The goal of business is not profit, but virtue

Most bookshops have a section devoted to business titles, and mostly they fall into two categories. In one you fill find volumes with titles such as Flexagility^TM – The Secret of Delighting Customers and Raking in Enormous Profits. You’ll see them in airport bookstalls next to the self-help section. In the other you’ll find titles such as Fleeced, Poisoned and Spied Upon – How Capitalism is Fuelling Inequality, Damaging our Wellbeing and Destroying the Planet. Books in this category are written for people who welcome confirmation of what they think they already know. These words are lifted from a business book that falls into neither of these categories: The Corporation in the 21st Century: Why (Almost) Everything We Are Told About Business is Wrong, by economist John Kay. It is intended, as Kay says in his introduction, for people who would never normally pick up a business book, but who would welcome an “intellectually serious, even sometimes challenging, approach” to the subject, and who might even be led to conclude that a career in business has something more to offer than just financial reward. Kay succeeds in his aim. The result may be, as Ed Smith says in a review for the New Statesman, a book without a theory. But that is no criticism – “because instead of theory it has wisdom”.

"Medicine is for the people. It is not for the profits"

The history and fate of the modern business corporation has been a strange one. On the one hand corporations have delivered products and a standard of living without which our lives would be economically and culturally impoverished, says Kay. And yet most intelligent and thoughtful people have a negative view of business, especially big business. Strangest of all, business in the 21st century describes and conceives of itself in terms that actually “invite that negativity”. For Marxists and their modern descendants on the left, businesses are the site of class struggle, where ruthless capitalists, through their ownership and control of business assets, sweat their exploited workers to maximise profit and fill their pockets. Economists and thinkers on the right have done little to challenge or alter that view except to add “and a good thing, too”. The details of economists’ vision and theories have varied, but all basically see business as an economically efficient arrangement for minimising inputs in terms of labour and resources, and maximising outputs in terms of goods and profits. Business leaders have accepted the characterisation and acted accordingly – to their own misfortune.

Kay opens his book with a case study from the pharmaceutical industry (and expands on the example with many more from other industries in the course of his 448 pages). In the early 20th century, the rise of scientific medicine was gradually replacing older medical practices that relied on folk wisdom and snake oil. The anti-bacterial properties of penicillin were first observed in 1928, but neither government nor business were especially interested until the outbreak of World War II concentrated minds. Howard Florey and Ernst Chain at Oxford University, who were seeking to synthesise the antibiotic, found a supporter in George Merck, the president of the firm that bears his name to this day. Merck was one of the first companies to recognise the life-changing potential of pharmacology and to benefit from it. Merck’s oldest son, also called George, turned the company into a research-oriented business, and it has been listed on the New York Stock Exchange since 1927. The aim of the business was articulated by Merck in 1950, when he told medical students: “We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear. The better we have remembered it, the larger they have been”. For many years Merck topped Fortune magazine’s list of most-admired companies.

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Maximising profits at all costs

The early history of the industry would tend to confirm that this was the guiding credo of all such businesses. But the tide turned when drug companies came under pressure from Wall Street to demonstrate their commitment to securing value for shareholders. Merck’s counterpart at Pfizer had a somewhat different credo: “So far as humanly possible, we aim to get a profit out of everything we do.” Jim Collins’s 1994 business classic Built To Last showed that, judged by stock returns alone, the likes of Merck outperformed their peers. Until, that is, Merck stumbled. It succumbed to the profit-maximising logic, becoming “totally focused on growth” instead – and hence took a starring role in Collins’ 2009 book, How The Mighty Fall. Merck had to withdraw a painkiller amid recrimination and lawsuits in 2004 when it had marketed the drug not just for the minority of patients who would derive benefit, but for the many who might just as well have taken aspirin.

Many more-egregious examples of wrongdoing motivated by profit-seeking will no doubt spring to mind, and not just in the pharma industry. But the point brought out by Kay is that this short history is depressingly typical of modern business. Its products may save millions of lives and improve the quality of life for almost everyone. Its revenues may fund new research and make large profits for investors, including retirement funds. The profits may support philanthropy on a large and global scale. Yet a turn to focus on maximising profits at all costs, and the misbehaviour that predictably follows from that, brings a fall, and explains why the public came to mistrust big business.

It is a “central argument” of Kay’s book that “by excessive emphasis on the transactional nature of business relationships we have undermined not only the relationship between business and society, but also the effectiveness of business, even in transactional terms”. Boeing was a world-leading engineering firm making superlative products that transformed the world until a change in the culture led to a focus on profit. The end result was aeroplanes falling from the sky. General Electric was for much of the 20th century regarded as the best-run company in the US. A ruthless turn to focus on “shareholder value” from the 1980s onward led in the end to the collapse of the firm. Shareholder value disappeared with it. Bear Stearns was once an investment bank that proclaimed, “We make nothing but money”. As Kay drily notes, it “ended up not even making any of that”. The last people to benefit from the pursuit of “shareholder value” are shareholders.

The pursuit of profits vs creating 'rents'

But doesn’t the pursuit of “shareholder value” describe the reality of what businesses are and should be? Are not businesses in fact owned by their shareholders and is it not a corporation’s “social responsibility”, as Milton Friedman put it, to maximise its profits? That view is simply not tenable, says Kay. To start with, figuring out who really “owns” modern corporations, with their complex web of financial, contractual and regulatory obligations, is no easy matter, and even in jurisdictions most friendly to the concept of shareholder ownership (such as the US), actually exercising the rights of ownership and control is far easier said than done. In big modern corporations, it is more likely to be senior management that is in ownership of a business’s general strategy, but even then, the rights and freedom of action associated with that ownership are unlikely to extend as far as might be assumed. The workers themselves, for example, will be bringing not just themselves to work, but knowledge, talents and skills that are not easily ordered about or replaced. Even the things the business actually “owns” may be hard to pin down – Amazon does not own its warehouses or the goods in them; Apple does not make its smartphones.

Success in business today is secured rather by “assembling the collective knowledge of many individuals and by developing collective intelligence – a problem-solving capability which distinguishes the firm from its competitors”. The modern corporation’s essential role is defined, then, not so much by the capital it can amass, the assets it owns, or the numbers of workers it can “exploit”, or by how efficiently it does this or makes tangible things, but by its ability to marshall human capabilities in a unique way that answers to customers’ needs. Success in this endeavour is hard to replicate by competitors, which means the corporate landscape is dominated by monopolies. And what monopolies earn as a reward for achieving that status is not so much a return on capital, or profit, as it is a “rent”. If Lionel Messi were not employed as a footballer, his earnings would be modest, as were the incomes of even the greatest footballers until recent times. The fact that his talents are greatly desired by modern football businesses, which skilfully attract viewers and advertisers in competitive global markets, means he can capture a fortune. The difference is known as economic “rent”.

And that is something to be welcomed. Economic rent – not the same thing as the rightly deplored “rent-seeking” of those who seek to appropriate some of the value created by others, by, for example, political means – is “not an anomaly, but a central and valuable feature of a vibrant economy”. Progress happens when people and businesses create rents by doing things better. The industrial revolution replaced manual labour with machines. Its further development is seeing physical labour replaced with “collective intelligence”. The hallmark of a successful business today is “harnessing collective intelligence that isn’t common property”. Apple, Amazon, Microsoft, Tesla, SpaceX – many modern success stories are based not so much on making something new (mobile phones, shops, computers, electric cars and space rockets were not exactly unknown before the advent of these firms), but on bringing together the right talents to turn what we’re all familiar with into something brilliant we can’t resist. Creating such collective intelligence successfully involves doing many things well, but rarely the things that would be visible to the Marxist or right-wing theories of what a firm is and how it works.

A transactional account of business is hence not just repellent, but mistaken. It does not describe how successful business works – or could work – in modern society. In the modern world successful commercial relationships are not simply instrumental and transactional, they are “social and embedded in a wider framework of communities and teams”, and Kay’s hope is that a “better account of how business and its stakeholders flourish will point the way not just to a better understanding of business, but to the better conduct of business itself”. Just what adopting Kay’s view would mean for business and public policy will be the subject of a successor volume. So those wondering just where Kay’s account differs from the familiar conflict over shareholder and stakeholder visions of capitalism will have to wait for that. In the meantime, readers of all political and ideological persuasions will benefit from reading this clear-eyed account of modern business – of why it should be celebrated, and why it urgently needs reform.

The Corporation in the 21st Century by John Kay (Profile Books, £12.99) is out now in paperback

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