This hack is one of ten winning entries in the Long-Term Capitalism Challenge, the third and final leg of the Harvard Business Review / McKinsey M Prize for Management Innovation.
Capitalism has been a tremendous engine of prosperity and progress for the last century. As practiced, however, it has also contributed to many potentially cataclysmic problems we urgently need to face as a global community—from climate change to a dangerously unstable financial system to rampant inequity.
There is broad agreement among most actors in the system that capitalism must be reimagined for a new age and this new set of challenges. If we want a new kind of capitalism that is fundamentally more sustainable, inclusive, and resilient, we have to get to the core of the problem—we must challenge the assumption that the for-profit firm is the only vehicle for organizing economic activity and creating value. The entire ecosystem of capitalism—from public policy to management theory and education to capital markets—is geared to promote the success of the profit-maximizing firm above all else.
To correct the course of capitalism, we need to move beyond this singular focus on for-profit firms and advance a new breed of "for-benefit" firms that are structurally designed to integrate social, environmental and financial value creation. For-benefits should be formalized as a fourth sector of the economy—alongside the public, private and social sectors—and we need to develop a supportive ecosystem that is tailored to their needs, similar to what exists for for-profit firms.
The good news: new for-benefit firms and many elements of a supportive ecosystem have been emerging over the last several decades. The challenge: for this ecosystem to offer equal footing to for-benefits in a for-profit dominated world, we need to accelerate its development with a more comprehensive and systemic approach.
Capitalism has been incredibly effective at creating prosperity and improving the standard of living for many, but its current form is on the brink of extinction. Its weaknesses—including short-termism, speculative trading, absentee ownership, profit- and shareholder-centric orientation, inability to account for non-monetary value, exploitation of labor, and extractive use of natural resources—are creating too many disruptions across the globe for the model to survive. Climate change, natural resource shortages, the growing gap between rich and poor, and the fragility of financial systems are just a few of the critical problems it has spawned. Together, they threaten to stir up a perfect storm.
Over the past few decades, countless approaches to course correction have been advanced. They include corporate social responsibility (CSR), sustainability, shareholder advocacy, social assessment and auditing, consumer action, government regulation, leadership development, ethics, realignment of incentives, attracting long-term investors, creating shared value, and more. While these are all constructive strategies, they don't go far enough to challenge one fundamental assumption at the core of capitalism: that the for-profit firm is the only vehicle for organizing economic activity.
To cure capitalism's ills, therefore, schemes tend to be advanced to modify the behavior of stakeholders toward the for-profit firm (e.g. getting investors to think long-term, or consumers to buy green products) or to modify the behavior of the for-profit firm toward its stakeholders (e.g. treating suppliers as partners, improving working conditions for employees). But we persistently stop short of questioning the underlying structure of the firm itself. For-profit firms are structured to maximize profits, hence minimizing labor, raw material and production costs. And the entire complex ecosystem around them—laws and regulations, capital markets, measurement standards, management education, etc.—is designed to reinforce that singular objective function.
Yes, some have started calling into question the actual purpose of business, suggesting that firms should be organized for something beyond profit maximization. But simply declaring a nobler purpose and rewriting the mission statement in a for-profit firm does its purpose change. The fundamental structure of the firm needs to be modified. That is at the heart of the problem—it is the DNA of capitalism. Unless and until we address it, we are just treating symptoms, and our reform efforts will not reach the scale and speed required to avert the looming storm.
To correct the course of capitalism—mitigating its harms and amplifying its positive contributions—we need to move beyond the singular focus on for-profit firms to advance a new breed of "for-benefit" firms that are structurally designed to integrate social, environmental and financial value creation. And in order for these for-benefits to thrive, we need to develop a supportive ecosystem that is tailored to their unique needs, similar to the supportive infrastructure that exists for for-profit firms and nonprofit organizations.
1. Formalize The For-Benefit Firm
Most capitalist economies are organized as three-sector systems consisting of a private (for-profit), public (governmental), and social (nonprofit) sector. Over the past few decades, however, the boundaries between these traditional sectors have been blurring as more and more organizations have been integrating social and environmental aims with business approaches. Many for-profit firms have been broadening their purpose beyond a narrow focus on profit maximization to taking responsibility for social and environmental outcomes, while an increasing number of nonprofits and governmental entities have been adopting market-based approaches.
At the same time, a growing number of pioneering entrepreneurs have been developing a variety of new for-benefit firms that defy classification within the traditional sectoral boundaries. Like nonprofits, these for-benefits are primarily driven to solve a wide array of social and environmental problems, and like for-profits, they generate income by selling goods and services that enhance the lives of consumers. Many for-benefits go even further by incorporating features like stakeholder ownership and governance structures, fair compensation standards, social and environmental cost internalization, asset protection, and triple-bottom-line transparency.
These for-benefits represent a new pattern of economic activity that, at scale, could yield the more inclusive, sustainable model of capitalism that our times demand. However, most countries’ legal and economic systems are designed to allow either for-profit or nonprofit activity, not a blending of the two. As a result, many for-benefit firms are forced to shoehorn their vision into one structure or the other and compromise their mission or values in the process.
The solution is to codify for-benefits as their own distinct class—or fourth sector—of organizations under law, on par with for-profits and nonprofits. This is precisely what governments around the world are starting to do. British law created the Community Interest Company in 2005, and a number of U.S. states have passed new corporate forms legislation in recent years, including Low Profit Limited Liability Companies, Benefit Corporations, and Flexible Purpose Corporations. Federal lawmakers in the U.S. are also considering enabling legislation. While nascent and imperfect, these efforts are hugley important first steps. What’s needed now is a more intensely-focused, comprehensive and systemic approach to designing and developing for-benefit organizations and formalizing the fourth sector.
The following is a list of key for-benefit attributes, derived from a study of a diverse range of these enterprises, which can serve to inform policy, organizational and ecosystem design efforts. While combining social and commercial ends is nothing new (think hospitals, universities, and arts organizations), the for-benefit model does much more than that. It redefines fiduciary duty, governance, ownership, and stakeholder relationships in fundamental ways:
Primary Attributes — shared by all for-benefits:
- Embedded purpose. A commitment to mission is in the organization’s DNA. Fiduciary duty is tied to purpose.
- Earned income. Sales of goods and services generate most of the income.
Secondary Attributes — present in some for-benefits:
- Inclusive ownership. Ownership rights are allocated among stakeholders in accordance with their contributions.
- Stakeholder governance. Decision rights regarding information and control are distributed among stakeholder constituencies.
- Fair compensation. Employees and other stakeholders are compensated fairly in proportion to their contributions.
- Reasonable returns. Limitations on investment returns protect the organization’s ability to achieve its mission.
- Social and environmental responsibility. Social and environmental performance is constantly improved throughout the stakeholder network.
- Transparency. Social, environmental, and financial performance and impact are fully and accurately assessed and reported.
- Protected assets. Social-purpose assets are preserved upon dissolution, conversion, or ownership transfer.
2. Develop a Supportive Ecosystem for the Fourth Sector
For-profits and nonprofits exist within supportive ecosystems consisting of well-established laws, accounting standards, financial markets, trained pools of talent, and customized tools and services. When an entrepreneur starts a conventional company, lawyers, accountants, investors, and consultants share an understanding of what that means and can provide tools and services that fit seamlessly together. All of those elements must be rethought in concert for the for-benefit enterprise to move from the margins to the core of the economy. It is crucial to design and accelerate the development of a robust supportive ecosystem for the fourth sector in which the for-benefit enterprise is given equal opportunity to thrive. Key elements of an effective fourth sector support ecosystem include:
Financial Markets: Most for-benefit entrepreneurs still have to rely on the standard for-profit and non-profit channels to capital. Among the elements that are needed, and in many ways are emerging, are new kinds of venture funds, financial intermediaries, holding funds, or stock exchanges that facilitate a harmony of aims between investors, donors, and for-benefit enterprises.
Legal Structures and Regulation: Despite the new for-benefit laws that have been created over the last few years, most fourth sector organizations are currently structured as nonprofit, public or for-profit entities, or some hybrid combination of these. New and better legal forms need to be created to facilitate formation of for-benefit enterprises, along with potential changes to corporate, nonprofit, intellectual property, securities, consumer protection and other laws.
Tax Policy: Current tax policies make little allowance for fourth sector organizations. New tax laws may need to be created to provide appropriate treatment for for-benefits and to ensure their accountability.
Education and Training: Active participation of our formal and informal educational institutions are required to disseminate fourth sector know-how and train its workforce.
Conflict Management: The for-benefit is fundamentally a more stakeholder-centric model of organization. Since different stakeholder groups have different and often competing interests, a healthy tension is inevitable within the organization. New mechanisms for effective dispute resolution may be needed to resolve conflicts.
Marketing and Communications Support: For-bnenefit enterprises need appropriate and authentic ways to market themselves and communicate their message to customers and stakeholders. Organizations with a true, demonstrable commitment to social and environmental performance need to be able to distinguish themselves in the marketplace from those who are less sincere or effective. This will require specialized marketing, communications and public relations support as well as alternative media channels that are aligned with fourth sector values.
Connection and Representation: Membership and trade associations, networks, affinity groups and conferences can have an important role in connecting and supporting the various constituencies within the fourth sector. They can facilitate knowledge transfer among practitioners, advocate for changes in public policy, create visibility for the sector and organizations involved in it, and provide important services to their members. There is also a need for new networking structures that enable collaboration and coordination among those engaged in the development of the fourth sector support ecosystem.
Research and Understanding: Academic and research institutions have an important role in advancing theoretical understanding and the state of knowledge about the fourth sector. While recent attention has been focused on pockets of activity within the sector, such as social enterprise, social metrics, and sustainability, a much more expansive effort is required.
Assessment and Reporting Standards: For fourth sector enterprises to be perceived as credible and trustworthy, rigorous assessment tools are required that accurately measure social and environmental value creation alongside financial value creation. Reporting protocols must be developed to ensure fourth sector enterprises will be fully accountable to all stakeholders, not just shareholders.
Ratings and Certification: Ratings and certification platforms are needed to verify and compare operating performance and social contribution of fourth sector organizations.
Exchange Mechanisms: Conventional methods of exchange narrow value to financial value. Ideally, fourth sector enterprises would be able to use mechanisms that facilitate the direct exchange of non-financial value.
Technical Assistance: Fourth sector enterprises require legal, accounting, strategy, marketing, technology and other types of support tailored to their unique requirements.
Information Technology: Fourth sector organizations will need customized information technology to help with social accounting and other unique aspects of management.
Fortunately, there are numerous efforts underway to make progress in each of these realms. For example, for-benefit entrepreneurs can obtain specialized legal assistance through the Lex Mundi Pro Bono Foundation. Access to sympathetic sources of capital is becoming easier with the rise of so-called impact investors and the advent of intermediaries such as the Global Impact Investing Network. (The financial opportunity is certainly there: According to a 2010 J.P. Morgan research report, five sectors of the global bottom-of-the-pyramid market collectively offer the potential over the next decade for up to $1 trillion in invested capital and up to $667 billion in profits.)
The management consulting world is beginning to address the technical challenges of delivering “blended value” (Bridgespan and the Monitor Institute are in the vanguard here). Duke University’s Center for the Advancement of Social Entrepreneurship and other business school programs are developing high performers who want to work in a for-benefit environment. Fellowship programs at Ashoka, the Schwab Foundation for Social Entrepreneurship, and Harvard Kennedy School’s Center for Public Leadership help further the careers of top-tier entrepreneurs who have a demonstrated commitment to leading social change. Assessment and certification tools include LEED certification for green buildings, ISO 14000 environmental management standards, and Green Plus and B Corporation certifications for small and midsize enterprises.
Social Enterprise UK and Social Venture Network are among the better-established support networks; since their beginnings in informal relationships and best-practice swapping, they have taken on the trappings of professional societies and trade associations. Conferences like the Skoll World Forum on Social Entrepreneurship and SOCAP provide vital cross-pollination, bringing together entrepreneurs, funders, and service providers from around the world.
Organizing The Ecosystem - What’s crucial now is to put all of the pieces together like a puzzle. That’s the approach of pilots like the North Carolina Fourth Sector Cluster Initiative (NCFSCI), launched in 2010. The NCFSCI is a collaboration of business, community, government, academic, and economic development leaders convened to accelerate the growth of the fourth sector across North Carolina. The initiative acts as a convening body to catalyze and coordinate activity among stakeholders on a regional and statewide basis—all toward making it as easy to start and grow a for-benefit enterprise in North Carolina as it is to start and grow a for-profit business or a nonprofit organization. The ultimate goal: to create a “21st-century North Carolina economy that is sustainable, competitive, resilient, and a national model for how the fourth sector can be integrated into traditional economic development and community problem-solving efforts.”
This is a model for what the future could look like: convene the various actors already pursuing a for-benefit agenda in a community (whether they’re entrepreneurs, investors, academics, government, nonprofit or economic development leaders); clarify the agenda and broader mission; and accelerate and amplify each actor’s activities through coordination and collaboration among them.
By actively supporting for-benefit enterprises and the transition to a four-sector economy, we can all help pave the way for a new, more sustainable, inclusive, and resilient capitalism that is struggling to be born.
At the most obvious level, formalization of the fourth sector creates a range of new options between the for-profit and nonprofit ends of the organizational spectrum for individuals who want to better integrate their values and social aims into their economic choices—as entrepreneurs, consumers, investors, workers, or in any other capacity.
The more profound transformation will come because there is a preponderance of such individuals all around the world, and among them there's a large pent up demand for new alternatives. Creating the infrastructure of a fourth sector will meet this demand. It will make the course correction capitalism requires by unleashing the power of the market and catalyzing a tremendous wave of entrepreneurship and innovation to confront the critical challenges we face.
At the firm level—where unsustainable social and environmental practices are rooted—we would see an overall reduction in negative externalities and an increase in positive ones as for-benefit entperises become a larger part of the economy, and as the supportive ecosystem that forms around them makes it easier (and more cost effective) for for-profit firms to adopt more socially and environmentally responsible practices.
As for-benefit entrepreneurs find innovative solutions to unmet social needs, the shift to a four-sector economy will create quality jobs and economic growth at a time when they are desperately needed. They will leverage private capital from mission aligned investors and funders, who will be part of a growing new social finance market. And consumption will shift more toward products and services that enhance quality of life rather than those that rely on manufactured demand.
We’ll see markets setting out to solve societal problems, reducing the burdens on governments and nonprofits. For-benefits will in fact serve as force multipliers for the work these sectors are already doing, by bringing new financial resources, new talent, and innovative solutions to those efforts.
There is tremendous entrepreneurial energy around developing for-benefit models of enterprise. There is widespread consumer demand for for-benefit brands, products and services. There is a profound and powerful desire among individuals to work for organizations that assert for-benefit values. And there’s a new class of investors who want to invest in these models. The elements are lined up—but the supporting ecosystem is weak.
In order to overcome all of the powerful institutional, cultural, and structural barriers to the creation of a true four-sector economic system, all of the actors in the system must contribute to the development of a robust, supportive ecosystem of services and infrastructure that is tailored to the particular needs of for-benefit organizations.
The scope of this undertaking is considerable—for-benefit organizations challenge conventional thinking about financial markets, legal and regulatory constructs, metrics, ownership, leadership, and more. New instruments, new institutions, and not least, new understandings are required. Each of us as an individual can play an important role in bringing this vision to life by understanding that every one of our actions and micro-decisions each day can make a big difference in the aggregate. By orienting ourselves toward for-benefit organizations through all those actions and decisions, we collectively can transform the system—through our purchasing decisions, how we invest our money, where we seek employment, decisions we make at our job, who we vote for, and so on. We make so many choices every day that can either contribute to the advancement of the fourth sector or keep us mired in a broken three-sector system.
Here are some more specific first steps for enlightened leaders of existing businesses and for socially motivated entrepreneurs who want to start for-benefits.
First steps for BUSINESS LEADERS:
Rather than trying to retrofit the for-profit model to do things it is not designed to do—against the grain of market forces, legal systems, and entrenched interests—enlightened business leaders can pave the way to a new capitalism by helping legitimize and mainstream for-benefit enterprise. Here are a few suggestions:
Lead by Example. They can launch new for-benefit ventures by leveraging their products and services, know-how, core competencies, and assets to develop market-based solutions to particular social or environmental challenges. They can invest in for-benefit enterprises. They can partner with for-benefits by incorporating them into their supply chains, or working with them to incubate new products, services, and business models. They can contract for-benefits to train individuals with barriers to employment, conduct R&D, or develop new markets; or they can support for-benefits with skilled volunteers, incubation, and mentorship. They can even put their own businesses on a path to becoming for-benefit, as circumstances allow.
Educate and Motivate Others. The time for incrementalism has passed. Bold, visionary leadership is needed. Business leaders can use their voice to champion the need for systemic reform and to draw attention to for-benefits as a pathway to a new capitalism. They can inspire other business leaders and entrepreneurs to start for-benefit enterprises to tackle a multitude of societal challenges.
Change the Rules. For-benefit enterprises currently operate at a substantial disadvantage relative to for-profits because our legal and market systems are not designed to recognize or support them. Working collectively with their peers and other allies, CEOs in particular can leverage their access, resources, and convening power to influence governments, industry groups, standards bodies, and other rulemaking institutions to remove the barriers and level the playing field for for-benefit enterprises.
First steps for ENTREPRENEURS:
The first step in forming a for-benefit enterprise is to be explicit about the fact that one is doing so. The next step is to be intentional about designing the right architecture for the organization—the rules, incentives, roles, and systems at the heart of an organization’s operations. Entrepreneurs tend to be excited about the new products or services they will offer, or the better way they will meet customers’ needs, or the underserved market they will reach. When it comes to administrative details, they are usually happy to rely on experts—legal counsel and accountants who have served many entrepreneurs before them.
The right architecture is critical for the success of any organization. For-benefits face unique challenges, however, because their default choices come from either for-profit or nonprofit norms. A for-benefit entrepreneur who is ready to form a legal entity will typically consult either a corporate or a nonprofit attorney, and thus be channeled into one body of law and legal options or the other. The choice of legal form will dictate the type of capital the enterprise can easily access: private investment in the case of a for-profit, philanthropic funds in the case of a nonprofit. Although there are exceptions, most for-benefit entrepreneurs find themselves in a binary world that forces them to compromise their objectives, complicate their organizational structures, and waste resources.
Socially minded entrepreneurs should realize that they don’t have to accept convention. They have license to be inventive and to question advice that seems inconsistent with their objectives. Form should follow function. Imagine starting out as an enterprise builder with no preconceived notions about structure. How might you create a reliable system for tracking social and environmental impacts throughout your supply chain? Could you build an investment structure that provides what economists call a “satisficing” level of return—sufficient to incentivize investment—without giving away perpetual ownership rights? Would a structure that allowed anyone to benefit from selling your offering make more sense than one that assumed a captive or formally contracted sales force? These questions merely hint at the range of possibilities. Coloring outside the lines requires more imagination, effort, and expense than a start-up typically requires, but it can maximize the potential for achieving financial, social, and environmental objectives in the long run.
The following items should be given priority on any for-benefit entrepreneur’s agenda:
Stakeholder value. Whereas for-profits emphasize shareholder value, for-benefits pay more attention to their impact on all stakeholders. After identifying the groups that are essential to the organization’s success, and clarifying the value proposition for each, entrepreneurs should feel free to negotiate unconventional roles, responsibilities, and incentives that will increase stakeholders’ engagement with the mission. The British start-up Riversimple, which makes cars powered by hydrogen fuel cells, allows all its stakeholders to have a voice in the governance of the business and a share in the profits. The company licenses its designs to an independent, open-source foundation, which makes it possible for engineers, designers, and manufacturers anywhere in the world to help develop and produce the cars.
Capitalization. A key challenge that for-benefits encounter is to design a structure that balances the financial interests of capital providers with the enterprise’s mission and stakeholder commitments. This balance should be reflected in shareholder agreements, loan contracts, and other financial instruments. Upstream 21, a holding company in the Pacific Northwest, chooses its portfolio companies on the basis of their demonstrated concern for stakeholders and local communities, and provides them with both growth capital and assistance in improving their financial, social, and environmental performance.
Ownership and governance. Will subsequent CEOs, directors, and investors share the commitment that inspired the founders? Preservation of the social mission after an ownership transfer is one of the thorniest challenges that for-benefits face. It’s often assumed that owners drive governance, but in fact ownership is a collection of legal rights that can be unbundled and repackaged in creative ways. Thoughtful ownership and governance design can protect the mission over the long term and deepen stakeholder engagement. Cafédirect, the United Kingdom’s largest fair-trade purveyor of hot drinks, was founded by a worker-owned cooperative, a public limited company, an international confederation of nonprofits, and an NGO. Since 2003 the producers that supply Cafédirect have been represented on the board and have held 5% of the company’s shares.
Legal form and tax treatment. For-profit and nonprofit legal and tax models are not designed for the simultaneous pursuit of social and financial bottom lines. For example, when founders choose a for-profit form, they have no reliable way of ensuring commitment to the social mission. And board members, mindful of their fiduciary duty, may find it hard to prioritize social and environmental concerns over the interests of shareholders. The Danish pharmaceutical company Novo Nordisk, founded with a mission to rid the world of diabetes, avoided those difficulties. It has a publicly traded operating company that is controlled by a foundation—which prevents hostile takeovers, enables executives to focus on the long term, and allows profits to be used for humanitarian purposes.
Some jurisdictions have started to recognize various types of for-benefits: the “community interest company” in the UK and the “low-profit limited liability company” (L3C), “benefit corporation,” and “flexible purpose corporation” (pending the signature of California’s governor) in various U.S. states. Although these models may not withstand the test of time, they are a harbinger of more-sustained attention by lawmakers to the needs of for-benefit enterprises.
Performance measurement and reporting. The fundamental value proposition for a for-benefit requires that the organization be able to account for its total impact and performance—financial, social, and environmental. Few conventional accounting systems and metrics are designed for such reporting, but efforts are under way to create new tools. Last May the sports apparel company Puma announced the initial results of its Environmental Profit & Loss Account, which relies on emerging methodologies to calculate the impact of the company’s operations and supply chain on greenhouse gas emissions and water consumption.