The Impact of Mutual Profit on Business Behaviour

Introduction

To appreciate the ambition of a project such as the mutual profit and loss statement (mutual P&L) at Mars, one needs to reflect on the role of accounting systems in society. Financial accounting systems are highly formalized. They follow strict guidelines, such as the International Financial Reporting Standards (IFRS) of the International Accounting Standards Board (IASB) or the Generally Accepted Accounting Principles (GAAP) of the US Financial Accounting Standards Board (FASB), and make use of universally implemented concepts such as double-entry bookkeeping. In fact, there is nothing as well defined and consistent across companies as financial accounting, where the book of operations serves as the ultimate determination of performance for all organizations.

But accounting is much more than just the numbers that companies record at the end of the day. A company’s accounting system forms the bedrock of corporate strategy and action. More fundamentally, it defines the ‘reality’ that exists within a company. In an early reflection on the roles of accounting in organizations and society, a group of important accounting researchers echoed this:

What is accounted for can shape organizational participants’ views of what is important, with the categories of dominant economic discourse and organizational functioning that are implicit within the accounting framework helping to create a particular conception of organizational reality. (Burchell, et al. 1980: 5)

It is important to recognize that these realities are neither given by nature, nor are they completely neutral. They are socially constructed and self-perpetuated by the people who use them and the institutions that legitimize them. Once adopted through national legislation, they become the reality of entire economies rather than just organizations, affecting issues well beyond the corporate borders, such as wealth distribution, social justice, and environmental degradation (Baker and Bettner, 1997). Adjusting the principles of accounting can therefore not only alter the reality of organizations, but, by its extension, also that of the society in which they are embedded.

The Growing Importance of Purpose

Over the last few decades, we have seen the transformation of the corporation from an organization predominantly focused on tangible assets (such as land and labour) to one that is increasingly concerned with intangible assets, such as intellectual capital and reputation, and the conservation of resources whose supply is finite (e.g. natural resources) (Barker and Mayer, 2017). This shift has been accompanied by a call for a new understanding of value and profit, away from a sole focus on the financial to one that is inclusive of environmental and social dimensions (important books in this area include Mazzucato, 2018; Mayer, 2018; Roche and Jakub, 2017; Eccles and Krzus, 2010, 2014). In addressing these issues, financial accounting is intrinsically limited and therefore incomplete in capturing what really matters for corporations, and essentially for society. The idea of extending the traditional P&L to a more inclusive, mutual P&L is directly linked to this.

By designing a management account inclusive of social, human, and environmental capital, the so-called mutual P&L (see Chapter 13 for detailed description), Mars Catalyst and the business units they work with enter a process of social construction themselves as they decide which issues are material, and therefore to be tracked in the mutual P&L. To arrive at this selection of issues, an extensive ecosystem map (see Chapters 6 and 7 for description) is drawn, which identifies the company’s main stakeholders and the challenges they face. From this list, first the key stakeholders and then material issues are chosen and prioritized by the company in view of which role they play in helping the business to achieve its self-declared purpose. The purpose is a statement defined at the corporate level which functions as a guide for action and decision-making for everyone working in the business. In the Mars petcare sector, for example, this purpose reads ‘creating a better world for pets’. Only issues material to this purpose are included in the mutual P&L. With this definition of materiality, the mutual P&L differs, for example, from the Sustainability Accounting Standards Board’s (SASB) definition of materiality, which is commonly used for impact-investing strategies and identifies material issues at the industry level according to their relevance for firm financial performance.

The Research Study

To study not only the construction but also the impact of this mutual P&L, we are accompanying one of the first pilots to implement it as a management accounting tool in a chosen business unit of Mars. As a pilot site, corporate leadership decided on the pet nutrition business in one of the Eastern European markets. The market that was chosen is one of the smallest in terms of revenues within the European market. However, it displays a comparatively high growth, which has repeatedly outperformed the growth of the same segment in other European markets in the last few years. Due to both, the market was deemed a ‘safe environment’ to test the mutual P&L. In the format of a longitudinal, ethnographic research, data will include interviews with the seven members of the local management team, regular attendance of meetings and document reviews before, throughout, and after the construction and implementation of this tool. The management team consists of the board (including the GM, CFO, the head of PNO, and plant managers), as well as the directors of sales, consumer market intelligence, corporate affairs, and operations. Through this, we seek to understand how this ‘alteration of reality’ at the business unit affects internal processes and operations, as well as the reasoning and decision-making of managers.

So far, we have attended introductory meetings with the pilot site’s director and CFO, and have completed a first visit to the business unit to conduct ‘benchmark’ observations and interviews with the rest of the management team that will be working with the mutual P&L. Our observations and interviews up to now show that expectations are high. The management team seems not only open and excited about the project, they also express a sense of pride in having been chosen by corporate leadership to serve as a pilot for this tool. Most interviewed members of the management team say that their interest in the project is driven by the expectation that they will be able to gather new insights about their ecosystem and their market. The possibility of using these insights to improve the so-called ‘calorie conversion’ in the market—one of the industry’s key performance indicators that describes how many pets are fed with pet food as opposed to human food scraps—was mentioned particularly often. However, beyond the excitement about the potential insights provided by an ecosystem map, it is so far unclear to us whether and how much the management team is aware of the changes a mutual P&L as management account can have for their business. Are they aware that their reality is going to change? At this early stage, we estimate that the project is still perceived as a philosophical exercise for management that will potentially lead to exploration of new market potentials, rather than as a fundamental accounting issue that has the power to transform the organization’s reality.

Changing the Definition of Profit

This observation speaks directly to our research interest: how will the mutual P&L be embedded within the company? And is there danger of a gap between the perceived and the intended purpose of the mutual P&L? The intended purpose of a mutual P&L is to have business operate under the account of ‘the right’ level of profit, as defined by Bruno Roche and Jay Jakub (2017) from Mars Catalyst, where the ‘right’ level of profit is that which also accounts for social, human, and environmental capital, in addition to the traditional measure of financial capital. In other words: ‘The main point of expanding the basket of metrics available to business managers to include non-financial forms of capital is to give them tools to manage hitherto unrecognized (squandered) assets available to them’ (Roche and Jakub, 2017: 132). To achieve this vision, the mutual P&L has to be implemented fully, as a prioritized management accounting tool, and with all the related managerial and operational consequences that management accounting traditionally implies. This includes the consideration of this tool for a wide variety of decisions, such as those of capital allocation, budgeting, incentives (pay), career development, market strategy, product portfolios, and more.

Since the intended purpose of a mutual P&L is that of an internal management accounting system, it does not replace the external side of financial accounting, such as the IFRS in public companies. If we think forward to a world in which the idea of mutual P&L could be scaled to public companies, this may lead to tension between internal and external definitions of performance. However, the information included in the mutual P&L would certainly also be of interest to investors, and therefore potentially turn external. In fact, reporting on non-financial information has already become increasingly important over the last three decades, especially with disclosure on the so-called environmental, social, and governance (ESG) issues. The attempt to seriously account for material non-financial issues in relation to a company’s level of profit has only recently seen a spark of interest in public companies. However, these attempts are diverse, somewhat experimental and, as far as we can tell, are usually used for reporting and disclosure rather than for management accounting. Examples of such tools include the environmental P&L at Kering,1 the so-called four-dimensional P&L (including financial and natural capital) at AkzoNobel,2 the calculation of ‘true earnings’ (earning adjusted by socio-economic and environmental values) at Samsung,3 and the ‘value-to-society’ measurements of BASF4 (who are, incidentally, currently developing an ‘integrated profit and loss statement’). These examples show that the idea of accounting for non-financial information is gaining momentum, especially in the context of increased interest in the topic from investors in the capital market. The implementation of the mutual P&L as a management accounting system in a private company (and thus without the external pressures of investors), however, is, as far as we know, unique to Mars. That is why the question of how the mutual P&L is embedded within this company, and with which consequences, is so important.

The Consequences of a Mutual P&L

When we think about the potential impacts of the mutual P&L in a private company like Mars (or any company for that matter), we can think about two key areas in which consequences are likely: first, the external environment of accounting systems, by which we mean the operations and formal processes in place; and second, the internal dynamics of an organization, addressing questions of leadership capability, reasoning, and decision-making. Furthermore, it is important to consider the conditions under which these impacts are likely or unlikely to occur.

In the external environment to accounting systems, such as operations, the mutual P&L has the potential for widespread impact, which is, however, subject to the degree of its implementation as a full management accounting tool. Used to optimize processes according to shifting priorities, a mutual P&L would affect a wide range of processes from capital allocation, budgeting, and purchasing to human resources and marketing. For example, the formal requirements for choosing suppliers could change from dimensions primarily focused on cost and quality, to including a range of other (i.e. social, environmental, and human) criteria. Similarly, guidelines about practicalities such as the logistics of sourcing, packaging, and storage could be affected. For example, the use of large cooling systems in mid-term storage units could be deemed unsustainable, leading to an increased use of just-in-time sourcing for short-life food and chemical products. These are just hypothetical scenarios, but they exemplify how scaling up a tool like the mutual P&L has the potential to lead to significant changes in business operations. Because of this, the full implementation of this tool is likely to bear several initial costs for a company until all processes are adjusted as necessary. For example, contracts with suppliers usually run for a certain number of years and the cost of finding new ones can be high. Although the mutual P&L allows for declaring these initial costs as investments, questions of how far and how fast an organization implements this new management accounting tool remain important, as rash execution may lead to disruption instead of transformation. A successful, full implementation of the mutual P&L would therefore, by our estimation, be a mid- to long-term, rather than a short-term objective.

Regarding internal dynamics, the mutual P&L will create a new framework for leadership to assess the organization. Managerial accounting has, by definition, the goal to provide performance information to managers on which they subsequently base their decisions. The mutual P&L as a management accounting tool therefore affects the prioritization of issues and frames a new organizational reality for them. This is not to be underestimated, as often managers have been educated and socialized in a way—learning the traditional definition of financial performance— that is quite different from what the mutual P&L measures for them. It cannot be assumed that all managers will have the immediate cognitive abilities that are needed to successfully translate findings of the mutual P&L into corporate decision-making. Whether or not leaders of a company accept this new reality can, however, play an important role in the implementation of the mutual P&L. If accepted, the potential for transformation and disruption—as elaborated above—is high. If not accepted, the consequence could be the creation of ‘alternate realities’ in which managers choose to use the mutual P&L only for some processes, such as human resource allocation, while continuing to use the financial P&L for other, more complex or costly processes, such as capital allocation and sourcing practices, to avoid the costs and other potentially unintended consequences associated with a full implementation. To avoid the creation of these alternate realities, incentivizing the use of the mutual P&L through compensation and career development perspectives can therefore be an important piece of the puzzle.

Since traditional notions of profit are deeply embedded in corporate decision-making, the new modes of profit also need to follow this model. However, just as the measurement of financial profit can have unintended consequences (for example, frequent measurement of performance can induce short-termism), this may also occur for the mutual P&L. Careful considerations of timelines and frequency in performance measurement can help to anticipate and manage such challenges. Decisions on how the new tool will relate to traditional management accounting practices, and where the mutual instead of the financial calculation of profit applies, could offer a sensible start for evaluation. Consequently, by deciding how to measure, for example, the internal rates of returns (IRR), what a cost volume profit analysis would look like and what the relation to already exiting balance scorecards would be, a company could take first steps in understanding what the new reality, created by the Mutual P&L, would look like.

Conditions of Effective Mutual Accounting

The above discussion suggests that the possible impact of the mutual P&L on an organization is conditioned both by the external environment of accounting (how easily are operations transformed?) and by the internal dynamics of an organization (how willing and capable are leaders to transform?). Empirical evidence in the literature on management accounting supports these expected limitations. For example, Naranjo-Gil etal. (2009) show how both management accounting changes and the implementation of innovations are highly dependent on the willingness and capability of leaders within an organization. The structure of an organization will hereby play an important role as well. In the case of the mutual P&L at Mars this topic also arises, as many strategic corporate issues are decided on a centralized, European level. The implementation of a mutual P&L, however, happens at the level of the business unit. This raises the question whether working with measures of mutual profit at the level of the business unit is inhibited insofar as decisions made at the European headquarters, who, at least for the moment, still work with a financial P&L, cannot be altered. In other words, if management considerations based on a mutual P&L challenge those considering a purely financial P&L, then the former can probably only trump the latter if the governance structure of the firm allows it. It is of course possible that a successful, gradual implementation of the mutual P&L at the pilot site leads to a firm-wide spill-over, eventually removing this conflict. However, if the mutual P&L is to be a tool with ambitions of scale beyond Mars, it is important not to underestimate the importance of corporate governance structures and the potential conflicts of interests that can arise if a mutual profit is implemented bottom-up, at the business-unit level, rather than top-down, at the firm level.

Studies which examine the implementation of innovation in management accounting further discuss timelines as an important factor in the implementation of management accounting tools. Kasurinen (2002) points out that management accounting tools can have relatively short life cycles, making them susceptible to incomplete implementation. This would suggest that only if tools are fully implemented will their lifetime be extended. However, the most important accounting innovations have taken a long time to be adopted and institutionalized, with up to ten years for techniques such as activity-based costing and balanced scorecards (Bhimani and Bromwhich 2010). For the mutual P&L, this indicates that a full and, as we suggest, gradual implementation of this tool may need a much longer time than managers may expect. Key changes in business and market environments, economic or natural crises, and technological advancements are all factors which may in the meantime have an influence on the implementation of this new tool. Willingness for change is often, for example, significantly influenced by moments of crises. Complementing a medium- with a long-term implementation plan for the mutual P&L may be a helpful tool for managers piloting mutual profit to not lose sight of their progress in the long run.

Conclusion

In conclusion, we repeat our point from above: there is nothing as well defined and consistent across companies as financial accounting. The most significant questions surrounding the impact of the mutual P&L will therefore be what a change in this consistent reality will imply for Mars. We find that the list of issues that the mutual P&L will encounter is large and the road will be a long one to travel. Nevertheless, we think it is a worthy and important challenge for Mars to face. We discussed how the consequences of the mutual P&L as a management accounting tool will likely affect both the external environment of accounting and the internal dynamics of organizations, specifically leadership. We therefore do not see the full implementation of the mutual P&L as a short-term objective. The transition from one management account to another must rather begin with the practical transformation of familiar accounting concepts and a gradual integration of the extended definitions of profit into mid- and long-term decision-making, in order to avoid disruption. Whether and how the definition of reality will effectively be changed is conditioned by the willingness and capability of leadership to understand and accept both the potential disruption and the opportunities which the mutual P&L can bring to Mars.

C-Suite Personal Leadership Coach for Major Corporations

By Robert Krenza, Founder & CEO, BlackWolf Consultants

Across the world many of the planet’s finest minds are beginning to align on the challenges facing today’s leaders.

As I said recently, while chairing the Master Class on Leadership at the 2017 Responsible Business Forum at Saïd Business School in Oxford, UK, ‘Business has never experienced a more demanding and disruptive, volatile, uncertain, complex, and ambiguous environment.’

Executing a vision of mutuality requires unprecedented leadership to navigate today’s rapidly changing business environment; that is, leadership that is focused on shifting the mindset of entire organizations, and measuring success from an ethos of sustainability, thereby having a positive impact on future generations.

In my opinion, the responsibility of today’s business leaders is to initiate a global mindset shift, and a radical change in the measurement of success. This is even more pressing due to the urgency of the task, and the way contemporary organizations are currently being designed and developed.

What I am writing will, by intention, create a tension in the thoughts and minds of the reader. This tension is fundamentally created by the awareness of the necessity of shifting from a mindset of ‘causality’, to ‘self-authoring’, and the resistance to take the ‘actions’ that need to be taken.

Leadership and the Urgency of a Global Mindset Shift

Beliefs and mindset are synonymous. Beliefs drive behaviour. They always have and always will. To shift our behaviour we must shift our beliefs. It is impossible to change our behaviours and our behaviour-based systems until we recognize that the source of our behaviours is our beliefs. This is fundamentally the meaning of transformation, which is: ‘Seeing and believing in a possibility that we have not considered before.’

Today’s leaders must shift from a ‘causality mindset’, where we react from a belief that others cause us to think, feel and behave the way we do, to a ‘self-authoring mindset’, where we respond from a belief of, ‘I am able to choose how I think, feel, and behave, and I can create whatever I believe or imagine.’

The question asked by those stuck in a consciousness of causality or reactivity is: ‘Is it too little too late?’ The consciousness of choosing to be the author and creator of your reality asks, as George Bernard Shaw said: ‘There are those that look at things the way they are, and ask why? I dream of things that never were, and ask why not?’

At present, we are in the middle of a perfect storm, and I use that phrase both figuratively and literally. Leaders are choosing to be in a causality or fear-based mindset by allowing themselves to be bullied into reactive behaviours.

Economics of Mutuality: The Urgency to Shift the Measurements of Success

Today’s leaders must courageously ask themselves, ‘How do I choose to live as a human being on this planet?’ ‘What impact do I want to have?’ ‘What legacy do I want to leave behind for future generations?’

For the sake of the planet and humanity, a radical change in the way we measure success must take place. In the business world, this means creating organizations that measure success against other forms of capital in addition to financial, which includes human, social, and environmental capital. Metrics that measure not only financial growth, but also the positive or negative impact we are having on the environment and humans need to be created and implemented.

If we see growth as the only financial goal, we must examine what the beliefs are that we are articulating as growth? If we believe that ‘the sole responsibility of corporations is to maximize shareholder return’, then we will act according to that belief. If we believe that measuring profit and growth against environmental, human, social, and financial metrics is imperative, then we will act according to that belief.

The factors that will create radical change involve consulting with organizations, with leadership teams, and with individual leaders.

Yet many corporations are still looking at the world through a lens that has been applied from post-World War II to the present. These leaders are using an old model, a model that was never comprehensive or inclusive; a model that is focused solely on growth. Ask yourself, ‘What is the belief that drives growth for growth’s sake?’

When it comes right down to it, if we ask business leaders what they really value in a business, it is to make a contribution and to leave a better world behind for their children and grandchildren.

As Albert Einstein so accurately declared, ‘No problem can be solved from the same level of consciousness that created it.’

___

Notes

1. http://www.kering.com/en/sustainability/whatisepl,lastaccessedSeptember2018.

2. http://report.akzonobel.com/2014/ar/case-studies/sustainable-business/

   measuring-our-impact-in-4d.html, last accessed September 2018.

3. https://www.samsung.com/uk/aboutsamsung/sustainability/strategy/,lastaccessed

   September 2018.

4. https://www.basf.com/en/company/sustainability/management-and-instruments/quantifying-sustainability/we-create-value/impact-categories.html and https:// www.basf.com/en/company/sustainability/management-and-instruments/quantifying-sustainability/we-create-value.html, last accessed September 2018.

Robert G. Eccles is a former tenured professor at Harvard Business School and is now a visiting professor of management practice at Saïd Business School, Oxford University. He is the founding chairman of the Sustainability Accounting Standards Board, an advisor to the Impact Management Project, and a member of the board of directors of the Mistra Center for Sustainable Markets at the Stockholm School of Economics. Eccles is a ‘capital market activist’ dedicated to ensuring that the capital markets support sustainable development through such mechanisms as integrated reporting. He is also a dedicated weight-lifter.

Judith C. Stroehle is a postdoctoral researcher at the Saïd Business School in Oxford, where her work primarily focuses on non-financial measurement and accounting, as well as sustainable investing and engagement strategies. Judith holds a PhD in economics and sociology from the University of Milan and has several years of industry work experience in the German online start-up scene and as a data strategy consultant for international channel marketing. Judith engages and works with several non-profits, companies, and asset managers on their non-financial strategies and reporting and measurement practices.

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