Clayton Christensen: How MBA-driven Profit focus is Killing the U.S. Economy

The Keynes quote made me think of something. We have in the U.S. what is probably best described as an ethical system based on profit. It's literally pervasive. "The only purpose of corporations is to maximize shareholder profit." "We should have economic policies that grow the pie." All of these statements are couched in a normative principle: that the singular pursuit of profit will lead to maximization of the pie, and thus the greatest overall welfare.<p>This normative principle was defensible in the 18th century, though Adam Smith never took it to quite the extremes that we have today, but is pretty solidly indefensible based on what we know about economics in 2011. And that's something I don't think even most economists would dispute today.<p>Yet, our ethical system is beholden to that principle, though we know it is based on assumptions we know to be wrong.<p>What MBA programs need to teach, and I think it is happening recently to some extent, is that "social responsibility" is not a dirty word. Considering the social impact of business decisions, something that is considered irrelevant under the current ethic because of the premise that profit-maximization == welfare maximization, is not only not a bad thing, it is an indispensable obligation of doing business in civilized society.

The root cause of the problem is the separation of ownership from control. This lead to the rise of the class of "professional managers", whose interests are intrinsically short-term. In the times when American wealth was created, the owners called the companies with their own names: Boeing, Ford, and MBAs did not exist. Their interests were to pass the earned wealth to their children. The historical mission of the MBAs and the professional managers is to dismantle the salvageable assets and sell them to more vibrant economies.

The Keynes quote is funny, giving the number of people that define their selves as Keynesians, and being Keynes dead long ago.<p>As some people had already stated, MBAs are not the problem, if you go to a good MBA you will have good teachers, and those people have very clear in their mind all those economic fallacies and more.<p>Ethics are the problem.<p>The problem is the fact that somebody could enter a company, increase the short term benefits, but destroy the company long term, and get out rich, and nobody going after them. HP(last CEO got at least 5Million) , GM(what are 50 Billion these days anyway?, nobody lost their seat), Golmand Sachs, buying bankrupt states CDS(enormously profitable while it does not break, the bill is payed by taxpayers when it breaks)...<p>E.g if Google decides to "monetize" all the info they have over me overnight they will increase their profit a lot (x5 or x10), but I will start looking after other companies search. As everything I use uses their services it will have to be a slow, progressive change, while the genius MBA graduate could declare victory and retire rich at 30, but it will make people spit at hearing the word Google.<p>Another example, there was a time in witch SCO was a serious software company, but some guy decided to make himself rich while destroying the company, and now the name have a different meaning.

I wouldn't say that the problem is "maximizing profits" per se. The problem is the focus on "maximizing profits in the short term".<p>Which brings us to another problem: that predicting the effects of a business decision on profits in the short term is easy enough, while predicting it in the long term is much more difficult (even impossible, depending on how you define "predicting").<p>Simplifying, for the long term you need vision, leadership and entrepreneurs. For the short term you need formulas, management and MBAs. Quite often the two needs clash with each other.<p>A century ago there was a lack of management skills and applying them brought big results. Now we are probably (well) past the point of diminishing returns - even negative returns in the long run, and what is missing is vision, both at the corporate AND at the political level.

This article was a bit odd. My b-school experience was almost the opposite. IRR was presented as inferior because it could put you in situations where you are giving up a lot of profit in dollar terms for a smaller dollar profit that had a higher rate of return.<p>In the end, one metric was not used as the be all and end all. Using multiple metrics to help inform an investment decision was the ultimate goal. The problems with American business are multiple and complex; it's not a matter of a simple financial metric.

Professor Christensen gave this talk (or one very similar) at Business of Software this year. He was phenomenal.<p>One thing I like a lot about the culture in younger companies, especially in tech, is that while we are conscious of the appropriate financial ratios, we're not <i>driven</i> by them. For example, Fog Creek, while profitable, isn't driven <i>only</i> by profit, and happens to be passionate about giving developers a great place to work and helping developers create better software (among other things).

Its unbelievable how business (school) buzzwords and tactics tend to overlook the most important aspects of a particular industry / problem / scenario that are non-financial in nature. There is an important strategic perspective(s) which cannot be accounted for in IRR, RONA or any of the other hundred such terms. Loved the quote from the founder of TSMC.<p>It is also surprising to see that most Asian conglomerates ( in India, Japan, Korea, Taiwan, China etc.) seem to have strong vertically integrated businesses where are they continuing to build and expand expertise in the core areas, while letting the west become their marketing managers.

I don't know, the general theory of "Companies outsourcing themselves to death" sounds fine, but somehow the examples are never convincing. I mean if you compare the development of Dell vs. Asustek in GoogleFinance, it really doesn't seem that Asustek is better off. Is it really such a tragedy if Dell isn't in the dying pc-manufacturing business anymore?

Not really sure in how far this is a new insight. Based on Drucker's old mantra <i>Business has only two basic functions - marketing and innovation</i> it is pretty obvious that in production based industries manufacturing and innovation are stronger related.<p>But it is great to see that influential business academics like him increasingly promote the fact that business success is not (only) about juggling numbers. Or to quote from my favorite paper by Christensen:<p><i>And all data are subjective. Each form of data is a higher-level abstraction from a much more complex reality</i><p>(2004 Carlile &#38; Christensen - The Cycles of Theory Building in Management Research)

Financial metrics are great to measure the health of a company, but I don't think anyone ever intended companies to be run by financial metrics. This isn't just happening in business though, these ideas were also brought into the public sector, police forces and military. Each are an ongoing disaster. John Raulston Saul has written many great books on the subject including Voltaire's Bastards, and The Unconscious Civilization.

I really like this quote: "The way we measure profitability is in ‘tons of money’."<p>I couldn't help but hear a loud 'cha-ching' in my head when reading this. I makes sense though, having a lot of money in the bank enables a business to make bold moves. I think its a delicate balance between making more sums of money and being more profitable.<p>Silly side note and stupid metaphor warning - if someone is right-handed, they never think to cut off their left hand just because they get less return or use out of it. Only when someone if forced to choose between the hands would they ever say, ok cut off my left hand and save my dominate hand. Thats like an extreme situation!<p>But in business, these companies make extreme moves like this, exiting whole biz sectors/markets, eliminating depts, segmentation etc. Add to this, that the bar is continuously raised, so if the factory quota for last year was x this year its x + 10. Thus 5-10 years later the exec's are surprised when the factory is not meeting "quota" and shutter it in the name of profitability.<p>Profitability is one issue, but I think the trend toward over optimization and greater year-over-year ROI is also to blame.

The same thing has been going on in European countries for several decades. Manufacturing is cheaper in Asia where the workers can be forced to do their job for low salaries and no healthcare. The solution is to massively increase VAT (and lower income tax). The other possibility is that our (average) living standard will drop until we are able to compete again.

I see this as a complement to a recent Planet Money podcast "How Money Got Weird"... about the rise of financialization in america.<p><a href="http://www.npr.org/blogs/money/2011/09/30/140954343/the-friday-podcast-how-money-got-weird" rel="nofollow">http://www.npr.org/blogs/money/2011/09/30/140954343/the-frid...</a><p>The validity of a particular metric is irrelevant. The point is, on a broad scale, we're collectively worshiping on an altar of financial indicators instead of managing businesses.<p>I've worked at a bunch of places where people who are utterly clueless about the business make really lousy decisions by applying magic formulas. Sometimes they are MBAs, other times they are wannabes that read Deloitte magazine on an airplane. In either case, because they are clueless, they have no way of assessing the validity of the metrics they are using to run the business. The right formula with the wrong inputs yields the wrong answer.

I'm a little disappointed by the fact that the Op needed to change the title, perhaps to artificially drum up more attention. It doesn't take an MBA to know that businesses seek profits. Also, NPS (Net Promoter Score), which the author argues for over IRR &#38; RONA, also &#60;shock&#62; gets taught in business school. It's up to the individual student to apply his/her craft correctly. If industry is demanding a certain way of thinking, it would seem pretty straightforward that business schools would like to incorporate that into its ciriculum so students can be prepared to work at those companies.<p>A business focused on profits? It is a business after all. Product development, R&#38;D, and long-term profits are nice, but only when you can at least get through the short-term. Just my perspective on the situation.

Multiples of Money is actually another way of saying IRR - it's just adding the dimension of time.<p>Christensen is ripping on the slaving devotion to single metrics that some firms follow. This is very true. Any individual metric can be gamed. If you focus on IRR only, people will game it. Same with NPV. Same even with the Net Promoter Score that the article pushes. (Easier to delight customers if you aren't worried about profit.)<p>The challenge of management is balancing these measurements, and minimizing sub-optimization. In short term there are conflicts between them, but firms with a longer term focus find profitability goes hand in hand with net promoter score. But in many ways it's long term versus short.

The key point of this article is that when you make decisions that are meant to optimize profits and lower costs, you're mortgaging your future. The money quote is that companies forget about the knowledge that's lost forever which prevents companies from further innovations in the future. But the argument can be made that companies can re-use the savings and re-invest in innovation. Look at Apple: they manufacture where it's cheap (China), but they keep design and innovation in the US.

I think that's a fair article, but it doesn't really say a whole lot that isn't already taught in a lot of MBA programs.<p>I think the key here is to realize that IRR, NPV are imperfect measures of profitability. In addition, the impact of decisions on factors that can't be measured: R&#38;D productivity, ability to respond to technological changes, can have serious consequences.<p>I think the article makes some excellent points, but very few people in business aren't aware of them.

I find it difficult to believe that this isn't taught in a proper MBA course.<p>Hell we were taught in 2nd year undergrad that IRR sucks for decision making, but if you absolutely must then at least use the modified IRR. <a href="http://en.wikipedia.org/wiki/Modified_internal_rate_of_return" rel="nofollow">http://en.wikipedia.org/wiki/Modified_internal_rate_of_retur...</a>

The first section of the article seems like a good argument for why firms should focus primarily on absolute long-term profit. Then the author ignores this and starts talking about "customer delight", without any justification for its importance.

What Clayton says about the focus on "learning about your customer" seems very similar to Eric Ries term "Innovation Accounting" in "The Lean Startup".<p>Have we been steering our companies using the wrong metrics for the last century?

This is similar logic to PE and VC funds who actually look at Multiples of Money rather than IRRs. At the end of the day, turning $100mm into $700mm is meaningful even if timelines differ by a couple years.

&#62;&#62; “Practical men, who believe themselves to be quite exempt<p>&#62;&#62; from any intellectual influence, are usually the slaves of<p>&#62;&#62; some defunct economist.”<p>&#62;&#62; John Maynard Keynes<p>Oh, the irony.

I don't get it. The Chinese guy says they measure "tonnes of money". But if I have an OI of 30%, it will take 100 of sales to make 30 of profit. If I have an OI of 10%, it will take 300 of sales to make 30 of profit.<p>It looks like the Chinese have problem in making good investments. And I understand that, somebody should always remember that the Chinese is an extremely controlled economy. Maybe that's why they are happy with low ROIs, maybe that's the only thing they can do.<p>Apparently, my hairdresser understand finance better than those guys.

Key characteristics of <i>Anglo-American capitalism</i>, i.e. capitalism created and mainly employed by American and British companies, is built around an "unholy alliance" of three things:<p>1. Professional manager class.<p>2. Principle of "shareholder value maximisation", mainly benefitting free-floating shareholders (including professional managers).<p>3. Leverage.<p>The primary industrial consequence of this triangle of factors is <i>reduced corporate investment</i>.<p>Other key consequences are:<p>a. a <i>feedback loop</i> occurs between the factors, i.e. they are inherently destablizing, particularly so in the face of ever increasing financial capital market efficiency;<p>b. the erosion of capital creates a system <i>prone to shocks</i>, both internal and external, and from the real economy or the financial economy;<p>c. <i>productivity improvements are capped</i> due to merely reducing headline numbers and making minimum incremental improvements to infrastructure and technology. No incentive for workers or employers to invest in company-specific skills or retraining;<p>d. gross increase in use of "excess" capital for <i>share buybacks</i> and other financial equity maximising techniques instead of investment or holding, even during boom times;<p>e. makes <i>central bankers management of monetary supply harder</i> due to the additional leverage use and other factors acting as a strong accelerator during cyclical upturns and a strong decelerator during cyclical downturns;<p>f. strong social impacts:<p>f.i. increasing <i>wealth inequality</i> between those who can benefit from the alliance and those who cannot. This is both from the asset side (shares) and liability side (borrowing);<p>f.ii. the easiest way to maximise profit today is to <i>reduce expenditure</i> instead of increasing revenues, so jobs are cut, wages and wage growth is minimised, work intensity and hours rise resulting in more errors, worker tiredness, forced imbalance of work/life.<p>When combined with globalisation, the efficiency of the global capital markets with its own problems (Too Big To Fail entities), tax and regulatory arbitrage, and capital flight, the above factors can be devastating to any economy no matter how advanced and results in global inefficiencies that produce sub-par growth and high instability.<p>These and other historical reasons are why most advanced countries outside of the Anglo-American world reduce the influence of free-floating shareholders and maintain a group of long-term stakeholders (including some shareholders) through formal and informal means. In addition, <i>corporate</i> leverage is usually more difficult to obtain.<p>What I find especially interesting is that a select few of the most globally successful American companies are well known for NOT partaking in this Unholy Alliance, specifically Apple, Google and to a lesser extent Microsoft are incredibly cash-rich companies! Other companies should learn something from these leaders.<p>Finally, there's a reason why Jack Welch, the long-time chairman of General Electric (GE), who is often credited with creating the term "shareholder value" in a speech in 1981 also denounced it in 2009 as probably the "<i>dumbest idea in the world</i>".

These easy definitions always bother me. "The only purpose of corporations is to maximize shareholder profit." Really? The only purpose? Shareholder profit or value is a side effect of producing products or services that people want. The purpose of a corporation is to focus on what it does and do it well. Shareholders benefit from this activity.<p>Anyone who starts or runs a company and says "My only purpose is to increase shareholder profit" is probably going to fail to deliver.<p>The other one is this issue of "corporate greed" or this idea of outsourcing to lower cost manufacturing centers in order to make more money. As someone who has the scars to show for it, I can tell you that "greed" is never a part of it.<p>Imagine, if you will. That you are making widget A in the US or Europe. You are doing well. Everything is manufactured in house or locally. Profits are good.<p>Now, imagine that a competitor decides that they can beat you at your own game and make widget A for less money if they outsource their manufacturing to, say, China.<p>Their list price is now lower than yours by a bunch. You don't want to loose market share, so you lower your list price. Only to discover that now your profits can't support your US-based operations. Just can't do it.<p>What are your choices? You can't automate your way out of the problem because you are already as efficient as you can be. You could leave the market altogether and move on. Lay off everyone in that division and lick your wounds.<p>Or, as it is more often the case than not, you can follow-suit and find your own manufacturing solution in China. Now you can lower your prices to match or improve upon your competitors's pricing and you've restored balance to the force.<p>Or so you thought. At this point nobody is making as much money as they used to. But, a race to the bottom ensues. Very soon Asian manufacturers enter the fray. Not only are they the beneficiaries of low-cost manufacturing, they also benefit from a far lower regulatory burden as well as not having to deal with progress-killing unionized labor and their ridiculous rules and costs.<p>The race to be bottom continues. Only that you and your local competitors are now at a serious disadvantage with respect to your Asian competitors.<p>What to do? Well, again, you could leave the segment, fire everyone and move on. Maybe you license IP and life is grand. Or, you could take it a step further and become a brand behind a product that you barely touch. Sure, you have to slim down the ranks but the business continues to exist in some form.<p>At no point in this slippery-slope is anyone thinking about getting rich. In fact, the effect can be quite the opposite. Profits become thin and the business suffers for it. You've taught your competitors how to make your products and have very little more than a brand to use as an advantage over them. You can't make anything any more and simply don't have the equipment, facilities, process, skill-set, network and people to even attempt to compete with anyone.<p>And life goes on.<p>To say that these corporations are "greedy" and that their "only purpose" is to provide shareholder value is, in my never-humble opinion, to be utterly ignorant of the day-to-day realities they have to face.<p>The reality of the situation is that, over the last 50 years, we have collectively opened Pandora's box. Consumers have voted with their buying power to overwhelmingly favor product that can only be manufactured in places like China due to cost structures. Given this, closing Pandora's box is as close to impossible as you can get.<p>MBA's and corporations cannot force consumers to behave altruistically and support locally made --higher cost-- product when they can drive over to Walmart and overdose on product at much lower price points and, yes, very good quality in most cases.<p>There's that scene the "Outsourced" movie that kind of encapsulates the whole phenomenon: A caller wants to buy a bald eagle statue but complains that it is made in China. The operator indicates that they have US-made versions and she'd be happy to sell him one. Only that the US-made version is over $200 when the Chinese version is $20. The caller goes with the Chinese version.<p>Attention Walmart shoppers: You reap what you sow.

What killed the economy is lack of demand, what killed lack-of-demand is a bleak outlook on future and lack of funds, and what has produced this is <i>efficiency</i> itself...<p>We are now at a time where technology and domain knowledge are stripping existing jobs while creating only a few new jobs.<p>Welcome to the new world people. It’s going to be a bumpy ride.

You could argue that unlike in earlier generations, MBA's have less or even no skin in the game.<p>If it is more or less a given that they will move from company to company to company in the course of their career, why should they care if a particular firm does not survive _long-term_? If the shareholders want short-term results, then they are just doing their job to deliver them.<p>If they can improve things for a company in the short-term, their job is done. They themselves can lead "successful" careers and live comfortable lives with that approach. And leave wealth to their heirs. No long-term survival of the company is necessary.