“Shareholder value is the dumbest idea in the world.” – Jack Welch
Early in Obliquity, John Kay devotes an entire chapter to examining why profit often evades those who seek it. This chapter, The profit-seeking paradox: how the most profitable companies are not the most profit-oriented, includes many summarized case studies, and draws upon research conducted by a number of academics and authors. Further examples are included throughout the remainder of the book.
Without repeating his arguments, I’ll simply say that Kay builds a convincing case that the largest long-term profits emerge as a consequence of focusing on some other aspect of business (e.g., devotion to aerospace, commitment to pharmaceutical research). That is, by focusing on research, or by building a company around a passion for a particular subject, the result is that the company endures, thrives, and makes money. Corporations ignore these lessons at their own peril: time and again, companies stray from what works and instead announce a corporate shift towards maximizing shareholder value and return on investment; as a result of deviating from what was driving the business, innovation falters and decisions are made only with the short-term in mind, and the company falls into obsolescence.
I suspect that Kay was preaching to the choir, in my case – I can’t stand the term “shareholder value”¹, I cringe as companies focus on next quarter at the expense of longer-term strategy, I despise the financial services industry², and I believe “the market” is hopelessly corrupt and disastrously unstable – so it’s no surprise that I took this particular message to heart.
Kay advocates that an oblique (indirect) approach is what leads to higher profits, and he explains why a mission statement that directly focuses on profit is ridiculous:
“The maximisation of profit is never an item on a boardroom agenda. The board members come to address the problem of inadequate profitability, discuss new products, express concern about the human relations of the business or the disappointing reactions of customers. Executives go to the office or factory to reduce costs, set prices or launch new lines. The director or executive manager pursues higher level objectives obliquely, and if successful they secure the continued viability of the business by constantly balancing the incompatible and incommensurable components of business success.” (Obliquity – p74)
That is, the board doesn’t meet to answer “How can we maximize profits?” Instead, they meet to discuss meaningful business items – take care of those correctly, and profit will follow.
Kay posits that one potential reason why profit-focused companies fail is that they succumb to greed: “The common feature of every one of these companies is that very large amounts of money were made by individuals in them while the business itself ultimately failed. A corporate culture that extols greed is, in the end, unable to protect itself against its own employees.” (Obliquity – p36-37)
“The common feature of every one of these companies is that very large amounts of money were made by individuals in them while the business itself ultimately failed. A corporate culture that extols greed is, in the end, unable to protect itself against its own employees.” (Obliquity – p36-37)
Near the end of Obliquity, Kay revisits the corporation:
“Today, people who deplore the activities of modern business and those who applaud these activities both agree that business is distinguished from other forms of organisation by having profit as its defining purpose. Yet this agreement covers evident nonsense. Who would want to work for a corporation whose defining purpose was profit, and why would society allow such an organisation to exist? People would join that corporation, and society would allow it to function, only if the business met their needs – the needs of the worker for rewarding employment, the needs of the community for goods and services that people want to buy. Needs that change over time, and that require that business adapt constantly to meet them. Business exists to serve social purposes and enjoys legitimacy in the short term only to the extent that such business meets these purposes. Profit can not then be the ‘defining purpose’ of a business.” (Obliquity – p153-154)
But hey, lest you think that Kay is a commie propagandist, let’s turn to a paragon of capitalism for the final word:
“Shareholder value is an outcome – not a strategy… The job of a leader and his or her team is to deliver to commitments in the short term while investing in the long term health of the business… Employees will benefit from job security and better rewards. Customers will benefit from better products or services. Communities will benefit because successful companies and their employees give back. And obviously shareholders will benefit because they can count on companies who will deliver on both their short term commitments and long term vision.” – Jack Welch, in Business Week
¹I say this with a full understanding that shareholders provide capital needed to drive the business. I just think that the pursuit of profit as the top priority is asinine (and guarantees the failure of the enterprise).
²This industry promotes ignorance and relies on people thinking that sound financial management is witchcraft. Do yourself a favour and read The Wealthy Barber, The Wealthy Barber Returns, and The Millionaire Teacher.