Thursday, April 01, 2010

The Big Idea: Leadership in the Age of Transparency

The Big Idea: Leadership in the Age of Transparency

Companies have long prospered by ignoring what economists call "externalities." Now they must learn to embrace them.

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Rarely do before-and-after business cases present such a neat study in contrasts. Compare the recent actions of the key players in the food industry with those of the tobacco industry two decades earlier.

In the 1980s, executives at Philip Morris were still fighting energetically to hold back the tide of evidence that cigarettes cause lung cancer, and claiming that customers were exercising free will in choosing to smoke. A 1993 Washington Post article titled "Scientists Testify Tobacco Company Suppressed Addiction Studies" tells the tale: Damning company-sponsored research had been spiked a decade before by senior executives.

Fast-forward to the turn of the millennium and you see a very different kind of behavior in the packaged food and restaurant industries. As the dangers of trans fats came to light, managers in the most powerful firms took the health implications to heart and responded quickly, before the issue became a cause célèbre, by changing recipes, funding public education campaigns, and pushing reduced-fat products. By 2005, a trade publication was already announcing "Kraft completes trans fat reformulation," and every one of the company's competitors was following suit. Given that the first U.S. state law outlawing trans fats in restaurants went into effect only this year, these were voluntary changes taken well in advance of legal or regulatory compulsion—or even public anger.

What transpired over those 20 years to drive such divergent managerial responses? Something very big, actually: As the impacts of business on the environment, on society, and on individuals became too substantial to ignore in many realms, and cheaper and easier ways to measure those impacts were devised, the rules of doing business shifted. Considerations that hadn't previously complicated the plans of corporate leaders started getting factored in. In other words, it was no longer possible to ignore externalities.

Externalities is the term economists use when they talk about the side effects—or in the positive case, the spillover effects—of a business's operations. They're the impacts that a business has on its broader milieu, either directly or indirectly, but is not obliged to pay for or otherwise take into account in its decision making. The classic example is pollution: A smokestack in Akron may send particulates into the air that descend on farmlands downwind, but in the absence of any measurement of those, the factory isn't charged for ensuing crop damage. Those effects are out of scope, and the company is off the hook. How a consumer disposes of your product at the end of its useful life is another form of externality, and so is the noise of your factory whistle.

The concept of externalities goes beyond impacts on the physical environment. Say your menu-driven phone system keeps callers on the line a bit longer and eats up their minutes, or your subcontractor decides to cut costs by using undocumented workers, or property values near your facilities start to slide: Those are impacts for which you will likely not be called to account.

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When Kraft, Nabisco, and Nestlé decided to reformulate their recipes, and national restaurant chains such as Wendy's and Burger King switched to less artery-choking fats in their fry-o-laters, they were choosing to internalize an externality. They were taking ownership of an issue that they could, by law, have continued to say was not their problem. Yes, they did so under some activist pressure, and yes, they could still do more. But unlike tobacco companies in the 1980s, the food companies didn't wait for regulation or lawsuits. They acted. That's a big change, and what's behind it isn't as simple as good public relations. There's something more nuanced, and at the same time more hardheaded, going on.

In this article, we'll explore the forces behind what we see as a coming sea change in corporate leadership. We'll make the case that the true measure of corporate responsibility—and the key to a business's playing its proper role in society—is the willing, constant internalization of externalities. Today, business leaders are bombarded with messages through many channels that they owe more to society, and many think so themselves. But often the result is an incoherent mishmash of charitable giving, CSR programs, and "going green" initiatives. Here, we present a far more disciplined way to respond to the challenge.

Copyright © 2010 Harvard Business School Publishing Corporation. All rights reserved.

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Written By

Christopher Meyer is the founder of Monitor Talent. He is the coauthor of three books with Stan Davis, including It's Alive: The Coming Convergence of Information, Biology, and Business (Crown Business, 2003).


Julia Kirby is an editor at large at Harvard Business Review Group.

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