The Purpose of a Business is NOT to Create Shareholder Wealth

by Rod Collins

 

Anyone who has ever taken a business course remembers being taught that the purpose of a business is to create shareholder wealth. This fundamental and often unquestioned assumption has guided management theory and practice for well over a century. According to this assumption, business success or failure is a function of one prime driver: profitability. This notion is continually reinforced by a mercantile priesthood of Wall Street analysts who worship at the altar of profitability. For the Wall Street analysts it’s very simple: the best performing companies make money; the poor performers don’t.

This simplistic focus on profitability has spawned a pervasive management culture that believes the primary attribute of good management is making profits. Accordingly, managers spend a great deal of time focused on the numbers, doing everything possible to make those numbers the best they can be. When the purpose of a business is to create shareholder wealth, the focus of management is riveted on managing the numbers.

However, there’s a fundamental flaw with this thinking. For something to be manageable, you must be able to directly influence its behavior. Because profitability is a reflection of product or operational performance, when things go wrong, the right action is to better manage the products or the operations. Making better products or improving operations are the places where managers can directly influence behavior. If there’s a problem in the numbers, there is very likely a problem in the workings of the business. Fix the business problems and the numbers will follow.

This understanding of the relationship between business delivery and profitability led Robert Kaplan and David Norton to create the Balanced Scorecard in the 1980’s. They noticed that poor performing companies were those who were most focused on their short-term financial results. In contrast, the better performing companies tended to focus their attention on what was most important to their customers and then found ways to delight those customers by building outstanding delivery systems.

In constructing the Balanced Scorecard, they defined four primary sections that serve as the container for 12 – 20 key measures: customer, internal business processes, learning & growth, and financial. These sections represent the flow of managerial work. First, you choose your customers and find out what they value most. Then you build business processes to deliver that value. Finally, you keep close to the market to see what’s changing and how you need to change and grow to keep your customers satisfied. Those three things are what managers can directly influence. If managers do those three things well, then profits are the rewards the market pays a company for its efforts.

The implicit logic in the Balanced Scorecard is that profitability is not accomplished by managing the numbers; it’s accomplished by continually delighting customers. The purpose of a business is NOT to create shareholder wealth: it’s to create customer value. The great irony is that companies, such as Google or Apple, that are clearly focused on creating long-term customer value and not beholden to the short-term thinking of Wall Street analysts are the ones who are more likely to enrich their shareholders in the long run.

 

Rod Collins is Director of Innovation at Optimity Advisors and author of the upcoming book, Wiki Management: A Revolutionary New Model for a Rapidly Changing and Collaborative World (AMACOM Books, November 1, 2013)