidently expect creative, socially or environmentally motivated entrepreneurs, as well as senior and middle corporate managers, to discover many more business opportunities that fall into this category.

Indeed, if all business activities were to potentially fit into Cell One, then advocates of Conscious Capitalism would have a strong, even compelling, case.

FIGURE 1. Categories of Business Activities

Cell One Profitable/Virtuous

Cell Two Not Profitable/Virtuous

Cell Three Profitable/Not Virtuous

Cell Four Not Profitable/Not Virtuous

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Unfortunately, most do not. In fact, Cells Two and Three are now, and are likely to remain, much larger. While some seemingly inescapable business tradeoffs can be avoided through the creative rethinking of a problem or policy (creating “win-win-win” polices, as Conscious Capitalists say), it is misinformed to claim that all or even most socially or environmentally desirable business activities can and will form into Cell One. For example, some anti-pollution (Cell One) practices literally pay for themselves in the long run: the cost of replacing an incandescent light bulb with a fluorescent one typically pays for itself, as Lovins claims, through lower electric utility bills within a year. However, not all do: for example, constructing a truly carbon neutral office building (Cell Two) is pos- sible but not financially viable, and no one has found an economical way of burning coal (Cell Three) that is carbon neutral. A major problem with the argu- ments typically put forward in favor of Conscious Capitalism is that they do not distinguish among the business activities that fall into each of these cells.

Consider an example of a potentially virtuous (Cell Two) practice that Wal-Mart, while lauded for its green initiatives, has not adopted. The company sells many small products—particularly electronics—in large, hard, plastic shells (the frustrating kind you can’t cut into even with a Ginzu knife!). These shells protect the products, allow for large colorful packaging, and reduce shoplifting. They are also non-biodegradable, typically not recycled, and their manufacture is highly energy-intensive. Indeed, it is not unlikely that, were Wal-Mart to stop using these shells, that action would produce at least at least as many environ- mental benefits as any of its well-publicized “green” initiatives.

However, Wal-Mart’s managers understand there is no economical way for them to replace the shells. So they continue to use them. Of course, if someone could come up with an effective substitute, or if consumers began to demand different packaging, Wal-Mart’s managers presumably would be happy to insist that their suppliers change their packaging. However, until this hap- pens, Wal-Mart sees little choice but to continue to use them.

Consider another example. Meat production is widely regarded as envi- ronmentally destructive: at the least, it is a highly inefficient way to deliver protein to consumers. Yet Whole Foods, which is committed to marketing sus- tainable food products and whose CEO is incidentally a vegan, continues to sell meat (albeit without hormones and antibiotics). It does so for the simple reason that meat sales are a highly profitable (Cell Three) product for which there is strong consumer demand.

The extent to which American businesses can be said to have become “more sustainable” over the last decade is due largely to their increasing adop- tion of Cell One environmental practices that are both profitable and virtuous. Unlike some critics, we do not question the motives of those who make money from their good deeds. Instead, our concern is that business students, corporate managers, entrepreneurs, and the general public are confusing those profitable activities with the unprofitable ones found in Cell Two.

To be sure, the distinction between which virtuous practices fall into Cell One and which belong in Cell Two is not always obvious. As we note above, one

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of the contributions of Conscious Capitalism has been to broaden the scope of Cell One by encouraging many managers to recognize that the number of virtu- ous activities that are, in fact, financially viable is both large and growing. More- over, the economic benefits of many business programs or policies associated with corporate social responsibility can be difficult to quantify and, thus, man- agers enjoy a considerable degree of discretion in deciding which responsible activities make business sense.

The decision of Merck to develop and distribute free of charge a drug to cure river blindness is a case in point. At various times, the firm’s managers had to decide whether to commit additional financial resources to this project. Because the business case for doing so was always unclear and uncertain, Mer- ck’s managers could just as easily have decided it was in the long-term interests of their shareholders not develop the drug and pay for its free distribution. Even with 20/20 hindsight, it is not clear how the decision that amounted to giving away hundreds of millions of dollars has affected Merck’s shareholder value in the long term.31 While Merck’s managers are to be commended for deciding that developing and distributing the drug free of charge fell into Cell One, other managers with different values, priorities, or perspectives could just have easily decided to place it in Cell Two. Again, the values of managers and the culture of firms do matter.

The Need for Government

During the recent political and ideological Sturm und Drang surrounding the passage of Federal health care reform, Whole Foods CEO Mackey suggested that the entire debate would be made moot if all employers simply adopted the Conscious Capitalist practice of providing private health insurance to their employees and their families. In theory, that statement is correct. If all employ- ers provided such insurance there would be no need for government health care programs (beyond those offered to unemployed and retired Americans and their families). Unfortunately, in practice, a great many employers cannot or will not provide such coverage to their workers.

The fact is, most American businesses are small, marginally profitable operations. Some of those employers might like to offer health insurance to their employees but, in order to do so, they either would have to substantially raise the costs of their products, or greatly reduce the number of workers on their payrolls. Thus, if the goal is to increase access to health care, private employers cannot be counted on to provide it, despite the urgings of Conscious Capitalists (who, by and large, are in high-margin, or relatively profitable, business sectors).

Note the issue here is neither health care nor ideology; instead, it is the over-promising of the business benefits of virtue. From our perspective as business professors, the effects of such unrealistic claims are corrosive. In the business press, the halls of Congress, the classroom and, ironically, even in the writings of the harshest critics of corporations, publicly stated expectations concerning the social and environmental benefits of marketplace behavior are becoming wildly

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inflated. Thus, for example, we now hear that the market can “solve” the prob- lem of making economic growth sustainable and also eradicate global poverty.

Business students are particularly susceptible to such hyperbole: caught up in the rhetoric of Conscious Capitalism, one enthusiastic team of MBA stu- dents competing in a global case competition recently claimed that the progres- sive policies of India’s Tata Corporation would “solve the problem of poverty in the developing world.” Now, Tata many be one of the world’s most socially conscious global companies, but its business decisions are highly unlikely to end, or even significantly ameliorate, third-world poverty. The fact is that some prob- lems are so large, or systemic, that they cannot be solved solely by the actions of individual businesses—even if all or most of those actions somehow could be “voluntarily” channeled in the same direction. That is why, for example, many corporate executives and entrepreneurs understand that government support is needed to fund high-risk activities for which there is no short-term payoff, such as research and development grants for renewable and clean energy as well as pharmaceuticals for which there is a very small market,

Government regulation is also necessary to overcome the effects of non- internalized costs and free-rider behavior. For example, the problem of urban air pollution in the 1970s could not have been addressed effectively by any one auto company virtuously installing costly catalytic converters in their vehicles. To do so would have put that company at a significant price disadvantage against its converter-less competitors. So Congress passed the Clean Air Act mandating such equipment for all vehicles sold in the United States, thus leveling the play- ing field for all car manufacturers. During the last five decades, thanks to these and other Federal mandates and regulations, America’s air quality has dramati- cally improved. However, it would have not done so had the American public relied on the conscience or consciousness of automobile manufacturers.

Conscious Capitalists must recognize there are many such large, systemic problems that require sensible government regulation and incentives to spur virtuous market behavior. As Adam Smith might have reminded us, we can’t depend on the benevolence of convenience-shop owners to prevent minors from buying alcohol and cigarettes. Those who acted virtuously would simply lose market share to competing merchants willing to peddle those products to underage children. In effect, government laws prohibiting such sales actually benefit virtuous storeowners by leveling the playing field. Similarly, it is unrealis- tic to expect virtuous manufacturers to voluntarily impose stringent health and safety standards in their own workplaces if their competitors are not also required to do so. There are thus valid economic reasons why such federal regulatory agen- cies as OSHA, EPA, CPSC, and the FDA exist.

That is why we suggest that a greater understanding of history— espe- cially the history of government regulation in free-market economies—would enhance the credibility of some of the most idealistic proponents of Conscious Capitalism (a reading of Upton Sinclair’s 1906 classic, The Jungle, might be a good place to start). The argument “that was then, but now the FDA is no longer needed because the Millennial Generation’s values have so evolved that no meat

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packers today would adulterate their products” requires one to believe, naively in our view, that market incentives have significantly changed. In this context, it is worth noting that, in the 1990s, the financial industry convinced many policy- makers in Washington that it was capable of self-regulation.

The Limits of Conscious Capitalism

Conscious Capitalists neither discovered the business benefits of corporate virtue, nor were they the first to practice enlightened business behavior. The singular fresh contribution of Conscious Capitalism is its philosophical squar- ing of free-market principles with progressive business practices by stressing the profit-making potential of responsible, ethical, and sustainable corporate behav- ior. Since no corporate managers want to be accused of taking advantage of shareholders, this re-branding is significant because it legitimates a wide range of more responsible corporate practices. The creation of a common ground for pro- gressives and libertarians is no mean feat (although it is easier to do at the micro, firm level, than the macro, national level). Indeed, we believe this creative squaring of the circle is why the movement is increasingly seen as so attractive.

Yet, at the same time we need to recognize that because markets have limits, various kinds of government intervention, along with the activities of non-profit organizations, remain essential to address many world problems. Clearly, Conscious Capitalism can inspire the improvement of many corporate practices, which is an objective we applaud and wish to encourage. However, its adherents need to develop a more realistic understanding of what even the most socially conscious capitalists can and cannot accomplish. By promising more than it can deliver, the Conscious Capitalism movement is in danger of imped- ing rather than promoting the kinds of social and environmental goals it seeks to achieve, most notably by ignoring the necessary role for government.

Our Recommendations

A good first step for the movement’s advocates would be to make clearer distinctions between “shoulds,” “cans,” and “wills;” otherwise they risk continu- ally engaging in the fallacy of composition: to wit, “because many virtuous com- panies are profitable, all are, or can be.” Yes, every company that can adopt the tenets of Conscious Capitalism should do so but, realistically, not all companies or industries can. In particular, many small businesses lack sufficient funds to behave generously to their employees and other stakeholders even if they would like to, and many profitable businesses can’t because of the nature of their busi- nesses or the technologies they employ. In this context, it is important to note that the firms associated with the Conscious Capitalism movement are far from a random sample of American businesses: In fact, a great many sell relatively expensive products to relatively affluent, socially- or health-conscious consum- ers. It is hard to imagine how a coal company could embrace the principles and practices of environmental sustainability.

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Moreover, since “sustainability” is central to the concept of Conscious Capitalism, it is important not to overlook two inherent threats to Conscious Capitalism, namely, the Body Shop Syndrome (when enlightened entrepreneurs seek to retire from the virtuous businesses they have founded) and the Ben and Jerry Effect (when shareholders demand that founders sell their company to a larger firm at a substantial premium). In both instances, virtuous entrepreneurs end up selling their companies to large corporations who promise to remain true to the founder’s values—but then seldom make good on that promise.

Real efforts are needed to discover how virtuous companies can be made to last beyond the careers of their founders. For example, should Conscious Capitalist entrepreneurs commit themselves to selling out only to their employ- ees and not to large, publicly traded businesses? Given the single-minded pur- suit of short-term profits that characterizes American stock exchanges, should Conscious Capitalists be focusing on alternatives to equity financing? Moreover, what happens when a CEO with strong Conscious Capitalist values leaves the firm, as has recently happened to Jeffery Hollender, an influential advocate of corporate virtue whom the board of directors recently removed from the man- agement of Seventh Generation.32 Will Whole Food’s corporate mission survive the retirement of Mackey? What will happen to Stonyfield Farms after the departure of Gary Hirshberg?

Conscious Capitalists might also benefit from acknowledging that a great many business people don’t care about anything more than enhancing the bot- tom line. Why should we expect the many people who enter business only to become more financially successful to change their values now and become Conscious Capitalists? Perhaps they should, and some will; but many won’t, or can’t.

On our part, we will continue to applaud virtuous business practices wherever we see them and to encourage our MBA students to behave ethically and responsibly. Nonetheless, we must warn the most enthusiastic of our fellow travelers that they may be over-promising what business can realistically deliver by promoting a false sense of complacency about the capacity of business to solve the world’s problems. This will in turn divert public and business attention from the many instances in which government support or regulation is essen- tial in order to enable firms to behave responsibly without disadvantaging their shareholders.

Notes

1. Irving Kristol, Two Cheers for Capitalism (New York, NY: Basic Books, 1978). 2. Mary Scott and Howard Rothman, Companies With a Conscience: Intimate Portraits of Twelve

Firms that Make a Difference (Secaucus, NJ: Carol Publishing Group, 1992); Mary Scott and Howard Rothman, Companies with a Conscience: In-Depth Profiles of Businesses that Are Making a Difference (Franklin Lakes, NJ: Career Press, 2002): Howard Rothman and Mary Scott, Companies with a Conscience: Intimate Portraits of Twelve Firms that Make a Difference (Denver, CO: The Publishing Cooperative, 2003).

3. Marc R. Benioff and Karen Southwick, Compassionate Capitalism: How Corporations Can Make Good an Integral Part of Doing Well (Franklin Lakes, NJ: Career Press, 2004); Ira A. Jackson and Jane Nelson, Profits with Principles: Seven Strategies for Delivering Value with Values (New

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York, NY: Doubleday, 2004); Fred Kofman, Conscious Business: How to Build Value Through Values (Boulder, CO: Sounds True, 2006); Rajendra Sisodia, David B. Wolfe, and Jagdish N. Sheth, Firms of Endearment: How World-Class Companies Profit from Passion and Purpose (Phila- delphia, PA: Wharton School Publishing, 2007).

4. Pete Engardio, “Beyond The Green Corporation,” Business Week January 28, 2007, pp. 51-64. 5. Some of these same firms were described in James O’Toole, “Do Good, Do Well: The Busi-

ness Enterprise Trust Awards,” California Management Review, 33/3 (Spring 1991): 9-24. 6. Ram Nidumolu, C.K. Prahalad, and M.R. Rangaswami, “Why Sustainability is Now the Key

Driver of Innovation,” Harvard Business Review, 87/9 (September 2009): 56-64. For a more recent exposition of this theme in HBR, see David A. Lubin and Daniel C. Esty, “The Sus- tainability Imperative,” Harvard Business Review, 88/5 (May 2010): 42-50.

7. Andres R. Edwards, The Sustainability Revolution: Portrait of a Paradigm Shift (Gabriola Island, BC: New Society Publisher, 2005); Bob Willard, The Next Sustainability Wave: Building Board- room Buy-In (Gabriola Island, BC: New Society Publishers, 2005); Daniel C. Esty and Andrew S. Winston, Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage (New Haven, CT: Yale University Press, 2006); Christo- pher Laszlo, Sustainable Value: How the World’s Leading Companies Are Doing Well by Doing Good (Stanford, CA: Stanford University Press, 2008); Adam Werbach, Strategy for Sustainability: A Business Manifesto (Boston, MA: Harvard Business School Press, 2009).

8. <www.bcorporation.net>. See also Hannah Clark Steiman, “A New Kind of Company: B Corporations worry about stakeholder, not just shareholders,” Inc. Magazine, July 1, 2007, pp. 23, 24.

9. Michael Strong, Be the Solution: How Entrepreneurs and Conscious Capitalists Can Solve All the World’s Problems (Hoboken, NJ: John Wiley & Sons, 2009).

10. John Mackey, “Creating a New Paradigm for Business,” in Michael Strong, Be the Solution: How Entrepreneurs and Conscious Capitalists Can Solve All the World’s Problems (Hoboken, NJ: John Wiley & Sons, 2009), p. 103. The need to reinvent capitalism by making the new pur- pose of the corporation the creation of shared value is echoed by Michael Porter and Mark Kramer. See Michael E. Porter and Mark R. Kramer, “Creating Shared Value,” Harvard Busi- ness Review, 89/1-2 (January/February 2011): 62-77.

11. G. Michael Maddock and Ralphael Louis Vitón, “Conscious Capitalism: Doing Good Via Self- Interest,” Bloomberg Businessweek, December 8, 2009.

12. Gary Hirshberg, “How to Make Money and Save the World,” address given at “Conceptual- izing Conscious Capitalism” conference, Bentley College, May 24, 2010.

13. James O’Toole, Leading Change: Overcoming the Ideology of Comfort and the Tyranny of Custom (San Francisco, CA: Jossey-Bass, 1995), chapter 11.

14. G.D.H. Cole, The Life of Robert Owen, Third Edition (Hamden, CT: Archon, 1966), p.187. 15. James O’Toole, Vanguard Management: Redesigning the Corporate Future (New York, NY: Dou-

bleday, 1985), pp 19-22 16. Simon London, “J&J stands proudly by its leader’s words,” Financial Times, August 31, 2004,

p. 10. 17. Ibid. 18. Ibid. 19. The firm was prominently featured in Rajendra S. Sisodia, David B. Wolfe, and Jagdish N.

Sheth, Firms of Endearment: How World-Class Companies Profit from Passion and Purpose (Upper Saddle River, NJ: Wharton School Publishing, 2007).

20. Mina Kimes, “Why J&J’s Headache Won’t Go Away,” Fortune, September 6, 2010, p. 100. 21. O’Toole (1991), op. cit. 22. Clayton Rose, Sandra J. Sucher, Rachel Gordon, and Matthew Preble, “On Weldon’s Watch:

Recalls at Johnson and Johnson from 2009-2010,” Harvard Business School Case #9-311- 129, October 21, 2010.

23. R. Fernando and D. Purkayastha, “BP: Putting Profits Before Safety,” IBS Center for Man- agement Research, 2007, p. 12; “Top Companies of the Decade,” Businessweek, December 12, 2005, <businessweek.com/magazine/content/05_50/b3963415.htm>.

24. Nelson Schwartz, “Can BP Bounce Back?” Fortune, October 16, 2006, pp. 90-99. 25. For an extended critique of this literature, see Phil Rosenzweig, The Halo Effect…and the Eight

Other Business Delusions That Deceive Managers (New York, NY: Free Press, 2007); Phil Rosen- zweig, “Misunderstanding the Nature of Company Performance: The Halo Effect and Other Business Delusions,” 49/4 (Summer 2007): 6-20.

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26. For example, see <http://www.businessweek.com/investor/content/jun2010/ pi20100616_807732.htm?chan=investing_special+report+--+bloomberg+businessweek+50 _special+report+--+bloomberg+businessweek+50>; <http://www.businessweek.com/inter- active_reports/bw50_table_wk26.html?chan=investing_special+report+--+bloomberg+busi nessweek+50_special+report+--+bloomberg+businessweek+50>; <http://money.cnn.com/ magazines/fortune/fortunefastestgrowing/2010/full_list/>; <http://money.cnn.com/maga- zines/fortune/fortunefastestgrowing/2010/companies/profitgrowth/>; <http://www.inc. com/inc5000/2010/index.html>.

27. For a more extended analysis of the tenuous relationship between ethics and profits, see David Vogel, The Market for Virtue (Washington DC: Brookings Institution Press, 2005), chap- ter 2.

28. Aneel Karnani, “‘Doing Well by Doing Good’: The Grand Illusion,” California Management Review, 53/2 (Winter 2011): 69-86.

29. Marc Gunther, Doris Burke, and Jia Lynn Yang, “The Green Machine,” Fortune, August 7, 2006, pp. 42-57; Erica Plambeck and Lyn Denend, “The Greening of Wal-Mart,” Stanford Innovation Review (Spring 2008), pp. 52-59.

30. Amory Lovins, interview by Lucy Siegle, The Observer, Sunday, March 23, 2008. 31. “Face Value: The Acceptable Face of Capitalism?” The Economist, December 12, 2002,

<www.economist.com/node/1491753>. 32. <http://dotearth.blogs.nytimes.com/2010/11/02/a-pioneer-in-green-business-is-fired/>,

<www.nytimes.com/2011/02/24/fashion/24HOLLENDER.html>.

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