The corporation in the 21st century

| Podcast

What responsibilities does business have to society, and what benefits do companies deliver to stakeholders and society at large? In this episode of the Inside the Strategy Room podcast, two authors of a new McKinsey Global Institute (MGI) report share recent research on how the value that companies bring to economies, societies, and households has changed over the past quarter century. Michael Birshan is the global coleader of McKinsey’s Strategy and Corporate Finance Practice, while Clarisse Magnin-Mallez leads the Consumer Packaged Goods and Retail Practices in Africa, Europe, and the Middle East and is McKinsey’s managing partner in France. The report they coauthored is the first in a series that MGI will publish on companies in the 21st century. The following is an edited transcript of the discussion. For more conversations on the strategy issues that matter, subscribe to the series on Apple Podcasts or Google Podcasts.

Sean Brown: What spurred the MGI team to undertake this research on the role of corporations in society?

Clarisse Magnin-Mallez: We have evidence all around us that societal expectations of business are shifting. I found it striking that 87 percent of people who were asked about the role of companies declared that they should create value for multiple interests, not just make profits. Understanding these shifts is particularly important in the context of Generation Z, who are polarized on these questions, both as consumers and employees. We launched this research to find out what value large corporations create for the economy and for households. We tried to measure this impact, how it has evolved over time, and whether it was changing by company archetype.

We looked at 5,000 companies with revenues above $1 billion over a 25-year period. We analyzed 30 indicators, ranging from taxes to compensation, and developed two models. One focuses on what we call “pathways,” meaning that when a corporation creates $1 of value, where does it go? How does it cascade to households, and what are the implications for decision makers? The second model clusters the companies by archetype, based on the nature of the value they created and the pathways through which their value reaches households.

Sean Brown: How are corporations doing at delivering this value to citizens and households?

Michael Birshan: Firstly, the research validates the enduring role of business in society. In Organisation for Economic Co-operation and Development [OECD] countries, $61 trillion of gross value is added every year; $44 trillion of that, or 72 percent, is generated by the business sector. That value represents the revenue minus intermediate costs to produce the products and services. While the share of total value that businesses add varies between 70 percent and 75 percent among different countries, the essential picture has been remarkably stable over time.

The percentages are higher for some economic benefits. Business, for example, contributes 85 percent of labor productivity growth and 85 percent of technology investment. Business leaders have a lot to be proud of, but to quote French revolutionaries and Spider-Man, “With great power comes great responsibility.” This is particularly true for those who lead large corporations. Between 1995 and 2018, the contribution of large corporations to their home countries’ economies rose by ten percentage points in terms of share of GDP. But those corporations are relying less and less on assets and labor—less physical capital and fewer employees per unit of revenue—which raises a wide set of questions.

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Sean Brown: How have these changes in how corporations create value affected the flow of benefits to households?

Michael Birshan: The value flows from corporations to households through eight different pathways. If you take a dollar of revenue that the average corporation generates, 25 cents of that flows through as labor income: wages, salaries, and other benefits to employees. Seven cents of that dollar goes to capital income, meaning dividends, share buybacks, and interest payments to debtholders. Six cents goes to investment—earnings that are retained to be invested in new productive assets—and four cents to production and corporate taxes. The remaining 58 cents goes to supplier payments, which then result in labor income, capital income, investment, and tax pathways for those supplier companies.

Collaborate with members of your archetype rather than just the traditional sector peers. When you think about your purpose in society, members of the archetype, some of which may be surprising, may provide inspiration.

Michael Birshan

There are three additional pathways. One is consumer surplus, which represents consumers’ willingness to pay higher prices than companies charge them for goods and services. That value is an additional 40 cents per dollar of revenue, so a very substantial contribution to households. Then you have two sets of spillovers beyond the purely economic. Negative spillovers include, for example, carbon emissions, land use, and impact on biodiversity. Global emissions are now at 40 gigatons a year and rising. Any pathway toward stabilizing the climate will require unprecedented levels of capital reallocation and creating new opportunities for building green businesses.

Of course, there are positive spillovers as well, such as productivity gains in the broader economy when a company’s innovations become more widely adopted. We looked at total factor productivity, which is how the economy combines capital and labor to create value—essentially, the grease in the machine of economic progress. It includes dimensions such as how we harness technology to get more out of capital and labor inputs and how we share best practices. That productivity rate has slowed down materially, from a 1.1 percent annual increase for the 1995–2005 decade to 0.2 percent for the more recent decade.

The world has become less effective at combining capital and labor in innovative ways to create economic gains, but this is a subject of debate among economists. During the dot-com boom, economist Robert Solow famously said, “You see the computer age everywhere except in the productivity statistics.” It turned out that it took a while for everybody to apply new technologies in ways that created productivity gains. Some of that may be true for the current investments in digital analytics and artificial intelligence.

Sean Brown: Did you see significant shifts over time in how corporate gains flow along these different pathways?

Clarisse Magnin-Mallez: Yes. The most striking is the declining share of value going to labor income versus capital income (Exhibit 1). It’s a trend we have observed for quite some time. If the share of capital versus labor had remained constant, an additional $1.2 trillion in value would have flowed to households as part of the labor pathway. In addition, capital income is usually concentrated in top-income households. In the US, the top-decile households increased their capital share of capital income by seven percentage points during the period we studied. The polarization is lower in other countries, but nevertheless this concentration triggers questions about how corporate value is shared.

Labor income and consumer surplus are corporations’ biggest direct pathways to households, but capital income is growing the fast.

Another change I would highlight is the reduction in supplier payments to small and medium-size enterprises. Small and medium-size enterprises [SMEs] account for a lot of employment in local communities.

On the plus side, the consumer surplus that almost everybody, in all income brackets, has benefited from has increased. However, we also have price increases—as much as 50 percent relative to inflation in some areas—that are putting education, healthcare, and some other services out of reach of lower-income households.

Sean Brown: How do the value pathways vary by country?

Clarisse Magnin-Mallez: Most of the trends are present across the OECD countries, but we do see some differences, mainly driven by the mix of company archetypes in the countries’ economies.

Michael Birshan: There are some nuances within the pathways as well. Among the largest OECD economies, the biggest surge in capital income has happened in US-headquartered corporations and the smallest in Japan. Also, Germany has seen an increase in the supplier payments pathway for German corporations, whereas most other OECD economies registered a decrease.

Sean Brown: What are the company archetypes, and how did you arrive at those categories?

Michael Birshan: For the 5,000 or so companies in our data set, we looked for similar uses of inputs, such as labor, physical capital, and intangible capital, and similarities in how economic value is created—for example, similar cost structures, levels of R&D spending, and impacts on society as measured through the pathways we discussed. We did this analysis primarily through an algorithm that clustered 150 subsectors of companies into eight archetypes of companies that do similar things and have similar impact on the world (Exhibit 2).

Clustering companies by their inputs and pathway impacts results in eight archetypes.

You have the Discoverers—companies that push the scientific frontier. They have high R&D expenditure, a lot of intangible capital, and high capital-income pathways. Think pharmaceutical firms, but also household-product companies with differentiated offerings and innovation-driven brands. Next are the Technologists. This group includes internet, media, and retail companies as well as hardware and software.

The Experts are businesses that harness human capital more than anything else to deliver services and on average offer higher wages than a typical corporation. These include business-services companies as well as private hospitals and education institutions. The Deliverers are retailers, distributors, restaurant chains—businesses that take inputs from elsewhere and sell them widely. The rise of these institutions has had a significant societal impact. The Makers are relatively capital-intensive manufacturers that nonetheless account for a large share of employment: aerospace, defense, and automotive, but also construction and engineering companies. The Builders create, use, and operate the physical infrastructure the world revolves around and include utility and mining companies. The Fuelers are predominantly oil, gas, and coal producers, and the Financiers are banks, insurance, and real-estate companies that price assets and provide capital.

Sean Brown: How broadly do these archetypes manifest in different countries’ economies?

Michael Birshan: They have a different presence around the world. It won’t surprise anyone, for example, that Makers are more prevalent in Germany and Korea than in most other OECD countries. Other archetypes such as Technologists are more prevalent in the US. The UK has numerous Financiers, Fuelers, and Discoverers relative to the average OECD economy. Keep in mind that these archetypes cut across traditional sector boundaries because, for example, relatively capital-intensive manufacturers and construction and engineering firms have similar impact, while R&D-driven firms of all kinds have similarly high-capital-income pathways and positive productivity spillovers for the economy.

Sean Brown: What is the benefit to business leaders of knowing which archetype their companies belong to?

Michael Birshan: Because the archetypes have broadly similar footprints in terms of positive contributions and challenges that they need to manage, they are kindred spirits. One thought is to collaborate with members of your archetype rather than just the traditional sector peers. You can see others in your archetype as sort of your purpose peers. When you think about your purpose in society, members of the archetype, some of which may be surprising, may provide inspiration.

Sean Brown: What patterns have you seen over time in terms of which archetypes are on the rise or in decline?

Clarisse Magnin-Mallez: The most striking element is the relative decline of Makers, which have been the preeminent archetype in the OECD.

They represent 30 percent of the total labor income, so they are central to employment, and 26 percent of R&D, so the decline of Makers may be part of the reason for the rise of capital income over labor income. Keep in mind that this analysis focuses on the OECD. We see a big global shift of makers to non-OECD economies.

The growth is coming from the Financiers, Experts, Deliverers, and Technologists. This reinforces two messages we have tried to convey: rising capital income, which comes from Financiers and Technologists, and a polarization of wages because Deliverers provide the lowest wages. The archetype mix is quite different from one country to another, but we see an overall growth of those four archetypes.

Sean Brown: What implications do these shifts have for how business leaders should think about their companies’ performance and broader responsibility to society?

Michael Birshan: We live in the era of ESG [environmental, social, and corporate governance issues] and we talk a lot about the “E,” but the “S” will also be crucial. This research shines a spotlight on some of the fundamental forces driving the phenomena we see today. One suggestion to business leaders is, know your numbers. What does your company’s value look like by pathway? What does it look like relative to your industry peers, or companies headquartered in your country, or companies within your archetype?

Secondly, do those numbers suggest there are pathways that you could or should broaden? If so, that has implications for the fundamentals of business operations. How do you view your labor pathway, including where you are locating colleagues? What is the income balance when you consider diversity, equity, and inclusion? How do you approach re-skilling at scale given that many of today’s jobs may become less relevant? How inclusive is your procurement, and are you developing new SME suppliers?

If we want to increase the consumer surplus, that requires building digital businesses because technology businesses create huge consumer surpluses. It may also require disrupting some higher-priced sectors such as healthcare and education. Of course, the capital-income pathway is enormously important, and many companies are not where they would want to be on that. It may call for fundamental business transformation and performance improvement. The climate challenge and how we think about positive spillovers also have major implications for organizational processes and capital allocation.

Clarisse Magnin-Mallez: With the concentration of value creation among large corporations, we also have a concentration of scrutiny. That comes with associated risks but also opportunities to have an impact on some of these dimensions. The concentration of capital is feeding the trend of stakeholders being more educated about the different elements of corporations’ economic and societal contributions. We would urge companies to assess those implications and find opportunities to differentiate by showing positive contributions, especially in job creation and introducing domestic suppliers that are important for employment in local communities.

Once you have a baseline, find some focus areas. Companies tend to have laundry lists of initiatives, but those that extract the most value out of ESG strategies are companies focusing on two or three areas where they make a genuine difference.

Sean Brown: How do you expect these pathways to evolve, especially given widespread digital transformations that the COVID-19 pandemic has dramatically accelerated?

Clarisse Magnin-Mallez: I think we can assume that the Makers will keep growing outside the OECD zone. The rise of Deliverers, Technologists, and Financiers will likely amplify in the years to come.

Michael Birshan: One forecast I have for the next few years is a continuing focus on the “S” in ESG. That does not mean the focus on the “E” will go down, but if one wants to be ahead of trends, think deeply about your company’s role in society.

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