Wednesday, February 24, 2010

Purpose of business

Why does business exist? For many the answer is obvious: to make money or, let us say, profit. But this is not a definition that is operationally useful, quite apart from the fact that it's not seen as palatable. If you say profit, is it in the short-run or the long-run? And how much profit? 'Maximisation' of profit is again not operationally useful because businesses are all the time doing that may not maximise profit in any meaningful time horizon.

If we accept that in a competitive market, business cannot make super-normal profit, then business can only make profit that is equal to its cost of capital. That is why Drucker did not accept the idea of business existing to make profit. He defined the purpose of business as: to create a customer. Only this, he argued, is operationally defensible.

FT columnist, Michael Skapinker, introduces a slight wrinkle to Drucker's definition. He says businesses, no less than people, crave for respect. He says that is what banks lost in the present crisis although here he confuses respect with trust. He says businesses exist in order to make profit and serve customers by doing things they can be proud of. Here again, I sense some confusion. Pride, respect, trust are the means to profit and customers. Are they ends in themselves? Perhaps they ought to be. You can bring out your best in people when there is pride in what they are doing.

So, here is a plausible, alternative definition of business purpose: creating customers and making profit so that people who do these things have a sense of pride and well-being. In this definition, you place the employee at the centre of things, not the customer or the shareholder. But this can only be a start. How do we tackle the measurement issues?


Raghu said...

Dear Professor,

Intriguing question; and I can only hazard some guesses. I would say, Businesses too tend to go up the famed Maslow's hierarchy. Initially existing to break-even, then to make a nice profit and then finally to find a meaning for its existence itself.

Man's search for a meaning could then be reflected in business too, perhaps?

Raghunath R

K.R.Srivarahan said...

How about 'creation of value-added utility'? This definition would stress the importance of employees through 'creation', of customers through 'utility' and of shareholders who get compensated from 'value-addition'.

Pankaj said...

Dear Sir,

Business is all about 'Adding Value to the Stakeholders'.
These stakeholders encompass customers,shareholders and employees for a given company/organization.We can't neglect one of them.
In the long term,it needs to focus on society in general for the 'common good'.


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