Milken Institute review

It's time to build 21st century companies: Learning to thrive in a radically different world

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With rising global prosperity and half the world soon entering the consumption economy, markets are burgeoning in places beyond the rich, industrialized nations. It is in this environment that the role of the corporation, in society and in the global economy, is changing — bringing new challenges for the CEO. This is especially true for large marketshaping companies that seek to capitalize on innovations that are altering the face of global capitalism.

Consider some of the choices the CEOs of such companies will need to make — choices very different even from those leaders confronted at the new century’s dawn.

How do you embody your company’s purpose in such a way as to attract and retain the talented and diverse work force you need and earn the social license to operate?

  • How should you balance the interests of diverse stakeholders — for example, between environmental commitments, your suppliers and the expectations of your workers and their communities, probably around the world?
  • How do you leverage data and technology responsibly to drive efficiency and power your business models? As you deploy artificial intelligence and automation, what responsibility do you take to retrain and redeploy workers displaced by technology?
  • What do you tell investors who continue to hassle you about your stock performance and short-term results, but now also demand details of your environmental, social and corporate governance performance?
  • How do you navigate the geopolitical and geo-economic challenges (including trade) you now face, through your value chains and platforms that span the globe?

Today and in the future, the rewards for success are outsized, but so, too, is the obstacle course that must be run.

An Era of Opportunity

Contemporary companies face a radically changed environment. Technology has had a profound impact on business and the economy. In the past 30 years, for example, the internet has facilitated global connection between nearly everybody — and nearly everything. Nearly, because there is still room for fuller and richer connections to everybody and everything. The same is true of digitization: our research at the McKinsey Global Institute suggests that digitization hasn’t nearly run its course, even in advanced economies in the United States and Europe. Artificial intelligence, the biological revolution and many other world-shaping innovations are still in their infancy.

Alongside this technology wave has come rising global prosperity, which has lifted one billion people out of extreme poverty over the past 30 years, 730 million of those in China alone.

Along with this disruptive technology has come rising global prosperity, which has lifted one billion people out of extreme poverty over the past 30 years — 730 million in China alone. This has contributed not just to improved human development in terms of basic services, but also enabled the emergence of vast middle and affluent classes. By 2025, for the first time in history, over half the world’s population will belong to the consuming class — that is, people who have some discretionary income left over after meeting basic needs. Equally striking, most of this growth will be concentrated in emerging economies.

These two shifts have helped expand participation in the global economy beyond a few large countries and the largest multinational corporations. Even small-scale entrepreneurs in provincial backwaters can now reach globally via digital platforms, transforming their business into “micro-multinationals.” Flows of goods, services and financial capital all grew as the world entered this century, propelled by the build-out of corporate supply chains and low-cost labor arbitrage.

The 2008 financial crisis crimped that growth. But today, a new factor is driving globalization: exponential increases in data flows. Indeed, cross-border data flows grew 148- fold (no misprint) from 2005 to 2017. That shift is, in turn, creating opportunities, even as it calls into question widely held dogma about physical supply chains. In all, it’s a fruitful time to be a market leader or an opportune time to become one — provided you can adapt to this fast-changing environment.

No Free Lunch

As digital technology diffuses through every aspect of the economy, concerns about its use (and possible misuse) increase accordingly. Cybersecurity breaches are no longer a question of if, but when. Perhaps even more challenging than threats by malicious actors, the world is also starting to grapple with the unintended consequences of technology, as well as questions of misuse by legitimate actors — customers, governments or corporations themselves. New business models relying on big data generate questions about data privacy, control, ownership and asymmetries in economic value created. Platform companies seek to understand the extent of their responsibility for the behavior of users — buyers or sellers — on their platforms. Artificial intelligence is proving its worth in myriad contexts, yet concerns about fairness, transparency and misuse, as well as persistent fears about the potential work force impacts of automation, may dampen its potential.

Income inequality among countries is in decline as per capita incomes begin to converge. But, seemingly paradoxically, inequality has risen within advanced economies over the past several decades. What amplifies discontent is the fact that most households in the mature industrialized world are making hardly any material progress. From 2005 to 2014, real incomes stagnated or fell in advanced economies for 65 to 70 percent of households. Any gains in nominal income have been largely offset by rising costs of housing, health care and education, leaving many households in rich countries with little capacity to save.

Employment and income growth are becoming more localized, concentrating around “superstar” ecosystems — often, but not always, in large urban areas. As benefits concentrate geographically, firms face questions about their responsibility for social well-being on a global as well as local scale. Today’s companies operate in a world in which the rise of new economic powers feeds a cascade of geopolitical, geo-economic and geo-technological rivalries that can disrupt trade and supply chains. Global-local tensions increase as the barriers and differences between economies — from data residency requirements to antitrust to the protection of intellectual property to health and safety regulation — become more pronounced, all while companies do more business across more borders than ever before.

Climate hazards could put millions of lives at risk, as well as trillions of dollars of economic activity and physical capital, and natural capital.

Societal expectations of leading actors — whether the issue is fostering more diversity and inclusion or the responsible use of technology — are also shifting. After decades of accepting shareholder primacy as the de facto corporate approach, and prioritizing shareholders as the primary beneficiaries in the economic success of corporations, consumers and employees are asking new questions about corporations’ broader social role.

Perhaps the biggest shift is potentially an existential one — climate change — which poses risks on a scale that communities, institutions and businesses haven’t had to grapple with before. Addressing climate change will require choices that could alter how the economy itself works. Intensifying climate hazards could put millions of lives at risk, as well as trillions of dollars of economic activity and physical capital, and the world’s stock of natural capital. Many of these impacts could be regressive, most significantly affecting the most economically vulnerable populations. Threats to supply chains designed for efficiency over resiliency, reductions in labor capacity as a result of heat stress, damages to physical assets and other potential impacts pose risks that companies will need to factor into their decision-making processes.

To make things even more challenging, all these external forces must be managed in a rapidly evolving competitive market environment in which many arenas have the potential to be “winner take most.”

Superstar firms capture 80 percent of profits — 1.6 times more economic profit on average than comparable superstar firms 20 years ago. As a group, these superstars are larger, more globalized and more productive than median companies, and invest more in R&D and intangible assets (software, data, supplychain partnerships and the like) than their lower-performing peers.

At the same time, it is competitive at the top. Many face threats from other established leaders as well as nascent stars, especially emerging-market firms, many of which have outpaced the incumbents’ revenue growth over the past two decades. No wonder nearly half the superstars fall out of the top ranks every business cycle, and 40 percent of those that fall end up in the bottom decile. At that bottom, many linger for long periods. Already, we can see strong rises in the number of “zombie” companies — which the OECD defines as loss-making firms that do not generate enough cash to cover interest payments on their debt for at least three consecutive years in a business cycle.

While these superstars generate significant economic value, they are also highly visible and face growing societal pressure to contribute in line with their returns. Hence, the question arises of who benefits from the outsized economic success of such firms.

What’s a CEO with Big 21st Century Aspirations to do?

Here, we focus on four (out of a list of 10 we have compiled) challenges that cut to the heart of the matter.

A Return to the Stakeholder Debate

The stakeholder capitalism debate is not new to this era, although it has taken on a different flavor. Consider that CEOs have been around for only just over a century. The term first came into use in the late 1910s with the establishment of the modern managerial form of corporations. Gone were the 19thcentury “captains of industry” (or “robber barons,” depending on how you judge their role), making way for trained executives who possessed specialized skills to manage the growing complexity of production, marketing and distribution. Still, business leaders in the first half of the 20th century — many of whom were entrepreneurs and founders, but whose ranks also included this emerging breed of executives — took their roles in society seriously and often saw good business reason to do so.

Henry Ford famously doubled wages for his auto workers to $5 a day in January 1914 (a remarkable $129 in today’s dollars), giving him leverage to demand very high productivity and even giving workers the means to buy the very cars they were making. At the height of the Great Depression in the early 1930s, Thomas Watson Sr. introduced his own “new deal” at IBM by shifting factory employee compensation from piecework to an hourly wage basis. His son Thomas Watson Jr. continued the tradition of prioritizing employee needs, notably declaring in 1958 that “this is a company of human beings not machines, personalities not products, people not real estate.”

Up to 375 million workers globally may need to shift occupations over the next decade, based on jobs displaced by automation and new labor demand created by spending and investment trends.

By the 1970s, the role of the CEO again evolved, and the focus shifted almost entirely to raising earnings per share. The economist Milton Friedman articulated that most clearly in a September 1970 article in The New York Times Magazine: “the social responsibility of business is to increase its profits,” read the headline. This thinking was possibly a reaction to a sense that companies were overreaching, taking on broader responsibilities for which they may not be the best-suited institutions. The paramount importance of shareholder value gained ground as the core business purpose in subsequent years amid deregulation, the opening of global markets and the introduction of the World Wide Web.

One way to track the changing debate is to look at statements issued by the Business Roundtable, which today represents some 180 U.S. CEOs in large firms. In 1981, the BRT was still calling on corporations to be a “positive force in society.” Sixteen years later, the BRT’s narrative had shifted: “The principal objective of a business enterprise is to generate economic returns to its owners.” Now, two more decades later, the BRT’s stance has changed considerably. The group’s new position statement, issued last August, asserts that the purpose of a corporation is to “promote an economy that serves all Americans.”

Of course, determining who your stakeholders are is only the first step. The question now facing many companies, especially as their commitment to stakeholders other than owners has been publicly recognized, is what exactly that commitment means. Do assurances to stakeholders include economic or social commitments? You might listen to their ideas and concerns, but do stakeholders truly get a seat at the table? What decisions can they influence, and how will you be held accountable?

To provide input, companies have experimented with models, including stakeholder advisory councils, board seats to represent stakeholder groups and more informal channels. Whether they can influence your decisions or not, do other stakeholders cross into what might be the main arena for your shareholders — sharing in the economic success of the business? While still early, some leaders are exploring channels to share these benefits tied to business performance.

Defining the Future of Your Work Force

It’s obvious that the nature of work is changing. While the 20th century brought promises of full-time, formal and permanent employment, the relationship between workers and employers is evolving once again. Over the past two decades, alternative work arrangements have gained prominence, with more individuals engaging in independent work, self-employment, temporary work or parttime work. At the same time, workplace “fissuring” has entered our vocabulary, referring to arrangements in which workers are not employed by the company that directly benefits from their labor. One consequence is clear: the average worker bears much more responsibility for his or her own economic outcomes in the face of wage stagnation, increased work fragility and declining benefits and opportunities for training and career advancement.

For companies, especially those with large (and often low-wage) work forces, these trends pose the question of where an employer’s responsibility begins and ends. Is it enough that you simply offer work and pay a competitive wage? A number of companies across many sectors, enterprises as diverse as Unilever, PayPal and Bank of America, have chosen to increase their minimum wages above the market rate without government mandate. With their size and influence in the market, they are poised to galvanize action among their peers.

For their employees, it’s a step in the right direction. But left unanswered is a related question: should those benefits extend to independent contractors, or individuals who do work through an affiliated company or platform? Would you go so far as to pressure your suppliers to take similar actions for their workers?

Automation fueled by AI is also shaping the future of work. While prior research by the McKinsey Global Institute estimates that there will be more jobs gained than jobs lost at the national level from automation over the next decade, workers and work itself will undergo some key transitions. As machines take on jobs performed by humans, we can expect to see a shift in skills demanded, an evolving mix of occupations, pressure on wages, diverse impact across people and places, and a need to redesign organizations and workflows to align with technology use. We estimate that as many as 375 million workers globally may need to shift occupations over the next decade.

The prospect of automation creates some difficult choices for employers. If technology offers efficiency gains at the expense of jobs, is going for the short-term financial win the right decision? Some companies have decided that retraining initiatives, both to redeploy displaced labor and meet skills gaps in their company, work for the bottom line as well as for workers. AT&T, SAP and Walmart are among the handful that have introduced large-scale training for workers.

But for low-wage workforces with high turnover, the economics of training doesn’t always compute. This recalls the hoary joke in which the CFO asks the CEO, “What if we train our workers and they leave?” The CEO responds, “But what if we don’t train them, and they stay?”

Regardless of your workers’ career paths, their livelihoods and communities are affected by decisions to replace human labor with machine labor. As a result, corporations face questions about their responsibility to help the places where they operate make these transitions.

Technology misuse has become a thorny issue, especially when what constitutes legitimate and illegitimate use becomes fuzzy. Technologies like facial recognition could be weaponized or used for mass surveillance.

Using Data and Technology Responsibly

Data increasingly drives not only improved processes within firms, but forms the basis of business models that depend on data collection, processing and monetization. As a result, the questions surrounding data and technology use grow more pointed. While data monetization appears to benefit everyone — firms have new ways to market, sell and provide services, and consumers often receive these services for “free” — risks to user privacy and control over their own data remain an issue.

CEOs face questions about what to make of these opportunities. Will you pursue the economic benefits of data monetization, despite the risks? For those who do, the broad spectrum of options to protect user privacy include some that can significantly affect how they do business. Some superstar companies — among them Amazon, IBM, Mastercard and Dell — have chosen to lead on the regulatory side, pushing for greater privacy legislation at the federal level.

Technology misuse has also become a thorny issue, especially when the line between what constitutes legitimate and illegitimate use becomes fuzzy. Technologies like facial recognition could be weaponized or used for mass surveillance. But second-order effects aren’t always straightforward even for seemingly simple products and services that help organizations or individuals reach their goals more efficiently. If, as a provider, you disagree with how your technology is used, when should you act on that judgment? Indeed, is it ever your place to do so?

In addition, risks of inadvertent bias come along with the use of artificial intelligenceenabled decision algorithms. Companies have already witnessed these fears become tangible in machine-assisted hiring and credit decisions, and have experienced the backlash when they got it wrong.

Responding to Climate Change

One challenge for firms is how to manage the damage their business operations pose to the environment. Most pressing is the risk arising from climate change. Response to environmental issues is, quite literally, a hot topic with customers, employees and regulators demanding a response from corporations on how they will respond to the outcomes they have played some role in creating.

The risks from a changing climate in terms of drought, extreme weather and rising sea levels are becoming clearer. Our world has been built on the premise of a relatively stable climate, and its increasing instability could create a series of tipping points that are of crucial importance — and danger — to business. For example, supply chains have generally been constructed with the goal of efficiency rather than resilience. But if thresholds are breached — for example, if flood defenses break down, if temperatures become too high to work outdoors, if crops fail — resilience will become the new watchword.

Climate change is a unique challenge, given the need for collective action to move the needle. Some individual companies have taken steps, but more decisive behavior is needed to meet to global emissions-stabilizing targets. For example, almost a quarter of companies in the U.S. have made a public commitment that by 2030 they will be carbon neutral, using 100 percent renewable power or meeting a science-based internal emission reduction target. And hundreds of companies are factoring a shadow price on carbon emissions into their business plans.

But such actions raise a thicket of other questions. What responsibility do corporations have to galvanize their peers? Where does their responsibility end and that of the other institutions of our society — notably, government — begin? Can you assess your own risk to climate-related events for your workers and investors, and can you help other firms to do so? You might run into a number of trade-offs, not just between short-term shareholder value and your environmental commitments, but also the resulting impacts on other stakeholders.

Almost a quarter of companies in the U.S. have made a commitment that by 2030 they will be carbon neutral.

If you commit to being carbon-neutral, but a reliable supplier does not, will you look for a new supplier? What if eliminating an environmentally damaging (but legal and profitable) product line costs jobs in communities where your operations are located?

Even when the scientific case for investment in climate stabilization or mitigation is clear, these trade-offs among stakeholders and the importance of collective action to address climate change makes it a difficult challenge for companies to solve — especially when acting alone.

If Not Now, When?

What works in one era is never guaranteed to work in another. The companies of the past either evolved or disappeared — “creative destruction” in the phrase coined by the economist Joseph Schumpeter. As the massive industrial firms of the past make way for hyper- globalized, technology-driven companies, the CEO’s role must evolve as well. In the last century, CEOs who learned to manage growing legions of middle management and to expand into markets far from home, barely dipped their toes into public policy issues that did not immediately affect the bottom line. Now they must be technology evangelists, geopolitical risk managers and social activists, or at least understand what it takes to earn the social license to operate in often multiple and different contexts.

EOs face choices about when to lead, as opposed to following their peers (or simply doing what is required by law). If you choose to lead, how far should you go? In some cases, the choices will be ones that competitively differentiate the company in the eyes of its customers or employers versus competitors. In other cases, the choice will be driven by where the company is most vulnerable. And for still others, the choice will simply be determined by what the company believes is the right thing to do, what aligns with its own sense of purpose. Leaders will need to decide what level of commitments to make, including how far those commitments will extend — just to your management and employees or, more broadly, to suppliers and ecosystem participants, customers and the communities in which you operate?

Companies can’t forget their core mission of making profitable products and services. But they can no longer be bystanders on social issues, especially those ever more closely intertwined with their business activities. Their shareholders — but also their customers, employees, governments and communities worldwide — will be asking.

This article appeared first in Milken Institute review.