Leadership Strategy

How ‘Maximizing Shareholder Value’ Re-Emerged As ‘Value Creation’


Figure 1

When, on August 19, 2019, several hundred CEOs of major corporations signed the Business Round Table declaration that the fifty-year commitment to ‘maximizing shareholder value’ was no longer the goal of big business and that these firms shared ‘a fundamental commitment to all our stakeholders,’ many wondered what, if any, corporate behavior would change. The answer is becoming clear: not much.

Instead, ‘maximizing shareholder value’ has re-emerged in big-business with an impressive-sounding new label: ‘value creation.’ For example, in an article entitled, “The Value of Value Creation”, McKinsey consultants Marc Goedhart and Tim Koller contend  that firms enhancing shareholder value should be seen as heroic value creators acting for the good of society. In effect, in big business, greed is still good. And it has a superficially-attractive new name that makes a mockery real value creation.

Real Value Creation Means Meeting Customer Needs

A case can be made that 21st century management began in 1954 with Peter Drucker’s insight that “there is only one valid purpose of a firm: to create a customer.” Only one. The primary goal of a firm is to create value for those for whom the work is being done in a sustainable way. By meeting customer needs in ways that customers are willing to pay for, a firm does indeed create value for society.

Like many of the great insights in human history, when this thought came into the world, no bells were rung, no celebrations were held, and no Nobel prizes were awarded. There were solemn nods to Drucker’s lengthy well-written tome, but little more. That’s because Peter Drucker’s brilliant idea ran contrary to what the human race had assumed at least since Adam Smith, namely, that the purpose of a business is to make money. This was as obvious as the ‘fact’ that the sun revolves around the earth, until we discovered that it just wasn’t so.

What was a bizarre new argument in 1954 is now a painfully obvious reality in 2021: in order to succeed in today’s customer-centric fast-moving digital marketplace, firms must obsessively focus on meeting customers’ shifting needs just to survive, let alone thrive.

The world has changed. A combination of universal connectivity of people and things, unlimited cloud storage and the power of quantum computing, means that everything humans do is being reinvented. As a result, customers are now in charge of the marketplace and have come to expect value that is instant, friction-less, intimate, interconnected, and preferably free. Delivering on this expectation is difficult and can only be systematically accomplished if there is a firm-wide commitment to accomplishing it.

To succeed, firms must also create great workplaces that attract the best talent and pay attention to broader social issues that customers care about, like climate change and equality. But customers have to be the primary focus.

When firms do all that, they prosper. It’s the principal reason why today’s trillion-dollar firms grew so big so rapidly. These firms have showered benefits on us as customers. In essence, they found ways to transform our lives with better, cheaper or faster ways of communicating, connecting, working, accessing knowledge, shopping, transportating and educating ourselves, health care, and entertainment. As a result, they made a great deal of money.

But making money is the result, not the goal. As shown in Figure 1, there is a fundamental dichotomy between those that firms that are continually asking themselves the self-interested question, “what’s in it for us?” and those firms that start from the customer’s needs and ask, “what’s in it for the customer?” They are two fundamentally different ways of looking at and operating in the world.

 Over the last two decades, firms that have crossed the Rubicon to the world of customer capitalism have generated trillions of dollars of shareholder value. The firms that have learned how to do this well have made more money more quickly than any firms in history. These value creators are now eating the world.

Figure 2

Meanwhile the giant firms of yesteryear, like IBM and GE, who persisted in their shareholder-centric thinking, have struggled, and delivered relatively meager value to their shareholders, despite massive digital investments, as shown in Figure 2. The standard bag of shareholder-value tricks—financial engineering, share buybacks, tax gadgets, ruthless cost-cutting, and hastily assembled acquisitions and innovation-theater activitiesdoesn’t get the job done in today’s marketplace.

Until firms cross the Rubicon and embrace the customer-driven worldview, they will continue to struggle in today’s customer-centric marketplace.

What is also nice about Peter Drucker’s customer orientation is that it not only makes money: it is inherently a moral posture. It is the opposite of the institutionalized selfishness of shareholder capitalism, in which the purpose of a firm is to make money for itself and its shareholders, whether for the short- or long-term. In customer capitalism, work, firms, and management, are in their essence about human beings creating more value for other human beings.

Nor is the shift from shareholder capitalism to customer capitalism simply an adjustment of the calculus by which firms measure their success. It entails a different mental model of how the world works. The shift is as fundamental in scope and implications as the Copernican Revolution in astronomy. As GE’s former CEO, Jeff Immelt, has written belatedly in his new book, Hot Seat (2021) “Since leaving GE, I have grown more aware of the link between innovation and value creation inside companies.”

A Firm-Wide Commitment To Customers

By contrast, when firms are focused primarily on filling their coffers with profits for shareholders, whether for the short- or long-term, they find that they cannot generate the needed commitment and nimbleness within the the firm for innovation.

It is the failure to instill the obsession with delivering value to customers value throughout the firm that is the principal cause of the disappointing results of massive digital investments in many big firms today. Despite hundreds of billions of dollars in digital investment, more than three quarters of big firms are frustrated with their poor returns. The primary reasons? As this insightful Harvard Business Revew article points out: unspoken disagreement about goals and a consequent inability to scale even successful pilot innovative efforts.

A Copernican Revolution In Management

Customer capitalism isn’t merely a suggestion as to how firms measure their success. It is a different vision of how the world works.

At the heart of customer capitalism is the idea that the world has changed. Power in the marketplace has shifted from the firm to the customer. Globalization, deregulation, and new technology, particularly the Internet, have provided the customer with choices, reliable information about those choices and the ability to interact with other customers. Suddenly the customer is in charge. Now firms survive and thrive only so long as they are nimble enough to adapt to customers’ shifting needs and desires better than the many other firms vying to do likewise. The result? A Copernican Revolution in management.

The Failed Case For Maximizing Shareholder Value

By contrast, the McKinsey article cited above reads as if we were still living in the pre-Copernican era of management. It admits that “public confidence in large corporations” has been “shaken.” This is presented as an attack on “the system in which value creation takes place,” thus presupposing without explanation that big business is “a system of value creation”.

The attack on big business is said to be “a call on companies to include a broader set of stakeholders in their decision making, beyond their shareholders. It’s a view that has long been influential in continental Europe,” with the innuendo that the idea is foreign to the United States, thus ignoring the fact that customer capitalism was born in the United States, with Peter Drucker’s insight of 1954.

“It’s critical,” the article says, “that managers and board directors have a clear understanding of what value creation means… maximizing a company’s value to its shareholders, now and in the future.” Once again, no evidence is presented for adopting this firm-centric definition of value creation, let alone recognizing its devastating consequences in those firms that have adopted it. After all, it is not without cause that even Jack Welch called it, “the dumbest idea in the world.”

“The chief culprit,” the article continues, for the loss of public confidence in big business, is “short-termism. Managers and investors alike too often fixate on short-term performance metrics, particularly earnings per share, rather than on the creation of value over the long term.”

“The best managers,” according to the article” don’t skimp on safety, don’t make value-destroying decisions just because their peers are doing so, and don’t use accounting or financial gimmicks to boost short-term profits. Such actions undermine the interests of shareholders and all stakeholders and are the antithesis of value creation.”

Thus “creating long-term shareholder value,” the article continues, “requires satisfying other stakeholders as well. You can’t create long-term value by ignoring the needs of your customers, suppliers, and employees.” The article offers examples of firms fostering long-term shareholder value with gestures towards the improving employee working conditions, the environment, gender equality, and assistance to education.

Customers are mentioned, almost in passing, as a factor in deciding “how high a price a company should charge for its products. A long-term approach would weigh price, volume, and customer satisfaction to determine a price that creates sustainable value.” It is assumed that the customer wants and needs the firm’s products: the only question is one of money: how much to charge for it.

The article also flirts with the idea of stakeholder capitalism: “The interests of shareholders and stakeholders can go hand in hand. Businesses make a vital contribution by creating value for the long term. Doing so in a sustainable manner calls for meeting the concerns of communities (including the environment), consumers, employees, suppliers, and shareholders alike.” Yet there is no recognition of the fact that stakeholder capitalism was tried for several decades in the mid-20th century with a singular result: it didn’t work. In the absence of a clear purpose, firms became confused as to their purpose.

The article concludes with the complacent thought that “long-term commitment toward value creation, by contrast, almost axiomatically takes a broad range of constituent interests into account,” again conflating what’s involved in real value creation with a concentration on shareholder value.

The problem for firms driven by a concern for shareholder value, whether for short- or long-term, is that customers quickly detect that orientation and are put off by it. As soon as they can find other options, they are likely to leave. In this way, a firm-centric approach to value-creation tends to generate, not value creation, but value destruction.

To see what’s involved in real value creation, read part 2 of this article, coming shortly.

And read also:

The Triumph Of Customer Capitalism

The Hidden Heart Of 21st-Century Management



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