Philanthropy & Competitive Advantage are not mutually exclusive

Corporate philanthropy is in decline. The reasons are not hard to understand. Executives increasingly see themselves in a no-win situation, caught between critics demanding ever higher levels of “corporate social responsibility” and investors applying relentless pressure to maximize short-term profits. Giving more does not satisfy the critics—the more companies donate, the more is expected of them. And executives find it hard, if not impossible, to justify charitable expenditures in terms of bottom-line benefit .

This dilemma has led many companies to seek to be more strategic in their philanthropy. But what passes for “strategic philanthropy” today is almost never truly strategic, and often it isn’t even particularly effective as philanthropy. Increasingly, philanthropy is used as a form of public relations or advertising, promoting a company’s image or brand through cause-related marketing or other high-profile sponsorships.

Given the current haziness surrounding corporate philanthropy, this seems an appropriate time to revisit the most basic of questions: Should corporations engage in philanthropy at all? The economist Milton Friedman laid down the gauntlet decades ago, arguing in a 1970 New York Times Magazine article that the only “social responsibility of business” is to “increase its profits.” “The corporation,” he wrote in his book Capitalism and Freedom, “is an instrument of the stockholders who own it. If the corporation makes a contribution, it prevents the individual stockholder from himself deciding how he should dispose of his funds. ”If charitable contributions are to be made, Friedman concluded, they should be made by individual stockholders—or, by extension, individual employees—and not by the corporation.

The way most corporate philanthropy is practiced today, Friedman is right. The majority of corporate contribution programs are diffused and unfocused. Most consist of numerous small cash donations given to aid local civic causes or provide general operating support to universities and national charities in the hope of generating goodwill among employees, customers, and the local community. Rather than being tied to well-thought-out social or business objectives, the contributions often reflect the personal beliefs and values of executives or employees. Indeed, one of the most popular approaches—employee matching grants—explicitly leaves the choice of charity to the individual worker. Although aimed at enhancing morale, the same effect might be gained from an equal increase in wages that employees could then choose to donate to charity on a tax-deductible basis. It does indeed seem that many of the giving decisions companies make today would be better made by individuals donating their own money. The nett effect is a whitewashing of CSR budgets as PR and marketing touchpoints.

But does Friedman’s argument always hold? Underlying it are two implicit assumptions.

The first is that social and economic objectives are separate and distinct, so that a corporation’s social spending comes at the expense of its economic results.

The second is the assumption that corporations, when they address social objectives, provide no greater benefit than is provided by individual donors.

These assumptions hold true when corporate contributions are unfocused and piecemeal, as is typically the case today.

But there is another, more truly strategic way to think about philanthropy. Corporations can use their charitable efforts to improve their competitive context —the quality of the business environment in the location or locations where they operate.

Using philanthropy to enhance context brings social and economic goals into alignment and improves a company’s long-term business prospects—thus contradicting Friedman’s first assumption. In addition, addressing context enables a company not only to give money but also to leverage its capabilities and relationships in support of charitable causes. That produces social benefits far exceeding those provided by individual donors, foundations, or even governments. Context-focused giving thus contradicts Friedman’s second assumption as well.

A handful of companies have begun to use context-focused philanthropy to achieve both social and economic gains. Absa Bank, to take one example, has invested in an ambitious educational program—the The Absa Cybersecurity Academy—to train young cybersecurity professionals from disadvantaged backgrounds, thus alleviating a potential constraint on its own growth while providing attractive development opportunities to school leavers. By focusing on social needs that affect its corporate context and utilizing its unique attributes as a corporation to address them, Absa has begun to demonstrate the unrealized potential of corporate philanthropy. Taking this new direction, however, requires fundamental changes in the way companies approach their contribution programs. Corporations need to rethink both where they focus their philanthropy and how they go about their giving.

Where to Focus

It has been true that economic and social objectives have been seen as distinct and often competing. Thankfully, this seems to be shifting. Set up as a false dichotomy; it represents an obsolete perspective in a world of open, knowledge-based competition. Companies do not function in isolation from the society around them. In fact, their ability to compete depends heavily on the circumstances of the locations where they operate. Improving education, for example, is generally seen as a social issue, but the educational level of the local workforce substantially affects a company’s potential competitiveness. The more a social improvement relates to a company’s business, the more it leads to economic benefits as well. In establishing its Cybersecurity Academy, for example, Absa focused not on the educational system overall, but on the training needed to produce cybersecurity professionals — the particular kind of education that made the most difference to Absa’s (and the financial services industry more broadly) competitive context.

In the long run, then, social and economic goals are not inherently conflicting but integrally connected. Competitiveness today depends on the productivity with which companies can use labor, capital, and natural resources to produce high-quality goods and services. Productivity depends on having workers who are educated, safe, healthy, decently housed, and motivated by a sense of opportunity. Preserving the environment benefits not only society but companies too, because reducing pollution and waste can lead to a more productive use of resources and help produce goods that consumers value. Boosting social and economic conditions in developing countries can create more productive locations for a company’s operations as well as new markets for its products. Indeed, we are learning that the most effective method of addressing many of the world’s pressing problems is often to mobilize the corporate sector in ways that benefit both society and companies.

That does not mean that every corporate expenditure will bring a social benefit or that every social benefit will improve competitiveness. Most corporate expenditures produce benefits only for the business, and charitable contributions unrelated to the business generate only social benefits. It is only where corporate expenditures produce simultaneous social and economic gains that corporate philanthropy and shareholder interests converge, as illustrated in the exhibit “A Convergence of Interests.” It is here that philanthropy is truly strategic.

A Convergence of Interests

Competitive context has always been important to strategy. The availability of skilled and motivated employees; the efficiency of the local infrastructure, including roads and telecommunications; the size and sophistication of the local market; the extent of governmental regulations—such contextual variables have always influenced companies’ ability to compete.

But competitive context has become even more critical as the basis of competition has moved from cheap inputs to superior productivity. For one thing, modern knowledge- and technology-based competition hinges more and more on worker capabilities. For another, companies today depend more on local partnerships: They rely on outsourcing and collaboration with local suppliers and institutions rather than on vertical integration; they work more closely with customers; and they draw more on local universities and research institutes to conduct research and development.

Finally, navigating increasingly complex local regulations and reducing approval times for new projects and products are becoming increasingly important to competition. As a result of these trends, companies’ success has become more tightly intertwined with local institutions and other contextual conditions. And the globalization of production and marketing means that context is often important for a company not just in its home market but in multiple countries.

A company’s competitive context consists of four interrelated elements of the local business environment that shape potential productivity:

• Factor conditions - or the available inputs of production

• Demand conditions

• The context for strategy and rivalry

• Related and supporting industries

By carefully analyzing the elements of competitive context, a company can identify the areas of overlap between social and economic value that will most enhance its own and its cluster’s competitiveness. Consider each of the four elements of context and how companies have influenced them through philanthropy in ways that have improved their long-term economic prospects.

Factor Conditions

Achieving high levels of productivity depends on the presence of trained workers, high-quality scientific and technological institutions, adequate physical infrastructure, transparent and efficient administrative processes (such as company registration or permit requirements), and available natural resources. All are areas that philanthropy can influence.

Philanthropy can also improve inputs other than labor, through enhancements in, say, the quality of local research and development institutions, the effectiveness of administrative institutions such as the legal system, the quality of the physical infrastructure, or the sustainable development of natural resources. Xylem inc, for example, has devoted substantial resources to improving basic conditions in water quality and sanitation across South Africa through their watermark programme.

Demand Conditions

Demand conditions in a nation or region include the size of the local market, the appropriateness of product standards, and the sophistication of local customers. Sophisticated local customers enhance the region’s competitiveness by providing companies with insight into emerging customer needs and applying pressure for innovation.

Philanthropy can influence both the size and quality of the local market. The Absa Cybersecurity Academy, for instance, improved demand conditions by helping customers and competitors obtain well-trained cybersecurity professionals. In doing so, it increased the size of the skills pool and the sophistication of platforms—and hence users’ interest in more advanced solutions.

OPPO cellphones donates smart devices to schools as a means of introducing its products to young people. This provides a clear social benefit to the schools while expanding OPPO’s potential market and turning students and teachers into more sophisticated purchasers.

Context for Strategy and Rivalry

The rules, incentives, and norms governing competition in a nation or region have a fundamental influence on productivity. Policies that encourage investment, protect intellectual property, open local markets to trade, break up or prevent the formation of cartels and monopolies, and reduce corruption make a location a more attractive place to do business.

Philanthropy can have a strong influence on creating a more productive and transparent environment for competition. For example, Integer (a spatial planning concern) have long worked in the renewable energy transition environment seeking to understand the transition ans its impact on communities and local economies. By measuring and focusing public attention on the opportunities renewable energy presents, the organization helps to create an environment that rewards fair competition and enhances impact. This benefits local citizens while providing business with improved access to markets.

Related and Supporting Industries

A company’s productivity can be greatly enhanced by having high-quality supporting industries and services nearby. While outsourcing from distant suppliers is possible, it is not as efficient as using capable local suppliers of services, components, and machinery. Proximity enhances responsiveness, exchange of information, and innovation, in addition to lowering transportation and inventory costs. Philanthropy can foster the development of clusters and strengthen supporting industries.

When corporate philanthropy improves competitive context, other companies in the cluster or region, including direct competitors, often share the benefits.

That raises an important question: Does the ability of other companies to be free riders negate the strategic value of context-focused philanthropy? The answer is no. The competitive benefits reaped by the donor company remain substantial, for five reasons:

• Improving context mainly benefits companies based in a given location. Not all competitors will be based in the same area, so the company will still gain an edge over the competition in general.

• Corporate philanthropy is ripe for collective activity. By sharing the costs with other companies in its cluster, including competitors, a company can greatly diminish the free rider problem.

• Leading companies will be best positioned to make substantial contributions and will in turn reap a major share of the benefits. Cisco, for example, with a leading market share in networking equipment, will benefit most from a larger, more rapidly growing market.

• Not all contextual advantages are of equal value to all competitors. The more tightly corporate philanthropy is aligned with a company’s unique strategy—increasing skills, technology, or infrastructure on which the firm is especially reliant, say, or increasing demand within a specialized segment where the company is strongest—the more disproportionately the company will benefit through enhancing the context.

• The company that initiates corporate philanthropy in a particular area will often get disproportionate benefits because of the superior reputation and relationships it builds.

Social investment strategy

Understanding the link between philanthropy and competitive context helps companies identify where they should focus their corporate giving. Understanding the ways in which philanthropy creates value highlights how they can achieve the greatest social and economic impact through their contributions. The where and the how are mutually reinforcing.

Maximising social value:

• Selecting the best grantees

• Signaling other funders

• Improving the performance of grant recipients

• Advancing knowledge and practice in the field.

These efforts build on one another: Increasingly greater value is generated as a donor moves up the ladder from selecting the right grantees to advancing knowledge.

The same principles apply to corporate giving, pointing the way to how corporate philanthropy can be most effective in enhancing competitive context. Focusing on the four principles also ensures that corporate donations have greater impact than donations of the same magnitude by individuals.

Selecting the Best Grantees

Most philanthropic activity involves giving money to other organizations that actually deliver the social benefits. The impact achieved by a donor, then, is largely determined by the effectiveness of the recipient. Selecting a more effective grantee or partner organization will lead to more social impact per rand expended.

Selecting the most effective grantees in a given field is never easy. It may be obvious which nonprofit organizations raise the most money, have the greatest prestige, or manage the best development campaigns, but such factors may have little to do with how well the grantees use contributions. Extensive and disciplined research is usually required to select those recipients that will achieve the greatest social impact.

This is where growZA is positioned in the market. A social investment agency NGO that understands competitive advantage and strategy. Through a network of partners, GrowZA delivers on partners social investment strategy, develops and review policies and procedures, and report to the donor on which support should be continued and, if so, how it could be directed. This level of attention and expertise is substantially greater than most individual donors or even government agencies can muster.

Signaling Other Funders

A donor can publicize the most effective nonprofit organizations and promote them to other donors, attracting greater funding and thus creating a more effective allocation of overall philanthropic spending.

Corporations bring uniquely valuable assets to this task.

First, their reputations often command respect, becoming imprimaturs of credibility for grantees.

Second, they are often able to influence a vast network of entities in their cluster, including customers, suppliers, and other partners. This gives them far greater reach than individual donors or even most nonprofits and foundations.

Third, they often have access to communication channels and expertise that can be used to disseminate information widely, swiftly, and persuasively to other donors.

Collective social investment by participants in a cluster can improve the context for all players, while reducing the cost borne by each one. By leveraging its relationships and brand identity to initiate social projects that are also funded by others, a corporation improves the cost-benefit ratio.

Improving the Performance of Grant Recipients

By improving the effectiveness of nonprofits, corporations create value for society, increasing the social impact achieved per dollar expended. While selecting the right grantee improves society’s return on a single contribution, and signaling other funders improves the return on multiple contributions, improving grantee performance can increase the return on the grantee’s total budget.

Unlike many other donors, corporations have the ability to work directly with nonprofits and other partners to help them become more effective. They bring unique assets and expertise that individuals and foundations lack, enabling them to provide a wide range of nonmonetary assistance that is less costly and more sophisticated than the services most grantees could purchase for themselves. And because they typically make long-term commitments to the communities in which they operate, corporations can work closely with local nonprofits over the extended periods of time needed for meaningful organizational improvement. By operating in multiple geographical areas, moreover, companies are able to facilitate the transfer of knowledge and operational improvements among non-profits in different regions or countries. Contextual issues within a particular industry or cluster will often be similar across different locations, increasing a company’s ability to add and derive value in multiple regions.

By tying corporate philanthropy to its business and strategy, a company can create even greater social value in improving grantee performance than other donors. Its specialized assets and expertise, after all, will be most useful in addressing problems related to its particular field.

Advancing Knowledge and Practice

Innovation drives productivity in the nonprofit sector as well as in the commercial sector. The greatest advances come not from incremental improvements in efficiency but from new and better approaches. The most powerful way to create social value, therefore, is by developing new means to address social problems and putting them into widespread practice.

The expertise, research capacity, and reach that companies bring to philanthropy can help nonprofits create new solutions that they could never afford to develop on their own.

Just as important as the creation of new knowledge is its adoption in practice. The know-how of corporate leaders, their clout and connections, and their presence in communities around the world create powerful networks for the dissemination of new ideas for addressing social problems. Corporations can facilitate global knowledge transfer and coordinated multisite implementation of new social initiatives with a proficiency that is unequaled by most other donors.

A Whole New Approach

When corporations support the right causes in the right ways—when they get the where and the how right—they set in motion a virtuous cycle. By focusing on the contextual conditions most important to their industries and strategies, companies ensure that their corporate capabilities will be particularly well suited to helping grantees create greater value. And by enhancing the value produced by philanthropic efforts in their fields, the companies gain a greater improvement in competitive context. Both the corporations and the causes they support reap important benefits.

Adopting a context-focused approach, however, goes against the grain of current philanthropic practice. Many companies actively distance their philanthropy from the business, believing this will lead to greater goodwill in local communities. While it is true that a growing number of companies aim to make their giving “strategic,” few have connected giving to areas that improve their long-term competitive potential. And even fewer systematically apply their distinctive strengths to maximize the social and economic value created by their philanthropy. Instead, companies are often distracted by the desire to publicize how much money and effort they are contributing in order to foster an image of social responsibility and caring.

As long as companies remain focused on the public relations benefit of their contributions, they will sacrifice opportunities to create social value.

This does not mean that corporations cannot also gain goodwill and enhance their reputations through philanthropy. But goodwill alone is not a sufficient motivation. Given public skepticism about the ethics of business—skepticism that has intensified in the wake of the string of corporate scandals this year—corporations that can demonstrate a significant impact on a social problem will gain more credibility than those that are merely big givers.

The acid test of good corporate philanthropy is whether the desired social change is so beneficial to the company that the organization would pursue the change even if no one ever knew about it.

Moving to context-focused philanthropy will require a far more rigorous approach than is prevalent today. It will mean tightly integrating the management of philanthropy with other company activities. Rather than delegating philanthropy entirely to a public relations department or the staff of a corporate foundation, the CEO must lead the entire management team through a disciplined process to identify and implement a corporate giving strategy focused on improving context. Business units, in particular, must play central roles in identifying areas for contextual investments.

The new process would involve five steps:

• Examine the competitive context in each of the company’s important geographic locations.

• Review the existing philanthropic portfolio to see how it fits this new paradigm.

• Assess existing and potential corporate giving initiatives against the four forms of value creation.

• Seek opportunities for collective action within a cluster and with other partners.

• Rigorously track and evaluate results.

The context-focused approach to philanthropy is not simple. One size does not fit all. Companies will differ in their comfort levels and time horizons for philanthropic activity, and individual firms will make different choices about how to implement our ideas. Philanthropy will never become an exact science—it is inherently an act of judgment and faith in the pursuit of long-term goals. However, the perspective and tools presented here will help any company make its social investment activities far more effective.

Were this approach to be widely adopted, the pattern of corporate contributions would shift significantly beyond the obligatory scorecard spend. The overall level of contributions would likely increase, and the social and economic value created would go up even more sharply. Companies would be more confident about the value of their philanthropy and more committed to it. They would be able to communicate their philanthropic strategies more effectively to the communities in which they operate. Their choices of areas to support would be clearly understandable and would not seem unpredictable or idiosyncratic. Finally, there would be a better division of labor between corporate givers and other types of funders, with corporations tackling the areas where they are uniquely able to create value.

NGO’s too would benefit. They would see an increased and more predictable flow of corporate resources into the nonprofit sector. Just as important, they would develop close, long-term corporate partnerships that would better apply the expertise and assets of the for-profit sector to achieve social objectives. Just as companies can build on the nonprofit infrastructure to achieve their objectives more cost-effectively, nonprofits can benefit from using the commercial infrastructure.

To some corporate leaders, this new approach might seem too self-serving. They might argue that philanthropy is purely a matter of conscience and should not be adulterated by business objectives. In some industries, particularly those like petrochemicals and pharmaceuticals that are prone to public controversy, this view is so entrenched that many companies establish independent charitable foundations and entirely segregate giving from the business. In doing so, however, they give up tremendous opportunities to create greater value for society and themselves. Context-focused philanthropy does not just address a company’s self-interest, it benefits many through broad social change. If a company’s philanthropy only involved its own interests, after all, it would not qualify as a charitable deduction, and it might well threaten the company’s reputation.

There is no inherent contradiction between improving competitive context and making a sincere commitment to bettering society. The more closely a company’s philanthropy is linked to its competitive context, the greater the company’s contribution to society will be. Other areas, where the company neither creates added value nor derives benefit, should appropriately be left—as Friedman asserts—to individual donors following their own charitable impulses. If systematically pursued in a way that maximizes the value created, context-focused philanthropy can offer companies a new set of competitive tools that well justifies the investment of resources. At the same time, it can unlock a vastly more powerful way to make the world a better place.

Join GrowZA in this journey of social investment strategy alignment and implementation for good.

A version of this article appeared in the December 2002 issue of Harvard Business Review.