What Is the Business of Business?

In 1970, Milton Friedman famously argued that the only social responsibility of business was to maximize profits. These profits, if only returned to the firm’s owners (the shareholders, on whose behalf the management should rightfully act), could be put to charitable purposes as shareholders saw fit. By essentially delegating the task of collecting and disbursing taxes to corporate managers, in Friedman’s analysis, shareholders allowed themselves to unwittingly become pawns in a larger battle to derail the capitalist system. Levitt (1958) captured this perspective succinctly when he wrote, “the business of business is profits.”

In the almost half century since Friedman’s admonition, business has evolved along a trajectory quite contrary to what he advocated. It seems as if the business of business is more than just business: socially responsible businesses, which pursue hybrid goals of social good and financial gain, are commonplace. Today it is standard to see for-profit businesses pursuing double-bottom-line objectives. At the same time, Dees (1998) notes that nonprofits are increasingly adopting business methods, writing, “Faced with rising costs, more competition for fewer donations and grants, and increased rivalry from for-profit companies entering the social sector, nonprofits are turning to the for-profit world to leverage or replace their traditional sources of funding.” Why has this occurred? Why have the lines between business and charity become so blurred?

One prominent view for why this has occurred is captured succinctly by (Benabou 2010) when they note that, “Society’s demands for individual and corporate social responsibility as an alternative response to market and distributive failures are becoming increasingly prominent” (emphasis added). This is the view that increasing awareness of the social cost of consumer goods, coupled with the difficulty government actors face when attempting to regulate across global supply chains or otherwise seek redistributive solutions, has driven the rise in corporate social responsibility (CSR).

The central aim of our paper is to put forward a different argument, one that centers on the importance of innovation in business practice. Our argument is that business model innovations from both charities and for-profit firms give these new hybrid firms a comparative advantage over traditional organizations in delivering what other non-market actors provide. The analysis we provide makes it clear that if we were simply living through a period of evolving preferences for financial and social returns, we would see increases in pure charity, not changes in business practice. In short, our analysis argues that the emergence of socially minded business activity must be the result of technological changes on the supply-side, rather than the result of demand-side changes in investor or consumer preferences.

There are many examples of firms that either sacrifice profits by operating in a manner that involves stricter environmental or social guidelines than they are required by law, or that take a share of their profits and donate them to causes that could easily be supported by the firm’s shareholders directly. At the same time, many organizations that would traditionally be labelled as “non-profits” adopt a hybrid approach that blends the pursuit of profit with charitable purpose. Take the example of VisionSpring, an organization that promotes vision correction in the developing world by distributing eyeglasses. While they rely on a combination of philanthropic support as well as strategic partnerships with eyeglass retailers like Warby-Parker, they also distribute eyeglasses at a profit through a variety of channels. One is a model in which local merchants who have been trained to diagnose and correct simple vision problems sell glasses at a modest profit in the communities in which they live. Another is retail outlets in local clinics and hospitals. Why do they blend the pursuit of profit with charitable purpose instead of operating like a pure charity?

This paper develops a simple framework for understanding the emergence of new organizational forms that blend profit and stewardship. For us, Friedman’s analysis is not just a convenient rhetorical straw man: the intuition that we develop hinges critically on Friedman’s observation that investors always have the ability to take “ill-gotten” profits and put them to work for social aims of their own desire. In other words, any of us can act as an impact investor by taking returns we have earned and directing them towards charities of our own choosing. This observation is the fundamental building block of a simple framework for how to think about the emergence of socially conscious business activity.

We start by assuming that investors have preferences over financial returns as well as social returns. That is, investors not only want to invest in profit-making enterprises, but they also place monetary value on social goods such as increased literacy in a developing country or better environmental stewardship. While many environmental, social or governance objectives—a clean environment, good working conditions, etc.—have the flavor of public goods, nothing in our analysis hinges on the existence of externalities. In other words, we do not assume that markets are broken in order to create a motivation for CSR.

We assume that for-profit corporations can choose to operate in a socially minded fashion in addition to simply maximizing profits, and that charities can make operational choices that sacrifice charitable output to stave off financial losses.

The mechanics of our framework are exactly what Friedman imagined: investors can choose to allocate their own wealth between social and financial returns, and therefore do not necessarily need corporations to act charitably. The question we ask is whether, and under what conditions, investors will ask corporations to operate with an eye towards social good even though these same investors are perfectly capable of acting charitably on their own account. In other words, we ask “What is the business of business?”

The key insight of our analysis is that the optimality of Friedman’s prescription hinges critically on the relative tradeoffs that investors and organizations face when they substitute between charity and profit. By relative, we refer to the fact that businesses, charities and investors each have the ability to make tradeoffs between financial and social output; to maximize overall output the tradeoff should therefore be left to the set of actors who do it most efficiently. The fact that shareholders can take profits and redistribute them to pure charities does not necessarily compel organizations to avoid a dual purpose; instead, it imposes constraints on them by establishing a minimum level above which organizations must trade off social and financial output. When the tradeoff between social and financial returns is sufficiently favorable inside for-profit corporations, competition for investment dollars requires for-profit corporations to produce below the maximal level of financial return and instead produce a blend of social and financial returns. In our analysis, this corresponds to the emergence of corporate social responsibility. Similarly, when the tradeoff is sufficiently favorable inside charities, they optimally pursue twin goals of social and financial return, which corresponds to the emergence of social entrepreneurship.

The complete paper is available for download here.