99% Of Businesses Practice Free-Market Capitalism. Our Largest Corporations Practice Something Else.

Markets are incredible. They are the poetry of economics. We use them every day to solve complex social issues.

These phrases are taken from Anthony J. Evans’s book Economics: A Complete Guide For Business. Professor Evans is right: we don’t appreciate the wonder of markets as much as we should. They enable people who don’t know each other to collaborate and exchange worldwide and to find their specialties and contribute individually in the most productive way they can to the economic growth, progress, and prosperity that eliminates poverty and elevates prosperity and makes lives everywhere more comfortable, safe and purposeful.

Within markets, there are producers and consumers – firms and their customers. 99.9% of the firms are what are often called small businesses. They’re the backbone of the economy, acting as the producer in collaboration with customers in the co-creation of the majority of economic value. Their mode is entrepreneurship, the customer-centric approach to business that elevates the identification and understanding of customer needs to the level of primacy above all other activities. The understanding of customer needs is the necessary and irreplaceable asset in which these businesses know they must invest. Once they have assembled the asset, they creatively apply it to the design and delivery of the best solution among all those the customer could choose from. These businesses understand what Austrian economists refer to as customer sovereignty: the customer is the boss and decides which firms are successful or not successful – i.e. receive the market’s reward or the market’s penalty – through their buying or not buying what’s on offer.

In these cases, we can think of business firms as mini-markets. They operate via the matching of supply with demand. The fundamental market signals of customer choice (whether the customer is willing to buy or not) and pricing (what the customer is willing to pay) flow through the firm as indicators of how the firm should allocate its resources – how much to invest in particular lines of production or service, how assets should be allocated and focused, who should work on what, what improvements are needed, what innovations should be targeted to the future, what to spend R&D dollars on. In the metaphor employed by Austrian economist Ludwig von Mises, the customer is the captain of the ship, and the business takes the captain’s orders and points the ship in the direction the customer wants to go.

In aggregate, that’s why markets are incredible. They are tools for us all to co-create the value we seek, and collaborate in making life better for all of us.

Outside of the 99.9%, however, value co-creation is not quite so pure or unadulterated. In the big corporations that dominate the business news and many people’s thinking about the production side of the economy, there are three significant distractions from customer value creation.

The focus on shareholder value detracts from customer value creation.

The maximization of shareholder value has been an almost exclusive focus of the largest S&P 500 companies over their recent history. Maximizing shareholder value means that the customer is not in first position for these corporations. Not their first priority, not the most important focus of their time, effort, resources, and investment. They have more important things to do.

One of those things is the buying back of their own stock from shareholders, a pure act of financial engineering designed to boost total stockholder returns. Reducing the number of outstanding shares on the market artificially inflates a key measure of a company’s value: its earnings-per-share, or EPS. Buybacks are often followed by an immediate surge in stock price, at least in the short term. According to Knowledge At Wharton:

The buyback boom began in the 1980s, and has only accelerated since. In the last decade, the author writes, “American firms have spent a stunning $7 trillion buying back their own stock — the equivalent of half their profits.” In the last two years, buybacks and dividends have actually exceeded the net earnings of publicly traded American companies. Adding insult to injury, companies like Apple often fund these buybacks, not by dipping into their substantial cash reserves, but by borrowing. In 2013, despite having $145 billion in the bank, Apple borrowed $17 billion.

The Institute For New Economic Thinking reports

The most egregious buybacks offender is Apple, which from October 2012 through December 2021 threw away $484 billion—92 percent of its enormous net income—on open-market repurchases, the sole purpose of which was to boost the company’s stock price. In addition, Apple funneled $118 billion in dividends to shareholders, sucking up another 23 percent of net income. For March 1, 2022, Apple’s safe-harbor daily “limit” for buybacks under Rule 10b-18 was $3.5 billion.

Knowledge At Wharton summarizes the financialization of American business this way:

Today, finance, while making up only 7% of the economy and creating a mere 4% of all jobs, generates more than a fourth of corporate profits. Large corporations increasingly came to mimic the banks that were supposed to serve them and to seek profits in ‘financial engineering.’

Bureaucracy Has No P&L Motive And Therefore No Customer Focus.

In his book titled Bureaucracy, published in 1945, economist Ludwig von Mises outlined the threat that an expanding bureaucracy poses to economic prosperity and a free society. His concern was with government bureaucracy. He did not believe that private companies would develop throttling bureaucratic structures, because bureaucracy develops where there is no profit and loss motivation. Companies can’t afford bureaucracy that is not responsive to customer signals, because the approval of customers determines whether the company is profitable or not, and whether it survives.

He was wrong. Our largest corporations have now been overrun with their own internal bureaucracy. It started as compliance: bureaucracy as a defense against government legislation and regulation. When government creates OSHA (Occupational Safety And Health Administration) for example, firms must create an OSHA compliance bureaucracy, people, and resources that are dedicated not to creating customers and fulfilling their needs but to compliance with OSHA directives and standards. There are many such government departments and repositories of regulations that require corporate compliance bureaucrats.

But recently, the role of bureaucracy in corporations has changed. It is no longer confined to the defensive role of avoiding the fines and jail sentences the government hands out to those who fail to comply with regulations. The corporate bureaucracy has now gone on the offensive. It proactively asserts, in the names of its acronymic policies of ESG, DEI and CSR, the right to compel corporate behavior that has nothing to do with serving customers and everything to do with curtailing the capitalist focus on profitably serving customers. Bureaucracies impose internal costs on the firms that employ them, and make sales and revenues more difficult to attain, not easier. The anti-capitalists have infiltrated capitalism.

Ludwig von Mises was right: bureaucracy lacks the profit-and-loss motivation that drives businesses to thrive. Now it’s no longer the external enemy but rather the virus inside the system.

Crony Capitalism Is Not Capitalism.

The third stage of corporate decline following financialization and bureaucratization is statification: they become the state, they merge with government so that it becomes hard to know whether the state owns the means of production or the means of production own the state. In the US, we refer to the outcome of this merger as crony capitalism, but it’s worse than that mild term for fascism implies. The corporations begin to be policy designers and implementers, such as Shell Oil on climate change policy and Ford Motor on energy policy. In the opposite direction, Amazon becomes a recipient of government subsidies.

As George Orwell put it:

The creatures outside looked from pig to man, and from man to pig, and from pig to man again; but already it was impossible to say which was which.

George Orwell, Animal Farm

For customer-first capitalism, we must look to the 99.9% who are not at the trough like the pigs and the farmers – the corporations and the government – and who uphold the promise of free markets and their customer-granted rewards.