Why do managers choose to pursue profit so directly? The word "profit" in this month's column provoked a wide range of issues and emotions among respondents. It set off several debates. They ranged from definitions of "acceptable" profit to profit's effect on decision-making and even to the future and viability of capitalism.
One debate concerned the primacy of profit as a goal. Deaver Brown led this argument by saying, "Profit is the only legitimate goal of a corporation …," pointing out that it serves many important functions for us as employees, citizens, and others. David Zemanek added, "Isn't that why they call them 'for profit' companies?" Ann Brown said, "There's nothing wrong with profit as a goal. What's important is how you achieve it." (Tony Hayward's replacement at BP, announced on July 26, may be a timely illustration of that point; BP is very profitable, but there is official evidence that it continues to compromise safety.)
Gerald Nanninga, on the other hand, argued that profit is a default measure, commenting that "It is easier to measure and reward a goal of 'producing a profit of x' than it is to set goals around creating value faster than costs (his preferred goal)." Deepak Alse reminded us that "the world of business … is an unbounded system! … The 'Corporation' is in effect an acceptance of the idea that profit seeking should happen through indirect approaches." Mark Nadler commented, "Operationally, profit as a final goal is probably impossible because of principal/agent problems and lack of information and knowledge. This makes intermediate targets that affect profit important." Steve Brogan, meanwhile, offered an interesting analogy: "Anyone who has ever gotten involved in serious marksmanship understands that there is a difference … between the intended target and the 'aiming point.' " In a pessimistic and somewhat lamenting tone, Tom Dolembo ventured another reason: "I suspect profit, in the pure capitalist sense, is obsolete … we're just not capitalists anymore … profit is just another archival number to be doubted."
One argument for measures other than profit as "direct" goals is the complexity of the corporation and the difficulty of drawing a direct line between any action and profit. Raymond Suarez said, "In a world characterized by increasing complexity … reconsidering profit as being the sole and superior criterion for business success, is the only rational approach to take." On the other hand, Dan Wallace argued, "The presumption that problems are complex is a self-fulfilling prophecy … the most profitable and successful companies I know are rigorous … about driving simplicity and … driving out complexity…."
Charles Green continues the discussion by suggesting, "The really interesting question raised is: if profitability is higher when pursued as a byproduct than when it is pursued directly, why then do managers (irrationally) choose to pursue profit directly rather than indirectly? I think the answer is to be found more in psychology than in economics." Does that account for the increasing interest in the field of behavioral economics, as suggested by the recent writings, discussed earlier in this column, of George Ackerlof and Dan Ariely? What do you think?
H.L. Mencken once said, "For every problem there is a solution that is simple, direct … and wrong."
This brings to mind experiences with leaders of the most profitable organizations that I have observed. Almost to a person, they treat profit as a by-product of other things to which they devote most of their attention, things such as a focused strategy that delivers results to carefully-selected customers while pursuing policies and practices that leverage results over costs, hiring people with the right attitude (one that fits with the organization's culture), and proper training and organization (often in teams). Financial targets are given no more or less emphasis than targets associated with employee and customer engagement, often by means of some kind of balanced scorecard. Rewards and recognition—whether based on the performance of the entire company, teams, or individuals—reflect this philosophy. The idea is to create what my colleague, Michael Beer, calls a "high commitment, high performance" (HCHP) organization.
This idea has been addressed at length in a new book, Obliquity, by British economist John Kay. You might guess that Kay thinks profit as a "direct goal" is overrated, otherwise he wouldn't have much substance for a book on the subject.
Kay argues that business problems cannot be solved by drawing a straight line between cause and long-term effect because they are so complex, a manager's information so incomplete, the competitive environment so complicated, analytic techniques so inadequate, and the number of things over which a manager has control so limited, that it is impossible to make the connection with any assurance.
As Kay puts it, "The mistake is to make inferences about the relationships between outcomes and processes when we cannot observe and do not understand the processes themselves." The argument is that those things that contribute to long-term shareholder value will be revealed and achieved by realizing intermediate goals or through some kind of overarching mission and vision that helps an organization achieve long-term shareholder value as well. Of course, it assumes that we know what those things (missions, visions, intermediate goals) are and that we have some understanding of how they contribute ultimately to shareholder value.
There is some empirical evidence to support Kay's thesis. For example, Fortune's 100 Best Places to Work regularly produce more profit than a matched set of competitors. Kay's response to this would probably be, "What does that prove?"
If it can be demonstrated that this approach yields more profit, why doesn't the leadership of more organizations pursue profit through "indirect" means? Or is it, as Kay might ask, as simple as this? Can this philosophy be carried too far? Is it compatible with the need in a public company to "make the numbers" every quarter? Is it dangerous or misleading to give too much emphasis to the idea that profits are a by-product of many other policies and practices? Is it wise to communicate this concept to all levels of an organization? If so, how is this best done without confusing people? Is profit as a "direct goal" overrated? Why then is it so frequently found among goals? What do you think?
To read more:
Michael Beer, High Commitment High Performance: How to Build a Resilient Organization for Sustained Advantage (San Francisco: Jossey-Bass, 2009). (The Mencken quote is from Beer's book, p. 79.)
John Kay, Obliquity: Why Our Goals Are Best Achieved Indirectly (London: Profile, 2010).