TOP ARTICLES: Capitalism’s Future Is Already Here

by Steve Denning | 10:00 AM September 10, 2014

On September 13, 1970, The New York Times published an article by Milton Friedman castigating any managers of businesses who were “spending someone else’s money for a general social interest” – in other words, requiring customers to pay more, employees to be paid less, or owners to accept smaller profits so that the firm could exhibit some amount of social responsibility beyond the requirements of the law. Already, in his 1962 book Capitalism and Freedom Friedman had declared that “there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Choices about whether and how to use money to remedy social problems should be left to individuals, he argued, who would be in better position to provide it if they were not being in effect taxed by corporate managers who thought they had better ideas for how to spend it.

The article shocked the sensibilities of many who worried about rising corporate power in the world, but for many executives struggling to chart courses through the chaos of newly globalized and deregulated markets, it offered an irresistible clarity: one need only focus on owners’ interests. In 1976, Professors Meckling and Jensen put a finer point on things with their economic rationale for maximizing shareholder value. Ronald Reagan and Margaret Thatcher gave the idea political cover. Very quickly, shareholder value became the gospel of capitalism.

The tight focus on generating returns drove many gains. It hurried along the formation of global supply chains with ever greater efficiency and economies of scale. As more firms became multinationals, fewer showed loyalty to particular communities or any hesitation to migrate their operations to wherever costs were lowest. Employees were viewed more as fungible inputs to operations, and customers viewed more as targets within more and less lucrative segments.

Yet it also began to be evident that, even if the goal was to serve the interests of a single stakeholder, the pursuit could not be so single-minded. Incentives to maximize shareholder value pushed managers toward decisions that paid off in the short term but were devastating to the long term viability of firms. As I’ve explored elsewhere, pervasive short-termism hampered the United States’ capacity to compete in international markets; encouraged a massive trend of offshoring that destroyed major segments of the US economy; generated “bad profits” that undermined customer loyalty; “financialized” the economy, making it vulnerable to increasingly severe financial crashes; undermined economic recoveries; and drastically reduced rates of return on assets and on invested capital of US firms.

These problems hardly arose overnight; they began brewing early. However, it was after the advent of the internet that the challenges to the shareholder value maximization became forceful. This is because the internet …

Shifted power in the marketplace from seller to buyer. Customers, who had access to reliable information about the available choices and a capacity to interact with other customers, were suddenly in charge.
Raised customers’ expectations. As “better, cheaper, faster, smaller, more convenient, and more personalized” became the new norm, the ability to innovate with committed employees and agile processes became critical.
Shredded vertical supply chains. Customers could buy a wider array of stuff online cheaper, and often quicker, than in a physical store. First books and music, then almost anything.
Spawned vast new horizontal value chains, in which millions of people began creating their own virtual meeting places and marketplaces with their own lateral economies of scale. First computer code, then ideas, then music, photos, and videos – and finally, physical things.
Enabled firms to create huge ecosystems of suppliers and customers that could achieve enormous scale without the sclerosis of big hierarchical bureaucracy.

As a result, a new era is emerging. Harking back to Peter Drucker’s insistence in 1973 that “there is only one valid definition of business purpose: to create a customer,” Roger Martin has declared that we are finally entering “the age of customer capitalism.” If firms serve customers well, Martin asserts, benefits for shareholders and the community follow. Customers as stakeholders become the new center of the capitalist universe and its new gospel.

The shift in goal entails a transformation in management practices from those of hierarchical bureaucracy, including a shift from controlling individuals to enabling teams, networks, and ecosystems; a shift in the way work is coordinated from rules, plans, and reports to agile processes and dynamic linking; a shift from the values of efficiency and predictability to those of continuous improvement and transparency; and a shift from one-way, top-down communications to interactive conversations. These shifts are not just a grab-bag of unconnected management gadgets. They constitute a coherent constellation of leadership and management practices, as described by more than a score of books.

The confusing reality of the moment, however, is that there are (at least) two different systems, operating simultaneously, at different speeds and on different trajectories.

One—the Traditional Economy—is the economy that we inherited from the 20th Century. It’s a world of command and control, focused on making money through economies of scale and comprising big hierarchical bureaucracies that push out products and services and get customers to buy them with sales campaigns and advertising. This is still the larger of the two economies. It’s been in steady decline for a number of decades. It doesn’t generate net new jobs. It’s not very agile. It’s becoming steadily more efficient. But it’s not good at innovation. It’s less and less able to capture the gains of its efficiencies. It’s still a big part of what’s going on in the world. But it doesn’t have much of a future.

The other economy—the Creative Economy—is an economy of continuous innovation and transformation. This is the economy of firms and entrepreneurs that are delivering to customers what they are coming to expect, namely, “better, faster, cheaper, smaller, lighter, more convenient, and more personalized.” The Creative Economy is still relatively small but it is growing rapidly and, when implemented well, is highly profitable. It is the economy of the future. It doesn’t have to be invented: it’s already under way. Its practices represent a paradigm shift in the strict sense laid down by Thomas Kuhn: it’s a different way of thinking, speaking, and acting in the world.

The shift from the Traditional Economy to the Creative Economy isn’t just a technical wrangle about economics or management theory. It’s a shift in what society demands of the managers of its most powerful institutions: from narrow definitions of their owners and decisions that serve their short-term interests, to broad acceptance of the responsibility that comes with power and leadership concerned with what is best for society. In the shift, we are learning that an argument about the proper activities of managers can be logical, can be strongly argued, can influence decades of practice in the world’s largest corporations – and can still be plain, flat, dead wrong.

This post is part of a series of perspectives by leading thinkers participating in the Sixth Annual Global Drucker Forum, November 13-14 in Vienna. For more information, see the conference homepage.