The Future of Moneyball Management May Be Rooted in CR
By Stephen Jordan and Steve Rochlin
The basic goal of every financial investor is to identify “alpha” investing opportunities. Alpha is gained when an investment generates a higher rate of return than its risk profile would suggest that it generate. Historically, alpha has often been linked to technology breakthroughs, new discoveries, superior insight, and better management practices. Our thesis is that some investors will find alpha by applying “Moneyball” techniques to what used to be seen as the domain of corporate responsibility managers – sustainability and social capital.
The great legends of business management – Frederick Taylor, Ben Graham, Peter Drucker, and Edward Deming all tended to focus on “black boxes” — aspects of business that were seen as mysteries or unruly or difficult to understand, and they were able to successfully analyze them and give them structure and create processes to replicate successful practices around them. In this way, Taylor and Deming revolutionized the assembly line and manufacturing processes of their eras. Ben Graham greatly enhanced financial analysis, and Peter Drucker was able to codify the basis of management itself. What these examples illustrate is that the so-called “black boxes” of business are where the biggest gains from effective management practices can be realized.
This is because once something becomes standardized, it tends to become a commodity. Quality (after Deming) is now a commodity. Globalization, information technology and enhanced logistics now make low cost supply chains standard across many industries.
Financial engineering has made real time spot markets a reality, so that basic materials and ingredients and all of the tangible building blocks of products are now commodities. The efficient market hypothesis would seem to be much closer to reality than it has ever been.
Except it isn’t. Markets and businesses still differ greatly from each other, and in some ways, more than ever. Some of this difference in valuation is explained through the power of brands; the creation and maintenance of customer loyalty programs has become a science too. Some of it is explained through design and aesthetics. Porsches really are more beautiful than many other cars.
Other components of this created value are created through reputation, knowledge, skills-development, diversity, inclusiveness, trust, and other fuzzy and frustrating concepts. What they all have in common is that they are intangible. Currently, 84% of the value of the S&P 500 is made up of intangible assets, and these assets are the preeminent driver of value creation in the stock market today.
We think that the remit of the CR team – sustainability and social capital – are assets that support and drive the creation of alpha. Our rationale is based on our continuing research that indicates that in a very real way, corporate responsibility and sustainability managers are on the front lines of this kind of value creation.
They have to engage with all kinds of not-easy-to quantify “black box” challenges like pricing corporate responses to the environment, social challenges, health and well-being, employee engagement, trust, social capital formation, stakeholder relations, community relations, and the like. They inherently contribute to strategy because the basic definition of sustainability rests on the concept of endurance over time – i.e. long term thinking and future value.
However, most companies assign arbitrary values to these programs, and criticize practitioners of these disciplines in much the same way that the precursors of Taylor, Graham, and Deming were criticized before they made their contributions to their respective management fields.
Until now, the CR field has been dominated by a significant amount of cheerleading on the one hand, and withering criticism or avoidance on the other. In contrast, what we are finding is that the methods, structure, and resource allocation undergirding corporate responsibility practices matters significantly, and that those companies that do it better can generate alpha returns compared to their peer group.
In the Moneyball movie, Peter Brand, the character played by Jonah Hill (a composite of several real life baseball statisticians), explains that the traditional scouts have been trained to look for many characteristics that are actually irrelevant for putting together a winning baseball team. Something similar has happened with regard to how most companies manage corporate responsibility, looking at it as a cost center, and not as a potential driver of business productivity, reputation, and shareholder value.
Our prediction is that in the next few years, demystifying the business contributions of CR management and how these are accomplished, will become a major element in the tool kit of leading 21st century managers.
Posted August 6, 2015 in 25115