Archive for category Economics

The Service Economy is Here to Stay

The President in his State of the Union address stressed the importance of returning manufacturing jobs to the American economy.  The only problem is that not only has the economy structurally moved away from manufacturing but economic goals have fundamentally shifted.  The big new ideas like cloud computing are fundamentally about how to provide a service not having something.

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Whitherto Profit?

In a pair of posts last year, Steve Denning, argued that companies shouldn’t be profit maximizing but instead show focus on delighting customers.In his first post, he highlighted the need for customer delight over shareholder value.  In his second, he noted that companies can only focus on only a single goal and that goal should be customer delight.

The economist in me naturally recoiled at the idea. Companies shouldn’t maximize shareholder value or customer delight but profits.  But why profits? Profit maximization is based on a complex argument about how companies benefit society. Is it possible that the simpler delight customers is actually a better goal?

The most subtle reason for profit maximization is that it helps guide companies to “interior solutions”.  The real world rarely sees companies going to extremes. The iPhone 4s may be the best phone on the market but Apple doesn’t charge a price well above other phones. Why? Profit maximization provides a universal objective function that measures the tradeoffs inherit in pricing and other decisions. Raise the price and the quantity sold will go down. If the profit in the new situation is less than before go back to the old price.

Could a company that was truly focused on focused on customer delight and its metric, net promoter score, find these interior solutions or does customer delight push a company towards extremes?  By itself no. We can all think of products or services that delights us that would delight us more if it were cheaper or better in some way, ah a free iPhone 4s. But Denning has a reasonable response.  Customer delight must be sustainable. Apple can’t just give away iPhones, an iPhone must cost enough not only to produce but also to provide Apple with resources to further delight customers.

This focus on sustainability leads to second leg up for profit maximization.  Finding and delighting customers is hard work.  While existing companies may be able to use revenue from current profits to provide the resources for further customer delight, if customer delight is the goal how does a new company start? Why would some one provide resources to a company that clearly does not provide customer delight because it is just starting and learning to delight customers?  How does one value a company with a net promoter score of 50%? 70%? If a 10% price increase moves your net promoter score from 70% to 50% would that be catastrophic?

Similarly if a competitor has a high net promoter score in that range, why should you compete?  The company is obviously delighting its customers. Sure there may be room to find other people who are not the company’s current customers but would you ever try to attract the competitor’s current customers if you were focused on delighting customers?  A profit maximizer might. If the delighted customers are generating huge profits for a competitor, it makes sense to try to delight them more or maybe even just settle for cheaper product.

Profits still provide a better goal than delighting customers.  Both goals provide for useful interior solutions that stop companies from running to extremes.  Customer delight does not provide a good answer as to why the resources should be given to a new company. Nor does customer delight explain why we see competition in the marketplace.

Delighting customer does have some appeal as heuristic. Profit properly measured needs to include not only this quarter’s profits  but this year’s profits and the next decade’s profits too. Understanding what the right decision that maximizes profit over all these periods is a challenge.  Customer delight is easy to understand.  Does this change make my customers happy without costing me too much profit? If yes, then do it because as Denning points out this seems to be a good marker for maximizing profits.

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