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Clayton Christensen: How MBA-driven Profit focus is Killing the U.S. Economy (forbes.com)
216 points by carterac on Nov 20, 2011 | hide | past | web | favorite | 100 comments



The Keynes quote made me think of something. We have in the U.S. what is probably best described as an ethical system based on profit. It's literally pervasive. "The only purpose of corporations is to maximize shareholder profit." "We should have economic policies that grow the pie." All of these statements are couched in a normative principle: that the singular pursuit of profit will lead to maximization of the pie, and thus the greatest overall welfare.

This normative principle was defensible in the 18th century, though Adam Smith never took it to quite the extremes that we have today, but is pretty solidly indefensible based on what we know about economics in 2011. And that's something I don't think even most economists would dispute today.

Yet, our ethical system is beholden to that principle, though we know it is based on assumptions we know to be wrong.

What MBA programs need to teach, and I think it is happening recently to some extent, is that "social responsibility" is not a dirty word. Considering the social impact of business decisions, something that is considered irrelevant under the current ethic because of the premise that profit-maximization == welfare maximization, is not only not a bad thing, it is an indispensable obligation of doing business in civilized society.


>"The only purpose of corporations is to maximize shareholder profit."

That's not true, and it's not event a popular opinion among the people who actually study the subject. It's only popular among the arm-chair internet specialists on corporate governance. For a well-rounded perspective on the subject I would suggest the "Corporations" text book by Alan Palmiter.

In brief, a corporation's purpose is maintaining balance between interests of various stakeholders such as shareholders, employees, management, creditors, regulators, consumers, the public, etc. Each stakeholder is exerting a different kind of influence on the corporation and suffers different consequences from the resulting consensus action (which motivates his influence).


We used the Klein textbook on Business Associations, but it should be the same material...

Yes, I agree that in the eyes of the law there is more to the corporate purpose than just maximizing shareholder profit. However, I'd argue that the law is really the last bastion of considerations of fairness and equity in the corporate sphere, and the idea that maximizing shareholder profit is morally right is dominant, both among business people and in our political discourse.


I'll provide few obvious counter examples:

1. As an employee, you will refuse to murder children, even if legally, to maximize corporate profit. You have your own ideas of what's right and wrong, and so do all other employees. Employees have a lot to say about what's going to happen.

2. Corporate management is often criticized for short-sightness and destroying shareholder value for their own benefit. This, and "the shareholder profit is holy" cannot be true at the same time. :)

3. Some corporations give shareholders little or no voice in governance (e.g. Google). The courts historically (per Plamiter's book) give the management benefit of the doubt in any ambiguous situation, and only slap the management down when it's clear they act against shareholder interests. Management has huge leeway. Further, corporate charter can be written such that profit motive is not the primary goal.

To the extent that a corporation behaves exclusively like a profit-seeking device, it does so on the consensus of the stakeholders, not due to its inherent nature.

If I may offer an analogy, American expansionism in the Middle East, is not an inherent property of a republican democracy, but only of this particular one, given to how interests of stakeholders (including foreign stakeholders) have balanced out.


The ethics of private property aren't based on profit, they're based on the self-evident fact that one owns his own will and is responsible for his own actions, and consequently the fruits of his labor.

Social responsibility isn't a dirty word, it's a completely meaningless and dangerous word used by ideologues of all types to serve their personal vision of the world. It means something different to everyone you ask.

I don't have responsibilities to obligations I never made.


If you read Adam Smith, his argument is that pursuit of individual gain produces social good. "By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it." The rhetoric we use today "a rising tide lifts all boats" and the like is thoroughly rooted in that thinking.

The fact of that matter is that we know this premise to be false. That knowledge is indeed irrelevant if you conceive of the profit-maximizing principle as being entirely rooted in an "every man is an island" hyper-libertarian conceptualization, but that is a relatively modern phenomenon and a wholly inaccurate description of the underpinnings of modern American ethics.

As a practical matter, only a few crazies actually believe that people have no social obligations. A large majority have some social conscience, but because they fully buy in to Smith's normative principle, they believe that their business decisions need not be guided by considerations other than profit. To the extent that this principle is invalid, their behavior is inconsistent with fostering desirable outcomes.


> As a practical matter, only a few crazies actually believe that people have no social obligations.

It depends. I live in a former Communist country in Eastern Europe, and you'd be surprised of how effective +50 years of communist rule were at destroying any "social feelings" whatsoever.

Of course you could say it's a bad thing, but on the other hand the fact that you've lived your entire life with the credo "rely only on yourself and yourself only and trust no-one" is really good in times of crisis like the ones we're going through right now.


"By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it." [..] The fact of that matter is that we know this premise to be false.

I disagree. If someone doesn't pursue their own interests then by logical necessity they are pursueing interests imposed on them. "Social interest" is merely a euphamism for State interests. Killing the Jews in gas chambers was a social interest. Of course, by disagreeing with that you would prove my point that "social responsibility" is anything but a completely subjective term that varies (greatly) by each individual, and only has power in the context of the State.

As a practical matter, only a few crazies actually believe that people have no social obligations.

But what does social obligation mean? If you didn't obligate yourself, then social obligation really means obligation by force, obligation to the State and whatever the State deems an obligation. Obligation to a small group's whim instead of obligation to your own actions, interests, and responsiblities.


You've got to the Godwin point at impressive speed, kudos.

> If someone doesn't pursue their own interests then by logical necessity they are pursueing interests imposed on them.

You fall for the fallacy that you actually could be free of social influence anyway. This isn't the case; see you've been Ayn-Randed to the bones, for instance. That makes you believe mad things that work against your own interest in the long term. See?

> But what does social obligation mean?

You're born to some family, speaking some language, walking some road, sheltering under some roof someone built, lighten by some power that was brought to you, etc. Are you pretending you don't need anybody else?


> You fall for the fallacy that you actually could be free of social influence anyway.

No, I never implied that I was free from the forceful influence of the State. Social obligation in the context of the post I was responding to is (I thought) referring to regulation and taxes, the social contract.

> You're born to some family, speaking some language, walking some road, sheltering under some roof someone built, lighten by some power that was brought to you, etc. Are you pretending you don't need anybody else?

I'm not pretending that I don't need anybody else. I just don't find moral legitimacy in being compelled to do things by force without my consent.

Private roads aren't allowed to exist, I pay for my own shelter presumably built by people who were already paid to build it, I pay for my power by the company that provides it, and language I acquired by picking it up from others at who provided it freely.


> I just don't find moral legitimacy in being compelled to do things by force without my consent.

By force? Were you subject to violence? You're free to head into the wilderness, live from your hunting and start your own civilisation on your own, perfectly free; others did. However it proves more cumbersome and less pleasant than simply living in our oppressive society.

I'm perfectly happy with paying taxes, and having roads, policemen, garbage collectors and street lights. What's the opposite stance?

> Private roads aren't allowed to exist

How so? The path going across my terrain is as private as possible. However private roads aren't really practical. It's commonly known that infrastructure work in general is less efficient when not a monopoly, and so far the only working monopoly is the state (monopoly of violence most saliently).


Private roads are very, very difficult to build in modern America. The biggest issue is that people traveling on a private road are not allowed by the government to sign away their right to sue, and the liability for the private road operator is enormous.

Other issues are the thicket of regional planning regulations. There's really not truly private property any more, roadbuilding of any type is subject to the state and local political process.


I'm afraid you're confusing a symptom (the over-complexity of our society) with a cause. My advice : read the always fresh and mind-blowing Joseph A. Tainter's "Collapse of complex societies".


As a resident of Central Texas there are 3 privately owned toll roads within 5 miles of my house, all built in the past 10 years.


   I just don't find moral legitimacy in
   being compelled to do things by force
   without my consent.
So, you're arguing in favor of anarchy?


You've got to the Godwin point at impressive speed, kudos.

Please drop the snark.


> I disagree. If someone doesn't pursue their own interests then by logical necessity they are pursueing interests imposed on them.

If you read the text surrounding the quoted language, it uses "own interest" in a narrow sense, not encompassing altruism. If you subscribe to the notion that there is a dichotomy between "own interest" (encompassing altruism) and "the state's interest" then yes your claim is logically valid, but also besides the point. The ethic underlying modern American business ethics conceives that profit maximization maximizes overall social welfare (i.e. it uses the narrower definition of "own interest" that Smith uses, not your broader definition).

> Of course, by disagreeing with that you would prove my point that "social responsibility" is anything but a completely subjective term that varies (greatly) by each individual, and only has power in the context of the State.

Guess what? We live in a state. And we live in a state where most people believe in welfare maximization: the greatest good for the greatest number. And many of those people, in the business context, believe that profit maximization leads to welfare maximization. To the extent that this assumption is incorrect, their behavior is inconsistent with their desired outcomes.

> But what does social obligation mean? If you didn't obligate yourself, then social obligation really means obligation by force, obligation to the State and whatever the State deems an obligation.

You obligate yourself by participating in civilized society. You obligate yourself by exchanging, for the protections of civilized society, the duties of living in a civilized society. You try to separate "the State" from "the people" but in reality "we the people" created "the State" to defend our property interests. "We the people" through "the State" keep big strong men from taking what you conceive of as "your property" and that obligates you to us.

That obligation doesn't necessarily have to involve coercion. To the extent that you don't consider how your business decisions impact society at large, it might simply make you a "bad person." The problem is that we have an ethical system that relieves you of the duty to make that consideration. You can ruthlessly try to maximize shareholder value and still be a "good person." That ethic is predicated on the idea that profit maximization ultimately serves to maximize social welfare. What I'm arguing is that this assumption has been empirically invalidated (or at least drastically limited) and as such we should move towards an ethic that labels people who are socially inconsiderate as "bad people."


> but in reality "we the people" created "the State" to defend our property interests.

No, I did not. I didn't consent to any such agreement creating the State.

> We the people" through "the State" keep big strong men from taking what you conceive of as "your property" and that obligates you to us.

We the people? I did not consent to the constitution. Just like I can't bind you to contracts that you didn't consent to, I am not part of "we the people" because I never consented to be represented. Funny that it's called a "social contract" when it doesn't conform to contract law!

> You obligate yourself by participating in civilized society.

If that's the case, why can't I levy taxes and impose rules on people without their consent, simply because I sold something to them?


"No, I did not. I didn't consent to any such agreement creating the State."

You do every moment you live in civilized society.

What is the alternative? Ask people when they reach the age of majority to sign an agreement to follow the laws of the land? What if they refuse?


No, "being here" is not consent. Suppose I come to your home with a bunch of armed friends, and tell you "You are free to leave, but if you stay you consent to following my rules." It would be absurd to consider that consent.

The alternative is a society based on voluntary exchange, by recognizing the State as an immoral initiation of force.


The fact is that people are born into society. People who lived before us created a system where rights are protected and, when you reach the age of majority, you have the option of participating in governance either by voting, or running for office or other political action (this is all assuming you live in a Western style democratic republic).

I am not sure where you get the idea that you are being violently coerced into living in civilized society and thereby following the pre-existing laws, simply because you never signed a contract or, equivalently, expressly consenting that you would. Contracts are a legal convenience. A convenience whos very enforcement is dictated by the laws that you rail against for not having explicitly agreed to them. A bit of a chicken and egg problem, wouldn't you agree?

Your argument is absurd. "I didn't agree to have red lights mean 'stop'!", "I didn't agree that murder should be punished!", "I didn't agree that I couldn't build a hog farm on my suburban front lawn!". I mean, come on. What is your alternative to expecting people to live by certain rules that their ancestors through their previous political action put in place? Start from scratch with each new person? How would we tell who agreed to what? There are laws that I don't wholeheartedly agree with either but, for the most part, they seem pretty reasonable. Your 'system' or lack thereof, wouldn't fly in a household much less a nation.


> The fact is that people are born into society.

Yes, and being born into society doesn't create any moral obligation to those who gave birth to you. Children should not be involuntary slaves to their parents.

> People who lived before us created a system where rights are protected and, when you reach the age of majority, you have the option of participating in governance either by voting, or running for office or other political action (this is all assuming you live in a Western style democratic republic).

Being able to participate in governance through voting does not negate the fact that being bound by the vote's decision is something that is forced upon you, and isn't imposed on you by consent. You either agree to the vote's result or you are forcibly jailed or executed if caught deviating from what was agreed by the voting system imposed on you.

> I am not sure where you get the idea that you are being violently coerced into living in civilized society and thereby following the pre-existing laws, simply because you never signed a contract or, equivalently, expressly consenting that you would.

If you don't follow the law and you are caught, you will be forcibly jailed or executed, or some other punishment inflicted upon you by force. It's a fact that law is upheld by force, and the vote that created the law is imposed on you by force. You have no choice whether or not to be bound by the vote's decision. You never consented to be bound by it.

> Contracts are a legal convenience.

This is self-evidently false. Individuals may make agreements between them without any involvement of a 3rd party.

> A convenience whos very enforcement is dictated by the laws that you rail against for not having explicitly agreed to them. A bit of a chicken and egg problem, wouldn't you agree?

Enforcing agreements does not necessitate a State enforcing them.

> What is your alternative to expecting people to live by certain rules that their ancestors through their previous political action put in place?

To live by rules that I consented to, and not to initiate force on another individual except in self-defense.


Pure fantasy. And not even of the interesting self-consistent kind.

" Individuals may make agreements between them without any involvement of a 3rd party." Sure. But, say there is a disagreement between the parties? What then?

"Enforcing agreements does not necessitate a State enforcing them." The 'State' is a label for a whole host of human activity. One of those activities is to act as arbitrator for agreements between parties. Arbitration would be without meaning without means to enforce the decisions reached.

"To live by rules that I consented to, and not to initiate force on another individual except in self-defense." That sounds exhausting. Do you really want to spend your energy, and everyone else's energy in any interaction whatsoever that you happen to have with them negotiating the rules for that interaction, /then/ getting on with the business at hand? (with the one a priori rule that you seem to agree with is that no one should physically force someone to do anything).

You might not believe this but these rules and laws were not set up to bend people to some terrible overarching will but as a means to lubricate human interaction. Without them almost every thought would have to be directed at confirming that every part in your environment that is human or ever touched or affected by any person living or dead meets your expectation.

For example: Say you want to leave your home to check your mail a half a block away.

First, you would have to get out of your home. Good luck. There were no building codes and the frame (which you could not see when you bought the house) has been built with roofing nails and has rendered your doorway a parallelogram. You were able to rip the door off its hinges and now you step outside. YOu are assailed by the smell of your neighbors new hog farm in their frontyard and the vision of them having sex in full view of your porch (they didn't agree with the vulgar display laws). As you walk down the street that is littered in garbage thrown out by passing motorists you almost fall into a sinkhole caused by another neighbor digging their own tunnel between their house and their meth lab across the street. Just then you notice that the end of the street is blocked off and the mailbox has been torn from its base and lying in the middle of the road on fire surrounded by a group you've never seen before. I guess you won't be getting your mail today.

This would never happen under your 'everybody comes to their own individual agreements' system because the human condition would not advance so far as to have things like houses with frames, sidewalks and farms. It is an impossible burden which is why things like government or the 'State' as you like to like to pejoratively call it came into being.


> Funny that it's called a "social contract" when it doesn't conform to contract law!

It is a basic principle of contract law that you ratify a contract (implicitly consent) by acting according to the contract.

You have, for some number of years, accepted the protection of the state. You have ratified the contract through your participation in civilized society.


Capitalism, personal liberty, and morality (e.g. traditional Judao-Christian morality, though I don't claim that's the only workable system) are like three legs of a stool. It will fall over without one of them. A moral person's "own interest" includes doing things that are consistent with his sense of morality. Personal liberty and private property rights are essential to allow capitalism to flourish. Decades of attacks on and marginalization of traditional morality in favor of more contemporary "social obligations" (code for "whatever feels good") have resulted in capitalism motivated by greed, rather than a more complete "self interest" that includes morality. We see the results.


I really think you are mixing up your units, so to speak. Smith spoke of men wanting to be loved and to be lovely. The reducibility of society to the individual is a feature of liberalism - indeed, it's probably the defining characteristic. Once we try to make a collective a unit of polity, we run into trouble.

Smith's math was - for every dollar in profit "p" you make, you create "x" dollars of consumer surplus, and "x" is always much more than "p" ( because people simply would not bother. The "unconscious" nature of consumer surplus, and the clear historical disasters wrought by large efforts based on intentions show clearly that we need discipline in our evaluation of what we do that does good. One was of doing that is price and profit.

There are the Adam Curtis films, in which he tries to use neocon logic to critique liberalism without being the sort of neocon one can spit on, but his films are problemsome. He at least asks the right questions, which are hard questions, and you can't blame him for being responsible enough to provide at least one answer.

Profit is little more than a "qsort callback" related to priority. it is a tool for the always difficult question of "what shall we do now?" There are certainly forms of gain which entail rent-seeking or despoilment which are called profit ( but are not, really - there are either economic rents or involve the creation of negative externalities ) but beyond that, Smith's read really is that of a moral philosopher first, and I've yet to see a really good counter to it that does not involve something akin to universe-building.


If you read Adam Smith, he has a more nuanced view of individual gain for social good when it comes to corporations and the elite. For example, I think he has a more pragmatic view of when free markets deliver benefits, vs assuming that free markets always (eventually?) optimize for the overall social good.

http://www.theglobalist.com/storyid.aspx?StoryId=4677


> ... they're based on the self-evident fact that one owns his own will and is responsible for his own actions, and consequently the fruits of his labor.

On the contrary, this is an extremely non obvious, loaded assumption. It is deemed true in many cases, such as in front of a court, but is then well known to be a judicial fiction.

The worst problem with some people (particularly libertarians) is that they actually believe that this is the simple, unadulterated truth, which unfortunately isn't nearly as easy as this, and this will bring our civilisation to complete collapse under the oh-so-wonderful pursuit of our own individual self-interest, the same way its huge antlers doomed the gigaceros (for the individual male gigaceros, bigger antlers were always a net advantage against competitors in the "struggle for life", but they assured the species inability to adapt as a whole).

Annoying as it is, this is again best explained with the famous joke: for every complex problem, there is a solution that is clear, simple, and wrong.


...the oh-so-wonderful pursuit of our own individual self-interest, the same way its huge antlers doomed the gigaceros (for the individual male gigaceros, bigger antlers were always a net advantage against competitors in the "struggle for life", but they assured the species inability to adapt as a whole).

Some actions have externalities and should be subject to pigouvian taxes to internalize the externality. Few people, including libertarians, dispute this point. Once harmful externalities are properly taxed/penalized, then it is no longer harmful for individuals to pursue their own self interest.

You are also correct that signalling (e.g., growing large antlers) generates harmful externalities. Thus, we should tax signalling activities such as obtaining a college degree, wearing a suit or writing in a moleskin.


> Some actions have externalities and should be subject to pigouvian taxes to internalize the externality. Few people, including libertarians, dispute this point.

I'm not so sure about the later, apparently dreamdu5t and many other libertarians find all and every sort of taxes unacceptable. Thanks for the Arthur Pigou reference.


Its like the American miss-understanding of Karma..

Karma is the balance between self interests and other people's/world's interests..


The ethics of private property aren't based on profit, they're based on the self-evident fact that one owns his own will and is responsible for his own actions, and consequently the fruits of his labor.

This is assuming that everyone is born into an equal setting, with an equal upbringing & that property & resources are dolled by a completely unbiased party. Something that is essentially impossible.


Individual sovereignty, the fact that you are responsible for your own actions, does not require an equal anything outside of being a human being that acts.


This is like saying an algorithm just needs the ability to compute & the computer it runs on or data set it's given plays no part regarding it's performance.


Individual sovereignty doesn't mean I'm not dependent on other people, it means I own my body and thus am responsible for its actions.

To deny individual sovereignty is tantamount to denying the concept of free will.


If worthiness of fruit is determined by the person's decision making, then in order for it to be truly fair, all persons must be offered the exact same opportunities for it to be an accurate benchmark of the person's character or will.

If you are giving some a head start, while handicapping others & your system doesn't account for this, it is no longer a useful benchmark.


This comment finally coherently explained to me why a carrot farmer who first farmed some land (after murdering the commie Indians who lived there beforehand) gets to own mineral rights in the volume created by extending a cone from the surface of his carrot patch to the center of the earth. Thanks!


The root cause of the problem is the separation of ownership from control. This lead to the rise of the class of "professional managers", whose interests are intrinsically short-term. In the times when American wealth was created, the owners called the companies with their own names: Boeing, Ford, and MBAs did not exist. Their interests were to pass the earned wealth to their children. The historical mission of the MBAs and the professional managers is to dismantle the salvageable assets and sell them to more vibrant economies.


Yea, I know, the legacy MBA culture of greed: http://www.cbsnews.com/8301-505125_162-31042419/alum-harvard...


Economists call these differences in incentives "agency costs". I learned this term in my MBA program :)


The separation of ownership from control began with the East India Company, the first known corporate entity. In 1600, the Queen granted a Royal Charter to EIT for pursuing trade with India. Professional managers have existed just as long.

The problem is not the managers, or people with MBAs. The problem is that the Delaware chancery courts, where most American corporations are incorporated, long ago ruled that the duty of the Board of Directors is to manage the company to maximize the returns of its shareholders' investments. They can, and frequently do, get sued if they do not do this.


Yet the timeline upon which they are to do this is unclear. Investors want to maximize for a decade, temporary holders want to maximize the quarter. The point Christensen makes is that short term maximization does not always lead to long term maximization. One thus must blame the shareholders themselves for not acting as investors, but rather as speculators, frequently not even participating in board elections, allowing the CEO to pack the board with allies, just waiting for a bump in the share price so that they can exit their position.


> temporary holders want to maximize the quarter

Serious question. Did the quarter system come from the agrarian economy? If not, where did the emphasis on three-month increments come from?


I don't know, but quarters also match the seasons, and for most of history manufacturing was directly tied to which season it was.

And a lot still is today. Homes, cars, clothing, [specific] food, it's all tired to the season.


In the US, it's probably something to do with quarterly dividends (which makes it the reporting period for financial results). Less frequent dividends would cause the value of shares to drop more significantly post dividend (which happens anyway, but with quarterly distributions, one doesn't have to think of shares as being 'almost there' w.r.t paying out). More frequently (monthly, say) would increase transaction costs too much.


I think it came from the corporate takeovers that happened back in the 1980s.


Unfortunately, if history is an indicator, the West has not been very good at thinking long term.

In my opinion the race has been run. The damage to our planet is probably irreversible insofar as that at some point human life will not be possible. At that time we can only hope that a more intelligent species will come along and do better than us.


East India Company was a British monopoly granted by the Queen (just like the Dutch East India Company was a Dutch monopoly) .

In the Golden and Gilded American Ages, the main shareholder of the wealth-generating American companies was almost always its owner (same person as the chief executive), or his heirs. No MBAs.


BINGO..someone on HN finally gets it..it was not MBAs concentrating on profits but the way ownership changed over the last 40 years to decouple owners from the goals of long term gains.,


The Keynes quote is funny, giving the number of people that define their selves as Keynesians, and being Keynes dead long ago.

As some people had already stated, MBAs are not the problem, if you go to a good MBA you will have good teachers, and those people have very clear in their mind all those economic fallacies and more.

Ethics are the problem.

The problem is the fact that somebody could enter a company, increase the short term benefits, but destroy the company long term, and get out rich, and nobody going after them. HP(last CEO got at least 5Million) , GM(what are 50 Billion these days anyway?, nobody lost their seat), Golmand Sachs, buying bankrupt states CDS(enormously profitable while it does not break, the bill is payed by taxpayers when it breaks)...

E.g if Google decides to "monetize" all the info they have over me overnight they will increase their profit a lot (x5 or x10), but I will start looking after other companies search. As everything I use uses their services it will have to be a slow, progressive change, while the genius MBA graduate could declare victory and retire rich at 30, but it will make people spit at hearing the word Google.

Another example, there was a time in witch SCO was a serious software company, but some guy decided to make himself rich while destroying the company, and now the name have a different meaning.


"there was a time in witch SCO was a serious software company"

I'm pretty sure the current SCO isn't even the same company as the original Unix Santa Cruz Operation - they are really what was Caldera who bought part of SCO (including the rights to UNIX) and then ended up calling themselves SCO, now TSG.

http://en.wikipedia.org/wiki/SCO_Group


There was also a time in which Caldera was a serious open source company. I remember using their Linux offering in the 90s.


The problem is the fact that somebody could enter a company, increase the short term benefits, but destroy the company long term...

is not necessarily a problem. There are many companies that should do this, but instead try to continue existing (mainly so the CEO/etc can keep their job).

The goal of most companies is to increase shareholder value. Shareholders, like most people, get more value out of money right now than money in the future. If a company has good short term profits, but their future prospects are not great, shareholder value can be increased by making shareholders a lot of money now and going out of business.

The shareholders would then be free to invest the money in other companies with better prospects.

In my opinion, Microsoft is a good example of a company that should do this. It's highly unlikely that shareholders would have chosen to invest in Bing were Bing a separate company. Rather, they would probably have preferred to invest the money in Google, Facebook and other such companies, or perhaps even diversified out of technology. But due to a misplaced desire of corporate executives for Microsoft to continue existing, shareholder value was not maximized.

(Admittedly, taxes complicate this picture, and encourage investment within a company rather than outside a company. But that's somewhat tangential to the main point.)


This nonsense that all companies exist to increase shareholder value, or that there's some legal imperative to, is total crap.

Who here started a company to increase shareholder value?

Companies exist to fulfil someone's dream. At some point they get corrupted. And then suddenly it's all about shareholder value.

And at that point you know they'll never produce another exciting product again.


Who here started a company to increase shareholder value?

My cofounders and I did.

A company that exists to fulfil someone's dream is a hobby. Occasionally you can make money from it, but very often not.

In contrast, by building what customers want (rather than what you dream of), you create customer value. In turn, the customers pay you and increase shareholder value.

As for whether all companies exist to increase shareholder value, clearly they do not. The Gates Foundation, any church, or the Committee to Elect Hillary Clinton are obvious counterexamples. I was discussing the companies who do have increasing shareholder value as their goal.


  Another example, there was a time in witch SCO was a
  serious software company, but some guy decided to
  make himself rich while destroying the company, and
  now the name have a different meaning.
By the time that SCO was claiming to own Linux, all they really had left was their name. Destroying the brand isn't such a big deal when your company is on its last legs.


I wouldn't say that the problem is "maximizing profits" per se. The problem is the focus on "maximizing profits in the short term".

Which brings us to another problem: that predicting the effects of a business decision on profits in the short term is easy enough, while predicting it in the long term is much more difficult (even impossible, depending on how you define "predicting").

Simplifying, for the long term you need vision, leadership and entrepreneurs. For the short term you need formulas, management and MBAs. Quite often the two needs clash with each other.

A century ago there was a lack of management skills and applying them brought big results. Now we are probably (well) past the point of diminishing returns - even negative returns in the long run, and what is missing is vision, both at the corporate AND at the political level.


This article was a bit odd. My b-school experience was almost the opposite. IRR was presented as inferior because it could put you in situations where you are giving up a lot of profit in dollar terms for a smaller dollar profit that had a higher rate of return.

In the end, one metric was not used as the be all and end all. Using multiple metrics to help inform an investment decision was the ultimate goal. The problems with American business are multiple and complex; it's not a matter of a simple financial metric.


My MBA is circa 1997, and I shared your experience. A friend with a much "better" MBA than me (his from Harvard) once remarked, "Modeling is a great way to determine if a business idea is awful, but it's not going to tell you if you have a good one." I might argue even further that modeling can lead one to dismiss profound ideas through the erroneous presumption of a static future. It was said that the original business justification for Xerox counted the number of typists in America and multiplied by the number of mimeograph copies produced from each document. Obviously, the copy machine found many more purposes once introduced into offices -- a much more dynamic effect than most could even imagine.

Perhaps Dell's artificially static future was the presumption that shipping a laptop or desktop with a pre-installed OS would continue to be a viable business model? What if Steve Jobs had been forced at gunpoint fifteen years ago to lead Dell? What would the outcome have been? He likely would have spoken harshly about the elephant in the room -- Dell produces a commodity, and its future depends on Microsoft's continued prowess. With such an admission out in the open, what actions could have been taken which would have been nearly impossible to quantify via traditional B-School modeling techniques?


What if Steve Jobs had been forced at gunpoint fifteen years ago to lead Dell? What would the outcome have been? He likely would have spoken harshly about the elephant in the room -- Dell produces a commodity, and its future depends on Microsoft's continued prowess.

What if Michael Dell had been forced at gunpoint fifteen years ago to lead Apple (and not liquidate it)? What would the outcome have been? He likely would have spoken harshly about the elephant in the room -- Apple produces bespoke designs to compete against commodities with bigger economies of scale and network effects, and its future depends on its (arguably not then demonstrated) ability to, by itself, out innovate both a larger software provider and several hundred hardware vendors.

(Which is a slightly artificial way to make the point, but I don't for one minute think Apple's past - or indeed future - success was even slightly guaranteed. Their position is remarkably precarious, IMHO.)


That's pretty much the rule for modeling in any domain. It can tell you with good confidence if an idea is bad and with fair confidence whether an idea might be viable, but it can't do more than guess and it won't tell you whether you're asking a stupid question.


My experience was more like yours as well. Here are some metrics you can use to evaluate certain things, but here are the 50 problems with using this metric in isolation.

Generally I think the curriculum taught in my school was fantastic, but I think there is a segment of my peers who failed to grasp the underlying meaning and walked away with simple metrics and formulas. Just like cut and paste programmers or those in my CS curricula who learned a few things but did not grok fully, they give everyone a bad name when they egregiously misapply concepts.

Just like those people who shallowly apply metrics, labeling an MBA as basing all decisions on IRR and then painting all MBA's as alike is shallow and overly broad. For example while accounting and finance were covered, there is also economics, operations, strategy, negotiation, leadership, communications, marketing, managerial accounting, and more. All of which look at things as much more than a collection of financial metrics.

The world is a very complex place. Simple sentiments, arguments or sound bytes rarely capture the essence of even the simplest underlying systems. Sweeping generalizations claiming to explain all of the problems of an extremely complex dynamic environment set all kinds of alarm bells ringing in my head.


That is why I distinguish between "legacy" and "modern" MBAs.


I never thought of this distinction. Excellent point.


For those of us without MBAs, which is which?


I regarded my MBA classes as semester-long courses in applied critical thinking. There were few right answers although there were those which clearly were wrong. At no point did any professor say, "Make business decisions based on the values of these metrics."

A good analogy might be found in some software I'm working on now. Part of it is a specialized serialization scheme designed to produce small serialized forms of large numbers of similar tree graphs. It is easy to quantify the size of the serialized form of N million trees, and it is easy to measure the CPU/IO time required to produce this form. However, when making design decisions, I only use these metrics as one input into my thought process. If I do X, how easy will it be for others to maintain after I leave (I'm a contractor)? Does a proposed design decision limit future opportunities for this module's use? Does "brittleness" increase? Does this decision move the design further away from using Mongo/HBase/whatever in the future, or does it lessen the current impedance mismatch? The easy metrics are time and space, but the might not be the most important ones.


I really enjoyed that. I am no MBA but a programmer who found himself as lead dev for a retail chain. Boss, owner, is MBA and we're pretty much learning off of each other.


[deleted]


I mean that even today's MBA courses don't have these problems, there are still many old MBA graduates that were taught the horrible stuff and still using it today.


Professor Christensen gave this talk (or one very similar) at Business of Software this year. He was phenomenal.

One thing I like a lot about the culture in younger companies, especially in tech, is that while we are conscious of the appropriate financial ratios, we're not driven by them. For example, Fog Creek, while profitable, isn't driven only by profit, and happens to be passionate about giving developers a great place to work and helping developers create better software (among other things).


"isn't driven only by profit"

I will argue that establishing such a reputation, even at the expense of short-term profits, likely is profit maximizing. So, you are profit driven -- just in a way which also happens ot feel good ;)


That is mixing up causality. Just because significant profit comes your way does not mean you are in any way driven by it.


Its unbelievable how business (school) buzzwords and tactics tend to overlook the most important aspects of a particular industry / problem / scenario that are non-financial in nature. There is an important strategic perspective(s) which cannot be accounted for in IRR, RONA or any of the other hundred such terms. Loved the quote from the founder of TSMC.

It is also surprising to see that most Asian conglomerates ( in India, Japan, Korea, Taiwan, China etc.) seem to have strong vertically integrated businesses where are they continuing to build and expand expertise in the core areas, while letting the west become their marketing managers.


I don't know, the general theory of "Companies outsourcing themselves to death" sounds fine, but somehow the examples are never convincing. I mean if you compare the development of Dell vs. Asustek in GoogleFinance, it really doesn't seem that Asustek is better off. Is it really such a tragedy if Dell isn't in the dying pc-manufacturing business anymore?


Exactly. How many Dell-like companies have we seen die off over the last fifteen years because they were stuck in their ways. The PC companies that have survived are those that made it in to services work - HP, IBM, Dell. Oracle has worked hard to get into the sector. Plenty of names that come to mind for great-computer companies who got squashed - Compaq, Digital, Gateway, Olivetti, Sun, SGI.


Not really sure in how far this is a new insight. Based on Drucker's old mantra Business has only two basic functions - marketing and innovation it is pretty obvious that in production based industries manufacturing and innovation are stronger related.

But it is great to see that influential business academics like him increasingly promote the fact that business success is not (only) about juggling numbers. Or to quote from my favorite paper by Christensen:

And all data are subjective. Each form of data is a higher-level abstraction from a much more complex reality

(2004 Carlile & Christensen - The Cycles of Theory Building in Management Research)


Financial metrics are great to measure the health of a company, but I don't think anyone ever intended companies to be run by financial metrics. This isn't just happening in business though, these ideas were also brought into the public sector, police forces and military. Each are an ongoing disaster. John Raulston Saul has written many great books on the subject including Voltaire's Bastards, and The Unconscious Civilization.


I really like this quote: "The way we measure profitability is in ‘tons of money’."

I couldn't help but hear a loud 'cha-ching' in my head when reading this. I makes sense though, having a lot of money in the bank enables a business to make bold moves. I think its a delicate balance between making more sums of money and being more profitable.

Silly side note and stupid metaphor warning - if someone is right-handed, they never think to cut off their left hand just because they get less return or use out of it. Only when someone if forced to choose between the hands would they ever say, ok cut off my left hand and save my dominate hand. Thats like an extreme situation!

But in business, these companies make extreme moves like this, exiting whole biz sectors/markets, eliminating depts, segmentation etc. Add to this, that the bar is continuously raised, so if the factory quota for last year was x this year its x + 10. Thus 5-10 years later the exec's are surprised when the factory is not meeting "quota" and shutter it in the name of profitability.

Profitability is one issue, but I think the trend toward over optimization and greater year-over-year ROI is also to blame.


The same thing has been going on in European countries for several decades. Manufacturing is cheaper in Asia where the workers can be forced to do their job for low salaries and no healthcare. The solution is to massively increase VAT (and lower income tax). The other possibility is that our (average) living standard will drop until we are able to compete again.


I see this as a complement to a recent Planet Money podcast "How Money Got Weird"... about the rise of financialization in america.

http://www.npr.org/blogs/money/2011/09/30/140954343/the-frid...

The validity of a particular metric is irrelevant. The point is, on a broad scale, we're collectively worshiping on an altar of financial indicators instead of managing businesses.

I've worked at a bunch of places where people who are utterly clueless about the business make really lousy decisions by applying magic formulas. Sometimes they are MBAs, other times they are wannabes that read Deloitte magazine on an airplane. In either case, because they are clueless, they have no way of assessing the validity of the metrics they are using to run the business. The right formula with the wrong inputs yields the wrong answer.


From my experience it is often a mixed bag. People use those metrics that support their subjective ideas/gut feelings. If these turn out wrong they can always fall back to some "its all the numbers fault" or "Deloitte said so" explanation.

In my opinion the whole Consulting industry strives substantially on the fact, that they provide management with a third external authority. This is an ideal constellation for a manager since first the consulting firm's suggestions don't have to be implemented if they are not representing his/her interest. But if they are in line with the personal view, they give additional weight to that position. Moreover afterwards if the project is a success the manager can still take the credit for for the project but if it fails it was all the consulting firm's fault.


What killed the economy is lack of demand, what killed lack-of-demand is a bleak outlook on future and lack of funds, and what has produced this is efficiency itself...

We are now at a time where technology and domain knowledge are stripping existing jobs while creating only a few new jobs.

Welcome to the new world people. It’s going to be a bumpy ride.


I'm a little disappointed by the fact that the Op needed to change the title, perhaps to artificially drum up more attention. It doesn't take an MBA to know that businesses seek profits. Also, NPS (Net Promoter Score), which the author argues for over IRR & RONA, also <shock> gets taught in business school. It's up to the individual student to apply his/her craft correctly. If industry is demanding a certain way of thinking, it would seem pretty straightforward that business schools would like to incorporate that into its ciriculum so students can be prepared to work at those companies.

A business focused on profits? It is a business after all. Product development, R&D, and long-term profits are nice, but only when you can at least get through the short-term. Just my perspective on the situation.


Well, given that this title is a pretty decent summary of the first sentence of the article, I think it's not really artificially drumming up more attention so much as accurately characterizing the content.


Multiples of Money is actually another way of saying IRR - it's just adding the dimension of time.

Christensen is ripping on the slaving devotion to single metrics that some firms follow. This is very true. Any individual metric can be gamed. If you focus on IRR only, people will game it. Same with NPV. Same even with the Net Promoter Score that the article pushes. (Easier to delight customers if you aren't worried about profit.)

The challenge of management is balancing these measurements, and minimizing sub-optimization. In short term there are conflicts between them, but firms with a longer term focus find profitability goes hand in hand with net promoter score. But in many ways it's long term versus short.


The key point of this article is that when you make decisions that are meant to optimize profits and lower costs, you're mortgaging your future. The money quote is that companies forget about the knowledge that's lost forever which prevents companies from further innovations in the future. But the argument can be made that companies can re-use the savings and re-invest in innovation. Look at Apple: they manufacture where it's cheap (China), but they keep design and innovation in the US.


I think that's a fair article, but it doesn't really say a whole lot that isn't already taught in a lot of MBA programs.

I think the key here is to realize that IRR, NPV are imperfect measures of profitability. In addition, the impact of decisions on factors that can't be measured: R&D productivity, ability to respond to technological changes, can have serious consequences.

I think the article makes some excellent points, but very few people in business aren't aware of them.


I find it difficult to believe that this isn't taught in a proper MBA course.

Hell we were taught in 2nd year undergrad that IRR sucks for decision making, but if you absolutely must then at least use the modified IRR. http://en.wikipedia.org/wiki/Modified_internal_rate_of_retur...


The first section of the article seems like a good argument for why firms should focus primarily on absolute long-term profit. Then the author ignores this and starts talking about "customer delight", without any justification for its importance.


Yes, I noticed that semi-dichotomy too.

It is like this Forbes author "Steve Denning" is trying to piggy-back his own ideas on Clayton Christensen's central thesis.


What Clayton says about the focus on "learning about your customer" seems very similar to Eric Ries term "Innovation Accounting" in "The Lean Startup".

Have we been steering our companies using the wrong metrics for the last century?


Gary Vaynerchuk also calls this "relationship capital":

"In the future, companies with tremendous "relationship capital" will be the ones to succeed. Society is creating an ecosystem that rewards good manners, high touch, honesty, and integrity. Ten years from now, every company will have a Chief Culture Officer on staff, and if big enough, a team dedicated to scaling one-to-one relationships."[1]

[1] - http://www.amazon.com/Thank-You-Economy-Gary-Vaynerchuk/dp/0...


This is similar logic to PE and VC funds who actually look at Multiples of Money rather than IRRs. At the end of the day, turning $100mm into $700mm is meaningful even if timelines differ by a couple years.


>> “Practical men, who believe themselves to be quite exempt

>> from any intellectual influence, are usually the slaves of

>> some defunct economist.”

>> John Maynard Keynes

Oh, the irony.


I don't get it. The Chinese guy says they measure "tonnes of money". But if I have an OI of 30%, it will take 100 of sales to make 30 of profit. If I have an OI of 10%, it will take 300 of sales to make 30 of profit.

It looks like the Chinese have problem in making good investments. And I understand that, somebody should always remember that the Chinese is an extremely controlled economy. Maybe that's why they are happy with low ROIs, maybe that's the only thing they can do.

Apparently, my hairdresser understand finance better than those guys.


You missed the essence of his quote. He said don't just emphasize on the ratio, "Americans measure profitability by a ratio." The basis (tons of money) that the ratio is measuring is more important.

Your hairdresser could have a fantastic ROI of 50%, but 50% of $1000/year is miniscule when compared to 10% ROI of a company making $100M/year revenue. If you pursue just the ROI in spite of everything else, your great ROI economy is only $1000, while the other lower ROI economy is $100M.

It's the same question of a small percentage of a big pie vs a big percentage of a small pie. Apparently they like a big pie better despite having a lower ROI. May be it has to do with more people are benefited with a big pie.


Yes, but still it doesn't make sense. If you invest money, you try to get as much as possible from it. Only reason not to do it is State control.

Also, you apparently didn't read my example, which is quite the reason why measuring the percentage is also (also) important.

I still think you guys are missing the point.


I really don't want to go into a piss contest with you, but:

- What you advocate is the problem Clayton's article tries to address. Your approach will kill the goose that lays the golden eggs.

- You emphasize the wrong thing, the return ratio, while other people prefer to measure it in the amount of money returned. That's what get the U.S. auto industry in trouble, as one executive put it clearly: "we spent all the efforts in the bottom line in cost cutting but ignored the top line revenue expansion. It got good ROI in the short term but destroyed the industry in the long term."

- You also missed his other quote, "use the return on assets ratio if cash is scarce. But if there is actually a lot of cash, ... economize on something that is abundant." Think about that for a moment in how to grow a business and why founders raise VC money in return for a lower return rate on their part.

- I am not their guys, as you implied in "you guys."

- Your fascination with State control system has no bearing in this discussion since the Chinese companies in discussion are in Taiwan. If your intent is to prove the Chinese economic system is inferior, you are barking up the wrong tree.

- Even U.S. has government managed economy - the Fed manages the economy via various monetary policies. And the Fed's mandate is not highest ROI. It's to have a robust economy that provides good employment.

- I read your example aplenty. What you don't understand is there're many ways to make money. Having the highest ROI is not the one rule to rules them all. Supermarkets have terrible ROI with razor thin margin yet they make lots of money for their owners. From your rational, everyone should become a hairdresser for its high ROI but no one would create the supermarket business.

Anyway, I've spent more than enough time on this and that's the end of my part of the discussion.


Key characteristics of Anglo-American capitalism, i.e. capitalism created and mainly employed by American and British companies, is built around an "unholy alliance" of three things:

1. Professional manager class.

2. Principle of "shareholder value maximisation", mainly benefitting free-floating shareholders (including professional managers).

3. Leverage.

The primary industrial consequence of this triangle of factors is reduced corporate investment.

Other key consequences are:

a. a feedback loop occurs between the factors, i.e. they are inherently destablizing, particularly so in the face of ever increasing financial capital market efficiency;

b. the erosion of capital creates a system prone to shocks, both internal and external, and from the real economy or the financial economy;

c. productivity improvements are capped due to merely reducing headline numbers and making minimum incremental improvements to infrastructure and technology. No incentive for workers or employers to invest in company-specific skills or retraining;

d. gross increase in use of "excess" capital for share buybacks and other financial equity maximising techniques instead of investment or holding, even during boom times;

e. makes central bankers management of monetary supply harder due to the additional leverage use and other factors acting as a strong accelerator during cyclical upturns and a strong decelerator during cyclical downturns;

f. strong social impacts:

f.i. increasing wealth inequality between those who can benefit from the alliance and those who cannot. This is both from the asset side (shares) and liability side (borrowing);

f.ii. the easiest way to maximise profit today is to reduce expenditure instead of increasing revenues, so jobs are cut, wages and wage growth is minimised, work intensity and hours rise resulting in more errors, worker tiredness, forced imbalance of work/life.

When combined with globalisation, the efficiency of the global capital markets with its own problems (Too Big To Fail entities), tax and regulatory arbitrage, and capital flight, the above factors can be devastating to any economy no matter how advanced and results in global inefficiencies that produce sub-par growth and high instability.

These and other historical reasons are why most advanced countries outside of the Anglo-American world reduce the influence of free-floating shareholders and maintain a group of long-term stakeholders (including some shareholders) through formal and informal means. In addition, corporate leverage is usually more difficult to obtain.

What I find especially interesting is that a select few of the most globally successful American companies are well known for NOT partaking in this Unholy Alliance, specifically Apple, Google and to a lesser extent Microsoft are incredibly cash-rich companies! Other companies should learn something from these leaders.

Finally, there's a reason why Jack Welch, the long-time chairman of General Electric (GE), who is often credited with creating the term "shareholder value" in a speech in 1981 also denounced it in 2009 as probably the "dumbest idea in the world".


These easy definitions always bother me. "The only purpose of corporations is to maximize shareholder profit." Really? The only purpose? Shareholder profit or value is a side effect of producing products or services that people want. The purpose of a corporation is to focus on what it does and do it well. Shareholders benefit from this activity.

Anyone who starts or runs a company and says "My only purpose is to increase shareholder profit" is probably going to fail to deliver.

The other one is this issue of "corporate greed" or this idea of outsourcing to lower cost manufacturing centers in order to make more money. As someone who has the scars to show for it, I can tell you that "greed" is never a part of it.

Imagine, if you will. That you are making widget A in the US or Europe. You are doing well. Everything is manufactured in house or locally. Profits are good.

Now, imagine that a competitor decides that they can beat you at your own game and make widget A for less money if they outsource their manufacturing to, say, China.

Their list price is now lower than yours by a bunch. You don't want to loose market share, so you lower your list price. Only to discover that now your profits can't support your US-based operations. Just can't do it.

What are your choices? You can't automate your way out of the problem because you are already as efficient as you can be. You could leave the market altogether and move on. Lay off everyone in that division and lick your wounds.

Or, as it is more often the case than not, you can follow-suit and find your own manufacturing solution in China. Now you can lower your prices to match or improve upon your competitors's pricing and you've restored balance to the force.

Or so you thought. At this point nobody is making as much money as they used to. But, a race to the bottom ensues. Very soon Asian manufacturers enter the fray. Not only are they the beneficiaries of low-cost manufacturing, they also benefit from a far lower regulatory burden as well as not having to deal with progress-killing unionized labor and their ridiculous rules and costs.

The race to be bottom continues. Only that you and your local competitors are now at a serious disadvantage with respect to your Asian competitors.

What to do? Well, again, you could leave the segment, fire everyone and move on. Maybe you license IP and life is grand. Or, you could take it a step further and become a brand behind a product that you barely touch. Sure, you have to slim down the ranks but the business continues to exist in some form.

At no point in this slippery-slope is anyone thinking about getting rich. In fact, the effect can be quite the opposite. Profits become thin and the business suffers for it. You've taught your competitors how to make your products and have very little more than a brand to use as an advantage over them. You can't make anything any more and simply don't have the equipment, facilities, process, skill-set, network and people to even attempt to compete with anyone.

And life goes on.

To say that these corporations are "greedy" and that their "only purpose" is to provide shareholder value is, in my never-humble opinion, to be utterly ignorant of the day-to-day realities they have to face.

The reality of the situation is that, over the last 50 years, we have collectively opened Pandora's box. Consumers have voted with their buying power to overwhelmingly favor product that can only be manufactured in places like China due to cost structures. Given this, closing Pandora's box is as close to impossible as you can get.

MBA's and corporations cannot force consumers to behave altruistically and support locally made --higher cost-- product when they can drive over to Walmart and overdose on product at much lower price points and, yes, very good quality in most cases.

There's that scene the "Outsourced" movie that kind of encapsulates the whole phenomenon: A caller wants to buy a bald eagle statue but complains that it is made in China. The operator indicates that they have US-made versions and she'd be happy to sell him one. Only that the US-made version is over $200 when the Chinese version is $20. The caller goes with the Chinese version.

Attention Walmart shoppers: You reap what you sow.


You could argue that unlike in earlier generations, MBA's have less or even no skin in the game.

If it is more or less a given that they will move from company to company to company in the course of their career, why should they care if a particular firm does not survive _long-term_? If the shareholders want short-term results, then they are just doing their job to deliver them.

If they can improve things for a company in the short-term, their job is done. They themselves can lead "successful" careers and live comfortable lives with that approach. And leave wealth to their heirs. No long-term survival of the company is necessary.




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