Two Very Different Ways to Run a Company

Which of these two companies would you rather invest in?

The first boasts in its annual report that it has a single goal: "maximizing shareholder value." A few lines later, it promises: "We are deeply committed to building the value of the Firm ... in everything we do, we are constantly identifying and evaluating ways to add value."

Its CEO repeats the line frequently in conference calls with analysts. Between discussing ways to boost the company's share price, he reminds that "our goal is simple; that's to create value for our shareholders."

The other company takes a different approach. Its annual report states that the business "was not originally created to be a company." Customers that are key to its future "believe in something beyond simply maximizing profits," it reads.

Its CEO once stated bluntly, "We're definitely not in it for the money," and admitted to a friend that "I don't know business stuff." One analyst wrote that the company's management simply "doesn't care that much about making money," which is probably true.

What are these companies? The first is Lehman Brothers. The second is Facebook (Nasdaq: FB  ) .

The irony here is too much to ignore. Lehman is responsible for the largest bankruptcy in history, and it ran its shareholders into the ground. Facebook pulled off one of the largest IPOs ever, holds the richest valuation among large-cap stocks, and has created more millionaires and billionaires in a short period of time than perhaps any company in the history of business.

There's something massively important to learn from that comparison. The goal of any public company should be to create value for its shareholders, but how that goal is prioritized and achieved varies wildly.

To keep using Lehman and Facebook as examples, it seems there are two distinct ways companies can attempt to create value for shareholders:

  1. The Lehman Brothers way: Start with the goal of making profit, and then find products that enable that goal.
  2. The Facebook way: Start with the goal of delivering amazing products, and then profit from those products naturally.

Facebook CEO Mark Zuckerberg says it better: "By focusing on our mission and building great services, we believe we will create the most value for our shareholders and partners over the long term -- and this in turn will enable us to keep attracting the best people and building more great services. We don't wake up in the morning with the primary goal of making money, but we understand that the best way to achieve our mission is to build a strong and valuable company."

My examples of Lehman and Facebook are cherry-picked, of course. But there are plenty of others. Amazon (Nasdaq: AMZN  ) has consistently sacrificed short-term profit in the name of creating the best products in the industry. Far from hurting investors, this has caused its shares to rise tenfold in the last decade. General Motors (NYSE: GM  ) , on the other hand, lost its way when the "car guys" were overrun by the "bean counters" and profits took precedence over products, as former vice chairman Bob Lutz put it. He elaborated last year:

Leaders who are predominately motivated by financial reward, who bake that reward into the business plan and then manipulate all other variables in order to "hit that number," will usually not hit the number, or, if they do, then only once. But the enterprise that is focused on excellence and on providing superior value will see revenue materialize and grow, and will be rewarded with good profit. … Is profit an integral part of the business equation and a God-given right, no matter how compromised the product or service? Or is the financial result an unpredictable reward, bestowed upon the business by satisfied customers?

Two years ago, Roger Martin, dean of the Rotman School of Management at the University of Toronto, tackled the meaning of that last question in a paper for the Harvard Business Review. According to Martin, the "need to swear allegiance to 'maximizing shareholder value'" began in earnest in the late 1970s. Profits had always been (and will always be) the end goal of a company, but views on them have changed over the years; something that was once seen as a reward for serving customers became the first priority.

In his book Origins of the Crash, Roger Lowenstein describes how the change in thinking materialized over the last three decades. Stock-based compensation increased dramatically throughout the 1980s and '90s -- as did leverage, acquisitions, spinoffs, and accounting games designed to maximize profits. "The total of companies forced to restate earnings because of accounting errors rose from a handful a year in the early '80s to more than 150 a year by the late '90s," writes Lowenstein.

But while the prioritization of profits shifted, there was no meaningful jump in shareholder returns. The S&P 500 (INDEX: ^GSPC  ) returned 10.8% per year from 1950 to 1980 and 10.9% a year from 1980 to 2010 (both periods include dividends). The era of maximizing shareholder returns seems to have produced no added benefit over the previous period. Indeed, according to an exhaustive study by Deloitte, the average return on assets and average corporate life expectancy has declined over the last four decades.

These are enormously complicated topics prone to generalization and confusion of correlation with causation. But the broader message, I think, is important. Lehman obsessed over profits and failed miserably. Facebook has obsessed over products and flourished -- with incredible profits and shareholder wealth as a result. Neither is likely a coincidence, and the comparison says a lot about what it takes to become a great company.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services have recommended buying shares of General Motors and Amazon.com. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (23) | Recommend This Article (62)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 22, 2012, at 1:25 PM, fun2bretired wrote:

    It good to hear some sense about Facebook. I signed on to Facebook everyday because it is a superior service. I purchased the stock because In believe not only in its business model, but as a long term investment.

    I'm not so worried about the day investing, but as an IPO like Visa and MasterCard and Dollar General which I have made some $$ off of all of them.

  • Report this Comment On May 22, 2012, at 4:48 PM, CoreAndExplore wrote:

    I'm surprised you picked FB instead of Apple for such a comparison, considering the intense focus on product development and customer loyalty, but then again FB is the flavor of the moment. It has left a bad taste in a lot of investors' mouths already.

  • Report this Comment On May 22, 2012, at 6:09 PM, TMFTomGardner wrote:

    CoreAndExplore,

    First of all, I think that's an excellent investor screenname.

    Second of all, I agree with you -- I probably wouldn't come out of the gate with Facebook for the lead-dog comparison here. I think it fits in the category, but it's probably a little too early to tell if they should be the poster child.

    But third, I don't think we can say that a bad taste has been left in the mouths of investors already. To be an "investor", I believe you have to look at least 3-5 years forward. Facebook's real "investors" may be shareholders hoping for another 25% downdraft. . . during which they plan to "invest" more capital.

    Now, FB traders are certainly spitting up their soup right now.

    Thanks for the comment. And Morgan, I enjoyed the article (and agree with your points). I recommend reading in detail the site and philosophy called "Conscious Capitalism" for further confirmation.

    Fool on!

    Tom Gardner

  • Report this Comment On May 22, 2012, at 6:14 PM, TMFMorgan wrote:

    Fair point, Tom and CoreandExplore. When talking about the wealth of Facebook shareholders, I'm referring to those who invested years ago and have made 1000x or more on their money -- not those who bought on Friday. Should have made that clearer.

    Thanks for reading!

    Morgan

  • Report this Comment On May 22, 2012, at 7:49 PM, sheldonross wrote:

    I think this article could easily have a corollary between "traders" and "investors."

    Or those focused on making a quick buck, vs those investing long term in a company they actually believe in.

    Or fools and Fools ?

  • Report this Comment On May 22, 2012, at 8:32 PM, jargonific wrote:

    I have a question for Mr. Zuckerberg. He states "By focusing on our mission and building great services, we believe we will create the most value for our shareholders and partners over the long term."

    Does he call issuance of an IPO and then splitting for vacation focusing on our mission, building great services, and creating shareholder value?

    Granted a wedding is important, so why issue an IPO a day ahead of one? Why take off when you know that your company will be under scrutiny and you should be available to make comments? Lots of questions. Now that the markets have been placed in turmoil and investor confidence is crushed by this, tell us how you plan to FIX things?

    Will you be working with Nasdaq, the SEC and Finra to satisfy the complaints/concerns of customers?

    Finally, did you plan to be on vacation, away from your business, at a time when it would be in turmoil so you would not have to make any comments? I'm honestly wondering. It seems you sold off a large quantity of shares. Was that to try to build share value for "us"?

  • Report this Comment On May 22, 2012, at 10:02 PM, CoreAndExplore wrote:

    Thanks Tom it pretty much sums up my investment philosophy, and good point about the difference between "investors" and "traders" in this instance. I should have picked my words more wisely.

    And Morgan, after I wrote that post, it occurred to me that you were probably talking about those who had already profited as private investors. Anyway, good article - btw where did you dig up the Lehman 10-K? Are those things still online? I would love to catch a glimpse of their books right before they were cooked, along with Bear Stearns.

  • Report this Comment On May 22, 2012, at 10:14 PM, MichaelDSimms wrote:

    I don't want to invest in a mantra or philosophy. I want to invest in a company that is profitable and not at the expense of the individual for the sake of a buck. A quality product for a reasonable price. FB provides a service that may appeal to some and certainly reaches many. 100 Billion evaluation on advertising revenue? Excuse me while I roll around on the floor laughing. 7-9 bucks a share maybe.

  • Report this Comment On May 23, 2012, at 12:52 AM, kahunacfa wrote:

    Facebook's IPO was a classic example of the Old Wall Street Adage: When the Ducks quwack, feed the Ducks.

    First the IPO opening price was increased, substantially AND the size of the IPO offering was increased by 25%. Symtomatic of the greed of the company and of the Underwriters. Morgan Stanley was the lead investment banker on the deal and ultimatly responsible for both the size of the offering, the price of the offering and providing the "Stabalizing" bid to keep the after-market price above the IPO price.

    On all accounts, Morgan Stanley FAILED. Facebook, the company, actually creates no value in the market-place for its users nor for the advertisers it seeks to attract.

    I know not where the price of Facebook(FB) will ultimately go, other than lower than it is now.

    Kahuna, CFA

    Venture Capital

    General Partner

  • Report this Comment On May 23, 2012, at 6:08 AM, dividendgrowth wrote:

    Facebook's situation is pretty clear: good business and too rich valuation.

    If it get's beaten down another 50% amid all the market mayhems, it will be an excellent buy.

  • Report this Comment On May 23, 2012, at 7:18 AM, daveandrae wrote:

    Good Grief-

    Personally, I am looking forward to the day when you guys start talking about something else, hell, anything else other than Face-crook.

  • Report this Comment On May 23, 2012, at 8:25 AM, MTC119 wrote:

    Excellent perspective on the difference between management philosophy. A company built primarily on profit motivation will not be sustainable. A company needs to start with great products and build a culture that primarily focuses on creating great products, and learns how to make profits based on those products......in the order of priority....great products lead to profits. Most sustainable companies (read: several decades and more) continue today because their culture is driven by the desire to create great products. The value of the products drives the profits. My definition of products includes services, as well. Whether FB is a great company with great products is too early to determine...even Apple would not meet my definition of a great company, as yet....however, all indications are that it will be.... Companies like Coke, Du Pont, 3M are a few examples of companies that are great because they are driven by creating great products.

  • Report this Comment On May 23, 2012, at 8:42 AM, DCUDFlyer wrote:

    @MTC - "even Apple would not meet my definition of a great company, as yet"

    ::::::anyone else read that and fall over?::::::::::

    Please note, I'm with you 100% on the principle products drive profits and not vice versa. I think AAPL is the quintessential company in this arena and I doubt many (any?) others would disagree.

    -DCUD

  • Report this Comment On May 23, 2012, at 11:40 AM, kahunacfa wrote:

    Just like thunder follows lightning the Lawyers are sueing Zuckerberg and Morgan Stanley over the greatly botched Facebook(FB) IPO.

    The IPO buyers who received a Facebook(FB) allocation from Morgan Stanley or from the broker syndicate that Morgan Stanley assembled to do the offering. Investors lost money, here come the lawyers to make things Right and by-the-way collect their usualy 40% of any damages awarded if they win their cases.

    Isn't the United States Great?

    Kahuna, CFA

    Venture Capital

    General Partner

  • Report this Comment On May 23, 2012, at 12:24 PM, ibuildthings wrote:

    I agree ... AAPL would have been a better example. But in both cases, their founders were tekkie-first and profiteer second. However, FB learned to monetize their database in a scary way, selling your private data and use profiles. Plus, your privacy settings may or may not work, so good look with those party photos ... last year, they were great fun, but now the employer is seeing them.

  • Report this Comment On May 23, 2012, at 1:11 PM, PedalHard41 wrote:

    Geez... Great to read all these experts above... I'm an IT guy... FB and Goolge go together, one minor exception, Google has very successfully spook'd millions of folks... reason being, they have an internet-based search engine and pretty good web-based email with clever advertising on the right hand navigation panel... let's see what else, oh yes, the infamous Google Maps with great directions, the 1st 10 instructions are how the exit your neighborhood... When reality sinks-in and no longer $600/share; like most "real" IT stocks, they will be~$25/share. As for FB, it's a cult, like all social media offerings; cults usually get replaced with a better mouse-trap, example, MySpace. FB has nothing of value, period... Now the biggie, Lehman Bros; don't know how the demise started, but their close friends Goldman Sux took 'em outa their misery with naked shorts which as we know are against SEC Reg, bankrupted Lehman within days... SEC steps in, smacks GS's knuckles, and fines them ~$500k... what a mockery of the system.

  • Report this Comment On May 23, 2012, at 1:16 PM, drborst wrote:

    Morgan,

    Maybe not the best choice of examples for your point, but maybe they were better than you realize. I don't want either CEO you described above.

    Even Bob Lutz knows that neither the pure bean counter nor the pure car guy can run a company, you need someone somewhere in the middle. Better yet, a company with both.

    Others think of APPL run by Steve Jobs, who was the tech equivilent of a pure car guy as a better example, and that might be true, but you have to add the contribution of a Tim Cook (the execution/supply chain guy) to make Steve Jobs as successful as he was.

    DRB

  • Report this Comment On May 23, 2012, at 4:12 PM, brigidl wrote:

    'Paper won't refuse ink'... lots of CEO's spout out what they think investors and media people want to hear. Leheman bros CEO trotted out the comforting slogan 'maximising shareholder value' with an almost 'don't worry about the details, just believe me when I say so.

    Mark Zuckerberg likes to trot out the philisophy of Jim Collins and Jerry Porras in their book 'Built to Last' The idea being that if you focus on core values and core ideology profits will come. They pointed out that their research showed that if a company appeared to be motivated purely by profit they actually ended up less profitable that the Visionary and Ideology driven businesses.

    No matter what you hear coming from the mouth of a CEO remember its what he does that counts not what he says.

  • Report this Comment On May 25, 2012, at 1:48 PM, whyaduck1128 wrote:

    I wonder if the writer of this junk can get his nose any farther up FB's rear.

  • Report this Comment On May 25, 2012, at 1:50 PM, 3l1ngeniero wrote:

    @kahunacfa:

    What's your alternative? Do you think the "market" will punish these people for screwing over Mom and Pop investors? Do you think regulators will do anything?

    Only three things will stop this from happening again:

    1) Fraudsters lose their lives

    2) Fraudsters lose their liberty

    3) Fraudsters have a net loss every time they pull this crap

    Of the 3, only the first is available to individual investors without the services of a lawyer.

    So let the lawyers have their 40%. And make it easier for them to win their cases. No one wants blood on their hands.

  • Report this Comment On May 25, 2012, at 3:38 PM, MCCrockett wrote:

    Using Lehman Brothers (investment bank/ broker) and Facebook (social media) doesn't seem as far fetched as some have suggested. They were/are businesses providing services.

    A major difference between the two is that the former derives its income directly from clients using its services. The latter derives its income indirectly by selling access to its clients to third-parties.

    What seems to have been overlooked when pricing the Facebook IPO is that social media companies are "walled gardens". They can register billions of clients but only have a few thousand clients that use it more than once a year.

    The only reason that I had a Facebook account was to investigate a "network problem" reported by an employee. Almost all IT personnel have one or more social media accounts that were created just to investigate problems. Do we use them? No. Half the time we create multiple accounts because we forgot that we had already created an account.

    As I don't use these accounts there is no revenue derived from ad impressions. There is no revenue from playing games. There is no revenue from selling authentication services. There is no revenue from selling client data. (The data I provide when creating the accounts is as bogus as I can make it.)

    Buying a "social media" stock at much more than 10 times current earnings is simply ludicrous.

  • Report this Comment On May 29, 2012, at 6:10 PM, conwaymech wrote:

    My feeling was that the true value was in the 3-5 dollar range so I tried to short it but the trades would not go through. I have a standing buy at $18 which I will cancel. To think you can make fast money on a non dividend stock with a ridiculus p/e goes against logic. There will be a decrease in revenues and a shrinking company before it goes away. There were no inocent victims, only victims of greed and ignorance.

  • Report this Comment On June 02, 2012, at 5:25 PM, nklswrth wrote:

    What's so different about thier business models? They both lose thier investor's money. Save the fact Facebook hasn't gone under yet......peas in a pod.

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