Monday, April 22, 2013

Profit Beyond Measure

The greatest gains and losses cannot be measured but they must be managed. 

This is not a very well appreciated sentiment in business today.  The relationship between measurement and management, characterized by such expressions as “if you can’t measure it, you can’t manage it” are considered common sense adages in any business context today - including sustainability.  A few years ago, an article in The Economist magazine discussing the merits of sustainability's most famous business framework, Triple Bottom Line, stated  “Behind it lies the … fundamental principle: what you measure is what you get, because what you measure is what you are likely to pay attention to.”  Having three bottom lines – the thinking goes – means having three areas to measure, and thus to focus management attention.

Redefining management as measurement has been promoted and fostered over the years by such management trends as MBO (Management By Objective), which was a system for setting targets and goals for business managers with emphasis on results rather than methodology.  As the popularity of MBO faded, another even more prevalent tool for measuring management success emerged and continues to thrive.  The Balanced Scorecard reduces management performance to impacts in four areas: financial results, customers, operations, and employee development.  A particular manifestation of the Balanced Scorecard, according to The Economist, is Triple Bottom Line.

To understand why or whether we need to rethink Triple Bottom Line, we might begin by studying the fascinating history behind The Balanced Scorecard.  The Balanced Scorecard grew out of a book by Robert Kaplan and Tom Johnson published in 1987 under the title Relevance Lost: The Rise and Fall of Management Accounting.  In short, it dealt with the failure of American business to see beyond the numbers.  Financially oriented management, in their view, was ruining American competitiveness.  Because of the way costs were being allocated, companies were shutting down profitable product lines because they looked costly on paper.  This was making companies less profitable and more vulnerable.  Relevance Lost was a hugely successful business book, named by Harvard Business Review as one of the most influential of the last century. 

Kaplan and Johnson together enjoyed their success, but when it came to talking about solutions to the problem, the deeper they dug the more they realized how much they differed.  Kaplan felt that the problem described in Relevance Lost was about failing to pinpoint accurately where the costs really lie.  If the costs could be allocated properly, through Activity Based Costing (ABC) and The Balanced Scorecard, then accounting would become relevant once again, and American competitiveness would return.

Johnson questioned the very premise of making decisions from quantitative information, rather than from explicit, detailed knowledge of how a company conducts work. As Art Kleiner discussed in his article in strategy+business about the Kaplan/Johnson feud, Johnson saw a business obsession in ‘looking good’ by the numbers, that threatened “to damage the underlying system of relationships that sustain any human organization.”  Johnson went on to say that quantitative generalizations apply to mechanistic systems.  By definition a mechanism is nothing but a system of parts whose interactions can be defined entirely in quantitative terms.  Businesses are systems but not mechanisms since they are planned and managed by and for human beings.  Johnson was trying to show that reducing to a number creates “a mind-set that leads people to pay less attention to the day-to-day particulars of work.”  Kaplan’s balanced scorecard, on the other hand, reduced the essential business activities to those that could be represented in quantitative measures.

New Management Thinking

A new kind of management thinking is going to be required if over the next twenty to thirty years billions of people are to emerge from poverty into a global economy that works for all.  It is becoming essential for corporate managers to understand the interconnections and interdependencies between once disparate and disconnected systems.  (The GreenBiz VERGE conferences are a great example of this – showcasing convergence to solutions to 21st century problems.)  As once fragmented parts of the economy are becoming more connected, systems thinking is more critical.  And there is a tremendous financial benefit in managing from a systems perspective as Johnson articulates in his book Profit Beyond Measure.  If sustainability is to succeed as an organizing principle for all business everywhere, the message of Profit Beyond Measure must become ubiquitous, as Triple Bottom Line has been over the last 15 years.  Profit Beyond Measure conveys a future of prosperity that understands the importance yet the limits of measures, and the necessity of understanding the interrelationships and dynamics of systems.  The most powerful and sustainable systems on earth are natural systems, and they are characterized by three important principles (1) Self-organization, (2) Interdependence and (3) Diversity (SoID).  As opposed to Triple Bottom Line, these are the Triple Emergent Properties (3EP) of sustainable systems.  

 In Profit Beyond Measure we are introduced to one of the world’s largest manufacturers (The Toyota Motor Corporation) where the Triple Emergent Properties of SoID characterized the manufacturing process.  The result was one of the most sophisticated, highest quality, and lowest cost automobile plants in the world (located in Georgetown, Kentucky.)  Indeed, Toyota’s quality calamities over the last several years have been recognized by the corporation as directly attributable to the company’s shift in focus to reductionist targets for growth (which may have made those keeping the scorecard happy for a while), but ultimately disregarded the systems appreciation of SoID.and degraded Toyota’s long-built reputation for impeccable quality.

Sustainability will become a property of the global economy when thinking in accounting metaphors is supplanted by thinking in systems.  Some might see this as a new-age management gimmick, but actually it’s an age-old management skill.  Even accounting itself used to embody a systems approach to professional and business development.  Arthur Andersen had been an organization of the highest reputation in the accounting industry.  It took the greatest care in whom it hired, whom it took on as clients, how fast it expanded its business and how carefully it imbued the “Arthur Andersen Way” to its employees, its customers and all its stakeholders.  Andersen saw itself as a system, and its high profits and impeccable reputation were outcomes of a self-organized, interdependent and diverse system.  Over time the firm changed, driven by programs like MBO and The Balanced Scorecard, corporate silos developed fostering a culture of profits and growth as ends in themselves.  Stephen Duggan, a long-retired senior partner who once ran Andersen’s entire northern European operations out of Brussels, reflected on the organization's transformation.  As his erstwhile firm lay in ruins from scandal, lawsuit, and criminal indictment, Duggan was asked how could this happen to such a great company.  He paused for a long while, thinking very carefully about his answer, and then said “I tell you, it really started to change when we began measuring everything.”

The greatest gains and losses cannot be measured, but they must be managed.

Wednesday, April 10, 2013

Moving Beyond the TRIPLE BOTTOM LINE

“Become the change you want to see in the world.” 
- Mahatma Gandhi

“Problems cannot be solved at the same level of understanding that created them.” 
– Albert Einstein

Bringing change and solving problems in the world of business and corporate practices is something sustainability leaders have been pursuing for decades.  One of them, John Elkington, the founder of the consultancy SustainAbility, formulated a way of framing that change way back in 1994.  He argued that companies should be thought of in terms of three different bottom lines: in addition to the traditional profit and loss, he saw the need to account for two other business impacts - the social and the environmental.

Triple Bottom Line looks to turn attention to the idea that managing well is more than just about financial performance. As both metaphor and moniker, Triple Bottom Line has been very successful: a veritable army of consultants, writers and advocates, 16 million search results on Google, a convenient shorthand ( 3BL ), and a straightforward message – profits yes, but people and the planet too.  Simple, easy and communicable. 

But is Triple Bottom Line the best frame for thinking about the problems of the 21st century?  How might it be adjusted to get influential stakeholders to actually see their stake in a sustainable future? How might it change so that the corporate mindset sees sustainability as something beyond a reallocation of resources away from financial performance?  What if a new framework implied an interdependence between people, planet and profit, where the bottom-line could only be optimized when considering the relationships among all of them?  What if sustainability were perceived not only as the work of the decent and noble, but also as the work of the most visionary and innovative business minds? What if instead of a triple bottom line we thought of sustainability in terms of profit beyond measure?

The Bottom Line and the Industrial Age

The concept of a bottom-line comes from seeing business as a machine whose multiple inputs result in a single output: profit.  This is a legacy of the industrial age, when hand craftsmanship was supplanted by machine-made replaceable parts.  This led to mass production, reduced costs, wealth creation, and a level of prosperity that lifted much of humanity from subsistence living.  The roots of this industrialization can be traced back to Sir Isaac Newton. 

Knowledge comes from theory, and the right theory can change the world.  Isaac Newton certainly did with his theories of gravity and motion.  Newton took something as simple as the movement of an object and broke it up into parts – reducing it to displacement and time.  Newton’s reductionism - breaking things into parts, reducing them to their components, and observing them – created the science of physics and, brought about the Industrial Revolution and the modern world.  Just as significantly, reductionism shaped the economic theory used by those that owned the factories and ran the machines, leading directly to the idea of a business operation as a machine whose single output – or bottom line – was profit.

From Reductionism to Systems Thinking

A century and a half after Newton, along came Charles Darwin.  He had a theory too, and it also had a huge impact on the world.  The scientist and author Richard Dawkins has called Darwin’s Theory of Evolution “the greatest idea of all time.”  If Newton’s thinking was foundational to the industrialized, modern world, Darwin’s thinking brought a new understanding of the workings of the natural world.  Newton was one of the greatest reductionist thinkers, and Darwin was one of the greatest systems thinkers.  His theory led to the advancement of sciences from botany to zoology.  Darwin was also able to understand a deeper truth, that the natural world was one system organized around a single aim – life – and human beings were very much a part of that evolving process.
Darwin’s legacy is seeing the natural world as a system.  Reducing things to their components and studying them in isolation in Newtonian fashion does not help in understanding the natural world.  In the natural sciences, new knowledge comes from recognizing interdependence, convergence and emergent properties of the system as a whole.  To use reductionism to study the natural world would be to fail to understand its very nature.

Two World’s Collide

The biggest challenges of the 21st century come from the collision of Newton’s reductionist world with Darwin’s systems world.  Will the solutions to these challenges come from breaking problems apart in reductionist fashion, or from seeing solutions as the creation and improvement of connections and alignments between systems?  Let’s look at geo-engineering, for example.  Geo-engineering looks at the problem of a warming planet and addresses that one piece, how to cool down a planet that’s getting hotter.  One particular reductionist solution is to pump sulfate aerosols up into the atmosphere to cool the planet really quickly.  As one geo-engineering advocate has said “If you want a 2ยบ C global reduction in temperature – we can get that in two weeks with geo-engineering.”  Little consideration is given to the system from which human-induced global warming is an emergent property, and little consideration is given to the impact on that system that reductionist solutions would have.  Alternatively, a Darwinian systems solution to global warming would look much different: less Geo-engineering, more Biomimicry.  A systems solution would look at how the natural world energizes itself - perhaps spurring human ingenuity to design a solar panel that works as efficiently as a leaf. 

Albert Einstein once said “Problems cannot be solved at the same level of understanding that created them.”  Triple Bottom Line reflects an understanding of separation and reductionism, with the allocation of desired outcomes into separate silos.  But rather than reducing and separating, we need an understanding that expands and connects, appreciating economy, ecology and humanity as interdependent parts of an evolving system.  With sustainability as the organizing principle, the desired outcomes of financial reward, a robust natural environment, and healthy people, are actually emergent properties of the system.  How can this kind of thinking be made accessible and relevant to business now?

A Foot in Both Camps

One of the great business minds of the 20th century was W. Edwards Deming.  Famous for improving quality in Japan, he wanted people to understand that his work went deeper by emphasizing “I introduced them [the Japanese] to the principles of a system.”  Those systems principles helped take Japan from economic devastation to become one of the most powerful forces in the global economy.  To this day, the highest quality prize awarded annually in Japan is The Deming Prize.

Deming’s ideas anchored him in both Newtonian and Darwinian camps: an expert on statistical methodology, a consultant to the world’s major manufacturers, and at his core a systems thinker.  He said that every business should be thought of as a system made up of smaller subsystems, and part of larger super-systems like economies.  Every system must have an aim.  If it doesn’t have an aim, it is not a system.  If the aim is unclear, the system can’t be optimized.  Every subsystem must align with the aim and workings of the other subsystems and the overall system.  Lack of alignment to aim inevitably leads to sub-optimization, decay, and the ultimate destruction of the system.

The global economy and the biosphere are systems.  But they are not separate.  Indeed one is a subsystem within the other.  Since the Industrial Revolution the human economy has – more or less – been treating the earth as a subsystem, to be shaped and used by the economy for the aims of the economy.  Today requires a new way of thinking – it’s called reality.  The global economy is one of the most powerful subsystems of the earth, and unless it is aligned with the workings of the earth, it will continue to lead to sub-optimization at best, and decay and destruction of the system at worst.

If, as Gandhi encouraged, we need to become the change we want to see in the world, and if, as Einstein suggested, solutions require thinking at a deeper level, then building a sustainable future means thinking in a new way.  We need to become system thinkers, where building the future begins with an understanding of the interdependence, alignment and convergence of people, planet, and profits rather than a reduction of these to bottom-line outcomes.  [Next Post: Profit Beyond Measure.] 

Tuesday, March 19, 2013

Disruptive Sustainability - The New Leadership Framework

At the GreenBIz Forum 2013 in New York in February, there was an informative and energetic panel discussion “The Power of Wall Street in Promoting Sustainability”, with Erika Karp, Head of UBS Global Research and Matt Arnold, Head of Environmental Affairs at JP Morgan Chase, moderated by Marc Gunther. 

In trying to forge the link between sustainability and business drivers like revenue and ROI,  Karp said “It’s not easy to prove this case … but they [Julie Hudson of UBS London and her team of ESG analysts] have figured out how to use traditional business analysis, Michael Porter of Harvard ‘Five Forces’ analysis, to talk about what [are] the most material issues, risks and opportunities, facing an industry and even facing a company … and when you have a framework, this is how you make things systematic.” 

Using traditional business analysis to elucidate the bottom-line benefits of sustainability seems logical.  After all, to show the relevance and applicability of sustainability to business metrics you need to speak the traditional language of business, and the keepers of that language are found in places like Harvard Business School (HBS) and personified by people like Michael Porter.  But as logical as that seems, is traditional business analysis really the correct approach?  As CSR and ESG professionals plead their case for relevance using the language of business strategy, the chief architect of that language, Michael Porter, is changing the vocabulary, and even more broadly, is building an entirely new framework. 

Creating Shared Value

When Michael Porter speaks today, he is unlikely to emphasize his famous Five Forces of competitive strategy (1. Bargaining power of suppliers, 2. Bargaining power of customers, 3. Threat of new entrants, 4. Threat of substitute products, and 5. Competitive rivalry within an industry).  Instead of the Five Forces, he is more likely to point out six ways the capital markets are undermining value creation.  In a presentation Porter made at a UBS conference in New York City in the fall of 2011, he listed these six value destroyers as:
1)      Search for short-term surprises” in earnings or revenue
2)      Use of industry-wide metrics that are misaligned with true economic value
and drive strategic convergence
3)      Encourage companies to emulate currently “successful” peers
4)      Strong pressure to grow faster than the industry
5)      Bias in favor of “doing deals” (M&A)
6)      A narrow view of economic value creation that overlooks shared value

Porter is attacking management’s short-term orientation, its blind use of metrics, its worship of growth, its group think and its narrow perspective.  This is not the typical message coming out of B-schools, and sounds a lot closer to ESG and CSR than HBS.  His criticism of the capital markets is part of larger framework for thinking about business strategy that Porter calls “Creating Shared Value” – a crunchy name itself.  It is hard to imagine that this is Michael Porter of Harvard Business School, once called the father of competitive strategy, and sought after by the world’s biggest corporations and institutions for his insights into fierce global competition.  He’s now talking about, of all things, sharing?  What changed?

Sustainability Happens

A lot changed: the collapse of the credit markets in 2008, the poor record of job creation and middle-class income growth in the last decade, the expanding concentration of wealth, the lack of U.S. leadership on global issues like climate change and in new sectors like clean energy.  And the never ending federal budget morass.  Just this month a poll by HBS of nearly 7,000 alumni business leaders found those foreseeing a decline in U.S. competitiveness outnumbered by more than two to one those predicting an improvement.

In formulating the Creating Shared Value framework, Porter may have come to realize that the current state of U.S.competitiveness is due in part to the failure of business education over the last 30 years that encouraged the next generation of business leaders to take actions that solely benefited their own firms even while they collectively weakened America's business environment.  Porter goes so far as to say that the benefits of the capitalist system are not being seen by greater society.  It’s not that profit is inconsistent with society’s needs, but rather it is seen as coming at the expense of society rather than to its benefit.  If the 20th century model for capitalism was ‘what’s good for business is good for society’, Porter sees the 21st century model as the converse: ‘what’s good for society is good for business.’  

Again, this sound a bit too much like CSR- and ESG-speak, with the argument for doing good evolving into doing well by doing good.  Yet sustainability is moving on from doing good and doing well to a third phase, doing differently, and while UBS’s ESG team may want to talk about doing well using the traditional language of business, it is strategists and gurus like Porter who are recalibrating their theories and ideas for doing differently.  And Porter is not alone. 

Another Harvard professor, Clayton Christensen, is also pushing back against the business-as-usual mindset of “measure what you manage and manage what you measure” which has also infiltrated the CSR and ESG vernacular.  Christensen has said “[T]he way they designed the world, data is only about the past.  And when we teach people that they should be data driven and fact-based and analytical as they look into the future, in many ways we condemn them to take action when the game is over.”  Christensen is the author of The Innovator’s Dilemma, a book that became an innovation bible in Silicon Valley in the late 1990’s and influenced many business leaders, including Apple’s Steve Jobs and Intel’s Andy Grove, helping them handle disruption within their industries.  [One might ask why it is that when HBS talks about disruption it makes the cover of Forbes magazine, but when sustainability professionals talk about resilience (the ying to disruption’s yang) it’s lucky to make it into the corporate CSR report.]

There are other leading business thinkers past and present , including Peter Senge, H. Thomas Johnson, Francis Gouillard, W. Edwards Deming, and many others who in their own way have shown the power of sustainability as an organizing principle for business.  Sustainability is strongly influencing the analysis in a number of business sectors – many leading food and beverage and consumer products companies are working closely with NGO’s like WWF, EDF, RA and others who bring a deep understanding of sustainability with decades of experience.  These engagements require a new way of thinking for business – measuring what you manage and managing what you measure frankly is not enough.  Extrapolation ought not be confused with prediction.  To address the problems facing business in the 21st century will require new thinking.  

And fortunately new thinking is still a transformational force in business.  As Matt Arnold, the other speaker on that Wall Street panel at the GreenBiz Forum, pointed out, some companies as they think about sustainability are looking beyond responsibility and opportunity and seeing disruption.  This disruptive threat is pushing them forward and yielding transformational change.  He gave the example of the Novelis Aluminum company looking for ways to make aluminum cans without mining bauxite.   CEO Phil Martens has pledged that by 2020 the cans Novelis sells will be manufactured with 80% of the aluminum coming from recycled cans.  They call it the EverCan.   “[T]hey are disrupting not just their company, but their entire industry,” Arnold said.  “And their sustainability strategy … is their business strategy.”

The new mantra of sustainability is becoming “disrupt or be disrupted”, and there are many examples of  disruptive sustainability emerging in today’s economy.  When a house can be heated and cooled to the same level of comfort using only 5% of the energy of a conventional home of comparable size – that’s disruptive sustainability.  When a high performance zero-emissions automobile can be driven from New York to Boston, with a half hour pit stop for refueling – and the fuel is free – that’s disruptive sustainability.  When the relationship between a utility and its customers is fundamentally redefined by changing roles – customer as generator and seller of clean energy and utility as buyer and distributor – that’s disruptive sustainability.  When a company that uses garbage as the source for making 300 million pounds a year of high grade plastics that satisfy the most exacting customer requirements – that’s disruptive sustainability.  When a small home cleaning supplies start-up can capture ever-growing market share from industry giants because their products don’t leave a thin film of toxins on kitchen and bathroom surfaces and actually clean them better – that’s disruptive sustainability.  When new financing models take the capital and operating expenses out of the cost of clean energy and provide electricity at competitive rates that are fixed for 10 years – that’s disruptive sustainability.  When a 100% recyclable industrial carpet, designed using a rainforest floor as inspiration, becomes the best-selling product in the company’s history and redefines an industry – that’s disruptive sustainability.  When a major real estate developer announces the construction of the largest net-zero energy commercial building in the U.S., and finds it fully leased two years before it even opens[1]  – that’s disruptive sustainability.  When a five year-old hospitality company that helps property owners increase their asset utilization through sharing and renting among peers, and brings in hundreds of millions of dollars in annual revenues without building, owning, leasing or managing a single property – that’s disruptive sustainability.  And when Michael Porter replaces his Five Forces framework with Creating Shared Value – maybe that too is disruptive sustainability. 

In the final analysis, management is prediction.  Data can inform, but it alone cannot predict.  As Clayton Christensen once observed, ”The only way you can look into the future – there’s no data – so you have to have a good theory.  We don’t think about it but every time we take an action it is predicated upon a theory.  And so by teaching managers to look through the lens of the theory into the future, you can actually see the future very clearly.  I think that’s what the theory of disruption has done.” 

So my advice to CSR or ESG professionals: don’t look to a 30-year-old framework from Harvard Business School to prove your relevance; formulate a good theory – a compelling, credible, disruptive theory - and make your case based on that.