As I outlined in my article „The 6th Force of Strategy“ I am a great fan of profit and free cash flow when it comes to define the purpose of a strategy. Especially in my role as a corporate leader I make it to my obsession to motivate my team to run for profits and to ensure cash flow. As said before: We are all stuck in a rat race. And I am having the very best arguments for having this approach. It is my responsibility to all of the stake holders of our company. The shareholders want to see an increased share value and dividends. Therefore profit and cash flow is needed. The employees want to get their wages and have the expectation that the company will succeed in competition and provide job security to them. Also profit and cash flow is needed for. Our customers and suppliers want to rely that we deliver goods and money to them. Again it’s about the profit and the cash. And also the public demands its stake in form of taxes. And again we are in need of profits and free cash. And of course also my ego as a manager is in place: At the end of the day profit and free cash flow (which defines the share-value) are the ultimate benchmark regarding the quality of my work:
Out of this we have formed an aggressive international team in our company and we have been very effective in gaining market shares in our industry, profits and cash over the last years. This lead us to an issue we are dealing today and which asks us to act highly sensitive and responsible.
The company I am heading as CEO is specialized in providing premium rate telephony numbers as micropayment tool. We are supplying this service presently in approximately 100 countries to media companies, TV-producers, advertisers, and many others. During the last years we have gained significant market share and are meanwhile global market leader within the niche of International Premium Rate Numbers. Even more important we became the most profitable company in this industry. We focused on highly educated staff within sales and purchasing what helped us gaining bargaining power with suppliers as well as with customers.
During the year 2013 we faced an untypical high volatility within our market. The volumes of phone-calls where below the 2012 figures and a forecast was hard to predict. I did what any profit and cash flow oriented CEO would do and ordered our team to avoid discounts on the customer side and use our market power to demand discounts on the supplier side. This worked out quite properly and we kept our cross margin stable. Even better was that some of our competitors did not survive the market turmoil and the following consolidation brought us a gain of market share again.
The year 2014 was a record year and we increased or revenue by 49 percent and our gross margin even by 53 percent. Profit rose even more. So everybody could be happy and celebrate the huge profit and cash we made.
But since the last two quarters of 2014 we are realizing that we might be heading for a dead end. Not just that the market is not infinite. The even bigger issue is that by our own market power we are damaging the value chain around us. Two of Mr. Porters five strategic forces – bargaining power of customers and suppliers – are becoming to have a tail-whip for our company because we drove it too far. During the period we drove our cross margin up our suppliers as well as our customers lost margin, profit and free cash flow and some of them are meanwhile on the brink of being profitable.
The dilemma created is obvious. If we continue our track we will lose customers and suppliers over the time. If we lower our margins we will knowingly refuse potentials of the development and work against our education of profit maximization. Even worse in the short run we would work against the interest of our stakeholders. If we continue our track of improvement we have to consider if too much players of the value chain are failing because of our strength we have to consider taking over bigger parts of the value chain with cheap takeovers of weakened partners and drive further market consolidation.
And of course the drive for growth of profit is the only acceptable approach to the dilemma. Because if I – as the CEO – would chose a different – more balanced – approach I would harm the dividends and share value of my owners, I would harm the bonus-payments of our staff and even the country and the tax authorities would not be happy because they aim for maximized taxes which depend on maximized profit. Our shareholders would vote with their feet and either walk away or kick me out, the best talent of the staff would leave for an entity which is going for the highest bonus-payments possible and the tax-authorities will send a controller because they expected to get more.
And again we face the inherent problem of profit and cash flow: a fair and balanced distribution of created value within an darwinistic system is impossible. Even if we are aware of the negative impacts and even if we can anticipate the downside of this approach we are forced into a system (a global belief) which you cannot rid off as an economic entity. If you don’t want to play the game, you are out. If you don’t play the game good enough, you’re also out! The problem is that there is no other game! And there are meanwhile more and more entities and people out of the game. There is presently no alternative to our global economic system available. So from an entrepreneurial point of view you play by its rules.
Corporate warfare for profits and cash does – unlike the Roman empire – not create colonies. Companies do not take prisoners but eliminate the enemy and most of its troops. If a company takes over a competitor or a supplier it is done for the synergies. Meaning getting more for less. And less means most of the time less human resources and less investment into infrastructure. So each time an acquisition or a merger is done or a competitor goes bankrupt the whole system gets a little bit more efficient and produces a little bit more profit at the cost of society and individuals who were laid off.
The idea of any entrepreneurial activity is to create growing profit and a sustainable cash flow. Out of this we will never be able to ignore this paradigm of economy, capitalism and society as we know it.
The critical issue and the potential downside of this approach is proper distribution of the value created where we will have to find balance among all the stakeholders. As already figured out in the previous chapter on the societal impact, we are living in world with an outraging imbalance of power and resources. And this imbalance will most probably get worse over the years. Since – as illustrated – these are inherent problems of capitalism and there is no idea how to regulate the „greed-is-good-mentality“ in our society and no plan to achieve a more balanced system, it will demand a lot of courage and insight of individual (corporate) leaders to influence for the good within their environment.
There are ways to achieve sustaining profit and cash flow by establishing a fair share along the value chain by neither skimming the customers nor pressing the suppliers. Strong entities have the power to enforce a fair distribution and to create the benefit of the sustainability of the value chain. But this demands a commitment that the best deal is not always the cheapest and that short term profit often with the cost of long term potential. Since most players of the corporate world are fundamentally driven by quarterly results and annual growth, this might be a long, long track ahead.
In my article „the 6th Force of Strategy“ I’ve chosen the formulation: „superior performance means establishing a strong and steady cash flow at a good profit.“ I avoided by purpose to claim profit maximization as a goal of strategy because this normally makes people think short term and make them focus too much on strong cash flows than on the steadiness of this vital essence of any business.
Concluding we can say on the entrepreneurial impact of profit and free cashflow lies in the nature of doing business. But more and more we are facing the need of not just achieving profits but achieving them in a kind of balanced, ethical and sustainable way. It will lead any company to a dead end over time if it does its profits on the shoulders of its employees, its clients or its suppliers because this will harm the steadiness of the cash flow over time. Finding ways of fair distribution of created value among all the stakeholders will be one of the most complex challenges for corporate leaders in the future. This challenge will demand a certain level of self control and established ethical standards in the corporate world since it is – as illustrated in the previous chapter – a field that hardly can be politically regulated because of its complexity, the nature of capitalism and the simple non-existence of valid global authorities who could develop and enforce global regulations.