Shareholder Value vs. Customer Focus

Washington Post Joins Foes Of ‘The World’s Dumbest Idea’

Shareholder Value vs. Customer Focus

Image courtesy of [Janaka Dharmasena] / FreeDigitalPhotos.net 

In January 2010, Roger Martin wrote in Harvard Business Review that we are passing from an age of shareholder capitalism to customer capitalism.

In November 2011, when I wrote critically in Forbes.com about the theory of maximizing shareholder value, the article attracted almost half a million page views.

In May 2012, Professor Lynn Stout, the Distinguished Professor of Corporate & Business Law at Cornell University Law School, published her book, The Shareholder Value Myth, showing that the shareholder value theory has no basis in law or policy.

In August 2012, the New York Times headline was “Down With Shareholder Value”, as Joe Nocera declared: “It feels as if we are at the dawn of a new movement — one aimed at overturning the hegemony of shareholder value.”

In July 2013, the Financial Times had a series of articles chiding business schools for still teaching what even Jack Welch has called the “world’s dumbest ideas”.

Now in September 2013, the Washington Post has joined the chorus of critics and published an article by Steven Pearlstein entitled, “How the cult of shareholder value wrecked American business”.

According Mr. Pearlstein,

“In the recent history of management ideas, few have had a more profound — or pernicious — effect than the one that says corporations should be run in a manner that ‘maximizes shareholder value.’ Indeed, you could argue that much of what Americans perceive to be wrong with the economy these days — the slow growth and rising inequality; the recurring scandals; the wild swings from boom to bust; the inadequate investment in R&D, worker training and public goods — has its roots in this ideology..

“What began in the 1970s and ’80s as a useful corrective to self-satisfied managerial mediocrity has become a corrupting, self-interested dogma peddled by finance professors, money managers and over-compensated corporate executives.”

Mr. Pearlstein goes through the disturbing history of the shareholder value idea and concludes that there is now an infrastructure in place that perpetuates it, regardless of its disastrous consequences:

“This infrastructure includes business schools that indoctrinate students with the shareholder-first ideology and equip them with tools to manipulate quarterly earnings and short-term share prices.

“It includes corporate lawyers who reflexively advise against any action that might lower the share price and invite shareholder lawsuits, however frivolous.

“It includes a Wall Street establishment that is thoroughly fixated on quarterly earnings, quarterly investment returns and short-term trading.

“And most of all, it is reinforced by gluttonous pay packages for top executives that are tied to the short-term performance of the company stock….

“For too many corporations, ‘maximizing shareholder value’ has also provided justification for bamboozling customers, squeezing suppliers and employees, avoiding taxes and leaving communities in the lurch.”

Customers first

Mr. Pearlstein suspects that executives want to change. “The truth is that most executives would be thrilled if they could focus on customers rather than shareholders. In private, they chafe under the quarterly earnings regime forced on them by asset managers and the financial press. They fear and loathe ‘activist’ investors who threaten them with takeovers. And they are disheartened by their low public esteem.”

He suggests that some executives are getting encouragement for trying: “A small and growing universe of “socially responsible” investing is made up of mutual funds, public and union pension funds and research organizations that monitor corporate behavior and publish score cards based on an assessment of how they treat customers, workers, the environment and their communities.”

He also suggests changes in tax and corporate governance laws that could help:

“The capital gains tax could be re-calibrated so that short-term trading profits are taxed the same as wages and salary.

“The Securities and Exchange Commission could adopt rules that discourage corporations from giving quarterly earnings projections or guidance,

“States could make it easier for corporations to give long-term shareholders more power.

A change in mindset inside firms is needed

But these proposals don’t go far enough. This is not a legal problem or one that can be solved by external regulations. Shareholder value theory is self-inflicted suffering, generated by the internal dynamic of the organization. Change has to come in the first instance from within the organization, not from outside. Regulation and investors can encourage and strengthen, but without an internal passion for change, there will always be the usual “dog-ate–my-homework” excuses, blaming the stock market for inaction.

The truth is that the stock market rewards organizations with viable long-term growth strategies. A whole array of major companies have broken free from the hegemony of shareholder value: Apple [AAPL], Amazon [AMZN], Salesforce [CRM], Costco [COST], Zara [BMAD] and Whole Foods [WFM], to mention just few of the well-known names among large public firms.

These firms weren’t punished by Wall Street for doing so: instead, they were handsomely rewarded both with extraordinary profits and with increased share prices. Mr. Pearlstein himself can take comfort from the fact that the new owner of the Washington Post, Jeff Bezos, is one of the most prominent and successful leaders of the movement.

A different kind of management

The heart of the problem isn’t regulation or Wall Street. It’s what’s going on inside the firm. To get beyond maximizing shareholder value and have an organization that profitably delights its customers, the firm has to be run very differently. 20th Century hierarchical bureaucracy simply won’t get the job done. Firms need to get beyond “administration of their businesses” and start delighting their customers with innovation.

Asking a bureaucracy to delight its customers with continuous innovation is like trying to get a dog to walk on its hind legs. As Gary Hamel told me last year, “You can do that, but you can’t get a dog to do that for long. It’s a DNA level problem. A dog has the DNA of a quadruped. Once you turn your back on the critter, and you put away the treats, the dog is back on all four legs. We’re never going to build a truly innovative company without a gene-replacement therapy. You’re going to try something and then be disheartened when you discover that three months or six months later, the dog is still peeing on lamp-posts rather than doing the tango.”

Fortunately we now know how to do this kind of management”gene-replacement therapy”. To escape the hegemony of shareholder value, organizations need a fundamentally different way of organizing work, a different way of coordinating work, different values and different way of communicating. It’s a different way of thinking, speaking and acting the workplace—a Copernican change in management.

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