“Asked what a business is, the typical businessman is likely to answer, ‘An organization to make a profit.’ The typical economist is likely to give the same answer. This answer is not only false, it is irrelevant.” – Peter Drucker
Almost four decades ago, Peter Drucker, one of the most highly-regarded writers on business and the role of business in society, described a business as an organization set up to fulfill a need which is significant enough that a group of people is willing to pay for it to be addressed.
But why are many people’s mental models for a business so different? It seems that the popular conception of a business is of a profit maximizing organization. Economics textbook treat firms as profit maximizing entities for theoretical simplicity, abstracting away essential qualities. Press coverage favors juicy but often exceptional stories, from record profits to scandals to boost profits. Moreover, in the last two decades, there’s been a growing obsession with covering the daily ups and downs of stock markets and financial metrics. In this context, you wouldn’t fault someone for viewing business simply from the lens of profit-making.
I think that’s the wrong mental model to have. Here’s Drucker again:
“It is the customer who determines what a business is. It is the customer alone, whose willingness to pay for a good or for a service converts… things into goods.”
Think about that for a second. Customers provide the financial commitment that enables a business to create, build, and improve products and services. Without this dynamic, we wouldn’t be able to do many of the things we care about today–from blazing computing power in our hands to robotic prostate surgery to an all-electric luxury car with no tailpipe pollution.
And this dynamic is only getting stronger as a deeper understanding of customer needs has become a source of competitive advantage. In the venture-backed startup world, Steve Blank and Eric Ries have advised startups to use a “get out of the building” approach called customer development. In healthcare, Kaiser Permanente, my wife’s employer, is innovating around patient-centric care. By better understanding households and families, Nest has created a self-programming thermostat that actually gets programmed and saves energy.
So what is the role of profit? Let’s go back to The Essential Drucker:
“[All the objectives of a business] require effort, that is, cost. And they can be financed only out of the profits of a business. They all entail risks; they all, therefore, require a profit to cover the risk of potential losses… Profit is, therefore, needed to pay for attainment of the objectives of the business. Profit is a condition of survival… Profit planning is necessary. But it is planning for a needed minimum profitability rather than for that meaningless shibboleth ‘profit maximization.’ The minimum needed may well turn out to be a good deal higher than the profit goals of many companies.”
So there you have it. Profits fuel a business. Society, as represented by customers and their needs, determines the flight path.
What does your experience tell you? Fire away in the comments.