The 3-Body Problem: Big Business Can’t Serve Both Customers And The Financial Sector.
In Newtonian physics, if there are two bodies that interact gravitationally, and an observer knows their positions and velocities at a given point in time, it is possible to predict all their future positions. However, the introduction of a third body surprisingly leads to an analytically unsolvable problem. This suggests that if there is a system of two bodies that are unsettled with respect to one another, there may be a hidden third body lurking around that, if identified and understood, could help us make better sense of the system as a whole. This metaphor of the three-body problem (which I borrowed from Henrik Berglund) can help illuminate a nagging problem in the economics of business.
Business exists to generate value for customers. This buyer-seller, user-maker, demand-supply 2-body relationship has been established in economics and business from the earliest days of both disciplines. Today, sophisticated analysis of economic systems and markets and the emerging new structures and arrangements of the digital world serve to emphasize more than ever what Steve Denning refers to as Customer Capitalism and Customer Primacy. As the digital age of business has evolved, there is an ever-greater shift of balance in the two-body system of business and customers to the latter. The power of search and knowledge and universal connectivity and ranking systems and all the other digital developments we have come to utilize for identifying and comparing choices have cumulatively empowered the customer and created winning businesses out of those who are most cognizant of and responsive to the changing balance of power. The most recent business organization innovation to emerge from China, Rendanheyi, calls for zero-distance to the customer – bringing the customer inside the firm for co-creation of value, shared engagement in service models and the development of new value scenarios.
Over time, the customer is becoming more and more influential in how business is done.
Except, that is, in the largest of corporations, the ones that are quoted on the most significant stock markets and are included in indexes like the S&P 500. These corporations practice something other than customer capitalism, with a different rule-book than customer primacy. There are several overlapping models.
Shareholder Value Maximization
The concept of maximizing shareholder value via total shareholder returns (stock price appreciation plus stock dividend payments) is often attributed to Milton Friedman of the Chicago Schol Of Economics and his 1970 essay in The New York Times titled The Social Responsiblity of Business is To Increase its Profits. Friedman’s position was a little more nuanced than his detractors allow, since he stressed legal and ethical norms and the expectations of society. Nevertheless, the Wall Street crowd who profess to pass judgment on the performance of corporate Boards and CEO’s habitually use total shareholder returns as their benchmark metric. Whatever else this is, it’s not customer primacy. If, for example, corporate resources are used for stock buybacks in order to better assure stockholders of their short term valuation gains, then these investment resources are not being used for building and combination of capital assets that will assure future perofrmance, nor are they being invested in innovations to further improve customer value. Shareholder value maximization puts shareholders and investors first, not customers.
A slightly modified version of shareholder value maximization is the concept of stakeholder return, whereby the corporation is advised that they will be judged by their contributions not to customer value and customer well-being, but to a much wider range of claimants. These may include employees and unions, the members of the community in which the corporation’s offices or plants are located, the government, the environment, the planet, the global poor, religious groups, or any selection from a wide range of constituent parties that stakeholder activists assert have a claim on corporate resources.
Many corporations claim to adopt this so-called stakeholder capitalism, but in reality, it’s just a PR stunt, a public front of social sensitivity and purported altruism. There is no substance behind it, although there is a herd of consultant companies who emerge from the swamp to join the feeding frenzy of advising corporate clients on how to maximize stakeholder returns (and escape the censorship and lawsuits of activists and governments).
Business has suffered a PR crisis, caused in large part by shareholder value maximization, which was perceived as favoring a few plutocrats over the broader mission of business to improve lives of customers and thereby improve society. The purpose of a firm is to satisfy the needs and wants of customers. If they do so successfully, then society, as well as the lives of individuals, are improved.
ESG, DEI and Other TLA’s.
Overlapping the stakeholder capitalism movement, and perhaps embedded in it, are the assertions of additional claimants on corporate resources. ESG asserts the primacy of claims concerning so-called sustainability, expressed in Environmental, Social and Governance concerns. DEI (Diversity, Equity, And Inclusion) asserts the claims of almost everyone on corporate resources: according to dei.extensio.org at Tuskegee University, individuals of diverse race, gender, religion, sexual orientation, ethnicity, nationality, socioeconomic status, language, (dis)ability, age, religious commitment or political perspective must not be under-represented. And that’s just the D in DEI.
There are more TLA’s (three-letter acronyms) to choose from, including CSR (corporate social responsibility), NZC (net zero carbon), and even IMP (integrity in management practices). There is an explosion of claims on corporate spending, corporate staffing and corporate resources in general from all over the parts of society that seek to benefit from the production of others, rather than produce for themselves.
The Third Body: The Financial Sector.
Why does financial sector growth crowd out real economic growth? That’s the title of a paper published by the Bank For International Settlements (the central bankers’ central bank) in 2015. It noted that growth in the financial sector of an economy reduces total growth – a fast-growing financial sector is a drag on total growth. The financial sector grows at the expense of the real economy, and financial growth disproportionately harms R&D intensive industries, i.e. those investing in future innovations. One of the reasons given in the paper is that skilled labor (all those graduates who take jobs at Goldman Sachs and JPMorgan) is attracted to the financial sector at the expense of other sectors like computing and transportation and health care.
But another reason surely is that financially-dependent industries (a term from the paper signifying those industries that depend on help from the financial sector with borrowing, debt issuance, M&A and other financial transactions) must accept the constraints the financial sector applies alongside their expert assistance. A perfect example of this phenomenon is found in the shenanigans of Larry Fink. He is the CEO of BlackRock, a financial asset manager with 10 trillion US dollars under management and 20 billion dollars in annual revenues. BlackRock is usually one of the top 3 institutional investors for every large company in the US, and therefore has the ear of the CEOs. He regularly writes threatening letters to those CEOs to press them into Fink-approved ESG and CSR activities and investments (and divestments). It’s an unveiled threat that BlackRock can take actions that will be detrimental to the stock values of those CEOs’ companies.
Fink is a large mountain on the big planet that is the third body in our Newtonian metaphor – the one that unsettles the behavior of the original two bodies towards each other. Left to their own devices, corporations would compete to succeed in serving customers’ needs better with valued services and value-enhancing innovations. The intervention of the third body diverts them.
As the financial sector gets bigger and bigger, it will distort the customer-oriented behavior of the largest corporations more and more. That’s why the future of business lies with the SME sector and the new evolution of networked decentralized production.