Stakeholder Theory: 101
Too many organizations, managers, and strategists have a narrow focus on generating profit for the benefit of whoever owns the company. Stakeholder theory aims to correct this tunnel vision by taking into account other parties affected in the course of business such as communities, customers, employees, investors, and suppliers.
A more holistic view of a given company and its products will improve the user experience and produce healthier long-term planning. Stakeholder theory doesn’t preclude planning for cost mineralization, marketing, or profits. It allows companies to reduce risk and build more realistic expectations.
Find out everything you need to know about stakeholder theory and learn some principles for applying it to your business practices with this introductory guide.
What is Stakeholder Theory?
Essentially, stakeholder theory is a strategic management tactic that expands the number of beneficiaries of value created by an organization. This widening of scope is not employed to create the impression that more people benefit. Rather, stakeholder theory is used to illustrate business practices more fully and tie business ethics into company practices.
Success metrics and overall planning both benefit from the more detailed view provided by a stakeholder outlook. Instead of catering to a small number of owners or a crowd of stockholders, managers and employees can include components of the supply chain, investors, employees, and society when they work on new projects or assess the effectiveness of their current products and services.
Focusing on the user is easier when they’re viewed as both the target buyer and a stakeholder in the product. The difference between these two approaches may seem minuscule at first, but understanding users as beneficiaries of value created by the product or company creates better marketing and a better user experience overall.
Who is a Stakeholder?
One of the most difficult aspects of developing a tailored stakeholder viewpoint on a given business is defining who the stakeholders are. Even in theoretical management studies, selecting stakeholders is a challenge.
Every product has a user or a viewer. Identifying the user as a stakeholder is a no-brainer, but determining the degree to which they benefit from added value is another matter. Does the user benefit the way a shareholder does when profits are up?
Consider the entire supply chain in the same way. When business is good, do the companies who supply raw materials or manufacture products see a difference, or do they simply receive payment the same no matter what? Incentive is a large part of stakeholder theory.
When managers and other decision-makers are determining who the relevant stakeholders are, what they’re really doing is balancing the company’s interests with those of other parties. In many ways, these interests are already aligned. But when they aren’t, accounting for each stakeholder helps make the situation mutually beneficial with as little compromise as possible.
Stakeholder Theory vs. Shareholder Theory
The principle that stakeholder theory has evolved as an answer to is called the Friedman Doctrine, named after economist Milton Friedman. In this theory, Friedman postulates that a firm’s only responsibility is to its shareholders. Contrast this with stakeholder theory, which says that companies have social and moral responsibilities in addition to the fiduciary duty to their shareholders.
Many people view these two ideas as essentially opposed to one another. However, that’s not necessarily the case. Generally, this mistaken view is based on a misreading of the shareholder theory.
Friedman’s idea can be taken as conditions under which a firm should solely prioritize profit to the shareholders. This is done in order to highlight why stakeholder benefits are so important to the long-term health of a company.
For example, shareholder theory states that companies have no competitive advantage in acts of charity or social responsibility. One dollar donated to a charity is the same no matter which company it comes from. Since this is the case, CEOs and other business leaders are just choosing their own pet causes with other people’s money when they donate to charity.
But this reasoning falls apart beyond charitable donations. Perhaps money donations are the same to a charity regardless of the source, but many times companies can put their infrastructure and expertise at the service of charities or begin social initiatives themselves and have a significant efficiency advantage over other businesses.
Physical donations of clothes or raw materials from apparel brands would help clothe the needy more than dollar contributions from other companies and they would spare existing charities the need to build and maintain their own manufacturing and distribution channels.
Other companies have perfected last-mile delivery services and as such have a unique opportunity to help transport needed materials like medicines and technology to underserved communities. So the idea that there is no competitive advantage in social programs is simply not true most of the time.
Shareholder theory takes the lack of competitive advantage as a premise for why companies should focus on maximizing profits and returns to the shareholders so that those individuals can decide what causes to contribute to. But it is on the individual level that competitive advantage actually disappears, which supports the idea that charities and social programs are better served by businesses that contribute their expertise and mobilize their supply chains in ways that would not otherwise be possible.
From a business standpoint, these contributions are also a convenient way to offset overproduction and they may also be tax-deductible. Given agreeable conditions, these acts of social responsibility can help boost shareholder profits in the short term as well as build a positive outlook for long-term returns.
The Business Ethics of Stakeholder Theory
Fairness and equality likely appeal to people on the individual level, but they aren’t great motivators for companies concerned about the bottom line. Luckily, stakeholder theory doesn’t base its usefulness solely on these abstract concepts even if the rhetoric surrounding the theory is usually worded along those lines.
Benefitting investors, suppliers, employees, and users is the best way to ensure the long-term health and profitability of a company. Since equity is a measurement of an imagined liquidation less debts and other payments, the long-term health of a company directly impacts the short-term benefits to shareholders and other stakeholders.
In that sense, the business ethics and the financial benefits of stakeholder theory are one and the same. Other more typically ethical considerations work in more qualitative ways. For instance, employees may work harder or stay longer with companies that have a positive social impact.
Without getting into absolutes or altruism, it simply stands to reason that the business process should benefit all parties involved or else there will be little incentive to keep it going. Accounting for stakeholders and ensuring they see benefits is ethically better than prioritizing profits to shareholders alone, but that doesn’t mean there isn’t a profit motive under riding stakeholder theory as well.
Ethical principles such as cooperation and trust give firms a competitive advantage by allowing them to be more flexible and strike deals or contracts with stakeholders that would not be possible if all parties were concerned with nothing but financial gains.
Value Creation: Relations in Stakeholder Theory
One of the central tenets of stakeholder theory is that companies increase their worth when they meet stakeholders’ needs in a mutually beneficial way. The mechanism for passing benefits along to and among stakeholders is based on the relationship between them in the structure of the business.
Stakeholders have different utilities and individual opportunity costs that compound into the total opportunity cost of production for the company. Value creation occurs when the consumer pays more for the product than it cost to produce, including the opportunity cost from stakeholders.
Each stakeholder that plays a role in the supply chain or production and distribution line has a bottom line with opportunity costs and expenses. For this reason, every stakeholder is kind of like a microcosm for the business process as a whole. The firm is a hub that combines all these interests into an aggregate and provides for value creation to the benefit of everyone involved.
But defining the relationship between the hub and stakeholders at different stages and levels of involvement is challenging. There are no definitive guidelines because the relationships between stakeholders and the central business are defined by individual contracts and differ depending on the nature of the business itself.
Traditional business models view investments, acquisition, and manufacturing as inputs that the firm coordinates until delivering a final output to the customer. Owners and shareholders are thought to hire management as their stand-ins or agents to handle this process.
However, companies with this limited model in mind create ample opportunities for corporate malfeasance and cut out other important actors needlessly. Businesses naturally have many more connections beyond investors and suppliers. For example, a company usually has the following kind of relationships beyond the production cycle:
Everyday people like having successful companies in their city or neighborhood. These companies provide job opportunities and ideally return some charitable donations to the community itself.
Highlighting a home city or selecting a location for a headquarters has a humanizing effect on large businesses, while small businesses tend to highlight their hometown connection from the earliest stages.
- Trade Associations
Whether they lobby government bodies or just protect the interests of the industry as a whole, trade associations are important engines of opportunity for member companies. They can increase local interest and facilitate social interaction between members, or they can seek new investments and clients for the industry.
Competitors can be stakeholders through vehicles like trade associations. While you might not be sharing any of your profits with the competition, you still have a common interest in sustaining the industry as a whole. Trade associations help in that endeavor.
- Environmental Groups
Misreading the Friedman doctrine has led many companies to recklessly overproduce with little concern for the effects their production has on the environment. The moral concern may seem outside the scope of duty for people with a strict reading of corporate responsibility, but customers and actors in the production cycle are more likely now than ever before to have a large concern for the environment.
Protecting this interest are groups that try to incentivize or support big changes to an industry with strategies that may or may not be related to government initiatives or regulatory bodies. Companies that protect environmental interests as stakeholders add benevolence to their brand and have access to a wider body of marketing points.
- The Media
Stakeholder media progresses beyond the impartiality that was thought to be an indispensable part of the news in decades past. More and more news networks are being founded and controlled by people with a vested interest in the stories they cover according to the American Press Institute.
That may sound like a recipe for biased coverage, but because these media outlets don’t disguise their interests, they are geared toward people who already agree that a given topic is important and want to know more about it. Often, stakeholder media has more expertise and a far deeper understanding of relevant issues than traditional media does.
As global issues become more pressing in the 21st century, neutrality is no longer the standard moral stance. Rather, people have come to expect transparency so that they can hear arguments. Media that covers a given industry or trade should be treated like stakeholders because they are a vital link to the public.
- Financial Institutions
Unless they have a direct investment or your business is somehow related to finance, banks and investment firms are unlikely to have a vested interest in your company in particular. However, financial institutions monitor markets when they determine interest rates and gauge confidence levels, so better business benefits them as well.
Where public policy initiatives involve regulating businesses, protecting the environment, employee benefits, and other problem areas, governments should be considered stakeholders. Not the least because they could resort to stricter regulation if their goals are not met.
The minimum wage is a classic example of government initiatives that apply directly to businesses. Rather than trying to find ways around paying a minimum wage, companies can consider governments as stakeholders and public policy as another party interest. If companies can pay more than the minimum wage, then regulations will remain static and the share value will stay more consistent into the future.
Does Stakeholder Theory Necessarily Rely On Compromise?
Detractors of the stakeholder theory argue that it naturally tends toward compromise among interested parties. Where the shareholders’ interests are not perfectly aligned with suppliers or the community, the company owners must have to make some sacrifices, right?
Thankfully, that’s not how it works. Stakeholder theory seeks to illustrate how all parties to a business process have a shared mutual interest and are not antagonistic parties in the way classic economics guessed they were.
Stakeholders are people and organizations who are affected by and can affect the success of a business. In that sense, they all have the success of the business as a priority. Individual goals and desires don’t necessarily contradict that priority.
Value creation is a collaborative effort according to stakeholder theory. Shareholders must understand that position so that the long-term benefits of strategic stakeholder initiatives are clear.
Productive stakeholder relationships also reduce risk and ensure greater company health. If the role of business in general or industry in particular begins to change, stakeholders will work with companies who benefit them to try and keep things as they were.
Companies that take care of their stakeholders rather than naively providing only for their shareholders are making a unique value proposition and deepening stakeholder interest in the business’ survival long term.
Stakeholder theory is an application of business ethics, but that’s not the only reason managers should use it as a framework for strategic thinking. Long-term company health and future profits are more likely if all stakeholders see benefits when business is good.
The interests of shareholders and stakeholders aren’t opposed like some people seem to think. Since everyone has an interest in the company’s success, business processes can be mutually beneficial.
Applying stakeholder theory will look different from company to company because no two organizations operate the same way. Failing to account for all the people affecting and affected by company success is a needless harm to the health of the organization.
Managers and owners can use the information in this guide to protect the long-term health of their businesses and turn their organization into an invaluable cornerstone of the community.