The Fundamental Purpose of Business – Part I

“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 stumble across a magic lamp; the one with the genie inside who grants you three wishes. With your one remaining wish, having already wished for world peace and an end to poverty, you ask the genie to grant you the ability to combine the right ideas with good choices. Imagine a bit further, how this wish can affect your business. Extraordinary performance isn’t the result of one or the other. It’s the combination. Business is a product of its decisions.

Extraordinary middle-market businesses have an uncanny ability to produce financial performance and seize opportunities dramatically better than everybody else. These businesses are rare but not mythical. Size alone is no indicator of an extraordinary business. Maturity is the secret-sauce that makes a business stand-apart. These businesses manage routine efficiently and effectively, make good decisions, and cope with uncertainty – collectively the essence of business maturity. The most distinctive characteristic of a middle-market business is the challenge of advancing maturity. Advancing business maturity requires mastering the basics. Let’s start with the most basic – The Fundamental Purpose of Business.

History is littered with attempts to define the purpose of business. In 1776, Adam Smith stated the purpose of business as the mechanism to generate profit and increase shareholder wealth (known today as the “shareholder view”). Smith’s definition of business purpose identifies profitability as the defining characteristic. This definition however is problematic. Relying on profitability alone ignores the ease of manipulation and ambiguity of profit as an appropriate 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. Should the appropriate measure of profitability include or exclude re-investments or costs associated with capital structure, of which there are alternatives, any of which can affect profitability? Rejecting, as an oversimplification, profitability alone, others have restated the definition of business as maximizing shareholder value or wealth. Relying on the premise that the principle purpose of business is to maximize value (over time) overcomes the distortions profitability alone experiences. Nevertheless, the reliance on maximizing value neglects the underlying mechanism that businesses use to create value – creating customer satisfaction.

Peter Drucker said, “There is only one valid definition of business purpose: to create a customer.” Drucker’s definition is useful. However, it suffers from two shortcomings. First, businesses create customer satisfaction not customers. Second, this definition is silent on a business’s dependency on capital. I suggest 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.  

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. 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.  

Every business is different. Businesses differ in scale and performance. They differ in what they do and how they do it. Despite countless differences there is an underlying principle that each and every business must conform: The Fundamental Business Purpose (Business Purpose). Failing to satisfy this fundamental purpose “will” (not “may”) result in business failure. This design applies to every business regardless of whether it is a sole practitioner or a multi-national enterprise; whether a technology company or a local pizza parlor; whether for profit or not for profit. 

The Fundamental Business Purpose requires a business to use revenues and capital to produce customer satisfaction and reward capital providers. This idea is easily dismissed as obvious and trivial.  Yielding to this temptation is an engraved invitation to disaster.  

The everyday analogy – the internal combustion engine – illustrates the Fundamental Business Purpose. Every internal combustion engine converts fuel and oxygen into power and exhaust. No matter the size. No matter the application. All internal combustion engines do the same thing. A lawn mower engine does exactly the same thing as the engine found on a Formula One racecar. The difference is the application of the engine and the infrastructure required to satisfy the application. No one would confuse a lawn mower engine with a Formula One racecar. Nevertheless, both engines do the same thing; just very differently.

The business purpose is the criteria any business decision must pass through to ensure the choice is framed to perpetuate success. The business purpose is an idea and a decision gateway. The fundamental business purpose is a lens to focus your attention on two essential outcomes that drive business success. Ultimately, everything a business does should in some form or another contribute to satisfying a customer and rewarding capital providers.