Here we go again – the debate over which group should be the most important focus for a for-profit business is on us again. Should it be shareholders (or owners for the private for-profit firm), customers or employees? Which group should take priority in setting the major goals for the for-profit firm? Due to space limitations and given the importance of these topics, this article will come in two parts.
I thought we had this settled years ago. But a very recent Harvard Business Review blog piece from a person I normally think is spot on has only caused confusion again. The author claims that a singular goal of maximizing shareholder value or owner wealth is a faulty goal. He suggests that customers and your people are more important than shareholders or owners. Let me give my answer that I have given for years: shareholders or owners are the most important group. Period. But as you will read, I qualify this to say all three groups of “stakeholders” are important at the right time and as a united system. How could we get off the rail again?
I think it is because every generation of executives has to learn this over again, and this is good. At any point in time, business schools and various writers or mentors stress one group over the other depending on their views. This is because there is no universal certification for strategists with an agreed to body of knowledge. I have been a consultant and on-and-off again professor of strategy for the last thirty-four years. I have seen the ebb and flow of this debate and let me try to give a convincing argument for my views.
The confusion in my view stems from faulty and loose definitions of customer value versus customer satisfaction, profit versus free cash flow and employee satisfaction versus engaging your people appropriately and effectively. Let me set out my definitions:
Customer Value – customers receive value from your products and services when the Benefits they receive are greater than the total Burden they must take on to receive those Benefits. Thus customer value has two parts – Benefits received versus the Burden to get those Benefits.
Customer Satisfaction – customers are satisfied when what you Delivered for them is equal to or greater than what they Expected you would Deliver for them.
Accounting Profit – Income minus Expenses (including taxes) from the income statement.
Economic Profit – Free cash flow return on investment that is greater than the weighted average cost of capital.
Free Cash Flow – Profit after tax less the incremental investments in fixed and working capital to cause a revenue increase.
Employee Satisfaction – the degree to which your people like working at your firm.
Engaging Your People Appropriately and Effectively – giving all of your people the chance and the means to become the best they can become.
There actually is a lot going on in and among these definitions so let me provide how I use them.
Customer value and customer satisfaction are related but providing customers superior value over what your competitors provide is key. Benefits are the things your products and services do for your customers. Burden is the price they pay but it is also anything they must do themselves to make your products and services work for them. If you do not provide warranties or a servicing capability, if you are inconvenient in location and cumbersome in resolving issues, you force the customer to take on these costs and hassles and this increases the Burden they bear to get the Benefits. If the Burden ever gets greater than the Benefit received, you are destroying customer value and your customers will flee to a competitor who provides more value. Your firm should strive to provide superior customer value over what rivals offer.
Customers can be satisfied as we have defined it in the short run, but can come to hate your products and services if the true customer value is exposed as faulty. Sometimes it takes time for a product’s value to reveal it is faulty. When was the last time it took nine months for your car to start having nagging problems that caused you to go frequently to the service department? For the first nine months you felt like a million bucks, only later to feel like you were duped. So customer value comes first and is followed by real customer satisfaction, not vicarious customer satisfaction.
Accounting profit is a very faulty measure as far as shareholder value or owner wealth is concerned. The measure uses only the income statement and ignores the time value of money. That is, a dollar earned today is more valuable than a dollar earned five years from today. Economic profit is the amount of free cash flow in excess of the weighted average cost of capital. Free cash flow uses both income statement and balance sheet accounts. And notice the bar that is set. If the firm is not earning free cash flow return on investment greater than the weighted average cost of capital, the firm is destroying shareholder value or owner wealth. Thus a firm can show positive accounting profit, but still can be destroying financial value.
Employee satisfaction is a useful goal. But it is loaded with problems. The typical Employee Satisfaction Survey asks questions like are your people satisfied with their supervisor, their compensation, vacation policies and the like. Take compensation for example. Typically only 30% of a firm’s people say they are satisfied with their compensation. Duh. Who does not want more money? A much better frame of reference is how do we Engage Our People Appropriately and Effectively to allow them to be the best they can be? Good training and holding people accountable for results is a part of this. This can actually cause Employee Satisfaction to drop in the short term. But firms who view their people as appreciating assets and not expenses will prepare their people for disciplined work that drives results and their wellbeing. Employee accountability and pride come first and then is followed by employee satisfaction, even in the toughest working environments.
Part 2 of this article will discuss how I tie all of this together for the benefit of shareholders and owners, but also your customers and your people.
This article is part of a series on what causes a firm’s value to increase
Dr. William Bigler is the founder and CEO of Bill Bigler Associates, He is the former MBA Program Director at Louisiana State University at Shreveport and was the President of the Board of Strategic Planning in 2012 and served on the Board of Directors for Nitro Security Inc. from 2003-2005. He has worked in the strategy departments of PricewaterhouseCoopers, the Hay Group, Ernst & Young and the Thomas Group. He can be reached at firstname.lastname@example.org or www.billbigler.com.