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No businesses are “small”. They’re all productive nodes in a tightly connected knowledge-building value-creating network.

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There are roughly 32 million businesses in the US, of which 99.9% are what the government calls “small”. This classification of business accounts for about half of GDP and of total employment (making it just as productive as “big business”), and usually more than half of new job creation (making it more dynamic than big business). It’s often where innovation first enters the market, since small business is more open to risk taking than big business. If we remove the Fortune 500 and the Russell 5000, we’ve still got 32 million, rounded up, so let’s think of them as a community.

Within the 32 million, there is a wide range of size, whether measured by revenue or number of employees. The government in the form of the SBA (Small Business Administration) uses a range of up to 500 employees and a revenue of $7 million per year. But they also relax this range in different classification categories; their “small” financial and insurance business range goes up to 1,500 employees and $38.5 million in revenues. Clearly, there’s no consistency or integrity in their definitions, and not much useful information.

A better way to look at these businesses is as an integrated network of productivity, information flow, knowledge-building, innovation and value creation. 

Productivity:

Dr. Samuel Gregg in his book The Next American Economy identifies the decline in the formation of new entrepreneurial businesses as responsible for the significant decline in American productivity. These businesses have an intensified motivation to be productive; it’s hard to get capital, so they need to make the most of what they’ve got and find agile ways to borrow, rent or originate capital. They can’t afford productivity-sapping bureaucracy. They find ways to accelerate cash flows. They adopt new technological innovations quickly so as to take advantage of productivity enhancements. Productivity is essential for them.

Knowledge-building:

Bartley J. Madden in his book Value Creation Principles, identifies knowledge-building proficiency as the fundamental driver of firm performance. In the integrated 32-million strong network of businesses we are analyzing, information flows faster and more freely as a result of more network nodes, more connections between nodes, and lack of barriers to learning such as bureaucracy. These businesses know they must learn at speed, apply their learning fast and use it to serve customers better. There’s no learning time to lose.

Dynamic Efficiency:

Efficiency is an economic concept that hasn’t been very helpful for business in general. It tends to mean doing less with less: cutting costs, saving on inputs, not risking innovation, not attempting experiments with uncertain outcomes. But economist Jesus Huerta de Soto developed the contrasting concept of dynamic efficiency: fast adaptation to changing customer preferences, and rapid creation and adoption of new market knowledge, with an economy of time and agile decision-making.  This is the entrepreneurial method, and the way that the 32 million competes effectively with larger, better resourced but less agile firms.

Pure value creation:

Businesses generate cash flow as a result of the valuable customer experiences they enable. The value that customers perceive turns into willingness to pay, resulting in cash flow that is the life blood of small businesses who have less access to credit and debt to fund their working capital needs. The 32 million are acutely sensitive to cash flow, and therefore to customer value. They remove all obstacles to customer value, including bureaucracy, complicated service arrangements that obscure value visibility and take time, and any other obstructions they can identify. These businesses know that they must pursue pure value creation.

Customer focus:

The disciplines of dynamic efficiency and pure value creation demand an intense customer focus. The 32 million choose their customers carefully, develop a deep knowledge of them and their needs, nurture empathy to get on the same wavelength with customers regarding those needs, and are constantly listening for feedback and adjusting to any new signals that come through the feedback channel. This intensity of customer focus sustains the innovation and elevated quality of service that, in turn, secures continuity and strengthening of business relationships. That’s why these businesses are the backbone of the economy.

Unentangled with government:

The greatest barrier to all business-driven economic growth, progress and innovation is government. Both taxation and regulation are business-killers by intent. Big business becomes entangled with government. They develop big bureaucracies to comply with regulation, keeping them close to government and saddling the 32 million with disproportionate compliance costs if they’re forced to match big-business compliance practices. And big businesses assemble lobbying forces and budgets to design, write and pay for government approval for regulations that protect them and over-burden others. It’s this entanglement with government that condemns big business to permanent inefficiency, and also results in the kind of government-directed surveillance scandals that are currently being uncovered.

The 32 million is in no way small. It’s the vital, leading edge group that brings innovation, growth, development and dynamism to the economy. Let’s find another term than “small business”.

Corporate Layoffs Occur At Firms That Don’t Prioritize Customer Value Creation.

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Recently (Dec 5, 2022), Pepsico announced that it would lay off hundreds of workers “in headquarters roles”. The lay-offs memo was signed by the CEO of PepsiCo Foods North America and the chief human resources officer of Frito-Lay North America. These executives stated their purpose was to “take steps again to simplify the organization so we can operate more efficiently”. Why, one wonders, were they not operating more efficiently prior to this announcement? Presumably, more efficiency is a good thing, and should be sought at all times.

Pepsico is not alone. A December 4, 2022 entry on intellizence.com has a long list of layoffs at companies including H&M (1,500 layoffs), United Furniture (2,700 layoffs), Alphabet (10,000), Hewlett Packard (6,000), Cisco (4,000), Amazon (10,000), Meta (11,000), and Credit Suisse (9,000). The list goes on.

The purpose of a firm is to create value for customers. Bartley J. Madden, in his book Value Creation Principles, expands the idea of purpose to “communicate a vision that can inspire and motivate employees to work for a firm committed to behaving ethically and making the world a better place”. This concept of purpose includes knowledge-building to learn how to serve customers better, and sustaining win-win relationships with all the firm’s stakeholders – including employees, of course. If employees are to be inspired, they should expect to be treated fairly and with respect. They should be treated as individual value creators, empowered, trained, informed, and given the autonomy to make decisions that further value creation for customers.  Fundamental to the Bartley J. Madden vision is long-term sustainability. Value creating firms ignore the demands of Wall Street for quarterly returns and the maximization of shareholder gains, and focus on building the real assets in the firm – through capital investment and innovation projects – that can continue to deliver customer satisfaction for decades and longer. Financial returns are an outcome of this commitment, but do not represent the purpose of the firm. Maximizing shareholder returns does not qualify as a vision in this worldview.

A value creating firm that aims at genuine sustainability adds to its assets when those assets are demonstrated to be value drivers. Madden points to the knowledge-building proficiency of the firm as the critical element in long-term success or failure. Knowledge-building is a learning process: learning what drives value for customers. Customer value is subjective – an experience, a feeling, something that can’t be measured via the standard quantitative metrics. But there is an indicator of customer value that can be relied upon, and that is cash flow. Cash flow is value created in the customer domain flowing back to the corporation as revenues. Customers advance through a value learning cycle that begins with evaluating whether or not any proposition has potential value for them, then comparing it with alternatives, and then arriving at the point of exchange which we can call  “willingness to pay”. If willingness to pay is positive, the firm receives revenue, indicating that the customer has committed themselves to the experience of value in the expectation of satisfaction. If the customer repeats the cycle and buys again, it’s an indicator that the value experienced met their expectations. There’s a second flow of cash to the firm.

There’s a direct connection between cash flow and value creation. Therefore, through experimentation and analytics, a firm can identify its value drivers, those assets most positively and most directly generate customer value. These value drivers can include assets like brands, specialized expertise, technologies that generate desired customer experience (like speed and convenience and ease of use), and highly refined knowledge that defines the firm as the go-to reliable expert. Value drivers can also include human capital – the people who work at the firm, immerse themselves in the knowledge-building process, contribute to its further development, and become value creators in their own right.

So why would a firm lay off hundreds of such people “in headquarters roles”? Presumably, they wouldn’t fire value creators, for that would be depriving customers of value, which is the opposite of the firm’s purpose.

Or is it? In fact, what these layoffs reveal is that customer value was never these firms’ purpose in the first place. In this age of financialization, the purpose of the firm is maximizing its returns to shareholders (who include the CEO and the Board and the rest of the C-Suite, as well as Wall Street and institutional investors, but seldom customers). Those returns are assessed at minimum quarterly and often more frequently. If those returns, or pre-indicators of those returns such as revenues or margins, turn downwards, the stock price can easily decline, slamming the brakes on shareholder returns. An easy fix is to reduce costs, to restore margins and profits, and the easiest cost to reduce in the short term is labor – people. 

Clearly, the people who have been laid off must not be in value creating jobs. They’re not driving trucks and stocking shelves. So why were they hired in the first place? The reason is that there’s a purpose of management other than creating value for customers. They want to increase their department size, and the number of people they supervise, because the incentive compensation system rewards them for that. It’s an increase in power for managers. They’re short-term thinkers, and they don’t anticipate the layoffs to come; they’ll take the power and compensation increase now, and worry about the layoffs when they come.

That’s why not only the purpose of the firm must be examined to make sure it’s truly oriented to customer value, but also management itself must be reimagined because it is too often not value creating, it’s value destroying. Middle management, especially, is value-destroying. Bart Madden points to the efficient value generation of firms like Nucor in the steel industry, with only 4 layers of management from CEO to the factory floor, and compares it with traditional steel industry competitors who might have as many as 12 layers of management.

When a firm is truly focused on customer value generation, they wouldn’t hire these bureaucratic “headquarters roles” in the first place, and then they wouldn’t resort to layoffs to solve the problem they created for themselves.

Customer Value Is All That Matters In Business.

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Value creation is – or should be – the number one concern of every business and everyone in business. The term means value for customers. If a firm does not generate value for customers, it is not in business and can’t possibly serve other constituencies like employees, shareholders, stakeholders, and local communities.

Businesspeople must think deeply about value and understand it fully, and it’s not always the case that they do. Let’s start at a higher level than the business firm, at the level of the economy. What is an economy? It’s how well-off a group of people make themselves with the resources they have available to them to work with. It’s the shared well-being of that group of people. It’s their quality of life, their enjoyment, and their satisfaction. In other words, the economy is not just the goods and services we produce or the dollars we exchange with each other to buy and sell goods and services. The economy is value that is generated for people – feelings of satisfaction, of joy and reassurance, and security, of meeting not just functional but also emotional and spiritual needs. The pursuit of economic value takes on purpose and meaning when it’s viewed through the eyes of people – and people are customers for business.

If we now return our focus to the level of the individual firm and its customers, we realize that value generation at this level in the economy must embrace and address the same feelings of satisfaction, joy, emotion, and spirituality. These feelings must be present in the value propositions that businesses make to customers. Each individual customer’s current state is a dynamic function of multiple values that they are trying to balance. You can refer to various analytical models for people’s value bundles. Here’s one called the Schwartz Theory of Individual Values. A quick look tells you that people are integrating values as diverse as pleasure, conformity, and security (and many more) into their everyday decisions and choices. The balance changes in every situation and from moment to moment.

Any business engaged with any customer at all must be conscious of the range of individual and cultural values that are in people’s minds and consciousness. If your customer is part of a firm in a B2B relationship with you, then you need to take account of the shared values of the firm you are dealing with, which will color and shape the decision-making of the individual you are engaged with.

From this perspective, value creation can be seen as pretty complex. Quite forbidding, even. How do businesses manage? There are a couple of simplifying approaches.

Get the direction right.

Value is a process. Your customer is continuously learning about value – what they themselves value in any specific situation and at any specific time. Their evaluation is changing. But they are seeking one direction, which we can call betterment: improving their feelings of satisfaction. Value is a change in status from one of less well-being to one of greater well-being. It is an increase in well-being. That means that you may not need to understand every nuance of the balance of the customer’s multi-functional values system. You just need to measure and monitor whether their feeling of well-being and satisfaction is moving in the right direction, towards betterment.

Get aligned.

While it is probably too demanding to try to identify every position of every customer on every vector of the Schwartz Value System or one like it, there is a less demanding way of value mirroring, and that’s alignment. If your position on your own value system is reasonably well aligned with your customer’s (you’re not in conflict, at least), and perhaps even better aligned than your competitor’s, then there’s a good chance of forming a value partnership: you make a value proposition that they can feel good about accepting. Alignment comes from an analysis of what matters. What matters most to your customer? You can ask them; it’s often very hard for them to articulate their values, but they might be able to answer a question about what’s important to them, at least at this time, in this situation, and regarding this deal. (Bill Sanders told us how just asking the question can “expand the value pie” in any contract negotiation with any customer.)

If what you think matters is close to what the client thinks matters, then there is the opportunity to become value partners, to make a deal or make a sale or make an exchange.

Empathy And Knowing Your Customer.

The business skill that underpins the generation of customer value is empathy. This is not a casual “get inside the customer’s head” routine. Value empathy is a product of the rapidly advancing knowledge of neuroscience that is spreading into business methods, combined with an understanding of complex adaptive systems thinking. Empathy starts from the concept of a mental model – a way of seeing the world and processing the information gleaned from sensory inputs – hearing, seeing, touching – into an individually cogent perspective. Every individual operates a unique and different mental model. The process of empathy is first to construct someone else’s mental model – the customer’s – and then run new information through it – the new value proposition that the business wants them to consider. If the business has constructed the customer’s mental model accurately, it should be possible to make a reasonable prediction as to how they will react to the value proposition. It’s not infallible, but it’s also not guessing, not projecting, and not wishful thinking. It’s not even marketing – that comes later if the business wants to attempt to change or modify the customer’s mental model. There’s a learning process, and humility is called for in thinking about customers’ complex mental processes.

Empathy is knowledge-based, unlike sympathy, which is emotional. Therefore, the more a business knows its customers and the more they know about their customers, the greater the potential for an accurate empathic diagnosis of the customer’s mental model. The first step in value creation is selecting the right customers for your business – customers you can know well and will enjoy knowing.

A Value-Dominant Business Culture.

Many of the criticisms aimed at big corporations today are the result of businesses’ failure to understand value. The claim to maximize shareholder value, but this is a financial calculation, not the generation of valued experiences for customers which is the true purpose of business. They claim to pursue stakeholder value, where the term stakeholder is amorphous, but generally taken to include employees, the population of the communities in which offices and factories are located, sometimes the environment, and sometimes even the government. None of these business activities fall under the true heading of value creation – only customer value fits. All else follows: profits (signals from the customer that they fully approve of the value they receive), stock price appreciation (reflecting the discounted future cash flows from satisfied customers), and stakeholder benefits (profitable companies with a loyal customer base are more likely to support all of their other constituencies).

Customer value takes care of all the other values. That’s why it’s all that matters.

How Can Big Companies Act More Entrepreneurially? Install A New Value Engine.

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Austrian economics recognizes the function of entrepreneurship as the driver of the market economy. It’s the process that recognizes consumer dissatisfaction – the experience they always have of knowing that something better than today’s status quo is possible but not knowing how to create it for themselves – and, with insight and brilliance and flair and a lot of experimentation, translates that expression of dissatisfaction into a design for a new offering, a product or service that will deliver the better experience the consumer craves. Entrepreneurship economic alchemy.

We tend to associate entrepreneurship with small, new, and fast-growing businesses. Disruptors. Gazelles. They’re on the fringe but aiming for incursion.

Yet this perception can’t be right. Entrepreneurship is the generation of new economic value, the improvement of lives in all kinds of ways all over the planet. Innovation and improvement are abundant and ubiquitous. Entrepreneurship is much more broadly distributed than just startups and small businesses.

In fact, many big companies deliver innovations and improvements to customers. Apple and Amazon, to pick a couple at random from the beginning of the alphabet, have consistently delivered both fundamental and incremental innovation in products, services, interconnections, and infrastructure. They have generated genuine customer value – improved lives through enabling greater productivity, resourcefulness, knowledge-sharing, convenience, low cost and new capacities for work, leisure and interconnection and collaboration.

But those same companies are burdened with the edifices of bureaucracy: the middle management layers that strangle the creativity of front line producers; the internal rules and regulations that crush creativity and flexibility and adaptiveness; the compliance functions of HR and finance that prevent exploration; the fixed allocation of resources that mandates against experimentation. In a modern dynamically complex economic system, bureaucracy can be destructive of future potential and sometimes fatal to it.

The entrepreneurial large company sustains innovation and destroys bureaucracy. We can highlight a few ways in which this can be brought about, although, of course, a complete cultural reversal will be required to bring about the end of bureaucracy entirely.

Bring customer value inside the firm.

The purpose of a firm is to facilitate customer value. For leading innovators, the concept of customer value is not simply an external outcome to be targeted, it’s an internal standard to be measured.

For example, the Vision and Mission for Microsoft under Satya Nadella’s leadership are:

  • VISION: to empower every person and every organization on the planet to achieve more.
  • MISSION: to help people and businesses throughout the world realize their full potential.”

Steve Denning at forbes.com writes:

Nadella gave operational substance to the abstract concept of empowering customers. Nadella embraced the idea of empathy and understanding customers and anticipating their unexpressed needs. He lived the mission and insisted on measurement to ensure that it was real. 

As Brad Anderson, Corporate Vice President of Enterprise Client and Mobility at Microsoft said, staff found that if they were having a meeting with Nadella, they had to begin with the numbers of customer usage, not technology, schedules, sales or profits. This underlined the principle that customers were truly number one. It turned Nadella’s concept of empathy into something tangible and measurable.

“When you go in to talk to Satya,” said Anderson, “you start with the customer. ‘What’s the customer’s problem? What are they trying to solve? How are we making their life better?’ And so, this concept of customer obsession and being really close to customers has been incredibly important.”

https://www.forbes.com/sites/stevedenning/2022/03/13/how-measurement-makes-deep-purpose-work/?sh=5f154094514c

Make Marketing the primary capability.

Marketing has been trivialized in business schools and in business thinking as communication of a company’s promise to the customer in persuasive terms. But its original role was to better understand markets, and how they generate value by aligning the value creation wants of the customer with the value facilitating capacities of the producer. As Fernando Monteiro D’Andrea and Fernando Bins Luce write, Marketing deals with everything that is relevant for the imagination, production, communication, and distribution of goods or services that might be valued by a group of customers.

This is a broad mandate. Marketing as a capability – spread through the firm and not just located in the Marketing Department – is charged with listening to the customer and deducing unaddressed wants from conversations about dissatisfaction, spreading this understanding throughout the firm to enable innovative responses, organizing all the responses into an offering to take back to the customer, and monitoring experience with the new offering, thereby opening the next feedback loop. Marketing is the dynamic integration of customer value and the productive capacity of the firm. It’s a core competency, not a department.

Establish a marketing-orchestrated co-creation process.

Value is co-created. Only the customer can identify value gaps from their own subjective perspective, even though they can’t articulate what will fill the gap for them, since it hasn’t been invented yet, and they are not the inventor. Only the producer has the resources to invent the new solution, recombining resources in new ways, experimenting with R&D, testing and perfecting. The integration of these two perspectives on value is co-creation. It’s ongoing dialogue, a mutual exploration of value potential and a shared development of value realization.

To follow the Microsoft example of empowering customers requires customers to imagine what they’d like to achieve and to illuminate what’s missing in current products and applications, and it requires listening and attentive producers who can creatively translate this information into innovation ideas. The orchestrator for this shared responsibility is Marketing – the capability, not the department.

Integrate Operations, Finance and HR into the co-creation flow.

In order to leverage the entire productive capacity of the firm in innovation, the orchestration process must engage all the parts. In addition to marketing, these are usually identified under the broad headings of Operations, Finance, and People, the latter usually being called the HR function. All of these functions need to be integrated into the flow of co-creation of value. As Cabrera Research Lab reveals from their study of firms as complex systems, this integration is achieved by getting all members of the firm in every function and every role aligned around the same customer-first mental model. Alignment confirms the vision and mission of value creation. That’s what Satya Nadella has done at Microsoft.

With these four organizational steps accomplished, corporations of all sizes can drive value creation with a new engine.