Good Profit and Bad

Our friend and mentor John Case coined the term Open-Book Management when he was an editor at Inc. magazine. He has written extensively about it for over twenty years.

His thoughts about the ethics of Profit form a cornerstone of our work. This article on the topic is reprinted here with his permission. 

Anyone paying attention to the news today will find one report after another of businesses whose pursuit of profit has robbed their unwitting customers, made their workers sick, polluted the environment, etc. Profit is a dirty word among many who are skeptical of—or downright hostile to—conventional business. In the United States, as elsewhere, that’s a significant number of people.

Profit by itself shouldn’t be a dirty word. It’s an indicator of financial stability and success. Companies that don’t earn healthy profits over the long term don’t stay in business. Even nonprofits—the label is something of a misnomer—have to bring in more revenue than they spend, or they too will go belly up.

The trick is to distinguish between bad profits and good ones.

We owe this distinction to Fred Reichheld, the Bain & Company guru who developed the Net Promoter System®. Reichheld is primarily concerned with how companies treat their customers, so he defines bad profits as “profits earned at the expense of customer relationships”:

 Whenever a customer feels misled, mistreated, ignored, or coerced, profits from that customer are bad. Bad profits come from unfair or misleading pricing. Bad profits arise when companies shortchange customers…by delivering a lousy experience. Bad profits are about extracting value from customers, not creating value. When sales reps push overpriced or inappropriate products onto trusting customers, the reps are generating bad profits. When complex pricing schemes dupe customers into paying more than necessary to meet their needs, those pricing schemes are contributing to bad profits.

It’s not hard to expand this definition a bit. Bad profits are profits earned at the expense of a company’s employees. They’re profits earned by underpaying or mistreating or exposing to danger the people who work for you. Bad profits are profits earned at the expense of the community, for instance by polluting the air or figuring out some barely-legal tax dodge.

Reichheld’s definition of good profits is equally useful and equally expandable:

 If bad profits are earned at the expense of customers, good profits are earned with customers’ enthusiastic cooperation. A company earns good profits when it so delights its customers that they willingly come back for more—and not only that, they tell their friends and colleagues to do business with the company….The right goal for a company that wants to break the addiction to bad profits is to build relationships of such high quality that those relationships create promoters, generate good profits, and fuel growth.

From an employee’s point of view, good profits are those that fund living wages, incentive plans, and decent benefits. Good profits ensure job security and open up new opportunities. From the community’s point of view, good profits are those that allow a company to pay its taxes, maintain and improve its property, and generally act as a good corporate citizen.

The issue, of course, is who determines which profits are good and which bad, and how that determination affects a company’s actions.

The essential step is measurement.

Reichheld’s Net Promoter System creates a metric—the Net Promoter Score—that tells how likely a company’s customers are to recommend it to friends and colleagues. It’s a useful gauge of how people feel about doing business with the company.

Measures of employee engagement — satisfaction levels, on-the-job behaviors, turnover rates, and so on — are a rough-and-ready indicator of how a company treats its workforce.

A company’s reputation in the broader community may be the best measure of its corporate citizenship, albeit an imperfect one. (Reputation is notoriously hard to track accurately, in part because it can be manipulated through corporate-image advertising.) Perhaps a company would want to ask a trustworthy third party to rate its citizenship every year in comparison with similar companies.

Negative changes in any of these indicators may indicate that a company is relying more and more on bad profits. Positive changes are likely to indicate the opposite. But will management teams and boards of directors feel an obligation to move these needles in the right direction? In most cases, they will do so only if they have made a public commitment. That’s why investors, co-op members, employee owners, and other stakeholders need to ask themselves: what is our corporate commitment? Are we standing by it, and are we measuring it?

If the commitment is there, if the company’s performance is tracked, and if leaders consistently take action to improve on all fronts—that’s when we’ll know that profit isn’t a dirty word at all.

– John Case