Papering Over Problems With Paper Profits

Advice to American companies trying to produce an attractive bottom line: Quit worrying so much about the bottom line. The bottom line, of course, is profits--what’s left after the company pays the costs of producing and selling a product. And just how is a good business executive going to fatten those profits by paying less attention to them?

Simple. By paying attention to a couple of things that are more important--customers and employees. In other words, put the cart behind the horse instead of the other way around.

It isn’t a new axiom, but it is something U.S. business leaders still practice more in words than in deeds. Beset by pressure from stock market investors and fears of hostile takeover attempts, corporate management seems bent on maximizing short-term profits without adequate regard for how to maintain them in the long term. The goal is to keep the price of the stock as high as possible today.

Peter Drucker, professor at Claremont Graduate School, put it succinctly at a seminar for business leaders last week: Companies in this country “don’t maximize profits, they maximize (profit) statements.” They do it through accounting gimmicks and by putting off research and other activities that cost money now but produce profits in the future.

Critics of management practices in this country often point to this short-term thinking as the key to why so many of this nation’s major industries are no longer competitive with foreign producers.

It is, as Drucker’s colleague Richard Ellsworth describes it, a question of the foreign firms defining the purpose of their existence differently. Here, the purpose most often is to serve the shareholders. There, it is to serve customers and employees. Serving shareholders too often means too much focus on that bottom line. Serving customers and employees generally means a focus on long-term growth.

System Requires Growth

In Japan, Ellsworth observed, companies feel obligated to provide stable, long-term employment. Moreover, the strong seniority system requires growth to provide room to bring in more workers at the bottom of the pay ladder and thus keep average labor costs down.

He tells of a conversation with the founder of the major South Korean company Daewoo. Asked what return on investment the company wanted to maintain, the Korean executive said he paid more attention to whether an operation helped the country and its industrialization efforts. “If it does that, I don’t need a return,” Ellsworth quoted him as saying. Similarly, the Japanese company Matsushita long ago abandoned profits as the primary goal and imposed a broader set of standards: whether the business improved living standards and served the welfare of society.

Many business leaders here would scoff at such lofty goals. Foreign producers, operating more on borrowed funds and less on equity raised in the stock market, can be cavalier about rates of return. The bankers aren’t so interested in rates of return as in the long-term health of the organization, insuring repayment of the debt. American executives, on the other hand, believe that they had better toe the line on profits or find stock prices depressed and their jobs jeopardized by a takeover.

The irony, Drucker maintains, is that many foreign firms, by concentrating on sales growth, market share and employee happiness, have been doing better at keeping their stock prices up than most American companies.

The reason for this is pretty obvious. When companies try to create the illusion of greater stock value by giving up some future benefits for more earnings now, all they really do is invite the very short-term investment in their stock that many of them decry. By now, investors are suspicious enough about current profit statements that they go for quick gains in the market and hope to find the so-called greater fool out there to sell the stock to before the company’s questionable longer-term profit outlook becomes apparent.

Profits are important, of course. Without them, there would be no investment unless the government made it. The question is how to produce them--on paper, or by diligence in developing the product, motivating the work force and serving the customer.