A Coaching Power Tool created by Ujjalendu Gupta
(Business & Executive Coaching, INDIA)
There is only one valid definition of business purpose: to create and keep a customer
– Peter Drucker.
This power tool has only business application and is to be used in business coaching situations.
Sub-prime lending
Sub-prime lending for housing finance had spread right across America by 2005. Cash surplus lenders loaned money for housing, against mortgage of property, at low rates of interest. The loans were being made solely against the value of the securitised property, without taking into account the capabilities of the borrowers to repay. Loans were given to persons who had inadequate or even no income but had good property to offer as mortgage. Several of such mortgages were then bundled together, by the lender, into securitized debts with high credit rating – high because of the generous margin on the property value and the credit rating of the lending institution itself. These complex derivatives were then traded in the market to generate profits for the lending banks or finance companies.
Bankers, insurance companies, investment bankers and other financial services companies started to play this game of making loans, converting them into structured derivatives and selling them to other financial companies. They were all chasing profits, generated for the shareholders, and in the process earning handsome incentives for the executives and managers themselves who were running this show. There was little concern for the customers, whether the borrowers or the buyers of the securities, they being just instruments in the process. There were several unscrupulous lenders among them who were enticing customers to take these loans at low rates of interest, with cleverly crafted agreements charging additional interest in the fine print. As a result of these cheap funds being available, demand of property and their prices went up and consequently more structured products were issued and bought and sold in the market, till the bubble finally burst in 2007/08.
The focus of these companies was not the customer nor to provide low cost housing solutions to the borrowers. Instead, the focus was on how to make quick profits for the company and consequently earn large bonuses for the executives themselves. Decisions were based on profit or shareholder perspective and not from the perspective of customer benefit.
These profits were not backed by cash flows and soon defaults started to take place from late 2006 onwards. The cycle of profits got reversed into a spiral of losses. The large amounts of securitized debts in the books, created in pursuit of large profits, soon became like junk bonds. The issue became such a massive “tsunami” that it turned out to be the beginning of the financial crisis of 2008 with several financial services firms, like Lehman Brothers, going down and some large ones, like AIG, being bailed out by Federal funds. The crisis spread across the globe affecting many countries.
What is the purpose of business?
A business has many stakeholders. They are the owners or the shareholders, the management, the employees, the customers, the suppliers of goods and services, the government and its different regulatory agencies, the lenders, the community, society and the environment. The question is, among all these, with some of them having conflicting interests, in whose interest the business and/or its management will work for.
“What is the purpose of business?” The typical response to this question is that the purpose of business is to make money. An economist, a businessman or even a common man will, in all likelihood, give the above answer. According to management guru Late Peter Drucker, profit cannot be the primary motive of a business. The prevailing economic theory, that the mission of business enterprise is maximation of profit, is a false one. Drucker said “The purpose of business must lie outside of the business itself, it must lie in society, since business enterprise is an organ of society. There is only one valid definition of business purpose and that is to create and keep a customer”.
The above definition of purpose of business has many positive implications. It implies that the basic functions of a business are (a) innovation and (b) marketing. It demands that the business identify the needs, realities and values of customers and define its goal as satisfaction of customer needs. Most businesses will have a chain of customers and the business must take into account, in defining its purpose, all the customers in the chain, including the final end consumer.
What is then the role of profit in business? Profit is an ingredient of business, an essential one. Profit is something a business must generate as a result of creating and serving a customer. A business will need to generate adequate revenues to cover all its costs, including the cost of capital employed. The economic surplus after meeting the expectations of investors of capital will be ploughed back into business as the resource to finance further innovation, greater value to customers and creation of more customers.
Unless a business makes profit, it cannot continue to create, serve and keep its customers. A loss making business will not be able to service its customers adequately and will cut back on essential expenses in order to keep its head above water. The management of the business, therefore, will need to know the minimum profitability the business requires to sustain itself. They will plan for and pursue this profit target so that the business survives and continues to achieve its purpose of creating and serving customers. This result will not be achieved when the business pursues the primary goal of profit maximization.
Profit maximization or perspective of shareholders’ benefit
What will happen when a business starts to take decisions solely on the premise of profit maximization, that is, the perspective of shareholders’ benefit, without due consideration of the impact of such decisions on the other stakeholders?
Let us take the case of a listed company chasing quarterly profit numbers as expected by the market/investors. The management will be looking at only the quarter to quarter numbers in order to hold its stock prices. It will start cutting down on investments necessary for continuing to create new customers, for new and improved products, for research and development activities and so on. It will start sacrificing the long term in favour of the short term quarterly earnings. Over a few quarters, the long term growth potential of the business will get affected. It will yield market space to newer products from competition and slowly move on to the path of decline.
The management staff members of listed companies are often paid a part of the remuneration in the form of incentives based on profits reported and also stock options. This results in the management decisions being influenced by short term profit considerations rather than longer term impact on the market place in terms of customer value addition.
The above perspective from the shareholders’ point of view will apply in case of unlisted private companies too. An entrepreneur trying to sell a stake in his business to a strategic investor will attempt to boost up the profit numbers (by cutting down on costs which have little short term impact but provide long term value) and thus get a better valuation for the company. I have seen several instances when small scale entrepreneurs have shown higher profits in a planned manner over a three year period, prior to disposal of stake, to improve valuation. Post dilution, profitability had taken a dip in such cases, because of the long term adverse impact of such short term cost cutting measures.
In case of a private limited company, the co-owners are often the relatives of the entrepreneur and are not active in day to day operations. Such family member-shareholders are likely to look at the year on year dividends that they earn and will be profit focused and not customer centric.
The shareholders’ perspective is thus more often than not focused on profits and dividends and the consequent effect on stock prices and company valuation. Such a perspective, not being customer oriented, results in strategic and operational decisions which are not aligned with the prime purpose of the business, that is, to create, serve and keep customers.
Perspective of customer service
Imagine what can happen when business decisions are based on its prime purpose of creating, serving and keeping customers. The business will have an innovative approach as part of its innate style; it will focus on creating new products, new markets and new customers all the time. The customer will be willing to pay for the value she continues to receive and will pay a premium when she knows that this business will continue to serve her in the future with new and better products. The business will be on a growth path with increasing customer base and increasing revenues, and with profits and cash flows on the rise as well. It will have adequate resources available to reinvest in the business to fund growth and its research and development activities. It will provide growth opportunities to its employees and the other stakeholders e.g., vendors, will thrive as well. The stock market will value such a company at a premium.
Case study – Apple Inc.
Apple Inc. is a customer centric company listed on the NASDAQ. It has a long standing reputation for its steady flow of new range of products in the market. Its products have a class of their own, are customer friendly, aesthetic in design and premium priced. It has brought revolution in the field of electronic consumer products through its continuous launch of innovative products like Palm Pilot, iBook, iPhone, iPod, iMac etc and also brought in game changing innovation in the music industry through its iTune services. It invests heavily in research and development activities and takes decisions based on the purpose of its business – create, serve and keep customers.
While its band of loyal customers are a happy lot, its revenues in 2012 rose to $156 billion with a average growth rate of over 50% in the last few years and a return on equity of over 35%, one of the highest in the industry. Its present market capitalization is $440 billion, significantly higher than that of both Google and Microsoft. Apple always took the empowering perspective of serving the customers with innovative and better products which resulted in excellent financial results and all the other stakeholders being happier too.
Coaching application
The coachee will first address the issue of the prime purpose of business and whether his motivation for running a business is aligned to his values and beliefs. In case he is in business primarily to make money, he will need to re-evaluate the method of making money, whether he could make money in some other way apart from running this business. The questions “Why am I in business?” and “Why in this particular business?” will be necessary to deal with first.
The coach will raise the level of awareness of the coachee about the perspective of being customer focused and the benefits derived from that. This can be done through appropriate questions and/or sharing real life stories as examples.
“What serves the customer the best?” Various decision options can be evaluated by responding to this question. Better decisions will be made in business when this empowering perspective is taken. As seen above, when the business focuses on customer’s long term benefit, all other stakeholders get benefited too. However the reverse is not true. When business focuses on profit maximization or on benefit to executives and managers, customers suffer and in turn all the other stakeholders suffer too, including the executives themselves in the long run.
Sometimes it becomes difficult to ascertain what the impact of a decision will be on the customer of the organization. This can happen when one department is providing service to another within the organization, e.g., the administration department or maintenance department. In such cases, the concept of internal customers will be useful and the departmental manager will best take decisions keeping in mind that his prime purpose is to serve his internal customers in the form of other departments within the organisation.
Reflection
- What is the prime purpose of the business that you work for?
- Which are the aspects of business where you are currently focusing on profit maximization as the prime purpose instead of focusing on customer benefit, customer service and creation of better products?
- How can you align the long term benefit for the customers with those for each of the other stakeholders?
- What are the ways sustainability issues, requiring the alignment of environmental, social equity and economic demands, can be addressed and served when focusing on customer creation over the long term?
- How will you be able to balance the need to provide the best economic value to the customer with the need to earn an attractive rate of return on the investments made in the business?