No thinker or writer understood how business and society relate to each other better than the late author and professor Peter F. Drucker. He integrated a deep grasp of economics, politics, demography, geography, sociology, and psychology. Drucker was obsessed with the responsibilities of leaders and managers. His wisdom extended to leaders in universities, hospitals, charities, and government, as well as business enterprises.
Drucker’s most comprehensive book, Management: Tasks, Responsibilities, Practices, written almost fifty years ago, contains truths that still ring true. His timeless ideas are as relevant today as they were when written. In the following paragraphs, I retrace his thinking on issues more important today than ever: the purpose and nature of business, the role of profit, and the social responsibility of business.
Any grasp of business requires we start with the purpose of a business – why does it exist?
The Purpose of Business
Peter Drucker tells us: “There is only one definition of business purpose: to create a customer.”
Another way of stating this might be the line I use, “There is only one reason for the existence of an enterprise – for profit or non-profit – and that is to provide goods and services to people, to somehow make someone’s life better.” Drucker goes on to say:
Markets are not created by God, nature, or economic forces but by businessmen. The want a business satisfies may have been felt by the customer before he was offered the means of satisfying it… The want may have been unfelt by the customer; no one knew that he wanted a Xerox machine or a computer until these became available. There may have been no want at all until business action created it – by innovation, by credit, by advertising, or by salesmanship.
Sam Walton founded Walmart, the largest company in the world and the first one to satisfy $500 billion worth of customers’ money in a single year. Walton said that if his executives did not know what to do, they should go to the stores, because “the customer has all the answers.” He also believed that no competitor could cause Walmart’s downfall, that only the customer could “fire” Walmart if they found a better option.
Peter Drucker pointed out, “It is the customer who determines what a business is. It is the customer alone whose willingness to pay for a good or for a service converts economic resources into wealth, things into goods… And what the customer buys and considers value is never a product. It is always utility, what a product or service does for him.”
This latter thought, that utility (usefulness) is what counts, is echoed in the writing of the innovation expert and late Harvard professor Clayton Christensen, who talked about how customers “hire” a company or person to do a job for them.
The idea that enterprises exist for the sole reason of satisfying (or “creating”) customers implies that other things are not the real, underlying purpose of a company. Examples include thinking that the purpose of a business is to create jobs, to do good in the community, to pay taxes, to make stockholders and executives rich, or to maximize profits (more on profits in a minute).
The Two Basic Functions of Business
This core definition of business purpose leads directly to Drucker’s statement, “Because its purpose is to create a customer, the business enterprise has two – and only these two – basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are ‘costs.’ “
In other words, everything else a company and its people do, from human resources to accounting to the use of computers, are costs, “expenses” that are incurred in the process of serving customers. Only marketing and innovation really pay off, for customers, employees, suppliers, communities, and investors. Marketing and innovation are the most important tasks of a company or service organization and its leaders.
Our first thought when we hear “marketing” is usually about advertising, promotional campaigns, and brand awareness. But Drucker defines marketing differently, writing, “…selling and marketing are antithetical rather than synonymous or even complementary…the aim of marketing is to make selling superfluous…The aim of marketing is to know and understand the customer so well that the product or service fits him and sells itself.”
Thus, marketing is not about running great ads, it is about deeply understanding the customer, about putting oneself in the customer’s shoes. This idea of marketing is so important that Drucker goes on to say, “Marketing is so basic that it cannot be considered a separate function….on a par with others such as manufacturing or personnel…It is the whole business seen from the point of view of its final result, that is, from the customer’s point of view. Concern and responsibility for marketing must, therefore, permeate all areas of the enterprise.”
In other words, the entire organization must be aligned with the customer and their best interests. No matter who carries the title, the real “chief marketing officer” of any business should be the person at the ”top” of the enterprise, usually the Chief Executive Officer (CEO).
Hand-in-hand with understanding the customer comes innovating for the customer. Says Drucker, “The second function of a business is, therefore, innovation… It is not enough for the business to provide just any economic goods and services; it must provide better and more economic ones. It is not necessary for a business to grow bigger; but it is necessary that it constantly grow better.”
When we think of innovation, it may be natural to focus on high technology, on inventions and science alone. But Drucker warns us, “Nontechnological innovations – social or economic innovations – are at least as important as technological ones.”
As examples of “nontechnological” innovations, Drucker lists the invention of the limited liability corporation about four hundred years ago and the creation of insurance and consumer and business credit. Other examples of “low and no tech” innovation include franchising, fast food, motel chains, the soap opera, the nightly news, the newspaper, the university, the library, the airline hub system, and social media.
Drucker also says, “Innovation can be defined as the task of endowing human and material resources with new and greater wealth-producing capacity.” When he talks of wealth, Drucker almost certainly means the total wealth of society, not just financial wealth.
The Danger of “The Profit Motive”
Another key idea in Drucker’s writings is the critical role profit plays in society and the economy. He says:
Profit and profit alone can supply the capital for tomorrow’s jobs, both for more jobs and for better jobs… profit pays for the economic satisfactions and services of a society – from health care to defense, and from education to the opera. They have to be paid for out of the surplus of economic production, that is, out of the difference between the value produced by economic activity and its cost.
Drucker understands that profit is the money we invest in the future. For a family, any excess of income over expenses – “profit” – is called “savings.” Savings are an investment in the future – money set aside for a future wedding, college education, or retirement. The same is true of a business enterprise or a non-profit: “surplus,” “retained earnings,” or “reserves” are investments for the future. Profits also provide the funds for a rainy day, for an unexpected recession or pandemic.
When a family pays its mortgage, we consider that a required cost of living. This “interest expense” covers the cost of capital that was required to build or buy the home. Likewise, companies require capital to prosper and grow. The cost of that capital, the return on investment required by those who put up the money, is the first use of and requirement for profit. While the public and the press see this as “profit,” the economist understands that the cost of capital is actually a cost of doing business, the required minimum profit that a company must earn in order to stay in business, create jobs, and deliver on its promise to its customers.
But profits are also the source of progress, of making products and services better. A company which spends every penny it takes in, that makes little or no profit, has no funds for taking risks, for experimentation, for new ideas – for innovation.
Those profits = savings = “wealth” are also the money that ultimately, through philanthropy, finances most of our charities, museums, and many of our universities, hospitals, symphony orchestras, libraries, and, yes, even opera.
In his book Management, Peter Drucker repeatedly rails against the rhetoric of the profit motive, how managers fail to explain what profit is and why it is needed by society. He writes, “…the mistaken belief that the motive of a person – the so-called profit motive of the businessman – is an explanation of his behavior or his guide to right action… We do not learn anything about the work of a heart specialist by being told that he is trying to make a livelihood…”
Drucker writes, “Businessmen these days tend to be apologetic about profit… No apology is needed for profit as a necessity of economy and society.” He continues, “Profit and profitability are, however, crucial – for society even more than for the individual business… Profit is not the explanation, cause, or rationale of business behavior and business decisions, but the test of their validity.”
Drucker here refers to the “feedback loop” nature of profit. If a company tries a new idea and it loses money, with no promise of future profits, it has made a mistake. Human and financial resources are wasted if the company continues to invest in such bad ideas. On the other hand, when an enterprise provides a new or improved product or service that “works,” that is highly profitable, additional resources result in more jobs and further innovation.
Profit is the signal that leaders are doing the right things; losses tell them they are doing the wrong things. Through this natural, organic, self-adjusting process, leaders continually learn and adjust their behavior. Drucker writes, “The business that fails to produce an adequate profit imperils both the integrity of the resources entrusted in its care and the economy’s capacity to grow.” He concludes:
The profit motive and its offspring, maximization of profits, are just as irrelevant to the function of a business, the purpose of a business and the job of managing a business. In fact, the concept is worse than irrelevant. It does harm. It is a major cause for the misunderstanding of the nature of profit in our society and for the deep-seated hostility to profit which are among the most dangerous diseases of an industrial society… the prevailing belief that there is an inherent contradiction between profit and a company’s ability to make a social contribution. Actually, a company can make a social contribution only if it is highly profitable.
Perhaps an analogy is helpful. Think about your own purpose on earth – why were you put here? Were you born only to serve as a vessel for your heart, brain, and other organs? Hopefully not. Hopefully you have or will find a purpose in life, a way to somehow make things better for others, a way to make the world a better place than you found it. Your purpose may be as straight-forward as raising a strong, healthy, productive family. No matter what your purpose is, your ability to do anything is nil if your heart and brain are not working. Likewise, enterprises do not exist to make a profit, but without profit they are dead and useless. Even non-profits must take in more money than they spend if they are to survive.
(For a more extensive discussion of profit and the many myths about it, please read my post, “The Ten Myths About Profits.”)
The Limits of Social Responsibility
Peter Drucker was among the first, and most outspoken, to write about the social responsibility of business. Decades before others, he spoke of the fact that business is an organ of society, embedded in every aspect of our lives.
Yet Drucker warns of the limitations and risks of businesses taking on “social responsibility.” While spending time, money, and energy on improving society at large, a company’s leaders may become distracted, failing to fulfill their core responsibility. UPS has a responsibility to deliver packages on time at reasonable prices; Delta Airlines has a responsibility to carry passengers safely through the sky; Ford has the responsibility to make good cars; Marriott has the responsibility of providing a safe place to stay when on the road. As Drucker says, “The first ‘limitation’ of social responsibility is, therefore, the higher responsibility for the specific performance of the institution.”
Drucker tells us that companies have a clear responsibility for their direct impacts such as dangerous waste chemicals produced by their factories. Yet corporations are often asked to do more for society than just fixing or mitigating such direct impacts.
If at all possible, Drucker urges companies to try to turn social problems into business opportunities. Maybe the waste chemicals can be used to generate energy, or sold for another application. If the government is having trouble distributing medicine to the disadvantaged, maybe Walgreen’s, CVS, or UPS has competencies to do it better and to do it at a profit, and thus to invest in innovation and expansion. He says:
There is no conflict between ‘profit’ and ‘social responsibility.’ To earn enough to cover the genuine costs which only the so-called profit can cover, is economic and social responsibility – indeed it is the specific social and economic responsibility of business. It is not the business that earns a profit adequate to its genuine costs of capital, to the risks of tomorrow and to the needs of tomorrow’s worker and pensioner, that ‘rips off’ society. It is the business that fails to do so.
If a company cannot find a way to solve a problem by creating a new business opportunity, the risks are great. Drucker tells stories of manufacturing companies building factories in poor areas in order to create jobs. Such actions are often taken out of sympathy and in reaction to political pressures. Yet, per Drucker, eventually these factories close and the jobs are lost, because they were built for the wrong reasons and ultimately cost society rather than benefitting society. He writes, “To do something out of social responsibility which is economically irrational and untenable is therefore never responsible. It is sentimental. The result is always greater damage.”
Peter Drucker warns of the risks of the public and press “requiring” companies to take responsibilities that go beyond their core competencies. He points to the example of the Du Pont Company, which is based in Delaware and has long had a great impact on the state. At the time of his writing, there was clamor for the company to “do more” for Delaware, to take responsibility for a wide range of social issues in its home state. But Drucker points out the tons of prior press and public outcry saying that the Du Pont company was “too powerful” in Delaware and should stay out of politics and people’s lives in the state.
As Drucker states, there can be no responsibility without authority, and vice versa. If a firm or individual is held responsible for solving a problem, they must have the authority to take some measure of control and set policies. Du Pont cannot “solve” Delaware’s problems unless it has the authority to make changes, to provide rules and guidelines. Yet at the same time, many Americans think corporations already have too much “power.”
To ask big companies to take on broad roles in solving society’s ailments is thus a slippery slope. What should Du Pont do? Drucker would tell us that Du Pont needs to make great chemicals, dispose of its wastes safely, and find new opportunities in the chemical industry, the company’s area of competence. He writes, “Managers of key institutions of society are not being paid to be heroes to the popular press. They are being paid for performance and responsibility… Before acceding to the demand that it take on this or that social responsibility, and go to work on this or that problem, management better think through what, if any, part of the task can be made to fit the competence of its institution.”
Today, the pressure on enterprises to solve all the world’s problems is greater than ever. Investors, outside observers, and bureaucrats have begun to rate companies based on their ESG (Environmental, Social, and Governance) performance. Peter Drucker would urge us to “be careful of what we wish for.” Most importantly, he would tell leaders in business, non-profits, and government not to bite off too much, to figure out what they are good at and where those competencies can be applied effectively. Doing good solely for the sake of doing good (or for publicity) wastes society’s valuable talents and resources.
Drucker’s voluminous books and articles cover many other aspects of leadership, management, business, and society. I urge every leader to read Management: Tasks, Responsibilities, Practice and his other books. And for those interested in government, as we all should be, try his provocative 1969 article The Sickness of Government, which can be found online and surprises the reader by its relevance to the 21st Century.