The greatest thinkers in history are those who sum up vast arrays of previously unconnected phenomena in a single sentence that is surprising at the time, yet obvious in retrospect, and understandable by everyday people. In physics, Albert Einstein illuminated the structure of the universe with “E=MC2”. Copernicus transformed astronomy with his insight that the Earth rotates around the Sun, not vice versa. In articulating the principle of gravity, Isaac Newton clarified what was hiding from us in plain sight.
And .Peter Drucker provided the guiding star of the discipline of management with his single sentence: “There is only one valid purpose of a corporation: to create a customer.” Only one.
This sentence appeared first in his 1954 book, The Practice of Management (Harper & Brothers), and was repeated, word for word, in his 1973 magnum opus. It was the foundational insight of his 1985 book Innovation and Entrepreneurship (HarperCollins) and remained a constant thread throughout all his 39 books.
Drucker saw that a company’s primary responsibility is to create value for its customers. The corporation must do many other things as well—create great workplaces, and do right by partners, society, the enviroment, and shareholders. But customers must come first: the customer is the boss. Profit is a result, not the primary goal: creating value for customers is the essential condition for the company’s continued existence and sustainability.
Of all Drucker’s insights, identifying the purpose of a firm in a single pithy sentence is his most profound. In retrospect, we can see that it was true, even before he articulated it. It showed why some corporations had prospered, while others had not.
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Today, almost seven decades later, we can see that Drucker was prescient in foreseeing that power in the marketplace would increasingly shift from the corporation to the customer and that creating value for the customer would become ever more central. In the first two decades of the 21st century firms that truly prioritize the centrality of the customer have become the first trillion-dollar companies, while the former giants of the 20th century like GE and IBM, which paid no more than lip service to the customer, have struggled.
The profits of the winners were not the goal. As Apple CEO Tim Cook said when asked about Apple’s soaring stock price, “The stock price and revenues and profits are a result of doing things right on the innovation side, on the creativity side, focusing on the right products, treating customers like jewels, and focusing on the user experience. And so that’s what we put our energies. And we have the faith that if we do them well, then the other things, [like the stock price], will follow.”
By contrast, the CEO of IBM, Ginni Rometty, capped IBM’s decade-long pursuit of shareholder value, with this summation: “At the end of the day, it’s about returning value to shareholders.” The financial results of this approach speak for themselves in Figure 1: Apple is worth $2.2 trillion, while IBM is worth a mere sliver: $0.1 trillion.
Drucker’s customer-first goal has also been the foundation of the subsequent evolutions in 21st century management, as shown in Figure 2. This includes the capability to create multiple new businesses, one after another, as at Amazon Amazon and SRI International.
It includes the creation of platforms that bring in partners to deliver more value to customers as at the Apple App store. And it includes ecosystems as at Haier and Spotify that make the customer themselves full partners in creating value. Without the underlying primacy of the customer, none of these evolutions would have been possible. And none of the evolutions are available to firms that are still prioritizing shareholder value, whether short- or long-term.
The Continuing Resistance To Drucker’s Insight
Yet despite the astonishing success of Drucker’s insight in terms of both finance and innovation, universal acceptance has been slow in coming. In one sense, this is not surprising: radical insights always take time to be digested and applied. For instance, the insight of Copernicus that the Earth revolves around the Sun took several centuries to win full acceptance, because it was at odds with the politics of the day, particularly the Earth-centric theology of the Roman Catholic Church.
In the seventy years following publication of Drucker’s insight, economists Milton Friedman (1970) and Michael Jensen and William Meckling (1976) led society down the opposite path with the notion that the purpose of a firm is to maximize shareholder value: in other words, to extract as much value as possible from customers, not create value for them. Amid the gung-ho money-making political climate of Ronald Reagan and Margaret Thatcher and the movie “Wall Street,” in which Michael Douglas as Gordon Gekko declared that “greed is good”, Drucker’s insight was out of step.
Thus, in a world where “the government [is seen as] the problem”, it was easy to pass regulations like SEC Rule 10B-18 which facilitated the extraction of value for shareholders. At the prodding of Michael Jensen in Harvard Business Review, corporate boards lavished CEOs with extravagant compensation as if they were entrepreneurs. Even today, CEO pay remains stratospheric when firms do poorly.
Another hurdle concerns the disciplines of economics and finance whose ambition is to explain the whole of human affairs in terms of money. Distinguishing between a goal of making money and a result of profits made is thus at odds with the very presumption of these professions: there can in principle be no difference. And when CEOs are compensated so lavishly for maintaining the status quo, it’s not obvious that they even want to do anything different.
Nevertheless, the grotesque short-termism and growing income inequalities in the economy could not be ignored forever. By August 2019, negative public reaction to the systematic extraction of value from customers induced CEOs to publicly renounce maximizing shareholder value as the explicit goal of a corporation in a declaration of the Business Roundtable. Instead, corporations declared themselves to be “creating value for all the stakeholders” and generating “long-term shareholder value.”
Astute observers however have not detected any significant change in corporate behavior since the BRT declaration. They tend to conclude, like Harvard Law Professor Lucian Bebchuk and his colleagues, that the BRT declaration was “mostly for show.” Value extraction remains the name of the game for most big firms, despite the existence of a more fruitful path.
Recognition Of Peter Drucker’s Foundational Role
Thus although Peter Drucker is often saluted as “the father of management”, his most important idea has not yet received the recognition that it deserves. It is to be hoped that, as the political mood shows itself to be more open to address the alarming social and economic consequences of corporations pursuing value extraction for over half a century, the time is ripe for the epoch-making nature of Drucker’s insight to be properly recognized.
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