Contribution from Subject Matter Experts (SME), General Information - Miscellaneous, Leadership

The Six Fundamentals of Business

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When one explores the concept of business, one will find wide interpretations of what constitutes the fundamentals of business that apply universally.

One can find hundreds (if not thousands) of interpretations of such principles – every commentator attempts to put a unique spin on this to justify their value and contribution. The reason they are incorrect or inappropriate is that one can find legitimate contexts where the proposed principle doesn’t apply, therefore that principle isn’t universal.

There are six fundamentals that apply in all business situations, are they are:

1. The business exists to further the objectives of its owners.

When one examines the mission statement of many of the world’s leading corporations, one will inevitably find references to the satisfaction of stakeholder objectives. These references not only acknowledge the owners of the corporation, but often, also identify other stakeholders such as employees, the community, the government, suppliers, and of course, the ubiquitous customer, among a range of stakeholder communities.

When one then examines the operating strategies employed by these corporations, one regularly finds that investment and operational decisions are made that attempt to maximise stakeholder satisfaction: i.e. they attempt to maximise the “benefits” provided to each of the corporation’s stakeholder constituents.

Philosophically, it is hard to argue against maximising value to stakeholders. The reality however, is that decisions to maximise stakeholder value never occur in an implications-vacuum. There are always implications and most often costs, associated with keeping stakeholders happy. And most frequently, one finds that to keep one set of stakeholders happy is inevitably at the expense of other stakeholders. Who then gets primacy over the organisation’s efforts in satisfying its stakeholders?

If one is both honest and rigorous, one must recognise that no organisation exists to satisfy its non-owner stakeholders, per se. Rather, organisations must satisfy their non-owner stakeholders in order that the owners’ objectives can be satisfied.

Business is all about delivering the best possible outcome to the owners of the organisation, whatever those desired owner outcomes may be. An owner never invests in a corporation because of the stakeholders or in order to satisfy them. However, owners know that for their objectives to be fulfilled, stakeholders must be “appeased”.

Generally speaking, and from an owner’s perspective, non-owner stakeholder satisfaction is about delivering the “lowest level of satisfaction” that the organisation, management and owners can “get away with” while still delivering the over-riding owner objectives. That does not imply that owners “abuse” or exploit non-owner stakeholders, but rather that any effort and resource applied to non-owner stakeholder satisfaction over the “minimum” needed to deliver owner objectives will detract from those objectives.

Although this may appear apocryphal and certainly politically incorrect in today’s environment, business is not about delighting stakeholders (customers or others) per se, but about satisfying owners in order to secure their desired benefits.

It is necessary sometimes to “delight” stakeholders (when “delight” is the difference between participation or purchase and non-participation or non-purchase) in order to satisfy those owners. Owners generally recognise however, that “unbridled” owner satisfaction is not possible in developed Western societies, and as such, it is widely accepted that owners must “invest” in non-owner stakeholder satisfaction in order for their own objectives to be satisfied.

Organisations that “elevate” non-owner stakeholders to primacy in their raison d’etre, risk making operational, management, strategic and investment decisions which maximise stakeholder objectives at the expense of owner objectives. Non-owner stakeholders are, from an organisational perspective, enablers. Maximising (rather than optimising) enablers risks significant organisational misalignment.

One major global chartered accounting and consultancy had as part of its Mission Statement the “maximisation of customer satisfaction”, and coincidentally no mention what-so-ever of partner profits. Logically, the quintessence of “maximising customer satisfaction” must inevitably be the provision of service at no cost to the customer – clear inanity. When asked how much investment in customer satisfaction was needed to deliver partner objectives, no partner could provide an answer, yet hundreds of millions of dollars were spent on enhancing customer satisfaction.

Responsible management is all about “optimising” non-owner stakeholder objectives in the context of, and to fulfil (and maximise where possible), owner objectives. It is not about treating owners and other stakeholders as equal (as is mooted by certain vocal community interest groups). No owner will remain an owner if non-owner stakeholders secure their own objectives at the expense of owners.

2. Owners have differing objectives therefore one can’t set a business’s objectives without knowing what the owners of that business want.

It is truly amazing how many boards and their management believe that owners are a homogeneous group who all share common objectives. And it is the belief in such common objectives that causes organisations to chase the mythical “maximisation of shareholder value or wealth” often at the expense of what shareholders actually want.

The fallacy of this belief in a unitary and generic objective can be illustrated on two levels.

Firstly, if “shareholder value” or “wealth” is represented by, say, a corporation’s net assets or dividend, and if all shareholders only sought to maximise either or both of these criteria, then even in an imperfect market, all shareholders would eventually accumulate and gravitate in those few corporations that had the highest dividend and/or net assets. Even a cursory examination of listed stock performance will confirm that this does not occur. Clearly other factors and issues impact upon shareholders that affect their investment/ownership decisions.

Secondly, in my research, it was found that the top 20 shareholders in the sample five banks behaved significantly differently to changes in, among other criteria, net assets and dividend. One bank’s top twenty shareholders might sell their holdings with a change in net assets while another bank’s top twenty shareholders might buy.

Interestingly also, was the fact that there was a very significant degree of overlap in ownership in the top twenty shareholders in each of the sample banks. Forty percent of the top 20 shareholders had top twenty equity in all five sample banks. Equity in some but not all of the other banks in the sample took the degree of overlap much higher as would an assessment of top fifty behaviour instead of only the top twenty.

The point here is that not only did the top twenty shareholders in Bank A behave differently to the top twenty shareholders in Bank B, but by and large, these were the same shareholders. Therefore, it is clearly erroneous to believe that all shareholders have the same generic objectives, and it is furthermore erroneous to believe that any one shareholder will have the same set of objectives across all their investments.

The implications for corporations are clear. All corporations must identify what their own shareholders want from their involvement in the organisation. Such identification must be in tangible, quantifiable and measurable terms so that boards and management can establish clear and unequivocal outcomes that the organisation undertakes to deliver.

Without a clear statement of end-of-period deliverables, effective organisational, strategic and investment decision cannot be made.

It is no longer acceptable for boards and management to use subjective judgement to determine what is a good outcome or not for shareholders.

The corporation is a “servant” of its owners. As such, and except in a purely legal sense, it does not have (nor should it have) a life of its own outside its owner context.

Knowing exactly what its owners want, and not guessing or assuming what they want, should be a primary accountability of all boards and management.

3. All that the business does must contribute in some way to its business objectives: if it doesn’t contribute, then stop doing it.

We have all heard of the “Big Bang” theory of the universe and the general diversity of opinion as to its accuracy as an explanation of how the universe started. When we seek the “Big Bang” theory of the corporation to identify where the corporation “starts” we tend to observe much more agreement.

In the corporate context, most observers of, and participants in, business would agree that the raison d’etre of corporations (i.e. where a corporation’s efforts “start” and from where it gets its legitimacy) is identified within its mission statement. And it is from this mission statement that organisations develop an enabling vision and extract from it a set of enabling objectives and strategies that will deliver this vision and fulfil its mission.

Unfortunately, this process is flawed since in most organisations the process of developing its mission is undertaken entirely by management. And it is management who, without the necessary metrics to define their owners’ objectives, make subjective assessments as to those objectives (albeit well-meaning), and incorporate them into the organisation’s strategies and plans. In other words, managers decide what it is that their organisation will do and what their organisation will deliver.

Since shareholder objectives vary significantly, management’s subjective assessments are therefore often wrong, inexact or inappropriate. The corporation’s mission then, is a statement of organisational deliverables that, because it has been subjectively derived, often diminishes the probability for owner satisfaction from the company that the owners collectively possess.

A key element of most organisations where management defines the mission statement, is that management sets the performance criteria against which it will itself be measured. These criteria may not be the criteria needed to drive toward owner objectives and owner satisfaction.

Since management is “merely” human and thus exhibits natural human traits and tendencies, the measures used to assess itself are frequently those that are less challenging, less confronting, are less risk-taking or threatening than they might be if they were set in a manner focussed exclusively on shareholder best-interest.

The question therefore is whether an organisation’s mission statement is the fundamental reason why an organisation exists. Strictly speaking, the mission statement does provide the rationale for an organisation’s existence and context to its operational and investment strategies.

However, the issue for those organisations where management subjectively develops the mission statement, is that if a mission statement fails to address the satisfaction of owner objectives in tangible, quantifiable and measurable ways, then the mission statement is not the definer of a corporation’s purpose. The mission statement will provide the necessary direction for the corporation if it is not a statement of subjective or uninformed management, but is an accurate representation of the outcomes desired by owners.

Mission Statements that speak of “quality”, “best practice”, sustained competitive advantage” and similar motherhood statements without convincingly demonstrating that such philosophies contribute to the enhancement of shareholder satisfaction threaten the use of shareholder funds toward projects that add little to the owners of those funds.

The only way to bridge this chasm between management perception and owner objectives is to quantify owner objectives in a way that enables the organisation to determine what it needs to deliver over time. Once quantified, a mission statement for an organisation needs to be “no more” than a statement of quantified owner objectives since the organisation “merely” exists to satisfy those objectives.

This approach to the organisation extends throughout the organisation and is operationalised with two simple principles: 1) everything the business does, must contribute in one form or another, to the business’s objectives; and 2) if it doesn’t, then stop doing it.

4. Non-owner stakeholders must be satisfied sufficiently to motivate them to engage with the business at the standard or quality required.

Many organisations claim that they exist, for example, “to satisfy their customers”, or to “maximise customer satisfaction”, or to “fulfil staff”, or some other variation on this theme relating to stakeholders including staff, suppliers, customers, etc. When one examines their operations, one often finds both an ethos and an operational environment that is trying to do just that – maximise customer satisfaction or value for example.

If we take this concept to its logical conclusion – what would an organisation that is providing “maximum customer satisfaction” actually be doing? Even if it is providing good service at a good price and thereby satisfying customers, it is inevitable that competitor reaction will find a way to provide slightly better service or product at a slightly better price. When we extend this logic to its extreme, then “maximum” customer service must, by definition, be the provision of exceptional service at zero price to the customer – an obvious inanity.

The provision of customer service (together with a host of other motherhood and apple pie concepts) must be applied in the context of owner satisfaction. It is only against such a yard-stick that management can determine how much investment into customer satisfaction “is enough” to generate the outcomes desired.

Customer service, as noble and important as it may be, is “no more” than an enabler through which the organisation achieves its ends. No owner has invested in or created a corporation in order to provide customer service, per se.

Customer service is however, seen as the enabler or channel that will deliver the benefit or outcome sought by owners. Doing it well may be important and doing it better than the competitor may also be important, but only when it serves owner objectives and is used as an enabler and not as the reason for existence.

Does satisfying customers more than one’s competitors motivate the customer to buy, buy more, cross-buy, up-buy, provide the company with a strategic advantage? If it doesn’t do any of these things, then why is the company spending money making customers happier?

Owners are therefore largely concerned with outcomes, while boards and management are understandably pre-occupied with means. It is not surprising then that management “elevates” the enabler to primal importance because that is the way management sees the world and it is the element that is largely controllable by them.

In the majority of corporations, management defines the outcomes that will be delivered by the corporation, and management’s definition of these outcomes is, more often than not, a product of what is achievable in the marketplace rather than of what owners want. Since a key determinant of what is achievable in the marketplace is dependent on customer service (among other criteria) it is not at all surprising to observe corporations who pursue it with almost religious zeal and often at the expense of higher-level objectives.

Elevating enablers to primacy is dangerous because most organisations attempt to maximise core objectives. For example, companies try to maximise profit rather than ever say “this is enough profit in the context of all the other things we are trying to achieve”. But since customer service has a cost and is to some extent “limitless” all efforts to enhance customer service will carry significant financial implications for most corporations. Often corporations strive for continual enhancement of it, even when the marginal benefit has long turned negative – a point of which most companies are oblivious.

It is important for corporations to recognise that customer service is “only” an enabler, and to limit endless enhancements to the point of Just Noticeable Difference (JND). That is, the point where the improvement in customer service is recognised by the customer, and seen by them as being of value and therefore acts as a differentiator in the customer’s buying decision. Less service is not enough, and more service is a waste. “Obsessive or chronic enhancement” of customer service, is a common ailment of corporations who see their reason for existence as the provision of service, rather than the benefit that service provides the business.

5. Business must comply with the legislative and regulatory framework within which it operates.

All aspects of the business must satisfy, comply with, adhere to and abide by all legislative and regulatory requirements of the markets in which it operates.

This is a non-negotiable aspect of business.

6. All else is a matter of context.

All other aspects of business are contextualised to deliver the objectives of the business. For example, strategy, finance, culture, process, logistics, human resources, production, purchasing, customer service, marketing, sales, public relations, legal, and so on; are all enablers and are variable.

None of these or other operational aspects of business contravene the fundamental principles.

However, all operational decisions must complement, satisfy and not contravene the fundamental principles.

If an operational decision is made that threatens these fundamental principles, then the board and management are responsible and must be held accountable. Such an action is likely to be both unsustainable, and to the detrimental cost (financial or otherwise) to the business and to its shareholders.

 

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