Tuesday, October 07, 2008

The Purpose of a Business

Look around financial texts and you'll come across the oft-repeated old mantra:
The purpose of a business is to maximize shareholder value.
This of course is related to the share price (and to discounted cash-flows, but the share price is supposed to reflect the real value). And indeed for listed companies, the share-price is the be-all and end-all of their existence.

Turn to Drucker, however, and he says:
"There is only one valid definition of a business purpose: to create a customer"

The Essential Drucker, page 20
In the same article then, he tackles profits: "Profit planning is necessary. But it is planning for a needed minimum profitability rather than for that meaningless shibboleth 'profit maximization.'". I cannot do justice to the breadth of this article - it has to be read in its entirety to appreciate the profoundness of this quote.

For my money, Drucker is right every time.

As I watch the near-collapse of the financial system and all those fancy funds, and hedge instruments, and swaps, and derivatives unravel, I'm reminded of this article and this quote.

To oversimplify grossly, these institutions have been thinking too much about maximizing share prices and therefore shareholder value and wealth and not enough about whether they are selling any real needs and creating any real customers. Flipping high risk mortgages from one balance sheet to another has nothing to do with creating customers.

If you take away all the layers and packaging, at the root of every mortgage is just one real person who bought a house somewhere sometime and is now unable to pay. And while the first bank that lent him money created a customer, all the other institutions who then took that loan, packaged it, securitized it, resold it, insured it....well they were just maximizing their top-lines, getting good reviews, cashing their bonuses, and seeing their share prices go up.

Somewhere along the way, the customer became irrelevant as the money-chain simply fed on itself. And so we're now seeing the Drucker definition in reverse:
No real customer ? No business.

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