Philanthropy isn’t for profit

By Felix Salmon
June 15, 2011
Daniel Altman is an economist who glories in the title of Director of Thought Leadership at Dalberg, and he's now written a paper which essentially seeks to eradicate the distinction between social impact and profit altogether

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Dalberg is an international consultancy which explains, on its About page, that “we value social impact above profit but recognize that a sustainable business model is essential to our success”. Makes a certain amount of sense: if you want to do a lot of good in the world, it’s helpful not to be having to beg for money all the time. And of course that mission makes it much easier for Dalberg to charge huge sums of money and help its owners on their path to wealth and fortune.

Daniel Altman is an economist who glories in the title of Director of Thought Leadership at Dalberg, and he’s now written a paper which essentially seeks to eradicate the distinction between social impact and profit altogether. Social impact, he says, along with similar ideas like double bottom lines or corporate social responsibility (CSR) and creating shared value (CSV),

are inefficient workarounds or substitutes that should ultimately lead back to a single bottom line – profit – with a long time horizon and rational expectations. Executives targeting profitability with a sufficiently long time horizon will make investments that generate social benefits because these investments serve the interests of their companies. Moreover, companies that take this approach will generate social benefits more efficiently and sustainably than those using typical strategies for CSR or CSV.

Altman’s paper cites Philanthrocapitalism. That book’s author, Matthew Bishop, has a similar essay this week in the Economist, comparing IBM to the Carnegie Corporation and concluding that the former has done more for society than the latter.

All of this is profoundly silly. Both Altman and Bishop are all in favor of companies engaging in philanthropic initiatives, although only Altman goes so far as to say that they have to be justifiable on a P&L basis. He writes:

If companies view social initiatives as cost centers rather than contributors to profitability, then these initiatives are likely to become procyclical, being cut in downturns and then reinstated when balance sheets are flush again. Their budgets will be arbitrary rather than being linked to a rate of return. As investments expected to be competitive and profitable, by contrast, social initiatives will enjoy more durable support from executives and become a core part of corporate operations.

The problem here is that Altman’s idea of profitability turns on the idea that “the time horizon for a company’s decision-making should be infinite” — and if he’d ever spent any time running a for-profit company, he’d know full well that in downturns, corporate time horizons are anything but. Even the most enlightened CEO will increase the discount rate with which she calculates distant profits when she runs into short-term trouble — and if you’re calculating philanthropic returns on an NPV basis over an infinite time horizon, a small tweak to the discount rate can easily mean the difference between profitability and being axed.

But the point in the paper at which Altman becomes a complete laughingstock to any genuine capitalist is in his third hypothetical of how corporate philanthropy can be profitable:

The chief executive of a major electronics manufacturer is deciding whether to develop a line of low-cost smart phones for sale at a small margin in poor countries. This investment would cost $100 million and generate an expected rate of return of only 2 percent. However, the chief executive is convinced that the investment is a moral one, and she would get substantial personal satisfaction from making it. Her salary is due to increase by $3 million during the period in which the investment would take place, but she will accept a raise of only $1 million if the investment goes forward. With this additional factor in mind, the expected rate of return on the investment doubles to 4 percent; it is now more competitive with the other investment opportunities in the company’s portfolio.

I had to read this a few times to be sure I understood it right: apparently the CEO of a major electronics manufacturer is going to take a $2 million pay cut just so that she can get “substantial personal satisfaction” from selling phones in poor countries. I can just imagine her presentation to the board: “we’ve created this wonderful line of phones which is profitable, but not very profitable, so in order to make it reach an adequate IRR, I’ve decided to ask you to pay me $2 million less.”

Bishop’s article doesn’t have anything quite that ridiculous, but it is based on an equally silly premise: that we can learn something useful from comparing IBM to the Carnegie Corporation, just because they were both founded 100 years ago:

Comparing the records of those giants of 20th-century American capitalism—or “philanthrocapitalism”—can shed light on a question that is keenly debated today: whether philanthropy or business is more effective at “Making the World Work Better”, to borrow the title of the book celebrating IBM’s centenary.

Well, no, actually, it can’t. Bishop’s conclusion is that Carnegie wins the first 50 years while IBM wins the second 50 years and the prize. But you’d want Carnegie to be front-loaded, since that’s how philanthropy works best. Bishop admits as much:

100 years is too old for a philanthropic foundation…

Many of today’s philanthropists aim, as Carnegie did, to give away all their money by the time they die, or at least put a time limit on the lifespan of their foundation after their death. The Gates Foundation will have to be wound down 50 years after the second of Bill and Melinda Gates dies.

On top of that, Bishop’s choice of IBM exhibits massive survivorship bias. The Carnegie Corporation was the only mega-philanthropy in the world in 1911: Bishop has chosen 100% of the big philanthropies of the day to see how they fared. But IBM was just one of thousands of companies founded that year, and it’s almost certainly the only one which could even come close to giving Carnegie a run for its money in this particularly weird competition. Carnegie never aspired, when he created his foundation, to outperform every single corporation ever to be founded. Instead, he simply aspired to make the world a much better place, which is exactly what he did.

The good news here is that these attempts by Altman and Bishop to elide the distinction between capitalism and philanthropy — to make rapacious executives feel good about being greedy — are such transparent failures that with any luck they’ll mark the turning point at which people do good to do good, rather than simply declaring that the best way they can do good is to chase profit as zealously as possible. You can’t just invest money in the stock market and declare it the best way to do good in the world, any more than you can start an arms or cigarette manufacturer and claim that your pursuit of profits is the best way to improve global welfare. And I must admit it’s a little depressing to find the likes of Altman and Bishop helping the global plutocracy think otherwise.

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