THE TITLE OF this chapter sounds like a simple enough question, but in recent years an impassioned debate has raged over very different views of the purpose of a business enterprise. Before spending any more time exploring business strategies, we should probably agree on what business executives should be trying to accomplish in the first place.
In the first class of my business strategy course at Columbia Business School, I often ask my MBA students the following question in intentionally broad terms: “If you were lucky enough to land a job as the CEO of a publicly traded corporation after graduation, what would be your highest priority during the first few years?” I add the caveat that “obviously business circumstances vary, but think about the most generally applicable business purpose that would guide your decision-making.”
After basking momentarily in the glory of their hypothetical good fortune, the most common answer from my students is “to maximize shareholder value,” followed by “build a strong management team,” “achieve market-share leadership,” and “drive socially responsible corporate behavior.”
The primacy of shareholder returns in shaping the thinking of next-generation business leaders is not surprising. Maximizing shareholder value (MSV) is preached as gospel at business schools, backed by an elegant and compelling theory supported by Nobel Laureates and other luminaries.
The Doctrine of Shareholder Value Maximization
The origin of the MSV doctrine is often attributed to one of the most widely cited academic business articles of all time: “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” by Harvard economist Michael Jensen and William Meckling, then Dean of Simon Business School at the University of Rochester.1
Jensen and Meckling and other MSV supporters note that of all stakeholders in a public corporation, only outside shareholders face the risk of receiving no return on their contributions to the firm, and therefore only they are entitled to profits if and when they materialize. As such, shareholders—the principals who own the enterprise—are entitled to the value created by the organization.
In this view, corporate executives serve as agents of the principals, and their job is to manage the company so as to maximize value that can be extracted by the principals. To avoid conflicts between the objectives of principals and their agents, Jensen and Meckling suggested that firms should turn their executives into major shareholders by offering generous stock-based compensation packages. In this way, both managers and shareholders would share a common MSV goal.
Jensen and Meckling had powerful allies to support their views on MSV, including Nobel Laureate Milton Friedman2 and two legendary CEOs who created enormous value for their shareholders (and themselves) in the 1980s and 1990s: Roberto Goizueta of Coca-Cola and Jack Welch of General Electric.
In 1970, Friedman wrote an article in the New York Times titled “The Social Responsibility of Business Is to Increase Its Profits,” in which he fiercely defended the MSV doctrine, asserting that any deviation from managerial adherence to maximizing profits and shareholder value would undermine the bedrock of American capitalism: the efficient allocation of capital to value-maximizing activities for the good of the country as a whole.3
Jack Welch also became an outspoken proponent of the MSV doctrine. Shortly after becoming CEO of General Electric in 1981, Welch gave a speech outlining his beliefs in divesting underperforming businesses and aggressively cutting costs in order to deliver consistent profit increases that would outstrip global economic growth. He told analysts, “GE will be the locomotive pulling the GNP, not the caboose following it.”4
Over the next twenty years, Jack Welch delivered on his prophecy. Under his leadership, GE’s market value grew from $14 billion to $484 billion, making it the highest-valued company in the world. Over one twelve-year stretch, GE met or beat consensus analyst earnings forecasts in forty-six of forty-eight quarters—a 96 percent hit rate, and in 89 percent of those quarters, GE met its earnings-per-share forecasts to the penny! No one in the history of business had ever delivered so much market value, so consistently, and Welch was recognized as “Manager of the Century” by Fortune magazine in 1999.5
And yet, fast-forward to March 12, 2009, nearly eight years after he retired, and we find that Jack Welch reversed course, renouncing his allegiance to MSV theory: “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy…. Your main constituencies are your employees, your customers, and your products.”6 Welch was undoubtedly reacting to the realization that GE’s shareholder value in 2009 had fallen to less than 25 percent of its peak under his leadership. But what had happened to make the greatest living disciple of MSV doctrine rethink his views on corporate priorities?
Consider how Jack Welch himself described an incident that occurred about two-thirds of the way through his tenure as CEO:
I was getting ready to leave the office for a long weekend on Thursday night, April 14, 1994, when Mike [Carpenter, head of GE Capital] called with one of those phone calls you never want to get. “We’ve got a problem, Jack,” he said. “We have a $350 million hole in a trader’s account that we can’t identify, and he’s disappeared.”
Carpenter told me that [Joseph] Jett, who ran the firm’s government bond desk, had made a series of fictitious trades to inflate his own bonus. The phony trades artificially boosted Kidder’s reported income. To clean up the mess we would have to take what looked like a $350 million charge against our first-quarter earnings.
The news from Mike made me sick: $350 million, I couldn’t believe it. It was overwhelming. I rushed to the bathroom, and my stomach emptied in awful spasms.
That Sunday evening, I called 14 of GE’s business leaders to deliver the bad news and apologize to each of them for what had happened. I felt terrible, because this surprise would hit the stock and hurt every GE employee. I blame myself for the disaster.7
Notice that Welch’s paroxysmal anguish wasn’t with the firm’s inadequate financial controls or with the possibility that GE had become too reliant on a risky, undercapitalized business unit (GE Capital), but rather that GE would uncharacteristically miss its earnings forecasts. Somewhere along the line, GE, and many other companies who adhered to Welch’s management philosophy, had conflated strategy with outcomes. They had focused so heavily on short-term profit and stock price gains, that they lost sight of the key drivers of long-term profitable growth.
Dissenting Views on the MSV Doctrine
Serious concerns about how the doctrine of shareholder value maximization has been practiced by many publicly traded corporations have been raised by a growing chorus of academics, CEOs, and respected business commentators, including Roger Martin, dean of Rotman School of Management, University of Toronto;8 Clayton Christensen, professor at Harvard Business School;9 William Lazonick, professor of economics at University of Massachusetts;10 Jeff Bezos, CEO of Amazon;11 Howard Schultz, CEO of Starbucks;12 Martin Wolf, CBE, economics commentator for the Financial Times;13 and Steve Denning, management commentator at Forbes magazine.14
Martin Wolf perhaps summarized this group’s sentiment best:
Almost nothing in economics is more important than thinking through how companies should be managed and for what ends. Unfortunately, we have made a mess of this. That mess has a name: it is “shareholder value maximization.” Operating companies in line with this belief not only leads to misbehavior but may also militate against their true social aim, which is to generate greater prosperity.15
Wolf’s assessment goes beyond Jack Welch’s belated recognition that generating value for shareholders is the result, not the driver, of enlightened business strategy. Wolf and others assert that companies that focus on MSV may actually be systematically destroying shareholder value and undermining societal and economic welfare.
Dissenters of MSV doctrine argue that stock buybacks often reflect a misallocation of corporate capital, diverting capital that might otherwise be reinvested in future growth, resulting in a weakening of corporate capabilities and global competitiveness. They claim that underinvesting in R&D and massive offshoring of product development and manufacturing undermine U.S. capacity to compete long term in global markets, impeding economic recovery. In their view, equity-based management incentives derived from inappropriate metrics skew management priorities toward short-term profit realization, exacerbating income inequality and stunting national growth. These are serious charges against a management doctrine that has been and continues to be broadly accepted. Let’s examine each of these criticisms in a bit more detail.
Capital Allocation
There is an inherent tradeoff in the allocation of corporate capital between activities that support value creation—e.g., investing in R&D, fueling market expansion, or for employee development—and activities for value extraction in the form of shareholder dividends and open-market stock buybacks. In the period between World War II and the 1970s, most major corporations emphasized the reinvestment of earnings in business growth.
But as the MSV movement gained momentum in the 1970s, corporate-capital allocation began to shift toward value extraction, and this process accelerated in the 1980s after the SEC removed regulatory restrictions on open-market stock buybacks. The motivation for shareholder buybacks is the belief that by increasing the demand for stock relative to available supply, the price per share is likely to rise, at least in the short term.
As shown in figure 3.1, distributions to shareholders in the form of dividends and open-market buybacks have increased markedly between 1981 and 2012, claiming an average of nearly 80 percent of corporate net income over this period. Stock buybacks have exhibited the greatest growth, particularly over the past decade, with some companies even raising debt capital to fund stock buybacks in excess of their annual net income.
Figure 3.1 Stock buybacks and dividends as a percentage of net income (S&P 500 Companies). Source: Lazonick, “Profits Without Prosperity” (Harvard Business Review, September, 2014).
What’s fueling this trend toward value extraction for shareholders relative to value creation by investment in business growth? I noted earlier that a key tenet of MSV doctrine was the alignment of the interests of principals (shareholders) and agents (executive management). In so doing, most corporate boards have established compensation plans that incentivize senior executives with bonuses for beating earnings-per-share (EPS) targets or with stock options and awards whose value increases with share price.
Companies routinely include EPS in the guidance given to investors about expected profitability for the coming year. Ideally, increasing EPS guidance reflects strong, profitable growth of an enterprise. But what happens if underlying growth or profit prospects dim?
When a corporation repurchases a significant tranche of its own stock on the open market, its EPS increases in direct proportion to the size of the stock buyback. And while there is no guarantee that buybacks per se will increase stock price, the market has generally viewed such activity favorably, at least in the short term. Many investors regard buybacks as a signal that a company believes that the market has undervalued its stock.16 Moreover, buybacks help offset shareholder dilution from the ongoing issuance of management stock options.
But herein lies a logical disconnect. If a company continuously needs to use stock buybacks to buoy its EPS because underlying earnings are simply not growing, is the company really worthy of such heavy investment? And if such investments come at the expense of R&D and capital expenditures for market-expanding assets, is this a wise allocation of the firm’s capital?
Boston Consulting Group studied the impact of capital allocation on stock prices and found that stock buybacks often destroys short-term shareholder value.17 In one study, BCG examined the share price movements of one hundred publicly traded companies following the announcement of an increase in the size of their share-repurchase program by 25 percent or more. Over the next two quarters, the median change in these companies’ valuation multiple was 5 percent lower than the valuation multiple change in the S&P 500 as a whole. The implication is that investors generally do not share management’s view that high stock-buyback activity is necessarily a wise use of corporate capital.18
The recent experience of IBM illustrates that major stock buybacks may undermine longer-term shareholder value creation as well. As illustrated in figure 3.2, IBM has extracted far more capital to return to shareholders (in the form of buybacks and dividends) than it has reinvested in future growth (in the form of R&D and capital expenditures). Lest there be any doubt that such an allocation reflects a clear tradeoff in management priorities, note that IBM’s investment in R&D has been much lower than most other large technology companies. Not surprisingly, IBM’s growth has stalled, with revenues declining by more than 15 percent between 2013 and 2015. Investors have taken notice, driving IBM’s share price down by 30 percent over the past three years, during which the S&P 500 stock market index grew by more than 40 percent. Despite its massive stock buybacks, IBM has been the poorest performer among all stocks in the Dow Jones Industrial Average index over the past two years.
Figure 3.2a IBM Capital allocation and shareholder value: IBM’s value extraction and creation spending
Figure 3.2b R&D as percentage of revenue, 2013
Figure 3.2c IBM’s revenue and cash profits
Figure 3.2d IBM vs. S&P 500
Weakening Capabilities and International Competitiveness
A second concern with the MSV doctrine is the tendency of many adherents to focus on short-term cost reduction, which shortchanges investments in market-differentiating capabilities to sustain global competitiveness over the long term.
Clayton Christensen has been a strident spokesperson on this point, suggesting that management decision-making is too often guided by financial ratio metrics (e.g., return on assets or benefit–cost measures) whose value can be enhanced by focusing mostly on the denominator.19 For example, it is argued that firms who aggressively outsource capabilities to reduce assets on their balance sheets or cut R&D to reduce operating costs may achieve short-term gains but weaken long-term competitiveness in ways that are admittedly difficult to measure.20 The downsides are, for instance, the cost of the knowledge that is being lost (possibly forever), and the missed opportunity for profits that could be made from innovations and capabilities based on this lost knowledge.
Financial theory suggests that the value of a company should reflect the discounted cash flows from all future earnings, yet management decisions are often based predominantly on short-term financial gains.
Inappropriate Management Incentives
The trouble with incentives is that they work. And in that regard, a central tenet of MSV doctrine—the need to align the interests of principals and agents—has undoubtedly contributed to the growing popularity of stock buybacks and other measures to enhance short-term EPS and stock price. With an increasing proportion of CEO compensation shifting toward equity-based rewards, executive pay has flourished. From 1978 to 2013, CEO compensation (adjusted for inflation) increased 937 percent, a rise more than two times higher than overall stock market growth and substantially greater than the 10 percent growth in a typical worker’s compensation over the same period.21
These trends have sparked questions over whether executive compensation practices exacerbate income inequality, with broader economic and societal consequences. This debate is well beyond my charter in this book. But from the standpoint of effective business strategy, it is relevant to question whether executive compensation practices are incentivizing behavior that will promote long-term profitable growth (which benefits all stakeholders) and sustainable increases in shareholder value.
With that concern in mind, William Lazonick studied CEO compensation at the ten companies making the largest stock repurchases over the decade 2003–2012.22 These companies spent a combined $859 billion on buybacks, representing 68 percent of their combined net income. During the same decade, CEOs of these companies received an average compensation of $168 million, yet only three of these ten companies—Exxon Mobil, IBM, and Procter & Gamble—outperformed the S&P 500 stock price index. Moreover, in the ensuing three years (2013–2015), only one of these companies—Microsoft—was able to grow its revenue at a rate in excess of the overall U.S. GDP. Three of the ten companies (Cisco, Intel, and WalMart) underperformed the GDP on revenue growth, while the remaining six actually shrank between 2013 and 2015 (Exxon-Mobil, General Electric Hewlett-Packard, IBM, Pfizer, and Procter & Gamble).
Thus most companies making the largest stock buybacks have simply stopped growing; they are no longer, in Jack Welch’s parlance, locomotives pulling the GNP. It is not clear if executive compensation programs are appropriately incentivizing management to maximize the long-term growth of shareholder value, revenues, profits, or societal welfare.
Let’s return this exploration to where I began by asking again, what should be the overarching purpose of a business enterprise? As we’ve seen, there is a rather significant divide in the arguments for and against the MSV doctrine. Maximizing shareholder value is either the defining bedrock of capitalism and a key driver of corporate value, or a flawed concept that undermines the very values it seeks to nurture.
In 1954, the venerable Peter Drucker addressed the question of corporate purpose in characteristically clear and insightful terms: “There is only one valid definition of business purpose: to create a customer. Any business enterprise has two—and only two—basic functions: marketing and innovation.”23 Drucker put a stake in the ground by placing customers ahead of other stakeholders served by a business: employees, shareholders, and the broader community in which the business operates.
Sixty years later, Jack Ma, CEO of Alibaba, explained why he subscribes to Peter Drucker’s dictate in an open letter to potential investors of what would become the largest IPO in history:24
I have said on numerous occasions that we will put “customers first, employees second, and shareholders third.” I can see that investors who hear this for the first time may find it a bit hard to understand.
Let me be clear: as fiduciaries of the company, we believe that the only way for Alibaba to create long-term value for shareholders is to create sustainable value for customers. So customers must come first.
Our company will not make decisions based on short-term revenues or profits. Our strategies will be implemented with mission-driven, long-term development in mind. Our people, capital, technology, and resources will be utilized to safeguard the sustainable development and growth of the Alibaba ecosystem. We welcome investors with the same long-term mindset.25
Ma’s ordering of stakeholder priorities echoes the philosophy of Jeff Bezos, who shared similar sentiments as CEO of Amazon in his first letter to shareholders in 1997:
We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position. The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital.
Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than some companies. Accordingly, we want to share with you our fundamental management and decision-making approach so that you, our shareholders, may confirm that it is consistent with your investment philosophy. We will continue to focus relentlessly on our customers. We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions….
We aren’t so bold as to claim that the above is the “right” investment philosophy, but it’s ours, and we would be remiss if we weren’t clear in the approach we have taken and will continue to take.26
Bezos has faithfully followed these principles, and in fact has included his 1997 missive in every annual report since as a reminder to shareholders of Amazon’s corporate purpose. Amazon’s “relentless focus on customers” has helped the company consistently set the industry standard for customer value, convenience, and service. Moreover, Bezos’s intent to “make investment decisions in light of long-term market leadership” has underscored a rapid escalation in capital expenditures and R&D, essentially wiping out any net income since the company’s founding (figure 3.3). As such, the company has never paid a dividend, or invested heavily in buying back company stock.27
Figure 3.3 Amazon’s revenue, profitability, and growth investments, 1998–2015, in billions
As he accurately foresaw, Bezos has angered many Wall Street analysts who have been clamoring for more profit realization and disbursements to shareholders. One observer summed up the negative sentiments well by calling Amazon “a charitable organization being run by elements of the investment community for the benefit of consumers.”28
Is there an inherent tradeoff between the interests of customers and shareholders? Amazon’s performance to date demonstrates that a relentless focus on customers and long-term growth can serve customers, employees, and shareholders exceptionally well.
Amazon has consistently achieved the highest customer satisfaction rating among over 230 companies included in the American Customer Satisfaction Index (ACSI), the most comprehensive national cross-industry measure of customer satisfaction in the United States.29 This is an extraordinary achievement, given the scale of Amazon’s business and the breadth of its product range. Other ACSI high performers tend to be upmarket brands (e.g., Mercedes-Benz, Nordstrom) or category-specific providers (e.g., Heinz).
Topline Growth
Amazon exceeded $100 billion in revenue in 2015—becoming the fastest company to reach this threshold.
Jeff Bezos ranks as number one in Harvard Business Review’s 2015 annual assessment of the 100 best-performing CEOs, based on total shareholder return and market capitalization. During his tenure, Bezos has overseen a nearly $200 billion gain in Amazon’s market value, representing a shareholder return on investment of more than 20,000 percent.30
Broader Business Purpose: Creating a North Star
Amazon and Alibaba represent successful companies, whose CEOs explicitly anchored their firm’s purpose on delivering exceptional customer value. More broadly, the best performing companies in the world—those that dominate the categories in which they compete over the long term—are also guided by clearly articulated corporate missions that are well understood by all stakeholders. Defining a company’s purpose, priorities and values provides a North Star to guide how the enterprise will operate. While the pace of change in the market, in technology, and in the competitive landscape seems to be getting ever faster, the foundations of a company’s purpose can and should be enduring.
As Jeff Bezos explains:
When I’m talking with people outside the company, there’s a question that comes up very commonly: “What’s going to change in the next five to ten years?” But I very rarely get asked, “What’s not going to change in the next five to ten years?” At Amazon we’re always trying to figure that out, because you can really spin up flywheels around those things. All the energy you invest in them today will still be paying you dividends ten years from now. Whereas if you base your strategy first and foremost on more transitory things—who your competitors are, what kind of technologies are available, and so on—those things are going to change so rapidly that you’re going to have to change your strategy very rapidly, too.
For our business, most [non-changing business drivers] turn out to be customer insights. Look at what’s important to the customers in our consumer-facing business. They want selection, low prices, and fast delivery…I can’t imagine that ten years from now [customers] are going to say, “I love Amazon, but if only they could deliver my products a little more slowly.” And they’re not going to, ten years from now, say, “I really love Amazon, but I wish their prices were a little higher.” So we know that when we put energy into defect reduction, which reduces our cost structure and thereby allows lower prices, that will be paying us dividends ten years from now. If we keep putting energy into that flywheel, ten years from now, it’ll be spinning faster and faster….31
Amazon isn’t the only successful company that abides by a clearly articulated corporate purpose, defined by deeply held values and beliefs. Take, for instance, Johnson & Johnson, IKEA, and Starbucks.
Johnson & Johnson
By any measure, Johnson & Johnson (J&J) has been an exceptionally successful company. Over the past twenty years, its stock price has grown at a compound annual rate of over 13 percent. Over this span, its operating margins and revenue growth rates have consistently outperformed its competitors in the pharmaceutical and medical equipment sectors in which it operates. Compared to companies of a similar size, J&J currently has by far the highest operating margin (nearly 30 percent) and a growth rate second only to Amazon.
Underscoring J&J’s consistently robust performance is a well-defined mission statement.32 Robert Wood Johnson II, chairman from 1932 to 1963 and a member of the company’s founding family, penned the company’s credo himself in 1943, just before J&J became a publicly traded company. Like Peter Drucker, but a decade earlier, Johnson singled out customer focus in articulating J&J’s corporate purpose:
We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs, everything we do must be of high quality.
Johnson & Johnson’s credo goes on to reference the company’s obligations to other stakeholders as well, in a prescribed order:
We are responsible to our employees. Everyone must be considered as an individual. They must have a sense of security in their jobs. Compensation must be fair and adequate, and working conditions clean, orderly, and safe.
We are responsible to the communities in which we live and work and to the world community as well. We must be good citizens […] protecting the environment and natural resources.
Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. When we operate according to these principles, the stockholders should realize a fair return.
Although J&J puts shareholders at the end of their list, the clarity of their overall business mission established an operating environment in which the company and its shareholders could thrive. With the company’s credo defining North Star corporate values, J&J management did not have to debate basic strategic direction in responding to changes in market circumstances.
A case in point is how the company handled the Chicago Tylenol murders, a series of poisoning deaths resulting from drug tampering in the Chicago metropolitan area in 1982. The crisis presented J&J with some tough choices. Tylenol represented almost one-fifth of the company’s profits, and concerns were raised that declining sales would be difficult to regain in the face of rampant fear and rumor. Yet, rather than attempt to downplay the crisis—it was after all, likely the work of an individual madman in a single metropolitan area—J&J did just the opposite. Chairman James Burke immediately ordered a halt to all Tylenol production and advertising, distributed warnings to hospitals across the country, and within a week of the first death, announced a nationwide recall of every single bottle of Tylenol on the market.33
Before relaunching Tylenol in the United States, J&J developed tamper-proof packaging, an innovation that would soon become the industry standard. These actions flowed directly from the company credo, which is engraved in granite at the entry to company headquarters, a North Star goal stating that the company will be guided first and foremost by serving the needs of customers. Yet, in the long run, all stakeholders were well served. Loyalty toward Tylenol soared after the company demonstrated that customer safety came first. Tylenol rapidly regained its pre-crisis market share, and J&J’s overall profitability and growth were quickly restored.
Contrast J&J’s behavior with how two major corporations lacking customer-centric core values have handled safety crises.
General Motors
General Motors (GM) has been widely criticized for decades for arrogant disregard of customer welfare.34 In 1965, a little-known congressional aide, Ralph Nader, published a book called Unsafe at Any Speed, in which he documented a dangerous design defect with the Chevrolet Corvair. This defect caused several fatal spinout accidents. However, GM disregarded the published evidence and tried to discredit Nader by hiring private detectives to tap his phones, to investigate his past, and to procure prostitutes in attempts to trap him in compromising situations. Nader sued the company for invasion of privacy. Ironically, the press coverage of the lawsuit gave Nader’s book the notoriety it never achieved on its own. As a result, a new case law precedent was established for illegal corporate surveillance, and GM was forced to redesign the Corvair suspension system.
Fast-forward four decades to 2004, and GM was once again found to have willfully disregarded internal evidence of a fatal design defect in its ignition switches that caused the deaths of over 100 people.35
GM, at one time the largest company in the United States, declared bankruptcy in 2009.
Lumber Liquidators
Lumber Liquidators, a specialty retailer of hardwood flooring, was on a roll as the building sector recovered from the 2009 recession. By 2015, its stock price had soared 476 percent over the prior two years. But if shareholders were happy, some customers were not. Reports began surfacing of consumers becoming sick, and noticing a strong chemical odor originating from their recently installed flooring.
The CBS newsmagazine 60 Minutes got involved, sending various flooring samples from different lots to independent labs to check the level of formaldehyde—a known carcinogen. Test results found that in the majority of samples, formaldehyde levels were higher than allowed by California law, and in some cases, dangerously so—as high as thirteen times the legal limit.
In a 60 Minutes segment aired on March 1, 2015, then-CEO Robert M. Lynch said he had no knowledge of the problem and promised an investigation, while steadfastly maintaining that Lumber Liquidators flooring was safe. But 60 Minutes had already dispatched reporters to Lumber Liquidator’s Chinese suppliers, who acknowledged that they had been knowingly using a cheaper manufacturing process with excessive formaldehyde but labeling their shipments as compliant with California law.
Lumber Liquidators responded by offering free testing kits for consumers to test the air quality in their homes, while still continuing shipments of the suspect flooring products. Two months later, the company finally halted all shipments from China, and the CEO unexpectedly resigned. By the end of the year, Lumber Liquidators’ stock price had plummeted over 75 percent from its 2015 peak.36
The clear takeaway here is that companies like J&J that remain true to a clear, customer-centric mission can survive and prosper through good times and bad. Two other successful companies that have been guided by an exceptionally strong set of core values are IKEA and Starbucks.
IKEA
From its founding by Ingvar Kamprad in 1943, Swedish-based IKEA has been singularly focused on delivering stylish furniture to global customers at competitively low prices as exemplified by the company’s two corporate mantras: “Low Price with Meaning” and “A Better Everyday Life.”
IKEA articulates its customer-centric corporate purpose as follows:
The IKEA business idea is to offer a wide range of home furnishings with good design and function at prices so low that as many people as possible will be able to afford them.
Most of the time, beautifully designed home furnishings are usually created for the few who can afford them. From the beginning, IKEA has taken a different path. We have decided to side with the many. That means responding to the home furnishing needs of people around the world: people with many different needs, tastes, dreams, aspirations and wallet sizes; people who want to improve their homes and their everyday lives.
It’s not difficult to manufacture expensive fine furniture: just spend the money and let the customers pay. To manufacture beautiful, durable furniture at low prices is not so easy—it requires a different approach. It is all about finding simple solutions and saving on every method, process or approach adopted—but not on ideas.37
The company has faithfully executed against this charter for over seventy years, growing to become the largest furniture retailer in the world. As a logical extension of its original charter, IKEA recently announced a “People & Planet Positive” commitment with the objective of creating and selling affordable products and solutions that help customers save money by using less energy and water and by reducing waste. The company also recently upgraded its global employment policies, ensuring better working conditions and compensation for its employees. The company believes that balancing its business and people needs is a wise investment that ultimately will contribute to delivering better service to consumers.
While IKEA is a privately owned enterprise with limited financial disclosure, it has reported consistently profitable operations, achieving 2015 revenues of nearly $36 billion, self-funding the development of over 328 stores in 43 countries.38
Starbucks
From its inception, founder and CEO Howard Schultz set out to make Starbucks a different kind of company. In his 2011 memoir, Schultz stated his company’s corporate purpose:
At the very heart of being a merchant is a desire to tell a story by making sensory, emotional connections. Once, twice, or sixteen thousand times.
Ideally, every Starbucks store should tell a story about coffee and what we as an organization believe in. That story should unfold via the taste and presentation of our products, and the sights, sounds and smells that surround our customers. Our stores and partners are at their best when they collaborate to provide an oasis, an uplifting feeling of comfort, connection, and a deep respect for the coffee and communities we serve.39
Following this North Star, Schultz’s strategy emphasized product quality and a superior customer experience, driven by extensive staff training and store layouts that gave customers a sightline to the “theater” of coffee preparation and proximity to barista personnel, many of whom developed a personal relationship with regular patrons.
Starbucks went public in 1992, and under Schultz’s leadership the company established a rapidly growing global footprint and powerful brand, supported by intensely loyal customers paying premium prices. By 2000, when Schultz stepped down from his role as CEO, Starbucks had opened nearly four thousand stores worldwide, with revenues in excess of $2 billion and a market capitalization of over $7 billion.
But in the ensuing years, Schultz’s successor Jim Donald strayed from the original corporate vision, pursuing hypergrowth at the expense of customer experience. Wooing Wall Street with aggressive growth targets, Starbucks quadrupled its store count between 2000 and 2007. The company installed faster, larger brewing machines, often blocking the customer view, cut back on barista training, and de-emphasized in-store ambience. McDonald’s and Dunkin’ Donuts began gaining market share as many Starbucks customers began to question whether declining quality still warranted the premium prices. By the time Howard Schultz returned as CEO in 2008, Starbucks same-store sales were rapidly declining and its market value was in free fall, from a peak of nearly $27 billion in 2006 to just $7.3 billion in 2009.
During Schultz’s absence, Starbucks had lost its North Star purpose, with dire consequences in the marketplace. Commenting on his priorities upon his return, Schultz observed, “This has been my life’s work, as opposed to a job. I didn’t come back to save the company—I hate that description—I came back to rekindle the emotion that built it.”40
Schultz engineered a turnaround strategy to return Starbucks to its original corporate purpose of delivering premium products and a superior customer experience.41 In implementing his strategy, Schultz rebuilt his senior management team, united around a clearly articulated corporate vision, and shut down hundreds of stores that were redundant or inconsistent with the company’s high standard of customer service. He increased barista training, at one point simultaneously closing over seven thousand U.S. stores for three hours of intensive staff training, which included a video message from the CEO beamed to every store. Schultz also invested in bringing ten thousand store managers to New Orleans in 2008 for a company-wide meeting to reinforce Starbucks’s core values. To restore the customer connection with baristas and the coffee-making process, he ordered new store designs with smaller coffee-making machines, and finally, Shultz introduced new products to reaffirm Starbucks as the coffee authority.
By restoring the company’s core brand values, Schultz’s turnaround strategy achieved outstanding results. Between 2008 and 2015, Starbucks reversed year-to-year changes in same-store sales from −9 percent to as high as +9 percent, increased annual sales and net income by 85 percent and 773 percent respectively, and increased market value nearly tenfold.
In summary, Johnson & Johnson, IKEA, and Starbucks all built great companies by creating or restoring a distinctive and well-defined customer-centric corporate purpose—a North Star guiding their management behavior and long-term strategy.
The Purpose of Business: Drucker Revisited
Before leaving this subject, let’s revisit Peter Drucker’s dictate on business purpose with an amendment to make it more broadly relevant to effective business strategy. Remember what Drucker said: “There is only one valid definition of business purpose: to create a customer.”42
While Drucker was directionally correct in placing customers ahead of other stakeholders, his singular focus on customer creation is too narrow. After all, any enterprise can attract customers by underpricing (and in the extreme, giving away) their products or services. So first, we need to add a qualifier—to create customers profitably.
Secondly, companies are most successful when they can capture lifetime customer value, so customer retention, not just attraction, should be pivotal to business purpose.
And finally, in order to both attract and retain customers over the long term, a business needs to consistently deliver high levels of customer satisfaction. Unfortunately, most of us are personally familiar with industries that have monopoly or oligopoly power, allowing individual companies to profitably attract and retain dissatisfied customers for years through coercive or deliberately confusing business practices.43 But such industries are highly vulnerable to disruption from new entrants that can find a way to provide an equal or superior value proposition to emancipate a legion of dissatisfied customers.
In summary, with a hat-tip to Peter Drucker, we can conclude:
The only valid definition of business purpose is to profitably create and retain satisfied customers
As I have shown by the examples in this chapter, a customer-centric corporate purpose that also seeks to create value for all stakeholders provides a North Star to guide effective strategy formulation. We can now add the outer ring shown in figure 3.4, reflecting the pivotal role of an appropriate corporate mission in achieving long-term profitable growth.
Figure 3.4 Corporate mission guides strategy formulation
Companies that establish and faithfully implement a distinctive version of this foundational definition of business purpose—a North Star that resonates with customers and other stakeholders—are best positioned to build enduringly successful businesses.
Does your current company (or the one you want to build) have a compelling and clearly articulated North Star?
