Tuesday, February 7, 2017

A monstrous model exposed.

The lie that tarnished the best social system humanity has ever created.

Not all lies are based on deceit and malevolence. Sometimes they are based on seemingly valid assumptions but then become a lie when they are fanatically promoted as a universal truth despite clear evidence to the contrary.

There is no better example than the 40 year persistent defence of and slavish adherence to the shareholder-value driven business model; once described by American business leader, Jack Welch as “the dumbest idea in the world.” The model proposes simply that the sole purpose of business is to maximise shareholder value. It found its intellectual and ideological roots in the teachings of American Nobel laureate in economics, Milton Friedman, and is still widely followed, especially by large quoted companies.

But it has had its critics from its earliest days. The latest has been published by the bullhorn of capitalism, Forbes Magazine, in an article by author and columnist, Steve Denning, titled: Resisting the Lure of Short-Termism: Kill 'The World's Dumbest Idea'. It is one of the most comprehensive indictments of the model I have come across and I urge you to read it at this link.  He is not the first. Some years ago Business Insider did a similar analysis, which I captured in a Moneyweb article “Profits of Doom.” Regular readers of this column will be aware that it has been a theme of many of my columns from the beginning.

Apart from Jack Welch, there have been many other critics and Denning mentions a few in his column. In addition, within a decade or so, we saw prescriptions and processes being developed to address the side effects of putting companies on profit steroids, especially short termism. These included the Triple Bottom line, Balanced Scorecard and accounting protocols trying to force business to broaden its view and adopt ethical standards, good governance and sustainable procedures and controls. In South Africa, we have had the King reports. While they obviously have their merits and no doubt have dampened many excesses, they do not, and nor are they expected to change the primary strategic direction of the company. In the end they do little more than treat the side effects of addiction and perhaps dampen excesses.

With the exception of King IV. While the previous King reports address business models, King IV defines a different business world – one where the overall task of business is creating value for all. Again, this is not really new. It was the predominant view before the 80’s. One should also add that not all companies have followed the steroid addicted model, and for most smaller to medium enterprises, it does not make business sense. To some extent this addresses a possible counter argument: that despite its blemishes, the model has promoted many advancements and prosperity. To this I would respond that this is not because of the model, but rather in spite of it.

Adapting to this new business world is a lot easier than one may think, and certainly does not need a huge turnaround intervention. In recently completing the Contribution Accounting Methodology (see here), which is based on decades of exposure to economics, organisational theory and my own consulting work, I was struck by how much of such a transformation is simply doing what comes naturally; is easily understood by all stakeholders, and still makes sustainable business sense. It can be captured in 4 brush strokes, the fine details of which are fully documented in the methodology material.

There should be absolutely no ambivalence that the purpose of a company is to serve its customers. This is rooted in existential logic and the natural laws of transaction. Again, this is not a huge leap and has been endorsed through the ages by great entrepreneurs, companies and organisational theorists. It strikes me that detraction from this truth is because we make no distinction between shareholder interests and company purpose. They are not synonymous. Individual stakeholders may have different motives for being involved in a company, including, but not limited to, maximum profit. But the purpose of the business itself remains creating value for customers. Obviously reconciling individual motives with that purpose has many advantages, including entrenching authenticity.

Nothing is more counter-productive than trying to propose a hierarchy of stakeholder importance. It is divisive and creates conflicting interests. Being loyal to its purpose, a company would clearly see relationships with customers as by far the most important. Stakeholder cohesion and inclusivity are established through a common purpose of service that translates into wealth creation; and a common fate which impacts on distribution such as profits and pay.

For the most part this redefinition would merely imply changing direction. If it is customer driven, it focuses on contribution to its market; if it is profit driven, it focuses on reward. Switching focus from reward to contribution has a fundamental impact throughout the organisation, including improved and more sustainable rewards. Strategy should rest on the three pillars of maximum wealth creation and the 2 of optimum wealth distribution. (See graphic here.)

The “value” in “creating value for all”, is captured in one very simple metric called value-added. It is the outcome of creating value for customers, and is the source of all rewards. It is the centre of an operational Contribution Account which portrays stakeholder inclusivity and a simple presentation of wealth creation and distribution, and from which one can extrapolate all the standard accounts. It embraces the measurements needed for 3BL, BS, and the King prescriptions.

The direct and indirect harm done by obsession with the shareholder value approach has been substantial. Denning gives a superb account of this in his article. For me the biggest harm has simply been the assumption that this monstrous model is an unassailable reflection of free enterprise itself. Criticism of it leads to all kinds of leftist labels. That lie has gone a long way to tarnish the true spirit of free enterprise and its standing in popular perceptions.

It is an aberration and has proved to be the world’s dumbest idea.

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