Beyond corporate social responsibility: Integrated external engagement

Obviously, companies must incorporate interaction with stakeholders into decision making at every level of the organization. That’s much easier said than done, however. Here is a brief excerpt from an article co-authored by John Browne and Robin Nuttall for The McKinsey Quarterly, published by McKinsey & Company, in which they explain how and why traditional corporate social responsibility (CSR) is failing to deliver, for both companies and society. They then share their thoughts about HOW to increase external engagement (EEI) in the given enterprise. To read the complete article, check out other resources, obtain information about the firm and a subscription to the Quarterly, and sign up for email alerts, please click here.

Source: Strategy Practice

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Executives need a new approach to engaging the external environment. We believe that the best one is to integrate external engagement deeply into business decision making at every level of a company. In this article, we show how to make that kind of integrated external engagement a reality. We set out to answer three questions. Are companies doing well at external engagement? Where might they be going wrong? How can they do better?

Are companies doing well at external engagement?

Properly understood, external engagement means the efforts a company makes to manage its relationship with the external world. This relationship can and should include a wide variety of activities: not just corporate philanthropy, community programs, and political lobbying, but also aspects of product design, recruiting policy, and project execution. In practice, however, most companies have relied on three tools for external engagement: a full-time CSR team in the head office, some high-profile (but relatively cheap) initiatives, and a glossy annual review of progress.

That traditional approach has had some positive effects. Companies certainly consider the external environment more carefully than they did in the past, and their philanthropic programs have helped many people. But in a majority of cases, CSR has failed to fulfill its core purpose—to build stronger relationships with the external world. The Occupy movement in the United States is the most visible sign of discontent, but polls show that levels of trust in business are below 55 percent in many countries. A significant minority views business executives as villains, enriching themselves at the expense of society. Even firms with the glossiest CSR reports have found themselves cast as public enemies. Take major Wall Street firms in the aftermath of the financial crisis or BP after the Gulf of Mexico spill: their relationships with the external world have been shattered, and they have lost billions of dollars of value as a result.

Many executives recognize that their current approach is inadequate. In a recent McKinsey survey of more than 3,500 executives around the world, less than 20 percent of the respondents reported having frequent success influencing government policy and the outcome of regulatory decisions.1This problem creates an opportunity for significant competitive advantage. In marketing or operations, companies struggle to raise their performance a few percentage points above that of their competitors. But as leading-edge companies such as Statoil and Unilever have discovered, effective external engagement can set you far above your rivals.

Where are companies going wrong?

Executives should not blame themselves alone. One reason they struggle is that the expectations of citizens and governments have never been higher. Companies are expected not only to obey the law or meet certain standards within their own businesses but also to ensure high standards across their supply chains. Large companies are expected to go further still, helping to solve major economic, environmental, and social problems—even those unrelated to their businesses. Moreover, as the expectations of citizens have increased, so has their power to scrutinize. Digital communication has enabled individuals and nongovernmental organizations (NGOs) to observe almost every activity of a business, to rally support against it, and to launch powerful global campaigns very quickly at almost zero cost. High expectations and scrutiny are here to stay. Successful companies must be equipped to deal with them.

What is wrong with CSR? Why have well-resourced teams, backed by the authority of CEOs, failed to deliver on their core purpose? In our experience, that centralized approach has four serious flaws.

First, head-office initiatives rarely gain the full support of the business and tend to break down in discussions over who pays and who gets the credit. Without the active participation of the big-spending functions—typically, production and marketing—the ambitions of a central team are difficult to realize.

Second, centralized CSR teams can easily lose touch with reality—they tend to take too narrow a view of the relevant external stakeholders. Managers on the ground have a much better understanding of the local context, who really matters, and what can be delivered.

Third, CSR focuses too closely on limiting the downside. Companies often see it only as an exercise in protecting their reputations—to get away with irresponsible behavior elsewhere. Effective external engagement is much more than that: it can attract new customers, motivate employees, and win over governments.

Finally, CSR programs tend to be short-lived. Because they are separate from the commercial activity of a company, they survive on the whim of senior executives rather than the value they deliver. These programs are therefore vulnerable when management changes or costs are cut.

Michael Porter and Mark Kramer summarize the result: “a hodgepodge of uncoordinated CSR and philanthropic activities disconnected from the company’s strategy that neither make any meaningful social impact nor strengthen the firm’s long-term competitiveness.”2

Notes

1 “Engaging and understanding governments: McKinsey Global Survey results” (PDF–561 KB), mckinseyquarterly.com, January 2012.
2 Michael Porter and Mark Kramer, “Strategy and society: The link between competitive advantage and corporate social responsibility,” Harvard Business Review, December 2006, Volume 84, Number 12, pp. 78–92.

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To read the complete article, please click here.

John Browne, former CEO of BP, is a partner of Riverstone Holdings; Robin Nuttall is a principal in McKinsey’s London office.

How to put your money where your strategy is

Here is an excerpt from another outstanding article featured by The McKinsey Quarterly, published by McKinsey & Company. It was co-authored by Stephen Hall, Dan Lovallo, and Reinier Musters. Most companies allocate the same resources to the same business units year after year. That makes it difficult to realize strategic goals and undermines performance. The co-authors explain how to overcome inertia.

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Source: Strategy Practice

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Picture two global companies, each operating a range of different businesses. Company A allocates capital, talent, and research dollars consistently every year, making small changes but always following the same broad investment pattern. Company B continually evaluates the performance of business units, acquires and divests assets, and adjusts resource allocations based on each division’s relative market opportunities. Over time, which company will be worth more?

If you guessed company B, you’re right. In fact, our research suggests that after 15 years, it will be worth an average of 40 percent more than company A. We also found, though, that the vast majority of companies resemble company A. Therein lies a major disconnect between the aspirations of many corporate strategists to boldly jettison unattractive businesses or double down on exciting new opportunities, and the reality of how they invest capital, talent, and other scarce resources.
For the past two years, we’ve been systematically looking at corporate resource allocation patterns, their relationship to performance, and the implications for strategy. We found that while inertia reigns at most companies, in those where capital and other resources flow more readily from one business opportunity to another, returns to shareholders are higher and the risk of falling into bankruptcy or the hands of an acquirer lower.

We’ve also reviewed the causes of inertia (such as cognitive biases and politics) and identified a number of steps companies can take to overcome them. These include introducing new decision rules and processes to ensure that the allocation of resources is a top-of-mind issue for executives, and remaking the corporate center so it can provide more independent counsel to the CEO and other key decision makers.

We’re not suggesting that executives act as investment portfolio managers. That implies a search for stand-alone returns at any cost rather than purposeful decisions that enhance a corporation’s long-term value and strategic coherence. But given the prevalence of stasis today, most organizations are a long way from the head-long pursuit of disconnected opportunities. Rather, many leaders face a stark choice: shift resources among their businesses to realize strategic goals or run the risk that the market will do it for them. Which would you prefer?

Weighing the evidence

Every year for the past quarter century, US capital markets have issued about $85 billion of equity and $536 billion in associated corporate debt. During the same period, the amount of capital allocated or reallocated within multibusiness companies was approximately $640 billion annually—more than equity and corporate debt combined. [Note: See Ilan Guedj, Jennifer Huang, and Johan Sulaeman, “Internal capital allocation and firm performance,” working paper for the International Symposium on Risk Management and Derivatives, October 2009 (revised in March 2010).]  While most perceive markets as the primary means of directing capital and recycling assets across industries, companies with multiple businesses actually play a bigger role in allocating capital and other resources across a spectrum of economic opportunities.

To understand how effectively corporations are moving their resources, we reviewed the performance of more than 1,600 US companies between 1990 and 2005. [Note: We used Compustat data on 1,616 US-listed companies with operations in a minimum of two distinct four-digit Standard Industrial Classification (SIC) codes. Resource allocation is measured as 1 minus the minimum percentage of capital expenditure received by distinct business units over the 15-year period. This measure captures the relative amount of capital that can flow across a business over time; the rest of the money is “stuck.” Similar results were found with more sophisticated measures that control for sales and asset growth.]  The results were striking. For one-third of the businesses in our sample, the amount of capital received in a given year was almost exactly that received the year before—the mean correlation was 0.99. For the economy as a whole, the mean correlation across all industries was 0.92 (Exhibit 1).

In other words, the enormous amount of strategic planning in corporations seems to result, on the whole, in only modest resource shifts.

Whether the relevant resource is capital expenditures, operating expenditures, or human capital, this finding is consistent across industries as diverse as mining and consumer packaged goods. Given the performance edge associated with higher levels of reallocation, such static behavior is almost certainly not sensible. Our research showed the following:

o   Companies that reallocated more resources—the top third of our sample, shifting an average of 56 percent of capital across business units over the entire 15-year period—earned, on average, 30 percent higher total returns to shareholders (TRS) annually than companies in the bottom third of the sample. This result was surprisingly consistent across all sectors of the economy. It seems that when companies disproportionately invest in value-creating businesses, they generate a mutually reinforcing cycle of growth and further investment options.

o   Consistent and incremental reallocation levels diminished the variance of returns over the long term.

A company in the top third of reallocators was, on average, 13 percent more likely to avoid acquisition or bankruptcy than low reallocators.

o   Over an average six-year tenure, chief executives who reallocated less than their peers did in the first three years on the job were significantly more likely than their more active peers to be removed in years four through six. To paraphrase the philosopher Thomas Hobbes, tenure for static CEOs is likely to be nasty, brutish, and, above all, short.

We should note the importance of a long-term view: over time spans of less than three years, companies that reallocated higher levels of resources delivered lower shareholder returns than their more stable peers did. One explanation for this pattern could be risk aversion on the part of investors, who are initially cautious about major corporate capital shifts and then recognize value only once the results become visible. Another factor could be the deep interconnection of resource allocation choices with corporate strategy. The goal isn’t to make dramatic changes every year but to reallocate resources consistently over the medium to long term in service of a clear corporate strategy. That provides the time necessary for new investments to flourish, for established businesses to maximize their potential, and for capital from declining investments to be redeployed effectively. Given the richness and complexity of the issues at play here, differences in the relationship between short- and long-term resource shifts and financial performance is likely to be a fruitful area for further research.

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To read the complete article, please click here.

Stephen Hall is a director in McKinsey’s London office, and Reinier Musters is an associate principal in the Amsterdam office. Dan Lovallo is a professor at the University of Sydney Business School, a senior research fellow at the Institute for Business Innovation at the University of California, Berkeley, and an adviser to McKinsey.

The authors would like to acknowledge the contributions of Michael Birshan, Marja Engel, Mladen Fruk, John Horn, Conor Kehoe, Devesh Mittal, Olivier Sibony, and Sven Smit to this article.