My business school professor: What is the number one goal of a firm?
I raise my hand.
My business school professor: Seth?
Me: To please the customer.
My business school professor: Wrong! To maximize shareholder value. You could please customers by giving your product away for free, but that wouldn’t please your shareholders.
Me: With all due respect, it wouldn’t please your customers for very long if you go out of business by giving away your product for free — especially if they value your product, now would it?
My business school professor: [This-discussion-is-over glare] [Proceed to explain why maximizing shareholder value is the key goal of a firm].
I never bought the ‘maximize shareholder value’ credo, or at least the moronic behavior it led to. I do believe it is the manager’s job to maximize shareholder value, but I never believed that was the goal. Rather, it is a result of pleasing customers.
I’ve seen too many short-sighted decisions come from the ‘maximize shareholder value’ mantra because the customer was left out of the equation.
I was pleased to see this article from Steve Denning on Forbes.com, The Dumbest Idea in the World: Maximizing Shareholder Value. Here’s a key snippet from the article:
Although Jack Welch was seen during his tenure as CEO of GE as the heroic exemplar of maximizing shareholder value, he came to be one of its strongest critics. On March 12, 2009, he gave an interview with Francesco Guerrera of the Financial Times and said, “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.”
I remember one example of this short-sighted focus on shareholder value when I as an engineer for a utility company. One of our big industrial customers — infected by the shareholder value mantra — approached us seeking to buy the electrical facilities at their plant. We delivered power to them at the low voltage they needed to run their equipment. We also had special switchgear at their site — that we owned — to provide the volume and reliability they needed. We charged them extra for this enhanced service.
They computed the simple math of the cash outlay to buy the equipment from us, the fees that would save them and the cost they thought it would take to maintain the equipment. I saw their analysis. On paper it looked like a good investment, one that would add to their shareholder value by reducing costs and increasing profits.
But, their experience was different. They quickly learned that the higher fees they use to pay us included something they didn’t have — expertise and opportunity cost. They realized that trying to figure out how to maintain electrical switchgear took time away producing the products they made for their customers.
They first hired us back to maintain the equipment and then eventually sold the equipment back to us and ‘got out of the business of maintaining electrical switchgear’ so they could again focus on delivering value for their customers.
In their initial analysis, they forgot to include their customers.