What is Profit?

I have been having these MBA style discussions with one my peers, Sarah. Sarah is bright young lady from Qatar. You can see the spark in her eyes when you talk about Qatar and what you can do to make things better in Qatar.

We discuss a lot of politics, religion and other stuff which are not suitable for this weblog however we do once in a while discuss our course too!

In working through the Introduction to strategy in our course (CMP) we have been constantly coming back to two topics - Competitors and Profit.

One of the problems that I see with the way we are taught is that there is a heavy emphasis on Competitors in most strategy models and ideas.

In the world that we live in it is surely the case that we cannot implement any strategy without dealing with competitors. I think that is a given. However, due to the over-emphasis on this particular idea a lot of the students only talk about Competitors as strategy.

From my point of view Strategy is about creating the future of your organization. It is about implementing the vision/mission. It is about realising the dreams that the organization has created itself for.

In the course of doing this we do encounted a lot of competitors and other players in the society. These players could be enhancing or disturbing your vision. This is when you learn to start dealing with them.

For example, the famed Porter's five forces model talks about how various market players will decrease the profits of an org. Porter also misses to add other factors like marketing & advertising. The biggest factor he misses is government. In a lot of cases all around the world the Government shapes the structure of the market.

This could be in terms of regulation (alcohol etc) or licensing (telecom, radio) or tariffs (import and export tariffs) or trade support (subsidies, anti-dumping policies) to shape the structure of the market.

Another important insight which he missed was that the various players in a market are not always going to decrease an org. profits. They can enhance them too. This is what Nalebuff and Brandengerger prove in their book Co-Opetition or what they call Value Net.

As I was discussing these various ideas I started to think about how and why strategy can be used in not-for-profits?

But, why have some org. labelled themselves not-for-profits?

Is it because of the obvious reason that being profitable is not connected to making a difference to the society. Do you have to be unprofitable to make a difference to the society? I cannot understand that.

For me I believe that business is a force for good. Not all businesses. But definately some of them are good. But why did profit come in the way?

What is a business?

Individual businesses are established in order to perform economic activities. With some exceptions (such as cooperatives, non-profit organizations and generally, institutions of government), businesses exist to produce profit. In other words, the owners and operators of a business have as one of their main objectives the receipt or generation of a financial return in exchange for expending time, effort and capital.

What is a non-profit organization?

A non-profit organization (often called "non-profit org" or simply "non-profit" or "not-for-profit") is an organization whose primary objective is something other than the generation of profit.

Wikipedia defines profit as :

Profit is defined as the residual value gained from business operations.

Profitability refers to the amount of profit received relative to the amount invested, often measured by a rate of profit or rate of return on investment.

Economists and accountants measure profit in slightly different ways, profit will only be the same when all the factors of production have been credited their full opportunity cost.

Economists usually define profits as revenues less the opportunity costs of labor, capital, and materials. Furthermore, profits are divided into two types:

• Normal profits are the salaries paid to executives in exchange for their entrepreneurial skills.
• Economic profits are what remain after normal profits are subtracted. It is the economic profit that economists see as the incentive for firms to enter or leave a market.

In the accounting sense of the term, net profit (before tax) is the residual after deduction of all money costs such as; wages, rent, fuel, raw materials, interest on loans and depreciation.

What we have see is the traditional definition. All organizations can be classified into what can be called a black-white classification. Org. whose goal is to make a profit and Org. whose goal is not profits.

Getting the entire world (we are a societies of organizations now) into just two categories is not only silly it is downright stupid.

What is or better what should be the goal of a business?

Drucker provides us the definition :

Three roles of Management

Drucker teaches us three roles of management. The first role is to accomplish the function that is specific to each organization; in other words, to contribute to society through its business. If it is a newspaper company, it is to publish the best paper. If it is a greengrocery store, it is to supply the best vegetables. It is only a monastery deep in the mountains that does not have to contribute to society directly. It is only a gangster connection that does not have any intention to contribute to society. All other organizations must contribute to society, because they are allowed to exist, occupy, and hire the most valuable in society.

The second role is to make work productive and people achieving. Man as a social existence seeks to exert his ability fully, to fulfill his potential, and contribute to society. Especially from now on, we will enter an age when people will leave an organization that cannot make work productive, and satisfy them in achieving through their strengths.

The third role is not to give any negative impact on society, and to contribute society in solving its problems. This is so-called the social responsibilities of the organization.

If this is true, then what is profit and why has it become the main cause of an existence for a business.

Drucker says profit is, first and foremost, a cost for today and tomorrow. Fortunately, it fulfills the role as a measurement to know how the organization functions well. According to Drucker, it is dubious that a desire called profit motivation exists. It is only an assumption of classical economics that could not explain the cause of economic activities.

In psychology, there are materialistic, sexual and other desires, but no profit desire. Running a business for profit motivation would end up as running a business for greed. Moreover the word profit motivation causes needless misunderstanding and antipathy against business activities. Sadly, even though a top executive himself is not working for the purpose of moneymaking, he uses the word without giving it much thought.

There you go : "It is only an assumption of classical economics that could not explain the cause of economic activities." This is the main reason profit has been understood wrongly. It has been ingrained in the minds of executives around the world that we have forgotten to ask the definition itself.

It is important for us to know the reason for the existence of profit so that we then design our organizations and implement our strategies without the burden to "maximize a firm's profits" as expounded by the classical economists.