Harvard Business Review in its Jan/Feb 2010 issue published an illuminating article by Roger Martin, dean of the Rotman School of Management at the University of Toronto. In The Age of Customer Capitalism, Martin argues that companies that make shareholder value their top priority often don't do as well as companies that focus first on satisfying customers.
According to Martin, one way to break down modern capitalism is into two eras. The first era, beginning in 1932, was characterized by the notion that firms need professional management (management should be divorced from ownership). The second era, beginning around 1976, is characterized by the belief that the purpose of business is to increase shareholder value.
The problem, as Martin details, is that shareholders are no better off in the second era than the first. With all the attention on shareholders, you would think there would be long-term metrics to validate the focus. Not so. From 1933 to 1976, shareholders of the S&P 500 earned compound annual real returns of 7.6 percent. From 1977 to the end of 2008, they earned real returns of 5.9 percent per year.
Shareholder value is largely driven by expectations about the future. The implications for managers' actions are clear. To increase shareholder value, one needs to raise expectations about the future, which is often done through rapid growth.
Martin cites GE and Coca-Cola under Jack Welch and Roberto Goizueta, respectively, two of the most iconic and successful figures of the shareholder movement. Both chiefs generated incredible market capitalization, but the executives who followed them "have struggled to deal productively with the legacy of rapid growth and frenzied acquisition." Growth works for a while but eventually catches up with firms, which cannot raise shareholder expectations indefinitely through such means.
Two companies that have pursued customer satisfaction as their top priority over decades and have performed admirably are Johnson & Johnson and P&G. In the case of Johnson & Johnson, the company's steadfast dedication to customers, expressed eloquently in its credo, which dates back to 1943, has guided the firm through serious storms, most notably the Tylenol poisoning cases of 1982.
For both companies, shareholder value is a by-product of customer satisfaction and not the top priority for the firms. J&J and P&G both lead their respective sectors in creating shareholder value over the long term, helping to demonstrate that focusing on customers over shareholders often returns greater rewards to owners.
My favorite anecdote from the article involves Research in Motion (RIM), maker of the BlackBerry. As the author recounts, back in 1997, just after the RIM's initial public offering of stock, the founders agreed that anyone who talked about share price at work would be obligated to buy donuts for the entire organization. When the company was small, mistaken pronouncements about the stock price were not as costly. But in 2001, when the chief operating officer slipped publicly, he was forced to buy donuts for all 800 employees.
The debate over the purpose of business and primacy of shareholder value intensifies. The conversation is healthy, as companies, business schools, governments, even the Vatican, search for ways to reform capitalism so that it increasingly delivers value to customers, pays fair returns to owners, and serves other societal stakeholders. What are your thoughts about the ultimate purpose of business?
John Terrill is the Director for the Center for Integrity in Business at Seattle Pacific University