My consultancy firm recently participated in one of a series of five workshops (entitled ‘Powers, Functions and Duties of Company Directors’), organised by the Malta Institute of Management and the Institute of Directors together with the MFSA.
In the final session (‘Protecting and Safeguarding Stakeholders’ Interests’), a heated debate arose on the subject of the purpose of the firm. An eminent local lawyer and co-speaker in the workshop claimed that the sole purpose of any business was ‘profit maximisation’. To him this was obvious, non-debatable and common sense.
Not many people realise, but the very concept of profit maximisation originally only came about as an assumption; an assumption made by economists and intended to explain the behaviour of firms. Over time, however, this neat and convenient assumption gained traction and eventually became a normative goal and simplistic explanation of the legal-economic model of the firm.
Don’t get me wrong: instinctively it sounds right. It makes sense. A business exists so as to seek to make profits and in the absence of profits there probably would be no business. But there is a huge difference between ‘profit maximisation’ and ‘profit-making’ or ‘profit-seeking’.
Allow me to elaborate: a business entering a new market or an existing market with a new product cannot immediately set out to ‘maximise profits’; no, it must first invest and carve market share and this can take time. During such time, the business might operate at a temporary operating loss or breakeven until it reaches critical mass and establishes itself.
It will be only then that the business can seek to make profits (not to be confused with ‘profit maximisation’). I would actually argue that it is never in interests of a business to ‘maximise profits’. To my mind ‘profit maximisation’ means squeezing (or even exploiting) every resource your business has to exhaustion. It means focusing only on the short-term. At business school, I was taught that this narrow-minded approach to running a business is the surest way to ruining it.
So if it is not ‘profit maximisation’ what is it? To my mind it is ‘sustainable competitive advantage’. This means that a business has obligations not just to its shareholders but also to all its key stakeholders. I would much rather make 20 per cent profits over a 15-20 year period and have excellent stakeholder relations than grab 50 per cent profits over three to five years.
To be clear: I am not saying a business shouldn’t have ‘profit making’ as a goal because it should. It is the word ‘maximisation’ that concerns me and perhaps the lawyer, co-speaker, who made the original claim, actually meant ‘profit efficiency’ rather than ‘profit maximisation’. I don’t know. But there is a huge difference between ‘profit making’ and ‘profit maximisation’.
From a practical point of view, a business typically employs, and if it doesn’t it will struggle or even fail, different strategies throughout the life cycle of a product or business. The reason for this is that each phase (birth, growth, maturity, decline and death) brings with it a different set of challenges than the previous and what works in the early phases of a business will not in the subsequent phases. For instance, profit maximisation doesn’t make much sense when you are in the start-up or growth phase but it might make sense (though not always) as the business or product approaches the maturity or decline phase.
Therefore, ‘profit maximisation’ (not to be confused with ‘profit making’) cannot be a constant goal of business since it can only ever be relevant to a business towards the end of the business life cycle. I would actually say that ‘profit maximisation’ is never really, ever, and especially in the 21st century, a realistic option. I think the global capitalist system has evolved and matured a lot since the early 20th century when exploitation of resources (including workers) and profit maximisation were more mainstream and thus tolerated but not in today’s day and age.
In fact, Michael E. Porter, a leading authority on competitive strategy and head of the Institute for Strategy and Competitiveness at Harvard Business School, and colleague Mark R. Kramer earlier this year penned an extremely interesting article on the subject, entitled: ‘Creating Shared Value: Redefining Capitalism and the Role of the Corporation in Society’. The argument, in a nutshell, is that post the 2008 financial crisis, business can ill afford to be perceived by society as the major cause of social, environmental and economic problems, which they increasingly seem to be doing, or for companies to be prospering at the expense of the broader economy.
Business must aim to create ‘shared value’ which according to Porter et al means: “Policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which [a business] operates.”
I genuinely believe that as a country we need to understand and recognise that ‘profit maximisation’ is not good for anyone: the business, the customer, the employee, the shareholder, the wider community. We also, however, need to protect the desire, instinct and will of businesspeople who continue to take risks in their pursuit of ‘profit making’ enterprise since that is what generates growth in our country. But to think that ‘profit maximisation’ is either good for society or business is irresponsible. Profit maximisation, no; profit seeking, yes! We get basic concepts like this wrong and business in general will increasingly be seen as an evil to society.
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Mr Fenech is managing director of Fenci Consulting Ltd.