Code of governance for sustainable business: sustainable

1. The sustainable enterprise and its governance

1.4. Code of governance for sustainable business: sustainable

sustainable development and the persistent creation of value

After reviewing the literature on sustainability and strategy, in this sub-heading, we reproduce Chapter 4 of the Code of governance for sustainable business ⁵. Its text constitutes the conceptual framework on which our analysis of the 18 market sector leaders of the ^DJSWIis based. As we will see, it draws heavily on the concepts and theories we have summarized above.

Introduction

1.4.1. It is well known that the purpose of all business strategies is to show companies how to create more value in a persistent manner. This depends basically on how attractive the industry is and how well-pitched the business model is. The success of the business model will also depend on the persistence of the competitive advantages on which it is based.

1.4.2. Both industry attractiveness and the suitability of the business model are decisively influenced by the concept of sustainable development. However, since this is the corner-

5The Code of governance for sustainable businessis the result of a two-year close collabora- tion between two bodies: the Editing Committee and the Executive Council. The Editing Committee included members from the three organisations backing the project: IESE, Fundación Entorno and Pricewaterhouse Coopers. Under the presidency of Mr. Ricardo Diez Hochleitner (the Executive President of the Club of Rome until the end of 2000), the Executive Council included more than 50 presidents and CEOSof Spanish companies and top level representatives of the administration and civil society.

stone of all successful strategies, in this chapter we will focus on the impact of sustainable development on the persistence of competitive advantages (Rodríguez and Ricart, 2000)⁶. 1.4.3. Business management literature has analyzed the persis-

tence of competitive advantages by means of two theories: the resource-based view of the firm and the activity- based view of the firm. Generally speaking the former emphasizes the portfolio of resources and capabilities that businesses generate and the latter the activities that they perform. Both lines of thought have been success- fully inter-related under the creation of value concept in the “dynamic view of the firm” (Ghemawat, 1999).

1.4.4. As Figure 1.2 shows, whether we refer to resources or activities, their capacity to act as the basis for the creation of persistent competitive advantages will depend on their ability to defend themselves from being copied by current competitors and replaced by potential competitors.

6 This article provides a large number of examples showing the impact of the envi- ronment on industry attractiveness, business model suitability and competitive advantage persistence.

Substitution Imitation

PERSISTENCE OF COMPETITIVE

ADVANTAGE

Resource

Commitments Activities

Resource Endowments

DYNAMIC AND SUSTAINABLE VIEW OF THE FIRM FIGURE 1.2: The dynamic view of the firm and the persistence

of competitive advantages

In this chapter, we will be seeing how the development of capabilities and activities, the possibility of them being copied and replaced, and the persistence of competitive advantages are influenced by the idea of sustainable development. In the first place, we will see what changes sustainable development brings to the competitive situation.

We will then go on to analyze how sustainable development influences the dynamic view of the firm and therefore the way in which businesses develop their capabilities and activities, and their possibility of being copied and replaced. Finally, we will see how all this affects business reputation and innovation capability and consequently the possibility of creating value in a persistent manner.

Sustainable development

and changes in the competitive landscape

1.4.5. The speed and depth of technological changes and dis- continuities have not really heralded the end of the industrial era, but its acceleration and growth. References to the post-industrial era, as proposed by sustainable development, imply fundamental changes in how the economic system affects and is related to the two major systems in which it resides, the social and natural systems. In this regard, sustainable development introduces the notion of scarcity of natural resources and the co-responsibility of businesses and societies where they operate in the development and use of social resources.

1.4.6. Scarcity of natural resources (Senge, 2001; Hart, 1995 and 1997;

Porter and van der Linde, 1995). The industrial era start- ed, developed and continues to operate on the implicit idea of unlimited natural resources. This has led the industrial system to be a linear one in which the basic ele- ments follow an extraction-manufacture-sale-use-elimina- tion sequence, generating waste at each link in the chain.

The consequences of this system were not too serious as long as the level of development remained within certain limits. However, the acceleration and growth of the number of its beneficiaries, plus the ethical need for it to be

broadened to encompass the planet’s inhabitants, has called our attention to the intrinsically non-sustainable nature of this development model. In this sense, acceptance of the scarcity of natural resources and therefore of the need to reduce the use of resources and the genera- tion of waste by business activities could be one of the prime movers of the development of new capabilities and activities that can give rise to persistent competitive advantages.

1.4.7. Business-society co-responsibility in the development of social re- sources. In practice, too many businesses disregard the social system of which they are part. Sustainable development introduces the need to change this situation both with regard to business operations in developed countries and especially in underdeveloped and developing countries.

And there are two reasons for this: the increasing transfer of power, and therefore responsibility, from society to the business world conveyed by the globalization phenome- non; and because of the possibilities to create economic value for shareholders (e.g., Prahalad and Hart, 2000) ⁷ generated by this behavior.

From the dynamic view of the firm to the dynamic and sustainable view of the firm

1.4.8. Companies have to develop new capabilities and activities for the acceptance of the notions of the scarcity of natural resources and the co-responsibilities of societies and businesses in the development of social resources to give rise to persistent competitive advantages. To be specific, and always bearing their concrete characteristics and circumstances in mind, it would seem to be convenient for them to develop the following: new relationships with their consubstantial stakeholders, new relationships with their contractual stakeholders and new relationships with their contextual stakeholders. This is evidently not a radically new issue, since

7 The examples provided by these authors show that there are great possibilities of creating value.

companies have rich and varied experiences in the field.

What we are suggesting is for new forms to be adopted and new content to be considered. Considering the tacit, path- dependent and socially complex nature of these capabilities and activities, they will be substantially more difficult to imitate and substitute. This idea is illustrated graphically in Figure 1.3.

1.4.9. New relationships with consubstantial stakeholders. In this section we will be referring specifically to employees. The image of the machine as the organizational paradigm of the industrial era has led to impressive productivity rates. How- ever, the process has also led to the dehumanization of la- bor relations and consequently to a lack of employee in- terest in their businesses. Although people are born with intrinsic motivation, self-esteem, dignity and willingness to learn (Deming, 1993), the fact is that employees are not part of their companies, but hire part of their time out to

Substitution

PERSISTENT COMPETITIVE

ADVANTAGE Imitation

Resource

Endowments Resource

Commitments Activities

DYNAMIC AND SUSTAINABLE VIEW OF THE FIRM

SUSTAINABLE DEVELOPMENT

FIGURE 1.3:The dynamic and sustainable view of the firm and the persistence of competitive advantages

them. In the so-called knowledge society, it is essential to change this state of things and cultivate people’s natural in- terest in learning. For the learning culture to become a re- ality, resulting in an increase in creativity and imaginative power in general, the control-oriented system in most firms needs to be replaced by a system driven by trust and self-control. As a large number of companies have had the opportunity to discover, no idea is as powerful in obtaining employee satisfaction, and therefore commitment and in- tegral involvement, as the idea of sustainable development, because of the strong alignment with personal values (Sen- ge, 2001) implied by it. Evidently, obtaining such a culture requires, among other things, changes in aspects such as management style, structure, transparency information policies, recruitment and salary systems, job security, etc., and time (Pfeffer and Veiga, 1999). But the results justify the effort⁸(Huselid, 1995; Pfeffer, 1998).

1.4.10.New relationships with contractual stakeholders. This section refers specifically to customers, suppliers and sub-contrac- tors. Traditionally, these relations have been seen as basically competitive ones. Even business management literature has emphasized the bargaining power of the different actors in the value creation chain. In this respect, their capacity for claiming value was more important than their capacity for creating, and therefore deserving value. The new competitive landscape assumed by sustainable development implies that businesses are capable of establishing new relationships with them in order to develop the products and services that the markets and society re- quire and, therefore, value and accept. For the reasons defined earlier (1.4.9), these relationships have to be based on trust rather than control. It will also be necessary to boost sharing information, training and technologies, etc., in addition to long-term commitments. Although these re-

8 In these articles and others, it is shown how changes along these lines can lead to spectacular increases in a firm’s sales, profits and market value.

lationships may formally be of a contractual nature, increasingly diffuse business borders mean that the most important, if not all of them, can ultimately be considered as partners in the innovation and creation of value process.

Obtaining this kind of collaborative relationships, even considering that there will evidently be some level of competitive tension, will become fundamental in firms’ corporate and business strategies (Champy and Nohria, 1996).

1.4.11.New relationships with contextual stakeholders. These stakeholders include the public administration, knowledge and opinion makers (the media, ^NGO^S, universities, scientific community, etc.) and the communities, countries and societies where firms operate or which are affected by their operations. The practical conviction that the business system resides in, and forms part of the ecological and social systems has important consequences for the nature of the re- lationship between firms and their contextual stakeholders.

It implies not only that businesses and society are not inde- pendent, or merely inter-related, but also that they are in- deed inter-dependent (Svendsen, 1998). It implies, therefore, shedding the belief that the only mission of firms, and therefore of their executives is to generate profit for shareholders, and starting to believe that the mission of firms is to discover opportunities that are beneficial both for the firms themselves and for society in general. It implies that since stakeholder relationships are a vital source of diversi- ty and involvement that give firms meaning and valuable resources (Kennelly, 1995), executives have to cease to be mere shareholder agents to become also builders of stakeholder relationships. They will thus be able to predict, un- derstand and respond better, faster and easier to changing situations.

1.4.12.Strategic nature of the new capabilities and activities. For capabilities and activities to have strategic value, and therefore generate persistent competitive advantages, they have to comply with the following conditions: they have to be difficult to imitate by our present competitors; they have to be difficult to replace by our present and future competitors,

and they have to be valuable, that is, positively valued by the markets (Barney, 1991). We will now see how the capabilities and activities proposed above help us to comply with these conditions.

1.4.13.Difficult to imitate. Certain capabilities related to issues such as location, technologies, products or productive processes can be difficult to imitate. However, they are all more or less subject to the possibility of our competitors copying them, or merely acquiring them sooner or later and to a greater or lesser extent. However, capabilities and activities that are socially complex because a large number of people are involved in their development and maintenance, in which history and experience are important, in the sense that their present status depends on their prior status, and which have a tacit nature, that is, are characterized by the fact that they can not be verbalized or formalized, are in practice inimitable. The types of relationships proposed (1.4.9 - 1.4.11) are perfectly compliant with these premises.

It can be said that they are difficult to imitate because they are intangible assets based on practical learning obtained through experience and refined by practice, and also because they depend on a large number of people or teams.

Because they are socially complex and tacit, our competitors will not be able to obtain them by hiring our employees.

1.4.14.Difficult to substitute. All business models run the risk of being replaced by another sooner or later. Internalizing the changes produced by sustainable development on the competitive landscape (1.4.5 - 1.4.7) and the development of the proposed stakeholder relationships (1.4.8 - 1.4.11) does not completely protect firms against this risk, although it is considerably reduced. In the first place because the information and knowledge involved will be considerable and constantly more complete. In the second place because most of the risk of capability and activity replace- ment will be increasingly related to the new implications introduced by the need for sustainable development.

1.4.15.Valuable. Sustainable development helps to develop capabilities and activities that are difficult to imitate and substi-

tute. But they will also be valuable if, in addition to distin- guishing our business model from that of our competitors, they also support and increase the persistence of competitive advantages. This partially depends on the evolution of society. And it is becoming increasingly unquestionable that society is moving towards demanding business conduct that permits sustainable development⁹.

Sustainable development, innovation

and reputation as the source of persistent competitive advantages 1.4.16. Acceptance of the changes in the competitive landscape

implied by sustainable development and the development of the capabilities and activities presented above leads, pri- marily, to promoting two unquestionable sources of persistent competitive advantages: innovation and reputation. As we shall see, both will help us to prepare a business model that is different from that of our competitors which, as we all know, is essential for any strategy.

1.4.17.Innovation. Innovation, understood as the result of basic and applied research and development (^R^&^Dand innovation) has become an essential condition for competitive success. In a discontinuous world, strategic innovation is a key factor of the creation of wealth. Strategic innovation is the capacity to re-conceive the existing industrial model to create new value for customers, outwit competitors and produce new wealth for all stakeholders (Hamel, 1988). In this respect, a great deal has been said and written (and much less applied) of the importance of intellectual capital as food for ^R^&^Dand innovation processes. Well, the chal- lenges derived from the demand to move towards sustainable development help firms to question their usual ways of thinking and acting and to approach the need to develop new products, services and technologies, so they are an invigorating organizational shake-up and an undeniable

9 See, for example, the results of the macrosurveys “The Millenium Poll on Corpo- rate Social Responsibility”, Environics, The Prince of Wales Business Leaders Forum and The Conference Board, May 1999.

source of innovation opportunities. Establishing new relationships with different stakeholders leads companies to possess the broadest range of present and future outlooks on the world, to obtain information and knowledge relat- ing to the opportunities concerned and to establish the collaborations that are essential to make them come true, besides providing them with the credibility required to se- cure social approval for their innovations.

1.4.18.Reputation. The asset of a good reputation is evidently one of the reasons for the difference between the book value and the market value of many companies. A large number of studies confirms this (Shrivastava, 2000; Vergin and Qoronfleh, 1998; Black, 2000). In all the studies that aim to analyze what is behind different business reputations, one fundamental variable is their environmental and social conduct, and therefore their contribution to sustainable development (Slocun and Turner, 1999) ¹⁰. A good reputation allows firms to obtain the loyalty of present customers and attract new ones, to attract and retain the best employees, to gain a good brand image, to have preferential relationships with the administration, to see how their products, services and proposals in different fields are ac- cepted by society, to have lower capital and insurance costs, to obtain preferential treatment in the growing market of socially responsible investment funds, and to obtain a greater license to innovate and, in general, more credibility when explaining their points of view to stakeholders. Like innovation, it is an unquestionable source of persistent competitive advantages. It may not guarantee success, but it certainly increases firms’ likelihood of success and survival.

1.4.19. We have seen how innovation and reputation depend on the development of new capabilities and activities linked to stakeholder relationships. Figure 1.4 shows how adequate management of new capabilities and activities, reputation

10See, for example, the annual studies conducted by Fortune magazine on America’s Most Admired Companies; the work of the Reputation Institute; or the recent MERCOindex published by the 5 Días newspaper.

and innovation leads to a business model different from our competitors’, creating a value in which economic, environmental and social factors are inextricably bound together.

From the traditional view of corporate governance to sustainable corporate governance

1.4.20. The ideas described in this chapter imply the introduction of fundamental changes in the concept of corporate governance and the goals it should target. The following figure shows a diagram of the fundamental aspects of this change:

1.4.21. Since the central value that has traditionally guided corporate governance is basically economic, the aim of firms’ activities has been to maximize share value by obtaining investor satisfaction. In the new concept of corporate governance presented in this Code, the central value is not economic growth but sustainable development. Therefore, the governance of sustainable businesses aims ultimately at creating value in a persistent manner, for shareholders and for society in general, by means of both investor and stakeholder satisfaction.

Sustainable development and changes in the competitive landscape

Natural capital scarcity Co-responsibility business-society in

social resources development

Persistent competitive

advantage

Creation of economic, environmental and

social value

Distinct business model

Innovation

Reputation

New capabilities and activities:

valuable and difficult to imitate and substitute

New stakeholders’

relationships

Contractual Contextual

Consubstantial FIGURE 1.4: Sustainable development and creation of economic,

environmental and social value

In document PDF The Sustainable Enterprise - Fundación BBVA (página 32-43)