Sometime in 2007, I called the Investor Relations head of a leading Indian power company. “I request for a meeting with your CFO,” I said.
“Where are you calling from?” she asked back.
“I work for an independent research company working for retail investors, and we are looking to initiate coverage on your stock,” I replied. “I had some questions before writing the report and thus wanted to meet your CFO.”
“Are you writing a Buy or Sell report on our stock?” she asked.
“How can I tell you that now?” I said “I need to finish my research and only then will I make a judgement on whether the stock is a buy or a sell.”
“Wait, you are from a retail research organization, right? She asked. “Sorry, we do not have a policy to meet companies focused on retail investors. We only meet the institutional guys because they can help up increase our market cap, not the retail guys. We want to maximize shareholders’ wealth, you see.”
I loved her honesty, but was shocked to hear such a response from a public company, which had a policy of maximizing shareholder wealth, and fast, and by excluding a large set of its shareholders.
What a Dumb Idea!
Peter Drucker said this in 1973 –
The only valid purpose of a firm is to create a customer.
Drucker’s perspective was that the goal of a firm isn’t fundamentally about creating profits or maximizing shareholder value. Profits and shareholder value are the results of adding value to customers, not the goal.
Even the legendary Jack Welch has come to see that maximizing shareholder value is “the dumbest idea in the world.
“On the face of it, shareholder value is the dumbest idea in the world,” Welch said, “Shareholder value is a result, not a strategy…your main constituencies are your employees, your customers and your products.”
Seth Godin wrote in a recent post –
The purpose of a company is to serve its customers. Its obligation is to not harm everyone else. And its opportunity is to enrich the lives of its employees.
Somewhere along the way, people got the idea that maximizing investor return was the point. It shouldn’t be. That’s not what democracies ought to seek in chartering corporations to participate in our society.
The great corporations of a generation ago, the ones that built key elements of our culture, were run by individuals who had more on their mind than driving the value of their options up.
Contrast this with what most companies and their managers do i.e., focus on short-term profits and stock price maximization, because this is an easy thing to do. Look at what the DCB Bank did recently.
Some days back, the management announced that the bank’s profits would take a knock as it tries to double its branch network in the next one year. On this news, the stock price crashed 30% in quick time. Shattered by this crash in the stock, the management revised its plan saying that, “after consultations with analysts and its chairman,” it would now not rush with the opening of new branches. Instead of setting up 150 branches over the next one year, it will do it over two years now.
While I have no view on the bank or how this branch expansion would have helped or hurt it, the questions that arise are –
- How can a management change its corporate plan while keeping an eye on the stock price?
- How on earth can you consult stock market analysts on what you want to do as corporate managers?
The answer again seems to be – focus on short term profit and stock price maximization versus long term goals.
All CEOs and corporate managers appearing on business channels talking about their profits and next quarter’s or year’s performance are focused on just that – maximizing their stock prices in the short term.
Companies that never organized analyst meets or conference calls and become active there when their stock price is rising are also focused on that – further maximizing their stock prices in the short term.
Companies that pay dividends out of borrowed money are also doing that.
Steve Denning wrote this in his 2011 article on Forbes…
CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services.
The real market is the world in which factories are built, products are designed and produced, real products and services are bought and sold, revenues are earned, expenses are paid, and real dollars of profit show up on the bottom line. That is the world that executives control—at least to some extent.
The expectations market is the world in which shares in companies are traded between investors—in other words, the stock market. In this market, investors assess the real market activities of a company today and, on the basis of that assessment, form expectations as to how the company is likely to perform in the future. The consensus view of all investors and potential investors as to expectations of future performance shapes the stock price of the company.
Roger Martin wrote this in his book Fixing the Game –
What would lead [a CEO] to do the hard, long-term work of substantially improving real-market performance when she can choose to work on simply raising expectations instead? Even if she has a performance bonus tied to real-market metrics, the size of that bonus now typically pales in comparison with the size of her stock-based incentives. Expectations are where the money is. And of course, improving real-market performance is the hardest and slowest way to increase expectations from the existing level.
Invest with People Focused on Customers, Not Stock Prices
The problem with short-term stock price maximization is that it’s not particularly difficult. If a company has a big market share, or if it’s difficult for the customer to switch away from the company’s product, or if the customer lacks the knowledge of better options, it’s easy for the company to hurt its customers on the way to boosting what its shareholders say they want.
So, it’s not difficult for Nestle to be casual about what its super branded food products contain (thanks to its large market share), or for Indian Railways to provide sub-standard travel experience (customers don’t easily switch), or for financial services companies to mis-sell bad products (customers lack knowledge about good products). But just because it works doesn’t mean that they should be doing it to maximize short term profits, and in many cases their stock prices.
Contrast this with what Jeff Bezos and Larry Page are doing at Amazon and Google respectively – focusing only, and only, on the customer. The reason they have created so much wealth for their shareholders is because they never cared about shareholder value maximization, but only about customer satisfaction.
Consider the Purpose Statement of Procter & Gamble (emphasis mine) –
We will provide branded products and services of superior quality and value that improve the lives of the world’s consumers, now and for generations to come. As a result, consumers will reward us with leadership sales, profit and value creation, allowing our people, our shareholders and the communities in which we live and work to prosper.
For P&G, consumers come first and shareholder value naturally follows. As per the statement of purpose, if P&G gets things right for consumers, shareholders will be rewarded as a result.
This I am sure has also been the mantra of India’s biggest long-term wealth creators like HDFC, Asian Paints, Sun Pharma, Infosys, and Wipro. They have created tremendous shareholder wealth as a result of their focus on their customers and building their business for the long term, and not the other way round.
This is how you can also find a few of the future wealth creators – businesses where managements are not focused on shareholder wealth creation but treat it just as a byproduct of delighting its customers, employees, and the society at large.
Such are the businesses where you will find long-term sustainable moats. Every other moat – especially if it appears a lot on business television, is worshipped by everyone around, and where the management often touts its shareholder friendliness – is often fleeting.
“Mr. Market suffers from incurable emotional problems,” Ben Graham wrote while describing the daily madness of stock price movements.
Why would you want to partner with business managers who focus on managing these incurable problems of Mr. Market, than minding their business?
Clayton Christensen: Are Investors Bad For Business?
The Dumbest Idea In The World: Maximizing Shareholder Value
I guess there is a serious mis-understanding in your piece on shareholder value creation
1) Lets do a thought experiment. Do you think a company thats not customer focused will be able to create value for shareholders in long term? To put it other way,shareholder value creation is a result of customer focus as the company that serves its customer itself will be able to sustain in market and serve better than competition and create value in long run
2) Do you just need to care about customers? Really? Customers will buy only when they find value in my product and it offers better value proposition than competitor. If as Peter Drunker said you just want to provide customer delight then there is nothing delightful to customer than offering the product free to her.
3) On the question of short term thinking, honestly markets are not short term. The thinking of market participants changes as per the corporate life cycle. Amazon was able to create value not because it was impervious to the market but because it was able to find the opportunities to deploy the capital. Google also rechristened itself as Alphabet as it feels market will start to catch up with the reality and start questioning Google’s investments and by setting up holding company Alphabet each of the investment will be accountable and thus market will gauge the performance and will price the company accordingly.
4. Having said the above things, if you want managers to invest for long term without taking into account the reality, managers will try to find the projects that give low returns and worse they will diversify into worst businesses. And the worst thing managers on whom the pressures of investment will increase will go and find a company to acquire and we know what the mergers&acquisitions do to acquiring company.
5. Shareholder value creation shouldn’t be seen in isolation and it is result of the products that company is offering and the product that company is offering is made by keeping customer in mind and the customer provides the demand only because there is a value proposition. Honestly there is no merit in argument that shareholder value creation is wrong because who ever said it have never really created any value for themselves and for the shareholders ever.
Vishal Khandelwal says
I think my thoughts have been mis-understood here.
What you have mentioned is exactly what I have also mentioned i.e., shareholder value creation is a result of customer focus. My post was about the concern that a lot of companies forget this aspect and focus only on shareholder value creation that leads them to maximize profits and stock prices in the short run, even as they lose focus on the long run.
Nowhere have I mentioned that shareholder value creation is wrong. But it’s a dumb idea to focus on the shareholder at the cost of the business, which a lot of companies do.
All that I am trying to say is shareholder value creation and customer focus go hand-in-hand. They are not inseperable.A short term profit seeking company will invest less in R&D which eventually will impact its competitive standing in the market and will deteriorate the shareholder value. I dont understand if this is soemthing that needs an explicit explanation. Value gets created as a result of the customer demand for produce of firm and its done more profitably then it benefits shareholders,customers and society at large (as employment opportunities get created).
I don’t think there is nothing wrong with Shareholder value creation as its doesnt happen out of thin air
R K Chandrashekar says
The Expectations market is the fruit and the Real market the duty as espoused in the Bhagvad Gita.
Now if you work on the real market, that is a happy employee, delighting the customer, the fruit of profits and shareholder value will automatically bear fruit!!
Vishal Khandelwal says
Indeed RKC…that’s the point. Regards.
This is one of the most relevant perspective of Building a Business v/s Instant Gratification. Investing for Long term means Company has to invest..No Company has been BORN/ BUILT BIG. Every Company was small at some point of time and they have grown and sustained only because of being relevant to the consumers/ customers. As referred, A good investor is a good business man and vice-versa. I believe most of the companies who have failed to create value of the shareholders have been due to one major reason – they failed to remain relevant to the customer (except for Fraud).
Vishal Khandelwal says
Thanks for sharing your thoughts, Raunak!