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A monstrous model exposed

The lie that tarnished the best social system humanity has ever created.

SWELLENDAM – Not all lies are based on deceit and malevolence. Sometimes they are based on seemingly valid assumptions but then become a lie when they are fanatically promoted as a universal truth despite clear evidence to the contrary.

There is no better example than the 40 year persistent defence of and slavish adherence to the shareholder-value driven business model; once described by American business leader, Jack Welch as “the dumbest idea in the world”. The model proposes simply that the sole purpose of business is to maximise shareholder value. It found its intellectual and ideological roots in the teachings of American Nobel laureate in economics, Milton Friedman, and is still widely followed, especially by large-quoted companies.

But it has had its critics from its earliest days. The latest has been published by the bullhorn of capitalism, Forbes Magazine, in an article by author and columnist, Steve Denning, titled: Resisting the Lure of Short-Termism: Kill ‘The World’s Dumbest Idea’. It is one of the most comprehensive indictments of the model I have come across and I urge you to read it at this link.  He is not the first. Some years ago Business Insider did a similar analysis, which I captured in a Moneyweb article “Profits of Doom”. Regular readers of this column will be aware that it has been a theme of many of my columns from the beginning.

Apart from Jack Welch, there have been many other critics and Denning mentions a few in his column. In addition, within a decade or so, we saw prescriptions and processes being developed to address the side effects of putting companies on profit steroids, especially short termism. These included the triple bottom line, balanced scorecard and accounting protocols trying to force business to broaden its view and adopt ethical standards, good governance and sustainable procedures and controls.

In South Africa, we have had the King reports. While they obviously have their merits and no doubt have dampened many excesses, they do not, and nor are they expected to change the primary strategic direction of the company. In the end they do little more than treat the side effects of addiction and perhaps dampen excesses.

With the exception of King IV. While the previous King reports address business models, King IV defines a different business world – one where the overall task of business is creating value for all. Again, this is not really new. It was the predominant view before the 80s. One should also add that not all companies have followed the steroid-addicted model, and for most smaller to medium enterprises, it does not make business sense. To some extent this addresses a possible counter argument: that despite its blemishes, the model has promoted many advancements and prosperity. To this I would respond that this is not because of the model, but rather in spite of it.

Adapting to this new business world is a lot easier than one may think, and certainly does not need a huge turnaround intervention. In recently completing the Contribution Accounting Methodology (see here), which is based on decades of exposure to economics, organisational theory and my own consulting work, I was struck by how much of such a transformation is simply doing what comes naturally; is easily understood by all stakeholders, and still makes sustainable business sense. It can be captured in 4 brush strokes, the fine details of which are fully documented in the methodology material.

Redefine purpose

There should be absolutely no ambivalence that the purpose of a company is to serve its customers. This is rooted in existential logic and the natural laws of transaction. Again, this is not a huge leap and has been endorsed through the ages by great entrepreneurs, companies and organisational theorists. It strikes me that detraction from this truth is because we make no distinction between shareholder interests and company purpose. They are not synonymous. Individual stakeholders may have different motives for being involved in a company, including, but not limited to, maximum profit. But the purpose of the business itself remains creating value for customers. Obviously reconciling individual motives with that purpose has many advantages, including entrenching authenticity.

Redefine relationships

Nothing is more counter-productive than trying to propose a hierarchy of stakeholder importance. It is divisive and creates conflicting interests. Being loyal to its purpose, a company would clearly see relationships with customers as by far the most important. Stakeholder cohesion and inclusivity are established through a common purpose of service that translates into wealth creation; and a common fate which impacts on distribution such as profits and pay.

Redefine strategy

For the most part this redefinition would merely imply changing direction. If it is customer driven, it focuses on contribution to its market; if it is profit driven, it focuses on reward. Switching focus from reward to contribution has a fundamental impact throughout the organisation, including improved and more sustainable rewards. Strategy should rest on the three pillars of maximum wealth creation and the two of optimum wealth distribution. (See graphic here.)

Redefine account

The “value” in “creating value for all”, is captured in one very simple metric called value-added. It is the outcome of creating value for customers, and is the source of all rewards. It is the centre of an operational Contribution Account which portrays stakeholder inclusivity and a simple presentation of wealth creation and distribution, and from which one can extrapolate all the standard accounts. It embraces the measurements needed for 3BL, BS, and the King prescriptions.

The direct and indirect harm done by obsession with the shareholder value approach has been substantial. Denning gives a superb account of this in his article. For me the biggest harm has simply been the assumption that this monstrous model is an unassailable reflection of free enterprise itself. Criticism of it leads to all kinds of leftist labels. That lie has gone a long way to tarnish the true spirit of free enterprise and its standing in popular perceptions.

It is an aberration and has proved to be the world’s dumbest idea.

COMMENTS   17

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Agreed Jerry. This error has an analogy in the pursuit of happiness. Happiness is a second thing that is derived from doing first things well. If one tries to pursue happiness directly by doing things that make one happy, one is likely to be unsuccessful. However, do first things well (live a life of integrity, serve others, love one’s neighbour as oneself etc.) and hey presto, you find that you are happy. It came as a second thing almost by surprise, even though it was not pursued directly.

Analogy with your point is that if one makes ‘creating value’ in business your aim, guess what, everyone is more successful. Much better than pursuing wealth directly. If you make too much then love your neighbour and give it to someone else who needs it more than you do. Bonus – happiness increases especially if gaining happiness was not your main aim.

Thanks for this article, Jerry.

It’s a timely reminder of what is really important in the Capitalist system.

I would argue that the responsibility for “value creation” goes MUCH further than merely to “the customers of the company”.

It extends to the TOTALITY of society.

For example, liquor companies supposedly bring value “and pleasure” to their customers, who enarmoured by the products, continually flock back as repeat customers.

But are these companies bringing “value to SOCIETY”? Nope! (I was going to say “not at all”, but that would be going too far. They DO bring SOME value with their products, but on balance, it has to be an overwhelming negative).

Tobacco companies and sugar companies (like Coca-Cola) and the bad-fat companies (McDonald’s and KFC) are also firmly in this group.

And that is the capitalist and societal dilemma.

How does one handle the ambiguity of companies like these that do provide both a positive and negative contribution to society?

I address that very issue in my proposal for a radical Tax Reform.

I have always believed in the “golden triangle” – Customer/client – Staff – Shareholder. Keep them in balance (really, not just paying lip service) and the business flourishes. Over-emphasize or neglect one and you’re in trouble. Thanks for a good article.

Semantics.
the purpose of a company is to make money.
If that does not suit you,feel free to register as a Non profit Organisation in terms of Act 71 of 1997.

You are right; but not at the expense of your customer.

@LouisvV’s comments above relates to finding a happy balance that is productive over a long term.

Agree with all the positives in the comments – great article. Just to add to your comment Muks (and African), it can never be at the cost of anyone. This includes both internal and external stakeholders – shareholder, employee, customer / consumer, supplier, govt and community. The perspective of Welch on this is telling too. Sustainability can only come from finding the delicate balance among stakeholders while still making money. No need for a Section 21, only a need for a mature and holistic outlook on the value that organisations need to offer.

Make money for who? Sustainability implies creating value (making money and more) for stakeholders (shareholders and more).

Sustainability is proven to be foundational to the longevity of a business (inclusive of its ability to add value and make money) ..so logically it cannot be semantics if making money is a reuquirements. In fact sustainability is a necessity to create long term profits.

I would go so far as to argue that sustainability (as a function of stakeholder value-add) is the missing piece of the capitalism puzzle ..but that’s a debate for another day.

It should be “the purpose of a company is to make money for as long as possible”, happy now? That should handle your sustainability concern.

Just had a good look at Steve Denning’s article “Resisting the Lure of Short-Terminism: Kill the World’s Dumbest Idea!”

Absolutely brilliant read – with some very powerful examples. All explained in a very easy reading style (definitely not the usual dull excitement-draining essay so typical of academics).

Thanks for that wonderful and inspiring reference, Jerry. You made my day!

Now, if I was Juju in the EFF, I would be poring over Dennings article. Yep, it’s so clear that even Juju will see that there are gems there that he can immediately start incorporating.

One thing that must be said is that maximising shareholder value and maximising wealth production are not mutually exclusive goals, in fact, they go hand in hand. Shareholder value growth is, of course, just one part of wealth production. The other stakeholders in the wealth produced being the regime (tax) and the workers.

That said, I have always held the view that there is a kind of natural selection in the business world that weeds out the unfit and leaves the fittest, most adapted to survive. It is not simply a dog eat dog contest fighting for market share, rather one of adding the most value for the customer thus having the premium product or service.

If you are in a high growth industry you are going to crash and burn if you ignore profits. Profits are the stepping stone to organic growth, high market share, economies of scale and spinning off cash.

One can use adjectives such as “monstrous”, “dumbest” and “aberration”. Actually the latter is a noun but is still name- calling. Nonetheless, the answer would really be do study those companies that survive long term and identify the common underlying factors. Certainly moats (in all their guises) would be a good place to start.

Thanks Richard.

A voice of reason in a sea of hand-wringing comments. The most idiotic were related to: “at the expense of customers” words fail.

Looks like more than a few have fallen for the socialistic propaganda of the past few generations. How on earth anyone can believe that maximising shareholder value is at odds with good customer service or with good business practices such as looking after employees by paying a fair wage is mind boggling.

This community notion is also total nonsense. Obviously one has to obey the laws of the land and not pollute; otherwise a business has no business giving more to any community.(If they want to they can, if they do not want to that is fine too.) This is a government function via taxation and has to be fully deductible from taxable income.

A company can afford to be generous to customers, staff and shareholders to the extent that it is making money. Idealism and business are not compatible unless there is a pay off to the business in terms of tax, brand image etc. So, the primary objective of business is to make money. The rest is academic.

A nice theoretical analysis but I think a little away from what has happened to the corporate world on a practical level. One aspect is that the opportunity for self-enrichment in the giant corporates created by artificial (regulatory mainly) barriers to entry, dozy unit trusts and pension funds. Company efficiency and profits are just what the “market” will accept. The ultimate end is the Sharemax type operation but there are plenty in between. Very like many of today’s politicians; it’s about the job and loot stupid.

Then there is the aspect of market manipulation to provide profit. Again the end is collusion but there is a ladder of tariff protection, subsidisation and regulation that needs massive size to cope with. SA is almost a poster child for these distortions. Lobbying power is way more important than sales, product or customer care.

Of course in SA there is another tier of business that ignores most of the rules and regulations. This tier extends from the pavement hawker to the Gupta’s.

The answer for me is encouraging small, pure business. Cut regulation, ease the red tape and simplify rules. Of course it will never happen as there are way too many vested interests.

This person needs to read the work of Ayn Rand. Let us make no mistake, companies exist for the interest of their shareholders, if you think they exist for the good of society I implore you to take a look at actions of corporations, and the stark truth will soon be revealed. As soon as we realise that companies exist to maximise value for shareholders the sooner we can overcome the true aberration that is ‘corporate altruism’. That is the truly malevolent model that needs to be squashed.

This is not to say that at times the agenda of companies maximising returns do not coincide with what can be considered to be the will of the consumer and the good of society. But this would be a happy coincidence and is definitely not their first priority.

As soon as we accept this, we will realise that we must monitor what companies do and must constantly question their actions and what they put in their products. We can no longer rely on the heuristics of the surety of a strong brand, as proof that a company is inherently good. This is a lie, the company is a bureaucratic abstraction from humanity which allows it to behave in an inhumane way, with little regard for the consequences of its actions. The only way to counteract the malevolent corporation is forced transparency of their actions so that invisible hand of the free market can discipline the wayward company with the only currency that it understands; that is a spending your dollars somewhere else.

Its a good lesson for ethics 101, but only fools subscribe tho this notion that the purpose of a company is to serve its customers well and that will spontaneously result in all stakeholder satisfaction. Wake up boys – money is what makes the world go round. Who will invest in a company that purports in its founding statement or ipo prospectus that its primary function is customer service. 99% of 5 star hotels offer fantastic guest or customer service albeit exorbitant prices charges – and only 1% of these hotels actually show spectacular financial returns.

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