Sustainablog

This blog will cover some news items related to Sustainability: Corporate Social Responsibility, Stewardship, Environmental management, etc.

5.11.05

The hidden wealth of the poor: Financial services are at last spreading from the rich to the developingworld?and even making money, writes Tom Easton


The hidden wealth of the poor
Nov 3rd 2005
From The Economist print edition






Financial services are at last spreading from the rich to the developing world—and even making money, writes Tom Easton (interviewed
here)

IN RICH countries, financial services on the whole work remarkably well, despite the exotic salaries, the crackpot deals and the occasional bust. The vast majority of people have access to interest-bearing savings accounts, mortgages at reasonable rates, abundant consumer credit, insurance at premiums that reflect the risk of losses, cheap ways of transferring money, and innumerable sources of capital for funding a business.

By contrast, financial services for poor people in developing countries—a business known as “microfinance”—have mostly been awful or absent. With no safe place to store whatever money they have, the poor bury it, or buy livestock that may die, or invest in jewellery that may be stolen and can be hard to sell. Basic life and property insurance is rarely available. Home loans are costly, if indeed they can be found at all. For many people, the only source of credit is a pawnshop or a moneylender who may charge staggeringly high interest and beat up clients who fail to pay on time. In the Philippines, lenders who zip from town to town on motorcycles expect six pesos back for every five they lend. That translates into an annual interest rate of over 1,000% on a loan for a month.

For workers from poor countries who venture abroad to earn a better living, sending money home to relatives can be hugely expensive. Such remittances have become an important source of income in many developing countries, dwarfing other inflows of capital from overseas such as foreign direct investment and multilateral aid. But if the money is being sent, say, from America to Venezuela, charges can amount to as much as 34% of the sum involved, according to Dilip Ratha of the World Bank.

Why are the poor so badly served? The easy answer, that people who have little money do not make suitable clients for sophisticated financial services, is at most a half-truth. A better explanation, this survey will argue, is that the poor have been hurt by massive market and regulatory failure. Fortunately that failure can be, and increasingly is being, remedied.

In most developing countries, the barriers to providing financial services for the masses are all too clear. Inflation tends to be high and volatile; government is often incompetent; and the necessary legal framework for financial services is often missing. Property laws can make it impossible for poor borrowers to use assets such as their home as collateral for loans.

In the past, many countries have outlawed “usury”, and today many Islamic countries prohibit the charging of interest. Governments in developing countries often impose caps on the interest rates charged on loans for the poor. Despite their popular appeal, such caps undermine the profitability of lending and thus reduce the supply of loans.

Incomplete and erratic regulation of financial institutions has also undermined the confidence of the poor in the financial services that are available. When they can find an institution that will accept their tiny deposits, it often lacks the sort of government deposit insurance that is routine in rich countries, so when a bank goes under, savers suffer. For example, Indonesia's PT Bank Dagang Bali, once known for its work with poor clients, was closed by regulators last year after it was discovered to be insolvent and riddled with fraud. Many savers did not get their money back.

Corruption is also commonplace in many developing countries. A recent study by the World Bank found that in two poor states in India where the financial system is largely controlled by the government, borrowers paid bribes to officials amounting to between 8% and 42% of the value of their loans. Corruption raises the cost of every financial transaction, allows undesirable transactions to take place and undermines consumer confidence in the financial system. This, and the related curse of cronyism, explains why access to financial services in countries where the state has control over the financial sector is poorer than where it does not.

Inadequate basic public services add to the burden on financial firms. SKS, a fast-growing microfinance institution in India, has had to build back-office systems that can work on two hours of power a day; it closely monitors voltage when its computers are running and keeps a diesel generator on hand. Many others simply give up on the idea of modern technology and continue to use paper instead. This makes them vulnerable. The tsunami in December 2004 wiped out financial records at many small Indonesian banks.

But not all the blame goes to poor-country governments. Financial-services firms too have failed to do enough to deal with the lack of the sort of data (for example, about a client's financial history) that are taken for granted in rich-country financial systems, and to find ways of reaping economies of scale. Many have simply dismissed the possibility that serving the poor might be a viable business.


The start of something big

In recent years, at least in some parts of the world, this bleak picture has begun to change, first in credit, then in savings and more recently in remittances. Even insurance—not only the basic life sort but also more sophisticated forms for things like cattle and weather risk—is gradually being introduced.




These changes have recently received a lot of attention in policymaking circles. Grand claims have been made that credit can end poverty. A World Bank report by Thorsten Beck, Asli Demirguc-Kunt and Soledad Martinez published last month shows a strong correlation between lack of financial access and low incomes (see chart 1). Earlier research by the first two authors and Ross Levine concluded that a sound financial system boosts economic growth and particularly benefits people at the bottom end of the income league. A long-term study in Thailand by Robert Townsend of the University of Chicago and Joe Kaboski of Ohio State University showed that families with access to credit invested more, consumed more and saved less than those without such access.

What makes microfinance such an appealing idea is that it offers “hope to many poor people of improving their own situations through their own efforts,” says Stanley Fischer, former chief economist of the World Bank and now governor of the Bank of Israel. That marks it out from other anti-poverty policies, such as international aid and debt forgiveness, which are essentially top-down rather than bottom-up and have a decidedly mixed record.

Studies by Stuart Rutherford, who runs an experimental bank that provides loans and takes deposits in the slums of Bangladesh, show that the poor attach great value to having a safe place to keep money and some means of providing for life's risks, either through savings or, better still, through insurance. When financial services are available to them, the poor, just like the rich, snap them up.

In one sense, microfinance has been around for a long time. What is now generating so much hope and excitement is less the discovery of some entirely new way to deliver financial services to the poor than the effect of the rapid innovation that has taken place in the past three decades.


From pawnshop to Citigroup

The oldest financial institution in the Americas is a pawnshop on Mexico City's central square. Set up in 1775 under an edict by the Spanish crown to assist people in financial trouble, it is called Monte de Piedad, variously translated as the mountain of mercy or the mountain of pity. Pity or mercy come in the form of cash in return for valuables. Unclaimed items end up for sale in a series of glittering rooms near the main banking hall.

By transforming trinkets into capital, pawnshops perform an important (if under-appreciated) service, but they have three limitations. They advance cash only to people with assets. Their loans are based on the value of collateral, not of a business venture. And the valuables held as collateral cannot be used to fund businesses, as banks' cash deposits can.

There have been two notable attempts to find alternatives. One has been the creation by developing-country governments of state banks, particularly to finance the rural poor. These have mostly been a disaster. The other, much more successful one involved a number of organisations extending uncollateralised loans to very poor borrowers. In 1971, Opportunity International, a not-for-profit organisation with Christian roots, began lending in Colombia. ACCION International, also not-for-profit, made the first of what it called “micro” loans in 1973. Grameen Bank started in 1976 and soon became extraordinarily famous for offering “microcredit” to women in small groups.

To qualify, Grameen's customers had to be extremely poor, probably earning less than a dollar a day. To overcome the lack of collateral or data about creditworthiness, group members were required to monitor each other at weekly meetings, applying varying degrees of pressure to ensure repayment. As loans were repaid, people were allowed to borrow more. The group replaced the security that pawnshops gained from collateral. The model is not perfect, but it does have real virtues and has since spread around the world.

Why did these organisations start with providing credit? They assumed that poor people were unable to save, and that their sole need was for capital. But that was not the whole story. When BRI, a failing state-controlled rural lender in Indonesia, was transformed into a bank for the poor in 1984, it offered not only the usual loan products but also a government-guaranteed savings account with no minimum deposit. This has been an extraordinary success: BRI now has 30m savings accounts.

Nobody knows how many institutions are providing microfinance in some form, but the number is certainly huge (see article). They are growing fast and serving a vast number of people in absolute terms, although still only a small proportion of the billions who earn only a few cents a day. Local banking giants that used to ignore the poor, such as Ecuador's Bank Pichincha and India's ICICI, are now entering the market. Even more strikingly, some of the world's biggest and wealthiest banks, including Citigroup, Deutsche Bank, Commerzbank, HSBC, ING and ABN Amro, are dipping their toes into the water.


The downsides

Not everyone has been pleased with the prospect of better financial services for the poor. Islamic fundamentalists have bombed branches of Grameen in Bangladesh and attacked loan officers of other institutions in India. Maoists have looted microfinance offices in Nepal. The head of a microfinance effort in Afghanistan was murdered, possibly by drug traders.

To drug lords in Afghanistan, the availability of credit is unwelcome because it gives a choice to farmers who were previously forced to grow poppies for want of other ways to finance their crops. For the elites in closed markets running inefficient monopolies, credit raises the prospect of future challenges from entrepreneurs. For radical Muslims, it means that women (who in many countries make up the bulk of microfinance borrowers) are able to run viable businesses and become independent. And for everyone in poor countries, credit can mean social upheaval as merit and enterprise replace inheritance, family ties and position.

Nor does microlending always have a happy outcome. The clients of K-Rep, an excellent Kenyan microfinance bank in a small town on the fringes of Nairobi, are a pretty resourceful lot, but when the government stopped repairing roads, picking up rubbish and spraying for malaria, some were at their wits' end. Drainage in the marketplace was plugged by uncollected garbage and customers stopped coming. Maria Njambi, a single mother with a ten-year-old child, used to have a viable business selling fruit and vegetables she bought with credit from K-Rep, but she had to watch her inventory rot and has stopped repaying her loan. She is not alone in her misfortune. A report in 2002 by CARD, a microfinance organisation in the Philippines, offers the following explanation for borrower attrition: “It is a tragic fact that over time, husbands will fall sick, sari-sari [variety] stores will be robbed, harvests will be poor and children will die.”

Yet microfinance institutions typically claim extraordinarily low loan losses of 1-3%, a bit better than the rate for big banks in rich countries and much better than for the big credit-card companies. Given the difficulties facing businesses in poor areas, some critics question the accuracy of these figures. Many of the banks lending to the poor are not-for-profit organisations whose accounts are rarely scrutinised by outsiders. Much of their capital has been provided by governments or philanthropists, and often does not have to be repaid, so perhaps microfinance institutions are being quietly lenient with their customers. Indeed, large-scale defaults in microfinance may go unreported. The Townsend-Kaboski research project in Thailand informally tracked hundreds of microfinance institutions and found that in the five years before the Asian financial crises, 10% failed and a quarter stopped lending.

So there is room for scepticism, but also plenty of reason for hope. The biggest of these is just how much progress the industry has made in the past 30 years.


What do you know?

Nov 3rd 2005
From The Economist print edition

A beginner's guide to microfinance

MICROFINANCE may be intended for the masses, but its vocabulary can be understood only by professionals, and then only up to a point. The industry is so fragmented as to be virtually unfathomable. There is not even a proper definition of the term, which could mean anything from what a village priest provides when handing out alms to what state banks and credit unions offer to their least affluent clients. The coveted title of a genuine “microfinance institution” from a “practitioner” may owe less to what the institution does than to its public-relations skills. Fortunately none of this matters to the customers, who simply want a service that makes their lives richer.

Nobody knows even roughly how many microfinance institutions there are. Indonesia alone says it has in excess of 600,000, and Bangladesh and Uganda too claim to have many thousands. Even on stricter criteria, such as recognition by a regulator, Indonesia alone has perhaps 60,000 finance companies that provide credit of one sort or another, often to people who have very little income and almost no assets. Self-professed experts distinguish between institutions providing consumer finance (which they do not count as microfinance) and business finance (which they do). But how do you classify the purchase of a stove that is used for cooking both the family meals and the food for sale on a tiny stand? Or a motorscooter that serves both as a delivery vehicle and as family transport? For people who have very little, money and assets are fungible.

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The foggiest place in the industry is “on the ground” (another favourite microfinance term), where familiar words suddenly become oddly unintelligible. An item labelled “profit” lets you keep mum about the losses transferred to a money-losing charity affiliate. An “operationally sustainable” business is one that can pay for its running costs but not its capital, which is often the largest single expense for a financial firm. But the worst thing are the acronyms, which make learned analyses of microfinance next to unreadable. All this may sound trivial, but industry practitioners seem to care deeply.


From charity to business

Nov 3rd 2005
From The Economist print edition

In its short history, the microfinance industry has undergone profound changes

Panos Can I borrow a lollipop?

TO ANYONE familiar with banking in the rich world, the world of microfinance can seem rather odd. The main providers have not been motivated by anything as straightforward as making money, at least until recently. The core of the industry today consists of some three dozen multinational networks of microfinance providers, which despite their superficial similarities and inspirational rhetoric compete fiercely and fight over everything.

The main areas of strategic disagreement are whether the financial needs of the poor are best met by group or individual loans; by market or capped interest rates; by catering for all the poor or only the very poorest; by concentrating on credit only or offering savings accounts and insurance too; and whether financial services should be provided alone or in conjunction with education, health care and, in a few cases, religion.

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The biggest networks include Opportunity International, FINCA, ACCION, ProCredit, Women's World Banking and arguably Grameen (which has no formal ties to other banks but a “replication” programme that it says encompasses more than 100 institutions around the world). There are also national networks, regional networks and even networks of networks, each with their own set of institutions and strongly held views.

At one end of the spectrum are those organisations and networks that, by intent, are barely profitable and concentrate on providing credit, such as Grameen and most of FINCA's and Opportunity's operations. They offer relatively lenient repayment terms and interest rates that do little more than cover costs. Typically, these groups are not-for-profit, or owned by customers or by investors of the religious and philanthropic sort, rather than by shareholders seeking a financial return.

Beyond their core operations in financial services, some of these institutions are also involved in a range of other activities, both charitable and for-profit. Grameen Bank has a loose relationship with a variety of other companies, including a highly profitable mobile-phone business that has been praised for providing jobs for women but criticised for charging excessive rates.

Rather than pursue profit, microfinance providers at this end of the spectrum often seek to be “sustainable”, a flexible concept that can mean anything from covering all costs to covering all costs but capital. However tenuous the “sustainability”, there seem to be plenty of donor funds, particularly for institutions that can generate lots of good publicity. During 2004 the big development-aid agencies committed about $1 billion to microfinance, according to CGAP, a donor consortium affiliated to the World Bank. Further significant sums have come from private hands. Added to that must be the benefit of very low-cost capital and free technical assistance.

As these financial institutions have grown, however, demand for their funds has often expanded beyond what can reasonably be obtained from donors and special funding deals. Retained earnings help; deposits, if they can take them, help far more, but still not enough. A growing number of microfinance institutions, taking their cue from the success of banks in developed countries, have concluded that the best way to reach the vast number of poor people in the world is to become profitable and operate much like conventional rich-world financial firms. Ultimately that will include things like issuing debt and equity and securitising loans.

Only this way, the institutions argue, will they be able to raise capital in sufficient quantity, at sufficiently low cost and with sufficient speed to transform microfinance from an interesting niche into a ubiquitous service. This argument is beginning to convince a growing number of policymakers interested in development and poverty eradication, who until recently would have regarded trying to profit from the poor as inherently evil.


Time for ACCION

The evolution of microfinance from a charitable social service into something resembling modern commercial banking can be seen in the work of ACCION International, a network of financial institutions based in Boston and Washington, DC, with 27 loosely affiliated members in 22 countries and direct investments in ten. ACCION has an odd history. It was founded in 1961 by Joe Blatchford, a young law student and accomplished tennis player who was sent on a goodwill tour of Latin American cities by the American government. Appalled by the poverty he witnessed, he created an aid group to build schools, install electricity and the like.

An experiment in Brazil in 1973 played an important part in defining ACCION's future role. The Brazilian unit kept clear of the usual development-agency activities, instead concentrating entirely on providing what at the time were called “micro” loans. Initially, the separation of finance from social services was controversial. But slowly a consensus has begun to form, particularly in Latin America, that this kind of specialisation makes it easier to build efficient (and therefore sustainably helpful) financial institutions.

Early on, financial institutions affiliated to ACCION offered “solidarity loans”—small loans to groups of five people that were collectively guaranteed. Variations on this model remain essential to Grameen, FINCA and many smaller microfinance providers. Each member of a group has a tiny amount of money allocated to him or her, and as they collectively meet their obligations the members establish a credit history that allows them to increase the size of their loans.

There are virtues to this model, notably the way that social pressure from group members encourages repayments and avoids the twin problems of moral hazard (an unwillingness to repay) and adverse selection (being stuck with bad payers who inflate costs for everyone). Credit screening costs the lender next to nothing. Group meetings may also have other advantages, such as the sharing of clients and effective business techniques.

Even so, a growing number of the institutions tied to ACCION soon discovered limitations to the group-lending model. Over time, businesses financed by group members grew at different rates, and so required different amounts of capital. The members whose businesses grew fastest felt constrained in what they could borrow, and those whose businesses grew more slowly found themselves guaranteeing big debts for other people. The meetings themselves became a problem, consuming time members wanted to devote to their businesses. And, perhaps most importantly, as group members developed personal credit histories through their loan payments, the need for collective guarantees disappeared.

At the beginning, simply providing credit was reason enough to start a small not-for-profit financial-services organisation. As time went on, clients started to demand more products, particularly savings accounts, but regulators were reluctant to grant the necessary banking licences to microfinance institutions that had no clear ownership structure and little prospect of profits. Success also increased the demand for capital.

In a major strategic change, in 1992 Prodem, a small Bolivian not-for-profit organisation in the ACCION network, turned part of its operations into BancoSol, a normal bank run on commercial lines, albeit still seeking to serve the poor. The transition was marred by bitter internal fights. Interest rates charged on loans were initially set at 65%. Yet in the end the transformation worked, enabling the bank to grow and to bring down its interest rates by two-thirds. True, BancoSol has not been an unqualified success, but it has remained viable even as Bolivia has suffered huge financial problems. It is now seen as a model for similar transformations in Latin America, Africa and Asia, with ACCION playing a critical role in managing the change.

Several other microfinance groups followed ACCION's lead. FINCA, another organisation with affiliates all over the world, last summer created a number of for-profit subsidiaries, which allowed it to tap outside investors and almost double its capital. But the best example of this trend is a Frankfurt-based organisation now known as ProCredit.


A credit to the industry

Like ACCION, ProCredit came to banking by an indirect route. Its founder, C.P. Zeitinger, began his career in the 1970s by examining Latin American financial institutions that were getting money from German development agencies. When he pointed out that the whole thing was a waste of money, he was, in effect, fired by the agencies . After working on the conversion of various not-for-profit institutions into banks in the 1990s, as ACCION had done, Mr Zeitinger became convinced that it would be cheaper and faster to start financial institutions afresh. Backed by investment from various development agencies such as the World Bank's International Finance Corporation, he started out in Bosnia and Hercegovina in 1996 and has since founded banks in 14 other countries and taken a controlling position in four others.

The most recent addition came this month in Congo, which speaks volumes about what ProCredit considers an opportunity. There is vast potential (60m people and only 50 bank branches), coupled with many evident risks (decades of intermittent war; nearby genocide; no local currency; frequent famine; sporadic government coups). Into this chaos, ProCredit introduces a consistent model (with minor local adjustments) that relies on the company having full control: “We are not polite, we know what we want, we have it our way,” explains Mr Zeitinger.

The back-office systems of ProCredit banks and its branding are identical around the world, and supervised by some of the same people. Their credit systems depend on careful analysis of the cashflow and business prospects of every client, and even competitors concede that they are unusually good at detecting problems before loans are granted. ProCredit does not do group lending, partly because Mr Zeitinger thinks it only really works in rural settings where people are genuinely close, and partly because he feels that individuals should not have to be responsible for the failures of others but should be judged on their own merits. ProCredit also expects clients to come to its branches to repay loans, rather than sending out collection agents to villages, as many other microfinance institutions do.

ProCredit's experience shows that there is a pent-up demand for credit and saving in even the poorest corners of the world, and that poor people will seek out institutions that provide these things effectively. Its growth has been remarkable. It now has 7,500 employees, of whom 2,500 were hired in the past year. With $2 billion in assets, it remains tiny by multinational banking standards, but it is not insubstantial. Fitch, a leading rating agency, recently gave it an investment-grade rating, noting that it had operated successfully in some extremely difficult environments. Even in Haiti, where it has lost money in euro terms because of a 30% currency devaluation, it continues to operate profitably in local money. “Any anarchy is frightening,” says Mr Zeitinger. “But it is an opportunity as well, because it allows you to impose your own structure and grow faster and become more important and become more profitable.”

ProCredit has not yet left the not-for-profit world entirely. When it moves into a new country, it often accepts subsidies for the first two or three years, a time of high start-up costs and little revenue. But its good performance is now opening up other sources of funds: it recently raised $54m in the German bond market with the help of Deutsche Bank at an interest rate of just over 5%. Its banks in three countries have been able to raise money via local bank syndicates. It has also seen a huge growth in deposits.

In the not-too-distant future, Mr Zeitinger foresees ProCredit becoming entirely independent of international financial organisations. In some poor countries, he hopes to be able to borrow and lend at rates below those for the government's own debt (which in well-run countries is usually the best-quality credit), reflecting his clients' and his firm's superior record of repayment. That would demonstrate the virtues of normal banking. But what do the mainstream banks themselves make of microfinance?


Giants and minnows

Nov 3rd 2005
From The Economist print edition

Big banks are discovering the market for poor customers

ONE of the most encouraging trends in microfinance is that the world's largest banks and insurers are becoming interested. At a minimum, they can do something that small local institutions cannot: move money around the world through their own systems, and tap and raise huge pots of capital. They can also reduce the risk and increase the liquidity of small institutions by packaging and reselling their loans, and even provide savings products through tiny institutions.


So-called “bottom of the pyramid” strategies (named after a bestselling book called “The Fortune at the Bottom of the Pyramid”, by C.K. Prahalad) are currently in vogue among the world's leading companies in many industries. The idea is that big business has so far ignored a huge number of people who have very little money but nevertheless represent a potentially lucrative market. The big banks have noticed, but they are moving slowly and with great caution. ICICI Bank of India reckons that providing $1.3m in loans to microfinance clients currently requires 40 times more manpower than a corporate loan of the same size.

Typically, the big global financial institutions are moving into microfinance via their corporate-responsibility or community-development departments, not their core for-profit banking operations. Most of them are pleased to do something that may win them good marks from their usual critics in non-governmental organisations. But they are also worried that if they turn microfinance into a real business, they will be slammed for profiteering from the poor. And there are people working in the big banks who honestly do not believe that microfinance can, or should, be a business.

One exception is Citigroup, which happily proclaims that, leaving aside its philanthropic activities, it is also getting into microfinance for its potential profits. But the foremost example is Bank Rakyat Indonisia (BRI). Founded by the Dutch in 1895 as an institution for the elite, by the 1970s it had become yet another badly run state bank with an impossible mandate. It was supposed to help farmers to increase rice production, but the government reserved the right to approve borrowers and required BRI to pay more for its deposits than it received for its loans. Not surprisingly, the bank did not bother to collect deposits, and many borrowers did not bother to repay their loans. According to a report by Marguerite Robinson of Harvard University, an analysis of BRI's 3,600 lending units concluded that not a single one of them made money.

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Facing disaster, in 1983 the bank embarked on a complete reorganisation in which it reversed every policy. It increased its loan rates by half and shifted its target client group from the well-connected to poor people without any ties to government or financial companies. It actively marketed deposits and abolished minimum limits on account. Success followed rapidly. The BRI formula has since been emulated around the world.

In some ways, a successful financial institution may find it tougher to move into microfinance than an ailing one. Bank Pichincha, the leading bank in Ecuador, has created an entirely separate subsidiary, CREDIFE, to serve poorer customers. Its results have been remarkable: small loans now make up 5% of its assets but 8% of its profits. Unibanco in Brazil and Banco Santander Chile took similar steps to attract the unbanked poor. Such efforts are not always welcomed by existing microfinance providers. In Colombia, for instance, Women's World Banking complains that mainstream banks are increasingly poaching its best clients.


The power of a balance sheet

After just two years in the field, ICICI, India's second-largest private bank, now has close to 1.5m customers that qualify as deeply poor, and an associated loan portfolio of $265m. It has achieved this by working through 53 small microfinance banks, which are superb at marketing loans but are constrained by having them sitting on their balance sheet. ICICI lends to the microfinance institutions at 9.5-11%, a bit more than it charges its corporate clients, and the microfinance institutions re-lend the money at 16-30%. The microfinance providers are responsible for the first 5-12% in loan losses to ensure that they proceed with caution. Returns are good and ICICI wants to expand the scheme.

 The seeds of a better life

There are ample opportunities. According to some estimates, demand for loans from poor but creditworthy people in India could amount to $40 billion, 40 times the current supply. Nachiket Mor, an executive director at ICICI, says very little of the demand could be met from charitable sources, but billions of dollars could be made available on commercial terms. Lots more could be raised by allowing small institutions to take deposits.

Many of the world's biggest banks have recently launched interesting pilot projects. ABN Amro owns a microfinance bank in Brazil, Real Microcrédito, jointly with ACCION, and provides credit to five microfinance institutions in India. Deutsche Bank recently raised a $75m investment fund and syndicated a large loan on behalf of ProCredit in Germany.

The most obvious way for large banks to get into microfinance is through handling remittances, a business that according to the World Bank is worth $225 billion a year and growing strongly. Until now it has been dominated by transfer agents such as Western Union and by informal arrangements, often with high charges or high risks. But money transmission is becoming more competitive, and global banks are well placed because they already have systems that can send large amounts of money around the world cheaply.

In September, Bank of America announced that all its account holders would be able to send remittances to Mexico without charge; the money can be retrieved at other banks and payment agencies. HSBC in May announced a joint-venture with Opportunity International that allows money to be sent to the Philippines via the internet and retrieved from local ATMs. In America, HSBC has just launched a scheme under which anyone with a minimum account balance of $1,500, or willing to pay $8 a month, can transmit money to HSBC's affiliates abroad without charge. To start with, this may not be profitable for the bank, but HSBC reckons that much of the money could be channelled into savings accounts from which other services might follow.

The most ambitious big bank in this area is Citigroup. It does not deal with individual microfinance customers, but has already established relationships with microfinance institutions in 20 countries and thinks the number could soon grow to 30. Working through its Banamex subsidiary in Mexico, it is providing life-insurance policies sold by microfinance firms and is preparing for various bond offerings, private placements and even the securitisation of a large microfinance institution's loan portfolio that will be resold to investors. For its wealthy clients, it has created guarantee funds that allow them to put up collateral in America for credit extended in poor countries. The list goes on.

Citi's biggest contribution, though, is its belief that microfinance can become a valid, profit-making business. If it is right, the other big banks will also pile into the market—and so will investors.


Critical acceptance

Nov 3rd 2005
From The Economist print edition

The emergence of rating agencies attests to the industry's growing maturity

WHEN representatives in Kenya of three of the world's largest banks were asked what single event would most encourage their institutions to become more involved with microfinance, they all came up with the same answer: the presence of credit-rating agencies.

Businesses love to complain about these agencies, and financial institutions grumble more than anyone else. It is rare for companies to get the ratings they believe they deserve. But nor are the users of ratings all that happy, because the agencies are generally not very good at predicting default rates. Banks tend to see the agencies as a form of competition, providing information that outside investors use to purchase debt, to the detriment of the banks' own lending business.

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Nevertheless, rating agencies provide a relatively objective and consistent credit benchmark that is a great help to big investors. Banks, despite their carping, rely on these outside ratings for developing their own internal credit models, even if their in-house evaluations come out a little different from those of the rating agencies. Without such models, tracking loans, assigning risk capital and managing cash would take up far too much management time.

Being relatively small, most microfinance institutions are reluctant, or perhaps unable, to pay much for a rating. The big agencies—Moody's, Standard & Poor's and Fitch—have so far rated only a few institutions, notably ProCredit of Germany, Compartamos of Mexico, Mibanco of Peru and Acleda of Cambodia. That leaves thousands unexamined.

Several specialist credit-rating agencies have recently stepped into this vacuum. However, they face huge barriers to establishing credibility in the marketplace, because ratings need to prove themselves over a period of time. Meanwhile some have launched other businesses on the side, but these can undermine their perceived objectivity.

MicroRate, the oldest specialist rating agency and the only one that sticks purely to this particular business, was founded in 1996 but did not reach break-even point until this year. It was fired by three institutions for being too hard on them, but that may have been no bad thing for its reputation. Demand from investors has steadily grown, and it now rates 45 microfinance organisations.

Many of those brave enough to have asked MicroRate to run a rule over them have received poor grades for having “financial, operational or strategic weaknesses that have the potential to threaten their viability”. This can mean anything from inexperienced managers and boards to a lack of internal controls, too much reliance on a single person (often a charismatic founder) or an inability to raise funds for growth. So why do such companies bother to get rated? They must believe that things can only get better.


Bankable banks

Nov 3rd 2005
From The Economist print edition

Are the poor a good investment?

 A credit to her business

THE enthusiasm for microfinance rests on the idea that people who have next to no money deserve financial services just as much as those who have plenty. This is often justified by notions of equity or fairness: everyone should have clean water and health care, and everyone should have the right to deploy their talent. But on that view microfinance becomes yet another public good, limiting its scope to whatever can be squeezed from philanthropists or governments.

A more optimistic justification is that microfinance can support equity in the strictly financial sense, meaning it can produce profits. If so, it will be able to attract all the investment the rich world can provide to fund all the opportunities poor people can handle.

The evidence cited by the optimists typically comes down to a single fact: that microfinance clients repay their loans. Undoubtedly many of them do, but whether the aggregate numbers hold water is less certain. Industry-wide data are in short supply, and those that are available suffer from what statisticians call “survivorship bias”: institutions with terrible repayment records go bust, taking their bad numbers with them and leaving only the better records to be examined.

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Worse, there are widespread suspicions that some microfinance banks hide poor repayment rates by rolling over bad loans or extending their due dates indefinitely, which they can keep up as long as there is an inflow of donor funds. Even when repayment rates are high, a microfinance institution may charge an interest rate too low to cover its overall costs or its costs of funds, thus making it more of a charity than a commercial enterprise. Successful microfinance banks often charge vertiginous interest rates, because that is what poor people must pay to be commercially viable customers.

A good test of whether microfinance customers are truly bankable is whether the microfinance banks are bankable themselves, in the pithy words of Peter Kooi, head of the United Nations capital-development fund's microfinance unit. In other words, are those banks worth investing in? So far, this test has rarely been applied. No microfinance institution has traded seriously on a public stock exchange. Only one, BRI of Indonesia, has a genuine public listing, and that has been going for less than two years, not enough to judge its quality. A handful of others, including Mibanco of Peru, Banco Solidario in Ecuador and Satin in India, are listed but rarely trade.

Until recently, when a flurry of microfinance investment funds were launched, most of the money backing microfinance institutions came from the least demanding sources of capital: governments, multilateral institutions, not-for-profit organisations and “socially responsible” private investors who either did not demand market rates of return or valued their returns in unorthodox ways.

There has, however, been one notable exception. In 1995, a handful of social investors, headed by ACCION International, Calmeadow of Canada, Triodos of the Netherlands and Fundes of Switzerland, raised $23m to create Profund, a Latin American investment pool intended to demonstrate that investing in microfinance could be commercially viable. It was designed to run for ten years, and true to its mission it sold off its last investment this summer. By liquidating its portfolio and turning it into real cash, it became a yardstick for the investment performance of a microfinance institution.

At first sight, its returns look unexciting: just 6% annually, despite lots of risk. But on closer examination this was a remarkable performance. All of Profund's capital was contributed in dollars and then invested in local currency. In every country it operated in, its dollar returns were reduced by local currency depreciations, reflecting the economic chaos in much of Latin America during that decade. Two of the countries in which it had investments, Paraguay and Ecuador, suffered system-wide financial collapse. Haiti, Venezuela and Bolivia faced riots and revolutions. Good banking is, in the end, no match for bad government. Most investors in the region watched their money burn.

Initially, Profund had expected to be a passive investor. It bought stakes in a dozen institutions, hoping simply to hold on and then sell out. But Profund's manager, Alex Silva, soon found himself attending monthly meetings of the institutions he had invested in and getting involved in managing them.

Mr Silva, with ACCION and a German consulting firm, IPC, played a crucial role in helping the institutions that Profund invested in to evolve from not-for-profit NGOs into regulated banks, able to receive deposits. During Ecuador's financial crises of 1998, when all private debt repayment was suspended by the government, Mr Silva helped to arrange a crucial $5m emergency loan to keep one local microfinance provider afloat. The loan, at an interest rate of 15%, was fully repaid within 18 months. Without it, this well-managed bank would probably have died, taking Profund's $2m investment with it.


Where's the exit?

Getting out of investments proved equally complex. Unlike in developed countries, there were no local stockmarkets eager for new listings, nor hungry groups of local investors. Profund had to work hard on each exit deal, often under pressure from larger shareholders hoping to orchestrate a squeeze. In the end, three of Profund's investments did blow up. But the fund's investment in Compartamos of Mexico performed spectacularly, and investments in Mibanco of Peru, BancoSol of Bolivia and Los Andes of Peru also did well. Several other investments failed to produce respectable returns only because of currency depreciations.

All this looked very much like the distribution of returns typical in venture capital—plenty of duds, a few stellar performers—rather than in mainstream banking. The fund's success owed at least as much to the efforts of Mr Silva and his investors than to the underlying economics of the industry. One lesson from Profund's experience is that interest rates in this business have to be pitched high to make the loans viable. Compartamos charged more than 100% annually when the initial investment was made, and Mibanco over 80%, though both of them have since dropped their rates somewhat. Initially, potential clients are less concerned about cost than access to money. Besides, even high interest rates charged by microfinance institutions are probably well below those being offered by moneylenders in the informal market.

Profund's investors were sufficiently impressed by its success to want to see its charter renewed, but Mr Silva has declined to do so. Unlike in 1995, there is now abundant capital available for investment in microfinance—perhaps too much, he says, at least for Latin America to absorb.

In the past three years, new investment opportunities in microfinance have been popping up all the time, and more are on the way. In the largest example yet, Pierre and Pam Omidyar, flush with money made from eBay, have pledged $100m to back microfinance projects, a source that is as yet almost entirely untapped. It will not stay that way for long.
Micro no more

Nov 3rd 2005
From The Economist print edition

Financial services for the poor and the rich are becoming increasingly alike

 Hewlett-Packard's Ugandan bank-in-a-box

THE group of 30 women in the dusty square of a poor village outside Hyderabad, their children on their laps, passing tiny deposits and loan payments to a young man in their midst, seem to be engaging in a form of finance quite unlike that practised in the City of London or Wall Street. But is it really that different?

Microfinance offers all the transactions you would expect in any branch of finance: loans, deposits, money transfers, insurance. It is distinct only because it involves amounts of money so small that in the past conventional firms did not think them worthwhile. That is clearly changing.

Many microfinance institutions report better returns on equity than do large banks. Five years ago, providing financial services to people with little money might have been dismissed as a tiny niche business or charity. Now all the participants in the capital markets, from big banks to investors to rating agencies, are beginning to open up to it.

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The evolution of microfinance into a serious and viable business has many benefits. It means that in future the bulk of the capital is likely to go to the most efficient institutions with the best growth prospects. They will select their clients on the basis of merit rather than cronyism or bribery, of which state banks (as well as some private banks) in poor countries have often been guilty in the past.

Sound institutions will be able to protect their deposits and attract new ones. In the most optimistic scenario, an open, viable financial sector will create a large body of people with economic stakes in their society who will demand decent public services, which in turn should help to promote growth.

Plenty of obstacles remain. Venezuela, Brazil and Colombia, for example, all impose interest-rate ceilings, and other countries are considering them. These discourage new financial firms from entering the microfinance market and encourage existing participants to evade regulation.

But within a few years, the number of people who have access to financial services may expand from hundreds of millions to several billions. Historical precedent suggests that this could bring huge opportunities. In the past, some financial institutions, notably Bank of America, Merrill Lynch and many large European insurers, did spectacularly well by nurturing clients only slightly too poor to be of interest to the leading firms of the day.

But to reach the vast number of people who currently lack access to the financial markets, microfinance will have to change. Four main areas need particular attention: culture, products, funding and the cost of operations.

The cultural challenge is to transform something that started as charity into a proper business. The pursuit of profit may not come easily, but change is already in the air. “We are not paternalistic, we do not lend to the poor,” says Mónica Hernández of Banco Solidario, a fast-growing and profitable bank in Ecuador. “We lend to those who do not have access.”

To reach this new group of customers, however, microfinance providers will have to abandon their old attitudes and vocabulary and join the mainstream of the global financial system. Transmitting funds, insuring risks, extending credit and holding deposits for people with almost no money will turn out to be little different from doing those things for anyone else.


Beyond credit

One priority is to expand microfinance beyond credit into all the financial products on offer in more sophisticated markets. Today only a few institutions are seriously offering insurance, even though it is particularly valuable to the poor; yet death and illness, for example, are major risks for banks making small loans, and inevitably they charge for bearing that risk. BASIX, a dynamic microfinance institution in India, provides not only basic life insurance, but other products that are particularly appropriate to its agricultural clients, notably insurance against drought or loss of cattle.

It matters enormously where the money comes from. At present, the main sources are charities, governments and international organisations. But serious interest from large banks and private investors would greatly increase the amount of capital available and bring down the cost of funds. The emergence of credit-rating agencies to provide an independent assessment of institutions will make it easier for the banks to come in. Credit bureaus for rating individuals too are now being established in a handful of countries.

Microfinance institutions may also tap wealthy investors directly. More than a dozen institutions recently raised money from American investors, including a university, in a deal structured by Developing World Markets, a specialised American firm of financial advisers, and Blue Orchard Finance of Geneva, a microfinance fund manager. True syndication of microcredit loan portfolios may not be far away, though governments in many poor countries will have to strengthen ownership rights and reduce barriers to foreign investment before it becomes commonplace.

Crucially, the cost of microfinance will have to come down. At present it is far too manpower-intensive, more like private banking for the wealthy than retail banking for the middle classes. Typically, borrowers receive visits from their bankers, sometimes daily, rather than going to a branch or using an automated teller machine. Credit evaluation relies on character or cashflow valuation rather than the statistical techniques used by credit-card companies in rich countries. This has been made possible by low wages and an abundance of highly talented people willing to work long hours, but it will not be sustainable.

More competition will help to reduce costs, but the biggest hope comes from new technology. For example, the cost of sending money from Hong Kong to the Philippines has declined dramatically because of new methods that transfer funds via mobile phones, says John Owens, of Chemonix International, a consultancy. And that is only one of their uses. Through arrangements with merchants in small towns, mobile phones can also be used to pay loans, make deposits and get cash, saving time and money. Vodafone is testing a similar system in Kenya, and Hewlett-Packard has just finished a pilot project in Uganda using a point-of-sale machine with mobile-phone technology. Such techniques may eventually make branches, cheques and even cash superfluous.

In the past, the two main obstacles to providing financial services to poor people have been lack of information and costs. Those obstacles are now being overcome. Ultimately lower costs and better information are good not just for the poor, but for everyone. Microfinance may have started as a niche business, but the chances are it will soon be micro no more.

Another false dawn? High oil prices are spurring investments in alternative fuels


Another false dawn?
Nov 3rd 2005
From The Economist print edition



High oil prices are spurring investments in alternative fuels

“OIL and natural gas availability has been severely impaired and the effects of this will reverberate through the economy of this country for some time.” Those chilling words were uttered recently by Samuel Bodman, America's energy secretary, as he pleaded for his country's gas guzzlers to start conserving energy. He warned that high prices could be here for years. Greens are ecstatic. They think high oil prices may spur a sustainable clean-energy boom. GE's wind-turbine business, which was inconsequential a few years ago, made over $2 billion in sales this year. Ethanol, a costly green fuel which in America is usually made from corn, now looks a better buy. And wind and solar power are also back in fashion.

Industry sources reckon that global sales of solar panels this year will reach $11 billion, up from $7 billion last year. America's Energy Conversion Devices, a pioneer in hydrogen storage and solar cells, has seen its shares soar by 50% this year and venture-capitalists are taking an increasing interest in the industry. Sun Edison, an American start-up, has persuaded Goldman Sachs to fund up to $60m of its solar projects, which BP's solar manufacturing division has agreed to provide. Sun Edison offers retailers fixed-price electricity contracts if they allow it to set up solar panels on their rooftops. At a time of ever-rising oil and gas prices, that kind of deal has its attractions—Whole Foods and Staples have already signed up.

All told, reckons Christopher Flavin of the Worldwatch Institute, a green think-tank, investments in “new renewables” (not including big dams, which nobody likes anymore) grew from $24 billion globally in 2003 to $29 billion in 2004—and, he thinks, the pace of growth is even faster this year. Mr Flavin says he is “blown away” by the development of the renewables industry.

Such jubilation is understandable, but it may be slightly premature. For one thing, clean energy is not the only sort of “alternative” energy that is enjoying a boom: dirty technologies like Canada's mucky tar sands (from which petrol can be made at great environmental expense) are also benefiting from high oil prices. In theory, there is as much energy trapped in Alberta as in all of Saudi Arabia. In practice, it has proved too complex and expensive to be a serious rival to oil—until now.

Today's oil prices, combined with cost reductions and innovations in tar-sands processing, are leading to a bonanza. Peter Tertzakian of ARC Financial, a Canadian investment firm, estimates that investment in tar sands will leap to C$7 billion ($5.95 billion) this year, up from C$4.2 billion in 2000. More impressive is the tidal wave to come. High oil prices have prompted a flurry of investment in new projects and expansion efforts in tar sands that will, he estimates, add up to a whopping C$70 billion in coming years.

To the chagrin of greens, today's high prices are giving even filthy coal, their bête noire, a new lease on life. Several American utilities are now talking of building new coal plants, partly to hedge against natural gas price risk. More striking is a coal deal recently announced by the state of Pennsylvania and a consortium which includes the oil giant Royal Dutch Shell. Using an innovative process (developed by South Africa's Sasol), the consortium will convert coal waste into a liquid that can be blended into normal diesel fuel.

The rise of coal and shale shows that the surge in oil prices is not an unambiguous win for the greens. And green investors might be unwise to rely on permanently high oil prices. The vast reserves of oil remaining in the Persian Gulf suggests prices will eventually moderate. And as the earlier failed renewables booms of the 1970s and 1980s showed, oil price drops can wipe out alternative energy. Technological breakthroughs and green policies like carbon taxes suggest that this renewable boom may be more sustainable than the last one. But investors counting on sustained high oil prices to justify otherwise uneconomic projects should beware.

4.11.05

How to Kick the Oil Habit


How to Kick the Oil Habit

Time Magazine, 31 October 2005 - If anyone harbored any doubts that hybrid cars are hot, last week the 2005 Tokyo Motor Show put them to rest. Carmakers practically ran over one another promoting their versions in attempts to catch up with Honda and Toyota, the technology's pioneers.

Companies such as Mercedes-Benz, BMW, Mazda, Mitsubishi, GM, Volkswagen and Porsche showed new models or talked about plans to sell them by the end of the decade at the latest. On display were not only regular hybrids, the kind powered by gasoline engines mated to electric motors, but also variations adding hydrogen to the mix and a system that puts electric motors at the wheels. The frenzy to churn out hybrids and their technological cousins is so fierce that archrivals GM, DaimlerChrysler and BMW have teamed up to build a research and technical center in the Detroit suburbs. And Ford is so desperate to fill 200 open jobs in its hybrid program that it's competing with Toyota to hire engineers from the software and aerospace industries. The stakes are high: Ford and GM announced third-quarter losses of nearly $ 2 billion combined last week, thanks in part to plunging sales of SUVs.

It doesn't take a Ph.D. economist to figure out why that's happening--just a stop at the gas station, where prices are roughly 25% higher than they were a year ago, and where, despite a slight easing as the effects of hurricanes Katrina and Rita recede, they will probably go higher still before too long. Home heating oil is 50% higher than last year too, and natural gas will probably jump similarly. Those dramatic increases, Federal Reserve Chairman Alan Greenspan said in a speech last week, will create a significant drag on economic growth "from now on."

The silver lining, said Greenspan, is that as oil gets more expensive, other energy sources and technologies that use less oil will become more competitive. And that's exactly what's happening. Says Daniel Yergin, chairman of Cambridge Energy Research Associates and author of The Prize, the 1991 best seller about the history of oil: "There's a lot of technological innovation kind of bubbling that really has captured the imagination and obsession of a lot of people." The question is, Are we moving fast enough?

The good news is that as the price of crude has headed steadily upward, technological innovation has driven down the cost of alternative energy sources. Wind farms cover hillsides near Palm Springs and Altamont Pass in California and are springing up in the breezy Midwest and on the Atlantic Coast too. Solar cells can churn out electricity at around 25[cents] to 35[cents] per kilowatt-hour, falling but still a multiple of the cost of energy from coal-fired power plants. Canada is extracting oil from the tar sands of Alberta for an amazingly efficient price of $ 15 to $ 20 per bbl., and the technology exists to convert the U.S.'s huge supply of coal into petroleum. This process, called coal liquefaction, creates a fuel that could power cars and is starting to look economically feasible. Conservation, too, benefits from technology: auto companies are suddenly getting more serious about boosting mileage by replacing steel components with materials like strong, lightweight carbon fiber.

At the same time, oil companies, worried that these changes could leave them behind, are starting to think of themselves instead as broad-based energy companies. "Shell and BP are already headed in that direction," says Amory Lovins, director of the Rocky Mountain Institute, a think tank that advocates a radical restructuring of the energy economy. Shell has become the largest seller of biofuels, he says: "We're talking about new processes for turning woody, weedy plants like switch grass and poplar--also crop waste like wheat straw--into cellulosic ethanol."

If this explosion of innovation has a problem, however, it may be that the developments are coming too late to allow a smooth transition to the postpetroleum era. Hydrogen fuel cells, ethanol from vegetable matter, solar cells, wind power, synthetic gasoline from coal--all could make a dent once they are available in sufficient quantities. But that won't be for years, maybe decades, says Richard Heinberg, a professor of culture, ecology and sustainable community at the New College of California in Santa Rosa and the author of The Party's Over: Oil, War and the Fate of Industrial Societies. Twenty years in the future, he argues, "regular old oil will still be the dominant fuel. We'll just end up paying more for it."

As consumers, we need time to make adjustments--often very expensive ones--to the new technologies. Not everyone can afford to junk a two-year-old SUV to buy a new hybrid. Most people can't afford to abandon houses built in developments 100 miles out in the countryside when oil was cheap. And although energy and power companies are investing in new technologies, they can't create a massive new infrastructure overnight. Coal liquefaction, nuclear power, wind power--"all of these things need an enormous lead time," says Heinberg. The problem with the free market, in short, is that while it may sort things out over the long run, people have to cope in the short run. "Price signals," he adds, "come much too late, and we will endure a tremendous amount of economic and social hardship that could have been averted if we'd acted sooner. We could see the equivalent of the Great Depression, fueled by extreme oil and natural-gas prices."

Things would have been different if we had been pouring money into alternative energy for the past couple of decades, as we did in the aftermath of the oil shocks of the 1970s. Back then, despite the ribbing Jimmy Carter got for appearing on TV in a cardigan and calling for sacrifice, there was a clear sense of national emergency. That crisis receded, thanks in part to conservation and investments in energy efficiency and in part to the worldwide recession the oil shocks helped trigger. As a result, a barrel of oil costs 30% less today, in inflation-adjusted dollars, than it did at its peak in 1981. This is not the first time the world has run out of oil. Yergin says it's the fifth or sixth.

But this may be the real thing. Matthew Simmons, chairman of Simmons & Co. International, an energy-industry investment-banking firm, says, "This is a shortage where demand actually exceeds supply. The two shortages in the '70s were artificially induced." Back then, OPEC was powerful and disciplined enough for Middle East oil producers, angry about U.S. support of Israel and the Shah of Iran, to be able to simply turn down production. But now a confluence of trends has made oil shortages inevitable, not optional. One is the unexpectedly rapid expansion of India's and China's energy needs. Fadel Gheit, senior vice president for oil research at the New York City investment firm Oppenheimer & Co., says, "They created the tight market we're in."

Another problem is refinery capacity. Even an unlimited supply of crude is useless if it can't be refined into gasoline, heating oil and other fuels. And for the past 20 years, says Gheit, the refining industry has been losing money--or has barely made it: "[The industry was] closing refineries because they weren't profitable." That set up a situation in which a hurricane like Katrina or Rita or last year's Ivan could trigger a shortage by putting even a few of the remaining U.S.-based refineries out of business for a few weeks. Yet the industry is reluctant to build more refineries, Gheit says, because "they've been burned before. It's like the boom and bust in real estate."

Beyond that, the supply of crude is not unlimited. Opening the Arctic National Wildlife Refuge or the coast of Florida for drilling, which congressional Republicans have been pushing for, is a relatively short-term fix. And the more oil that is removed, the more expensive the cost of extracting the remaining oil becomes. At some point--possibly as early as 2010--production will therefore reach a peak, though not necessarily a sharp one, and then gradually start to decline. "The problem," says Simmons, "is that the global economy and the U.S. economy are structured on the assumption that the oil supply will only increase."

The upheaval could be alleviated significantly if the government had a long-range policy for moving beyond oil. But no Administration or Congress in the past 25 years has put one together because such a move would involve spending money and offending powerful interest groups. Republican Senator Pete Domenici of New Mexico, chairman of the Energy and Natural Resources Committee, astonished environmentalists last month when he suggested that federally mandated auto-mileage (CAFE) standards had to be reconsidered. But because that could cut into automakers' profits, there's virtually no chance that such legislation would pass. Tax incentives for switching to alternative energy may be easier. Republican Representative Richard Pombo of California, chairman of the Resources Committee, says, "There is already an incentive to develop new technology. You just have to send a real clear signal that the Federal Government wants to." But a wholesale push to change our highway culture is unlikely. European countries decided long ago that it paid off to interfere in the free market by discouraging oil consumption and subsidizing mass transit, but that's not the American way.

The one thing that will probably cushion the blow of this new and permanent energy crisis is something old, with an air about it of discomfort and duty: conservation. There's nothing particularly sexy or chic about consolidating shopping trips, carpooling, turning the thermostat down in winter and up in summer, or biking to the office and back, but it does work. In the early '80s, in the midst of soaring oil prices, we doubled the average efficiency of cars, furnaces and insulation. Katrina and Rita might not have pushed us into another energy-crisis mind-set yet. With the inevitable price jolts to come, though, we're heading that way soon enough.

BOX STORY:

21 million Total barrels of oil that are consumed daily in the U.S.

10 million Barrels of imported oil that are consumed daily in the U.S.

1 million Barrels of oil that could be produced daily by drilling in the Arctic National Wildlife Refuge

Source: U.S. Energy Information Administration

3.11.05

Rethinking the Social Responsibility of Business: debate featuring Milton Friedman, Whole Foods? John Mackey, and Cypress Semiconductor?s T.J. Rodgers


Rethinking the Social Responsibility of Business
A Reason debate featuring Milton Friedman, Whole Foods’ John Mackey, and Cypress Semiconductor’s T.J. Rodgers

Thirty-five years ago, Milton Friedman wrote a famous article for The New York Times Magazine whose title aptly summed up its main point: “The Social Responsibility of Business Is to Increase Its Profits.” The future Nobel laureate in economics had no patience for capitalists who claimed that “business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends; that business has a ‘social conscience’ and takes seriously its responsibilities for providing em­ployment, eliminating discrimination, avoid­ing pollution and whatever else may be the catchwords of the contemporary crop of re­formers.”

Friedman, now a senior research fellow at the Hoover Institution and the Paul Snowden Russell Distinguished Service Professor Emeritus of Economics at the University of Chicago, wrote that such people are “preach­ing pure and unadulterated socialism. Busi­nessmen who talk this way are unwitting pup­pets of the intellectual forces that have been undermining the basis of a free society these past decades.”

John Mackey, the founder and CEO of Whole Foods, is one businessman who disagrees with Friedman. A self-described ardent libertarian whose conversation is peppered with references to Ludwig von Mises and Abraham Maslow, Austrian economics and astrology, Mackey believes Friedman’s view is too narrow a description of his and many other businesses’ activities. As important, he argues that Friedman’s take woefully undersells the humanitarian dimension of capitalism.

In the debate that follows, Mackey lays out his personal vision of the social responsibility of business. Friedman responds, as does T.J. Rodgers, the founder and CEO of Cypress Semiconductor and the chief spokesman of what might be called the tough love school of laissez faire. Dubbed “one of America’s toughest bosses” by Fortune, Rodgers argues that corporations add far more to society by maximizing “long-term shareholder value” than they do by donating time and money to charity.

Reason offers this exchange as the starting point of a discussion that should be intensely important to all devotees of free minds and free markets. Comments should be sent to letters@reason.com.

Putting Customers Ahead of Investors

John Mackey

In 1970 Milton Friedman wrote that “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” That’s the orthodox view among free market economists: that the only social responsibility a law-abiding business has is to maximize profits for the shareholders.

I strongly disagree. I’m a businessman and a free market libertarian, but I believe that the enlightened corporation should try to create value for all of its constituencies. From an investor’s perspective, the purpose of the business is to maximize profits. But that’s not the purpose for other stakeholders—for customers, employees, suppliers, and the community. Each of those groups will define the purpose of the business in terms of its own needs and desires, and each perspective is valid and legitimate.

My argument should not be mistaken for a hostility to profit. I believe I know something about creating shareholder value. When I co-founded Whole Foods Market 27 years ago, we began with $45,000 in capital; we only had $250,000 in sales our first year. During the last 12 months we had sales of more than $4.6 billion, net profits of more than $160 million, and a market capitalization over $8 billion.

But we have not achieved our tremendous increase in shareholder value by making shareholder value the primary purpose of our business. In my marriage, my wife’s happiness is an end in itself, not merely a means to my own happiness; love leads me to put my wife’s happiness first, but in doing so I also make myself happier. Similarly, the most successful businesses put the customer first, ahead of the investors. In the profit-centered business, customer happiness is merely a means to an end: maximizing profits. In the customer-centered business, customer happiness is an end in itself, and will be pursued with greater interest, passion, and empathy than the profit-centered business is capable of.

Not that we’re only concerned with customers. At Whole Foods, we measure our success by how much value we can create for all six of our most important stakeholders: customers, team members (employees), investors, vendors, communities, and the environment. Our philosophy is graphically represented in the opposite column.

There is, of course, no magical formula to calculate how much value each stakeholder should receive from the company. It is a dynamic process that evolves with the competitive marketplace. No stakeholder remains satisfied for long. It is the function of company leadership to develop solutions that continually work for the common good.

Many thinking people will readily accept my arguments that caring about customers and employees is good business. But they might draw the line at believing a company has any responsibility to its community and environment. To donate time and capital to philanthropy, they will argue, is to steal from the investors. After all, the corporation’s assets legally belong to the investors, don’t they? Management has a fiduciary responsibility to maximize shareholder value; therefore, any activities that don’t maximize shareholder value are violations of this duty. If you feel altruism towards other people, you should exercise that altruism with your own money, not with the assets of a corporation that doesn’t belong to you.

This position sounds reasonable. A company’s assets do belong to the investors, and its management does have a duty to manage those assets responsibly. In my view, the argument is not wrong so much as it is too narrow.

First, there can be little doubt that a certain amount of corporate philanthropy is simply good business and works for the long-term benefit of the investors. For example: In addition to the many thousands of small donations each Whole Foods store makes each year, we also hold five 5% Days throughout the year. On those days, we donate 5 percent of a store’s total sales to a nonprofit organization. While our stores select worthwhile organizations to support, they also tend to focus on groups that have large membership lists, which are contacted and encouraged to shop our store that day to support the organization. This usually brings hundreds of new or lapsed customers into our stores, many of whom then become regular shoppers. So a 5% Day not only allows us to support worthwhile causes, but is an excellent marketing strategy that has benefited Whole Foods investors immensely.

That said, I believe such programs would be completely justifiable even if they produced no profits and no P.R. This is because I believe the entrepreneurs, not the current investors in a company’s stock, have the right and responsibility to define the purpose of the company. It is the entrepreneurs who create a company, who bring all the factors of production together and coordinate it into viable business. It is the entrepreneurs who set the company strategy and who negotiate the terms of trade with all of the voluntarily cooperating stakeholders—including the investors. At Whole Foods we “hired” our original investors. They didn’t hire us.

We first announced that we would donate 5 percent of the company’s net profits to philanthropy when we drafted our mission statement, back in 1985. Our policy has therefore been in place for over 20 years, and it predates our IPO by seven years. All seven of the private investors at the time we created the policy voted for it when they served on our board of directors. When we took in venture capital money back in 1989, none of the venture firms objected to the policy. In addition, in almost 14 years as a publicly traded company, almost no investors have ever raised objections to the policy. How can Whole Foods’ philanthropy be “theft” from the current investors if the original owners of the company unanimously approved the policy and all subsequent investors made their investments after the policy was in effect and well publicized?

The shareholders of a public company own their stock voluntarily. If they don’t agree with the philosophy of the business, they can always sell their investment, just as the customers and employees can exit their relationships with the company if they don’t like the terms of trade. If that is unacceptable to them, they always have the legal right to submit a resolution at our annual shareholders meeting to change the company’s philanthropic philosophy. A number of our company policies have been changed over the years through successful shareholder resolutions.

Another objection to the Whole Foods philosophy is where to draw the line. If donating 5 percent of profits is good, wouldn’t 10 percent be even better? Why not donate 100 percent of our profits to the betterment of society? But the fact that Whole Foods has responsibilities to our community doesn’t mean that we don’t have any responsibilities to our investors. It’s a question of finding the appropriate balance and trying to create value for all of our stakeholders. Is 5 percent the “right amount” to donate to the community? I don’t think there is a right answer to this question, except that I believe 0 percent is too little. It is an arbitrary percentage that the co-founders of the company decided was a reasonable amount and which was approved by the owners of the company at the time we made the decision. Corporate philanthropy is a good thing, but it requires the legitimacy of investor approval. In my experience, most investors understand that it can be beneficial to both the corporation and to the larger society.

That doesn’t answer the question of why we give money to the community stakeholder. For that, you should turn to one of the fathers of free-market economics, Adam Smith. The Wealth of Nations was a tremendous achievement, but economists would be well served to read Smith’s other great book, The Theory of Moral Sentiments. There he explains that human nature isn’t just about self-interest. It also includes sympathy, empathy, friendship, love, and the desire for social approval. As motives for human behavior, these are at least as important as self-interest. For many people, they are more important.

When we are small children we are egocentric, concerned only about our own needs and desires. As we mature, most people grow beyond this egocentrism and begin to care about others—their families, friends, communities, and countries. Our capacity to love can expand even further: to loving people from different races, religions, and countries—potentially to unlimited love for all people and even for other sentient creatures. This is our potential as human beings, to take joy in the flourishing of people everywhere. Whole Foods gives money to our communities because we care about them and feel a responsibility to help them flourish as well as possible.

The business model that Whole Foods has embraced could represent a new form of capitalism, one that more consciously works for the common good instead of depending solely on the “invisible hand” to generate positive results for society. The “brand” of capitalism is in terrible shape throughout the world, and corporations are widely seen as selfish, greedy, and uncaring.This is both unfortunate and unnecessary, and could be changed if businesses and economists widely adopted the business model that I have outlined here.

To extend our love and care beyond our narrow self-interest is antithetical to neither our human nature nor our financial success. Rather, it leads to the further fulfillment of both. Why do we not encourage this in our theories of business and economics? Why do we restrict our theories to such a pessimistic and crabby view of human nature? What are we afraid of?

Making Philanthropy Out of Obscenity

Milton Friedman

By pursuing his own interest [an individual] frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

—Adam Smith, The Wealth of Nations

The differences between John Mackey and me regarding the social responsibility of business are for the most part rhetorical. Strip off the camouflage, and it turns out we are in essential agreement. Moreover, his company, Whole Foods Market, behaves in accordance with the principles I spelled out in my 1970 New York Times Magazine article.

With respect to his company, it could hardly be otherwise. It has done well in a highly competitive industry. Had it devoted any significant fraction of its resources to exercising a social responsibility unrelated to the bottom line, it would be out of business by now or would have been taken over.

Here is how Mackey himself describes his firm’s activities:

1) “The most successful businesses put the customer first, instead of the investors” (which clearly means that this is the way to put the investors first).

2) “There can be little doubt that a certain amount of corporate philanthropy is simply good business and works for the long-term benefit of the investors.”

Compare this to what I wrote in 1970:

“Of course, in practice the doctrine of social responsibility is frequently a cloak for actions that are justified on other grounds rather than a reason for those actions.

“To illustrate, it may well be in the long run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government.…

“In each of these…cases, there is a strong temptation to rationalize these actions as an exercise of ‘social responsibility.’ In the present climate of opinion, with its widespread aversion to ‘capitalism,’ ‘profits,’ the ‘soulless corporation’ and so on, this is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest.

“It would be inconsistent of me to call on corporate executives to refrain from this hypocritical window-dressing because it harms the foundations of a free society. That would be to call on them to exercise a ‘social responsibility’! If our institutions and the attitudes of the public make it in their self-interest to cloak their actions in this way, I cannot summon much indignation to denounce them.”

I believe Mackey’s flat statement that “corporate philanthropy is a good thing” is flatly wrong. Consider the decision by the founders of Whole Foods to donate 5 percent of net profits to philanthropy. They were clearly within their rights in doing so. They were spending their own money, using 5 percent of one part of their wealth to establish, thanks to corporate tax provisions, the equivalent of a 501c(3) charitable foundation, though with no mission statement, no separate by-laws, and no provision for deciding on the beneficiaries. But what reason is there to suppose that the stream of profit distributed in this way would do more good for society than investing that stream of profit in the enterprise itself or paying it out as dividends and letting the stockholders dispose of it? The practice makes sense only because of our obscene tax laws, whereby a stockholder can make a larger gift for a given after-tax cost if the corporation makes the gift on his behalf than if he makes the gift directly. That is a good reason for eliminating the corporate tax or for eliminating the deductibility of corporate charity, but it is not a justification for corporate charity.

Whole Foods Market’s contribution to society—and as a customer I can testify that it is an important one—is to enhance the pleasure of shopping for food. Whole Foods has no special competence in deciding how charity should be distributed. Any funds devoted to the latter would surely have contributed more to society if they had been devoted to improving still further the former.

Finally, I shall try to explain why my statement that “the social responsibility of business [is] to increase its profits” and Mackey’s statement that “the enlightened corporation should try to create value for all of its constituencies” are equivalent.

Note first that I refer to social responsibility, not financial, or accounting, or legal. It is social precisely to allow for the constituencies to which Mackey refers. Maximizing profits is an end from the private point of view; it is a means from the social point of view. A system based on private property and free markets is a sophisticated means of enabling people to cooperate in their economic activities without compulsion; it enables separated knowledge to assure that each resource is used for its most valued use, and is combined with other resources in the most efficient way.

Of course, this is abstract and idealized. The world is not ideal. There are all sorts of deviations from the perfect market—many, if not most, I suspect, due to government interventions. But with all its defects, the current largely free-market, private-property world seems to me vastly preferable to a world in which a large fraction of resources is used and distributed by 501c(3)s and their corporate counterparts.

Put Profits First

T.J. Rodgers

John Mackey’s article attacking corporate profit maximization could not have been written by “a free market libertarian,” as claimed. Indeed, if the examples he cites had not identified him as the author, one could easily assume the piece was written by Ralph Nader. A more accurate title for his article is “How Business and Profit Making Fit Into My Overarching Philosophy of Altruism.”

Mackey spouts nonsense about how his company hired his original investors, not vice versa. If Whole Foods ever falls on persistent hard times—perhaps when the Luddites are no longer able to hold back the genetic food revolution using junk science and fear—he will quickly find out who has hired whom, as his investors fire him.

Mackey does make one point that is consistent with, but not supportive of, free market capitalism. He knows that shareholders own his stock voluntarily. If they don’t like the policies of his company, they can always vote to change those policies with a shareholder resolution or simply sell the stock and buy that of another company more aligned with their objectives. Thus, he informs his shareholders of his objectives and lets them make a choice on which stock to buy. So far, so good.

It is also simply good business for a company to cater to its customers, train and retain its employees, build long-term positive relationships with its suppliers, and become a good citizen in its community, including performing some philanthropic activity. When Milton Friedman says a company should stay “within the rules of the game” and operate “without deception or fraud,” he means it should deal with all its various constituencies properly in order to maximize long-term shareholder value. He does not mean that a company should put every last nickel on the bottom line every quarter, regardless of the long-term consequences.

My company, Cypress Semiconductor, has won the trophy for the Second Harvest Food Bank competition for the most food donated per employee in Silicon Valley for the last 13 consecutive years (1 million pounds of food in 2004). The contest creates competition among our divisions, leading to employee involvement, company food drives, internal social events with admissions “paid for” by food donations, and so forth. It is a big employee morale builder, a way to attract new employees, good P.R. for the company, and a significant benefit to the community—all of which makes Cypress a better place to work and invest in. Indeed, Mackey’s own proud example of Whole Foods’ community involvement programs also made a profit.

But Mackey’s subordination of his profession as a businessman to altruistic ideals shows up as he attempts to negate the empirically demonstrated social benefit of “self-interest” by defining it narrowly as “increasing short-term profits.” Why is it that when Whole Foods gives money to a worthy cause, it serves a high moral objective, while a company that provides a good return to small investors—who simply put their money into their own retirement funds or a children’s college fund—is somehow selfish? It’s the philosophy that is objectionable here, not the specific actions. If Mackey wants to run a hybrid business/charity whose mission is fully disclosed to his shareholders—and if those shareholder-owners want to support that mission—so be it. But I balk at the proposition that a company’s “stakeholders” (a term often used by collectivists to justify unreasonable demands) should be allowed to control the property of the shareholders. It seems Mackey’s philosophy is more accurately described by Karl Marx: “From each according to his ability” (the shareholders surrender money and assets); “to each according to his needs” (the charities, social interest groups, and environmentalists get what they want). That’s not free market capitalism.

Then there is the arrogant proposition that if other corporations would simply emulate the higher corporate life form defined by Whole Foods, the world would be better off. After all, Mackey says corporations are viewed as “selfish, greedy, and uncaring.” I, for one, consider free market capitalism to be a high calling, even without the infusion of altruism practiced by Whole Foods.

If one goes beyond the sensationalistic journalism surrounding the Enron-like debacles, one discovers that only about 10 to 20 public corporations have been justifiably accused of serious wrongdoing. That’s about 0.1 percent of America’s 17,500 public companies. What’s the failure rate of the publications that demean business? (Consider the New York Times scandal involving manufactured stories.) What’s the percentage of U.S. presidents who have been forced or almost forced from office? (It’s 10 times higher than the failure rate of corporations.) What percentage of our congressmen have spent time in jail? The fact is that despite some well-publicized failures, most corporations are run with the highest ethical standards—and the public knows it. Public opinion polls demonstrate that fact by routinely ranking businessmen above journalists and politicians in esteem.

I am proud of what the semiconductor industry does—relentlessly cutting the cost of a transistor from $3 in 1960 to three-millionths of a dollar today. Mackey would be keeping his business records with hordes of accountants on paper ledgers if our industry didn’t exist. He would have to charge his poorest customers more for their food, pay his valued employees less, and cut his philanthropy programs if the semiconductor industry had not focused so relentlessly on increasing its profits, cutting his costs in the process. Of course, if the U.S. semiconductor industry had been less cost-competitive due to its own philanthropy, the food industry simply would have bought cheaper computers made from Japanese and Korean silicon chips (which happened anyway). Layoffs in the nonunion semiconductor industry were actually good news to Whole Foods’ unionized grocery store clerks. Where was Mackey’s sense of altruism when unemployed semiconductor workers needed it? Of course, that rhetorical question is foolish, since he did exactly the right thing by ruthlessly reducing his recordkeeping costs so as to maximize his profits.

I am proud to be a free market capitalist. And I resent the fact that Mackey’s philosophy demeans me as an egocentric child because I have refused on moral grounds to embrace the philosophies of collectivism and altruism that have caused so much human misery, however tempting the sales pitch for them sounds.

Profit Is the Means, Not End

John Mackey

Let me begin my response to Milton Friedman by noting that he is one of my personal heroes. His contributions to economic thought and the fight for freedom are without parallel, and it is an honor to have him critique my article.

Friedman says “the differences between John Mackey and me regarding the social responsibility of business are for the most part rhetorical.” But are we essentially in agreement? I don’t think so. We are thinking about business in entirely different ways.

Friedman is thinking only in terms of maximizing profits for the investors. If putting customers first helps maximize profits for the investors, then it is acceptable. If some corporate philanthropy creates goodwill and helps a company “cloak” its self-interested goals of maximizing profits, then it is acceptable (although Friedman also believes it is “hypocritical”). In contrast to Friedman, I do not believe maximizing profits for the investors is the only acceptable justification for all corporate actions. The investors are not the only people who matter. Corporations can exist for purposes other than simply maximizing profits.

As for who decides what the purpose of any particular business is, I made an important argument that Friedman doesn’t address: “I believe the entrepreneurs, not the current investors in a company’s stock, have the right and responsibility to define the purpose of the company.” Whole Foods Market was not created solely to maximize profits for its investors, but to create value for all of its stakeholders. I believe there are thousands of other businesses similar to Whole Foods (Medtronic, REI, and Starbucks, for example) that were created by entrepreneurs with goals beyond maximizing profits, and that these goals are neither “hypocritical” nor “cloaking devices” but are intrinsic to the purpose of the business.

I will concede that many other businesses, such as T.J. Rodgers’ Cypress Semiconductor, have been created by entrepreneurs whose sole purpose for the business is to maximize profits for their investors. Does Cypress therefore have any social responsibility besides maximizing profits if it follows the laws of society? No, it doesn’t. Rodgers apparently created it solely to maximize profits, and therefore all of Friedman’s arguments about business social responsibility become completely valid. Business social responsibility should not be coerced; it is a voluntary decision that the entrepreneurial leadership of every company must make on its own. Friedman is right to argue that profit making is intrinsically valuable for society, but I believe he is mistaken that all businesses have only this purpose.

While Friedman believes that taking care of customers, employees, and business philanthropy are means to the end of increasing investor profits, I take the exact opposite view: Making high profits is the means to the end of fulfilling Whole Foods’ core business mission. We want to improve the health and well-being of everyone on the planet through higher-quality foods and better nutrition, and we can’t fulfill this mission unless we are highly profitable. High profits are necessary to fuel our growth across the United States and the world. Just as people cannot live without eating, so a business cannot live without profits. But most people don’t live to eat, and neither must a businesses live just to make profits.

Toward the end of his critique Friedman says his statement that “the social responsibility of business [is] to increase its profits” and my statement that “the enlightened corporation should try to create value for all of its constituencies” are “equivalent.” He argues that maximizing profits is a private end achieved through social means because it supports a society based on private property and free markets. If our two statements are equivalent, if we really mean the same thing, then I know which statement has the superior “marketing power.” Mine does.

Both capitalism and corporations are misunderstood, mistrusted, and disliked around the world because of statements like Friedman’s on social responsibility. His comment is used by the enemies of capitalism to argue that capitalism is greedy, selfish, and uncaring. It is right up there with William Vanderbilt’s “the public be damned” and former G.M. Chairman Charlie Wilson’s declaration that “what’s good for the country is good for General Motors, and vice versa.” If we are truly interested in spreading capitalism throughout the world (I certainly am), we need to do a better job marketing it. I believe if economists and business people consistently communicated and acted on my message that “the enlightened corporation should try to create value for all of its constituencies,” we would see most of the resistance to capitalism disappear.

Friedman also understands that Whole Foods makes an important contribution to society besides simply maximizing profits for our investors, which is to “enhance the pleasure of shopping for food.” This is why we put “satisfying and delighting our customers” as a core value whenever we talk about the purpose of our business. Why don’t Friedman and other economists consistently teach this idea? Why don’t they talk more about all the valuable contributions that business makes in creating value for its customers, for its employees, and for its communities? Why talk only about maximizing profits for the investors? Doing so harms the brand of capitalism.

As for Whole Foods’ philanthropy, who does have “special competence” in this area? Does the government? Do individuals? Libertarians generally would agree that most bureaucratic government solutions to social problems cause more harm than good and that government help is seldom the answer. Neither do individuals have any special competence in charity. By Friedman’s logic, individuals shouldn’t donate any money to help others but should instead keep all their money invested in businesses, where it will create more social value.

The truth is that there is no way to calculate whether money invested in business or money invested in helping to solve social problems will create more value. Businesses exist within real communities and have real effects, both good and bad, on those communities. Like individuals living in communities, businesses make valuable social contributions by providing goods and services and employment. But just as individuals can feel a responsibility to provide some philanthropic support for the communities in which they live, so too can a business. The responsibility of business toward the community is not infinite, but neither is it zero. Each enlightened business must find the proper balance between all of its constituencies: customers, employees, investors, suppliers, and communities.

While I respect Milton Friedman’s thoughtful response, I do not feel the same way about T.J. Rodgers’ critique. It is obvious to me that Rodgers didn’t carefully read my article, think deeply about my arguments, or attempt to craft an intelligent response. Instead he launches various ad hominem attacks on me, my company, and our customers. According to Rodgers, my business philosophy is similar to those of Ralph Nader and Karl Marx; Whole Foods Market and our customers are a bunch of Luddites engaging in junk science and fear mongering; and our unionized grocery clerks don’t care about layoffs of workers in Rodgers’ own semiconductor industry.

For the record: I don’t agree with the philosophies of Ralph Nader or Karl Marx; Whole Foods Market doesn’t engage in junk science or fear mongering, and neither do 99 percent of our customers or vendors; and of Whole Foods’ 36,000 employees, exactly zero of them belong to unions, and we are in fact sorry about layoffs in his industry.

When Rodgers isn’t engaging in ad hominem attacks, he seems to be arguing against a leftist, socialist, and collectivist perspective that may exist in his own mind but does not appear in my article. Contrary to Rodgers’ claim, Whole Foods is running not a “hybrid business/charity” but an enormously profitable business that has created tremendous shareholder value.

Of all the food retailers in the Fortune 500 (including Wal-Mart), we have the highest profits as a percentage of sales, as well as the highest return on invested capital, sales per square foot, same-store sales, and growth rate. We are currently doubling in size every three and a half years. The bottom line is that Whole Foods stakeholder business philosophy works and has produced tremendous value for all of our stakeholders, including our investors.

In contrast, Cypress Semiconductor has struggled to be profitable for many years now, and their balance sheet shows negative retained earnings of over $408 million. This means that in its entire 23-year history, Cypress has lost far more money for its investors than it has made. Instead of calling my business philosophy Marxist, perhaps it is time for Rodgers to rethink his own.

Rodgers says with passion, “I am proud of what the semiconductor industry does—relentlessly cutting the cost of a transistor from $3 in 1960 to three-millionths of a dollar today.” Rodgers is entitled to be proud. What a wonderful accomplishment this is, and the semiconductor industry has indeed made all our lives better. Then why not consistently communicate this message as the purpose of his business, instead of talking all the time about maximizing profits and shareholder value? Like medicine, law, and education, business has noble purposes: to provide goods and services that improve its customers’ lives, to provide jobs and meaningful work for employees, to create wealth and prosperity for its investors, and to be a responsible and caring citizen.

Businesses such as Whole Foods have multiple stakeholders and therefore have multiple responsibilities. But the fact that we have responsibilities to stakeholders besides investors does not give those other stakeholders any “property rights” in the company, contrary to Rodgers’ fears. The investors still own the business, are entitled to the residual profits, and can fire the management if they wish. A doctor has an ethical responsibility to try to heal her patients, but that responsibility doesn’t mean her patients are entitled to receive a share of the profits from her practice.

Rodgers probably will never agree with my business philosophy, but it doesn’t really matter. The ideas I’m articulating result in a more robust business model than the profit-maximization model that it competes against, because they encourage and tap into more powerful motivations than self-interest alone. These ideas will triumph over time, not by persuading intellectuals and economists through argument but by winning the competitive test of the marketplace. Someday businesses like Whole Foods, which adhere to a stakeholder model of deeper business purpose, will dominate the economic landscape. Wait and see. 

Have You Riven a Ford Lately? Ford green guru Niel Golightly discusses cars, climate, and time-warp activism



Have You Riven a Ford Lately?
Source:
Grist.org

Ford green guru Niel Golightly discusses cars, climate, and time-warp activism. By John Elkington and Mark Lee



Last month, Ford Motor Co. CEO Bill Ford laid out a new vision to turn his company into a leader in technological innovation and, just perhaps, an environmental performance champion as well. His announcement, including the promise to produce 250,000 hybrids annually by 2010, comes during a time of trouble for the industry, and we watched it with keen interest.

First, our own "full disclosure": We work for
SustainAbility, a think tank and consulting agency headquartered in London, and Ford Motor has been a client since the late 1990s. It's a relationship that endures in spite of periodic doubts on both sides.

Early on, for example, we advised Bill Ford (then the newly appointed chair of the board) to go public with his concerns about the sustainability of SUVs. He did -- and was pounced upon by, among others, The Wall Street Journal and The New York Times. Friedmanesque journalists sputtered that William Clay Ford Jr. was a "poor little rich kid" bleating about products crucial to his company's profitability. At one stage, Ford muttered that if we were his friends, God spare him from his enemies.

At other times, even after media coverage turned positive, our company teetered on the edge of resigning its relationship with Ford, feeling that, far from making progress on issues like climate change, it was going into reverse. Many environmentalists seemed to agree. The automaker has been the target of several aggressive and well-orchestrated campaigns accusing it of, among other things, being recalcitrant (to put it mildly) on climate change. Greenpeace
compares the new Land Rover's fuel economy to that of the Model T, and suggests Ford's environmental performance is worse today than it was eight decades ago. Meanwhile, the Rainforest Action Network and partners are running an entire campaign dedicated to "jumpstarting" the company.

While environmentalists see the major U.S. automaker and its kin as dinosaurs flailing in a tar pit largely of their own making, financial pundits confirm that the company is reeling -- costs are high, market share is falling, critics
love the new Mustang but not much else, and there is even talk of bankruptcy. Many business analysts paint all Detroit automakers with the same broad brush, citing high legacy costs related to pensions and health care as the primary reason these companies can't compete with the Asian automakers generally, and Toyota in particular.

So are American automakers headed for extinction? To give readers a glimpse of the Ford view of the universe, we turned to Niel Golightly, the company's optimistically titled director of sustainable business strategies, who spoke to us from his office at Ford's headquarters in Dearborn, Mich.

Niel, since we got involved with Ford, we have been on a roller-coaster ride in terms of our sense that the company is making progress. Will this latest round last?


Yes. There is no going back. The race is on to deliver sustainable mobility options with the features, performance, safety, styling, and lifestyle appeal consumers expect. You're right to say that there have been highs and lows since we publicly touched the third rail called global warming six years ago, but even when our progress wasn't as visible as some wanted, we were beavering away at new technologies (like hybrids and hydrogen) and new product segments (like cross-over vehicles that blend SUV and car attributes).

Those efforts put us in a better market position today than many appreciate. And this continues -- for example, we just announced an innovation partnership on nanotechnology with Boeing and Northwestern University that could provide new breakthroughs in fuel efficiency.

We were struck by your recent hybrids pledge, a tenfold increase over current hybrid production that could establish Ford as the American leader in bringing this technology to market. But even your 2010 hybrid production numbers will lag far behind Toyota's, and 250,000 vehicles is but a fraction of Ford's overall production. Is this deck chairs on the Titanic?


Hey guys, give me a break! This is huge -- in impact, investment, and strategic commitment. A quarter million hybrids is our plan today, but as Bill hinted, we're not likely to sit on our thumbs as the segment continues to grow.

You also announced that Ford would take steps to offset the carbon emissions that occur in the production of these vehicles. Why not do this for every vehicle you produce?


This is a pilot program. No other automaker is doing it at all. We want to explore how well this will be received, how much impact it will have on our greenhouse emissions footprint, and if (and how) we should leverage the idea further. Actually, it would be great to know what readers think of this part of our plan.

Some campaigners have gone after Ford with searing ads and direct action. Did they influence your hybrid decision?


No. And I have to vent a little here. I've spent considerable time talking with activist groups, and I actually share their concerns. Climate change worries me a lot -- it worries most people at Ford. We share a belief that societies need more energy-effective ways to live, work, and travel. So given that common ground, I'm baffled to see some campaigners stuck in a time warp.

Old-style sticks-and-stones attack ads and PR stunts worked when corporate leaders needed to be whacked upside the head to get them to pay attention to the issues. Then, the relatively simple challenge was to get environmental issues on the agenda -- but the issues are anything but simple, and finding solutions requires more nuance. We got the message a long time ago. Now we're spending time, energy, and billions of dollars on real solutions. More attacks won't get us to move faster.

The groups that are having an influence on us are the ones who get the fact that we're a business, and that we can help solve environmental problems only if the solutions also meet our obligations to customers, shareholders, employees, retirees, regulators, communities, dealers, and suppliers. I believe there is a growing convergence between environmental interests and business, but it will take sophisticated cooperation to realize the potential here.

If you were running a campaigning organization like Greenpeace or RAN, how would you pressure Ford?


By buying more Ford products! I'm partly kidding, but the pressure that matters most to us is what consumers decide on the showroom floor. Campaigning organizations need to understand the importance of "demand pull," i.e., the importance of what customers buy, what they are willing to pay, and which attributes they value most. As one example, the Sierra Club gets it. As an organization that has beaten us up in the past and which will continue to insist that we make our products more fuel-efficient, they also take an active role in encouraging customer demand for fuel-efficient technologies like hybrids.

At Ford, we know that our future business depends on shifting from a fossil-fuel-intensive automotive business model to more sustainable mobility options, but we can't afford to arrive at that future before consumers are willing to make the leap with us.

In a speech to Ford engineers and scientists in September, Bill pledged to "focus every aspect of the business on innovation." Why should we believe that better environmental performance will result?


As Bill put it in our
newest sustainability report, we're a 100-year-old company that wants to reach 200. We're focusing on innovation because meeting 21st century needs in innovative ways is the surest way to business success. And I think it's pretty obvious that, over time, markets will demand innovation around fossil-fuel efficiency, lower greenhouse-gas emissions, a decreased ecological footprint, greater safety, lower congestion, less noise, more equitable access to mobility ... and that's just a partial list.

You are also working on a report dealing specifically with the degree of risk climate change poses to your business. Given our "Full Disclosure" calling card, how full will this year's disclosures be?


Sometimes it feels like the debate about climate change and the auto industry is going on as if we -- the auto companies -- weren't even in the room. Part of the reason we write sustainability reports is to give investors, policy makers, and NGOs an industry view on why we consider sustainability generally and climate change in particular significant business issues -- and to explain how market and business forces might be leveraged to help solve it.

Anyone expecting our climate report to deliver a "eureka" solution or unilaterally to assume the burden for rolling back 100 years of accumulated infrastructure, policy, economic interest, and consumer habit will be disappointed. But anyone looking for a proactive contribution to the policy debate, an understanding of the dynamics at work in our industry, and near-term actions we can all take will, I hope, see that we're intent on skirting the tar pit. And to achieve that, our footprints are going to have to get a whole lot smaller.

--------
London-based John Elkington is cofounder and chair of SustainAbility. He blogs at johnelkington.com. Canadian Mark Lee is a director of SustainAbility and makes his home in San Francisco.

This article has been reprinted courtesy of
Grist.org. It was first published on Oct. 18, 2005.

2.11.05

Sustainable business: the need for new business models in a changing world



Sustainable business: the need for new business models in a changing world

Address by Travis Engen, President and Chief Executive Officer, Alcan Inc., at the Birkbeck Lecture Series (London, 27 October 2005)

Thank you, Robert.

And thank you, Lord Marshall, for inviting me to be part of the Birkbeck Lecture Series.

Alcan Inc. is a company that relies on a wide spectrum of skills in our workforce. We believe in lifelong learning and we make the training tools available to our employees to move ahead with and within our organization … whether that be shop floor skills training, trades apprenticeships, or post-graduate pursuits. You might be surprised to know that in 1946 Alcan founded an International management college for Alcan executives that in the early 1990s was merged with a similar Nestle management college to found what is today IMD in Lausanne.

So, it is a privilege to be asked to speak by as unique an institution of higher learning as Birkbeck because you embody the kind of opportunity that my company tries to make available to all our people, according to and respectful of their interests and aspirations.

And you do it in the heart of London, one of the world’s truly great cities. As CEO of a leading international aluminum, engineered products, and packaging company, I can’t overstate the influence London has on my industry. Home to the London Metal Exchange that sets prices for our commodity products and headquarters of the International Aluminum Institute, your city is the international seat of the aluminum industry.

London is also widely considered one of the world’s most important global centres of thinking when it comes to sustainability and Corporate Social Responsibility … a reputation that I have come to understand more fully through my company’s association with the Prince of Wales International Business Leaders Forum – or IBLF.

On that note, I would like to acknowledge Robert Davies and the fine work carried out by the organization he represents.

Alcan came to know the IBLF through the Alcan Prize for Sustainability. I’ll have more to say on the Alcan Prize later but, for now, suffice it to say that the IBLF manages this program for Alcan … and does so with dedication, objectivity, and clarity of vision.

I was honoured earlier this year to be named Chairman of the IBLF … honoured both because I have developed considerable respect for the organization through our Alcan Prize partnership and because I believe deeply in the work they do. International business needs forums like the IBLF that allow us to benefit from each other’s experience as we grapple with the challenge of defining the role of business in preserving our planet for future generations, and ensuring a more equitable distribution of the world’s wealth and use of its natural resources.

My topic for this evening is a mouthful: “Sustainable business: the need for new business models in a changing world.” I certainly don’t have all the answers, but I’m pleased to have the opportunity to share some of what I have been learning over 40 years of global business experience… and some of what Alcan is learning as we adopt sustainable business models and strive to play a constructive role in tackling the economic, environmental, and social issues facing today’s world.

I believe it is important to emphasize that this is a path of learning. I don’t believe it will ever be possible to say, “That’s it, we’ve arrived.” The needs of the world will continue to evolve as will our own awareness of them and of the possibilities for action. But the more of us who are engaged, the better the chance that our world will evolve in ways that will continue to offer opportunities to future generations.

Our common challenge is to meet the needs of a world that is expected to have a population of nine billion and a global economy of $135 trillion by 2050. A world that, at today’s pace of change, will need not one – but three – planets to support it. Indeed, if the entire world were consuming at the rate we do in Western economies, it would take five planets to support us.

Finding ways for the one planet available to us to accommodate this growth within the window of the next few decades is a daunting task. One that requires an international, cross-sector, all-out effort.

So how are businesses and business models addressing this? To start with, the corporate world can be placed on a continuum that ranges between Milton Friedman’s view that “the business of business is business” and Ebenezer Scrooge’s revelation that “mankind was my business.”

More and more of us are lining up with the redeemed Scrooge. The time he spent in the spirit world didn’t make Ebenezer less of a business man. It helped him to understand how his business interests, and every decision he made with respect to them, had an impact on the lives of his fellow human beings.

At Alcan, we get it. And getting it is creating so much opportunity that I can’t do justice to it all in the brief time I have with you tonight.

First and foremost, the debate within Alcan is not about whether or not the business case exists for social responsibility. We have no doubt that it does. Every day, we see the return on investment that comes with having an engaged discussion on an opportunity or project that includes all elements of sustainability … economic, environmental and social, not just the economic. To many outside of Alcan, this is seen as recognizing and fulfilling our responsibilities as an international business … one that directly employs tens of thousands of people and has an impact on the lives of many more thousands in our operating communities. But, to us, this is executing our sustainable business model.

We know that our social license to operate and our ability to shape our own destiny depend on relationships of mutual benefit with society at large, and with the governments and non-governmental organizations that represent society’s interests.

We also know that, while we’re looking after our own house, there is a collective contribution that the global business community can – and, in my view, must – make to address issues that threaten our sustainability as a business community.

I’m talking about issues like the heavy consumption of resources by the world’s wealthiest countries. Realities like the developed world’s tendency to lecture emerging economies on conservation when they know full well that our own growth has been based on consuming more than pro rata amounts based on our population. I’m talking about the need to strengthen governance models in emerging economies, eliminating corruption as a way of doing business and transitioning to better investment frameworks for better economic performance.

The IBLF and many other organizations, such as the World Business Council on Sustainable Development or WBCSD, are helping business leaders to think deeply about the role of business in society. I believe these collective initiatives on the part of global business are crucial at this juncture – on a planet that is increasingly stressed. I also believe they carry the promise of significant benefit for civil society.

I have the privilege of co-chairing the WBCSD’s “Role of Business in Society” initiative. This initiative brings together CEOs from some of the world’s most successful companies to define our role and identify how the global business community can help itself by helping sustain the planet. Discussions like this are critical and urgent because it is clear that the answers won’t be found by going about our business as usual.

“Business-as-usual” thinking will not conserve our diminishing fresh water sources, which support all life on this planet. Nor will it address the inequities between the developed and developing worlds, or between rich and poor within the same borders. We have seen far too much evidence of how disaffection through a sense of inequality manifests itself … in the kind of terrorism the world was horrified to witness here in London last July; in wars within and between nations.

The participation of business in tackling these issues is by no means philanthropic. Consider the words of the co-chairs of the WBCSD’s “Sustainable Livelihoods Project.”

In a report entitled “Business for Development,” released last month, they point out that the products and services provided by the Council’s 175 member companies touch the lives of an estimated 2.5 billion people each and every day. Yet most of the world’s population remains trapped in poverty, left out of the world’s markets.

The WBCSD estimates that, by 2050, 85 per cent of the world’s population of some nine billion people will be in developing countries. Its report states that if these people are not, by then, engaged in the marketplace, our companies cannot prosper and the benefits of a global market will no longer exist.

While one could be frightened by these projections, I believe that a better course is to see the opportunities. It is the challenge and the opportunity of the markets that are growing fastest, that are not yet integrated with the more developed regions that should drive us. The sustainability of our businesses, their ability to continue to innovate and raise living standards through productivity gains, their ability to build bridges and relationships, and their ability to continue generating wealth that enables reinvestment and growth depend on the creativity and resolve we bring to working with governments, academia, and NGOs toward equitable participation for all societies in the world’s marketplace.

To quote the UN Secretary General: “It is the absence of broad-based business activity, not its presence, that condemns much of humanity to suffering. Indeed, what is Utopian is the notion that poverty can be overcome without the active engagement of business.”

The WBCSD’s “Business for Development” report, which I encourage you to seek out, presents 14 case studies on companies that are helping to overcome human suffering through innovative business models in some of the most impoverished regions of the world.

Companies like SC Johnson in Kenya, GrupoNueva in Guatemala, and Rabobank in Indonesia are helping local farmers boost their competitiveness, thereby improving their individual livelihoods and the quality of life in their communities.

ConocoPhillips is helping Venezuelan women to develop entrepreneurial skills. EdF is providing affordable solar energy to villagers in Morocco. Procter & Gamble has developed a low-cost product to purify drinking water.

BP, Eskom, and Rio Tinto are cited in the report for the work they’re doing to support small to medium-sized enterprises in bolstering local economies. Philips is expanding the provision of specialized health care to India’s poor. Vodafone is making it easier for African entrepreneurs to receive financing. Holcim is doing something similar with regard to financing low-cost housing in Sri Lanka. Unilever is finding new ways to deliver fortified food and hygiene products in Africa and India.

While this may sound like a list of anecdotes I remind you that it is said that the plural of anecdote is data. What’s really relevant is that all these solutions are business solutions. These companies are developing and selling affordable products or services aimed at solving economic, social, and environmental challenges in impoverished regions. By doing so, they are opening up new markets for themselves and improving the standard of living for the customers they serve.

These are all fine examples of the new business models that hold so much promise for improving the lot of our troubled world. There are many more. Just among WBCSD members alone, there are 66 companies actively creating business-based economic development initiatives in various parts of the world.

The WBCSD is only one of many global forums promoting the notion that business must be an equal partner with governments and non-governmental organizations if we are ever to achieve a greater balance across the economic, social, and environmental dimensions of sustainability.

Many other forums – the WEF, the IBLF, the Global Compact, IISD, ISO, GRI, the G-8, the OECD … the acronyms go on and on – have reached the same conclusion: that no one sector can solve the world’s problems but, together, we have the means.

Governments can create the policy infrastructure that stimulates sustainable growth. NGOs are skilled at early identification of issues and priorities, and facilitating communication among often disparate parties. Business has the resources and expertise to activate solutions that are self-sustaining through the application of business models. By working together and taking each other’s interests into account, we become a formidable force for the betterment of the planet.

I’d like to share a few examples from our own experience at Alcan.

First, I should not assume that all of you are intimate with Alcan Inc. Let me give you the 30-second tour. The past five years have been a time of tremendous growth for us. We were a $7-billion company in 2000. By 2004, we had grown to become a $25-billion enterprise. Our growth has been fueled mainly by acquisitions, most notably algroup of Switzerland in 2002 and Pechiney of France in 2004.

At the end of last year, we spun off our rolled aluminum products division into a new $6-billion company, called Novelis.

Today, Alcan is a world leader in aluminum production, packaging, and engineered products with 70,000 employees in 55 countries. Our global headquarters is in Montreal, Canada where our company was founded 104 years ago. That makes us a youngster by London standards but, by Canadian and aluminum industry standards, we’ve been around a long time.

Our preoccupation with sustainability stems partly from our product. We are very fortunate to produce aluminum, one of the world’s most recyclable products. This puts a special pressure on us to ensure that our products are designed and manufactured in ways that maximize their recyclability.

The fact that we produce a sustainable product has helped our employees understand the logic and accept the responsibility of adopting a sustainability agenda throughout our operations. This is perhaps one of the reasons we have been able to drive a sustainability mindset quite quickly and consistently throughout such a large and geographically diverse organization.

Let me give you a few examples of how our sustainability mindset and determination to build relationships with governments, NGOs, and other stakeholders are helping us to identify business opportunities of mutual benefit in our far-flung operations.

Our facilities in British Columbia, Canada occupy land that is claimed as traditional territory by several First Nations. In the past, Alcan protected its rights in the face of unresolved land claims almost exclusively by legal means. In recent years, we have been consulting with First Nations, creating relationship-protocol agreements with them based on mutual respect, and entering into mutually beneficial business relationships with them.

Recently, three First Nations in the Nechako Watershed area – where the reservoir that feeds our hydroelectric station is located – signed the Three Nation Forest Stewardship Agreement with Alcan. Under this agreement, the three Nations will work together to harvest still-salvageable timber on Alcan-owned property around the reservoir. Forests in much of the B.C. interior have been ravaged by a pine beetle infestation and, while the trees still have commercial value if harvested in time, they have to be removed to halt the infestation. Through this program with Alcan, the three Nations will receive the economic benefit of the harvest and build their capacity for silviculture and forest management. Alcan will solve the problem of the pine beetle infestation on its lands. And local communities will benefit from an economic development fund which the three Nations will create with a portion of their earnings.

Another logging initiative of the Cheslatta First Nation, one of the Three Nations involved in the land-based project I just described, is underwater logging in the Nechako Reservoir. At the time Alcan built its huge hydroelectric and aluminum smelting facilities in B.C. back in the early 1950s, the timber on land flooded to create the Nechako Reservoir – with a surface area roughly the size of Belgium, by the way – was not considered valuable enough to harvest. So it was left standing when the water filled the reservoir.

For a number of years, Alcan engaged in the time-consuming process of clearing submerged timber for safety and navigational purposes … just along the edges of the reservoir and in boat-traffic areas. The wood was burned on shore to dispose of it. However, about 10 years ago, the Cheslatta demonstrated that this timber had been perfectly preserved under water – that it was, in fact, often higher quality than trees on land because it had not been exposed to the air. Alcan worked with the B.C. Ministry of Forests to arrange to tender rights to harvest the submerged timber. With underwater logging equipment provided to them by Alcan, the Cheslatta Resource Corporation won the bid and have since been licensed to harvest six million cubic metres of this highly desirable wood.

Early reservoir logging methods were slow, awkward, and posed some risks to the underwater habitat. Today, however, the Cheslatta have partnered with a B.C. company that has developed a remote-controlled underwater saw … faster, environmentally sound technology that has elevated trees from the Nechako Reservoir timber to the status of eco-friendly wood products. The Cheslatta are profiting economically and socially from the harvest. Alcan is able to ensure safer, more navigable conditions on the reservoir we control. And there are benefits for B.C. as a whole in terms of enhanced tourism values in a breathtaking part of the province.

An example from Cameroon … this one speaks to the need to examine management decisions across all three dimensions of sustainability in our dealings with stakeholders. Our Cameroon site came to us in a recent acquisition. Alcan’s EHS FIRST program to ensure World Class health, safety, and environmental standards is a requirement at all Alcan sites. Unfortunately, the Cameroon operation was nowhere near up to its standards.

There was an area outside the plant gates where slag from the production of aluminum was placed. Local villagers were accustomed to scavenging this for the recovery value of aluminum in the slag, at a fairly high risk of injury. By applying EHS FIRST principles, Alcan would have cleaned up the site for compelling environmental and social reasons, failing to take into account the economic impact … scavenging for discarded industrial materials was the only source of income for some of these villagers.

Our managers there understood the economics of the region and our community stakeholders and they integrated the environmental, economic, and social dimensions into their decision-making. Today, villagers continue to scavenge the slag but in clean, safe circumstances and wearing personal protective equipment provided by Alcan.

EHS FIRST has enormous potential to lead by example. Because we apply a high set of standards across the board – regardless of how little local law or regulation may demand – we can influence what others do. Last year, after becoming a 50% partner in a joint smelter venture in China, we successfully introduced EHS FIRST to our two Chinese partners, raising environmental and health and safety standards to World Class standards.

Management and employees at this smelter have embraced the new standards, are very proud of the leadership they have shown in the Chinese industry, and are better positioned to understand what is involved in developing a World Class aluminum smelter.

In Gladstone, Australia where we have a 41.4% interest in Queensland Alumina Limited, we have entered into a long-term partnership with the Gladstone City Council to use the city’s treated effluent for the final wash process in alumina refining. The treated effluent doesn’t affect the quality of our alumina, but its use conserves 14,000 megalitres a year of fresh water in a drought-prone region of the country.

At our Awaso bauxite mine in southwest Ghana, Alcan owns and operates a fully-functional hospital and clinic that provides care to our employees, their families, and the surrounding community. The thinking behind this facility and other health initiatives, like our HIV/AIDS management strategy in Cameroon, is that employee health issues are business issues. By contributing to the overall health of the community, our Awaso hospital is helping our employees and their neighbours build a more sustainable future. Our HIV/AIDS profile has dropped from 24% to under 3% of our employees … a performance that we successfully extended to the community through outreach and education programs.

Ironically, as we learn more and more about the business and strategic opportunities opening up to us through sustainability, we have some social and economic problems of our own industry’s making to contend with.

Commercially-viable aluminum production is not much older than Alcan. Those of us who have been in this game since the beginning have been in the painful process over the past couple of decades of retiring the first generation of aluminum smelters in favour of cleaner, safer, environmentally superior new smelters.

Why painful? Because, while the new technology is preferable from the perspectives of environmental stewardship and industrial health and safety, it has an impact on employment.

Typically, new smelters can produce more than twice the metal with less than half the people. And that’s an economic and social problem for aluminum-producing regions that have traditionally relied on an abundance of 24-hour-a-day, 365-day-a-year jobs.

In the Saguenay—Lac-St-Jean region of Quebec, North America’s most concentrated centre of aluminum production, Alcan has invested heavily in new smelting technology over the past 20 years. The result? A quadrupling of aluminum production capacity, and a close to 50% reduction in employment. How do we deal with that?

We work with our host communities to diversify the economic base of the region. We use the industrial infrastructure to attract new, secondary manufacturing businesses. Thanks to the combined efforts of Alcan and many other stakeholders, close to 800 new jobs have been created in the region over the past few years.

Or, as in the cases of former aluminum-producing regions that are not large enough to support today’s mega-smelters – Kinlochleven and Lochaber in Scotland, for example – we help our communities use their industrial heritages to transition to service economies, based on the great geography that brought Alcan to them in the first place.

Alcan does not abandon these communities. We work with them toward sustainable, if different, economic success.

Let me wrap up with a few words about the Alcan Prize for Sustainability.

Two years ago, we realigned our corporate sponsorships and donations – which we call Community Investment – to our sustainability platform. We view our Community Investment Program as a very visible expression to the outside world of what’s important to us.

Our criteria today for sponsorships and donations are based on the extent to which a proponent integrates the economic, social, and environmental dimensions of sustainability in a project or program.

To launch this new approach to corporate giving, we created the US$1-million Alcan Prize for Sustainability. The Alcan Prize is an annual award to recognize not-for-profit, non-governmental, and civil society organizations that are doing great work … every day, at the grassroots level … to make our world a better place.

It’s our way of emphasizing our belief that the goals of sustainability are best served when we all work together.

And, if the first year of the program is any indication, it has been a success beyond our initial expectations. The first Call for Entries for the Alcan Prize resulted in close to 500 submissions from 79 countries around the world. The Forest Stewardship Council was the inaugural winner – to my mind, a great first choice … although Alcan, by our own decision, didn’t have a vote. To ensure the credibility and objectivity of the Alcan Prize, we have entrusted its management to the IBLF and a globally-renowned panel of judges, with some 70 NGOs serving as regional assessors.

In establishing the prize, we knew it had to be long term to do real good so we committed to nine years of funding in its first cycle. We hope it will be around for a very long time to come.

I mention it tonight … not just because two U.K.-based NGOs are on the 2006 short list that we announced in Zurich last month … but because it is opening a new world to us. A world of potential partners, teachers, collaborators, and friends … many, if not most, of whom we would have had no exposure to, if not for the Alcan Prize.

We’re learning about sustainability initiatives that are taking place all over the world … some of them international in scope, some of them very local, all of them innovative and inspiring. This learning has tremendous value for us as an organization, in terms of improving our own approaches to sustainability and in the relationships, and new partnerships, we’re building in the NGO sector.

I hope it will make a difference in the world. I know it’s making a world of difference for Alcan. It’s about vision. It’s about leadership. It’s about innovating, letting go of old ideas and embracing new ones.

When we consider the examples we’ve discussed tonight, there can no longer be any serious doubts as to the significant influence business can bring to bear in improving the lot of people around the world … economically, socially, and environmentally.

At Alcan, as we discover more and more ways to do things better in our operations and in our relationships with the outside word, we’re finding substantial economic returns in the form of social license to operate, waste reduction and process efficiencies, shareholder confidence, customer retention, employee recruitment, brand, and reputation.

Alcan has been honoured with many awards and accolades in the past few years for our accomplishments in the practice of sustainability and social responsibility. It’s very gratifying to have our efforts recognized externally, but even more so to know that each accomplishment – each new lesson learned – makes us a better company.

Thank you for listening to the lessons we’ve been learning inside and outside of Alcan. I have only skimmed the surface of how business is redefining its role in society, and am delighted that we have a little more time together to explore any questions you may have.

Thank you.

More information:

Interesting broadcast on CSR


----- Forwarded by Jean-Francois Barsoum/Markham/IBM on 01/11/2005 15:39 -----
An interesting broadcast on CSR by Roland J. Alsop on May 6th, 2005 is finally available for download (as a Podcast).  The first URL takes you to the City Club of Cleveland Podcast download instruction page, and the second is the URL from iPodder for the Alsop broadcast.

http://www.cityclub.org/content/podcasts/index/index.asp

http://www.cityclub.org/content/podcasts/CityClubPodcast-050506.mp3

Penelope Everall Gordon

New Generation Innovation and Technology from Young SD Managers


New Generation Innovation and Technology from Young SD Managers

Geneva, 1 November 2005 - “It’s not a debate -- business has an important role to play in sustainable development”, says Albrecht Gerland, a team lead for the WBCSD Young Managers Team (YMT) 2005. “Yet knowledge of sustainable development with the broad base of employees across company functions is surprisingly low.”

The YMT 2005’s overall theme is to look within the functions of their own companies and explore new ways to communicate sustainable development to wider audiences. There are three workstreams, each looking at this issue from a different functional perspective.

Albrecht is the coordinating lead for the YMT 2005 workstream focusing on media. He is attracted to this topic for the “open space it provides and the opportunity to be totally creative.” Albrecht is a Geneva-based Marketing Manager and Regional Segment Leader for the Advanced Fiber Systems division at WBCSD member company DuPont.

He says that his interest in the YMT was to gain broader learning on sustainable development (SD) issues and dilemmas. However, for him this has been even more robust in terms of valuable leadership skills that stem from the opportunity to work with a group of dynamic and diverse leaders from his peer group.

“Bringing awareness and knowledge of sustainable development more into the mainstream of a company requires fresh thinking,” says Albrecht. “For this reason our group has chosen to develop an innovative tool to be shared between employees, and that is meant to peak interest and create ‘buzz’ around sustainable development. The tool will utilize new technologies and aims to initiate a bottom-up effect versus the traditional top-down communication approach.”

During this one-year project, Albrecht and his YMT 2005 colleagues are seeking to generate interest and excitement in sustainable development among a wider set of employees that may have previously been naysayers or were simply not exposed to this way of thinking.

At the WBCSD’s June 2005 Liaison Delegates meeting in Nagoya, Japan, the concept was met with enthusiastic encouragement from SD experts who have been working in the field for many years and continue to face challenges communicating SD. One senior executive stated that, “this kind of fresh thinking, challenging the norms of how SD is communicated, is what is needed. This new generation of future leaders is a great breeding ground for new ideas. It is much less likely that my generation would have come up with this idea.”

“We wanted to do something different, something ‘funky’ -- the buzz word of our group -- and we were pleasantly surprised to be encouraged to challenge traditional thinking by sustainability experts within our own companies,” says Albrecht.

The development of the YMT media workstream’s new tool is well underway. Albrecht and his colleagues are currently “think-tanking” new concepts for communicating sustainable development through technologically advanced media. The group expects to have a product to test drive by the end of the year.

The WBCSD Young Mangers Team program, set up in 2002, aims to extend corporate engagement in sustainable development issues from the CEO and senior executive levels to younger managers who will lead the companies’ future initiatives. “These are tomorrow’s leaders”, says a WBCSD member company senior executive and member of the advisory committee that initiated the YMT program. “It is critical that tomorrow’s business leaders be experts in sustainable development. But more than that, we hope that they will question and challenge traditional approaches to global challenges.”

Albrecht recognizes that business has an important role to play in the advancement of sustainable development, and sees the YMT providing the means “to live up to it.”

For more information:

1.11.05

Large-Business Buyers Drive 1000% Growth in Green Power Purchasing



Large-Business Buyers Drive 1000% Growth in Green Power Purchasing

GreenBiz.com, 24 October 2005 - Renewable energy capacity in the United States supported by voluntary demand rather than regulatory requirements now tops 2,200 megawatts (MW) -- up more than 1000% in just five years, according to a new report from the U.S. Department of Energy. The report notes that purchases by large businesses, institutions and governmental entities are driving the growth of the U.S. voluntary green power market.

Green power currently accounts for about 2% of America's electricity supply, but voluntary purchasing of renewable energy is accelerating development of new renewable energy sources. The report, from DOE’s National Renewable Energy Laboratory (NREL), Green Power Marketing in the United States: A Status Report, shows that renewable generating capacity in the United States installed to meet voluntary green power purchasing soared from 167 MW in 2000 to more than 2,200 MW by the end of 2004.

While the number of residential customers buying green power has more than doubled over the past 5 years, green energy purchases by large businesses and other U.S. organizations have increased dramatically. This is further illustrated by new data released by the U.S. Environmental Protection Agency’s Green Power Partnership. The partnership, a voluntary program that encourages large organizations to switch to green power for a specified minimum portion of their annual electric usage, has grown from 21 founding partners in 2001 to over 600 partners, including Fortune 500 companies, universities, trade associations, and local, state, and federal government agencies.

These green power partners are collectively purchasing over 3.1 billion kilowatt hours of green power annually, a figure which has doubled over the past 15 months. This represents a growth of 1000% since the partnership began in 2001, with founding partners purchasing 3.1 million kilowatt hours annually. Three billion kilowatt hours is enough electricity to power about 300,000 average American homes for a year, and is roughly equivalent to the annual output of a 1000 megawatt wind farm.

"Five years ago, the voluntary green power market was focused primarily on residential purchasers, and there were only a handful of significant non-residential purchasers," said Douglas L. Faulkner, acting assistant secretary for Energy Efficiency and Renewable Energy at the U.S. Department of Energy. “The entry of commercial, industrial, and government purchasers into the renewable energy market has resulted in tremendous growth in the development of clean and limitless renewable energy resources.”

“Leading retailers, universities, manufacturers and federal agencies are demonstrating outstanding environmental leadership by choosing to purchase clean, renewable energy sources for their electricity,” said Kathleen Hogan, director of EPA’s Climate Protection Partnerships Division.

The new report also notes that over the past five years, average renewable energy price premiums for utility programs have declined at an annual average rate of 8% as wind-generated power becomes increasingly competitive against natural gas-fueled generation. In Colorado and in Texas, escalating natural gas prices have pushed electricity rates for regular utility customers higher than rates being paid by customers subscribing to green power options.

Sowing seeds of change: social and environmental issues are forcing agribusiness to reassess its approach in the developing world


Sowing seeds of change


A recent Ethical Corporation conference highlighted how social and environmental issues are forcing agribusiness to reassess its approach in the developing world
The private sector is changing its approach to developing world agriculture, and companies are beginning to understand that they have an important part to play in the industry's development.

Speaking at Ethical Corporation's conference on the "new role" of companies in the developing world, Andrew Bennett, executive director of the Syngenta Foundation for Sustainable Agriculture - the non-profit arm of major agribusiness Syngenta - said corporate responsibility issues are likely to have a huge impact on the sector in the coming years.

The issues he identified as the most significant were: Aids with its "huge impact on rural labour"; climate change and the potential for weather-related damage; energy costs - as agriculture is a high energy-user; and, the increasing scarcity of water.

Bennett noted that the environment for agribusiness was "unstable, where perceptions and values are changing".

Reform required


He cited the Millennium Ecosystem Assessment, a recently published UN-sponsored study, as evidence that agriculture needs reform. The combined work of 1600 scientists from 90 countries, the report found that two-thirds of the world's ecosystems have been "seriously damaged", with agriculture partly to blame.

"The implications of the Millennium Ecosystem Assessment for agribusiness are that this could result in more regulation, a threat to the license to operate, further damage to reputation and brand, increasing costs of inputs like water, increased vulnerability to floods and other disasters, and conflicts and corruption," Bennett said.

On the other hand, the current situation presents opportunities for Syngenta to develop profitable systems to reduce energy use and waste, and to promote the use of biofuels, Bennett said.

At the same time, the sector can improve its reputation. "Agribusiness doesn't normally enjoy the best of reputations. If you make pesticides, manipulate genes, and make profits in different places, you don't always end up at the top of the popularity leagues," he said.

Ethical 'relativity'


Bennett noted that perceptions of ethical issues in agriculture differed depending on whether participants were in the developing or developed worlds, their size, and where they resided in the food supply chain. The relativity of ethics makes drawing up uniform standards in agriculture more difficult, he said.

One frequent problem, which the conference identified, is that of the "missing middle" or the lack of viable SME businesses in the developing world. Bennett said multinationals like Syngenta need to find better ways of encouraging and seeking alliances with such enterprises.

Addressing this issue, Greg Vaut, an advisor to USAID on public-private partnerships in western Africa, described a number of projects where there is co-operation between US companies and African agriculture.

He mentioned a programme set up by USAID with (mostly US) chocolate makers to improve conditions for cocoa growers. The project - known as STCP - delivers technology and business advice to farmers. It has the aim of improving yields and thus ensuring stable cocoa supplies. Vaut said the project has provided greater income for farmers.

Aid alone will not solve Africa's deep problems, so USAID is looking to the private sector for new types of solutions, Vaut said. "At USAID we believe that alliances with the private sector can increase our effectiveness and increase our efficiency. Sometimes companies know better how to operate in different parts of the world."

Vaut, like Bennett, made the case that enlightened self-interest - the profit principle - would create better outcomes in developing countries than domestic and international government interference.

However, it remains to be seen whether, on the one hand, the likes of Syngenta will follow through on think-tank ideas and develop more sustainable farming techniques, and, on the other, whether public-private initiatives of the sort advocated by USAID will work better than the previous aid-only programmes.

Useful links:

www.millenniumassessment.org
STCP:
www.treecrops.org

31.10.05

Is Chile the new Norway?



Is Chile the new Norway?


Enviable natural resources and a small population – could Chile and Norway have more in common than you might at first think?
Pollution remains a major issue in Santiago
Pollution remains a major issue in Santiago


If the statistics are to be believed, life in Chile has never been better. With an export-led economy registering growth figures of about 6% a year, low unemployment (8.5%) and comparatively high per capita income, it’s universally touted as the success story of South America.

A land of beautiful mountain ranges and glacial fjords; a population of only 16 million; high public investment in social and educations programmes – anyone would think it was Norway. But then perhaps the comparison isn’t so far off?

Like it’s Nordic counterpart, the Chilean government has worked hard over the past two decades to open its markets, while at the same time not letting go of the strategic tiller. Both countries take an active role in managing the exploitation of their natural resources (oil in the case of Norway; minerals for Chile).

Chile still has a long way to go to make sure its new-found wealth is redistributed fairly. That said, nearly one in five of the population have been lifted out of poverty since 1990. Strategic social spending has also ensured that the rich-poor divide is considerably smaller than that in, say, Brazil.

As for politics, Chile’s democratic star may not shine quite as brightly as that of squeaky clean Norway, but it’s come a long way since the dark days of the Pinochet dictatorship.

In a continent where “institutionality” could easily be mistaken for a trip to the funny farm, Chile has enjoyed remarkable political stability in the past decade. President Ricardo Lagos from the centre right administration is not only set to finish his five-year term (Argentina has had six presidents over the same period), but does so with record-high popularity ratings.

A raft of political and judicial reforms have ensured Chile the kind of reputation that wins praise not only from pro-democracy groups but from investors too.

As for the knotty question of corruption, Chile is one of the few countries in South America to have tackled the issue head on, obtaining a merit-worthy 20th place out of 159 in Transparency International’s corruption perception index (more than 100 places above neighbouring Bolivia).

All is not perfect; environmental issues remain sidelined and abuses of indigenous rights are also reported. Still, Norway isn’t a paradise either. I hear the snow can sometimes make it difficult to get to work.

Chile’s top ten responsible companies


1. Banco Santander Banefe
2. Banco Santander Santiago
3. CCU
4. Chiletabacos
5. Gerdau Aza
6. Forestal Bío Bío
7. Asociación Chilena de Seguridad
8. Mc Donald´s
9. Masisa
10. Nestlé

Source: Fundacíon ProHumana, October 2005