Inclusive business and strategy

THE VERY timely theme of inclusive growth of the recently concluded Manila Apec conference has spawned a new mantra for the local business community—inclusive business (IB).

Indeed, IB is the main focus of this year’s theme of the Management Association of the Philippines (MAP), the sponsor of this column.

While business leaders and corporate managers have been quick to embrace IB, I suspect that a good number of them are woefully unaware of what it implies for the way of doing business.

Quite a lot, it turns out.

In a commentary posted early last year in the Skoll World Forum provocatively  titled “To be an inclusive business, forget business school lessons  on strategy” , Bhaskar Chakravorti of the Fletcher School at Tufts University urged his readers to move beyond typical business classroom discussions on strategy.

He concludes his piece with this strongly worded counsel to business managers:  “Business strategy needs to be re-thought and re-learned. If you remain trapped in axioms developed for twentieth century industrialized markets, you will suffer trapped value in the emerging opportunities of the twenty-first century.”

Rethinking the goal of profit maximization

The generally accepted goal of business organizations in capitalist societies is the maximization of profits, or shareholder value in the case of corporations. We resolutely adhere to this longstanding business objective. 

However, there is a need to rethink the way we pursue this objective. We ought to approach this goal from a different direction.

Embracing IB and at the same time achieving our usual profit goals require us to make a 90-degree turn in the way we do business.

We believe that pursuing profits with single-minded determination and being driven by the overpowering urge to make big money often leads to short-sighted strategic choices that are intended to immediately enhance revenues on the one hand and to reduce costs on the other.

While doing so makes both intuitive and mathematical sense, efforts to widen the difference between current revenue and costs tend to actually prevent the firm from achieving even higher profits in the future.

There are several reasons for this paradoxical outcome.

Avoiding short-termism

Short-termism is the tendency of businesses to exaggerate the difference between current net revenue and current costs. Quite often, the revenue side of the profit equation is boosted by setting up high prices for products that are in great demand among select groups of customers and for whom price is not an issue.

Doing so, however, deprives many other potential buyers of the opportunity to benefit from these products and, more significantly, prevents the firm from generating additional revenues. 

This strategy discourages efforts to create economic value for less affluent customers by developing less costly variants of existing product lines and selling these at reasonably low prices (known to students of microeconomics as product differentiation).

This marketing strategy has the salutary effect of creating additional economic value not only for the firm but also for the less economically endowed members of our society, the so-called “bottom of the pyramid.” This illustrative example clearly demonstrates that creating economic value for the other stakeholders of the firm—its customers, in this case—is a potentially effective way of creating more value for its owners.

Let’s look now at the cost side of the profit equation.

Managers are often focused on cost effectiveness as a means of improving business performance.

However, most short-run costs savings, on deeper reflection, turn out to be investment opportunities foregone.

These include investment in human capital through skills development and improved working conditions, and investment in market development through product innovation and customer care—current business expenditures that potentially generate revenues and enhance productivity in the future.

Significantly, they also create economic value for the employees and customers of the firm, and by extension, for its suppliers and the community of which it is an integral part.

In a word—inclusive!

From profit maximization to value maximization

We concede that making major shifts in strategic thinking and in the way we manage is a tall order, especially for established business managers who have gotten habituated in their old ways and who have established their well-deserved professional reputations from their highly touted managerial skills.

Perhaps a small first step in that direction is to change our concept of the firm from an entity that seeks to maximize profits to one that aims for the maximization of economic value.

To do so requires professional managers to focus more on the economic interests of their customers rather than that of their shareholders.

A customer-focused strategy

An old business adage goes “the customer is always right.” Customers are, after all, the ultimate arbiters of economic value.

They are the ones who determine what they want and what they need, and to decide on the maximum prices that they are willing to pay for the goods and services that are offered to them.

They are the ones who determine the firm’s revenue streams, the lifeblood of any business enterprise.

By giving highest initial priority to its customers and thus generating substantial revenues from them, the firm will be better positioned to appropriate economic value to its other stakeholders who contributed to the value creation process, notably its workers and its suppliers.

We take it as blind faith that the residual value that goes to its owners through this circuitous route will be maximized.

(This article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines. The author is a retired UP professor, and until recently was professorial lecturer at its school of economics. Feedback at <[email protected]> and < [email protected]>.  For previous articles, please visit <map.org.ph>)