To stay in business.
Yes, I know this is counterintuitive to everything you may have learned or heard about running a business, but hear me out.
Maximizing shareholder wealth.
When I was in business school, we were told that the purpose of a business is to maximize shareholder wealth (shareholder profits and shareholder value are common variations of this phrase).
This idea was coined by the Nobel Prize winning economist Milton Friedman and was featured in his book Capitalism and Freedom. It has since become known as the Friedman Doctrine and is celebrated in businesses and business schools throughout the country.
The Friedman Doctrine.
The logic behind the Friedman Doctrine is straightforward. Shareholders invest capital into a company because they expect a return that will make them wealthier than they would be if the capital were invested elsewhere. Company employees and executives are expected to use the invested capital to generate a return (i.e. profits) in the most efficient way possible. The returns that are generated are then passed along to the shareholders who can use the money however they see fit.
Under no circumstances are the employees and executives to use the capital for anything that does not generate a measureable, direct return on investment.
Theoretically, the Friedman Doctrine is bulletproof—it’s great for businesses, shareholders, and the economy. Businesses will work to drive costs down and bring prices up, increasing their margins and the payout to shareholders. Shareholders will receive higher returns, and the people of the economy will benefit because the shareholders will use their returns for philanthropic purposes.
Unfortunately, we don’t live in a theoretical world.
The Friedman Doctrine is celebrated in businesses and business schools throughout the country.
The reality of the situation.
In practice, the Friedman Doctrine hasn’t worked as well as it should—history is rife with companies who were driven by the Friedman Doctrine who only ended up decreasing shareholder wealth exponentially.
Although the causes for this are numerous, the underlying problem is: The Friedman Doctrine places an emphasis on short-term goals and thinking.
Company executives become subservient to quarterly profit and revenue targets, rather than long-term survival and growth. This leads them to make drastic decisions and take on unnecessary risks to improve short-term profitability. More often than not, these drastic actions and unnecessary risks destroy long-term company and shareholder value—some of these drastic actions and unnecessary risks are even known to cripple entire economies.
Lehman Brothers: A short case study on the Friedman Doctrine.
Is this case study a perfect example of cherry picking? Absolutely. However, I can’t think of a company that better exemplifies the pitfalls of the Friedman Doctrine.
Although it has been almost 10 years since Lehman Brothers filed for bankruptcy, the wounds still feel fresh and many of us can recall the events as if it happened yesterday. The distrust for financial institutions—especially investment banks—is still alive and well, growing stronger by the day (in 2016, only 27% of Americans had “a great deal” or “quite a lot” of confidence in banks).
While many still stand by the Friedman Doctrine, Lehman Brothers, will forever stand as a monument to the catastrophic nature of increasing shareholder wealth.
Between 2003 and 2004, Lehman Brothers acquired 5 subprime and Alt-A lenders with the goal of quickly increasing revenue and profits (I would call this an unnecessary risk).
The plan worked, and Lehman Brothers reported record profits every year from 2005 to 2007.
However, starting in 2007, things began to take a turn for the worst. In the first week of September 2008, its share value dropped 77%, and on September 15, 2008, Lehman Brothers officially filed for bankruptcy and 25,000 Lehman Brothers employees lost their jobs.
Lehman Brothers will forever stand as a monument to the catastrophic nature of increasing shareholder wealth.
Although it is easy to blame Lehman Brothers‘ management (and trust me, it is their fault, I’m no Lehman Brothers apologist), the glaring fact that nobody wants to admit is this: They were simply playing the game that is the Friedman Doctrine.
Lehman Brothers was expected to use shareholder money to generate a higher returns quarter after quarter. This focus on short-term earnings led them to make stupid decisions and take on unnecessary risk, without a thought toward long-term sustainability.
In the end, Lehman Brothers‘ management not only eliminated shareholder value completely, they accelerated the decline of the entire US economy.
(PS: If you don’t think Lehman Brothers‘ management was driven by the Friedman Doctrine, look no further than the CEO Dick Fuld who graduated from NYU’s Stern School of Business. A quick Google search of the keywords “maximize shareholder NYU” brings up pages of publications and presentations by students and professors of the school heralding the Friedman Doctrine.)
The purpose of a business is to stay in business.
I did not come up with this concept. In fact, I don’t know who did, but I’d like to buy them a drink.
I first heard this line from an operations management professor who was giving a lecture on W. Edwards Deming (the famous statistician who became the forefather of lean manufacturing and total quality control).
The premise is simple: We, as a society, allow businesses to exist because they provide us with goods and services.
We also expect them to provide us with macroeconomic benefits such as jobs and tax revenue.
In essence, businesses exist to not only help society function, but to help it grow and evolve.
As soon as a business ceases to exist, it becomes a hindrance to society. It no longer provides goods, services, jobs, or taxes—making it a burden for everyone in the economy.
The purpose of a business is to stay in business.
When I first heard this phrase, I didn’t think anything of it—after all, every other professor had preached the Friedman Doctrine as law, why would I listen to the one outlier?
The truth behind this concept never actually hit me until I started my own business—long after I had finished my degree and started my career.
When I was laying out the vision and strategy for my business, I decided to look at what my previous employers had done well and what they had struggled with—so that I could try to build a successful business without having to reinvent the wheel.
In doing this, I noticed something: The businesses who focused on staying in business were thriving—the business who focused on margins and profits were falling behind.
Staying in business: A long-term strategy.
Ask anybody who has founded and run a business and they will tell you that keeping the business alive and well is considerably harder than starting the business.
The reasoning behind this is simple: To stay in business, you must continually provide value to your customers.
To continually provide value to your customers, you must be willing and able to innovate and adapt.
By shifting the purpose of your business from maximizing shareholder wealth to staying in business, you’ve changed the mindset of your business from short-term to long-term thinking.
When you have a long-term mindset, you become more adaptable and agile. You begin to realize that short-term targets—although important for long-term success and decision making—mean nothing if your business won’t exist in 5 years.
Focusing on the long-term requires you to start making decisions a little differently—with an eye toward the future. This forces you to consider the lasting business and economic impact of your decisions.
What you’ll find is that, over the long run, when you focus on staying in business you end up generating more shareholder wealth if you were to simply focus on maximizing profits and margins.
Southwest Airlines: A short case study on staying in business.
If you travel, chances are you’ve heard Southwest referred to as the “low cost” or “no frills” airline.
Southwest is known for its lack of assigned seating, its free checked bag policy, and its focus on servicing smaller airports.
What most people don’t know is that Southwest is the only airline that has been profitable every year for the past 44 years.
Want to know something even more impressive?
How does Southwest do it?
Many would point to the fact that Southwest has a unique, well defined business strategy that they execute almost to perfection. Southwest exclusively uses Boeing 737 planes, which helps keep maintenance and training costs low. Southwest does not overbook its flights, which keeps customers happy. Southwest flies specific routes and legs within the United States (and now other countries) on a consistent basis, which keeps costs low and doesn’t surprise customers.
Yes, all of those things help them make money and create customer value.
However, the main reason Southwest remains profitable year of year is because it is focused on the long-term sustainability of its business, not on maximizing quarterly profits.
Southwest is the only airline that has been profitable every year for the past 44 years.
Southwest knows that its business is dependent on its customers, so it bends over backwards for them—offerings like free checked bags and ticket changes, although not profitable in the short-term, pay dividends over the long-term in the form of repeat customer purchases.
Southwest also understands that the fate of the entire airline industry lies in the available travel spending of consumers. Therefore, Southwest invests time and resources into its business now, so that it can lower costs and make travel more affordable in the future.
This eye toward long-term thinking and staying in business is what has allowed Southwest to thrive in an industry that experiences consistent downturns.
Value is generated over the long term—even the startups that IPO for billions of dollars spend years getting the business and product to the point where it can do so.
For your business to stay alive long enough to generate value, you must shift your focus from increasing shareholder wealth to staying in business—from short-term thinking to long-term thinking.
In doing this, you give yourself a better chance of staying agile, adaptable, and open to change. Although none of these traits are guaranteed to make you succeed, they put you in a better position to do so.
Did you enjoy this post? I sure hope so.
If you did, you’re in luck: I’ve got plenty more content to go around.
All you have to do is sign up for my mailing list and I’ll email you once a week with all of my blog posts, so that you never miss out.
Just type your email address in the box below and hit “Subscribe”: