For want of profitability

Pick out the major stories in the business world since the dot-com bubble burst: scandals, layoffs, offshoring, more scandals. All of these are predictable outcomes of a flawed mentality of business. The focus on short-term shareholder value creates incentives for companies and executives to do whatever is necessary to maintain the profit line for this quarter, or fiscal year, and to mortgage the future to keep the stock price up.

Let's consider the short-sighted activities that companies engage in to meet quarterly goals. Profit appears to be the primary metric used to judge the company's achievement, which creates two possible paths to success -- increase revenue or decrease expenses. Creating additional revenue is a less than certain endeavor, because it's based on a lot of outside sources. If you're having a tough quarter, there's a fairly good chance your customers are too (otherwise they'd be buying more of your product). Not only that, but you will likely face increased competition as everyone in the industry scrambles for any dollars left on the table. The obvious answer is to look to cut expenses.

In my limited experience, the first things to go are employee development programs: education, tuition reimbursement, etc. There are two deleterious effects from cutting development. First, you are reducing the skill growth of your employees, which may hurt you in future years, as the industry changes and new skills are needed to compete. Second, and perhaps more damaging, you are creating negative feelings in your best employees. These employees are likely the ones who desire to enrich themselves through education. They are also the employees you least want to lose. Driving away your best employees obviously is going to have a negative impact on performance at some point. If you're lucky, it may just be having to pay more to keep these employees from jumping to another company. If you're not so lucky, you're going to be stuck with a bunch of low performing employees.

I've also heard of examples where companies have cut travel that wasn't projected to lead to immediate revenue. That means that any sales calls or marketing efforts requiring travel were stopped unless the results were going to be realized within 90 days or less. While this is a much more extreme measure, and consequently much less frequently used, its downside is much more obvious and much larger. Is the effect on future revenue really worth the savings that cutting travel costs will bring?

Now let's turn our attention to the executives and the conflict of interest many are faced with. As anyone the least bit familiar with the tech industry in the late 90s knows, stock options are a very common component of compensation for executives. The rationale behind stock options is mostly solid -- it ties compensation to results -- requiring the executive to be more concerned about his or her decisions. This can go too far, however. Options reward stock price growth rather than company growth. And stock prices all too often don't accurately measure a company's long term value. The day-to-day, or month-to-month fluctuations in stock price are driven more by the latest earnings results (or even the projected results) than a full understanding of a company's future possibilities. The fact that earnings results are so influential creates a great deal of pressure for executives to guarantee those earnings are as high as possible, which in turn encourages behavior ranging from short-sighted (see above) to illegal (see Enron, MCI, etc).

So what can be done to rectify the situation? Recent legislation, including the Sarbanes-Oxley Act, takes some steps -- increasing independent oversight from the Board of Directors among them. However, the root of the problem is outlook, not enforcement. Creating an environment where profits are valued above all else and shareholders are more important than any other stakeholders leads to the decisions described above. The focus for a company should be on long-term revenue growth and should take the views of all stakeholders into account -- employees are too often neglected. The balance of power from the employee to the employer shifted from one extreme to the other as the bubble burst, and it needs to return to an equilibrium. An environment where employees feel appreciated and aren't always looking over their shoulder is an environment more conducive to productivity and profit. That day will not come until companies and executives are rewarded for real growth rather than imagined profitability.