Stakeholder Theory Overview
Milton Friedman is one of the most famous economists of all time. He put forward a theory (among many others) that companies are ultimately beholden to just one stakeholder - their shareholders.
He called this 'Shareholder Theory'. Stakeholder Theory is in many ways a direct contradiction to the mono approach suggested by Friedman, in that it suggests that organizations are responsible to many different stakeholders, of which shareholders are only one.
When you think about it, your own position on this is probably one of the first things you should do before creating a strategic plan. It goes to the very foundations of what you want to achieve and why you're doing it.
Are your shareholder interests your #1 priority and it’s all about making money? Or are you here to also improve the lives of internal and external stakeholders - your employees and the community?
There are countless strategy frameworks out there, and we have already covered a few key frameworks which we think are extremely flexible and battle-tested over the years:
- Value Disciplines Model & Your Competitive Advantage
- The Ansoff Matrix Helps Organizations To Grow
- Maslow's Hierarchy As a Business Framework
- Unlocking the Power of the Balanced Scorecard
- Using the VRIO Framework to Create Sustained Competitive Advantage
- McKinsey's Three Horizons of Growth Can Help You to Innovate
In this post, we're going to explore not only what the stakeholder theory actually is, but also the benefits of applying it to your business and how to go about doing that.
What is Stakeholder Theory?
Stakeholder theory is based on the assumption that businesses can only be considered successful when they deliver value to the majority of their stakeholders. It goes hand-in-hand with CSR (Corporate Social Responsibility) and, therefore, sustainability as well. That means that profit alone cannot be considered the only measure of business success, and value creation is not just about money.
One of the first and most influential books that explore this approach is Strategic Management: A Stakeholder Approach by R. Edward Freeman. A very interesting read for all business leaders that see various stakeholder interests as crucial factors for success.
Stakeholder theory is widely applicable and can be used in many key fields such as project management, strategic management, and business ethics.
Now let's take a look at some of the common stakeholders for a typical business:
No problem here - despite stakeholder theory being positioned as the antithesis of shareholder theory, the reality is that shareholders (or yourself if you own the business) will always be one of the biggest stakeholders you are responsible for.
They are, therefore, entirely in keeping with the philosophy of stakeholder theory.
Another no-brainer, even the most hard-nosed business person will agree that happy employees are a good thing.
Customers are another obvious stakeholder group to consider in the ecosystem of your business.
You can define community in a variety of different ways, from local to virtual. Either way, they are a key player in stakeholder theory.
Friends & Family
This may seem a little odd, but your own friends and family (as well as those of your employees) are also critical stakeholders to satisfy under stakeholder theory.
Now things are getting a bit weird - why would you want to satisfy the needs of your competitors? Well, stakeholder theory suggests that a healthy competitive environment benefits everyone, including other stakeholders such as customers.
There are plenty of other stakeholders you could identify such as suppliers, unions, trade associations, political groups, etc.
As you read the list above, you might think to yourself: "Sure, it makes perfect sense to keep the likes of my employees and customers happy - because the happier they are, the more money I'm likely to make." And this is one of the most common misunderstandings behind the stakeholder theory.
The stakeholder theory is not all about keeping stakeholders happy to make more money - and is, therefore, less prone to be exploited by managerial opportunism.
Instead, it argues that companies play a vital role in the very fabric of our society (creating jobs, innovating, etc.) and that therefore their success must be valued as a whole, not just in the returns they make for their shareholders. It’s about value maximization, not wealth maximization.
Benefits of Stakeholder Theory
Here's where things get a little complicated. Despite what I said in the final sentence of the previous section of this post, there are financial benefits to applying stakeholder theory to your organization. They include things such as:
- Higher productivity through employee satisfaction
- Improved retention/referrals from happy customers
- Increased investment from happy financiers
- Improved talent acquisition from a positive image in the community
So yes, applying stakeholder theory can literally help you drive profits to your business. However, these are more incidental outcomes of applying stakeholder theory than the benefits of the philosophy itself.
To understand the true benefits of stakeholder theory, we have to look at a more ethical/societal level. I'm talking about things like:
- The increased mental health of the workforce through job satisfaction
- Scientific progression which benefits all
- Elevation of the socio-economic status of the local community
- Contribution towards a healthy competitive ecosystem where other companies can also thrive and bring benefits to their own stakeholders in turn
And, on an entirely personal (and selfish) level:
- The opportunity to work with like-minded awesome people who believe in making a difference
- The sense of pleasure one derives from being part of positive change in your own little corner of the world
I actually liken the stakeholder theory to implementing Maslow's Hierarchy of Needs, in which Maslow states that to achieve true happiness one must go beyond material wealth toward a state of self-actualization.
The stakeholder theory is a great way to work towards that for both yourself and your company. By looking at things from a stakeholder perspective you can emphasize with their basic needs and help them move up the Maslow pyramid.
So, if making the world a better place and likely achieving a whole range of profitable side benefits sounds like your kind of thing - the stakeholder theory might just be for you.
Stakeholder Theory Example
To provide an example of how stakeholder theory works in reality, let's use Cascade as an example. Say a few years down the line we decide that an IPO is the best course of direction for Cascade. The shareholders would obviously want to see the value of their stock rise, and we want this to happen as those shareholders have money invested in us.
This is where stakeholder theory says that these investors are only one class of stakeholders involved. Stakeholder theory takes into account all our other stakeholders, such as employees, customers, contractors, etc. Meaning we can't only consider our investors in our decision-making process. We need to make a thorough stakeholder analysis and take into account their needs when making decisions.
Applying the Stakeholder Approach to your Business
We've presented the stakeholder theory as one of a number of different strategic models that you can apply to help your organization succeed. You may even have found your way to this post from our popular 5 of the Best Strategy Frameworks post.
But I'll say upfront that the best way to apply the stakeholder theory model to your business is in conjunction with another business framework. That's because the stakeholder theory model isn't really a strategic framework - it won't help you to innovate or grow your business directly.
Instead, it's more like a way of running your business, in a manner that's aligned to your own personal values.
Step 1: Define Your Stakeholders
Begin with stakeholder identification and figure out who your stakeholders are. You can start with the list we prepared above, but you need to think carefully about your own personal set of circumstances.
The normative approach is to examine the function of your organization and then decide who you care about. Who will be impacted by your work and activities? Which constituencies is your board of directors willing to consider? List them out in simple bullet point form - you should have at least 5 or 6 and possibly many more.
Keep in mind that you’ll also have to create stakeholder engagement plans - at least for some groups. Without engagement, they’ll just be letters on paper.
If you're struggling to come up with a satisfying list of stakeholders, talk to your colleagues, friends, and family - ask them whom they think your organization should consider a stakeholder.
Step 2: Analyze Your Activities
Look at your strategic plan - the objectives, goals, projects, and KPIs you use to run your business. Start categorizing these activities into the list of stakeholders you have identified.
Do this by thinking about which stakeholders will benefit from your success against any given goal.
- Focus on the 'outcomes' or 'objectives' in your strategic plan rather than the projects and KPIs.
- Don't think of this as a 1:1 relationship - a single outcome can contribute to multiple stakeholders.
- Don't be afraid to think broadly - it's likely you won't have specific goals that are aimed at friends and family for example, but by thinking laterally you'll probably find that some of the things you're working on will help your friends and family indirectly at least.
Step 3: Understand Your Gaps
Let's be realistic - the majority of your goals will likely be contributing to either your shareholders, customers, or employees. At least that's true for most commercial businesses.
And that's perfectly ok. Have a look at how your own strategy maps against the stakeholders you've said you consider important. Does the breakdown look about right? This is how it looked for us here at Cascade:
So if I summarize Cascade’s stakeholder alignment as our mini-case study:
- We're predictably highly focused on shareholders, customers, and employees.
- We have more goals contributing directly to customers than shareholders - which makes sense as we are arguably more product-focused than sales-focused as an organization.
- We're doing more in the competitor space than I expected - I suspect that's because part of our strategy is to help actually create/define the market for strategy execution software.
- We are seriously under-represented in the friends/family and community stakeholder groups.
The biggest action for me comes around that last bullet point. I really do value the positive impact we can have on our community and will be recommitting to tangible activities that can help this stakeholder group.
Step 4: 'Do Something Different'
The whole point of exercises such as this is to aid your understanding of your own organization, but then to take tangible steps to address any gaps that you identify.
Hopefully, you've found this approach of reviewing your strategy interesting and insightful. Don't forget to check out our article on the 5 Best Strategic Frameworks - you'll want to implement at least one of them alongside your implementation of stakeholder theory.
Let me leave you with a final question to ponder. Imagine a business that:
- Has hundreds of incredibly happy employees
- Creates awesome products which significantly enhance the lives of their customers
- Has increased employment prospects for the local community
- Has inspired its competitors to improve their products and their customer service
Sounding pretty good so far right? Here's the final bit of information: They consistently make a loss of $1 each financial year.
Do you consider this a successful business or not? Would your answer be different if they made a profit of $1 a year instead? The answer will be a personal one but is a great way to test your own position on stakeholder theory.
Bonus - a few classic texts by experts and theorists for those of you who want to dive deeper into the topic:
The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications by Thomas Donaldson and Lee E. Preston
Stakeholder Theory: The State of the Art by R. Edward Freeman, Jeffrey S. Harrison, Andrew C. Wicks, Bidhan L Parmar, Simone de Colle
Stakeholder Theory and Organizational Ethics by Robert Phillips
Toward a Theory of Stakeholder Identification and Salience: Defining the Principle of Who and What Really Counts by Ronald K. Mitchell, Bradley R. Agle and Donna J. Wood