Capitalism
clearly has its downsides, but it is often justified as the best system
for generating wealth in society. But could it be that one of the
central pillars of capitalism actually undercuts this productivity?
Imagine you are a CEO of a publicly held corporation. You have done a careful and comprehensive analysis (including effects on brand, morale, reputation, etc). You have found you can maximise shareholder value - not only in the short term - by firing long-term, loyal employees whose net present value to the company tilts to negative.
Do you do it?
The answer is a resounding yes, especially since this is a requirement by law in many countries. Standard economic theory, laws, organisational power systems and incentives are all in alignment; acting on behalf of the financial investors/owners, your job as a CEO is to maximise the returns on investment.
Employees have a different perspective. Consider, the following. There are two firms - one that treats well insofar as it serves the company's bottom line i.e. a firm that sees you purely as a means to maximise returns for shareholders, and a firm that is interested in your welfare and of itself i.e. one that treats you as an end unto yourself. As an employee, which of the two firms would you be more attracted to, more likely to stay with and more likely to give your greatest effort for?
No one wants to feel that they are not valued in and of themselves. We are more distrustful, less engaged and less committed to any friend, spouse or firm that sees you merely as a tool or means to achieve their own goals.
How much does this really matter to a firm's performance? Strategy research shows that employee disengagement can have a tremendous impact on a firm's performance.
In the 1960s and 1970s, strategy scholars focussed on the question of where to play, since some industries are much more profitable than others.
But in the 1980s and 1990s, a series of studies revealed that while industry choice explains between 15-20% in the variance of profitability of the firm, about half of the variance is explained at the business unit level. Even within the same industry, some firms are more successful than others.
This led to what was called the resource-based view of the firm and to the second big question of strategy: how to win?
But today, i'm going to introduce two new questions of strategy centred on the critical resource of knowledge. We now know that the firms that are the best at creating, sharing and using knowledge - whether it is reflected in business models, products, process innovation, core competencies or change management - are the firms that win.
Research now strongly suggests that employee engagement is of critical importance to performance, since it is the employees that create, share and utilise knowledge within the firm. They, therefore, undergird their firm's performance better when they put their hearts, minds and efforts into their work. It is striking to observe that the ownership structure of the firm inherently affects this employee engagement.
Do you see the paradox? Capitalism is intended to optimise value creation. Capital-owned and controlled firms are the engines behind this. Yet this very ownership structure undercuts employee engagement, which is critical to the firm's ability to create value.
Recognising the importance of employee engagement, firms often try to improve performance through stock options. At first look, this seems reasonable. Through stock options the fortunes of the employee and those of the firm are effectively linked, since the employee becomes owner as well. However, additional effort by a single employee is unlikely to impact share price; thus, employees won't be moved by stock options to increase their efforts.
The alternative: employee cooperatives that better serve the knowledge creators. As an alternative solution, i suggest repurposing the organisation by shifting ownership primarily (though not exclusively) to employees - to serve not the financial investor, but the employees who generate the knowledge needed to improve the firms' competitiveness and value creation potential.
This isn't pie in the sky theorising. Changing the ownership of the firm to include employees has been shown to add to their engagement and the value creation of the firm. Employee-owned cooperatives already exist and are growing steadily in numbers. For example, in the UK, co-ops had turnover growth of 21% over the tough years of 2008-2011, far outpacing the economy as a whole. In Switzerland, cooperatives account for 16% of GDP, in Finland that number is 21%, in Sweden 13%.
Furthermore, empirical evidence suggests that such firms provide comparable financial returns to financial investors, better returns to employees and, in total, create greater value.
A partial explanation for the magic behind the performance of such cooperatives is the employees' belief that the organisation is for them. This creates radically different attitudes and organisational cultures than the ones commonly found in most publicly traded large capitalist firms where the disengagement of employees is provoked by the sentiment that they are only a means to serve an end.
To realise the full value creation potential of capitalism, we need to re-envision the ownership and purpose of the very emblem of capitalism today, the capital-owned firm.
The writer is a professor at IMD.
Imagine you are a CEO of a publicly held corporation. You have done a careful and comprehensive analysis (including effects on brand, morale, reputation, etc). You have found you can maximise shareholder value - not only in the short term - by firing long-term, loyal employees whose net present value to the company tilts to negative.
Do you do it?
The answer is a resounding yes, especially since this is a requirement by law in many countries. Standard economic theory, laws, organisational power systems and incentives are all in alignment; acting on behalf of the financial investors/owners, your job as a CEO is to maximise the returns on investment.
Employees have a different perspective. Consider, the following. There are two firms - one that treats well insofar as it serves the company's bottom line i.e. a firm that sees you purely as a means to maximise returns for shareholders, and a firm that is interested in your welfare and of itself i.e. one that treats you as an end unto yourself. As an employee, which of the two firms would you be more attracted to, more likely to stay with and more likely to give your greatest effort for?
No one wants to feel that they are not valued in and of themselves. We are more distrustful, less engaged and less committed to any friend, spouse or firm that sees you merely as a tool or means to achieve their own goals.
How much does this really matter to a firm's performance? Strategy research shows that employee disengagement can have a tremendous impact on a firm's performance.
In the 1960s and 1970s, strategy scholars focussed on the question of where to play, since some industries are much more profitable than others.
But in the 1980s and 1990s, a series of studies revealed that while industry choice explains between 15-20% in the variance of profitability of the firm, about half of the variance is explained at the business unit level. Even within the same industry, some firms are more successful than others.
This led to what was called the resource-based view of the firm and to the second big question of strategy: how to win?
But today, i'm going to introduce two new questions of strategy centred on the critical resource of knowledge. We now know that the firms that are the best at creating, sharing and using knowledge - whether it is reflected in business models, products, process innovation, core competencies or change management - are the firms that win.
Research now strongly suggests that employee engagement is of critical importance to performance, since it is the employees that create, share and utilise knowledge within the firm. They, therefore, undergird their firm's performance better when they put their hearts, minds and efforts into their work. It is striking to observe that the ownership structure of the firm inherently affects this employee engagement.
Do you see the paradox? Capitalism is intended to optimise value creation. Capital-owned and controlled firms are the engines behind this. Yet this very ownership structure undercuts employee engagement, which is critical to the firm's ability to create value.
Recognising the importance of employee engagement, firms often try to improve performance through stock options. At first look, this seems reasonable. Through stock options the fortunes of the employee and those of the firm are effectively linked, since the employee becomes owner as well. However, additional effort by a single employee is unlikely to impact share price; thus, employees won't be moved by stock options to increase their efforts.
The alternative: employee cooperatives that better serve the knowledge creators. As an alternative solution, i suggest repurposing the organisation by shifting ownership primarily (though not exclusively) to employees - to serve not the financial investor, but the employees who generate the knowledge needed to improve the firms' competitiveness and value creation potential.
This isn't pie in the sky theorising. Changing the ownership of the firm to include employees has been shown to add to their engagement and the value creation of the firm. Employee-owned cooperatives already exist and are growing steadily in numbers. For example, in the UK, co-ops had turnover growth of 21% over the tough years of 2008-2011, far outpacing the economy as a whole. In Switzerland, cooperatives account for 16% of GDP, in Finland that number is 21%, in Sweden 13%.
Furthermore, empirical evidence suggests that such firms provide comparable financial returns to financial investors, better returns to employees and, in total, create greater value.
A partial explanation for the magic behind the performance of such cooperatives is the employees' belief that the organisation is for them. This creates radically different attitudes and organisational cultures than the ones commonly found in most publicly traded large capitalist firms where the disengagement of employees is provoked by the sentiment that they are only a means to serve an end.
To realise the full value creation potential of capitalism, we need to re-envision the ownership and purpose of the very emblem of capitalism today, the capital-owned firm.
The writer is a professor at IMD.
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