“The great argument for the market,” as Milton Friedman wrote in his book, Capitalism and Freedom, “is its tolerance of diversity; its ability to utilize a wide range of special knowledge and capacity. It renders special groups impotent to prevent experimentation and permits the customers and not the producers to decide what will serve the customers best.”  Yet if one reads that classic book carefully, as I’ve been doing recently, one notes only a handful of reference to “customers”, but scores of references to “consumers.”  That’s no accident. The 20th Century literature in economics and business is mainly about “consumers”— passive individuals who uncritically buy and use whatever product or service is being pushed at them. The consumer is someone who can be manipulated by clever sales campaigns—a target to be exploited. The whole idea, as Eric Schmidt and Jonathan Rosenberg write in their interesting new book, How Google Works, was to “build up a sustainable competitive advantage over rivals and then close the fortress and defend it with boiling oil and flaming arrows.”  The consumer becomes a customer  As the 20th Century wore on, businesses only gradually realized that the game was changing in a fundamental way. An epic shift of power in the marketplace from seller to buyer was occurring. As a result of globalization, deregulation and rapidly evolving technology, buyers had steadily more choices available to them. Then, as a result of the Internet, they had reliable information as to what those choices were and an ability to communicate with other customers. The result? The customer was, collectively, in charge of the marketplace.  The passive “consumer” who could be easily manipulated to buy and use whatever was being delivered was becoming extinct. The unthinking “consumer” was evolving into the thinking “customer”, with whom the producer of products and services needed to have an active, interactive relationship. The customer was someone who explored the available choices and made a conscious decision as to what to buy.  The shift from a consumer to a customer was a potentially frightening prospect to business. It meant a fundamental change in the relationship between sellers and buyers, and required a basic shift in thinking about how to succeed in business. Before this, businesses could succeed, as the title of the 1950s musical suggested, “without really trying.” Now, suddenly, businesses could only truly succeed by really trying.  This shift wasn’t an easy fit with 20th Century business which had essentially taken the consumer for granted. Success in business was principally about cutting costs and being more efficient than competitors and having sales campaigns to sell the products. It was all about money. The very reason for the existence of the firm, according to Nobel Prize winner Ronald Coase, was its ability to lower transaction costs.  It is also ironic that at the very moment power in the marketplace was starting to shift from the corporation to the customer, requiring firms to deliver ever more value to customers, economists like Milton Friedman, Wiliam Meckling and Michael Jensen were urging executives to focus all their attention on delivering more value to shareholders.  What these approaches missed was that, unlike the consumer, a customer had to be respected and courted with superior products and services that met real needs. The shift in management focus wasn’t an option. It flowed inexorably from the shift in power in the marketplace.  The approaches that focused on costs and shareholders were responses to a symptom, not the underlying disease. The symptom was the fact that in the late 20th Century firms were finding it steadily more difficult to make money. The underlying disease—the root cause of that difficulty—was the shift in power from seller to buyer, which was rendering prevalent management thinking, attitudes and practices obsolete. Cutting costs more vigorously didn’t work. Increasing returns to shareholders pushed firms in the wrong direction. The disease could only be truly cured by being understanding customers better, anticipating their needs before even they were aware of them, being more responsive to them and steadily delivering more value to them.  This in turn led to a rethinking of the very meaning of the term “profits.” In the leading textbooks of 20th Century economics, which are still in use in colleges and business schools, all profits are good. The possibility of such a thing as “bad profits” is a contradiction in terms. The books show no awareness of some thirty years of research done by Fred Reichheld and his colleagues summarized in The Ultimate Question 2.0 which shows that if the firm is making profits while leaving customers disgruntled, then the profits generating brand liabilities that will have to be repaid one day.  ”Whenever a customer feels misled, mistreated, ignored or coerced, then profits from that customer are bad. Bad profits come from unfair or misleading pricing. Bad profits arise when companies save money by delivering a lousy customer experience. Bad profits are about extracting value from customers, not creating value. When sales reps push overpriced or inappropriate products onto trusting customers, the reps are generating bad profits. When complex pricing schemes dupe customers into paying more than necessary to meet their needs, those pricing schemes are contributing to bad profits.”  In a world in which power in the marketplace has shifted from seller to buyer, pursuing bad profits can have disastrous medium-term consequences for the firm. Such consequences are not even alluded to in basic economics textbooks. Example after example, analysis after high-powered analysis, graph after complex graph, reiterate the fundamental assumption: the basic job of a manager is to maximize short-term profits, no matter what.  The role of customers? In basic economics textbooks, under the influence of shareholder value theory, consumers are still targets to be exploited for the good of the firm and its shareholders. Those books even “identify a variety of strategies to raise the costs to consumers of ‘switching’ to would-be entrants, thereby lowering the threat that entrants will erode your profits.”  They miss the risk that customers might use the power of choice and information and collectively revolt against companies that treat them as objects to be exploited and instead give their loyalties to firms who understand their needs and delight them by delivering products and services that meet those needs.  As Roger Martin points out in his book, Fixing the Game, we have entered the age of customer capitalism.  Of course, old habits die hard. Even though the old way of doing business isn’t working, this hasn’t stopped executives from seeking to succeed once more without really trying, and, as William Lazonick has recently explained, using share buybacks in massive quantities–some $3.4 trillion over the last ten years–to boost the share price of their corporations and cover up the steady declines in rates of return on assets and on invested capital. However since that the practice of share buybacks has now been shown to have disastrous economic effects and is unsustainable, business will sooner or later have to earn it by really trying: like Google [GOOG], Apple [AAPL] and other forward-looking companies, they will have to delight their customers.
Share buybacks and financial engineering can't conceal the economic reality: genuine prosperity depends on businesses delighting their customers