The Purpose of Business

Richard Field on Management and Information Science

Home > Archive > What is the Purpose of Business?

What is the purpose of business? [By Richard Field, November 1, 2002]

In my job as a university professor, the question sometimes arises in class discussions about the purpose of business. One usual answer is "to make money", but I don't think that is right. It is unsatisfying to be in business and have as your only reason that of making money. There is a saying that "you need health to live, but you don't live to be healthy". Profits are like that for business. A company needs profits to continue, but profits are not what the business is for.

As one example, let's think of the three kids at the lemonade stand that you drive by on a hot Saturday afternoon. Do you really think those kids are out there making a profit? No, they have parents financing their venture, supplying the sugar, lemons, the use of a table and chairs, the paper for the sign. When they report back at the end of the day that they have made $10, do they then have to pay for their raw materials? Do they pay for their mother's labor when she helped them squeeze the lemons? Do they pay for the electricity they used to make the ice cubes? No, of course not. The purpose of the lemonade stand is not to make a real profit but to provide experience in making and selling a product, dealing with the public on a proprietor/customer basis, and to have something to do. It's worth it to the parents to spend $20 on materials to get the kids out of the house for the afternoon. They can sell lemonade at a loss and it's ok. The same is true for all kinds of supported businesses like Junior Achievement. There an attempt is made to show the kids what the real costs are, but it's still subsidized learning.

Now, how much different is the owner of a hobby business or a hobby farm from our lemonade stand? It isn't necessary for that business to make a net profit of income less expenses because the owner of the business is looking for something else from the business. Something like having fun, or being among a community of businesspeople. If you always wanted to have a place out in the country and raise chickens, does it matter if you are making a profit or not? I don't think so. Even if you can get tax credits and the like to defray your costs, the reason you buy the land and build the coop is because you wanted to. It satisfied your needs to live on the land, to be productive, to meet the people who live around you, to be part of that network. My mother once started and owned a travel agency. As part of it she had a women's travel club. There was a newsletter and monthly meetings to get women together, to meet, to find a travel companion. That part of the business never made economic sense. It never made a profit. But she continued with it year after year because as a female owner of a travel business she wanted to give something back to women travellers.

On a larger scale, think of organizations like museums, schools, or hospitals. People start these to provide a service that is needed. In the past when land was settled these services had to be provided. People created schools to educate their children, built hospitals to care for their sick, and founded museums to learn about and understand their past and the wider world. Now that corporations are so powerful in the world, it's hard to imagine people coming together to build what was needed. But that's why it was done and is still done in some cases. Yes, we now have for-profit museums, schools, and hospitals. But those are latter-day variants of the initial forms. There is still the underlying purpose of providing a good or a service to the population.

One problem that can come about in the running of those for-profit forms is that management can lose sight of the fact that service provision is the reason for being. If a for-profit organization, like a hospital, is a public corporation, then its ownership is divided into shares. These shares, or pieces of the company, are traded publicly in a stock market. Management of the organization may say, and worse yet may even believe, that their purpose is to increase the stock's value. After all, that is what management does. But they are wrong. An increase in a stock's value is the result of good management, not the objective. Management's job is to increase efficiency and effectiveness, and sometimes to even decide what business to be in. It is to further the objectives of those who set up the organization. And those objectives are to provide goods and services to the population. To add value. To take in resources from the community and to use them to make the community better. When this vision is lost then we lose sight of why we work, why we exist.

Why do stock markets exist?

Now we turn to the question of why stock markets exist. When a business is started it may run for some time as a private organization. It might be a partnership, a proprietorship, or even incorporated. There are many large and small privately owned organizations in the world today. Sometimes the founders and owners of these organizations want to raise capital for expansion of their business. They would then go to a venture capitalist for an investment. Later on an Initial Public Offering (IPO) could be made in a stock market. In essence, shares of ownership in the company are being offered to the general public.

Why do people buy shares in organizations? Again, the easy answer would be to say "to make money", but that still isn't true. The primary answer is that you buy shares in a company as a way to provide your capital (money you have) for that company to use in pursuit of its objectives. You might buy shares in a hospital because you support their values of taking care of the sick. You might buy shares in a beer distillery because you enjoy their products. Now, in return for providing your money you would like some return. That might be a dividend, a payment for every share you own, let's say $.25. It's like getting interest on a loan. Or, maybe the stock appreciates in value because of underlying inflation in the economy (everything is worth more so your company and its assets are worth more too) or because the management of the company is doing well. For example, sales of beer might be so good that income is higher than expenses and there is a profit being saved or reinvested in the company.

Now it is true that people buy shares in an organization with the hope that they can sell those shares and make a profit. They might care nothing about what the organization does, what business it is in, and how it relates to its community. People who day-trade stocks would fall into this category. They buy now and sell a few minutes to a few hours later. They never expect to actually hold onto stock or become part of the company. This activity is possible given the way stock markets work, and nowadays is easy because of the Internet. But it is not why stock markets were created. The underlying reason for a stock market is to provide a place for you as an individual to invest in organizations and to divest (or sell) that investment should you change your mind.

A common misconception about the stock market is that a rise in the market, let's say of 5%, has "created wealth". This is in the newspapers and on TV all the time. When the stock market drops 5%, analysts will say that there has been a "loss of wealth". It just isn't true. To make this example more particular, analysts love looking at Bill Gates' wealth. They take the number of shares that he owns in Microsoft, and it's a large number because he co-founded the company, and multiply that number by that day's price of Microsoft stock. The answer is in the billions of dollars. Now let's say that Microsoft stock goes up $2 a share. Does that mean that Bill is that much wealthier? No it doesn't ... because Bill isn't selling! Bill Gates started Microsoft in order to provide programming for micro-computers, not to make money on the stock. Yes, it's nice to make money, and it's nice that Microsoft stock has risen, but I don't think that's the fundamental and underlying reason he and Paul Allen started the business. Or when Microsoft stock goes down $2 a share, Bill hasn't lost money either. Think of your house. Let's say it's worth $200,000 today and next year you read in the newspaper that in your neighborhood houses are worth on average $230,000. You haven't made $30,000. You still want to live in your house don't you? Yes you do, just like Bill Gates doesn't sell his shares in Microsoft because they went up $2. He still wants to own his company, to work for it, to make a difference in the world of microcomputers. You could make the $30,000 on your house if you sold, but then you'd need to buy another house and you would have the transaction costs to think about -- realtor fees, lawyer fees, and moving expenses. Two years from now house prices have dropped back to $200,000. Did you lose $30,000? No you didn't. It was all on paper! You're still in your house. Nothing has changed. It's the same with the stock market. It goes up and down but the only losses and gains are from the people who actually bought and sold. And that, compared to the total value of stock, like the total value of houses in a neighborhood, isn't a lot.

Now you would think that the price of a stock would rise when the company was doing well, when they were "making money", when income was greater than expenses. But this isn't always true. Take any one of the many dot com companies formed around the year 2000. Hardly any had more resources flowing in from sales than they had flowing out. The logic of that time, and it is still true in a few cases today, was that there was an Internet land rush going on and companies had to get out there and stake out their claims. If you wanted to claim the .com market for, let's say, selling toys over the web, then you had to spend a lot of money to buy programming staff and equipment to get your .com site up and running. You weren't expected to actually make more money than you spent. And stock prices rose as people who wanted to buy some of that .com stock bid up the price. The price rose not because of underlying fundamentals (the product or service was worth more than it cost to provide). Of course, many of these companies had a burn rate (how fast they went through money) that was so high that they spent all of their venture capital investments before they had any significant revenue stream to speak of. But they didn't actually go bankrupt until the dot com crash hit and it became difficult or impossible to get the next round of funding. The venture capitalists and the stock market simply stopped the flow of money into the organization. People who bought into the .coms were betting that there would be lots of potential in the future. The dot com crash came when it became more clear how hard it would be to realize that potential -- that the costs of doing business on the web are so high that it isn't easy to bring in more revenue than you spend.

What if a new continent were discovered?

As a thought experiment, think of the earth and that a new continent the size of North America were discovered. What would happen next? Let's say there are no people there, it's just bare land. If this were a thousand years ago then small bands of people would set out to settle. They would start farms and as they became more established and could spare time from food production they would start organizations to make their lives better, easier, more orderly, more secure. We can see from this example that the organizations they create would have as a deep reason for existing the provision of goods and services to support the settlement. But if a new continent were discovered today, what would happen? Governments might divvy up the land, then the global multinational corporations would come in to explore and build. If all they were doing was looking for a way to make a profit then they would be in business for the wrong reason. Their management would have to be encouraged to go beyond thinking about the short term and the next quarter's profits and instead think of why they want to be in business, why they want to be part of the exploration and development of the new land. Now think of Mars. We will get there eventually. Governments will be set up, people will live their lives. Whatever currencies those people develop, whatever way they divide up the land, whatever companies they set up and stock markets they create, they won't be on Mars to "make money".