Hack:
Poly-capitalism: what if we aren't capitalistic enough?

The cause of these symptoms is rooted in the structure of our organizations.  Specifically, there is a problem with one of the basic assumptions of our capitalistic system:  What counts as capital?

The current economic system was designed with only financial capital in mind.  Indeed, it was created at a time when financial capital was scarce while labor and raw material were plentiful; so paying particular attention to financial capital only made sense.  But times have changed; and it now takes more than money to compete.  It takes talented, focused, creative people who are committed to serving customers, inventing new products and constantly improving processes.  It takes partnership with suppliers who integrate their internal systems and processes with yours, take on more responsibility for managing inventory, and contribute expertise to the design and improvement of products.  It takes customers who can’t live without your product, tell everyone they know about it and share their suggestions for improvements with you.  It takes a local community that provides a stable legal and regulatory context, an efficient transportation system, an educated and motivated workforce, and a healthy, vibrant political process.  It takes access to a ready supply of raw materials and natural resources.  And it takes investors who share and support your long-term strategic plan for the company.  In short, it takes a lot more than money to build a business. 

While business people were busy inventing ways to make money; academics (and others) have been busy studying a variety of other types of capital.  The list of productive resources (i.e., “capital”) employed by firms to create value includes: 

• social capital-- the connections and relationships which accounts for a firm’s ability to attract and mobilize resources and provide the framework upon which a productive enterprise is constructed. 
• intellectual capital—the cognitive and creative capacity to solve problems and design new products which is presumed to be at the heart of the company’s value-creation process, and therefore driving its earnings and stock price.
• human capital—the uniquely human talents and skills of a firm’s employees which enable them to provide personalize service and produce the company’s tangible outputs. 
• natural capital--  the store of natural resources and regenerative capacity of the eco-system within which the company operates and upon which it depends.
• spiritual capital-- the deeply embedded values and traditions which provide a coherent sense of meaning and moral foundation for people and societies. 

The problem with capitalism is a too-narrow conception of the firm as existing exclusively for the benefit of those who provide the financial capital.  As a result, we systematically and structurally neglect the investors of other types of capital.  The problem with capitalism is that it is not capitalistic enough.

All these alternative forms of capital contribute to a firm’s productive and wealth-creating capacity; but they are not owned by the providers of financial capital.  Indeed, these other types of capital belong to, and must be contributed by, other constituencies—employees, customers, suppliers, communities, etc.  The problem is that such contributions are not treated like investments of capital at most modern “capitalistic” companies.   To be sure, there are efforts in this direction. For example, many companies—especially in the technology sector—recognize how deeply dependent they are upon the talent and ideas of their people (i.e., intellectual capital), so they grant stock-options in order to align and reward employees’ efforts (and often use lengthy vesting periods to keep employees tied to the company).   By granting an ownership stake to contributors of intellectual capital, this is a step in the right direction.  But as I’ll show, it only taps into one of the Principles of Capital Management.  

Poly capitalism is a very simple idea: to treat all forms of capital, as capital.

Principles of Capital Management [PCMs]:   Capitalism has been amazingly effective at nurturing, deploying and leveraging financial capital (albeit with a few notable periods of exception).  The dynamic energy generated around managing capital—raising it, investing it, managing it and enjoying it—has produced an incredibly productive system.  So what can we learn from how we treat financial capital in order to apply it to the other types of capital?  I want to highlight 3 basic principles and 1 corollary. I’m calling them the “universal” principles of effective capital management, or PCMs, for short.

1. Return on Investment--   The first, and central, principle of effective capital management is that those who contribute capital expect to earn a “return” on their investment.  Capitalism is predicated upon private ownership of capital and the construction of corporations which give rights to those who contribute capital.  Key among these rights is the right to compensation for the use of one’s capital.  Here the distinction between investors and lenders is critical.  Lenders have conferred control over their capital to the borrower with the promise that their original capital will be returned to them along with a pre-specified amount for the privilege of using it.  In contrast, investors commit their capital to an enterprise without any guaranteed compensation—but with the explicit expectation that they will share in any benefits produced by the enterprise (in proportion to the amount of capital she has contributed relative to other investors).  As a result, the rights and returns for investors are very different from lenders.  Lenders are entitled to a set return (pre-negotiated and explicitly not dependent upon the performance of the enterprise; and often secured by a lien upon the assets contributed by investors) and in exchange have essentially sold their right to determine what is done with their capital (i.e., control).  Investors have no such guarantee of return on their capital investment, but they do have a claim upon the net proceeds generated by the enterprise and a say in the governance of the firm.  Therefore, both lenders and investors expect a return on their capital, but of a very different type and/or amount.

Under traditional Capitalism, only those who invest financial capital are granted shares of stock.  Until the contributions of other forms of capital are recognized as valid investments, they will not be granted the rights or returns due to them.  This has started to change.  As mentioned already, many companies are granting stock or stock-options to employees in recognition of the value of their contributions to the productive outcomes of the enterprise.  However, this is often conceived of more as a form of additional or deferred compensation for labor than as a return on invested capital.   The perception by some financial investors that widespread stock-option grants are tantamount to “gifts” from shareholders to employees (rather than a fair return on investment for committed human and/or intellectual capital) reflects a misunderstanding of this first principle of capital management. 

 2.  Replenishment (or Preservation of Capital)--  The second principle of effective capital management is: replenishment.  Every wise investment decision always considers not only the rate of return, but also the risk of losing one’s investment.  The greater the likelihood of loss (i.e., higher risk), the higher the expected return on investment.  There is an underlying assumption that investors expect to recoup their investment—and more.  Risk entails the potential loss of capital, which is equivalent to the diminishment of the productive capacity of a resource.  So even if it is impossible to physically separate an investor from her capital (e.g., intellectual capital), the value of her capital can still be negatively impacted (i.e., by obsolescence and neglect).    Therefore, invested capital must be carefully nurtured, monitored and developed in order to maintain its productive capacity. 

The old-fashioned agrarian term “husbanded” seems appropriate.  The core idea of this principle is that every form of capital must be actively maintained and carefully managed.  Historically, land was a more important form of capital than money.  But the productivity of a piece of land is dependent upon several factors: its location, the local weather patterns, the quality of the seeds planted, the skill of the farmer, and the inherent fertility of the land itself.  Without proper care the land could be over-worked and soon become unproductive.  Only with intentional maintenance and nurturing (and sometimes rest) could the productivity of the underlying asset be sustained.  The same principle applies to other types of capital.  As we draw upon the resource of a particular form of capital we must be aware of the need to replenish and “re-invest” in the resource in order to maintain its productive capacity—otherwise we risk impairing the value of the capital. 

While financial capital is invested in order to be used, it is not “used up.”  It is used to build tools, acquire material, lease facilities, hire personnel, fund development, and the like, in order to build a productive enterprise that will continue to yield revenue in an on-going fashion.  The financial capital is transformed into productive capacity designed to generate profitable outcomes, which in turn pay dividends to the shareholders and enhance the enduring value of the enterprise (i.e., the stock price).  A good use of capital is one that will add sufficient value to more than pay back its original investment—i.e., replenish the original capital as well as pay a return on investment.   

To simply burn through capital is to waste it.  This would be like spending the principle as well as the interest of a trust account—a short-term “gain” at the cost of long-term sustainability.  Wise capital utilization is as concerned about capital preservation as immediate return on investment. To consume one’s capital is short-sighted; yet this is precisely how corporations often treat the non-financial forms of capital.  Many employees, who were hired for their talents, experience, motivation and commitment (i.e., human capital), are used-up until they are so burned-out that they are no longer as productive as they used to be.  Or an organization’s culture, which takes years to build, but then due to neglect or misguided cost-cutting is dismantled and destroyed.  Each is thought of as a valued resource, but neither is typically considered to be capital; nor are the creators and contributors of such capital given the rights or representation necessary to insure that it is maintained (i.e., they are not treated like investors). 

Part of the cost-of-capital is the expense of continuously re-investing in the resource to maintain its productive capacity.  For financial capital, this means increasing the principle (or stock price) to keep pace with inflation.  Similarly, for other forms of capital, it means intentionally maintaining and developing the underlying productive capacity of the resource.  However, given the non-financial nature of some types of capital, one cannot simply write a check to replenish it, which leads to the third, corollary principle. 

 3. In Like Kind (or, the non-fungibility of capital)--  The third principle of effective capital management is an extension of the replenishment principle.   “In like kind” means that how one replenishes a store of capital depends upon the type of capital.  Not everything is reducible to money.  The nature of the replenishment must be in keeping with the form of the capital. Many things cost money, but money cannot be substituted for all things.  Additional compensation cannot make up for lost time (with one’s family, hobbies or other interests).  Cash does not make very good fertilizer for the natural environment.  A bonus check does not keep one up-to-date in one’s field; nor does a fat bank account confer spiritual contentment.  Therefore, as we think of replenishing each form of capital, we must resist the tendency to reduce everything to the common-denominator of money.  Each form of capital requires appropriate replenishment in order to maintain its productive capacity—i.e., “in like kind.”

For example, the “half-life” of technical knowledge and expertise varies by specialty, but is a very real fact of life for many professionals.  Unless there is continual renewal and updating (i.e., “keeping current”) there will be an erosion of the value of the intellectual capital.  And while a financial return is important to reward those who contribute their intellectual capital, they also need the resources and opportunities to upgrade their knowledge and skills.  While doing so certainly costs money, it is a very different sort of expenditure than salary or wages.  Too often specialized knowledge and technical skills— because they are expensive to acquire— are so rigorously leveraged as to preclude their needed upgrading.  They are “milked” for all they can give and their value is literally sucked out of them; and when they are no longer relevant, or current, they are replaced or discarded. 

Similarly, if a local community “invests” social and human capital into creating a healthy, conducive context in which to do business—i.e., a highly educated workforce, efficient social infrastructure, a stable regulatory environment, etc.—then to avoid paying taxes is tantamount to robbing one’s investors of their return on investment and capital preservation.  But beyond paying taxes, participating in the life of the community through “citizenship” or CSR-type initiatives is not simply some charitable, “do-gooder” activity, but rather it is an “in like kind” replenishment to the community’s store of social- and/or human-capital.  

It is important to point out that, when it comes to financial capital, these first 3 principles tend to collapse simply into financial pay-back—i.e., return on investment, replenishment and “in-like-kind” all boil-down to money.  But when considering other forms of capital, it is important to maintain these distinctions... and manage them deliberately.

 4. Control--  The fourth and final principle is that investors have a say in how their capital is utilized.  This might also be called the ownership-principle.  Investors are granted voting rights with each share of stock and, as a group, have representation in setting the strategic direction of the firm and exercise executive oversight via the Board of Directors.  In the same way, those who invest other forms of capital deserve a voice in how the collective enterprise is operated.  The exact shape of their role in governance or the extent of their voice in the enterprise needs to be worked out (and will probably be different depending upon their role in the company); but the basic principle still applies: those who invest their capital in a firm have a right to help decide how it is utilized.

With this basic framework of principles in place, let’s turn our attention to applying these principles: how do our management innovations rate on these 4 PCMs?