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Finding your purpose in business

Most Kiwis aren’t desperate to get rich. Even our entrepreneurs are happy with a boat, a bach and a beamer. Rejoice in their happiness: Mike Booker discovers our small business shouldn’t be bullied into growing, and James Hurman thinks growth is the wrong target anyway. Plus: will our SMEs save us?

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Photograph: Tranz / Corbis

Most Kiwis aren’t desperate to get rich. Even our entrepreneurs are happy with a boat, a bach and a beamer. Rejoice in their happiness: Mike Booker discovers our small business shouldn’t be the wrong target anyway

Rejoice in their happiness

Economic theory, and popular belief, would have it that businesses are money-grubbing (or in economic speak, wealth-maximising) opportunists. Theory and belief are both wrong, however, at least in the case of small to medium sized enterprises (SMEs) which, depending on your definition, represent around 96 percent of the Kiwi commercial landscape.

“Nine out of ten of these SMEs just want to be happy and see chasing an extra dollar by growing their business as getting in the way of that pursuit,” says Waikato University finance academic Ed Vos. They expand to a self-imposed plateau along which they then contentedly trundle in their BMWs, taking holidays in their baches and making waves in their boats.

Cynics call this the ‘three Bs’. Vos has a simple explanation why this is so—SME owners want peace. They shun any growth other than what they can fund themselves. Even those with spare cash will use it to repay debt rather than expand, preferring to stick to business as usual. Growth, made possible by taking on outside debt, is seen as a threat to their contentment, control and independence.

Conventional wisdom is that businesses persist with organic growth, tapping their own financial resources, because it’s easier than the alternative. Hence one focus of agencies funded to encourage business growth is lowering barriers to taking on external debt. This, Vos says, presupposes that SMEs want growth, that they suffer from a lack of funding and that the desire for greater wealth drives their business decisions. He’s not buying it.

“In reality,” he says, “the underlying primary motivation for SMEs managing their capital structure is to seek peace or happiness.”

These claims are based on studies by Vos and fellow researchers looking at SME long-term debt, ownership and retained earnings (their capital structures) to understand their behaviour. They found that something funny happens to the relationship between risk and return in SMEs: it seems low risk may mean high returns.

Vos is outspoken about what this means. To start with, he says, our SMEs should be left alone—for example, not badgered into aggressive growth plans (and debt)—and the country should rejoice in their happiness.

The first piece of evidence for his “contentment hypothesis” is a survey with colleague Yi Shen of 626 independent, private New Zealand companies with fewer than 200 employees and assets of less than $25 million. Their working paper, The Happy Story Told by Small Business Capital Structure, examines the capital structures of the surveyed companies.

These companies showed “substantial financial contentment”, they say, and there was little evidence of a restless search for investment to grow. “These findings describe a capital structure theory [that] is not a byproduct of the wealth maximisation imperative, but rather a window, or a reflection, of peace-seeking financial behaviour.” Peace and profits.

“The fact that New Zealand is a country of SMEs warms my heart,” says Vos. He believes the burden of expectation placed on SMEs to grow comes from the mistaken belief that small independent businesses should behave like listed companies.

“In listed companies shareholders and managers are separate, and the only reason that shareholders pool their resources to give to managers is to maximise wealth.” Vos has no problem with this model for listed companies, but says SMEs should not be treated as “financial clones” of their NZX, ASX, or whatever, counterparts. In the more connected world of SMEs, where the owner and shareholder are usually one and the same, a different set of business drivers should be expected.

“In a listed company, a manager is looking for more growth because more growth equals more money. But if I’m in charge of a small business, I have to manage that growth—it’s drama, drama.”

The drive to maximise wealth as an explanation for economic and business behaviour dates back to the godfather of market economics, Adam Smith. Smith recognised that all humans want to be happy and believed we’d all be happier if we were wealthier. He said an individual’s self-interested struggle to become wealthier increased, through an “invisible hand”, everyone’s wealth and happiness. Whether wealth has been maximised, or not, has become a standard economic test.

Vos is not happy with economists using wealth maximisation as the default explanation for the way SMEs organise their finances. He says that although the model fits publicly-listed companies, SMEs need to be treated differently because of their small size and the different motivations of their owners. While listed companies, like SMEs, have a predilection for low debt, the reasons for this are different. Listed companies are usually seeking financial flexibility and lower costs while SMEs want “independence, control and contentment”.

Once SME owners get their boat, they are not interested in rocking it by taking on debt to grow their business and maximise their wealth. SME owners’ connectedness with their businesses means they are not driving for more money. “Money is a means to an end, not the end itself.”

A Massey University survey found similar sentiments among SMEs. It was not growth at any cost. “Many of the respondents in this (Massey) study placed the need for stability and quality of life before firm growth,” the survey says. Owners put limits on their growth, such as total staff numbers, instead focusing on intangibles such as the freedom to spend time with their family when they wanted.

Vos doesn’t see getting richer or being happier as an either/or option. “I see it more as a ranking. Top priority is happiness, next is wealth, and so on.”

Organic growth

It’s a well-known fact that small businesses prefer to use their own financial resources to organically fund growth. Where Vos departs from the accepted analysis is in his explanation of why this is the case. The established view is that businesses prefer organic growth because alternative sources of funding are just too hard.

However, Vos reckons it’s more likely they stick to their own financial resources because, once again, they want independence, control, and to stay happy.

Where they can, SMEs reduce debt. This is the case even when they can handle more debt because they have spare cash and the security of fixed assets. Nor does it change as size, fixed asset levels, profit levels, or net profit per owner change. As the business ages, owners continue to reduce debt, building up enough financial resources only to fund the ongoing business and move it toward financial safety. And the few businesses that want to grow by using outside funds do get the money they need.

Business surveys support Vos’ claim that businesses are not financially frustrated. Statistics New Zealand’s 2004 Business Finance Survey of companies with between one and 500 employees found 85 percent of respondents didn’t apply for debt financing (such as bank overdrafts and loans) because they didn’t need to. The next most likely reason for not trotting off to the bank was that business owners didn’t like to be in debt.

In the 2007 PricewaterhouseCoopers Clever Companies/EMA Survey, access to and costs of capital ranked 12th of 14 issues seen as growth barriers, well behind increased operating costs, government regulations and increased competition. And a New Zealand Trade and Enterprise survey last year of factors that made exporters successful showed businesses had a form of “cognitive dissonance” when it came to thinking about capital. Most complained about a lack of resources for funding, but also showed little interest in getting more capital to fund growth.

Vos says a capital structure lifecycle for SMEs has emerged from his research. “As SMEs grow, they do not increase debt levels, even with adequate financial choices to do so.”

UK and US also happy

This type of behaviour is not peculiar to New Zealand SMEs. Vos, in research co-authored last year with economists from the New Zealand Reserve Bank and two British Universities in the Journal of Banking and Finance, found that fewer than ten percent of SMEs in the United Kingdom sought significant growth and only 1.3 percent of American SMEs listed a shortage of capital as a problem. He believes similar numbers apply in New Zealand. The authors suggest traditional risk-return models used to explain SME financing need to be rethought.

Vos is now investigating how two as yet unconnected findings connect. Firstly, SMEs choose to cut debt when and where they can to reduce risk and forgo opportunities to grow and maximise their wealth. Secondly, his research shows shows there’s a link between a high level of working involvement by an owner in their business and high profitability. “It seems true that lower risk is related to higher returns.” He hypothesises that the owner actually increases returns by being more connected to the business.

If a substantial number of businesses are putting limits on their wealth accumulation, where does that leave everyone else? If you believe Adam Smith, are we poorer overall because business owners have usurped wealth maximisation for maximising their own happiness? But Vos asks what does ‘poor’ mean? “If it means we take more drugs for depression, then could it be argued that America is poorer today than it was, despite its increased wealth? Does the society get richer when it is more happy, peaceful, content, or does wealth bring happiness? The science of happiness says that—beyond a point—wealth is not related to happiness, but connections are, relationships are.”

In a country where we pretty much know everyone—or a least their good-looking sister—that just might make us the richest folk in the world.

The paradox of growth

Recently, I watched a focus group huddled around a medley of gluten-free snacks in a small dark room while they debated the merits of the latest hyper-generic consumer good. Subject to the approval of these eight mothers, chosen not for their insight or judgement but rather their unmitigated averageness, this good would soon be launched onto the market amid a colourful fuss of promotion.

In an effort to forgive the gaping crevasse between the product’s modest worth and the price the manufacturer was intending to ask, one of the mothers spoke pragmatically. “Well they are a business,” she said, “and they do need to make a profit.” The group ruminated for a moment before letting out a hum of agreement and nodding in tacit submission.

Her comment, and the reaction of her contemporaries, was a show of both how savvy, and how disillusioned, we’ve become.

Most consumers know well that any business’ principal ambition is to turn a profit. We accept that the relentless pursuit of bottom-line growth is in the spirit of the free market and part of a healthy economy.

But the necessary consequence is the knowledge that, despite what the rhetoric of marketing might have us believe, our needs as consumers and as communities come a firm second to those of shareholders. Corners are cut on the products we consume, and environmentally and socially unfriendly practices are unconcernedly adopted by the businesses we patronise. It’s not because the people who control them are inherently corrupt, but because the mandate under which they operate is singular: grow profits.

As evidenced by more people buying more things than ever before, most of us accept that our needs come second just as compliantly as the mothers in the focus group did. But, over time, our disillusionment is turning to cynicism. A hallmark trend of this decade has been elevating consumer suspicion of the motives of the corporate community. America’s Yankelovich Research, which has been studying consumer attitudes since the 1950s, periodically asks the question, “Can you trust business people to do the right thing, most or all of the time?” In the early 1990s, the majority of people said they did trust businesses to do the right thing. In 2002, only 36 percent of people said yes. By 2004, it had dropped to 31 percent, then by 2006 to 28 percent.

We can hypothesise the catalysts—the Internet having given consumer watchdogs louder barks, the collapse of Enron, the association of corporate agendas with the wrongdoings of the Bush administration, or Al Gore’s persuasive presentation on the effects of capitalist ambition on the environment.

But we can’t duck the reality that in many cases, the winners in the free market plainly subtract from the world more than they add.

The three most profitable companies globally, according to the 2007 Fortune Global 500, were oil giants ExxonMobil, Royal Dutch Shell and BP. Held up as the Olympic medallists of the business world, they respectively made US$38 billion, $25 billion and $22 billion in pure profit, while the rest of us struggled to afford soaring fuel prices, bemoaned dwindling forecourt service and wondered whether there’d be anything left for our children.

No matter how unwilling we are to engage in an ethical debate about capitalism, it’s difficult not to acknowledge the inequity of the oil situation. And although I’ve used the most dramatic example available, it’s that same singular quest for profit growth that guides decision-making in all but the most unusual of business organisations. It’s what leads businesses to make decisions that compromise the trust consumers have in them, and consequently it’s turning more and more of us into discontented voices.

But so what? The anti-capitalist intellectual left deplores the ethical injustices of the free market and hopes the world will recalibrate itself in line with its own philosophical leanings. Is anti-corporate sentiment, even from consumers, anything more than empty idealism? Are there any real consequences on the horizon or will it be business as usual no matter how far trust drops?

Edelman, the world’s largest independent public relations firm, tracks levels of trust in the business community. It speaks to people it terms ‘opinion elites’ from around the world—educated, high-income individuals who report a significant engagement with the media.

This year, the Edelman Trust Barometer found that cynicism toward companies was prompting action among opinion elites. Eighty-five percent said they’d refuse to buy from a company they distrust, 78 percent said they’d share a negative opinion of companies they distrusted with others, and 65 percent said they’d support legislation controlling or limiting the activities of those companies.

An extrapolation of the study’s findings might reveal a world in which businesses that weren’t trusted struggled to maintain their customer base, find investors and escape legislative pressure. A world in which their brands and advertising floundered within a context of widespread negative word of mouth.

Perhaps that’s a sensationalist prediction. What’s less disputable is that companies that command a high degree of trust and goodwill from their customers will have a much easier time growing than those who don’t.

It’s a notion that hasn’t been lost on the business community. For years, armies of management consultants have advocated practices that seek to engender goodwill from consumers. Customer-centricity has been accepted as beneficial ever since the archaic days of adages like ‘The customer is always right’. And in the 90s, the authors of the seminal management bestseller Built to Last introduced widely-lauded ideas like the ‘Values Based Organisation’, which puts a set of authentic and benevolent principles at the heart of all decision making. More recently, having a corporate social responsibility strategy and a plan for reducing environmental impact have become the workstreams du jour.

It’s the elephant that’s ignored by all of us daily. We sincerely proclaim our values to our staff and our customers and then sell them out as soon as they become inconvenient. Which, unfortunately, is often

These ideas are all unequivocally good and well-meaning. Yet their efficacy remains undermined for a disarmingly simple reason. As long as profit growth is the single most important objective of an organisation, customer-centricity, organisational values, social responsibility and environmental impact will always be compromised when a dissonant way to increase profit presents itself.

It’s the elephant that’s ignored by all of us daily. We sincerely proclaim our values to our staff and our customers and then sell them out as soon as they become inconvenient. Which, unfortunately, is often.

We’re effectively saying, “Look, our intention is to grow sustainably, to live by our values, to serve our customers well and to be socially and environmentally responsible. And wherever possible, we’ll act that way. But we’re still a business, and the purpose of a business is to grow. So if there are opportunities to grow unsustainably, forgive us, because we’ll be taking them.”

It’s that dissonance that breeds distrust in consumers. When ExxonMobil says on its website “We are committed to meeting the world’s growing demand for energy in an economically, environmentally and socially responsible manner,” then engages in blatant global warming denialism and price-gouging to become the world’s most absurdly rich company, it’s only reasonable to expect people to dismiss the hype.

In the last decade, companies have spent more of their communication budgets than ever before on communicating their good intentions, especially in the arenas of social and environmental responsibility. You would expect, given such an increase in messaging, that consumer trust would have risen. But Yankelovich’s figures suggest that consumer trust in companies is inversely proportionate to the amount of money companies spend on trying to appear trustworthy.

What’s clear is that intending to do good by consumers and communities doesn’t count for anything if, at moments of truth, your actions are contrary to those intentions.

And, while profit growth remains the single most important objective of business, we’ll be continually incentivised to break with our good intentions.

And, as long as we do, we’ll sacrifice consumer goodwill, thereby struggling to maintain a relationship with those consumers that’s conducive to growth.

Which is something of a Catch-22. A kind of emerging free-market paradox. It seems that being desperate to grow should be detrimental to doing so.

There are, in my observation, two sorts of companies. There are the conventional ones which mandate getting bigger, then set about figuring out ways, positive or otherwise, to achieve that. And then there are an inspirational few that appear to be more concerned with getting better, comfortable that if they do, growth will follow.

Consider Google’s commitment to the betterment of the Internet. “While many companies claim to put their customers first,” says Google, “few are able to resist the temptation to make small sacrifices to increase shareholder value. Google has steadfastly refused to make any change that does not offer a benefit to the users who come to the site.” It’s that mentality that led to a dramatically better search algorithm, to encouraging all engineers to spend 20 percent of their work time on projects that interest them (which has subsequently led to over half of Google’s innovations including Gmail, Google News and AdSense), and to revolutions like Google Earth. Google’s philosophy, ‘never settle for the best’ and unofficial slogan, ‘don’t be evil’, speak clearly of a resolve that led to it becoming a $10 billion company and mass market consumer darling within a decade.

More locally, Vodafone was the first company in New Zealand to call its own customers proactively and advise them to switch to a cheaper plan: a small token at first glance but immeasurably valuable in creating a loyal customer base. Vodafone launched an SMS service by admitting to students that it hadn’t figured out how to charge for texting, creating huge goodwill and plenty of eager texters. Vodafone also treats staff well, putting call centre staff on the top story of its downtown building and throwing famously immoderate Christmas parties. That consistent drive for improvement, staff goodwill and customer delight led to market share triumph over Telecom in just five years. By contrast, the more conventional global Vodafone has recently suffered prodigious losses.

And it’s difficult to imagine Steve Jobs’ brief for the iPhone beginning with an objective to grow profitability.

“We all had cellphones,” Jobs told Fortune, “we just hated them, they were so awful to use. The software was terrible. The hardware wasn’t very good. We talked to our friends, and they all hated their cellphones too. Everybody seemed to hate their phones. It was a great challenge. Let’s make a great phone that we fall in love with. We had a big debate inside the company whether we could do that or not. And that was one where I had to adjudicate it and just say, ‘We’re going to do it. Let’s try.’”

It’s Jobs’ uniquely personal drive toward improvement that pervades the entire organisation. “We did iTunes because we all love music. We made what we thought was the best jukebox in iTunes. The team worked really hard. And the reason that they worked so hard is because we all wanted one … I mean, the first few hundred customers were us. It’s not about fooling people, and it’s not about convincing people that they want something they don’t. When we created the iTunes Music Store, we did that because we thought it would be great to be able to buy music electronically, not because we had plans to redefine the music industry.”

What if successful businesses of the future were those that prioritise quality over quantity? It would bode well for us smaller Kiwi companies. It comes more naturally to us, with our youthful business spirit, than to the old dogs

In the absence of results, Apple’s approach might seem whimsical, but its 36 percent profit growth result in March is the latest in a run that led one analyst to observe, “They’re defying the laws of gravity when it comes to profitability.”

The sense you get from these companies is that it’s far more important to them that they get better, than that they get bigger. It’s difficult to imagine Sergey Brin or Steve Jobs satisfied with an okay product, no matter what the profit growth. Their decision-making simply isn’t guided by growth objectives, allowing them to always act in line with their values. Gratifyingly, those actions have driven increases in scale and profitability well above the averages.

Perhaps it’s that mentality that holds the key to achieving growth without sacrificing consumer goodwill.

What if a focus on becoming better proved to be a more sustainable way to drive growth than a focus on becoming bigger? What if successful businesses of the future were those that prioritise quality over quantity and let the loyalty of their customers drive growth rather than corner cutting and monopolising?

It would bode well for us smaller Kiwi companies. After all, as a nation we’re about quality, not quantity. It comes more naturally to us, with our youthful business spirit, than to the old dogs. They’re great at chasing bigness because it requires the kind of dispassionate, businesslike proficiency that thrives in the cubicles of lumbering multinationals.

But getting better requires talent. It takes the sort of creativity and passion that we’ve got in droves. Which is why, if I may make one prediction for the future of business, it’s that the successes of tomorrow will bear a far closer resemblance to innovative New Zealand SMEs, in spirit and in action, than they will to the ExxonMobils of the world.

I believe that in the coming years, the corporate community will recognise growing consumer attraction toward companies that truly prioritise quality over quantity.

And that the smart companies will capitalise on this trend by ensuring their mandate shifts: from getting bigger, to getting better.

The twist is, to truly achieve that shift in focus, I believe those companies will eradicate growth objectives from every level of their organisation; that they’ll intentionally set a static bottom line objective; that growth will remain a desirable side effect, but will never be projected or measured in performance targets in the way it is today.

I believe that’s what will happen because until it does, profit growth will always incentivise organisations to make decisions that erode consumer trust.

And I believe that’s what will happen because if it did, it would truly liberate the people in organisations to focus singularly on innovation, on improvement, on sustainability, where today their energies are torn.

Furthermore, I believe that this way of working will be branded in a way that acts as a lighthouse for consumers, as a proof point of an organisation’s true customer-centricity. Like a Heart Foundation Tick or a carbon neutrality rating, there’ll be a name given to this model that’ll act as an independent witness, a beacon that says if you buy from this company, you’re guaranteed to buy something that isn’t the product of cut corners and social and environmental ill.

Lastly, I believe the organisations that engage in this practice will grow more surely, and more sustainably, than the average.

At which point the sound of ruminating focus groups might more closely resemble a gasp of delight than a hum of quiet submission.