The urgent transformation of the theory of economics and the science of business
Doing less bad - is not good
The onslaught of bad news about the environment, poverty, unemployment, human rights abuses and the inaction of policy makers combined with the business as usual approach by corporations leaves many concerned citizens baffled. The data before us are clear: climate change is advancing, there is no chance to absorb the hundreds of millions of unemployed youth while competitiveness of most of the nations around the world continuous to erode. The only solution economists imagine to all the problems and the wrongs is growth driven by more consumption for which citizens are expected to accumulate more debt.
There is a lot of time and effort spent on the analysis of all available information. While many desperately search for alternative solutions, there is not one, or a few that seem capable of reversing the negative trends. There is a blind belief in one solution: growth and those nations that lack growth should first pass through a period of austerity. Every expert approaches the bulk of information from her or his perspective framed in a clear silo, robbing the world of the knowledge that is required to create a vision indispensable to design a fresh and effective pathway forward. This article attempt to open our minds.
The lack of comprehensive knowledge of how economic and social systems operate leaves no space for the wisdom urgently needed to mobilize the best minds and the committed individuals to evolve from analyses of the unfolding dramas to a pragmatic portfolio of initiatives. In my view, too much effort is reserved to analyze the problems, to theorize solutions and fiercely debate these options as if the prevailing theory is considered a dogma. Hardly anyone focuses on the demonstration on the ground that it is possible to outcompete the present growth model by performing better - even according to their parameters of success.
A recent exchange with the Rt Hon Anders Wijkman, co-president of the Club of Rome and one of the thought leaders in policy design towards sustainability, it became clear that few people have realized that analysis and theory, concept development and case studies cannot make a dent in the present negative trends unless there is a fundamental shift in the business model. We should evolve from the logic of economies of scale and cost cutting towards a society that uses what it has, responds to basic needs of all first, and circulates the newly gained purchasing power in the local communities.
Blind Belief in Growth
While we can imagine many shifts and models, there is one factor that determines the corporate world's culture and modus vivendi: the focus on the core business and the unfettered belief in growth ad infinitum. Whatever is imagined, from tax policies, to international conventions, and new innovations to recycling programs will fail to steer society towards an environmental and socially competitive model unless we overhaul the business model itself. While I very much appreciate the efforts by many thought leaders like Walter Stahel, Michael Braungart and Ellen McPherson, and I believe in the best of their intentions and those of many others, their valuable proposals all remain trapped in the logic of the MBA: the Master of Business Administration.
The millions of students aspiring to a better financial reward thanks to their investment in an MBA diploma hardly realize that they are all learning the same business models that was once conceived at the world famous Harvard Business School. The MBA is as much a product of economies of scale and standardization than the industries they are supposed to manage in the future. Everything is translated into financial results, market share, economies of scale and ranking. This dominating model prescribes that you sell what you produce and that growth combined with market dominance will not only offer the best return on investment to the shareholders, it will even align performance through the management of rewards and bonuses. And if the company were faced with pollution scandals or social problems then the system will do its best to cut pollution and reduce the social injustice. We know that doing less bad simply is no good. Business needs to embrace the opportunities to do much better.
This prevailing business model that has guided the corporate world is framed by a simple logic: compete on the basis of price and quality. This core adagio has been translated into the theory and the practice of the economies of scale, with an unrelenting search for ever lower marginal costs through standardization, leading to a dramatic concentration of production with only a few market leaders determining the standards on the market. The obsession to cut costs, especially the reduction of labor input, has lead to a logic which confirms that merging companies that lay-off thousands of workers are immediately rewarded by the stock exchange with a higher stock valuation.
The sheer size of these mega-mergers leads companies to focus on their core business only building on their core competence eliminating all outside activity through outsourcing and a strict discipline known as supply chain management. Let there be no doubt: companies are on a permanent search for low cost and are continuously sacrificing quality in order to ensure growth through multiple consecutive sales. And if this strategy needs to be pursued through the design of service models, then there are the consultants to implement that part of the new strategy to generate more profit and a secure cash flow.
The logic of free trade enhanced the rapid globalization of fewer players through the adoption of this business model driven by lower costs. Amazing, people are prepared to buy 3 refrigerators over 25 years saving 30% on the first one and 50% on the third one, not realizing that over a generation lasting a quarter of a century double the amount of disposable income has been spent on imported cheaper goods than on the "good old local manufacturer" who produced white goods that lasted 25 years and would have offered ongoing opportunities for maintenance services, while dramatically improving resource efficiency and cutting back on the waste management.
The sales and marketing strategies have successfully blinded the customer with a lower price and the promise of the latest innovation, as well as the best energy efficiency not realizing that in the end of the day this strategy leads to the predictable collapse of local industries. Worse, the monies that used to circulate in the local economy are now channelled outside the community leading to a deceleration of local development, a loss of competitiveness and an increase of unemployment draining more purchasing power out of the community. This is where the notion of “under-developing nations” emerges.
The Urgent Shift
The core shift in the business model is to go beyond this relentless cost cutting drive and to embrace a business strategy that aims to generate more value with what is locally available. This fundamental shift requires companies to get out of the straight jacket to only focus on one product portfolio. This is a major challenge, since it is fundamentally different from what MBA’s have been brainwashed to believe is the pathway to success.
The upside is that this new business model offers opportunities to generate multiple revenues with resources that are within the immediate reach of enterprise and entrepreneur. The surprise is that when one generates several income streams from available resources then one can extract its business from the hard game of world market prices! Imagine, farmers and miners can look at the flashing numbers on their Bloomberg screen and relax: it is only an indication of one of their revenue streams and does not decide on life and death anymore.
How often are farmers or small scale producers booted out of the market by overseas competition that can beat the prices including transport, and that finds a ready partnership with local distribution that is indifferent about the generation of local purchasing power? What would the remedy be? It is quite obvious that if the workers' compensation is reduced to one dollar per day, that the European social security is subjected to a free fall into bankruptcy with the urgent call of all industrialists that the market should become more flexible. But even African and Latin American wages cannot match the dumping in salaries that is applied elsewhere in the world.
The call for “flexible labor markets” is a sublimation for a demand to cut labor costs and social security. The elaborate assessment of the competitiveness of nations is determined on the basis of the core business logic where the overall cost performance decides the position on the market. While this game is successfully played by less than one percent of the largest corporations in the world, the remaining 99 percent has hardly any chance of survival. As a result consumers are increasingly purchasing globally sources materials, nutrients and energy provided by a few players who control the capital. Europe seems to have accepted the inevitable demise of its social system and imagines solutions that are based on "more of the same", like the free trade agreement with the United States claiming to create a level playing field for 800 million consumers.
Use local resources first
The new business model which we have tested in over 100 sectors of the economy will generate not only more value locally, it also secures that more money will circulate locally. Better: it outcompetes the present globalized model in return on investment, cash flow, poverty alleviation, and the capacity to respond to the basic needs including jobs without the need for subsidies. Governments can now dedicate time and effort to ensure that there is a level playing field.
We cannot stress enough the difficulty to pursue a smart and inclusive growth strategy in any region or nation when cash is permanently drained out of the economy. When the primary and the secondary sectors are not capable of competing with the prices dictated by the international market, then the hard earned income leaves the local economy engendering an unemployment and economic contraction that has become characteristic of the majority of the Europe and Japan (and other nations). The only way to reverse the trend of high unemployment and the downward spiral of economic development is to ensure the generation of more value added with available resources creates more money that flows through local businesses. While this logic goes against the prevailing dogma of free trade at the macro-economic level, and ever lower costs at the micro-level, based on our experience on the ground, we see no other way to extract societies out of the poverty and unemployment trap.
Well there is another way, that is to dramatically reduce cost of labor, even to embrace social dumping and saddle the government with health care, unemployment compensation and pension costs which translates into an untenable increase of government debt, which is followed up by a long period of austerity in order to keep the tax burden that is already too high for a dwindling working population within limits. Let us not forget that global corporations do not pay taxes, and therefore the burden is squarely on the shoulders of the citizens only. Now if we accept that the increase of government expenditure, and the widening of the government deficit beyond the 3% of GDP are not options to embrace, then there is an urgent need to change the rules of the game because the present correction to the misguided spending has only one option: austerity.
Thus the first and foremost rule of the game that needs to be changed is the shift from "ever lower costs" to "ever higher generation of value" with what is locally available. The ZERI Foundation which is in reality a network of organizations throughout the world, has demonstrated through study and practice that this shift is not only viable, it can be implemented short term. We have seen the mobilization of €4 billion and the implementation of +100 projects that generated 3 million jobs and embraces this logic with such ease. The pursuit of value - and not the urge to cut costs - very quickly brings additional products and services to the local market which can also and quite easily outcompete the internationally traded merchandise. This puts the local economy into a growth spiral that goes beyond overconsumption of scarce resources. This is counter- intuitive, yet easy to explain.
China is the leading supplier of photovoltaic panels to the world. The cost per unit has dropped so low that it is within cents of competing with traditional sources of fossil fuels. However, an innovative technology from Sweden permits the combination of energy from the PV, with hot and cold water generated by the capillary pipes inside a sandwich of PV. This is a thicker panel that now is strong enough to be the roof, instead of being put on the roof provided that the base is heat resistant, ideally made from recycled heat resistant plastics offering more jobs since this substitutes aluminum. The cascading of benefits continues since now water is stored at high temperature, not only killing bacteria, but also storing energy, replacing the batteries that all too often make renewables uncompetitive. The break-even of local assembly is reached with only 200 units per month sold. The combination of all these benefits translates into a cost per kilowatt hour that is a fraction of solar. This is not a game of beating the Chinese PV makers on cost, it is winning the competitive game by generating so much more value! It is not surprise that Solarus won this year the innovation price for process industries in China!
The coffee case has been at the core of our work for the past 20 years. The recent developments amply demonstrate this internationally traded commodity has a tremendous growth potential that goes way beyond the cup of coffee. Both at the farm and in the city, coffee waste can be converted to a substrate for mushrooms. The spent substrate, the left-over after harvesting the mushrooms can be converted to animal feed, generating three revenues instead of one. Now the cost of protein (mushroom and animal feed) is lower than the cost of imported food and feed. Better, this generates local jobs and local income. Whereas this program has been dismissed as too little too late, we need to remind ourselves that the worldwide volume of coffee waste surpasses the 10 million tons, good for 10 million tons of mushrooms and 4 million tons of animal feed, all produced locally. And now new biochemical industries have emerged selling UV protection and odor control. If one could earn the same per ton a soy today, then the triple income stream adds another 14 billion dollars to the coffee economy, a cash that not only comes in, it is a cash that does not flow out of the local communities!
Any Change is Hard
Large corporations have great difficulty to embrace this multiple revenue model, incapable of explaining to the financial analysts on the stock exchange their shift from a core business to a multiple cash flow model beyond the established markets. This situation is exemplified by Nestlé’s response to the opportunity of mushroom farming. Indeed, the largest coffee processing company in the world, with an guesstimated 3 millions tons of waste, decided to recover energy from coffee waste, reducing its reliance on fossil fuel. Whereas the generation of power from waste figures prominently in its sustainability report outlining the performance of this food group to cut its carbon emissions, it inscribes itself into the traditional logic of cutting costs. This case would be celebrated in the traditional business logic. Waste that needed to be discarded at a cost now generates power and adds to the bottom line. This fits perfectly in the prevailing business model where the company demonstrates its social and environmental responsibility by “doing less bad”! Would it be possible to convert the strategy to one that is “doing more good”?
Imagine that Nestlé would have shifted from the "cost cutting" to the "value generation" model. The financial, social and ecological benefits from burning a few million tons of coffee waste would look very pale compared to the generation of healthy food at low cost (edible mushrooms offer a healthy nutrition), and the provision of feed for animals that now rely on the importation of soy from Brazil or the conversion of slaughterhouse waste. One does not need to be an experienced economist to quickly calculate the impact of mushrooms and feed on the local economy. The internal opposition to the proposal cites first that mushrooms are not one of Nestlé’s businesses. Second, we often hear in the grapevine that mushrooms are not part of our daily diet. Our response is that hamburgers and corn flakes were not part of the daily food intake either. However, the greatest obstacle the pervasive logic of the food and feed proposal is that Nestlé has determined it is not in the mushroom nor in the animal feed business. Therefore Nestlé will not pursue this chance to add a few billion dollars in turnover.
We realize that companies are not prepared to embrace this business model, and the millions of MBAs who leave the thousands of business schools around the world are all impregnated with the same logic streamlining competition with the search for cost cutting as the safe way to improve cash flow. This imposes a tight discipline on the supply chain enforcing strict adherence to the financial objectives outlined in budgets, reducing the number of suppliers and putting the screws on only price negotiation. These budgets determine the management's bonuses and so secure that everyone performs as is expected. Whatever insensitivity that may be perceived is then quickly overcome through a corporate social responsibility program that projects the company as a responsible citizen even when it just reneged on the opportunity to generate thousands of jobs and provide millions of tons of quality feed at local cost stimulating the local economy with readily available resources and helping to stamp hunger out of this world - not through genetic modification that puts the seeds in the hands of a few producers in the world - but rather by using readily available resources.
We need to shift from the present model to an inclusive growth model, and that can never be achieved through massive additional taxation on citizens nor by a forceful austerity program throwing thousands out of a job, cutting pension plans and reducing health care programs. Time has come to accept that the only way forward to change the way we do business. That will require more than one economist who is preaching to the converted, it requires a minimum winning coalition ready to demonstrate on the market that this new model can outcompete whatever has dominated the logic until today. After all, we are not against anyone or anything, we are in favor of much better.
The aim of this blog is to present a fresh look at realities around us. Whereas I do not pretend to present the truth nor a definite position, I do wish to push the reader to think beyond the obvious. After all, time has come to dramatically improve the plight of millions, and that requires more than the predictable. Sometimes it forces us into spheres of discomfort.