Wednesday, June 29, 2005

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.

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.


Blogger Andrea said...

It is interesting you should be discussing 'profit' my MBA, which is with a major in Environmental management, our recent discussions have been very much about the impacts of a growth based society on all manner of things- community, environment, GDP etc.
Profit is closely related to the discussion, and I had never really thought of this 'not-for-profit' concept. This concept of 'not-for-profit' is essentially about community/grass roots or charitable groups, as far as i can tell.

It is interesting how such groups thrive and fail within a capitalist system.....a little bit like weeds pushing through the concrete.

They are using capitalism to their advantage....and often to repair damage to community or environment that is a result of capitalism....very ironic i think

29 June, 2005 16:50  
Anonymous Anonymous said...


30 June, 2005 16:43  
Anonymous Anonymous said...

I like your blog a lot but must make two comments on the "What is Profit?" post:

First, you are correct that Porter's 5-Forces model doesn't include the government, which does not belong in that model. Check out his Diamond Model and you will find the government is included.

Second, it is naive and utopian to glorify the non-profit sector. I have worked in investment banking and management consulting for world-class firms. I now have a bird's-eye view of the nonprofit sector as a program officer in a private foundation and have never before seen the scale of mediocrity, inefficiency, mismanagement, hypocricy, bureaucratism and power-mongering that goes on in the non-profit sector. The absence of market-based forces of competition and performance metrics means that everything is a negotiation for power and those who succeed are often turf-warriors and bureaucrats. Far from looking noble, this sector is rife with abusive management practices, exploitative salary structures, whole organizations that exist to provide jobs for the employees rather than achieve outcomes for their ostensible beneficiaries, antiquated and grossly inefficient operations, etc. This is not to say there are not good people doing fabulous things. But the absence of market forces absolutely contributes to profoundly politicized behaviours meant to advance the professional agendas of the perpetrators. As for those who condescend to the capitalist system and its entrepreneurs who made the money upon which the nonprofit sector depends: they are largely too incompetent themselves to have ever succeeded in the competitive markets which created all that wealth while employing people and funding charities. The sanctimonious sneers of such folks are amusing but predictable. Working in the nonprofit sector has succeeded in making me MUCH more conservative than my MBA program ever could have. Take away the markets, take away competition, and you have an ecology of widespread inefficiency, bureaucracy, self-serving power-mongering, and ineptitude. When I someday run my own foundation I will ONLY hire people from the for-profit sector (and only those who have a healthy appreciation for the power of market-based solutions to resolving social problems - a la Grameen Bank, etc.)

13 July, 2005 13:34  
Blogger Suhit Anantula said...

I agree with you totally.

I did not ever mention that the notfor profit sector is better than the for profit sector.

One of the problems is the absence of market forces as you rightly pointed that which has created wrong performace metrics for the not for profit sector.

However, it does not negate the fact that a lot for for profit firms are only doing that - looking for profit.

I beleive that business a force of good. Because of the kind of people whom it can attract and the way things are organized if "maximizing profits" are not the only reason for the existence of a business then we can make a this world a better place.


13 July, 2005 16:56  
Blogger Andrea said...

I think it is worth discussing Ethics in relation to profit!

10 August, 2005 19:14  
Blogger Crazy Dan said...

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28 January, 2006 02:50  

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