Profit is a necessary condition for a business to operate, not a sufficient purpose for its existence.
Let me explain.
To mistake a business’s need for making a profit for its purpose is actually illogical. Charles Handy, recognized as one of the leading business management thinkers of our time, puts it this way in his Harvard Business Review article, “What’s a Business For?”:
We need to eat to live; food is a necessary condition for life. But if we lived mainly to eat—making food a sole or sufficient purpose of life—would become gross. The purpose of a business in other words is not to make a profit, full stop. It is to make a profit so that the business can do something more or better.1
Profit generation is a lagging indicator of the demand for the product or service that a business is offering combined with the business’s ability to effectively produce and deliver that product or service to its customers.
Generally, the current or future profit that is generated by a business is a key metric in determining its “value.” Profit and value, however, can be achieved by good or bad means—a business can become profitable by creating value for or extracting value from its neighbors.
To be clear, a business’s neighbors are best understood as its stakeholders:
What Is Right Is What Is Smart
It is easy to see how creating value for stakeholders is the right thing to do, but more research and evidence is showing that it is also the smart thing to do, highlighting the reciprocal relationship between a business’s success and the success of its neighbors.
In other words, while many today tend to see a company’s stakeholders as those who are affected by business, what’s often overlooked is the effect that stakeholders have on business.
Edward Freeman, business professor at Darden School of Business, one of the leading thinkers and promoters of what is known as “Stakeholder Theory,” describes the theory in these terms:
The 21st Century is one of “Managing for Stakeholders.” The task of executives is to create as much value as possible for stakeholders without resorting to tradeoffs. Great companies endure because they manage to get stakeholder interests aligned in the same direction.2
With this in mind, business professionals and academics alike are dedicating research to exploring how each of a business’s stakeholders impact the future success of the business.
Customers and Employees
Fred Reichheld, for instance, explores the reciprocal relationship between a business and its customers in his book, The Ultimate Question. He has this to say about his findings:
Too many managers have come to believe that increasing [profits and shareholder value] requires exploiting customer relationships. So they raise prices whenever they can. They cut back on services or product quality to save costs and boost margins. Instead of focusing on innovations to improve value for customers, they channel their creativity into finding new ways of extracting value from customers.
In short, companies regard the people who buy from them as their adversaries, to be coerced, molded, or manipulated as the situation permits. The Golden Rule—treat others as you would like to be treated—is dismissed as irrelevant in a competitive world of hardball tactics. Customers are simply a means to an end—fuel for the furnace that forges superior profits. This view is utter nonsense. Companies that let themselves be brainwashed by such a philosophy are headed into a sinkhole of bad profits, where true growth is impossible.3
Reichheld’s research was conclusive. Companies that failed to delight their customers, seeing themselves instead as in a “win-lose” relationship with their customers, were far less likely to grow at the same sustainable pace compared with a company focused on creating value for their customers.
In a similar vein, Zeynep Ton provides deep research on the correlation between a company’s success and how it invests in its employees. In her book, The Good Jobs Strategy, she focuses on how low-cost retail stores treat their employees.
She recounts how companies whose primary focus was on reducing labor budgets resulted in a vicious cycle of low-quality and/or quantity of labor, which then produced poor operational execution, which resulted in low sales and profits, which caused labor budgets to be reduced even more, perpetuating the cycle.
On the other hand, she observed how companies displaying sustainable growth in sales and profits did so by investing more in their employees through what she calls “the good jobs strategy”—a strategy that prioritizes paying for quality training, respectable wages, and effective operating procedures.4
The late Herb Kelleher, cofounder and former CEO of Southwest Airlines, known for aiming to provide the best jobs in the airlines industry, described his strategy this way:
Your employees come first. And if you treat your employees right, guess what? Your customers come back and that makes your shareholders happy. Start with employees, and the rest follows from that.5
The Essential Question
That the long-term success of a company is impacted by how its stakeholders are treated is inescapable. And this brings us to the essential question concerning the true purpose of business: If profit is merely a necessary means to accomplishing a more sufficient purpose, what is that purpose?
It is, in the words of Jeff Van Duzer, the former dean of the business school at Seattle Pacific University, “to provide a community with goods and services to enable it to flourish [and to] provide people with opportunities for meaningful work.”6
Put simply, a good business loves its neighbors. It just so happens that loving your neighbor is also good for business.
*Cover photo by Sawyer Bengtson on Unsplash
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4733-NLD-7/17/2020Posted July 22, 2020