Grow the Pie, How Great Companies Deliver Both Purpose and Profit by Alex Edmans
Economics professor Alex Edmans recasts the concepts of corporate social responsibility and shareholder value into what he terms “Pieconomics.” He posits that increasing the economic pie for everyone is better – and more profitable – than just reallocating its slices to some. He cites numerous instances of companies that are “pie growers,” creating value for society as well as their bottom lines. Executives and business students will find this a refreshing take on an increasingly important task for companies.
- Businesses must decide whether they want to split the existing economic pie or increase its size.
- “Pieconomics” asks leaders whether they are reallocating pieces of the existing pie or creating new value.
- Kodak refused to expand the pie.
- Businesses must create value instead of only extracting it.
- Some business practices, like enlightened management, can generate value. Others, like executive pay, create controversy.
- Companies should seek projects that meet three criteria: “multiplication, comparative advantage and materiality.”
Grow the Pie Book Summary
Businesses must decide whether they want to split the existing economic pie or increase its size.
Consider the total contribution a business makes to society as an economic pie.To illustrate, take Martin Shkreli, who was CEO of Turing Pharmaceuticals in 2015 when he increased the price of Daraprimby 5,500%, from $13.50 to $750 per pill. Doctors use Daraprim to counter toxoplasmosis, a parasitic infection that can cause severe complications and even death, if left untreated.
“The pie-splitting mentality is attractive. Pie-splitting can be done almost immediately and at zero cost…Shkreli increased the price of Daraprim by 5,500%.”
Society has different constituencies – including local communities, the government, investors and customers. But Shkreli wanted to please only one constituency: investors seeking higher profits.He regarded the pie as limited. Shkreli had previously set up two hedge funds that failed. He then decided to buy rights to approved drugs, restrict their availability and jack up their prices. On August 10, 2015, Turing acquired Daraprim for $55 million. The next day, he sharply increased its price.
Compare his behavior to the track record of how Merck handled its drug, Mectizan. In 1978, a Merck scientist found that the drug Ivermectin, which the company discovered and developed to treat parasitic infections in livestock, could treat onchocerciasis, or river blindness, in human beings. In 1987, regulators approved the use of Ivermectin with people under the brand name Mectizan.
The West African people who suffered from river blindness could not afford the drug. Merck’s then-CEO Roy Vagelos appealed to American and international agencies for funding, but they refused. On October 21, 1987, Vagelos announced that Merck would give Mectizan to people worldwide for free. Accordingly, the company set up the Mectizan Donation Program, working with international agencies, governments and nongovernmental agencies.
Vagelos expanded the size of the pie. He was a “pie grower,” someone who tried to make the pie larger and to provide more value for society. In doing so, pie growers offer benefits for the public as well as for investors and stakeholders. Such companies seek to increase societal value and boost their profits as a consequence.
Merck gained public esteem for its Mectizan program. Fortune magazine highlighted Merck America as its “most admired company” from 1987 through 1993. Merck investors also gained: From 1998, its stockholders realized an annual average 13% return, compared to the 9% they would have earned had they invested in the S&P 500.
Pieconomics asks leaders whether they are reallocating pieces of the existing pie or creating new value.
Leaders must consider whether their offerings command higher prices because their products are better or because they dominate the market. They should also ascertain whether their profitability is built on ignoring their operations’ impacts on the environment.
The corporate social responsibility (CSR) movement and other initiatives are built on the understanding that businesses should serve society. However, in terms of societal benefit, Pieconomics has an edge over CSR in several critical ways: For example, some businesses use CSR as a separate donation function that doesn’t affect how the overall company behaves. It is charity, but it doesn’t focus on societal change. In some cases, the CSR department even seeks to hand out charitable donations to ameliorate the harm the company has done in the form of environmental damage or in some other field. But if your business harms society, it doesn’t matter how many donations you make: You won’t expand the pie.
“Pieconomics is an approach to business that seeks to create profits only through creating value for society.”
Pieconomics focuses instead on a company’s primary operations. It suggests that a corporation must try to benefit society. A firm must have access to significant financial reserves to carve the social pie differently or to make newsworthy CSR contributions. However, any business can increase the size of the pie by pursuing excellence in whatever it does, thus contributing to society’s betterment. This may require a shift in attitude and a great desire to create social value.
Kodak refused to expand the pie.
In discussions about CSR, many people suggest that companies should mostly refrain from doing harm, such as by increasing their prices sharply. However, companies can make errors of commission – for instance, by giving too large a slice of the pie to investors. But they can also err by omission – “failing to grow the pie by coasting and sticking to the status quo.”
“Purpose…binds together the members of an enterprise and inspires them to go above and beyond what’s required in the contract.”
Kodak invented the digital camera in 1975, but the company became complacent. Its leaders didn’t think digital cameras would replace photographic film for at least a decade. At the time, Kodak’s photographic film sales exceeded $10 billion, and its executives saw no reason to rock the boat. Their inaction led to Kodak’s bankruptcy in 2012. By being unwilling to expand the pie, Kodak’s senior management destroyed a leading company.
Businesses must create value instead of only extracting it.
A business’s understanding of why it exists – its purpose – indicates how it intends to contribute to its community. A company should narrowly define a purpose that describes why and for whom it exists. Pieconomics suggests that a corporation can profit without making money at society’s expense.
The media and elected officials often highlight how much money businesses make, but generally they don’t explore the reason for such high profits, which are often the result of expanding the pie. For example, in February 2019, Amazon decided against building half its additional North American headquarters in New York City’s borough of Queens. Had it erected the new office, Amazon would have hired 25,000 to 40,000 people, each earning average annual wages of $150,000. It also would have paid Queens $27.5 billion in taxes. Amazon decided against locating its headquarters in Queens because local leaders objected to giving the corporation some $3 billion in tax rebates.
“Defeating Amazon didn’t mean that Queens won. Everyone lost because the pie shrank.”
The borough of Queens would have given Amazon a tax break only if the company increased its economic activity and paid nine times more in taxes than the amount it received as a tax rebate. By opposing Amazon’s proposal, leaders harmed their community by impeding the expansion of the pie.
Some business practices, like enlightened management, can generate value. Others, like executive pay, create controversy.
Many people feel that senior executives who earn giant salaries are benefiting at the expense of other stakeholders. This belief is rooted in a “pie-splitting mentality.” That viewpoint had merit when wealth consisted mainly of land, which imposed finite physical limits on the amount of wealth stakeholders could share. However, the bulk of today’s wealth is monetary. With monetary wealth, entrepreneurs can create more for themselves without having to pay their colleagues or workers any less.
In 1990, an article appeared in the Harvard Business Review titled “It’s Not How Much You Pay, But How.” The authors suggested that attempts to calibrate executive pay fairly should not seek to cut what bosses make but should instead give leaders incentives to generate long-term value for society.
Investors can increase an enterprise’s societal value by engaging in or fostering “stewardship.” For example, ValueAct, an activist fund, used enlightened stewardship to help revive US software company Adobe. Before ValueAct came on the scene, Adobe had hit a slump. After its share price grew 584% from the beginning of 1999 to the end of 2007, Adobe began to drift. In 2005, it acquired its rival Macromedia and merged Macromedia’s products with Adobe’s Creative Suite package. Unfortunately, sales of the Creative Suite began to decline. In addition, Apple decided not to allow Adobe’s Flash program to run on its products. Instead, Apple decided to use HTML5. As a result, Adobe laid off 2,000 employees between 2008 and 2011.
ValueAct understood Adobe’s challenges. It also saw that long after most software companies quit selling their programs and started licensing them, Adobe was continuing to rely on sales of its products. Adobe also concentrated on desktop products and failed to capitalize on the booming mobile sector. Despite these problems, ValueAct believed Adobe had possibilities other investors hadn’t recognized. ValueAct acquired a 5% stake in Adobe between September and December 2011.
“With a ringside seat, ValueAct started to do what its name promised – act to create value. Far from the common portrayal of going for the quick buck, this was a long-term game.”
Because it wasn’t involved in Adobe’s acquisition of Macromedia, ValueAct felt no attachment to that deal. It urged Adobe to move away from Flash and advocated the use of HTML5; Adobe concurred. The company went on to develop mobile applications and to switch to a subscription model. From the time ValueAct acquired Adobe stock until it sold its holdings in March 2016, Adobe’s share price increased 300%.
Companies should seek projects that meet three criteria: “multiplication, comparative advantage and materiality.”
Many people see share buybacks as just another way to carve the pie that benefits investors and senior management. In contrast, businesses that aim to increase the size of the pie should pursue only activities that add value to society, even if they don’t always provide long-term profits. They should seek projects that meet three criteria: multiplication, comparative advantage and materiality.
The principle of multiplication asks whether the money a business is spending on a stakeholder gives that stakeholder more benefit than the money initially invested. If it doesn’t, the effort won’t generate value, so it has a “negative social net present value.” The business then must consider whether it should instead disburse the resources to other stakeholders who could use it more productively by, for example, paying higher wages to employees or reducing prices to customers.
The principle of multiplication provides managers with a perspective, not an exact calculation. For example, the New Belgium Brewing Company acknowledges on its website that its operations are polluting. But when it invests $1 in reducing pollution, that investment benefits the environment by more than $1. Toward that end, New Belgium added 1,235 solar panels on the roof of its packing hall in Fort Collins, Colorado. Its employees travel around its 50-acre factory on bikes rather than by car. It also imposes an “energy tax” on itself when it buys energy from outside its plant. It uses this money to improve energy efficiency and renewable energy with “multiplicative” benefits for the environment.
“Evaluating whether creating value for society will also create profits can’t be done through calculation, but through judgment.”
Businesses can assess their activities with more rigor by using the principle of comparative advantage. It proposes that businesses should evaluate whether they can generate more value by undertaking an activity themselves than they would if other firms or entities carried out that activity. The pie becomes larger only if companies follow this rule to decide which operations to undertake internally and which to delegate to their vendors or others.
The principle of materiality considers whether stakeholders play a pivotal role in a company, either because they affect its work or because the company considers their interests vital. Businesses can create societal value even if it doesn’t make money for them. For example, Merck CEO Vagelos worried about the people who needed Mectizan, though his decision to give it away did not add to Merck’s profits. Managers should use the principles of multiplication, comparative advantage and materiality to select activities that increase the size of the pie.
About the Author
Alex Edmans is a finance professor at the London Business School and the academic director of the Centre for Corporate Governance.
Video & Podcast