"I would not give a fig for the simplicity on this side of complexity, but I would give my life for the simplicity on the other side of complexity." —Oliver Wendell Holmes
When it comes to managing their costs, most companies operate with a simple model. They start by trying to maximize their gross margins so that they have a high cushion for spending in areas where they feel they need to spend heavily in order to compete, such as advertising and promotions. But a growing number of high-performing companies are showing that there is a better way to manage spending and improve performance. These companies live and operate on the other side of complexity.
Over the past several years, we have studied a group of companies that defy conventional wisdom and at first glance seem to perform financial alchemy. These companies pay their rank-and-file employees much better than their peers, have suppliers who are profitable, invest heavily in their communities, pay taxes at a higher rate, provide terrific customer service, invest in making their operations more environmentally sustainable, and do not externalize costs onto society. With all this spending, it would seem that there would be less left over for investors.
On the contrary, we have found that these companies dramatically outperformed the market over a 10-year period, by an astounding 9 to 1 ratio (see our book Firms of Endearment: How World Class Companies Profit from Passion & Purpose, Wharton School Publishing). We refer to this business philosophy as conscious capitalism.
We have been working to understand how conscious businesses are able to operate with superior financial results while creating many forms of wealth and wellbeing for all of their stakeholders, including society. It boils down to something quite simple: these companies knowingly operate with lower gross margins, but are still able to achieve higher net margins than their traditional competitors.
Most companies try to maximize their gross margin by looking for the cheapest suppliers they can find, and then using whatever bargaining power they have to squeeze them as much as they can to get ever lower prices. As a result, they end up with low-quality suppliers who struggle to stay profitable, and who can ill afford to invest in new technologies or anything else that will improve their quality or make their products more innovative.
Most companies also try hard to keep their payrolls down, minimizing what they pay to their rank-and-file employees, and are stingy with critical benefits such as health insurance. They try to use part-time employees as much as possible, keeping them under the threshold where they would qualify for any kind of benefits. They provide minimal training to their employees, and accept high employee turnover as inevitable.
Conscious businesses are very selective about their suppliers, looking for innovative, quality-focused companies that also operate in a conscious manner. They enter into mutually beneficial long-term partnerships with their suppliers. Suppliers are well paid, and in turn pay their own suppliers and employees well. For example, Costco is very selective when it comes to picking suppliers, but once they select a supplier, the two parties work closely and are in it together for the long haul.
Conscious businesses also pay their rank-and-file employees very well, significantly above the industry norm, and are generous with benefits. Since their direct costs are higher, the gross margin of a conscious business is typically lower than average.
The next line item on the income statement is "GSA," and this is where conscious businesses really shine. Traditional businesses squander their hard-won but ill-gotten high gross margins by having to spend heavily on marketing, managerial overhead, legal fees, and high levels of executive compensation. They incur high recruiting and training costs due to high employee turnover. Their employees are disengaged and unproductive. Their product quality is suspect, leading to low customer loyalty and high levels of product returns.
Conscious businesses typically have to spend very little on marketing. This is because they have legions of satisfied and delighted customers who are loyal and passionate advocates for the company. We have found that many conscious businesses spend as little as 10 to 25% of the industry average spending on marketing. This represents an enormous cost savings, at a time when marketing costs have been growing rapidly for most companies.
For example, retailer Jordan’s Furniture spends a quarter of the industry average on marketing (as a percentage of revenues) but achieves sales per square foot that are six times higher. Such companies receive the benefit of the best kind of marketing there is—free marketing—not only from their customers but also from their employees, their suppliers, their communities, and the media.
Conscious businesses typically operate with extremely low levels of employee turnover, thus saving greatly on new employee hiring and training. Turnover at The Container Store, a perennial on "best places to work" lists, is in the low single digits, in an industry where turnover often exceeds 100%. Employees at such companies are loyal, experienced, highly engaged, and extraordinarily productive. Such businesses take great care to hire people whose personal passions are aligned with the corporate purpose. At a time when overall employee engagement levels are shockingly low, conscious businesses have employees who are loyal, passionate, energetic, and creative. For them, their work is not just a job or a career--it is a calling. For example, REI is passionate about reconnecting people with nature, and all of its employees are outdoor enthusiasts for whom every day at work is deeply fulfilling because they get to help customers discover the joy and beauty of being with nature.
Conscious businesses have lower administrative costs because they continuously strive to eliminate non-value-adding expenses, gathering ideas from their employees and suppliers about how to do so. They also look to control essential expenses such as healthcare costs, not through across the board cuts, but by devising creative ways to achieve win-win outcomes. For example, Whole Foods Market is combating rising healthcare costs through a range of comprehensive employee wellness initiatives that go way beyond what you would find at a typical company. They are not only lowering costs; they are transforming lives in the process.
Conscious companies typically operate with much leaner management structures than do traditional businesses. They have created systems in which the right people are doing the right jobs and are given a great deal of autonomy. Most employees operate in the “value zone” (to use HCL CEO Vineet Nayar’s term), where they are actively creating real value for customers rather than “managing” each other. These companies are designed to be largely self organizing, self motivating and self managing.
And finally, conscious companies operate in a system of very high trust between all stakeholders, and thus their legal costs are much lower than the norm. They understand their customers deeply, produce outstanding products (due in no small part to the fact that they have world-class suppliers), and thus have much lower levels of product returns.
The notion of pay equity at such companies is driven more by internal equity rather than external equity. Senior executives at such companies are modestly paid relative to their peers at other companies. For example, Whole Foods Market has adopted a policy that no one can be paid more than 19 times the average salary (the typical ratio at publicly traded companies is 450-500 times). The only way for executives to earn more at such companies is to raise the average salary of all employees.
We must never forget that businesses create and destroy many kinds of wealth and well-being. Too many of them generate financial wealth, but at the expense of social, cultural, environmental, intellectual, physical, and spiritual well-being. They are value extracting rather than value creating. Conscious capitalism is about doing business with a spectrum of positive effects, not having one positive "main" effect and many negative "side” effects.
Conscious businesses spend money where it makes a positive difference. They don't waste money on unnecessary advertising, gimmicky promotions, and the revolving door of high employee and supplier turnover. They empower people and engage their best contribution in service of a higher sense of purpose. They make a net positive impact on the world. It is simply a better way to win.
Conscious capitalism is a fast growing global movement (www.consciouscapitalism.org) built around a business philosophy that has four key characteristics:
First, business can and should be done with a higher purpose in mind, not just with a view to maximizing profits. A compelling sense of purpose creates an extraordinary degree of engagement for all stakeholders and releases tremendous organizational energy.
Second, the business is explicitly managed for the simultaneous benefit of all of its stakeholders, represented by the acronym SPICE: Society, Partners, Investors, Customers, and Employees. A conscious business aligns the interests of all stakeholders, so that what is good for one is good for all. Society is listed first for an important reason: businesses must ensure that they are on the “right” side of society, that they have a positive net impact on the world.
Third, such businesses have conscious leaders, driven primarily by service to the firm's purpose, rather than by power or money. They lead by mentoring, motivating, developing, and inspiring people, not through command-and-control or the use of “carrot and stick” incentives.
Finally, such businesses have some unique cultural characteristics, captured in the acronym TACTILE: Trust, Authenticity, Caring, Transparency, Integrity, Learning, and Empowerment. The word tactile also suggests that the cultures of these companies are very tangible to their stakeholders as well as to outside observers; you can feel the difference when you walk into a conscious business versus one that is purely driven by a profit motive and just for the benefit of shareholders.