This normative principle was defensible in the 18th century, though Adam Smith never took it to quite the extremes that we have today, but is pretty solidly indefensible based on what we know about economics in 2011. And that's something I don't think even most economists would dispute today.
Yet, our ethical system is beholden to that principle, though we know it is based on assumptions we know to be wrong.
What MBA programs need to teach, and I think it is happening recently to some extent, is that "social responsibility" is not a dirty word. Considering the social impact of business decisions, something that is considered irrelevant under the current ethic because of the premise that profit-maximization == welfare maximization, is not only not a bad thing, it is an indispensable obligation of doing business in civilized society.
That's not true, and it's not event a popular opinion among the people who actually study the subject. It's only popular among the arm-chair internet specialists on corporate governance. For a well-rounded perspective on the subject I would suggest the "Corporations" text book by Alan Palmiter.
In brief, a corporation's purpose is maintaining balance between interests of various stakeholders such as shareholders, employees, management, creditors, regulators, consumers, the public, etc. Each stakeholder is exerting a different kind of influence on the corporation and suffers different consequences from the resulting consensus action (which motivates his influence).
Yes, I agree that in the eyes of the law there is more to the corporate purpose than just maximizing shareholder profit. However, I'd argue that the law is really the last bastion of considerations of fairness and equity in the corporate sphere, and the idea that maximizing shareholder profit is morally right is dominant, both among business people and in our political discourse.
Social responsibility isn't a dirty word, it's a completely meaningless and dangerous word used by ideologues of all types to serve their personal vision of the world. It means something different to everyone you ask.
I don't have responsibilities to obligations I never made.
The fact of that matter is that we know this premise to be false. That knowledge is indeed irrelevant if you conceive of the profit-maximizing principle as being entirely rooted in an "every man is an island" hyper-libertarian conceptualization, but that is a relatively modern phenomenon and a wholly inaccurate description of the underpinnings of modern American ethics.
As a practical matter, only a few crazies actually believe that people have no social obligations. A large majority have some social conscience, but because they fully buy in to Smith's normative principle, they believe that their business decisions need not be guided by considerations other than profit. To the extent that this principle is invalid, their behavior is inconsistent with fostering desirable outcomes.
On the contrary, this is an extremely non obvious, loaded assumption. It is deemed true in many cases, such as in front of a court, but is then well known to be a judicial fiction.
The worst problem with some people (particularly libertarians) is that they actually believe that this is the simple, unadulterated truth, which unfortunately isn't nearly as easy as this, and this will bring our civilisation to complete collapse under the oh-so-wonderful pursuit of our own individual self-interest, the same way its huge antlers doomed the gigaceros (for the individual male gigaceros, bigger antlers were always a net advantage against competitors in the "struggle for life", but they assured the species inability to adapt as a whole).
Annoying as it is, this is again best explained with the famous joke: for every complex problem, there is a solution that is clear, simple, and wrong.
This is assuming that everyone is born into an equal setting, with an equal upbringing & that property & resources are dolled by a completely unbiased party. Something that is essentially impossible.
The problem is not the managers, or people with MBAs. The problem is that the Delaware chancery courts, where most American corporations are incorporated, long ago ruled that the duty of the Board of Directors is to manage the company to maximize the returns of its shareholders' investments. They can, and frequently do, get sued if they do not do this.
In the Golden and Gilded American Ages, the main shareholder of the wealth-generating American companies was almost always its owner (same person as the chief executive), or his heirs. No MBAs.
As some people had already stated, MBAs are not the problem, if you go to a good MBA you will have good teachers, and those people have very clear in their mind all those economic fallacies and more.
Ethics are the problem.
The problem is the fact that somebody could enter a company, increase the short term benefits, but destroy the company long term, and get out rich, and nobody going after them. HP(last CEO got at least 5Million) , GM(what are 50 Billion these days anyway?, nobody lost their seat), Golmand Sachs, buying bankrupt states CDS(enormously profitable while it does not break, the bill is payed by taxpayers when it breaks)...
E.g if Google decides to "monetize" all the info they have over me overnight they will increase their profit a lot (x5 or x10), but I will start looking after other companies search. As everything I use uses their services it will have to be a slow, progressive change, while the genius MBA graduate could declare victory and retire rich at 30, but it will make people spit at hearing the word Google.
Another example, there was a time in witch SCO was a serious software company, but some guy decided to make himself rich while destroying the company, and now the name have a different meaning.
is not necessarily a problem. There are many companies that should do this, but instead try to continue existing (mainly so the CEO/etc can keep their job).
The goal of most companies is to increase shareholder value. Shareholders, like most people, get more value out of money right now than money in the future. If a company has good short term profits, but their future prospects are not great, shareholder value can be increased by making shareholders a lot of money now and going out of business.
The shareholders would then be free to invest the money in other companies with better prospects.
In my opinion, Microsoft is a good example of a company that should do this. It's highly unlikely that shareholders would have chosen to invest in Bing were Bing a separate company. Rather, they would probably have preferred to invest the money in Google, Facebook and other such companies, or perhaps even diversified out of technology. But due to a misplaced desire of corporate executives for Microsoft to continue existing, shareholder value was not maximized.
(Admittedly, taxes complicate this picture, and encourage investment within a company rather than outside a company. But that's somewhat tangential to the main point.)
Who here started a company to increase shareholder value?
Companies exist to fulfil someone's dream. At some point they get corrupted. And then suddenly it's all about shareholder value.
And at that point you know they'll never produce another exciting product again.
I'm pretty sure the current SCO isn't even the same company as the original Unix Santa Cruz Operation - they are really what was Caldera who bought part of SCO (including the rights to UNIX) and then ended up calling themselves SCO, now TSG.
Another example, there was a time in witch SCO was a
serious software company, but some guy decided to
make himself rich while destroying the company, and
now the name have a different meaning.
Which brings us to another problem: that predicting the effects of a business decision on profits in the short term is easy enough, while predicting it in the long term is much more difficult (even impossible, depending on how you define "predicting").
Simplifying, for the long term you need vision, leadership and entrepreneurs. For the short term you need formulas, management and MBAs. Quite often the two needs clash with each other.
A century ago there was a lack of management skills and applying them brought big results. Now we are probably (well) past the point of diminishing returns - even negative returns in the long run, and what is missing is vision, both at the corporate AND at the political level.
In the end, one metric was not used as the be all and end all. Using multiple metrics to help inform an investment decision was the ultimate goal. The problems with American business are multiple and complex; it's not a matter of a simple financial metric.
Perhaps Dell's artificially static future was the presumption that shipping a laptop or desktop with a pre-installed OS would continue to be a viable business model? What if Steve Jobs had been forced at gunpoint fifteen years ago to lead Dell? What would the outcome have been? He likely would have spoken harshly about the elephant in the room -- Dell produces a commodity, and its future depends on Microsoft's continued prowess. With such an admission out in the open, what actions could have been taken which would have been nearly impossible to quantify via traditional B-School modeling techniques?
What if Michael Dell had been forced at gunpoint fifteen years ago to lead Apple (and not liquidate it)? What would the outcome have been? He likely would have spoken harshly about the elephant in the room -- Apple produces bespoke designs to compete against commodities with bigger economies of scale and network effects, and its future depends on its (arguably not then demonstrated) ability to, by itself, out innovate both a larger software provider and several hundred hardware vendors.
(Which is a slightly artificial way to make the point, but I don't for one minute think Apple's past - or indeed future - success was even slightly guaranteed. Their position is remarkably precarious, IMHO.)
Generally I think the curriculum taught in my school was fantastic, but I think there is a segment of my peers who failed to grasp the underlying meaning and walked away with simple metrics and formulas. Just like cut and paste programmers or those in my CS curricula who learned a few things but did not grok fully, they give everyone a bad name when they egregiously misapply concepts.
Just like those people who shallowly apply metrics, labeling an MBA as basing all decisions on IRR and then painting all MBA's as alike is shallow and overly broad. For example while accounting and finance were covered, there is also economics, operations, strategy, negotiation, leadership, communications, marketing, managerial accounting, and more. All of which look at things as much more than a collection of financial metrics.
The world is a very complex place. Simple sentiments, arguments or sound bytes rarely capture the essence of even the simplest underlying systems. Sweeping generalizations claiming to explain all of the problems of an extremely complex dynamic environment set all kinds of alarm bells ringing in my head.
One thing I like a lot about the culture in younger companies, especially in tech, is that while we are conscious of the appropriate financial ratios, we're not driven by them. For example, Fog Creek, while profitable, isn't driven only by profit, and happens to be passionate about giving developers a great place to work and helping developers create better software (among other things).
I will argue that establishing such a reputation, even at the expense of short-term profits, likely is profit maximizing. So, you are profit driven -- just in a way which also happens ot feel good ;)
It is also surprising to see that most Asian conglomerates ( in India, Japan, Korea, Taiwan, China etc.) seem to have strong vertically integrated businesses where are they continuing to build and expand expertise in the core areas, while letting the west become their marketing managers.
But it is great to see that influential business academics like him increasingly promote the fact that business success is not (only) about juggling numbers. Or to quote from my favorite paper by Christensen:
And all data are subjective. Each form of data is a higher-level abstraction from a much more complex reality
(2004 Carlile & Christensen - The Cycles of Theory Building in Management Research)
I couldn't help but hear a loud 'cha-ching' in my head when reading this. I makes sense though, having a lot of money in the bank enables a business to make bold moves. I think its a delicate balance between making more sums of money and being more profitable.
Silly side note and stupid metaphor warning - if someone is right-handed, they never think to cut off their left hand just because they get less return or use out of it. Only when someone if forced to choose between the hands would they ever say, ok cut off my left hand and save my dominate hand. Thats like an extreme situation!
But in business, these companies make extreme moves like this, exiting whole biz sectors/markets, eliminating depts, segmentation etc. Add to this, that the bar is continuously raised, so if the factory quota for last year was x this year its x + 10. Thus 5-10 years later the exec's are surprised when the factory is not meeting "quota" and shutter it in the name of profitability.
Profitability is one issue, but I think the trend toward over optimization and greater year-over-year ROI is also to blame.
http://www.npr.org/blogs/money/2011/09/30/140954343/the-frid...
The validity of a particular metric is irrelevant. The point is, on a broad scale, we're collectively worshiping on an altar of financial indicators instead of managing businesses.
I've worked at a bunch of places where people who are utterly clueless about the business make really lousy decisions by applying magic formulas. Sometimes they are MBAs, other times they are wannabes that read Deloitte magazine on an airplane. In either case, because they are clueless, they have no way of assessing the validity of the metrics they are using to run the business. The right formula with the wrong inputs yields the wrong answer.
In my opinion the whole Consulting industry strives substantially on the fact, that they provide management with a third external authority. This is an ideal constellation for a manager since first the consulting firm's suggestions don't have to be implemented if they are not representing his/her interest. But if they are in line with the personal view, they give additional weight to that position. Moreover afterwards if the project is a success the manager can still take the credit for for the project but if it fails it was all the consulting firm's fault.
A business focused on profits? It is a business after all. Product development, R&D, and long-term profits are nice, but only when you can at least get through the short-term. Just my perspective on the situation.
Christensen is ripping on the slaving devotion to single metrics that some firms follow. This is very true. Any individual metric can be gamed. If you focus on IRR only, people will game it. Same with NPV. Same even with the Net Promoter Score that the article pushes. (Easier to delight customers if you aren't worried about profit.)
The challenge of management is balancing these measurements, and minimizing sub-optimization. In short term there are conflicts between them, but firms with a longer term focus find profitability goes hand in hand with net promoter score. But in many ways it's long term versus short.
I think the key here is to realize that IRR, NPV are imperfect measures of profitability. In addition, the impact of decisions on factors that can't be measured: R&D productivity, ability to respond to technological changes, can have serious consequences.
I think the article makes some excellent points, but very few people in business aren't aware of them.
Hell we were taught in 2nd year undergrad that IRR sucks for decision making, but if you absolutely must then at least use the modified IRR. http://en.wikipedia.org/wiki/Modified_internal_rate_of_retur...
It is like this Forbes author "Steve Denning" is trying to piggy-back his own ideas on Clayton Christensen's central thesis.
Have we been steering our companies using the wrong metrics for the last century?
"In the future, companies with tremendous "relationship capital" will be the ones to succeed. Society is creating an ecosystem that rewards good manners, high touch, honesty, and integrity. Ten years from now, every company will have a Chief Culture Officer on staff, and if big enough, a team dedicated to scaling one-to-one relationships."[1]
[1] - http://www.amazon.com/Thank-You-Economy-Gary-Vaynerchuk/dp/0...
>> from any intellectual influence, are usually the slaves of
>> some defunct economist.”
>> John Maynard Keynes
Oh, the irony.
It looks like the Chinese have problem in making good investments. And I understand that, somebody should always remember that the Chinese is an extremely controlled economy. Maybe that's why they are happy with low ROIs, maybe that's the only thing they can do.
Apparently, my hairdresser understand finance better than those guys.
Your hairdresser could have a fantastic ROI of 50%, but 50% of $1000/year is miniscule when compared to 10% ROI of a company making $100M/year revenue. If you pursue just the ROI in spite of everything else, your great ROI economy is only $1000, while the other lower ROI economy is $100M.
It's the same question of a small percentage of a big pie vs a big percentage of a small pie. Apparently they like a big pie better despite having a lower ROI. May be it has to do with more people are benefited with a big pie.
Also, you apparently didn't read my example, which is quite the reason why measuring the percentage is also (also) important.
I still think you guys are missing the point.
1. Professional manager class.
2. Principle of "shareholder value maximisation", mainly benefitting free-floating shareholders (including professional managers).
3. Leverage.
The primary industrial consequence of this triangle of factors is reduced corporate investment.
Other key consequences are:
a. a feedback loop occurs between the factors, i.e. they are inherently destablizing, particularly so in the face of ever increasing financial capital market efficiency;
b. the erosion of capital creates a system prone to shocks, both internal and external, and from the real economy or the financial economy;
c. productivity improvements are capped due to merely reducing headline numbers and making minimum incremental improvements to infrastructure and technology. No incentive for workers or employers to invest in company-specific skills or retraining;
d. gross increase in use of "excess" capital for share buybacks and other financial equity maximising techniques instead of investment or holding, even during boom times;
e. makes central bankers management of monetary supply harder due to the additional leverage use and other factors acting as a strong accelerator during cyclical upturns and a strong decelerator during cyclical downturns;
f. strong social impacts:
f.i. increasing wealth inequality between those who can benefit from the alliance and those who cannot. This is both from the asset side (shares) and liability side (borrowing);
f.ii. the easiest way to maximise profit today is to reduce expenditure instead of increasing revenues, so jobs are cut, wages and wage growth is minimised, work intensity and hours rise resulting in more errors, worker tiredness, forced imbalance of work/life.
When combined with globalisation, the efficiency of the global capital markets with its own problems (Too Big To Fail entities), tax and regulatory arbitrage, and capital flight, the above factors can be devastating to any economy no matter how advanced and results in global inefficiencies that produce sub-par growth and high instability.
These and other historical reasons are why most advanced countries outside of the Anglo-American world reduce the influence of free-floating shareholders and maintain a group of long-term stakeholders (including some shareholders) through formal and informal means. In addition, corporate leverage is usually more difficult to obtain.
What I find especially interesting is that a select few of the most globally successful American companies are well known for NOT partaking in this Unholy Alliance, specifically Apple, Google and to a lesser extent Microsoft are incredibly cash-rich companies! Other companies should learn something from these leaders.
Finally, there's a reason why Jack Welch, the long-time chairman of General Electric (GE), who is often credited with creating the term "shareholder value" in a speech in 1981 also denounced it in 2009 as probably the "dumbest idea in the world".
Anyone who starts or runs a company and says "My only purpose is to increase shareholder profit" is probably going to fail to deliver.
The other one is this issue of "corporate greed" or this idea of outsourcing to lower cost manufacturing centers in order to make more money. As someone who has the scars to show for it, I can tell you that "greed" is never a part of it.
Imagine, if you will. That you are making widget A in the US or Europe. You are doing well. Everything is manufactured in house or locally. Profits are good.
Now, imagine that a competitor decides that they can beat you at your own game and make widget A for less money if they outsource their manufacturing to, say, China.
Their list price is now lower than yours by a bunch. You don't want to loose market share, so you lower your list price. Only to discover that now your profits can't support your US-based operations. Just can't do it.
What are your choices? You can't automate your way out of the problem because you are already as efficient as you can be. You could leave the market altogether and move on. Lay off everyone in that division and lick your wounds.
Or, as it is more often the case than not, you can follow-suit and find your own manufacturing solution in China. Now you can lower your prices to match or improve upon your competitors's pricing and you've restored balance to the force.
Or so you thought. At this point nobody is making as much money as they used to. But, a race to the bottom ensues. Very soon Asian manufacturers enter the fray. Not only are they the beneficiaries of low-cost manufacturing, they also benefit from a far lower regulatory burden as well as not having to deal with progress-killing unionized labor and their ridiculous rules and costs.
The race to be bottom continues. Only that you and your local competitors are now at a serious disadvantage with respect to your Asian competitors.
What to do? Well, again, you could leave the segment, fire everyone and move on. Maybe you license IP and life is grand. Or, you could take it a step further and become a brand behind a product that you barely touch. Sure, you have to slim down the ranks but the business continues to exist in some form.
At no point in this slippery-slope is anyone thinking about getting rich. In fact, the effect can be quite the opposite. Profits become thin and the business suffers for it. You've taught your competitors how to make your products and have very little more than a brand to use as an advantage over them. You can't make anything any more and simply don't have the equipment, facilities, process, skill-set, network and people to even attempt to compete with anyone.
And life goes on.
To say that these corporations are "greedy" and that their "only purpose" is to provide shareholder value is, in my never-humble opinion, to be utterly ignorant of the day-to-day realities they have to face.
The reality of the situation is that, over the last 50 years, we have collectively opened Pandora's box. Consumers have voted with their buying power to overwhelmingly favor product that can only be manufactured in places like China due to cost structures. Given this, closing Pandora's box is as close to impossible as you can get.
MBA's and corporations cannot force consumers to behave altruistically and support locally made --higher cost-- product when they can drive over to Walmart and overdose on product at much lower price points and, yes, very good quality in most cases.
There's that scene the "Outsourced" movie that kind of encapsulates the whole phenomenon: A caller wants to buy a bald eagle statue but complains that it is made in China. The operator indicates that they have US-made versions and she'd be happy to sell him one. Only that the US-made version is over $200 when the Chinese version is $20. The caller goes with the Chinese version.
Attention Walmart shoppers: You reap what you sow.
We are now at a time where technology and domain knowledge are stripping existing jobs while creating only a few new jobs.
Welcome to the new world people. It’s going to be a bumpy ride.
If it is more or less a given that they will move from company to company to company in the course of their career, why should they care if a particular firm does not survive _long-term_? If the shareholders want short-term results, then they are just doing their job to deliver them.
If they can improve things for a company in the short-term, their job is done. They themselves can lead "successful" careers and live comfortable lives with that approach. And leave wealth to their heirs. No long-term survival of the company is necessary.