Financial Objectives Are Not Strategies

The Volkswagen scandal has me thinking that objectives like “become the number one automaker in the world” or “earnings of $20 per share by 2015” are too common and too often substitute for strategy.

Financial objectives like market share, profit, earnings per share, gross profit margin, “shareholder value” and so on are not strategic objectives.  They are, instead, lagging indicators of the success of your strategy.  Peter Drucker said the purpose of a business is to create a customer. Theodore Levitt expanded on that to five simple statements about the “requisites for competitive success”:

1. The purpose of a business is to create and keep a customer.
2. To do that you have to produce and deliver goods and services that people want and value at prices and under conditions that are reasonably attractive to those offered by others to a proportion of customers large enough to make those prices and conditions possible.
3. To continue to do that, the enterprise must produce revenue in excess of costs in sufficient quantity and with sufficient regularity to attract and hold investors in the enterprise, and must keep at least abreast and sometimes ahead of competitive offerings.
4. No enterprise, no matter how small, can do any of this by mere instinct or accident. It has to clarify its purposes, strategies, and plans, and the larger the enterprise the greater the necessity that these be clearly written down, clearly communicated, and frequently reviewed by the senior members of the enterprise.
5. In all cases there must be an appropriate system of rewards, audits, and controls to assure that what’s intended gets properly done and, when not, that it gets quickly rectified. [i]

To those who say that the purpose of a business is to create a profit, he continues:

“Not so long ago a lot of companies assumed something quite different about the purpose of a business. They said quite simply that the purpose is to make money. But that proved as vacuous as saying that the purpose of life is to eat. Eating is a requisite, not a purpose of life. Without eating, life stops. Profits are a requisite of business. Without profits, business stops. Like food for the body, profit for the business must be defined as the excess of what comes in over what goes out. In business it’s called positive cash flow. It has to be positive, because the process of sustaining life is a process of destroying life. To sustain life, a business must produce goods and services that people in sufficient numbers will want to buy at adequate prices. Since production wears out the machinery that produces and the people who run and manage the machines, to keep the business going there’s got to be enough left over to replace what’s being worn out. That “enough” is profit, no matter what the accountants, the IRS, or the Gosplan calls it. That is why profit is a requisite, not a purpose of business.

“[T]o say that profit is a purpose of business is, simply, morally shallow. Who with a palpable heartbeat and minimal sensibilities will go to the mat for the right of somebody to earn a profit for its own sake? If no greater purpose can be discerned or justified, business cannot morally justify its existence. It’s a repugnant idea, an idea whose time has gone.

“Finally, it’s an empty idea. Profits can be made in lots of devious and transient ways. For people of affairs, a statement of purpose should provide guidance to the management of their affairs. To say that they should attract and hold customers forces facing the necessity of figuring out what people really want and value, and then catering to those wants and values. It provides specific guidance and has moral merit.”[ii]

Having a stated strategy of “Earnings per share of $20 by 2015” is a bit like a football coach saying that his goal is to score 20 points in a game.  That isn’t the objective – winning the Super Bowl is.  You get to the Super Bowl by winning games over a long season.  And you win games by building talent, innovating in game plans, executing well, reacting to the situation on the field.  In general, being better than your competition. You don’t even know if 20 points is going to be enough to win games until you see the nature of your competition.

Real world example – on May 12, 2010, Sam Palmisano outlined IBM’s strategy for reporters:

IBM CEO Sam Palmisano doesn’t talk publicly all that often, but when he brings a little heat. Palmisano said the company will deliver earnings of at least $20 a share in 2015 and generate $100 billion in cash flow between now and then. IBM will also spend $20 billion on its acquisitions between 2011 and 2015. He also mocked the fashionable view that consumer technology will dominate the enterprise.[iii]

Four and a half years later, his successor, Ginny Rometty, abandoned those goals.

With falling revenue, Rometty tried to grow profits to keep that $20 EPS promise by trimming expenses and laying off workers. She sold business units. IBM even agreed to pay GlobalFoundaries $1.5 billion to take its money-losing microchip business off its hands. 

IBM tripled its debt to buy back billions of dollars of its own shares, at one point, spending $8.2 billion in a single quarter on repurchases. (Since 2000, IBM has spent $108 billion buying back shares, $12 billion of that in the first half of this year.) This to reduce the number of shares and make that $20 EPS goal. 

Ultimately, none of it worked.

So on Monday [October 20, 2014], Rometty and CFO Martin Schroeter had to tell Wall Street that they would not hit the target.

“Given our third-quarter performance, the actions we’re taking and with only 15 months till the end of 2015, we no longer expect to deliver $20 operating earnings per share in 2015,” Schroeter said on the quarterly conference call.

Rometty doesn’t usually join these quarterly calls, but she did on Monday because of this news, and the unusual agreement IBM made with GlobalFoundaries.

A huge IBM selloff followed the news, and the shares dropped 7% in heavy volume. Some analysts on the call then questioned if IBM was in a “crises.”

But here’s the thing.

This could really be good news for IBM and Rometty. She’s no longer jumping through hoops to meet an arbitrary EPS number selected by the previous CEO from a tactic that made sense in 2007.

She is now free to run this company, and implement her own ideas and strategy to start growing revenue, such as the agreement with Apple.

She may still fail. But she didn’t really have a chance until now.[iv]

What gets measured gets made, goes the saying.  Here, chasing the “arbitrary EPS number” led to the loss of thousands of jobs, share buybacks, ballooning debt, jettisoned businesses – all to make the number.  These actions did nothing to create and keep customers, nothing to create value.  As of this writing (September 2015), IBM has reported 11 consecutive quarters of declining revenue.

Like a football team, a successful company needs to build talent, innovate in offerings and business model, plan strategically, execute well, and react to the situation in the marketplace.  In general, be better than the competition.

Unlike a football team, there is no “Super Bowl” in business.  There is no finish line.  (Well, there is, but crossing it isn’t called “winning”. See Figure 1.)  Companies must plan for the long term, over several “horizons”, to create and capture real customer value.

Financial metrics are the score, and will reflect the success of your strategic decisions over time.

[i] Levitt, T. (1983). “The Marketing Imagination”. Simon and Schuster. Pg. 6.

[ii] Ibid.

[iii] http://www.zdnet.com/article/palmisano-outlines-ibms-2015-roadmap-earnings-to-double-consumerization-mocked/

[iv] http://www.businessinsider.com/ibm-gives-up-on-its-2015-promise-2014-10