The NOC Worldview vs. IOC Worldview – or, Homo Sapiens vs. Homo Economicus

Media197As I’ve mentioned in a previous post (Tradeoffs), an objectives hierarchy is an excellent tool for gaining clarity around what your objectives are, how they relate to one another, and where tradeoffs between objectives are likely to be needed.  A rather generic example can be seen in the figure below.

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An objectives hierarchy makes the relationships between objectives apparent and can help to unite various teams, divisions, partners, etc. by demonstrating how all of their objectives are important and how they all contribute to and support the Primary Objective (you can download a free objectives hierarchy tool from our web site at http://www.decisionstrategies.com/toolbox).

One of the most effective uses of an objectives hierarchy I have ever witnessed came during a framing workshop for a large oil & gas project.  This project was a joint venture between a major international oil company (IOC) and the national oil company (NOC) of a developing nation.  Such joint ventures are often fraught with problems as the two partners struggle to work together smoothly.  Cultural differences, geopolitics, national pride, and Western arrogance can make for tense meetings.  The partners often find themselves talking past each other, as if neither is really hearing what the other is saying.

In addition to all of the issues listed above, there is another key one: the two partners have different primary objectives.  The primary objective of an IOC is generally fairly straightforward: maximize the return to shareholders.  The primary objective of an NOC is almost never so simple.  Providing employment to its citizens, installing valuable infrastructure, funding public projects, preserving resources for future generations – all of these are likely to be significant objectives for an NOC.

In the case I witnessed, the joint venture framing workshop generated a rarity: a bimodal objectives hierarchy.  The two companies’ primary objectives were displayed for all to see.  This didn’t eliminate the differences between the objectives of the IOC and those of the NOC, of course, but it cleared the air immensely by showing that the two partners were fundamentally trying to accomplish different things.  It wasn’t a case of one being right and the other being wrong; they were just different.  It also demonstrated which objectives were shared by both partners.  With clarity on these issues, discussions between the two partners became much more straightforward and far less frustrating.  The NOC recognized the IOC’s responsibility to its shareholders; the IOC acknowledged that the NOC’s desire to develop the portfolio at a slow, steady pace did not stem from a lack of business savvy, but rather from a sense of responsibility to future generations in its country.  No more cries of, “This is obviously the best plan; why don’t they see it?”

Most Westerners, of course, identify more readily with the IOC.  Most of us work for publicly traded for-profit companies that are in business to make money.  But there’s an irony here:  If you ask any of us about our personal objectives, they probably resemble those of the NOC far more closely than they do those of the IOC.  Things like investing for the benefit of future generations, providing for our families, generating opportunities for our friends, improving the quality of life for those we care about – for most people (Westerners included), these are more important objectives than just making lots of money.

The NOC behaves more like a real human being, a homo sapiens, constantly making judgments regarding tradeoffs between a complex set of competing objectives.  The IOC behaves like the mythical homo economicus of many a classic economics textbook, someone who makes all decisions solely on the basis of maximizing present value to oneself.  The question is not why the NOC behaves as it does – it is just reflecting actual human values.  The real question is why the IOC behaves as it does.

It wasn’t always this way.  It wasn’t so long ago that corporations saw themselves as serving multiple stakeholders: shareholders, employees, customers, and the communities in which they operate.  Most companies still pay lip service to these ideas, usually with statements about the “social license to operate,” but that’s about all.  When push comes to shove, shareholders are the only stakeholders that matter.

This has been a mantra of big business ever since Milton Friedman’s famous proclamation, “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.”[1]  The pendulum has begun to swing back now, as people reject this notion in principle.  But we still use NPV to calculate overall value of an asset or strategy (rather than as a proxy for the financial value of a specific cash flow scenario), we still measure a country’s economic vitality by its Gross Domestic Product (GDP) growth rate, and we still hold business accountable for essentially nothing other than the financial return they give their shareholders (provided they stay within the law.  Most of the time.).

So why does the IOC behave as it does?  Why do almost all publicly traded corporations behave this way?  Because we reward them for doing so.  We like the idea of socially responsible corporations, but only if they are every bit as profitable to invest in as socially irresponsible corporations.  Tobacco companies have no trouble at all finding buyers for their shares.
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It’s sort of like listening to people complain about the millions of dollars professional athletes are paid.  We can change that any time we want to: just stop watching the games.  But, of course, we don’t.  The same thing applies to complaints about greedy corporations lacking a conscience.  If no one bought their shares (or their products), they would change their ways.  To take a line from a famous Pogo comic strip, “We have met the enemy, and they are us.”

So what do we do about this?  It is unrealistic to expect the stock-buying public suddenly to stop considering the expected financial return from their investments.  I do believe that a company that takes the lead in sustainable business practices will gain a loyal clientele and establish a strong reputation in the market.  But they will still have to be profitable.  We just need to look at short-term profitability in business the same way we look at short-term profitability in our own lives: it is one of a number of objectives we hold.  We value cash in the near term, but we value other things, too – some of them more than near-term cash.

We need to find better metrics for measuring the performance of corporations.  In the 21st century, metrics will need to incorporate concepts like long-term sustainability and responsibility for the natural environment we are bequeathing to future generations, metrics that reflect our actual, personal values, not the values of homo economicus.  Or Milton Friedman.

In my next post, I’ll talk about what those metrics might look like.

PAST COMMENTS

Patrick, I completely disagree with your position on this issue. IOCs are specifically constructed as an economic instrument by like-minded people with the objective of maximizing the value of their investment, typically in a capitalistic economy. This is measured via traditional financial metrics: total asset value, profitability, rate of return, etc. Investors advance their funds towards this end expecting an acceptable financial return. That return, when earned and paid out to the shareholders, allows individual investors to then make their own choices about “social” issues such as sustainability, environmental stewardship and other now-popular concepts. If you object to tobacco companies, don’t buy their products or their stock. Note that these are almost entirely social or lifestyle issues rather than economic. NOCs, however, are extensions of governments designed as a means to an end. Government is part of the economic structure but in this case it is designed with the group rather than the individual in mind. If there are valuable oil deposits, organize a NOC to exploit it and finance it with collective funds for the benefit of the collective.

Your concept that IOCs should take the lead and pursue their business more like NOCs confuses the purpose for each entity and tries to mix the purely economic with the social. This is borne out by reaction in the market (stock) to various policy announcements that influence a company’s ability to make an acceptable return (e.g. we’re buying only free-range organic chicken to serve at our McDonalds restaurants). This can be positive or negative, largely dictated by how investors perceive the policy to impact the business.

As an example, I don’t own any Apple stock not because I don’t think their products are good or they aren’t “green” enough, but because they collect unbelievable amounts of cash at ridiculous profit margins (compare Apple’s profit margin to Exxon Mobil and then decide which is garnering “obscene” profits), but return very little to the shareholder/investor (until recently, they paid NO dividend and held well over $100 billion in cash for a number of years). While I like some of their social philosophy, I don’t like how they choose to treat their owners. Therefore, I’m NOT an Apple investor because my purpose is to increase my own net worth so that I can choose how to live socially, not to put my money with them and let them decide for me. Again, individual versus group (collective). I think that’s the real key to this issue.

– by Gary Davis, Wed, 2015-Sep-30 at 5:48 PM

Hello, Gary – it’s good to hear from you!  I hope all is going well for you and Hat Creek.

Thanks for the comment.  I actually think we agree on most of your points.  We just may disagree on whether the current situation is optimal or even appropriate as we move forward into what I believe is an increasingly resource-constrained economy (as opposed to a labor-constrained one, which is what it has been since the beginning of human commerce).

As you have pointed out, these days Western corporations are indeed given the single purpose of delivering as high a return as possible on the financial capital invested in them.  My concern is that corporations make decisions involving many areas in which most people (individuals as well as groups) have objectives that are much more complex than simply maximizing financial return.  The consumption of natural resources is one of these.  Actions which result in environmental degradation represent another.

As you and I have both pointed out, if people don’t like a corporation’s actions, they can refuse to buy their products and/or their shares.  But I think it’s worth taking a step back and asking whether it is optimal in the first place to have an organization designed specifically for one purpose making decisions that affect us well beyond the purpose for which the organization was formed.  I think it’s worth discussing (which we are doing, thanks to your comment).

To me, the current situation is analogous to putting your financial manager in charge of your child’s day-care.  Maximum return on investment might not be your number-one priority.

In the blog, I pointed out that NOCs typically make their decisions closer to the way we would as individuals than IOCs do.  And I question why it is that we seem to be fine with large corporations (including IOCs) routinely making decisions based on much more narrow criteria than pretty much any real person would use.

If the ramifications of these decisions were limited to the realm of finance, I wouldn’t be concerned.  Corporations are judged and rewarded for generating good financial results.  But that’s not the case.  Global business activities result in huge secondary and tertiary effects – many of which are unintended.

As I’ve mentioned in previous blogs, I agree with Peter Bakker’s assertion that capitalism is a wonderful system, provided it recognizes and appropriately deals with all three kinds of capital – financial, natural, and social.  The problem is that our current system recognizes only financial capital, and rewards only those activities that maximize financial capital.  I also like Eric Beinhocker and Nick Hanauer’s suggestion that the real purpose of companies is to find clever solutions to society’s problems.  Making money is just an outcome of successfully doing so.

That’s why I suggest that we need new metrics by which to measure corporate performance – measures that align more closely with most humans’ objectives.

Thanks again for the thoughtful comment!

Regards,

Pat
– by Patrick Leach, Wed, 2015-Sep-30 at 7:49 PM

Patrick, unlike Mr. Davis, I mostly agree with your thinking. I’ve worked closely with NOCs and found that their objectives are indeed different than IOCs. The real problem is that NOCs are even more political than IOCs and usually NOC management behavior and decision making becomes more about which individuals within the structure will advance and look good than their objectives hierarchy. Classic normative versus descriptive distinction!

In terms of metrics, I agree that the quarterly earnings obsession many companies have is dysfunctional. Rob Kleinbaum in his “Creating a Culture of Profitability” book correctly notes that adding shareholder value is not a strategy. A credible and clearly articulated statement of why a company exists – what they are trying to do – and then management’s diligence in accomplishing that mission is important (for example, DuPont used to be “better things for better living through chemistry” – they lost that vision a couple of decades ago and have floundered ever since).

Another metric that Kleinbaum suggests is important is employee buy-in to the company mission and leadership (or lack thereof). Motley Fool also agrees with this and uses it as a selection criteria for their portfolios.

Mr. Davis brought up Apple – Steve Jobs added more shareholder value than any other human in history. He didn’t do it by focusing on making money- he focused on making elegant (cool) devices that people loved. (You’ll pry my iPad 2nd gen from my cold dead fingers.) Profit was the byproduct of their collective genius. By most reports Jobs was not a pleasant manager. But he changed the world in great way.

[1]Friedman, Milton, Capitalism and Freedom. University of Chicago Press, Chicago, 1962.

Patrick, I completely disagree with your position on this issue. IOCs are specifically constructed as an economic instrument by like-minded people with the objective of maximizing the value of their investment, typically in a capitalistic economy. This is measured via traditional financial metrics: total asset value, profitability, rate of return, etc. Investors advance their funds towards this end expecting an acceptable financial return. That return, when earned and paid out to the shareholders, allows individual investors to then make their own choices about “social” issues such as sustainability, environmental stewardship and other now-popular concepts. If you object to tobacco companies, don’t buy their products or their stock. Note that these are almost entirely social or lifestyle issues rather than economic. NOCs, however, are extensions of governments designed as a means to an end. Government is part of the economic structure but in this case it is designed with the group rather than the individual in mind. If there are valuable oil deposits, organize a NOC to exploit it and finance it with collective funds for the benefit of the collective.

Your concept that IOCs should take the lead and pursue their business more like NOCs confuses the purpose for each entity and tries to mix the purely economic with the social. This is borne out by reaction in the market (stock) to various policy announcements that influence a company’s ability to make an acceptable return (e.g. we’re buying only free-range organic chicken to serve at our McDonalds restaurants). This can be positive or negative, largely dictated by how investors perceive the policy to impact the business.

As an example, I don’t own any Apple stock not because I don’t think their products are good or they aren’t “green” enough, but because they collect unbelievable amounts of cash at ridiculous profit margins (compare Apple’s profit margin to Exxon Mobil and then decide which is garnering “obscene” profits), but return very little to the shareholder/investor (until recently, they paid NO dividend and held well over $100 billion in cash for a number of years). While I like some of their social philosophy, I don’t like how they choose to treat their owners. Therefore, I’m NOT an Apple investor because my purpose is to increase my own net worth so that I can choose how to live socially, not to put my money with them and let them decide for me. Again, individual versus group (collective). I think that’s the real key to this issue.

– by Gary Davis, Wed, 2015-Sep-30 at 5:48 PM

Hello, Gary – it’s good to hear from you!  I hope all is going well for you and Hat Creek.

Thanks for the comment.  I actually think we agree on most of your points.  We just may disagree on whether the current situation is optimal or even appropriate as we move forward into what I believe is an increasingly resource-constrained economy (as opposed to a labor-constrained one, which is what it has been since the beginning of human commerce).

As you have pointed out, these days Western corporations are indeed given the single purpose of delivering as high a return as possible on the financial capital invested in them.  My concern is that corporations make decisions involving many areas in which most people (individuals as well as groups) have objectives that are much more complex than simply maximizing financial return.  The consumption of natural resources is one of these.  Actions which result in environmental degradation represent another.

As you and I have both pointed out, if people don’t like a corporation’s actions, they can refuse to buy their products and/or their shares.  But I think it’s worth taking a step back and asking whether it is optimal in the first place to have an organization designed specifically for one purpose making decisions that affect us well beyond the purpose for which the organization was formed.  I think it’s worth discussing (which we are doing, thanks to your comment).

To me, the current situation is analogous to putting your financial manager in charge of your child’s day-care.  Maximum return on investment might not be your number-one priority.

In the blog, I pointed out that NOCs typically make their decisions closer to the way we would as individuals than IOCs do.  And I question why it is that we seem to be fine with large corporations (including IOCs) routinely making decisions based on much more narrow criteria than pretty much any real person would use.

If the ramifications of these decisions were limited to the realm of finance, I wouldn’t be concerned.  Corporations are judged and rewarded for generating good financial results.  But that’s not the case.  Global business activities result in huge secondary and tertiary effects – many of which are unintended.

As I’ve mentioned in previous blogs, I agree with Peter Bakker’s assertion that capitalism is a wonderful system, provided it recognizes and appropriately deals with all three kinds of capital – financial, natural, and social.  The problem is that our current system recognizes only financial capital, and rewards only those activities that maximize financial capital.  I also like Eric Beinhocker and Nick Hanauer’s suggestion that the real purpose of companies is to find clever solutions to society’s problems.  Making money is just an outcome of successfully doing so.

That’s why I suggest that we need new metrics by which to measure corporate performance – measures that align more closely with most humans’ objectives.

Thanks again for the thoughtful comment!

Regards,

Pat
– by Patrick Leach, Wed, 2015-Sep-30 at 7:49 PM

Patrick, unlike Mr. Davis, I mostly agree with your thinking. I’ve worked closely with NOCs and found that their objectives are indeed different than IOCs. The real problem is that NOCs are even more political than IOCs and usually NOC management behavior and decision making becomes more about which individuals within the structure will advance and look good than their objectives hierarchy. Classic normative versus descriptive distinction!

In terms of metrics, I agree that the quarterly earnings obsession many companies have is dysfunctional. Rob Kleinbaum in his “Creating a Culture of Profitability” book correctly notes that adding shareholder value is not a strategy. A credible and clearly articulated statement of why a company exists – what they are trying to do – and then management’s diligence in accomplishing that mission is important (for example, DuPont used to be “better things for better living through chemistry” – they lost that vision a couple of decades ago and have floundered ever since).

Another metric that Kleinbaum suggests is important is employee buy-in to the company mission and leadership (or lack thereof). Motley Fool also agrees with this and uses it as a selection criteria for their portfolios.

Mr. Davis brought up Apple – Steve Jobs added more shareholder value than any other human in history. He didn’t do it by focusing on making money- he focused on making elegant (cool) devices that people loved. (You’ll pry my iPad 2nd gen from my cold dead fingers.) Profit was the byproduct of their collective genius. By most reports Jobs was not a pleasant manager. But he changed the world in great way.

– by Dave Charlesworth, Tue, 2015-Oct-6 at 5:50 PM, www.decisions-books.com

 

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