The role of profits

BREAKTHROUGH - Elfren S. Cruz (The Philippine Star) - July 30, 2020 - 12:00am

There is no question that the world today is under siege as all major institutions are going through a period of revolutionary change. Any major institution – government, business, religion, education, social sector, arts – that is undergoing internal re-examination and debate on its purpose will not survive the ongoing cataclysm subjecting old beliefs and traditional practices to questions and even opposition.

Even long held views such as liberal democracy is in danger of being replaced with the argument that it has not worked. The period since the end of the 2nd World War until the early 21st century was the time liberal democracy hand in hand with capitalism and globalization were considered as the forces that would bring peace and prosperity to the world. Instead it has brought an era where income inequality is at its worst. This is a period where 67 individuals own as much wealth as the bottom 50 percent of the world’s population. This means that 67 individuals have the same wealth as the bottom 3.9 billion population of the earth.

The last decades were still the era when economists still believed that the primary economic goal was to increase the Gross Domestic Product of a nation. This was based on the belief that “enlarging the economic pie” meant that  there would be a bigger slice for everyone. What happened was that capitalists simply increased their share of the pie.

Until now, there are still businessmen who argue that minimum wage must be kept low so that business is “competitive.” Now even Pope Francis has said that the “trickle down” theory does not work. Even in the United States it did not work.

All these inequalities and feeling of powerlessness have been exploited by populist leaders who have risen to power by attacking the elite and  the very rich as the source of all these evils. Even liberal democracy which combines representative democracy and capitalism is now losing ground.

It is not just populist leaders who are attacking liberal democracy. It is also a growing body of people who are proposing a new ideology which is often called democratic socialism or its more traditional name social democracy. Although this ideology saw its roots in Europe as a counter balance to the ideology of communism, its leading exponents and ideologues are now in the United States. Among its early leaders are Bernie Sanders and Elizabeth Warren. But its most exciting leaders are a group of very young congresspersons and intellectuals who are increasingly winning congressional seats. Its most visible leader is Congresswoman A.O. Cortez who is the youngest member of Congress and used to work as bartender. She represents the South Bronx which is one of the poorest areas in the United States.

This political development is critical because if it succeeds, this new ideology will spread throughout the world, including the Philippines.

Major businessmen all over the world are now re-examining the role of the corporation. A major American business group is advocating that businesses shift their goal from focusing on the stockholders to focusing on all the stakeholders of a company. These stakeholders are the stockholders, employees, customers, suppliers and the community it serves.

In these debates, the question business leaders  ask is: What is the role of profits?

From a business point of view, I think this explanation written by Professor Richard Ellsworth is very enlightening. He wrote:

“Profits provide a discipline for management decisions, act as a guide to value creation, and are an important criterion in selecting which customers to serve. The critical issues are the ‘level of profitability’ that companies seek, whether profits are viewed as ‘ends in themselves’ or as a ‘means to achieving other ends’ (and therefore must be adequate to achieve these ends, rather than being maximized), and how managers trade off profitability against other  strategic concerns that directly affect competitiveness.

Peter Drucker, considered the father of modern management, saw profits as a means, not an end. In his book, Management: Tasks, Responsibilities, Practices, he warns of the danger of misunderstanding the role of profits:

“ A business cannot be defined or explained in terms of profit. Asked what a business is, the typical businessman is likely to answer, ‘an organization to make a profit.’ The answer is not only false, it is irrelevant...the concept of profit maximization is meaningless...

“In fact, the concept is worst than irrelevant: it does harm. It is a major cause for the misunderstanding of  the nature of profit in our society and the deep-seated hostility to profit which are among the most dangerous diseases of an industrial society. And it is in large part responsible for the prevailing belief that there is an inherent contradiction between profit and a company’s ability to make a social contribution. Actually, a company can make a social contribution if it is highly profitable...

“Profitability is not the purpose of but a limiting factor on business enterprise and business activity...”

If a business is ready to transform its corporate purpose from stockholders to stakeholders, it must ask three questions. First, for whose benefit does the enterprise exist? To what extent are the expectations of each stakeholder being met? What is the priority among stakeholders?

If there is a conflict among the priorities of each stakeholder, does one prevail over the other? Only when the stakeholders’ priorities are given equal weight can we say that the business is now a socially responsible business.

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Email: elfrencruz@gmail.com

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