Tuesday, April 13, 2010

Corporations and Profit

"People forget that Apple is a corporation, and that the purpose of a corporation is to make money."

While this cliche is widely accepted, it's incomplete and often misleading. The purpose of a corporation is to create value by serving customers. Often that value is used to reward shareholders, but that's not the sole purpose. The distinction may be subtle, but it is not unimportant as I explain below.

Consider a company that sells a product in the market.  The company creates "use value" in the eye of their satisfied customers who buy the product.  They then use the corresponding cash value to pay their employees, suppliers, and reward their shareholders. Saying the purpose is to reward shareholders is putting the cart before the horse. Rewarding shareholders or "capitalism" is a tool for raising and concentrating capital.  An important tool to be sure, but not the purpose of business itself.  You don't go into business to raise capital, you raise capital to expand and grow your business.

The confusion arrises because CEO's often serve at the pleasure of a Board of Directors who are elected by the shareholders, so Wall Street investors like to claim the CEO's job is to serve the shareholders because it gives them more leverage. But before a company becomes a giant publicly held corporation, the original CEO was a self appointed company founder who had an idea to start a business by serving customers.

If you are an engineer or product developer working at Apple or any other technology corporation, what keeps you awake at night? Are you obsessed with how to make money for your shareholders, or do you spend more of your time thinking about how to create something of value for your customers?

Here's a simple thought experiment:  What is the purpose of our economy?

 A.  To organize production in such a way as to provide the goods and services people want.

 B.  To provide a profit to shareholders.

Business organizations exist within the context of an economy whose purpose is to serve customers. Of course both points of view are valid. They are just different interpretations of our economic process. But B leads to awkward economic distortions like high executive compensation and accounting shenanigans as companies are tempted to finagle their books to make a stock appear more attractive. In many ways, this mis-understanding of business is at the core of our recent financial and banking woes. Even our education system is suffering from confusion over measuring standardized test results ("the bottom line"), versus serving students where they are.

Imagine a CEO of a company with a large market cap who sees their stock price increase by 10% on his watch.  To his shareholders, this could be worth billions, so paying the CEO tens of millions is a small fraction of the value created for shareholders.  Yet the company hasn't really created more value if it isn't creating more satisfied customers.  You could say the shareholders are bribing the CEO to pay themselves (or threatening to fire him if he doesn't deliver).

If you are the CEO of Enron, you might be tempted to sell lucrative contracts to companies that you agree to buy back later and count these sales as revenue. If you are an investment bank, you might be tempted to securitize sub-prime mortgages... Looks great on paper, but nothing of use value has actually been created, only a contract or paper that appears to be something it isn't. All the while your executives and shareholders enjoy a nice windfall and will be very pleased with you until the bubble bursts. The last years I worked at DEC, I saw the company repeatedly mortgage its future to serve its shareholders.

Thankfully many business leaders know better. But the pressure to serve shareholders can be a huge distraction.


A good lens to evaluate Apple's competitive moves is whether maintaining tight control of the platform and user experience helps Apple continue to innovate and serve their customers more than it hinders 3rd party developers who would like to help the platform serve those same customers.

A key component of previous business computing platforms has been access to 3rd party solutions that need to work in more than one context to be cost effective and manage risk (other companies don't like being totally dependent on a single vendor either). From Apple's perspective, allowing these cross platform solutions reduces Apple's unique differentiation and ability to advance the platform on their own terms. Apple claims that cross platform tools produce substandard apps, but Apple uses many such tools in its own software and has made code re-use and cross platform UNIX tools and technology the basis of its Mac OS X strategy. If Apple wasn't worried that such solutions could be compelling, there'd be no reason to restrict them. The issue is not whether cross platform tools can be effective, but how they are applied and shape the platform experience.

Apple's usual strategy is to focus on the consumer first while doing just enough to remove barriers to corporate acceptance. Outlawing the use of any(!) platform independent language tools threatens to upset this balance. [Update, Apple has backed off on this issue as expected.]


Why No Apple In The Food Industry?
"Focus on delighting customers, not on making money"

Another perspective on Adobe's situation

Steve Jobs Solved the Innovator's Dilemma

The Dumbest Idea In The World: Maximizing Shareholder Value