20

ON THE RIGHT SIDE OF HISTORY

The 1998 International Conference
on Servant-Leadership
Indianapolis, Indiana
August 7, 1998

TODAY, I WANT TO mix some corporate history and some personal philosophy, and try to impart some sense of how the idealistic vision of the servant as leader, and of the leader as servant, can have—and has had—an impact on the pragmatic, dog-eat-dog competitive world of American business. I'm going to use as my example the burgeoning mutual fund industry, next to the Internet, I suppose, the fastest-growing industry in the United States, and the Vanguard Group, its fastest-growing major firm.

What is of interest, I think, is not our mere success—a word so elusive in its connotations that I use it here with considerable reluctance—but the fact that, whatever we have achieved, it has been by marching to a different drummer. Our unique corporate structure has fostered our single focus on being the servant of our fund shareholders, our disciplined attitude toward the costs that they bear, and our conservative investment strategies and concepts (many of which we created de novo). In remarks that I hope will be especially relevant to all of you who are interested in servant-leadership, I plan to demonstrate how so many of those concepts have served us well—implicitly to be sure, but served us well nonetheless—in bringing us to where we stand today.

The Fund Industry and Vanguard

Hesitant as I may be to do so, I must establish my bona fides, as it were, by drawing a brief sketch of the mutual fund landscape today and identifying Vanguard's position in the scene. The mutual fund industry is booming:

• Its asset base has swelled to $4.7 trillion, compared to just $50 billion a quarter century ago—a 90-fold increase, equivalent to a compound growth rate of 20% annually.
• Cash inflow from investors is running in the range of $500 billion per year, compared to an outflow of $290 million in 1974. Mutual funds have become the investment of choice for American families at the moment, accounting for 100% of net additions to the financial assets of our households.
• Twenty-five years ago, the market was tumbling, with the Dow Jones Industrial Average on its way to a 12-year low of 578. Today, the Dow is at the 9000 level. While the relative returns of the average managed equity mutual fund have fallen far short of those achieved by the unmanaged market averages, the absolute returns of even the most mundane funds have been little short of spectacular.
• As a result of the great bull market, common stock funds are again the driving force of the industry with 53% of its assets, although money market funds have had their turn as the industry's largest component (75% of industry assets in 1981), followed by bond funds (37% of assets in 1986). This is a market-sensitive industry!
• The character of the industry has changed rather radically. As investors have become better educated, more aware, and more self-reliant, the no-load (no sales commission) segment of the mutual fund industry has become its largest component—surging from just 15% of industry assets in 1979 to 35% currently. In fact, the industry's two largest firms, and five of its ten largest, offer primarily—often solely—no load funds.

Using the conventional measuring sticks, Vanguard, a firm that did not even exist 25 years ago, is emerging as the industry leader. We have by far the fastest growth rate of any major firm, and as a result have become one of the two largest fund organizations in the world. A scattering of measures makes the point:

• Assets recently topped $400 billion, up from $1.4 billion in the mutual funds for which we assumed responsibility at our inception in 1974—a near 300-fold increase, equivalent to a compound growth rate of 27%.
• Cash inflow is running at a $50 billion annual rate, compared to an outflow of $52 million in 1975, an even more extreme turnabout than the industry has enjoyed.
• Typical of the industry, Vanguard funds carried sales loads at the outset. However, we abruptly made an unprecedented switch to no-load distribution in 1977, less than two years after the firm began operations. We led the industry shift to no-load dominance, and are today that segment's largest unit.
• Our market share has risen from 2% of industry assets in 1980 to 8% today, and from 9% of no-load assets to 24%—one dollar of every four invested in no-load funds.
• And, driven by our preeminence in money market funds, bond funds, conservative stock funds, and index (market-matching) funds, we currently account for fully 50% of the net cash flowing into no-load funds. Our three nearest rivals account for 15%, 7%, and 6%, respectively.

My point in presenting you this context is not merely to illustrate, with what I hope is not false pride, our position in the industry, but to set the stage for how and why this situation has developed, and what it says about the important principles of business ethics—so closely aligned with the principle of servant-leadership—we have established for ourselves. Most important of all, I want to strike an important and optimistic keynote at this meeting: that it is possible to do well by doing good, to succeed by serving others, to lead by having principles hold sway over opportunism. Indeed it is my deeply held conviction that, by doing the right things in the right way, we are on the right side of history.

Turning Back the Clock

Let me now turn back the clock. In 1925—nearly three-quarters of a century ago—an aging professor said to his university class, “There is a new problem in our country. We are becoming a nation that is dominated by large institutions—businesses, governments, universities—and these businesses are not serving us well. I hope that all of you will be concerned about this. But nothing of substance will happen unless people inside these institutions lead them to better performance for the public good. Some of you ought to make careers inside these big institutions and become a force for good—from the inside.”

Those words could have as easily been said today. But, as some of you here today will surely recognize, they were in fact the words that inspired a college senior named Robert K. Greenleaf to cast his lot with business as a career. On graduation, he joined American Telephone and Telegraph Company, in important measure because it was then the largest employer in our nation. He described himself as one who knew how to get things done and as a pursuer of wisdom, and his objective was to work on organizational development for the company. He worked there for nearly 40 years, until he retired in 1964.

I have no way of knowing about the influence that Robert Greenleaf exerted on the AT&T organization. But the work he did after his retirement, beginning with his brilliant 1969 essay, “The Servant as Leader,” has surely brought much-needed wisdom and insight to the subject of corporate and institutional leadership in the United States. And I salute with admiration the leadership of the Greenleaf Center for its extraordinary accomplishments in carrying on his crusade.

Remarkable Relevance

I must acknowledge that I did not read “The Servant as Leader” until the early 1980s, well after it had become one of a series of a dozen related essays, published in book form under the title Servant-Leadership. But as I read his words then, and as I re-read them again in preparing my remarks for today, I was thunderstruck by the power and relevance of his philosophy. Not merely to the great world out there, beyond my ken, but to me. To me, directly and personally, as if this man of my own parents’ generation had placed me in the crosshairs of his telescopic sight, and would not rest until he captured the mind of his quarry.

Now, I hope—and indeed I suspect—that many others who have shared in his concepts feel the same way. And that acceptance, that feeling of revelation, more than anything else suggests the force of his mind and the power of his ideas. In this sense, then, the fact that he speaks to me with such relevance may be far more important than if he had in fact been directly responsible for inculcating in me the values and principles of the enterprise I founded in 1974, years before the uncanny yet powerful reinforcement I received from his accumulated wisdom.

What I want to do today is to directly quote at reasonable length some of the words that Robert Greenleaf has written (taking only the most minimal liberties in paraphrasing them), and then describe the extraordinary parallelism their spirit holds with the spirit of Vanguard. I hope in this way that I can persuade you that his dreams of long ago can not only find their way into the hard reality of the world of business, but can form the basis for a corporate success story.

I'm going to touch on five areas: (1) his essay, “Building a Model Institution”; (2) the linkage between foresight and caring; (3) his reflections on the superior company and on the liberating vision; (4) a series of powerful parallel phrases; and finally, somewhat poignantly, (5) his “Memo on Growing from Small to Large.” In each case, I'll then follow with examples of how directly Robert Greenleaf's wisdom has spoken to me, and has fortuitously been manifested at Vanguard.

Building a Model Institution

In August 1974, Robert Greenleaf spoke about building a model institution. Interestingly, he was speaking, not about a business, but about a woman's college affiliated with a religious order, at the celebration of its 100^th anniversary. His blueprint identified the four cornerstones.

As it happened, Vanguard was a month away from its creation when Mr. Greenleaf spoke to this century-old institution. But our resemblance to his model is striking. Our original concept, for example, was to transform the very focus of a mutual fund business from serving two masters—something Matthew describes as, well, impossible—the fund shareholder and the owners of the funds’ external manager-adviser alike. We would be the servant of the fund shareholder alone, since the mutual funds—and thus their shareholders—would own our funds’ manager, and would operate at cost. In effect, our fund shareholders would become the beneficiaries of the entrepreneurial rewards that managers traditionally arrogate to themselves. While I happen to believe that this concept lifts a fund enterprise to nobler stature, the fact that no others have chosen to follow down “the road less traveled by” suggests a profound disagreement with that assessment. So be it.

But it is a fact that our concept of an institution that serves solely its own investors has provided measurably greater effectiveness. The combination of our focus on conservative equity funds, on bond and money market funds of high-quality securities within specific maturity ranges, and of stock and bond market index funds—of which we were the pioneering creators—has worked effectively. Our at-cost operation is now producing annual expense savings to our investors of—think of it—nearly $3 billion. Together, these successful strategies and these minimal costs have provided virtual across-the-board superiority in the long-term returns we have earned for the shareholders of the funds we serve, relative to their peer funds with similar objectives.

While I cannot in all honesty say that we began with an understanding of leadership and followership, the second Greenleaf rule for a model institution, I can say that I've spent much of my career developing similar concepts. For example, in one of my early talks to our tiny 28-person original crew, I said, “I want every one of us to treat everyone here with fairness. If you don't understand what that means, stop by my office.” I constantly stressed the values that I wanted to distinguish Vanguard, above all the need to recognize that both we who serve and those whom we serve must be treated as “honest-to-God, down-to-earth human beings, with their own hopes, fears, ambitions, and financial goals.”

Over the years, I have come to love and respect the term “human beings” to describe those with whom I serve and those whom we at Vanguard together serve. I even gave a talk at Harvard Business School on how our focus on human beings enabled us to become what they there call a “service breakthrough company.” I challenged the students to find the term “human beings” in any book on corporate strategy that they had read, but as far as I know, none could meet the challenge. (Surprisingly, I do not believe that I've seen that term in any of Mr. Greenleaf's vast writings, but I'm certain that he'd love it too.)

Organization structure, or modus operandi, was also integral to our new model of an investment institution. Power and authority would rest not with the managers, as is the mutual fund industry convention, but with the fund shareholders. Of necessity, to be sure, much of the power would be delegated to the managers, but the ultimate authority would be vested in the collective power of those we serve. One rule set forth in modern-day business books is, “treat your clients as if they were your owners.” It is a good rule, but it is particularly easy for us to observe it: our clients are our owners.

It was obvious, of course, that our managers would require more direct oversight than a large mass of widely dispersed investors, most with moderate holdings in our funds, could provide. So we quickly determined that we needed truly independent trustees, who, as in Mr. Greenleaf's fourth and final requirement for a model institution, would be able to provide objectivity and detachment, and in whom the ultimate trust would be placed. Ever since, at least eight of our ten trustees have been unaffiliated with Vanguard in any way other than in the capacity of directors of our funds. In all, the Greenleaf model, described for a venerable institution, was to closely resemble a model created for a new company, with a new concept, that, as he spoke, was just coming to birth.

Linking Foresight and Caring

I now want to single out two subjects that, perhaps surprisingly, Mr. Greenleaf seemed to link: foresight and caring. He led into his subject with a few words about great leaders.

While in 1986 I had not read the essay by Robert Greenleaf from which those paragraphs were excerpted, I had read an earlier speech which must have been the source of his inspiration. It was a speech given in 1972 by Howard W. Johnson, Chairman of the Massachusetts Institute of Technology. It inspired me profoundly, and as 1986 drew to a close, I quoted it amply in my speech to our crew. Note the similarity:

My 1986 speech was but one of many times when I spoke of the importance of caring. Then, I reminded the crew that “only if we truly care about our organization, our partners, our associates, our clients, indeed our society as a whole, can we preserve, protect, and defend our organization and the values we represent.” Again, I emphasized our responsibility “to faithfully serve the honest-to-God human beings who have trusted us to offer sound investment programs, with clearly delineated risks, at fair prices. We must never let them down.”

Five years later, in 1991, I returned to the same theme in a talk entitled “Daring and Caring.” I illustrated daring by using Lord Nelson's victory at the Battle of the Nile on August 1, 1798. That battle is part of our history (indeed at Vanguard, we're celebrating its 200^th anniversary at this very moment) for Nelson's flagship was HMS Vanguard. Only weeks before the firm was incorporated in 1974, I had fortuitously learned of the battle, and, inspired by Nelson's remarkable triumph, chose Vanguard as our name.

At Vanguard, I reminded the crew, we dared to be different, in our unique corporate structure, in our unprecedented switch to commission-free distribution, in our decision to provide candid information to investors, and in forming the first market index fund, an idea considered so, well, stupid, that it wasn't even copied by anyone else for a full decade.

But caring quickly took center stage in my talk. I emphasized that caring must be “an article of faith,” pointing out that each of those daring decisions that I had mentioned was driven by a philosophy of caring for our clients. And I reinforced the concept that caring must be also accorded to our crew, even then urging a spirit of “cooperation and mutual courtesy and respect,” and reminding them that while we were so large as to require a policy manual, “it will never replace our own selves as the ultimate source of a caring attitude.” Yes, a great deal of the spirit of Robert Greenleaf (and Dean Johnson, too) had found its way into our young business enterprise.

The Superior Company and the Liberating Vision

I now want to spend a few moments on Robert Greenleaf's views on the superior company and the liberating vision. Here is what he said:

I leave to far wiser—and more objective—heads than mine the judgment about whether or not Vanguard meets the definition of a superior company. Of course, I believe it does. But I have no hesitancy in saying it is the product of unconventional thinking about what we want to be, how we set priorities, and how we organize to serve our clients. And surely our competitors—even the most successful of them—look with a sort of detached amusement and skepticism at our emergence as an industry leader. We have dared to be different, and it seems to be working just fine.

I cannot responsibly describe the ideas on which I founded Vanguard as part of a liberating vision. But I can tell you that, way back in 1951, I was writing my senior thesis on a little-known industry, which Fortune magazine described as “tiny but contentious” in the 1949 article that first aroused my interest in an industry about which I had never before heard. In my thesis, I sketched out my ideas of how a better industry—if not a model institution—might be built. Nearly a half-century ago, I called for a fairer shake for investors, urged lower sales commissions and management fees, cautioned against claims that mutual funds' managements could produce miracles, warned that unmanaged indexes had proved tough competition for active managers, and ended up with a ringing call for fund managers to focus, not on the peripheral diversions of the business, but on the duty to provide prudent stewardship. “The principal function of investment companies,” I concluded, “is the management of their portfolios. Everything else is incidental to the performance of this function.”

If all of that sounds much like Vanguard today, so be it. But it was not a dream that easily became a reality. And it was most certainly not a deterministic series of linked events. Rather it was really a long and random series of happy accidents that led from 1951 to 1981, when the essential structure of today's Vanguard was finally put in place.

But it is, I think, remarkable how the original, if crude, dream hinted at in that Princeton thesis about the need to serve a single master—our investor-owners, now more than ten million human beings in the aggregate—has to this day determined our basic corporate strategies. I've often emphasized that “strategy follows structure,” a relationship that has logically led to business decisions that are shaped around our unique shareholder-owned structure. It is what makes our enterprise work. Belying the competitors to whom Greenleaf referred when he pictured them as saying “it ought not to work,” putting the shareholder in the driver's seat “ought to work.” And it does.

For example, as nearly all now concede, cost is a factor in shaping long-term investment returns. If a firm achieves low-cost provider status, its bond and money market funds can follow lower-risk strategies and still offer higher yields than their peers. If low-cost is the key to a successful index fund (and it obviously is), index funds can appropriately be a major focus of development. If money spent on marketing consumes shareholder assets while offering no countervailing benefit, it would seem foolish to spend much money on marketing. And all of these things are what aware investors should want. It turns out that they do. In the world of investing, in fact, it turns out that a superior company can be built on these strategies, all of which flow from a structure in which service to shareholders is the watchword.

Powerful Parallel Phrases

I've now touched on three broad areas of commonality between Robert Greenleaf's thinking and my own—building a model institution, foresight and caring, and the superior company and the liberating vision—as I've tried to manifest them in Vanguard's development. In this fourth section, I want to briefly describe some particularly powerful phrases that I observed in his writing that paralleled those that I have used at Vanguard forever, or so it seems. I do so because it suggests once again that his idealistic visions can in fact be successfully incorporated into a caring, sharing, serving business.

“Everything begins with the initiative of an individual.” So reads the second sub-head in “The Leader as Servant.” “The very essence of leadership” Mr. Greenleaf says—and I am confident that he was referring, not only to a sort of grand idea of corporate leadership, but to the infinite number of tasks where less sweeping forms of leadership are required if an enterprise is to succeed—is going out ahead to show the way, an attitude that is derived from more than usual openness to inspiration. Even though he knows the path is uncertain, even dangerous, a leader says: “I will go, come with me.”

Almost uncannily, my words about the importance of the individual leader convey the same idea. “Even one person can make a difference” has become a Vanguard article of faith, and is in fact engraved on the Awards for Excellence that we make each quarter to individuals who have met the highest standards of service, initiative, and cooperation. And even as Mr. Greenleaf defines individual initiative as “showing the way,” Vanguard's very name suggests the same idea, for the motto on the HMS Vanguard ship badge is “leading the way.”

And then there is the matter of the dream. Greenleaf speaks of the need for a leader to state and restate the goal, using the word goal “in the special sense of the overarching purpose, the visionary concept, the dream. Not much happens without a dream. And for something great to happen, it must be a great dream. Much more than a dreamer must bring it to reality, but the dream must be there first.”

And I've talked often about Vanguard's dream. In particular, my 1975 speech to the crew was entitled “The Impossible Dream.” In it, I said:

I don't mind at all being a bit of a dreamer, if I can share the attribute with the likes of Robert Greenleaf.

Finally, I was struck by a third powerful parallel, nautical in derivation. Mr. Greenleaf gave this advice: “No matter how difficult the challenge or how hopeless the task may seem, if you are reasonably sure of your course just keep on going!” Leaving aside the obvious similarity with the words from “The Impossible Dream” (“no matter how hopeless, no matter how far”), his words come remarkably close to my often repeated theme, “Press On Regardless,” which was in fact the subject of a speech I gave to a graduating class at Vanderbilt University. But “just keep on going” is also a statement of what may well be the most universal of all the nautical themes we use—and sometimes perhaps even abuse—at Vanguard: “stay the course.” It is wonderful advice for a career, superb wisdom for a project, and probably the best single piece of investment advice ever offered: “Establish a sound balance of bond funds and stock funds in your portfolio. Then, no matter what the financial markets do, stay the course.”

Memo on Growing from Small to Large

In about 1972, Robert Greenleaf wrote this memorandum at the request of the head of a small company that had achieved the reputation for unusual quality of products and service, which had grown rapidly to its present size, and was in the process of becoming a distinguished large institution:

To say that I found this memorandum both relevant and poignant when I first read it just two weeks ago, as I was preparing these remarks, would be quite an understatement. For what struck home to me was that, while there was much that I thought of when I decided in 1996 to relinquish my position as head of Vanguard, I had not seriously considered abandoning the traditional route of simply recommending to the directors a qualified successor to replace me. The directors agreed without hesitation, perhaps in part because my weak heart was quickly deteriorating and because of my age (I was 67 at the time), and in fairness—although they did not suggest this—perhaps because they had tired of my leadership style.

In any event, within a year I had undergone a remarkably successful heart transplantation, miraculously receiving an infusion of new energy and confidence that had to be seen to be believed. A second chance at life is not to be taken lightly! But my decision had been made, and only time will tell whether it was the correct one. But whatever the case, I have no doubt that the service-caring-ethical principles of Vanguard will remain in place for as far ahead as one can see.

In the Vanguard structure, of course, the entrepreneur is not the owner. (The stock in the company is held by the funds for their shareholders.) When one leaves office, then, power devolves to another. And, as Robert Greenleaf wrote:

Vanguard, in my view, has been built on an extraordinary crew—now 8,000 strong—“who know what ought to be done, and who have done the right things at the right time.” And while my strong leadership may well have been described as power-driven, my drive (I think) was focused on intellectual power—to devise sensible investment policies, an efficient structure through which to offer them, and a sensible strategy for their delivery—and moral power—to make certain that both structure and strategy were founded on a sound ethical base. Those kinds of powers do not vanish when one leaves office. But other kinds of power do, including the power of the purse, the power to direct people, the power to reshape values, even the power to change what lies firmly in place. But I hope and believe that our crew and my successors will continue to hold high what we have built, its structure and strategy, and the ethical foundation that is Vanguard's rock.

Where History Comes In

Vanguard has had the marvelous opportunity to test in the real world marketplace the concept that serving is the essential ingredient of true success, and that servant-leaders—and leader-servants—can successfully dedicate their careers to serving the human beings who depend upon their services. All of that may sound idealistic—it is!—but we live in an era of consumerism (in the best sense) in which business has no recourse but to make a determined effort to build a new level of trust in consumer products and services alike. In the world of finance, if we are going to make the United States a nation of investor-capitalists, we'd best give our citizens the maximum possible proportion of the fruits of investing, rather than consuming large portions of those returns with excessive costs.

The fact is that “the Vanguard way” works. Not because our principles give us some divine right to success, but because we are creating extra value for investors. And, as the numbers I presented at the outset illustrate and the growth that Vanguard is enjoying relative to our peers makes clear, investors have clearly recognized that value advantage.

Yet it is a curious fact of competitive life in the mutual fund world that, while our investment policies—most notably in index funds and in bond funds—are being copied (albeit often with little enthusiasm), our low-cost philosophy and our focus on management rather than marketing are not. But as the investing public makes known its preferences, this industry will finally change. To use a computer analogy, all mutual fund organizations have pretty much the same software—common ways to invest in securities—but the industry must adopt a new operating system—serving the fund shareholder first.

I have no way of knowing whether the coincidence of Robert Greenleaf's philosophy and my own is merely fortuitous—a happy accident, random molecules bumping together in the night—or powerful evidence of the mysterious universality of a great idea. Perhaps it is a little of each. But in the mutual fund industry the central idea of serving is being proven in the marketplace by tens of millions of investors. I've long thought that servant-leadership is on the right side of evolving corporate history. And so too, in that small but growing corner of the financial world that is the U.S. mutual fund industry, the policies and principles that Vanguard adopted a quarter-century ago—which we continue to treasure today—are on the right side of history, too.