What is the principal source of profits – Part One

This seems to be the fundamental debate between researchers in industrial organisation economics (IOE) and the field of strategic management (SM). This debate can be traced all the way back to Ed Mason who in the 1930s argued that there was a rather deterministic association between market structure and profitability.

The logic of the argument rested on the promise that there are structural characteristics of the market (such as concentration) that placed constraints on which strategies a firm could pursue – which in turn led to differential performance among firms according to which industry the firm operated.

Within this field, companies within an industry were considered to be alike in all important strategic aspects – except for scale – and therefore the analysis focus was on the industry, not the company.

Although this was receiving strong approval by commentators, there was some disturbing research pointing in a different direction. One of them was done by Richard Rumelt in 1991. Rumelt found that effects connected to the business itself were the main contributor for profits, not the market the business was operating in.

From a practical standpoint, the identification of the factors which most sustainably contribute to your company’s performance would enable you as a manager to focus on the influential factors. For obvious reasons, economist would also be interested in predicting which firms will earn high rates of return.

In the forthcoming posts, I will go head to head with the market- and management arguments in order to seek what is driving profitability .

Is profit-maximizing finally social responsible?

Since the term was made common in the late 70s, Corporate Social Responsibility (CSR) has had its fair share of attention. It seems like we have come a long way since Milton Friedman’s statement that a company’s obligation to society is solely to “make profit, pay taxes and provide jobs”. According to a report in 2003, only one of ten adults shares Friedman’s view of corporate responsibilities. A follow-up poll actually found that over 80 percent agree that “larger companies should do more than give money to solve social problems”.

But what is really corporate social responsibility all about? Only one thing seems to be certain; whatever it is, it is not correlated to making organisational profit.

Government, activists and the media have in recent years become adept in holding companies responsible for social consequences of their activities. In order to keep such important stakeholders happy, managers have done very much to improve their companies ranking(s) among the many CSR performance-indexes. 

Simplified, the traditional view of corporate social responsibility is that you have got the profit-maximizing companies on one hand and the generous companies thinking about the future generations on the other hand

In a Harvard Business Review article from 2006, Michael Porter and Mark Kramer argue that there are four justifications for why companies should invest in CSR; first is the argument that companies have a duty to be good citizens and to “do the right thing”.

The second argument for investing in CSR is sustainability. “You should meet the needs of the present without compromising the ability of future generations to meet their own needs”, as former Norwegian Prime Minister Gro Harlem Brundtland once said it.

Third is the license to operate. Each company needs license from various stakeholder groups to operate, and an investment in CSR will help the company get this permission.

The fourth (and maybe the most common) justification for CSR; it will improve the company’s reputation. 

Last year the world’s biggest retailer Wal-Mart told its 1,000 Chinese suppliers last year that it would hold them to strict environmental and social standards. This might not be surprising in itself - a lot of companies have said that to its employees over the years.

However, Wal-Mart is not social responsible because of sustainability or because it improves the company’s reputation. They are doing it purely based of economic factors. Wal-Mart has been encouraging companies to cut down on packaging. This enables it to fit more goods into each delivery truck, not only reducing its emission, but also cutting the amount it spends on petrol!

Another example is Mars, the world’s biggest confectionery company, who announced that its entire cocoa supply will “be produced in sustainable manner” by 2020. Also Cadbury, the UK confectionery group, announced that all the cocoa in Dairy Milk, Britain’s biggest-selling chocolate, would be certified by Fairtrade.

For the fourth successive year, cocoa production fell in 2008. Mars and Cadbury are both worried about how few cocoa farmers’ children intend to go into the business. They are hoping the investment in farms that Fairtrade encourages will persuade them cocoa farming is a worthwhile occupation.

Someone please call Porter and Kramer and tell them to add a fifth justification for investing in corporate social responsibility; profits!

Step 1: Analysing the Resources

When Strategic Management is your main field of interest, the natural approach to find the purpose of the blog would be to analyse the resources both externally and internally. However, as I haven't got any mission, vision nor objectives here, I will make the introduction as informal and far from methodology as possible.
Currently studying at London Metropolitan Business School, I am pursuing my MA Management degree. Therefore, the blog's purpose is to be basis for discussion and a method for learning and development - for all of us, if there are any other than me.
Best regards,
Ove