How Management Discovered How To Create Value Rather Than Extract It

Big business and the stock market are often demonized as being irretrievably evil—selfish, greed-driven monsters, totally devoted to making a quick buck for the company, its executives and their shareholders.

Yet something unexpected has happened. Some companies have discovered that creating value for customers makes more money than the pure pursuit of self-interest. And the stock market also learnt the lesson. It is now rewarding value-creating firms with higher long-term valuations, while downgrading firms that focus on short-term returns.

Bad Management Theory

Management for much of the last half-century was governed by what the late business scholar Sumantra Ghoshal called “bad management theory.” His seminal 2005 essay, “Bad Management Theory is Destroying Good Management Practice,” explains how the doctrine that firms should maximize shareholder value (MSV) was by 2005 all-pervasive. It had taken over not only business, but economics and much of social theory and research. Ghoshal showed how MSV was based on the questionable notion that greed is both inevitable and good. It is a gloomy amoral view of humanity and society. Ghoshal lamented that business schools, economists, and social scientists all embraced MSV. He noted that “few managers today can question it.”

Ghoshal explained how MSV thinking permeated both business and academia:

“MBA students are not alone in having learned, for decades, these theories of management. Thousands-indeed, hundreds of thousands-of executives who attended business courses have learned the same lessons…Even those who never attended a business school have learned to think in these ways because these theories have been in the air, legitimizing some actions and behaviors of managers, delegitimizing others, and generally shaping the intellectual and normative order within which all day-to-day decisions were made.”

Ghoshal also made a prediction that happily turned out to be false. “Ultimately if the trend in management theory is to be reversed, only business school academics can do it.“ He did not foresee that in 2019, even the U.S. Business Round Table would unanimously condemn MSV.

Yet Even In 2005, Some Businesses Were Different

Ghoshal failed to note that even in 2005, reform was already under way in a different quarter: management practitioners. Already in 2005, several fast-growing firms were already practicing the opposite philosophy of MSV.

Thus:

· In 1997, Amazon was creating a store in which anyone, anywhere, could buy anything online.

· In 2001, Steve Jobs was creating the iPod, a product that would “put a thousand songs in everyone’s pocket.”

· In 2004, Google had gone public with a goal of “organizing the world’s information and making it widely useful.“

In these firms, MSV was not the goal. Making long-term profits was a result of consistently delighting millions of customers.

Ghoshal did not foresee that these three companies would go on to become trillion-dollar businesses because we as customers flocked to use their amazingly useful products and services. In the process, our lives were changed, and these firms became emblematic of many firms that are similarly committed to creating value, rather than extracting it.

The Unexpectedly Positive Role Of The Stock Market

It is common in some circles to demonize the stock market as inherently evil, and there is obviously much to lament in the chaos of the stock market’s short-term speculation and gambling.

Yet what is often overlooked is that the stock market represents the wisdom of crowds—including some of the world’s most knowledgeable crowds—and provides much valuable information as to which companies are creating value and which are not. When one looks at long-term indicators, like the 5-year total return, the stock market’s relative judgments are remarkably stable and meaningful in terms of rewarding value creation and punishing value-extraction. (See table below).

In 2024, the stock market is conferring immense rewards not only on Apple, Google and Amazon, but also on as much as 20% of public firms that focused on creating value for customers, rather than pursuing MSV.

At the same time, famous big old firms like IBM, ATT, Disney, ITT, J&J and Volkswagen (perhaps 80% of all public firms) have continued to pursue MSV and receive below-average valuations. Unless these firms change course, they will face downsizings, breakups, CEO replacements and other negative consequences.

Should we not be celebrating this as a positive, optimistic development for society? Are not markets playing a central role in creating real wealth and advancing economic progress?

Venture Capital Also Got The Memo

An unlikely follower of the value-creation philosophy is a sector previously known or its ruthless slash-and-burn tactics: venture capital. For instance, Kohlberg Kravis Roberts & Co (KKR) which had below-average 5-year total return in the period 2014-2019, enjoyed well-above average returns when it changed its approach.

KKR head Pete Stavros has championed a model where employees across all levels, particularly hourly workers, receive equity stakes in the businesses they help grow. This not only boosts engagement and retention but has resulted in remarkable financial outcomes, as seen with companies like C.H.I. Overhead Doors, where profit margins soared under the ownership program.

A Viable Management Model Has Thus Emerged

A case can therefore be made that we already have the elements of a viable management model that is both right and good because it is value-creating, rather than value-extracting. It induces behaviors that lead to better economic, social and moral outcomes, for the actors and for society.

This is not to say that these value-creating firms are perfect: all have serious flaws and need to improve, particularly in areas of compensation, privacy, and the environment. Nor are all the 80% beyond hope. For instance, Microsoft, Walmart, and GE have all made remarkable transitions.

When Will Business Schools Catch Up?

Thus many management practitioners and the stock market have made the transition to an ethically positive, value-creation mindset. When will business school academics and theory catch up?

Ghoshal noted in 2005:

“This is not going to be easy. The nature of the academic process naturally favors building on the existing edifice of theory instead of starting over, on fresh ground. The currently dominant theories have so much commitment vested in them that the temptation of most scholars would be to incrementally adapt these theories, if and as necessary, rather than to start afresh on the more positive agenda.”

But business schools have the advantage that, now in 2024, real businesses, including the most valuable firms on the planet, and the stock market, have already made substantial progress in executing the change. So business schools don’t have to start afresh.

Moreover, the shift builds on ancient wisdom. For millennia, sages have urged the wisdom of doing things for others, ahead of prioritizing self-interest. This ageless truth should not be too hard to learn.

And read also:

How The 5-Year Total Return Helps Measure Value Creation Performance

How Management Became More Than Tools And Processes