Corporate responsibility
GEOFF COLVIN: Do you think of American corporations these days as generous, big-hearted and socially responsible? Or as amoral outsourcers obsessed with the stock price? Surprising new research and new attitudes are changing the way executives and investors think about corporate social responsibility. And in the long-running war between the suits and the Birkenstock brigade, there's seemingly less to fight about. Marc Gunther is a senior writer at FORTUNE magazine and author of Faith and Fortune: The Quiet Revolution to Reform American Business.
Marc, in your book you say a growing number of big corporations now believe that doing good is good business. After all that has happened with Enron and Tyco and WorldCom and Adelphia and the mess at Fannie Mae, why in the world would anybody believe that?
MARC GUNTHER: Because it's true would be the reason I hope they'd believe it. And I think the way to think about it is to take a little bit longer view and get beyond the scandals. I mean if we were to go back 10, 15, 20 years, on the environment most corporate executives hated the environmental groups and vice versa. Now you see them working hand in hand to try to solve problems like global warming and to become more efficient in their energy use.
Look at the composition of the workplace. Companies were essentially enclaves of white males if you go back some period of time. Now they're incredibly diverse, much more reflecting society, more opportunities for people, the quality of products, how products are made. When you and I were growing up, we didn't think about where our sneakers and T-shirts came from. Now there's a whole movement out there to protect the rights of people making clothes and shoes in factories in the developing world, and it's a movement that big companies like Gap and Timberland have embraced. So if you take any kind of long-term view, you can't help but see that companies are more and more aligned with the broad goals of most Americans.
COLVIN: And they do seem to be finding, companies do seem to be finding that this is a financially advantageous position for them to take. But it has to be said that an awful lot of companies were dragged into this realization rather than welcoming it with open arms, right?
GUNTHER: Well, there's no question about that, and one of the surprises is that probably the company that has the most sophisticated view of corporate social responsibility today in America I would argue is Nike, and of course they got dragged into it. They got hit by the scandals where kids were making basketballs and sneakers.
COLVIN: The sweatshops, right.
GUNTHER: Now every time, not only are they rigorous in their monitoring of factories in the third world, but every time a Nike employee takes a plane trip somewhere, they're measuring the carbon emissions and offsetting it by planting a tree somewhere else. Now you can laugh at that. You can say that's a Birkenstock or a Ben & Jerry value, but believe it or not, talk to people at Nike. They feel very good about working at a company where the CEO and others care about the environment and where they know the products they're going to sell are not coming out of exploitative factories.
COLVIN: Well, and this gets to what turns out to be one of the main reasons this kind of behavior is advantageous for companies, which is the effect on employees. Is this number one?
GUNTHER: That's absolutely number one, and I think the reason is fairly obvious when you stop and think about it. All the surveys I've seen show that roughly half the people who go to work in America every day don't care about what they do. About 25 percent seem to care a great deal, and a small number are going to work to actively undermine what their company is trying to accomplish.
COLVIN: What we always suspected.
GUNTHER: So if you're an owner of a company, a CEO, don't you want to get the most engaged, the most committed people, the people who say I'm proud to go to work at Starbucks, I feel good about Timberland, I love working at Herman Miller, I'd do anything for UPS? - I'm ticking off the companies I write about in the book. Southwest Airlines, all you have to do is get on one of their planes and see the energy level and commitment of the people who work there. And that's what these companies are really tapping into.
COLVIN: There's another factor that has been a big influence on these companies and it's fairly new, and that is the so-called non-government organizations. They call them NGOs in the rest of the world. What effect have they had?
GUNTHER: They've had a tremendous effect, and the way I would think about that issue is this. We all know on a local level that good companies do well. The mechanic who's honest, the restaurant in town who employees teenagers and treats them decently, because their reputations spread in a small town. What NGOs have really done, combined with the Internet and the media, is turn the world into a small town. So if you are an oil company and you are fueling corruption in Nigeria, you can't do it quietly anymore. And because reputation matters to these companies, they pay a lot of attention, as well they should, to groups like Amnesty International, Greenpeace, the Sierra Club. These are groups that sit down and talk with people at these companies, and their views are taken seriously now.
COLVIN: You raise a good point. I have spoken with some of the protestors at these big meetings of the G7 and the G8 and so forth, and they have said forthrightly they couldn't do what they do today, they couldn't organize these protests - that you may disagree with violently, but they do have an effect - they couldn't do any of this stuff without the Internet. Is it fair to say that that really has been a huge factor in what we've seen?
GUNTHER: Yeah. There's a book out about transparency in companies called The Naked Corporation…
COLVIN: By Don Tapscott.
GUNTHER: By Don Tapscott, and his argument is because of the Internet and because of other pressures in society, companies can't hide anymore, and the less they can hide then the more they have to feel good about all their practices, whether it's accounting, employee practices, environmental practices. Now I don't want to get carried away here. Not every company is rushing in this direction, and there are a lot that are saying I don't want to be bullied by the NGOs, I don't want to tell people what I'm doing. But my argument is more and more are being sensitive and the laggards, such as they are, are coming under pressure, and that would be companies like a Wal-Mart or an Exxon which have been slow to embrace these issues.
COLVIN: Who are the companies that have been quick to embrace these issues, the real leaders as you see them?
GUNTHER: Well, what I really do see is a kind of a seeping of the Ben & Jerry's, Timberland, Stonyfield Yogurt, New England Granola kind of companies into the mainstream. So the leaders are really those smaller companies that said "We're going to be green. We're going to be socially responsible. We're going to give away our profits." But that ethic is now part of companies like Johnson & Johnson, which has been driven by values for a long time. Herman Miller, which runs an environmentally very forward thinking company, all their furniture is made out of non-toxic materials. It's easily recyclable. The employee relations at UPS and Southwest, which hire and promote almost entirely from within and have created a tremendously valuable esprit décor. I mean, it's actually a fairly long list. Starbucks has decided, because they think long term, that rather than buy coffee on the open market at X cents per pound, they are going to pay a much higher price but they're going to build long-term relationships with the suppliers in the Third World so that those suppliers do well, so that they're environmentally responsible, so the quality of coffee is good. And by thinking of things that way, Starbucks says that's good for business in the long run.
In fact, if I was going to sum up this whole change, Geoff, I would say it's a shift from the industrial model of thinking about business as a series of transactions, where you're always trying to get the better of the other guy, you're going to try and charge your customers more, you're going to pay your employees less, you're going to squeeze your suppliers. That really is the factory line model of the early 20th century. Now businesses that are thriving are thinking of all their transactions as relationship-driven, that it's a win-win with your employees. You're going to pay them as much as you can afford to pay them so that they feel good about coming to work. You're going to want your suppliers to thrive so you can thrive, and of course you're going to serve your customers. You're going to take that word service in a very serious way.
COLVIN: And as you say, it's certainly not true that every company does that. But you are saying that those that do it are finding it pays.
GUNTHER: Absolutely. I mean look at the reputational hits that companies known for poor customer service have taken over the years. The cable industry, which I pay a lot of attention to, is still trying to dig itself out of a reputational problem created by John Malone throughout the early '90s. They're doing better today, but they're still paying a price for it as their industry becomes more competitive.
COLVIN: There was a lot of talk in the last election about the role of moral values and how Americans feel about them and so forth. Is there something societal going on that's influencing what you're describing in companies?
GUNTHER: I do think there is. And one reason I think you find that the companies that treat their employees well also are good, say, on the environmental issues -- Starbucks, UPS, Herman Miller all fall into that category -- is that it does spring from the values of the company and it does go to a sense of what is the purpose of a company.
This is going to sound like a crazily radical thing to say, but it isn't -- the purpose of a company is not to generate profits. Profits are essential. They're like our blood, they're like the air we breathe or the food we eat. But we don't get up in the morning and say, "I'm going to breathe today, I'm going to eat today." We have a larger purpose, and the great companies also have a larger purpose. It may be to sell great technology. It may be at Southwest to get people from place to place in an affordable way. But that's their big purpose, and from that purpose profitability and big business success then flow.
COLVIN: Can these companies you're talking about ever say any of this stuff out loud on Wall Street?
GUNTHER: They do say it out loud. If you talk to Herb Kelleher, as you have, Geoff, you know that he is driven by a mission that's greater than quarterly earnings.
COLVIN: But my question is does Wall Street buy it? If you say it to them, are they going to roll their eyes? Or are they going to say, yeah, this is a company I want to know more about?
GUNTHER: I think they're going to roll their eyes today, but I think they're slowly coming around. I think they see the success of these companies. I mean Southwest and Hewlett-Packard and Johnson & Johnson are fantastic companies. Look at the price of the stock of Starbucks over the last 10 years. When Starbucks came out and said they would give their part-time employees health insurance, I doubt Wall Street applauded, but today they think it's a pretty good model.
COLVIN: Marc Gunther, thank you.
GUNTHER: Thank you, Geoff.
Real estate
KAREN GIBBS: For five consecutive years, investments in real estate have outperformed the stock market. It used to be a game for the big boys who buy and sell property around the country. Savvy investors have also been getting into the action through real estate investment trusts, or REITs. But now it appears we're all becoming mini Donald Trumps. Almost a quarter of all homes purchased last year were for investments -- not shelter. Signs of a bubble, or prudent investing? Andrew Davis manages the Davis Real Estate Fund and joins us in the studio to tell us more.
Well, Andrew, is a housing bubble the same as a real estate bubble? There seems to be some fear that we're on the edge.
ANDREW DAVIS: I think the key thing is to understand that there are several kinds of real estate. Housing is but one kind, and housing, you generally don't know how much money you're going to make on it until you sell it, so in that sense it's speculative. The kind of real estate that we do most of our investing in is real estate that actually has leases, and these leases are contractual obligations. They're for office buildings, apartment buildings, self storage facilities, industrial space, all of these. So when we talk about a bubble, we want to be very careful about the terms that we're talking about, and you I think are specifically referring to housing.
GIBBS: Do you think investors are seeing it only as housing and missing the big picture of real estate investment trusts?
DAVIS: Well, housing is the easiest one to talk about because so many people own a home now, so it's very easy. Everybody is very aware of it. And I think when we talk bubble, if I had to be concerned about anything I'd think about maybe the coasts of the country, whether it's Los Angeles, San Francisco, Palo Alto on the West Coast, San Diego, and maybe Boston, New York, DC, down in Miami, southern Florida, those areas as well. They all feel bubbly a bit. But if you start looking at the rest of the country, it doesn't feel quite so much, so I don't worry quite as much I think as others do.
GIBBS: Why do you think the coasts are having such a bubble in price and in real estate of homes?
DAVIS: Well, it comes down to land an availability of it, and you know on Manhattan Island there just isn't anymore land. They're not making anymore of it. Now in Texas you can continue to push out further away from Dallas into the suburbs, and as a result housing pricing can be constrained by the cost of new development. In New York that's not necessarily the case. Demand can really drive that, and demand has been pretty good lately.
GIBBS: And housing is one of the few investments that actually continues to appreciate.
DAVIS: Yeah, I actually can tell you that it's actually been 54 years, pretty much since the government started keeping the statistics, the average price in the United States for housing has never gone down. Now I don't, again I don't know if that's good or bad. It's really not, again, we don't focus our fund in investing in this kind of real estate, in single family home developers and whatnot. But it does give you reason for pause that something that's gone up for 54 years in a row has, can it continue to do so?
GIBBS: Well, let's talk about your fund and the real estate investment trusts that you find attractive right now.
DAVIS: Well, I think the overall worry that people have with real estate investment trusts is they think the same thing, that we've had great returns for a number of years now. What I try to keep people focused on is the fact that in the early '90s and certainly in the late '80s, returns on real estate were disastrous, so coming out of that depression of real estate, we're now at a point where we can look at investing in these businesses and think of them not as real estate investments but as businesses that use real estate as their product, much in the way Microsoft uses software or Ford uses automobiles, that real estate is a product on which you try to earn a return.
GIBBS: Can you expand on that a bit more, how real estate investment trusts could be considered like a GE or a Microsoft…
DAVIS: Well, sure. I mean again it comes down to return on invested capital. It's how much can you earn? What's your return going to be? I mean we all understand what a return is. That's what we're trying to get. Using real estate as the product is what these real estate investment trusts tend to do.
Now the difference is that historically, there have been REITS for many years. I mean in the '70s there was an iteration of REIT that failed very badly. In the '80s it failed as well, generally because they were horribly conflicted. Managements thought like managers. They didn't think like owners, and that, usually when you don't have alignment of interests where the money is really earned and shareholders earn money, management makes money, that can be a problem.
We don't see that now. We see a real alignment of management and an alignment of shareholder interest, and that's very different.
GIBBS: Well, what changed? Why is real estate looking better now?
DAVIS: Well, what changed I think is we did come off a depression in real estate, and so that gave a lot of opportunity I think to intelligent investors who looked in the morass of real estate and said, you know, real estate is still, it has value, but what you pay for it is really what counts. So we spent a lot of time looking at those kinds of businesses and trying to find people that we considered very smart who were running some of these REITs. And now what we're finding is that real estate managers who are really good, they're buying real estate when it's appropriate, they're selling it when it's appropriate, they're building it when it's appropriate. They're not just trying to build giant kingdoms of real estate. They're trying to build profitable niches of real estate, and that's a big change from the 1980s.
GIBBS: Who are some of the good ones that are building these profitable niches?
DAVIS: One of our favorite businesses is CenterPoint Properties.
Now there are two things about CenterPoint that I think are very important. One is it focuses its efforts in Chicago and on the industrial, on industrial real estate, so it has a niche in that area. Now it's five times bigger than its nearest competitor and Chicago is a 1.2 billion square foot market. I always have to remind myself a billion is a one followed by nine zeros. I mean that's a lot of space, and they only have a 6 percent or 7 percent share, so there's a lot of room there so I think they have a protectable franchise. Then you talk about the management team they have, and management, I argue that they could run any business in the FORTUNE 500, any business. They are that sophisticated. Their CFO is top drawer. Their CEO, newly-appointed CEO, their prior CEO just retired, he has been in the Chicago market for practically his entire career. He really knows what he's doing, so this is a good business and one I said that has a defendable niche, and that's something that we look for.
GIBBS: Good business and defendable niche, but it still has some headwinds, and I'm talking about signs of maybe a sluggish economy, this week's leading economic indicators declining for the fourth month in a row. And the Fed has already signaled that interest rates are on the rise, and prevailing wisdom says both of those things are bad for real estate.
DAVIS: It does. This is a very interesting, we've lived through a very interesting decade and it continues to be interesting. Think of the last recession, the one we're now more or less pulling out of. This was a recession where real estate did incredibly well. The economy was in the doldrums, we had a terrorist attack. The economy shut down for a period of time, yet nonetheless real estate seemed to do well. Well, why? The cost of capital, interest rates. Interest rates have remained very low, and that usually augers pretty well for real estate, but in the long run you're exactly right.
What we would ideally like to see is a better economy, we'd like to see a little inflation -- not a lot now -- but just enough inflation to keep rents moving forward, and that is the type of environment that we'd like to see. One of my heroes in the real estate world, a guy by the name of Milton Cooper who is the CEO of Kimco, he talks about what he would like to see, and he talks about exactly that, a better economy, interest rates that are slightly higher, and a little bit of inflation, and that recipe makes for a very good marriage in the real estate world.
GIBBS: Well, you know even some folks on the Federal Reserve are getting a little bit nervous about some of the prices that they see in the real estate market. Do you think higher interest rates might cut some of that froth?
DAVIS: Yeah, it's one of the great conundrums in the world of real estate right now, which is I think the general wisdom argues that if interest rates back up, that's got to be bad for real estate.
Now what I find is that, yeah, it's bad in one way and one way only. As the rates move up, cost of capital goes up, and interest expense goes up, and the more you're paying out in interest, the less you have in earnings, so that's not good news.
But the good news is that higher interest rates mean that the marginal building doesn't get built, and nothing kills real estate quicker than supply. If you want to understand competition, I mean imagine owning an office building and somebody puts up an office building right across the street from you. You're going to be competing on rent, on space, on everything. That's what kills real estate, new supply. Higher rates slow supply down. So we think in a way in a longer run that that's not bad news.
GIBBS: What about hotel REITs?
DAVIS: Hotel REITs, I love to pick on them only because it's the single most difficult product to put in a REIT. Remember REITs pay dividends, and dividends, the way you get secure income is by signing leases that are relatively long. Imagine again you want to have a three-year lease, a four-year lease. Even with an apartment building it's a one-year lease on average, maybe six months to a year. How long is a hotel lease? Well, think, when you go to a hotel, what do you do? You sign in for the night. It's a one-day lease. So they literally have to reinvent their book every day. Now that's a very tricky business from the standpoint of structure. Now there are certainly very good hotels out there, and I mean Starwood Lodging is a company that we've owned for some time and we still like it. But as a REIT, I'm not sure that the hotel business is ideally situated for it.
GIBBS: When we're looking at some of these REITs, in particular we talked about the lifestyle REITs, we're seeing an explosion in the retail real estate market, particularly in Seattle, Orange County, Phoenix, Oakland, and how can we forget Las Vegas? Talk about these high-end lifestyle centers that seem to be putting almost those closed malls to bed?
DAVIS: Well, the closed malls aren't necessarily going to bed. What they're doing is they're adapting. Now there are some enclosed malls that do incredibly well. There's no question. I think what's important is to understand the mall business itself, its death has been predicted too many times. I mean if we remember the catalog businesses were going to wipe out the need for a shopping mall. Then it was the Internet. It was going to wipe out the need for the shopping mall. The reality is the shopping mall is a relatively good place to do business. If you're a tenant and you have product to sell and you want to get national distribution quickly, you can go to one of many now shopping mall companies who can get you space in malls all over the country and now internationally as well. I think that's a trend we're going to see more of is international acquisition.
GIBBS: You have General Growth in your portfolio. Is that looking at a shopping mall or do you see something else?
DAVIS: General Growth is a great business.
Again, they are in the enclosed shopping mall business. They own more than 200 malls around the country. What I like about General Growth predominately is the alignment of management and shareholder. Again the management team owns more than 30 percent of that company. Now when you think about them spending your earnings, I mean you as a shareholder are entitled to those earnings, and to the extent that they're not dividended out to you, you're counting on them doing a good job with that money. Thankfully these guys seem to do a very good job. They're very good at taking an average mall and making it a better mall, and as a result getting a very good return on that.
GIBBS: In the big picture for investors, how should they look at themselves? As an owner or as a landlord?
DAVIS: That's a tough question. I think you have to have a little bit of both in the real estate business. I mean the landlord business is a pretty good business when handled properly. I mean generally you want happy tenants, you want people who think highly of you in that business, and you want to make money off of it. But there's no question ultimately when you buy shares in one of these companies, you're buying a management team that is acting as a landlord on your behalf. You want them to do a good job.
GIBBS: And is that a difference from the old way of doing business, the kingdom builders or so?
DAVIS: I think yeah. That's been a big change for this iteration of REITs, the REITs that really started in 1992 and have existed very profitably until today. The old adage was bigger is better, we want to own as much real estate as we possibly can. And you can think of many people who sort of built these kinds of kingdoms in the real estate world. Well, the message today that I like to think about is profitable real estate. It's not about building the biggest kingdom. It's about building the most profitable one, and those are the kinds of businesses we want to be a shareholder of.
GIBBS: Andrew Davis, it was a pleasure. Thanks very much for joining us.
DAVIS: Thank you. Nice to be here.
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