Capitalism's Dilemma

Addressing shareholders
recently, Warren Buffet defended 3G Capital’s method of cutting costs
and shoring up short-term profits. The comments came in the aftermath of 3G’s $143 billion failed bid for Unilever.
It is worth examining the two
models of capitalism that 3G and Unilever represent.
3G’s last success was with Kraft Heinz. Kraft Heinz today is
notable for its clock-like efficiency. The company has closed many of its
plants, sold off non-productive assets and has waged
war on costs. Fortune
magazine has reported that the company has been able to shrink overhead costs from 18%
to 11% in two years.
As noted by Professor Julian Birkinshaw of London Business School, the executives
at Kraft Heinz (mostly planted by 3G) have transplanted the performance culture
of an investment bank to the world of fast-moving consumer goods. The culture transformation is nothing short
of breathtaking. If you perform
well, rewards and bonuses await you. If you are sloppy, you lose your job. Period. There is no scope for
emotions or empathy. 3G’s overarching
mission is the maximization of shareholder wealth. Although not
explicitly stated, but evident from its actions, other stakeholders simply do
not matter.
It is possible to argue that
3G’s approach is perfectly consistent
with the core principles of capitalism.
After all, “Capitalism demands the best of every man – his rationality –
and rewards him accordingly. It leaves every man to choose the work he likes,
to specialize in it, to trade his product for the products of others, and to go
as far on the road of achievement as his ability and ambition will carry him.”
(Ayn Rand: Capitalism: The Unknown
Ideal, PP20).

Unilever
is at the other end of the spectrum. Unilever’s mission is to “make sustainable living commonplace.” Paul Polman is at the forefront of “pro-social” goals and wants to double Unilever’s revenues while
reducing its environmental footprint and increasing social impact. Unilever extolls performance but in a much more nuanced way. Integrity and impact mean a lot more than hard
numbers. Unilever’s executives may not earn as much as their counterparts at
Kraft Heinz, but they do have a more
relaxed work setting, devoid of relentless pressure to deliver quarterly
results.
We have these two companies,
both in the consumer goods space, trying hard to push their brand of capitalism.
3G capital controls Kraft Heinz and has become a force to reckon with notwithstanding the fact that some of its
methods are open to debate. Unilever has become the poster-company for “conscious
capitalism.” When you think of corporate social responsibility, you cannot but think
of Unilever. The notion that corporations exist to serve all stakeholders and
not just shareholders is equally debatable.
Jorge Paulo Lemann (3G) is not
accustomed to failure. His strategy is simple – slash costs and merge. 3G’s
ruthlessness emanates from the fact that thousands of workers have lost their
jobs in the target companies. That does not seem to deter either Lemann or 3G.
After all, investors are happy (at least in the short term) and should owners
(shareholders) worry if people lose jobs in the process of wealth creation? This
is one end of capitalism where inequalities will increase, jobs will be
disrupted, and people who do not or cannot acquire new skills just won’t
survive. The whole idea may make you squirm, but you cannot wish it away. After
all, 3G represents what textbooks advocate and very few firms can pull off –
managers who act like owners (and are rewarded accordingly). It is worth noting
that Kraft Heinz’s sales have fallen in four of the six quarters since the two
companies combined, placing a big question mark on whether cutting costs relentlessly
is compatible with growth.

Paul Polman of Unilever is one of the most
ardent exemplars of responsible
capitalism. In his worldview, products that meet the highest standards of
social and environmental sustainability perform better than products that don’t.
Polman’s assertion appears to hold in the long-term
but not in the short term, as the graphs above and below show.

At the heart of capitalism’s
dilemma is the ultimate goal of the corporation. Agency theory suggests that managers are “agents” and hence “maximizing
shareholder value” is the primary responsibility of managers.
Professors Joseph Bower and Lynn Paine of Harvard
Business School point out in their illuminating article “The Error at the Heart of Corporate
Leadership” (HBR May-June 2017) how flawed the agency
theory is. “The idea that shareholders are owners of the corporation is at best
confusing and at worst incorrect.”
Come to
think of it; shareholders have absolutely no incentives to think like owners.
Therefore, the agency theory produces a moral hazard. Shareholders are not
worried about the morality of decisions nor do they have a clearly defined
responsibility as to the consequences. It is unrealistic to assume that all
shareholders have a common purpose or an overarching vision. Managers feel
constrained in their ability to perform due to the constant pressure from
over-zealous shareholders.
What is the way out? Which “brand” of capitalism do you
espouse? Why?
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