The Fundamental Purpose of Business
“I went to a bookstore and asked the saleswoman, 'Where's the self-help section?' She said if she told me, it would defeat the purpose.” ― George Carlin
Imagine, for a moment, you had the ability to combine the right ideas with good choices. Business is a product of that combination.
Knowing how a business comes about, the next logical question is what is its fundamental purpose?
Throughout history, many academics have tried to answer that very question.
Adam Smith, in 1776, answered the question by saying it’s the mechanism that generate profit and increases shareholder wealth. That definition of business purpose identifies profitability as the main characteristic. Doing so is problematic. If you rely only on profitability, you ignore the reality that profit is easily manipulated when used as a measure. Profitability is simply a measure of the surplus (or the deficit) remaining after costs are deducted from revenues. Trusting profitability alone obscures the role of investments made for the future and alternative capital structures.
Peter Drucker said, “There is only one valid definition of business purpose: to create a customer.” Drucker’s definition is useful. However, there are two problems with it. First, businesses create customer satisfaction not customers. Second, it doesn’t mention a business’s dependency on capital.
Andrew C. Harvey with the National Center for The Middle Market suggests a better description of business purpose is: use revenues and capital to produce customer satisfaction and capital provider rewards.
“Extraordinary businesses use revenues and capital to produce customer satisfaction and capital provider rewards. Failing to satisfy this fundamental business purpose is unsustainable. There are examples of businesses that operate in violation of this principle but not for very long,” Harvey said.
“There is a temptation to include the interests of other stakeholders (employees, suppliers, communities, or others) in the definition of business purpose. The interest of other stakeholders is noticeably excluded from my description,” Harvey said. “Other stakeholders are not unimportant however business sustainability can be achieved absent their special consideration. Nevertheless, there are compelling reasons that the interest of other stakeholders should be explicitly identified. Doing so should be addressed as part of the business’s intentions that I’ll discuss separately.”
The reality is every business is simply different. They differ in size and action. And that’s just the beginning. There are countless differences. But even so, there is an underlying principle that each and every business must conform: business must use revenues and capital to produce customer satisfaction and reward capital providers. Dismissing this fact is the proverbial death wish.
The following analogy is a good way to think about the purpose of business: an internal combustion engine. Every internal combustion engine, regardless of size or application, converts fuel and oxygen to power and exhaust. All internal combustion engines do the same thing. It doesn’t matter if it’s in a lawn mower or a race car. Both do the same thing, just in different devices.
Businesses are the same way. Regardless of industry, businesses must use money to produce customer satisfaction and reward capital providers.