The Age of Customer Capitalism



The Age of Customer Capitalism

Introduction

In the current Harvard Business Review, Rotman school dean Roger Martin (author of “The Opposable Mind” and “The Design of Business,” both books endorsed by this blog) argues that it's time for a new overarching goal for the firm (”The Age of Customer Capitalism“). Martin argues that since the 1980s companies have been focused on the wrong objective: shareholder value. He states that shareholders are frequently short-term holders and overwhelmingly indirect (i.e., you buy a share of a mutual fund that invests a fraction of that share in a particular firm). Therefore, the side effects of shareholder maximization strategies are short-term thinking and lack of concern for anything not directly financially-related.

Discussion

Reading Martin's piece brought to mind the chill that went through me years ago when I read Michael Jensen's (the godfather of shareholder maximization) 1980s HBR article “The Eclipse of the Public Corporation.” In this piece Jensen argued vociferously that older, low-debt versions of company capitalization were antiquated, and the companies of the future would be highly leveraged in order to tightly tie owners to the performance of their companies.

We see where that got us. Perhaps there were others who also instigated the era of private equity, but I first and foremost blame Jensen. He got what he wished for and as a result saddled the rest of us with an unmitigated disaster - an economy teeming with overleveraged investments - which looked great as long as the economy kept growing, but which changed into albatrosses around our collective neck when the (inevitable?) downturn came.

Professor Martin suggests that shareholder value capitalism is also a flawed theory, and provides some compelling evidence that the shareholder value paradigm did not pay off for shareholders (in short - between 1933 and 1976, when management capitalism was king, the S&P earned compounded annual returns of 7.6%; between 1977 and 2008, during which shareholder value capitalism has been in vogue, the S&P created compounded annual returns of 5.9%). Further, Martin argues that shareholder return cannot increase in perpetuity.

So, what is a firm to do? Martin suggests that the answer is Customer Value Capitalism - that is, the path to shareholder value creation comes by maximizing what we at Walker call customer loyalty. In Professor Martin's words:

“…companies should seek to maximize customer satisfaction while ensuring that shareholders earn an acceptable risk-adjusted return on their equity.”

Why can't the firm focus on both customer value as well as shareholder value? Professor Martin provides two arguments. First, from the perspective of optimization theory, you can only maximize one variable while controlling for all other variables. While this is technically correct, the second reason cited is more compelling - shareholder value reflects the value stockholders place on the company's future earnings, and it is impossible to any firm to continuously raise -and deliver on - expectations. If we assume that customers are the source of all future earnings, then logic would suggest that maximizing customer value would be the ...