Ries had been arguing that what people call mission drift is better described by the old word corruption, in the sense of slow corrosion. Here he blames the standard governance playbook built around shareholder primacy. He went on to set out four tests for good governance: compliance, purpose, coherence and integrity.
It's incredible. The most recent one someone sent me was a tortilla company. But go on the Reddit forums for any of these companies, and you can find the customers like up in arms about how the tortillas are disgusting now and they don't taste good. And it's just, it's like it's this predictable pattern. If you go on those forums or any of these places where people talk about this, everyone says this is inevitable. Why does it happen? It's inevitable. Because money is involved, because of human nature, because of greed, because of quarterly capitalism, because of the public markets, because of this, that. But the second mystery in the book, the one I think is the most important one for us to grapple with, is if this is inevitable, why are there exceptions? Because if it was inevitable, there would be no exceptions, and yet there are many. And we interact with them every day. And most of us could not say why they're different. But if you take those exceptions as a class of companies and say, what do they have in common? It's kind of hard to put your finger on it. It's not really their values because they have very different values. It's not their culture or country they come from or decade they were founded, how old they are. Some are decades old, some are hundreds of years old. What do they have in common? The one thing is that they violate our modern best practices around governance. The ones that are public routinely get the worst possible score you can get from governance ratings agencies. In fact, since 2008 now, the data set's getting pretty big now. Since 2008, companies that have been rated to have bad governance have outperformed companies rated to have good governance. So what are we doing here? So anyway, once you have that realization, you start to be like, where did these best practices come from? Why do we show obeisance to them? And why are the alternatives so not well known when they're old, they're established? They have whole branches of academia who study them and their performance. So that to me, that was all kind of part of the stew to answer these mysteries. That's how the book is organized.
So we should probably talk about the governance piece, but that gets us to section two, the blueprint, which is how to build with structural integrity. And you give us quite a few examples. Devoted Health I had not heard of before, which is a wonderful love-driven healthcare company that serves seniors, which is nice that you have the connection to Medicare, which makes building fairly straightforward. But yet it's the counterpoint to the private equity nursing homes, which are destroying the families and the well-being of families, and they're distributing it for parts. What is the governance difference there? And one of my favorite lines in the book is how you define profit in this section.
Sure. Yeah. Okay, so yes, part one of the book is called The Shape of the Abyss. So you can say where my head was as I was writing this thing. And I promise I was like, I'm not going to sugarcoat this for anybody. I have been to the belly of the beast and this system that we're all complicit in has these like terrible moral failings. And for most of us, it's psychologically comfortable to think that this is inevitable because then we don't have to reckon with the fact that we have complicity with it. I just want to put that out in the open and recognize that for most of us, that is a deeply uncomfortable conversation, me too. In fact, I've even had quite a few mission-driven leaders who were like test readers of the book react very negatively to the book because they were like, wait a minute, are you saying that I could have done differently? And therefore it's my fault all these horrible things that happened. I don't really like that part of the book. So yeah, sorry. But I really wanted the book to be hopeful because I do believe it is possible to get ourselves out of this mess. And when I first started working on these issues, I thought it was going to require some kind of massive intellectual breakthrough to discover, like to invent new forms that are unheard of. But no, it really isn't. What's happened is that our governance class has been captured by a set of ideas, which you're all very familiar with. You all know the history of shareholder primacy, I presume. You all understand the catastrophe that that idea has become. And we understand that that is the moral contradiction at the heart of the ESG movement. Because what governance best practices have actually produced good environmental or societal outcomes. Our governance best practices are designed to create weak companies that are extremely vulnerable to outside pressure, therefore lacking in integrity, therefore subject to this kind of collapse. So, if we want to build organizations that can last, that have what I call the architecture of institutional longevity, we need a new governance, a new idea of what it means to have good governance. In the book, I lay out four criteria for the new governance: compliance, just like before, that's, of course, important. The second is purpose, which you're all very familiar with, but I think we have to think much more radically about that. We'll get back to the very definition of what it means to be a for-profit company in a second. But then, adding two operational disciplines to governance: one, coherence. To what degree is every resource that an organization controls directed towards achieving its purpose? And then, last, integrity, structural integrity. To what degree is it capable of resisting both external pressure and the internal temptation to betray its promises? And when you start to see governance in this way, the blueprint becomes clear, both for how we have to change how we teach leadership on the inside of organizations and how we have to change how we teach governance, the structure of the outside. So, maybe we start with the definition of profit, because what's interesting to me is that when we talk about these issues, it sounds very philosophical and abstract, but I am not interested in abstraction. My job every day is to counsel people who are trying to build companies. So, this is not like an abstract debate to me. This is highly practical. People come to me literally every day of my life. Someone calls me up and says, I need your help, either starting a new company, revitalizing an old company, protecting a company that's planning to go public. I did three of those phone calls yesterday, like during the lunch break of this conference. And so, I need to be able to tell people what to do, and yet these seemingly abstract choices we make have tremendous consequence. So, let's take what does it mean to be a for-profit company? Like, what is a profit anyway? Most entrepreneurs, you ask them this question, like, duh, that's the most obvious thing you've ever asked. Like, of course, I know what a profit is. I run a for-profit company, it's how much money is left over. Revenue minus expenses, very simple. I take a $50 piece of wood, I make a $200 table out of it. I make $150 profit. But as you all know, I don't have to belabor this point, but just quickly review: take an Econ 101 class or maybe an Econ 201 class, you will discover all the problems with this definition. What about a Ponzi scheme? Is that profitable? No, of course not, because of deferred liabilities. Oh, I see. So, when we said it was simple, what we actually meant was revenue minus expenses minus deferred liabilities. Got it. What about negative externalities? What if I pollute the river and the people downstream get sick? Have I created more value or have I just shifted the expenses onto somebody else's balance sheet? Is that really a profit? No, of course not. Ah, I see. So, the simple definition is actually revenue minus expenses minus deferred liabilities minus negative externalities. Ah, yeah. But what about the input factors of production? What if I steal a $200 piece of wood and make a $100 table out of it? Have I made a profit? Most people will be like, no, of course not, because you stole, but you won't get away with it. But again, imagine I did get away with it. Did I make a profit? Again, most people have this intuitive sense that no, that's not right. It's like a kid who's got $200 of their organic lemons from Whole Foods from their parents who opens a lemonade stand and takes $25 and they think they made $25 of profit. No, we understand that we have to account for the true value that was destroyed in the making of the thing. Ah, okay. So it's very simple. Revenue minus expenses minus deferred liabilities minus negative externalities minus the input factors of production. But what if one of the input factors of production is a human life? What if I make money by murder? Is that profitable? Most people will be like, well, but that's illegal. Ah. But what if I made so much money doing that that I could make it legal? Now is it profitable? It's profitable but unethical. You know, it's like people struggle with this so much because they don't want to call it profitable because of course we know a human life is precious and making $100 from the murder, that can't possibly be right. The whole enterprise collapses. So in the book, I say, look, if we all carry this intuitive understanding of profit, that it's supposed to be about creating more value than you capture, why do we nonetheless show obeisance to this formal definition, which is so flawed? Why don't we use a better definition that is more aligned with what I call the builder's intuition? The idea that to make a profit is to maximize human flourishing. So simple, so much easier. And if we have the tools to measure it, don't worry, there's a whole chapter on how it can be measured. Don't worry. When you do that, a lot of these problems go away. We are able to unlock things that today we find impossible. For example, many mission-driven companies that I work with can't decide if they should really be incorporated as a for-profit or a non-profit. That's because that category makes no sense when you see the definition of profit properly. Non-profit versus for-profit is an arcane element. The tax code. That's not fundamental. What we should be thinking about is that today, most nonprofits are fundamentally self-controlled or autonomous corporations. And today, most for-profit companies are investor-controlled companies. What we really want to build, most of us, is what I call mission-controlled companies. What would it be like to build an organization where the mission is truly at the center, taking that purpose pillar of governance and reclaiming it from the idiots who turned it into shareholder primacy and saying, no, almost every organization that we admire has extra financial concerns that are at the core of what they do. And they're very different. It could be sustainability, I'm sure, for many of you. But even as simple as, I just want to build a quality product. I just want to make my customers' lives a little bit better. I just want to make tortillas that taste good, for God's sake. Even that simple commitment makes you a business revolutionary, whether you admit it or not. So why don't we acknowledge that that is the reason why we form corporations in the first place? In fact, prior to the 1980s, every person on this planet for the hundreds of years that we have had joint stock corporations thought it was completely obvious that these things were far too dangerous to be incorporated and to be allowed to exist without some level of public purpose to bind them. So we're not the revolutionaries here. We are trying to restore what was seen as common sense for how long.
Judy needs a hug.
Yeah. What's so funny to me about this? God bless you, right? Thank you for carrying this torch for such a long time. This is not a new idea. There's nothing new here at all. But we have to make it practical for people to implement. And the vast majority of people that I meet have never heard of any of this. They've never heard of B Corps. They haven't heard about any of our capitalism reform organizations. They don't know what ESG is other than a bunch of forms that people send you to fill out. They have zero awareness of any of the alternative forms that have been driving this change for hundreds of years. So we, as a class of people who want to advocate for these changes, have failed them. And it's time for that to stop.
So, I told you the book was emotional.
