What does profit cost?
10 December 2020
Often, we calculate success with only a spreadsheet. Quarterly profit, shareholder value or outside investment – we measure money because “of course a business is supposed to make profit” and then disregard whatever else happens outside of the financial statements.
But that’s not the whole story of profit, it’s not a complete accounting of the real costs.
What is profit?
A business should be profitable – it should be profitable because it’s productive and beneficial overall, meaning a business should produce – the output of its activity is greater than all of its costs.
Importantly, however, leaders of businesses must consider costs that are also off its financial statements. We call a business profitable (and it’s usually in the short term) when it creates costs or damages that aren’t contained in a specific line item. The income statement shows profit, but the business creates costs outside of itself. Collateral damage, if you will.
Is counting our money the only measurement?
Has a business truly achieved success if significant costs that are not on the financial statements are shouldered by others? Is a business really good for the community and the greater world if the business creates a negative effect aside from counting only their money?
A broader point of view of “profit” is more meaningful to the world because a narrower view often hides costs not included in the company’s P&L. If we consider the broader aspects of business’s activity, we can call a business successful if it is internally profitable and we account for the costs and benefits outside of the realm of the business’s line items.
As leaders, we are responsible for all the effects that our business has on the economy, the employees, and the community – all over time. We must consider a myriad of issues – environmental sustainability, pollution, traffic, employee health, community disruption, people’s rights, waste . . . the list is endless. 1The UN’s great report on sustainability and what business can do to help.
Businesses must make a profit, but if the profit comes at the expense of people’s lives or community, it’s not a net positive.
There are laws and policies that help rein in pejorative (and sometimes malevolent) business behavior, but they will never match the ability of humans to craft a work-around when we really try. Some businesses get caught, some do not, and the penalties for disregarding all manner of rules are often light. It is up to all of us to consider our actions and make the best choices because this is what makes people, their families, and our communities thrive and be healthy. Leaders can and should help pave the way of making businesses responsible for all their activities.
How leaders can help (or hurt)
As a simple example, look at how bad leadership can create costs outside a business. In a (sometimes honest) bid to improve something like profit, sales, or adherence to a particular rule, a leader can reduce overhead by cutting jobs, and use a big stick to motivate remaining employees while increasing their workload. This will probably create a short-lived increase in profitability. A leader could report “success” to the board, but what are the costs outside of that narrow view?
Burnout is one result of poor leadership decisions that prioritize short-term profit before the health and wellness of employees. Giving employees unsustainable workloads is not a successful strategy, even if the business can make money in the short term. The reason: burnt out employees are unhappy, unable to fully contribute to their community, their family or successfully parent. Burnout costs money, and even if it does not directly effect the business that creates it, absent parents cost family cohesion and youth development, and poorly rested-employees get sick more, make poorer decisions and are more likely to leave their job, which makes the business unstable and more likely to fail, often costing the community.2To be clear, bad businesses should fail. I agree with Nassim Taleb that responsibility, early failures and not having a “too big to fail” strategy makes the overall system more stable.
Undoubtably, some businesses are top-heavy and need of lower overhead – I’ve managed overhead reductions myself. I don’t condemn reducing overhead any more than increasing it. We need to examine all the costs, no matter what the move.
The right decision includes a broad examination of all the decision’s results.
On the other hand, the opposite move might also create outside costs. Increasing overhead and reducing employees’ load without consideration to the revenue capabilities of the business could be just as costly, and can end up financially ruining the businesses which would leave employees without jobs or waste resources.
So the right decision isn’t always in a certain direction – the right decision includes a broad examination of all the decision’s results.
Examples, like the endless list above, never stop. As leaders, we must include both the financial result plus other effects of our decisions when guiding companies. We must consider and take heed of the broadest definition of business success – what’s good for the company, its employees, their families and community, both now and in the future. We must use more than just the metric of profit.
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