How to build companies that are a force for good in society
For a company to leave the world a better place than they found it, we believe a large-scale change in mindset is necessary.
Apr 20, 2018
Most technology startups say they're "making the world a better place", as anyone who watches the TV show Silicon Valley knows. Reality is, of course, murkier.
In some cases, it can pretty objectively be argued that a company is really making something the world needs if they’re innovating on renewable energy or a cure for a terminal illness, for instance.
In most situations, assessing whether the company has a net positive impact on society is nonetheless difficult. Some devout defenders of entrepreneurship might argue that any company that creates jobs is already making the world better by default, even if the impact of the company’s products is neutral. This view can, however, be challenged, especially if the employees of the company consist mostly of “scarce resources” like programmers or designers, who are high in demand. Opportunity cost needs to be taken into account.
The Upright Project, a company that measures the net impact of companies, argues that if a company mainly employs people from this group of “scarce resources”, its impact is, by default, negative: if this particular company wouldn’t exist, these people would immediately find jobs elsewhere in companies that might produce something more valuable. In other words: if a company is taking these scarce resources off the job market, it better do something useful with them.
Companies that reach profitability are, of course, providing value to certain stakeholders: their customers, employees, and shareholders — and to society in the form of taxes. However, if this value is created by burning fossil fuels or convincing people to smoke cigarettes or buy more things they don’t need, it can be argued that the net value is negative.
I’ve been a tech entrepreneur for almost 7 years. What drives me to startups and for-profit entrepreneurship is the scalability of my impact. If I was a doctor or a teacher, my work would certainly have a high positive impact, but it would only benefit a small group of people. If I build a company that manages to develop a cure for a common disease or create educational technology that helps millions of kids in developing countries learn to read, the impact of my work touches a vastly larger group of people even though the amount of hours I put in is the same. That’s powerful.
During all these years, I’ve struggled when trying to figure out how to make sure that our business — or any business — is truly serving society, not taking more than it’s giving. I’ve come to the conclusion that the answer lies in how the company is structured and what kinds of incentives it offers its management.
Why being “mission-driven” is not enough
Many modern technology companies are created by teams of young, idealistic founders who truly want to make the world a better place. Their business ideas are often born from a genuine desire to fix a certain societal problem. In an ideal scenario, they can align their purpose and their profits: every dollar they make also advances their cause. Think of a company that produces solar panels or makes an app to buy food that would otherwise go to waste. On the surface, this sounds like a perfect equation: as the company’s business scales, so does its positive impact.
Unfortunately, this genuine willingness to be mission-driven is not enough. The world is complicated. What sounds like a business model that generates a purely positive impact can have surprising negative side effects. As the company grows bigger, it might need to venture into business areas that are no longer aligned with its original mission in order to sustain growth.
If a company is structured in a traditional way, it still needs to ultimately listen to the demands of its stockholders. If the stockholders are primarily interested in maximizing their profits — and this is often the case for any company that is public or has sold more than 50% of its equity to venture capitalists — the company’s management is incentivized to put its social mission on the back burner and focus on profits and growth instead.
Let’s take a few examples to illustrate this problem. My work is in the field of the sharing economy and peer-to-peer marketplaces, so I’m choosing my examples from this industry. I’m picking three companies that seem to have genuinely mission-driven founders who have always heavily emphasized the social impact side of their business: Airbnb, Lyft, and Etsy.
Airbnb is a pioneer of the so-called sharing economy. Their claim has been that we have lots of underutilized space that should be put to better use. If people use the extra space in their homes to turn them into hotels, we will need fewer new hotels, and the space for hotels can be used for something else.
It sounds great on paper. Unfortunately, the reality isn’t quite so straightforward. The hotel industry is seeing more profits than ever. My theory is that instead of decreasing the demand for hotels, Airbnb has simply expanded tourism — because of more affordable places to stay, more people choose to travel. This also means a lot more flights and, with them, a lot more emissions. And Airbnb doesn’t even want to disrupt hotels anymore; it just announced that it is now offering its platform to hotels as well, helping them find more guests.
But doesn’t it still mean that Airbnb increases the utilization of existing spaces? Not necessarily. According to some studies, 40% of Airbnb’s revenues come from professional landlords. They have turned the apartments they own, formerly available for permanent rental, into vacation rental homes. This means there are fewer apartments available for people living in a city, all the while vacation rental apartments are empty half of the time during the off-season. Because of this, rental prices have gone up in some cities, pushing less well-off people into the suburbs.
This is, of course, not what the founders originally intended; it’s simply a side effect of their business model — something economists call an “externality”. But there’s no denying that it’s an important factor when considering whether Airbnb’s impact on society is a net positive.
For a long time, the Lyft founders have been working towards a noble goal: reducing congestion and car ownership. On the surface, it sounds that Lyft’s business model is doing just that. Who wants to own a car in a city when I can summon a personal driver in a matter of minutes for a relatively affordable cost? Lyft’s main competitor, Uber, has the same effect, but it’s been Lyft that has made its claim to fame by focusing on this positive aspect of its business model.
However, like Airbnb, Lyft is also causing externalities it probably didn’t expect. Several recent studies show that Uber and Lyft actually increase congestion in cities. Because of their affordability and convenience, they often convert people from biking, walking, and public transport. Meanwhile, between rides, Uber and Lyft drivers spend on average 50% of their time alone in their cars, adding to the problem of congestion.
Etsy was born as a statement against the world of mass-produced goods, best represented by Amazon. Etsy wanted to get more people to buy hand-crafted goods while providing an income to micro-entrepreneur crafters.
Etsy went further than Airbnb and Lyft to emphasize its position as a company that puts its mission before its profits. It acquired a B Corp certificate, which obliged it to submit annual proof that it meets rigorous standards of social and environmental performance, accountability, and transparency. In a speech to his employees, Etsy CEO Chad Dickerson read the Milton Friedman quote about profit maximization as a sole responsibility of a business and said: “You’re all free to hiss”. Then he hissed himself, showing his distaste for Friedman’s thinking.
Similarly to Airbnb and Lyft, Etsy decided to raise lots of venture capital to accelerate its growth. Eventually, this meant that Etsy needed to offer investors a way to liquidate their investments, which meant going public in 2015.
In 2017, a hedge fund called Black-and-White Capital saw an opportunity to make a profit. It started buying Etsy stock, after which it launched an activist campaign, accusing the company of careless spending and demanding that Dickerson be ousted as a CEO. The company’s board proceeded to fire Dickerson, along with 8% of the company’s staff.
Friedman 1 — Dickerson 0.
Etsy used to have a “Values-Aligned Business” team, which oversaw the company’s social and environmental efforts. The new CEO Josh Silverman dismantled this team. Etsy also gave up its B Corp certificate. Even before going public, it had started allowing the sales of manufactured goods on its platform.
These moves have been applauded by Etsy stockholders: it has tripled its share price within the past year. But Etsy is no longer the same company it used to be.
The ultimate solution: remove the incentive to maximize profits
An attentive reader might have noticed a pattern in the three stories above. All three companies had a clear way to tackle the negative externalities caused by their business models. Airbnb could ban professional landlords and only allow people to rent out the places they themselves live in and their second homes. Lyft could make its services less attractive during peak hours by volunteering to pay a congestion tax that would increase its prices. Etsy could reinstate the B Corp certificate, ban manufactured goods, and monitor the origin of goods sold through its platform more carefully.
In reality, these companies are not in a position to do so because of their company structure. They can’t escape Friedman. The main incentive for their management is to grow the business and maximize shareholder profit. All the proposed solutions are in conflict with this goal as they could have a significant negative impact on revenue and growth for these companies. And that’s why we most likely won’t see them happen.
Their structure. Their incentives. Perhaps therein lies the answer to the original challenge: how to build companies that are a force for good in society.
One can’t argue with Friedman since he is simply stating the facts: this is how companies are structured, and this is what their duty is. But what if we change the structure and duty?
In her excellent 2017 book Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist, economist Kate Raworth explains that we need to build an economy that lifts people out of poverty and brings them well-being while respecting the natural ceiling for growth caused by the limited resources of our planet. She believes that in order to achieve this, we need to make fundamental changes to our society and to our organizations. She writes:
“The most profound act of corporate responsibility for any company today is to rewrite its corporate bylaws or articles of association in order to redefine itself with a living purpose rooted in regenerative and distributive design and then to live and work by it.”
The key insight here is that we don’t need to create companies that maximize profits at all costs. In their articles of association, we can write that their profits are only a means to pursue their social mission, not an end goal in themselves. In some cases, this means that the company might make decisions that deliberately decrease its profits or slow its growth if its management feels that it is the right to do, all things considered.
Such company structures can be created without changing our current legislation, and some pioneering tech startups are already adopting these structures. Kickstarter, the world’s largest crowdfunding platform, paved the way in 2015 by reincorporating as a public benefit corporation and stating it will never sell or go public. An recent example from traditional retail is Patagonia, which was donated to a non-profit dedicated to fighting climate change. By remaining independent from the control of outside stockholders, it can be sure that its management is forever incentivized to put its mission first.
Putting our money where our mouth is
Our company, Sharetribe, helps entrepreneurs and organizations create their own peer-to-peer marketplace platforms. With our technology, you can essentially create something like Airbnb, Lyft, or Etsy. Like these three companies, we also have a social mission. In our case, it is to democratize the sharing economy by making platform technology accessible to anyone. We truly admire these three companies and the tremendous technological and cultural innovations they’ve made. However, we’re also worried about the negative consequences of their pursuit of even higher growth. Our thinking is that if we make their innovations available to local platforms operated by small businesses, social enterprises, co-operatives, non-profits, or even cities, we can reap the benefits of the sharing economy without causing many of the downsides.
When our founders traveled the world telling people about this mission, many asked whether there was a risk that we would become another profit-maximizing platform giant ourselves. What if we started generating unintended negative externalities as well, and our shareholders wouldn’t allow us to do anything about them? At the time, we didn’t have a good answer. After all, we’ve had a traditional startup structure, and we’ve recognized that if we raised any more money with that structure, the final decision would no longer be in our hands. Even if we decided not to raise money, there was no way for us to make a binding commitment to our stakeholders that we wouldn’t do so in the future.
This made us worried and frustrated.
Finally, we decided to do something about it. A few weeks ago, the Finnish Trade Registry approved our new articles of association that officially transitioned our company into a structure called steward-ownership. We are the first company in Finland and one of the first tech startups in the world to do so. Steward-ownership is a company structure designed to ensure that our company’s profits are purely a means to pursue its mission. It forever removes any personal financial incentive of profit maximization from the company’s management. Unlike B Corp certificates, the steward-ownership structure is protected with a foundation structure and can never be dismantled once introduced.
From now on, it’s in the best interest of our management to put our social mission first, even if that means slowing down our growth. Everyone working in the company is incentivized, first and foremost, to make decisions that benefit not just the owners of the company but all other stakeholders, the environment, and society at large. After this change, we can finally — confidently — say that our company will always be a force for good in society.
How does our steward-ownership model work in practice? That is the topic of another post.