Pure profit

Christopher Tugendhat, chairman of Abbey National, rejects John Kay's claim that profit, like happiness, is best pursued indirectly
June 19, 1998

The fact that it has taken Oxford so long to establish a business school, and the controversy which attended its birth, attest to the strength of the doubts about the validity of business as a fit subject for study at our oldest university. In his inaugural lecture as director of the Said business school (Prospect, March 1998) John Kay makes a valiant attempt to secure a place for business on the Oxford scale of values. He does so by scorning the idea that profit is the defining purpose of business and asserting that, like happiness, it is best pursued indirectly. He holds up for particular obloquy a statement by the Confederation of British Industry to the recent Hampel committee on corporate governance that "while business has relations with customers and employees, its responsibilities are to shareholders."

John Kay says that this approach "treats business behaviour as very different from the standards that apply in ordinary life." He equates it with a "pure" profit motive and asks what we would think of a medical school which declared "that the responsibility of doctors was to maximise their incomes"? Even boyhood heroes of mine such as Stanley Matthews and Don Bradman are presented as examples for businessmen to follow. Business, he suggests, ought to require "the same sort of breadth of understanding of the complexities of society and individuals, the same sort of sensitive understanding of people as parenthood, education, sport or any other complex human activity."

Amen to that. Of course it should. But is that incompatible with an overriding duty to the owners or shareholders and does the existence of such an overriding duty differentiate business in some unique way from other forms of human activity? My answer to both questions is no. John Kay is setting up a false dichotomy by suggesting otherwise.

Many activities, including some of those mentioned in Kay's lecture, have overriding responsibilities. For example, a doctor's responsibility is clearly to his patients. Doctors no doubt have relationships with their colleagues as well as with the NHS which employs them. But their primary duty is clear and when it is thought-as may happen-that they are putting self-interest or professional solidarity before their patients' interests, they are pilloried.

Successful sportsmen also have an overriding objective. As Charles Williams shows in his biography, Bradman was as single-mindedly dedicated to the amassing of runs as any individual can be to a given objective. He wanted them for their own sake. He also believed that if he succeeded Australia would win and he could secure for himself a post-cricket career which would mean he would never have to return to the poverty of his youth.

Business has some of the attributes of both medicine and sport. Like doctors, businessmen can only fulfil their primary duty if they are capable of successfully managing and balancing a number of other relationships. For a business, these are likely to be diverse, complex and sometimes running counter to each other. In the case of opening hours staff may not wish always to be on duty at times most convenient for customers. Customers may be ruthless at taking their business to the lowest cost provider even when that means threatening the livelihood of those with whom they have dealt for many years. Preserving those livelihoods, or at least some of them, in the face of such a challenge involves painful choices. Conflicts may also arise between the interests of different groups of employees or potential employees, for example, when managers are faced with a decision about where to locate a new investment.

However dedicated managers may be to the objective of maximising returns to shareholders, "pure" profit will not provide a sufficient guide to resolving these and other problems. The "breadth of understanding of the complexities of society and of individuals" for which Kay calls will still be required.

The international footballer or cricketer who does not deliver what he was selected to deliver-be it goals or runs-will not last long in the national team. He knows by what criteria he has been selected and that whatever other contribution he might make to the sport or to society, his place depends on his performance. Likewise in business. A company that fails to provide satisfactory returns to its owners over a period will find its reputation going steadily down hill. At first the criticism may be muted and confined to the City pages. Over time, it will spread to a wider public. The company's ability to carry out its activities will be undermined and at the end of the day-not always a very long day-if someone comes along with an attractive offer for its shares and a credible promise to do better than the existing managers, its fate will be sealed. Closures and job losses will almost invariably follow. Whatever the company's green credentials, its work on behalf of equal opportunities or the scale of its charitable programme, the pension funds, unit trusts and other large institutions which gather up the nation's savings will accept the bid. Indeed, just as a player who is doing well may be dropped in favour of someone the selectors think will do even better, so can a successful management lose out to a bidder whom the financial institutions think will provide them with an even better return; as I discovered when I was a director of LWT and it was taken over by Granada.

Managers who forget this basic fact do so at their peril, even if they are graduates of INSEAD, Harvard and, perhaps in due course, Oxford's Said school. Moreover, those who are at risk of dying by this sword also live by it. They expect their colleagues who act as trustees of their company's pension fund to insist that the great City institutions which manage it should perform as well as possible. Those who do not measure up in the performance tables risk losing their mandates.

None of this is to say that a management should think only in terms of profit and certainly not only in terms of short-term profit. To survive and prosper over the long term a company requires a work force that is contented and motivated (which are not exactly the same thing); it must satisfy its customers on the basis of a raft of criteria including price, quality and service, while recognising that it must constantly earn its orders and never presume on its customers' loyalty. Depending on its field of activity, it will need to be innovative and adjust its product range to changing tastes. This in turn requires programmes of training and retraining at levels ranging from the fast-stream managers going to business schools to those in the workplace learning new skills. In the financial sector (as well as other sectors) a company must ensure that it meets the highest compliance and regulatory requirements, whatever the cost.

This is a demanding programme which obviously requires "breadth of understanding of the complexities of society and individuals." In the case of many companies it also requires a broad and sophisticated understanding of the company's place in society and the direction in which society itself is moving. For example, those companies that first understood the importance of environmental considerations and the need to promote equal opportunities may have found these expensive in the short term but of great benefit in the longer term. Those who over time seek to identify with their local communities or parts of the wider society will have to invest money and time in those areas. The benefits will be hard to measure but are none the less worthwhile.

However, while pursuing these objectives, managers must know what the cost to the bottom line will be. If it is negative they must not only know what they are doing and why, but be ready to justify themselves to demanding interrogators.

Every six months, top managers of quoted companies have to present their results to the public and to explain them at meetings of analysts and fund managers who are looking for weak spots and points to criticise. Managers also have to make regular visits to big investors who are likely in private to be even more searching in their questioning. Any rise in the cost base, deterioration in the cost income ratio or reduction in revenue will be seized upon. Beyond this inner circle, the media is always ready to report and amplify bad news. Among the criteria which together determine a company's reputation for the wider public, financial performance is the one on which it is above all judged.

A company, no less than an individual, is a citizen and a member of society. It is bound by the same web of reciprocal rights and obligations. If it is large and successful, its potential for contributing to society by example and in other ways, as well as by earning profits, is considerable.

But there is one big difference between a company and an individual which goes to the heart of my disagreement with John Kay. So long as an individual remains within the law he is in a free society, ultimately beholden only to his own conscience. By contrast, a company exists at the discretion of its shareholders. So long as it provides them with what they regard as satisfactory returns, its management will enjoy considerable freedom. If it ceases to do so it will find itself increasingly hemmed in. Changes will have to take place at the top, activities cut back, staff numbers reduced and pro bono projects slashed. If it fails to rebuild its fortunes, someone else will sooner or later take over its assets. That is why a company's responsibilities to its shareholders are different in kind from those it owes to anyone else.

If, on the other hand, a company can deliver good returns to its shareholders, much else becomes possible. In 1989 my own company, Abbey National, converted from being a building society to a public limited company. Between then and the end of 1997 its shareholders received a total return on their investment of 1,157 per cent. Helped by acquisitions, our customers and staff have both more or less doubled. Those members of staff who signed up for the employee sharesave scheme shared in the prosperity of our 2m-plus shareholders to the tune of many thousands of pounds each.

To the extent that we, our shareholders, customers and staff have achieved that fragile and all too often transient state known as happiness, it has been by focusing very clearly on profit; certainly not by pursuing it indirectly.