Never measure a 3D world with a flat ruler
1970 was a difficult year for humanity.
The Vietnam War was in full swing.
The Bhola cyclone struck Pakistan and India in November, killing over 150,000 people.
But on September 13, 1970, something happened that didn’t take any lives but had devastating long-term consequences.
That day, American economist Milton Friedman dropped a ticking time “bomb” of sorts. He published the article in the New York Times called ‘The Social Responsibility Of Business Is to Increase Its Profits.’
In the article, Friedman proclaimed the shareholder primacy approach. He affirmed that shareholders were the sole group to which the organization is socially responsible, making profit maximization the firm’s primary goal.
Beware of those who see people as sheets, charts, and diagrams.
Around the same time, another prominent American voiced an idea that was misinterpreted. However, when combined with Friedman’s concepts, it amplified their destructive impact.
The failure of the year
2024 hasn’t ended yet, but I believe we already know what the world’s biggest business failure of the year is.
Financial Times reports in its article about Boeing:
“The company that virtually created modern commercial aviation has spent the better part of five years in chaos, stemming from fatal crashes, a worldwide grounding, a guilty plea to a criminal charge, a pandemic that halted global air travel, a piece breaking off a plane in mid-flight and now a strike. Boeing’s finances look increasingly fragile and its reputation has been battered.”
In an effort to uncover the root causes, Financial Times delves into the company’s history:
“Phil Condit and Harry Stonecipher, who ran Boeing in the late 1990s and early 2000s, were admirers of Jack Welch, the General Electric chief executive known for financial engineering and ruthless cost cuts.
Condit even moved Boeing’s headquarters from its manufacturing base in Seattle to Chicago in 2001, so the “corporate centre” would no longer be “drawn into day-to-day business operations”. Jim McNerney, [CEO of Boeing 2005 to 2015], another Welch acolyte, instituted a programme to boost Boeing’s profits by squeezing its suppliers during his decade in charge. He remarked on a 2014 earnings call about employees “cowering” before him, a dark quip still cited a decade later to explain Boeing’s tense relationship with its workers.”
Jack Welch, who inspired Boeing leaders, was a big fan of Friedman’s ideas. He believed that shareholder value was the only idea managers should wake up and go to bed with.
However, his approach pays off today but hits hard later. It destroyed General Electric and caused many executives to make fatal mistakes.
Proclaiming a single idea as a vital principle is like seeing the world as a 2D picture.
Why do the world’s most powerful CEOs believe in shareholder value so much?
Numbers junkies
A quote attributed to another famous American, W. Edwards Deming, when mixed with Friedman’s ideas, created a Molotov cocktail that has blown up many businesses.
This quote is, “If you can’t measure it, you can’t manage it.” Deming followers insist he didn’t say, or at least didn’t mean it. They even claim that Deming put the idea of running a company on visible figures alone on his Seven Deadly Diseases of Western Management list.
But the quote lives its own life and has become enormously popular. We shouldn’t be surprised by that, given that most American CEOs have a business, finance, or engineering background.
Picture source
When the two ideas met, the world became much simpler for executives:
- Manage what you can measure
- Increase shareholder value, forget about everything else
- Ignore everything you can’t measure
Every time you encounter a bad product, remember — the company’s CEO has read Jack Welch’s books.
Running a company on visible figures alone is like raising kids based just on their school grades.
Jim McNerney, who was proud that employees were “cowering” before him, wasn’t an arrogant villain. He sincerely believed they were just assets, something he had to squeeze the most out of.
Their emotions were immeasurable. Payroll was.
Such worldviews are not only inappropriate and unethical, but they also destroy long-term value for the company. So, they are also impractical.
Invisible business value
We love to squeeze our nonlinear, complex world into linear scales, formulas, and charts. The question is, what data do we lose along the way?
A business creates value for customers and captures value from them. The value created isn’t measurable. The value captured is measured in money.
The business also exchanges value with employees and business partners. Some aspects of this exchange are measurable, but most aren’t.
From an economist’s point of view, it may look like this picture:
A company’s Profit = potential profit – missed profit.
Missed profit = created value – captured value. A company can’t capture more value from customers than it creates for them, but sometimes it captures less value than it creates, for instance, if its products are underpriced.
Wastage = any losses associated with operational inefficiency.
Effective costs = value created for employees, suppliers, and other partners by paying for labor, supplies, etc.
In economic theory, the value created for employees and suppliers is equivalent to the value captured from them.
And this is what happens in real life:
A company can gain additional value from customers, partners, and employees, but it’s immeasurable. How do you measure employee enthusiasm and creativity, genuine customer loyalty, or the selfless support of suppliers?
You won’t find this additional value in a P&L statement or balance sheet, but it doesn’t mean it doesn’t exist.
To capture this additional value, you need to create extra value in the form of attention. You won’t reflect it in managerial accounting either, but it’s incredibly important.
Boeing’s former CEOs believed they should receive more value from employees and suppliers than they gave. Today, the company pays a very high price for their convictions.
Our world is a vast marketplace of value where there are two unwavering rules:
- You can never receive more than you give for long
- You should always give first
Focus on pleasurable, not measurable
It is easier to manage what we can measure. But it doesn’t mean we shouldn’t manage immeasurable.
In our urge to measure a 3D world with a flat ruler, we’ve created surrogates like “customer satisfaction” or “employee engagement.”
But these metrics tell us little about those real people’s thoughts and feelings.
Can we measure customer pleasure? Employee creativity?
A few good talks with customers and employees are worth dozens of metrics. All top executives should spend at least 10% of their time talking to customers and 70% talking to employees.
Never rely solely on numbers when it comes to people.
You can’t measure them with a flat ruler.
Svyatoslav Biryulin
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