Here’s a provocative question I like to ask business leaders: How do you generate value? It’s provocative because it focuses on the core of what their businesses actually do, and that sometimes shines a bright light on questionable business models and practices. For decades, and especially since the 1970s, many leaders have used a one-dimensional, reductive view of what business should do: the idea promoted by Nobel Prize-winning economist Milton Friedman that the purpose of a business is “to make as much money as possible.” That idea has led to a proliferation of what I call “extractive” business models — businesses that don’t actually generate value, but rather extract it from somewhere else: from the planet, from people, or from communities. We need to shift how we design our business models and business strategies: away from extractive approaches and towards models that create incremental value. We need business strategies founded on real problem-solving and real ideas. This paradigm shift is critical for building a sustainable economy with shared prosperity.
The term “extraction economy” describes economies that derive value by extracting non-renewable resources from the planet, people, or communities, and leave harm in their wake. These economies ultimately fail when those resources are depleted. Some of the clearest examples of this business model are oil and gas companies that employ climate-change denial to maintain profits as they extract a non-renewable resource that does harm to the planet. Other examples include the tobacco industry and much of the soft-drink and fast-food industries, where profits correlate to long-term health consequences for customers. Amazon, an enormously profitable company, is also notorious for exploiting workers to generate those profits — like a case in 2011 when workers were subjected to 11-hour days in a 100+ degree warehouse to support the company’s revenue targets. Amazon had paramedics outside the warehouse to wheel away workers who collapsed, and fired people who complained. The high profits were extracted from employees’ health.
Perhaps the most egregious extractive business model is the for-profit prison industry — a $5 billion behemoth with a business model that monetizes mass incarceration. According to the Justice Policy Institute, the commercial prison industry lobbies heavily for tougher sentencing laws, thus further increasing incarceration rates. This diverts tax revenue away from communities, and is a fundamental reason why the US imprisons more of its citizens, per capita, than any other country on Earth. Commercial prisons ultimately profit by increasing inequality and further marginalizing poor communities — so the value the industry extracts from families, communities, and human suffering is incalculable.
THE PARADIGM SHIFT: FROM GENERATING “SHAREHOLDER VALUE” TO GENERATING IDEAS AND SOLUTIONS
The fundamental issue with these and many other extractive businesses is that their profit doesn’t come from creating incremental value in the world; rather, they generate profit by shifting, i.e., extracting, value and dropping it to their bottom line. Good businesses, by contrast, create incremental value by generating ideas and solving problems in a way that customers are willing to pay for and that doesn’t leave harm in its wake.
I’ve heard the counter arguments: that we sometimes need products with significant externalities (like fossil fuels); that some consumers enjoy sugary soft drinks and Twinkies; that businesses shouldn’t take up the role of judging what’s good and bad for their customers. All of these are correct in the traditional, narrow approach to business. However, the point of conscious business is to take a more principled view, a view that includes the full impact we have on the planet and people and the impact of any externalities we generate. Focusing on the “how you generate value” question is a clear way to assess and hold ourselves accountable to net impact.
Here’s a more sophisticated and expansive view of the role for business, to contrast with that of Milton Friedman: The purpose of every good business is to generate ideas and solutions for customers’ needs. When a business does that well, profits and increased share value are the end result. In many ways this is a paradigm shift back to the original core purpose of business and commerce. It’s actually a liberating shift, because there is no shortage of problems that need to be solved — the list grows longer every day.
IT’S MORE THAN HACKING, DISRUPTION, AND “INNOVATION”
Some might argue that we’re already making this shift, and especially in the high-tech sector where companies “hack” and “disrupt” their way to innovative solutions. However, when I hear the word “hack,” I think about my undergraduate days in engineering school (longer ago than I’d care to admit) when “hack” was a negative term. It typically came scrawled at the top of a computer science assignment along with a grade of D or F. It meant that although you’d produced working computer code, you’d taken an unsophisticated approach and hadn’t fully understood the problem — i.e., you’d produced a “hack,” not an elegant solution. Ironically, this applies to many of today’s business ideas that are incorrectly labeled as “innovation” — in truth they are hacks to make a quick profit, not innovative solutions to important problems.
As Allison Arieff explores in a recent New York Times article, we’re under siege by so- called innovative products that target inane problems, and thus don’t improve quality of life; i.e., generate real value. And too many supposedly “innovative” business models ignore the problems of the people most in need — the poor, single mothers, minorities, etc. My favorite of her examples (which I initially thought was a joke) is Noti-FLY — technology to notify you if your y is down. We can — and must — do better.
HOW TO BUILD BUSINESSES BASED ON IDEAS, PROBLEM-SOLVING, AND VALUE GENERATION
There’s a framework I often use to help companies answer the “How do you generate value?” question. It’s a way to build business models and strategies that are based on truly valuable ideas and problem-solving. The framework is rooted in five deceptively simple questions. (See below). There’s a bonus, too: In order to answer these questions, you need a deep understanding of your customer — something else that’s essential for a successful business.
HOW DOES YOUR COMPANY GENERATE VALUE?
ASK THESE 5 QUESTIONS TO FIND OUT.
1 // WHO IS YOUR CUSTOMER?
Describe the customer in detail, and perhaps create personas for each type of customer. For example, your customer might be “a mother concerned about finding affordable organic food.”
2 // WHAT PROBLEM OR NEED DO YOUR CUSTOMERS HAVE THAT YOU’RE INTERESTED IN SOLVING?
The key here is that you must state this answer from the customer’s point of view, and ideally in the first person. That helps make sure you understand the customer. Our example customer might say, “I want to feed my children organic, humanely raised food, but most brands are beyond my budget.”
3 // HOW DO YOU SOLVE THE CUSTOMER’S PROBLEM?
Answer this one from the company’s point of view — honestly. It gets at how you are able to bring value to the market, and asking it can unearth issues. In 2011, Amazon would have had to honestly answer this question with, “We can ship goods quickly and cheaply because we push our workers hard and subject them to unsafe working conditions.”
4 // WHY IS YOUR CUSTOMER BETTER OFF AFTER YOU’VE SOLVED THEIR PROBLEM?
Once again, state this answer from the customer’s point of view. The question is essentially a test for delivery of incremental value. Going back to our example customer, she might say, “I’m better off because I can now afford to feed my family in a way that’s consistent with my values.” However, if we switch to a product like junk food, it becomes much harder to find a compelling value-add answer.
5 // WHAT “EXTERNALITIES” HAVE YOU CREATED WHILE SOLVING THE CUSTOMER’S PROBLEM?
In other words, what problems have you created for your customer, employees, the planet, or communities? Again, this is a question that requires extreme honesty, and you should revisit it over time. For example, before we understood the dynamics of pollution and climate change, fossil fuel-based energy seemed like a tremendous benefit to humanity, rather than a harmful product with serious externalities.
A PRINCIPLED AND COURAGEOUS APPROACH
One day, focusing on value-generation will become the normal way of doing business. Until then, this approach requires extreme courage to go beyond the simplistic “Milton Friedman-esque” thinking that dominates today — and not everyone is (yet) up to that challenge. The paradigm shift to a more expansive, value-generating approach to business thinking requires three things: 1) equipping business leaders with the knowledge to use this more expansive approach; 2) encouraging investors to use this type of value-add framework in making investment decisions; and 3) ultimately arming consumers with the knowledge to ask these questions when making purchasing decisions. That paradigm shift starts with each of us taking a principled approach to our businesses. Start by asking the hard question: How do you generate value?
Gerry Valentine is the founder of Vision Executive Coaching. He helps build companies that work, and that work for all — supporting profit, people, and the planet. Gerry focuses on business strategy, innovation, and leadership. He has 30 years of experience with multiple Fortune 100 companies, an MBA from NYU, and a BS from Cornell University. Connect with Gerry on Twitter @gerryval or by email at gerry@VisionExecutiveCoaching.com.