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Occupy Movement and the Existential Purpose of a Firm

November 2011 Corporate

Why do firms exist?  Why should society allow corporations to exist?  What moral reason should we, as a society, allow firms to exist?  At the most fundamental level, the Occupy movement is asking this question.  Shouldn’t we be addressing this?

Capitalism itself is under attack.  And, we cannot sit on the sidelines and let those who would destroy such a useful construct take us backwards towards state owned enterprises under the banner of “doing good”.   And yet, we also cannot rest on the construct given to us by Milton Freidman that a firm exists to maximize shareholder value as the basis of our defense.

In teaching at the university, I often start the quarter asking students this precise question.  Being business students, their first answer is along the lines of “to make money, to profit, to make profit for shareholders”.  Not bad.  Milton Friedman would be proud.  But it is also a failure of a construct.

Profit?

If profit is the core reason that a business exist, we have the basis for creating a psychopathic entity as has been claimed in the much popular film, “The Corporation”.  According to this construct, the firm should do whatever it can to make a profit, and if an activity can be made more profitable, it should be.  Unfortunately, this construct leads to failure.

  • Under this construct, corporations have a mandate to squeeze labor if it improves profits – a mandate which sets up a direct conflict between labor unions and corporations – and results in less than fully productive behavior.  Just compare historic US automotive labor and corporate profit relationships to that of Toyota and the profitability of these firms, or compare the labor relations at United, American, and Delta Airlines to Southwest, and also consider the profit history.  Antagonism between labor and the firm does not create a good basis for productivity.
  • Similarly, under this construct, corporations have a mandate to pillage the environment if it improves profits – which sets up a direct conflict between society itself and corporations – and results in less than fully productive behavior.  Protesters in front of certain operations, lawsuits, excess regulation, government intrusion, and customer backlash all increase the cost of doing business for both offending and non-offending firms, and it reduces the desirability of an industry’s output.  Antagonism between the environment and the firm does not create a good basis for productivity.
  • At its worst, firms which bilk customers out of their cash are deemed “good corporations” under this construct precisely because they are highly profitable.  By this metric, one could state that a beggar on the street is an excellent business since every dollar someone gives them is pure profit.

No, Dr. Freidman, on this point, I believe you were wrong.  Freidman was right on many things, but wrong on the defining the purpose of the firm.

Jack Welch championed this profit construct while proving wonderfully successful at GE for over 20 years.  However, upon retirement where presumably he had a bit less pressure and a bit more time to reflect, he stated in a Financial Times interview “On the face of it, shareholder value is the dumbest idea in the world … Shareholder value is a result, not a strategy.”  Even the master of shareholder value and the profit orientation came to realize that this construct was incomplete.

Employment?

The second answer I often get from students on why corporations exist is to provide employment.  (Students are often motivated to go to school in order to find employment, so this answer is not surprising.)  However, this would encourage corporations to operate under state intrusions, if not outright state ownership, with a mandate to increase employment.  As a species, we tried that experiment under the auspices of communism and fascism.  The idea failed.  Horribly.  Let’s not do it again.

Customers?

Ok, is there something else?  Yes, the third constituency.  Customers.

Firms exist to serve customer needs profitably. 

Let’s take this construct and think about its implications.  Let’s parse it.  I believe you will find it both logical and morally virtuous.

  • From an economic perspective, it is logical and would point to maximizing welfare (increasing productivity).  If a firm can serve a customer need profitably, it should as doing so improves the welfare of both the customer and the firm.  If the firm cannot serve a customer need profitably, it shouldn’t undertake the activity since, by stating that the activity is unprofitable, the customer is stating that she/he can find a more efficient means of meeting a specific need.
  • From an employment perspective, it states that the firm should hire people as long as it can derive productive efforts from them in serving a customer need.  If it can’t use those employees to serve a need, then it shouldn’t keep them.  Instead, that labor should seek employment where their output is valued.   Again, overall productivity is maximized.
  • From an environment perspective, we again find such a statement defensible.  If the firm is doing environmental harm and the customers don’t approve, it should cease the activity because, from a whole product perspective, it isn’t meeting customer needs.  (Perhaps a little Pigouvian externalities are needed to further support this claim.)
  • From a stockholder perspective, it would imply that if the firm has anticipations of low profitability, it should have lower valuations, and if it has anticipations of higher profitability, it should have higher valuations.  Yet, in any case, stock valuations are an outcome, not the sole driving focus.
  • From a moral perspective, who would object to an organization focused on meeting my needs, or the needs of others in my society?  Meeting needs of others is generally thought of as virtuous.

Hence we see that this focal purpose leads to positive outcomes.  Is it perfect?  Perhaps not and I invite others to parse this directive for the existential purpose of a firm.  (The Wiglaf Journal is a journal where ideas are to be explored, like other journals which explore thoughts and consequences.)

Are we the first to make such a claim?  No.  This third organizing premise for firms is known as the Marketing Concept.

If we read the work of Peter Drucker, we find a similar sentiment.  He is known for stating “The purpose of a company is to create a customer…The only profit center is the customer.”  He continually focused the firm on customers, identifying their needs and serving customer needs, profitably.

Alternatively, if we read the work of Theodore Levitt, we find a similar sentiment.  He is known for stating “People don’t want to buy a quarter-inch drill. They want a quarter-inch hole!”  He drove this point home to change the focus of the firm from selling products at a profit to serving customer needs at a profit.

And, the construct isn’t exactly contrary to Adam Smith.  Stating that the purpose of business is to serve customer needs profitably isn’t a contradiction with the claim that people do business for their own profit.  Employees may provide their labor for wages but the purpose of work isn’t to earn a wage, it is to enable the business to accomplish a goal.  In the same sense, a business will seek profits for the risks and effort they undertake, but profits isn’t the purpose, serving customers is the purpose.

So, what is the existential purpose of a firm?  I along with others propose it is to serve customer needs profitably.  If businesses acted this way and the Occupiers believed it, would they be protesting or out searching for ways to meet customer needs, perhaps through entrepreneurship?

 

References

  • Francesco Guerrera, “Welch rules short-term profit ‘obsession’”, Financial Times, 12 March 2009.
  • Robert E Gunther, “Peter Drucker – the grandfather of marketing” an interview with Dr. Philip Kotler,” J of the Acad. Mark. Science (2009) 37:17-19.
  • Clayton M Christensen, Scott Cook, and Taddy Hall, “What Customers Want from Your Products”, Harvard Business School Working Knowledge, (2006) Jan 16.


About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

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