Can You or Should You Escape The Profit Motive?

Production of goods and services for financial gain is a relatively modern invention (it took off with the full-fledged adoption of self-regulating markets in the late 18th century) that distorted the original meaning of being industrious and self-sustaining householding prevalent in the world up to the 18th century.

In the latter half of the 20th century, Milton Friedman from the University of Chicago turbocharged the notion of producing for gain with his doctrine that the “social responsibility of business is to increase its profits.” This doctrine was very different than that of what Adam Smith, who was a proponent of firms giving social consideration to the beneficiary of the production – modernly referred as “The Consumer.”

My interpretation of the modern market capitalism is that companies must, first and foremost, have a purpose, a mission, for existing and that this purpose must necessarily pursue or fulfill a meaningful and recognized role in the society they operate in. The concept of producing primarily for gain, in my view, naturally leads to the desire of accumulating resources to extract preferential social and political standing.

How would a firm that defines its purpose on the actual social contribution it delivers look like? Economic profit or gain naturally results from producing something society values, given the right skills and other inputs. It might look like a bakery making bread and other foodstuffs for its local town, owned cooperatively by its workers; or like a touring company responsible for the stewardship of the natural wonders of the region by offering highly specialized experiences to local, regional, or international travelers; or like a medicinal manufacturing company that researches local diseases to identify and promote treatment, in cooperation with other companies of the same kind across the world. Once put in a secondary order of importance, the drive for profit serves its function to promoting efficient use of resources by allocating them wisely in support of the organization’s mission.

What about those firms that make tools for other firms that make the products society needs? The multiple tiers of vendors generate large multipliers “upstream” from the end customer or user. This multiplier implies the creation of firms specialized in bringing the components of the final solution to market. This is typically done in industrial clusters or regions that share an affinity for the kinds of activities associated with the making of the end-product.

We can all agree, I think, that demand for end-use goods and services is very much colored by cultural and societal customs and norms. But how are these shaped? Does culture lead to consumption which then leads to the supply of goods and services or does the availability of such goods leads and promotes their consumption, ultimately shaping culture?

My unscientific observation is that the explosion of content and the technology it is delivered through (since the printing press was invented) has shaped our culture more radically than any other phenomena in our history. As the late McLuhen said “The Medium Is the Message,” meaning the form and structure of a communication channel (the medium) have a greater impact on society than the specific content it carries, shaping how we think, feel, and organize. And now with AI, this impact is several orders of magnitude greater.

What can new startup founders – especially those bringing the results of their academic research to underpin products and services to address real (or not) problems in society – do to avoid following the dangers of the siren song of gain for its own sake? Here are some thoughts:

Mission orientation

Know your mission. Articulating your mission statement guides your decisions ensuring they align with your goal for being in business.

Mission-driven teams

Hire and organize mission-driven people who share values and whose goals are aligned with your organization’s purpose. This alignment drives each person to do their best work, expanding their contributions in ways one cannot anticipate nor incentivize. People are intrinsically motivated and it’s a privilege to receive their time and energy voluntarily.

Mission-driven capitalization

Seek sources of capital, both equity, debt, and combinations thereof that understand and support your mission. It is common for investor interests to diverge from your mission at key developmental milestones. This divergence often creates rifts, sometimes explicit, most of the times implicit, between investors and founders that if not addressed can lead to shifts that make the company veer off its mission or even worse, reinvent itself to reflect its investors’ interest for financial gain.

In summary, to avoid the siren song of profit, ensure you know why you are in business, what is your mission, and center your entire organization and effort on its fulfillment. This will help you go through hard times and reap the rewards of good times as measured by delivering on what you promised yourself and your customers.

Three foundational business equations everyone thinks they know well

Many people I have encountered throughout my professional and personal life believe in having a job, making money by hustling a side gig or creating a new business. Very few question the economic principles underlying their respective businesses and why they are sound.

This is not a fault nor a mistake. It’s just that these principles, expressed in very three simple equations, are so obvious that many have this false sense of knowing them deeply. I say false sense because, sometimes, one thinks one knows something when in fact and practice there is a lot of room to learn and improve.

But, what are these three equations and why are they so important? Well, as you will see, they are well known and you will – almost undoubtably – roll your eyes and be tempted to stop reading when presented with them.

And they are:

  • Income Statement: Profit = Revenue – (Costs and Expenses)
  • Balance Sheet: Assets = Debt + Equity
  • Cash Flow Statement: Change in Cash = Cash in – Cash out

Now, you will say: “I know these equations and what a lame way to get me to read half of you article, baiting me into thinking you were presenting something cool, new and different.” I beg you to continue, as in my experience 100% of the time (yes, all the times!) I go through these with my clients, they acknowledge gaining a new perspective for building a better intuition about their business.

Understanding the meaning of and interrelations between these equations will make your business life better. Here is their fundamental meaning in a nutshell:

  • The first equation, the Profit and Loss Statement, reflects the contractual obligations of the business
  • The second, the Balance Sheet, points to claims or rights on the assets of the business
  • The third, the Cash Flow Statement, manifests the impact of contracts on the cash of the business

Profit and Loss Statement: Contractual Obligations

Profit = Revenues – (Costs and Expenses)

This statement is widely used and referred to, but more as an accounting tool that highlights what happened in the past, which may not be as relevant looking forward (believe me, I’ve seen people pay little attention to it). However, what people often miss is the meaning behind the numbers. This equation tells you the contractual arrangements, reflected in money, the business has earned or incurred during a specific period.

Let’s talk about Revenues, which is one of the two components of the equation. Revenues are defined as the income generated from normal business operations and includes discounts and allowances for returns. This income is “earned,” that is, you have had to do something for someone or deliver something to someone to call that earned income. This is where explicit or implicit contractual obligations come to play.

For example, if you “sell” a car to someone, for let’s say, $100k and you sign a contract, you can be happy, right? Well, it depends on whether you delivered the car or not, and also on whether, if you delivered the car, they have paid or not. These variables pop up from the contractual obligation to deliver the car and to collect the cash. You can only “earn” revenue once the car is delivered and accepted.

Now, turning to Costs and Expenses. The same principle as Revenues applies here. When someone is supposed to deliver something to you (product or a service), you owe them once you have used or accepted their offering. This obligation can be implied by accepting the service or product or explicit as part of statement of work on a contract. Costs are typically associated with quantities that vary with items purchased or demanded and expenses are typically linked to a business period (week, month, quarter, year). Contracts govern what you pay for quantity and periods for things and people, so it’s very important to know what obligations you are getting yourself into.

The Balance Sheet: Claims on the Asset

Assets = Debt + Equity

This is a simple yet potent equation, as it tells you who has claims on the business’ assets at a specific point in time (typically, end of a period like a month, quarter or year). An asset is anything that can be converted to cash. Short-term assets are those that can be converted to cash in less than 1 year, and long-term assets are those take more than 1 year to convert to cash. I am not going to cover the whole gamut of assets that exist here, but one important one is cash! Cash is the fundamental, simplest asset a business owns. In addition to cash, a business can own property (both physical and intellectual), and other things that are needed for operations.

Assets are owned by “the business”, but it in turn the business is owned by people or other entities. People that hold equity typically have claims on the assets as owners, which means that I we were close the business, converting all assets into cash and distributing the cash to owners, people holding equity will receive the cash in exchange for their shares and the business would cease to exist. This class of ownership claim is called equity.

Debt, on the other hand, has also a claim on the assets of the business (there are many types of debt I will not get into here), but only if the business does not fulfill the obligation to the debt-holder. That is, if the business does not pay the interest or principal it agreed to pay on a given period, then the debt-holders (those people or entities who own the debt), can have a claim on the assets they had secured as collateral for making the loan. This claim has priority over the Equity holders, which means they have first-dibs at the cash proceeding from any liquidation event.

The Cash Flow Statement: Impact of Contracts

Change in Cash = Cash in – Cash out

You often hear people say “cash is king.” Well, that is very true. It means the cash account of your business is the reservoir that provides it with the necessary funding to run. Running the business, in this case, means understanding how the contractual obligations you have incurred, on revenues, expenses, costs, equity and debt, manifest themselves in cash flow.

For example, if you are very good at selling, but not good at delivering your product, you may start inadvertently accumulating debt that may hinder your ability to operate in the future. Let’s say you sell a set of large pipes to a refinery, but fail do deliver them on time, you can’t recognize the revenue until you deliver them. If the customer gave you cash, you have incurred a prepaid revenue liability. That is, you have cash in your bank account that is not yours yet! Imagine if you spend that cash on a retreat you promised your staff and you found out that something happened at the pipe plant that increased costs of production. If you realize you will not be able to produce enough pipes, you may end up in breach of contract, which may incur penalties and trigger remedies…not a good scenario. This is why knowing how your business’ cash flow works is key.

The whole point of looking at these equations through this new lens is to help you build the intuition of how various contractual obligations and claims on the assets impact your cash position. Without cash, a business cannot survive. Cash is like blood. You need an optimal range to live (not too little, not too much).

Your goal as a business owner, leader, or manager is to make sure these equations are balanced for the industry you are in, which signals a healthy business.  There are prototypical de-facto standards that emerge for each type of industry, function and business configuration.  Knowing which of those are relevant for your business can help you determine whether you are doing a good job or not.

Hope this helps you think differently about the financial statements.

Brief opinion on the state of the economy

I don’t know what to make of the data, as the economy overall seems to be all over the place.  First, looking at people’s debt levels causes alarm.  Since the pandemic, both housing and non-housing debt, skyrocketed to $18 trillion from around $14 trillion.

If you look at what has happened with the housing market, median property values also jumped significantly since the pandemic, from a median value of $320k to roughly $420k in only five years!

Well, looking at employment by firm size, although the unemployment levels are “low” hovering 4-5%, the share of employees working at large firms – those with more than 1,000 employees – is consistently increasing, going from around 35% in 1993 to more than 40% in 2024.  This implies that any variation of employment at large firms due to efficiency gains from using new technologies (GenAI, I am looking at you), may put additional downward pressure on salaries and employment.

However, looking at the number of new business starts we can see a significant jump during the pandemic, from around 320k in 2020 to 440k in 2024.  This means that people are starting more businesses per year while larger companies employ increasingly more people. 

But this increase of new business starts seems to do little to the concentration of employment issue happening at larger firms.  As the next two graphs show, large firms are a tiny fraction of the number of total firms in the U.S., but account for an increasing share of employment.

So, I am not sure what to make of all this seemingly conflicting data.  My approach is to continue supporting founders, helping them build great companies that make a difference in society.  People are still eager to make a mark and entrepreneurship is a path for doing so.

GenAI, a good complement to advisors.

Pundits, experts, gurus, serial founders of incredibly successful AI-native companies, and even top researchers from Google, and the like, say that Generative AI will eventually evolve into an Artificial General Intelligence (AGI) entity. This drive is so intense, the belief so real, the torrent of money flowing so fast, that I thought worth adding it to my repertoire of tools.

Thanks to life’s everydayness and what happens to humans on a regular basis, the business turmoil brought by a series of circumstances beyond a client’s control propelled me to use ChatCPT as a sounding board. Given that ChatGPT is available 24/7, I started to complement my research on the client’s issue to devise ways to address it (not disclosing any specifics, of course).

I saw how powerful the tool is. In fact, it got so good that I even started to feel it was giving more concise, crisp, and better researched guidance than many experts I have talked to in my client’s field (who have decades of industry and academic experience). Am I beginning to witness the on-ramp towards AGI?

The good thing about using ChatGPT for brainstorming ideas on client challenges is that is, by firing up its Retrieval-Augmented Generation – or RAG for short – capability, it tailors the searches and summaries to the hypothesis I pose (via carefully crafted prompts). I shape the results into solid propositions for my clients (after rigorous vetting with known sources and my own experience, of course). The tool gives suggestions on sources of information, key people to talk to, and even on sequencing of activities for an optimized path to value creation.

So, although the verdict on how AI will impact knowledge work is still out, what I know for sure is that it complemented my ideas and challenged some of my views on specific situations my client faced. I imagine how powerful end-to-end AI buildouts could be for knowledge work, meaning, connecting data sources, humans, and business processes to create results more efficiently (using less resources) that have positive business, societal, and environmental impact.

Design matters more than you think

I’ve been reflecting on the myriad of projects and startups I am advising and exposed to and continue to be amazed by the sheer creativity and deep knowledge creators and founders of these projects and companies have. Their commitment to making the world a better place is palpable and their willingness to work hard to achieve such impact genuine.

However, where I see them stumbling often is at the moment they need to connect their vision with what people are actually interested in using. This disconnect is devastating, as it often follows after months if not years of work they’ve dedicated to the idea, project or company. They often have the vision for how people *should* use their offering (good or service) and people typically end up having a very different idea.

A good example of this in everyday life is illustrated in this picture:

Photo: Kai Schreiber/Flickr

As you can see, the designers built a nice paved path people can enjoy. But, given the realities of people using the path and their needs, they found a faster way to get to where they need to go and ended up carving out a new path over the grass. If this can happen with the simplest of products – a path – can you imagine how hard it is with a high-tech/hard-tech product or service?

This one of the the main reasons I am a firm advocate for talking to people who might benefit from your idea before you build anything! Having a bunch of interviews (more than 100 is better than less) under your belt will give you the opportunity to shape in your mind what the reality of your potential user/customer base is, instead of you pushing your own vision into that reality (which never works, by the way).

It’s critical, though, that you formulate those interviews in ways that reduce the risk of biasing the person towards what you want to build. I use, along with my colleague instructors at MIT, a methodology called Customer Discovery to identify the group of people to talk to and structure the interviews to gain the best data and thus derive meaningful insights.

But what does all of this have to do with design? Any product or service that will be used by someone who is not you, or not on your team, needs to experience it on a stand-alone basis. That it, they need to feel that the product or service is complete and therefore useful. Good design is essential for this. No one I’ve talked to likes to use an incomplete product. The product may not have all features, or bells and whistles, but it needs to be able to perform whatever function it’s sought for clearly and unambiguously.

To get to “completeness”, talking to people and understanding what they need to achieve and how they know they are achieving is a great start. So, if you want to increase your chances of success in building a product people actually want to – and can – use, start with interviews and talk to people. This is the fundamental basis on which good design can stand on, making products and services people actually want to use.

From Idea to … a business?

When you are on a vacation, relaxing, you typically have the time and luxury of thinking broadly about your life, what you have accomplished thus far, and what your next set of goals, ambitions, desires are. The downtime afforded by a vacation may lead you to start thinking about ideas for starting something on your own, a business, a project, something that embodies your uniqueness in the world, that encapsulates your insights into a need, a problem, an opportunity to help people in society.

If you are like most people, these ideas are great but fleeting. They do not stick. Most of us forget we even had them the moment we landed back in the reality of the day-to-day grind. It does not have to be this way.

In my experience, people abandon their ideas because the process of morphing them into a somewhat more tangible thing quickly becomes overwhelming. Where do I start? How much is this going to cost? How do I get people interested in my idea? I don’t have the skills to build the thing?, and so on. It is natural to feel overwhelmed, because developing a business out of just an idea is one of the hardest things one can do. The good news is there are many resources available to support you on the journey.

Here I am sharing a few such resources that has helped me and my clients in the process of forming their ideas into more tangible concepts that can be developed into businesses.

  • Customer Discovery. This process was proposed by Stanford Professor Steve Blank and centers on developing a simple Hypothesis -> Evidence loop to confirm your hunches about the idea. The goal here is to talk to as many people as possible that represent the group of people who will either use, buy or decide to buy your thing (product or service). This group, called in business terms, a market segment, shares a common interest or need that you have identified and that you want to solve or address.
  • Talking to Humans. This is a short, straightforward book that helps you configure your conversations with the people you will talk with to do the customer discovery. If you follow the suggestions in this book, you will be in a good position to gather the evidence you need to convince yourself to invest further in your idea.
  • Business Model Canvas. This is also a basic tool that helps you organize your ideas around the delivery of value to customers. The book that brought the canvas was the product of a large collaboration of people orchestrated by the consulting firm Strategyzer. It’s worth taking a look at their model and pairing it with the customer discovery approach developed by Steve Blank.
  • Disciplined Entrepreneurship. This is a book by MIT Professor Bill Aulet and it’s a straightforward guide to starting a company. It goes from the idea stage to building a minimum-viable-business-product, which allows you to confirm there is market interest in the solution you are proposing. I highly recommend reading this book after you have done a few dozen interviews, as you will be able to connect the dots faster.

Of course, these are just a few of the many resources available. I work with clients in navigating this confusing landscape and choosing the approach that best works for them. The goal of this journey is to deliver the impact you seek while remaining somewhat objective on the effort in money, resources, and time, to get there.

Happy to discuss more, just fill a contact form and we can setup a quick call.

Enrique

What is wrong with the modern rendering of Adam Smith’s “Invisible Hand”?

Adam Smith, in his seminal book, “An Inquiry into the Nature and Causes of the Wealth of Nations” makes many valid points about the economic system, such as: the value of money as a medium of exchange, the division of labor as a form to increase productivity and allocation or resource, the negative impacts of cartels and colluding on pricing, etc. One of the most cited passages involves the one that mentions the “invisible hand,” in the context of merchants preferring to engage with domestic industry rather than with foreign firms.

The passage, as conveniently shown in Wikipedia states:

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. (Book 4, Chapter 2) – Wikipedia

Basically, Adam Smith was spot on!! Individuals do show self-interest WITHIN THE CONTEXT of the society they are in. So, the invisible hand is really the social norms that allow an individual to function in a society.

So, what is wrong with the concept of the Invisible Hand in today’s world? In a world in which a handful of people own as much wealth as millions? Well, some people interpret this concept literally as if an invisible hand is magically making things work, all the while the individual selfishly pursues his or her own interest. I have heard many say they are self-made, driven entrepreneurs that will stop at nothing to succeed. That by securing their success, they are securing the success of their people. I can see how this concept is appealing: Focus on yourself, make a ton of money, build vast wealth, and your people will thank you later.

However, I have found one key distortion to be true in all cases: These people assume everyone was born with similar conditions and had access to the same opportunities. Reading books about people like Jack Welch, Oprah, Steve Jobs, Bill Gates and even Barack Obama and Mitch McConnell you come out with the idea they are fighters, that they beat the odds. But in very few of these texts you see references to or acknowledgement of a society that has been warped to favor only a small set of people at the expense of many sets of others. These so called leaders often fail to take direct responsibility for promoting the distorting behaviors, such as wealth accumulation, suffocating federal, regional and local governments of much needed tax revenues, and cult of personality.

So, the invisible hand, which emerges from healthy societies in which its members are looking after each other by being their best at their trade, morphs into a monstrous shadow that obscures the lives of many to favor the few. This happens because the basis of society are eroded by disinvestment, obsolescence and trade agreements between sets of people that represent narrow interests instead of those of the broader society.

My sense is the Invisible Hand functions when society is well balanced and has strong, inclusive institutions that tend the need of almost all members. However, it becomes a problem when “the few” overpower these institutions or exert extreme influence over decision making. This is what has happened to our democracy and we need to come together to offer an alternative path.

Got productivity? Why cooperation and accountability can help.

written by Enrique Shadah

Over the last 40 years, several management styles have emerged to increase productivity and streamline operations across sectors, from Just In Time manufacturing to Agile software development. Gains were made but key aspects of the daily work life were ignored. Each new methodology ultimately failed to improve morale, sustain collaboration, or establish a culture of accountability through empowerment.

A knowledge worker is like a mini factory contained within a person. When they can fully understand and define their contributions to the organization, they become more reliable, resilient, and productive.

According to Peter Drucker, there are 6 factors that characterize the productivity of a knowledge worker:

Task definition: Workers have to decide what tasks are needed to do their job

Autonomy: Workers are responsible for their own contributions

Innovation: Workers have unique insights on how to improve their own tasks

Learning: Workers require continuous learning, which in turn requires continuous teaching, in order to maintain optimal performance

Quality: Workers need to define what quality is and when something is done

Value: Workers’ knowledge is a non-fungible asset to (not of) the organization

Yet many business leaders we encounter find it difficult to implement all of these factors to improve the productivity of their knowledge-based workforce. Although each organization has reasons for not achieving the productivity they deserve (based on talent they employ), we distilled a list of common reasons that we observed in a cross-section of our clients:

  • Pre-defined tasks/jobs that do not take into account a worker’s input nor allow for self-reflection
  • Micro-managing workers, curtailing their autonomy
  • Inflexible approval guidelines for changing (and improving) how tasks/jobs are accomplished
  • Perennial focus on inputs (e.g., hours worked) versus outputs (e.g., the quantity of the work)
  • A lax definition of output quality
  • Salaries are seen as cost that needs to be contained

We believe knowledge worker productivity can improve substantially by embracing time-tested techniques wrapped around a framework of cooperation and mutual accountability. Our early implementations suggest better alignment amongst workers, better tasks definition, reduction of extraneous tasks, and improvements in worker morale that led to more output per worker.

Expert Collective is now seeking business leaders who want to tackle the challenge of improving the productivity of their knowledge workforce by piloting this approach. Are you ready to do things differently?

Get Started

Reference
Drucker, P. (Winter 1999). “Knowledge-Worker Productivity: The Biggest Challenge.” California Management Review, vol. 41, No. 2, p. 83-84.