Principle 2: Maximizing Value Rather Than Profit

The 2nd Principle of the Contributist Business Model

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This is the second of the three principles of the Contributist Business Model, part of the Reclaiming Business series.

Principle 2: Maximizing Value Rather Than Profit

What does a contributist business look like in action?

Consider the below excerpt from a 2005 New York Times article describing Costco’s business strategy under its then-CEO Jim Sinegal:

Combining high quality with stunningly low prices, [Costco’s private-label dress shirts] epitomize why some retail analysts say Mr. Sinegal just might be America's shrewdest merchant since Sam Walton.

But not everyone is happy with Costco's business strategy. Some Wall Street analysts assert that Mr. Sinegal is overly generous not only to Costco's customers but to its workers as well.

Costco's average pay, for example, is $17 an hour, 42 percent higher than its fiercest rival, Sam's Club. And Costco's health plan makes those at many other retailers look Scroogish. One analyst, Bill Dreher of Deutsche Bank, complained last year that at Costco "it's better to be an employee or a customer than a shareholder."

Mr. Sinegal begs to differ. He rejects Wall Street's assumption that to succeed in discount retailing, companies must pay poorly and skimp on benefits, or must ratchet up prices to meet Wall Street's profit demands.

Good wages and benefits are why Costco has extremely low rates of turnover and theft by employees, he said. And Costco's customers, who are more affluent than other warehouse store shoppers, stay loyal because they like that low prices do not come at the workers' expense. "This is not altruistic," he said. "This is good business."

I recommend reading the full NYT article, which details how Costco continues to outperform its more profit-centric competitors, and how Wall Street analysts continue to oppose its generous strategy despite the evidence. Although Sinegal, who started his career as a grocery bagger, argues persuasively that his business model is more sustainable in the long run, you can tell that what truly motivates him is providing value to his customers and caring for his employees (his dual responsibility).

In other words, the difference between Sinegal and his competitors and critics is not simply about business savvy, or shrewdness. (And he’s certainly not a careless spender — the article describes his cutthroat negotiations with suppliers, and his unwillingness to overcompensate executives.) The true source of controversy here is his business’s contributist orientation.

But wait, you might be thinking. You can’t call Jim Sinegal a contributist! He’s almost certainly never even heard that word. Isn’t he basically just a different kind of capitalist?

He certainly might describe himself that way. But I would argue that one of the key first steps to developing better ideas is to start using more precise language. And Costco’s business strategy is strikingly different from its competitors; I think this difference is something worth naming.

So, humor me. For the sake of this discussion, let’s use a somewhat more precise definition of capitalist: a person who operates according to the principles of capitalism, chief among which is the profit motive. A contributist is someone who instead operates according to the principles of contributism, chief among which is the right to give — to participate in society by contributing to it.

In practical terms, this means that the capitalist business aims to maximize the profit that they can sustainably extract, while the contributist business aims to maximize the value that they can sustainably provide. As Costco’s example shows (and as I’ll get into more detail on below), this means that contributist businesses tend towards increased quality and lowered prices as compared to their capitalist competitors.

To be perfectly clear, when I say the capitalist does this or the contributist wants that, I’m talking about the perfect capitalist and the perfect contributist. In messy reality, no one is a pure capitalist and no one is a pure contributist. But we are capitalists insofar as we choose to let the concerns of capitalism guide our behavior. And we are contributists insofar as we choose to be guided by the concerns of contributism.

By my understanding, most of our business leaders actually fall somewhere in the middle — encouraged, perhaps, by their communities and their consciences to be contributists, but ultimately guided by the current prevailing ideologies and corporate structures to become capitalists.

Also, I’m focusing here on primary motives. Of course the capitalist wants to create a good product, but this goal is secondary to their goal of achieving profit. When improving their product is helpful for increasing profit, as it often is, the capitalist will improve the product. But when the two goals are in conflict, they will always choose a better profit over a better product. The contributist, on the other hand, will strive to make a profit when it helps them to provide a better product. But when the two goals are in conflict, the contributist will choose a better product over a better profit.

My goal in this article is to show you why I think the contributist business’s orientation is better than the capitalist one, both holistically and economically. Because while maximizing profit may appear to be in the best interest of the business, it only looks that way from a very short-sighted perspective.

What Is a Good Business?

According to capitalist economists, a good business is one which is able to maintain low production costs while maintaining high consumer prices. The difference between these two amounts is called the margin, and it is what the business takes as its profit. Capitalist businesses will tend to increase their prices to the point of maximum profit — that is, the highest price point at which consumers will still buy the product. In a capitalist economy, prices will settle here, having reached what is called an equilibrium — each party having maximized the value they can extract from the other.

But not all businesses are capitalists, nor are all economists. Alongside the economists who designed the capitalist models that have now become normative (John Maynard Keynes, Milton Friedman, etc.), there have always been those who saw deep inefficiencies within capitalism. Henry George, whose book Progress and Poverty was reportedly more popular than Shakespeare in the early 20th century, coined the term economic rent to refer to the practice of charging more for a good or service than is warranted based on its cost of production. He saw this practice as the primary cause of poverty in developed societies, and famously argued that a tax that effectively recaptured economic rent (specifically from land-owners) and redistributed it across society would be sufficient to eradicate poverty entirely.

The contributist is more Henry George than Milton Friedman — though reasonable contributists might disagree on the proper role of taxation. In any case, from the contributist perspective, maximizing margin is not a hallmark of a good business. Instead, the contributist sees maximizing value as the best business strategy.

Remember the NYT excerpt from the beginning of this article? Here’s another excerpt from the same article, explaining Costco’s approach to profit margins:

He also dismisses calls to increase Costco's product markups. Mr. Sinegal, who has been in the retailing business for more than a half-century, said that heeding Wall Street's advice to raise some prices would bring Costco's downfall.

"When I started, Sears, Roebuck was the Costco of the country, but they allowed someone else to come in under them," he said. "We don't want to be one of the casualties. We don't want to turn around and say, 'We got so fancy we've raised our prices,' and all of a sudden a new competitor comes in and beats our prices."

At Costco, one of Mr. Sinegal's cardinal rules is that no branded item can be marked up by more than 14 percent, and no private-label item by more than 15 percent. In contrast, supermarkets generally mark up merchandise by 25 percent, and department stores by 50 percent or more.

How is it possible that this strategy works for Costco? Because contributist businesses see business strategy differently. Although extracting maximum value from the consumer might increase the capital controlled by the business in the short-term, the contributist takes a more expansive view, and sees that this isn’t necessarily the best outcome for anyone involved, holistically or economically.

Maximizing Profit Hurts the Human

First, let’s look beyond economics. The profit maximization strategy may look good when we maintain a purely economic lens, but if we take a more holistic perspective, it becomes easy to see that seeking to maximize margin is not an optimal way of being for the business leader.

Giving is the act of providing value to another that might otherwise be kept for oneself. This act humanizes us and provides us with dignity. In an act of giving, the giver and the receiver see one another, and thereby enter into a true human relation; the giver both becomes and feels valued by their community. For business leaders, these benefits only multiply as a business scales — a business leader whose business provides value to a large swath of society becomes a person of immense dignity.

But when a business leader’s goal is to set the price of their goods or services at the highest point that people will pay, they forfeit all of these benefits. They are no longer giving, because they refuse to provide any value to the consumer without full compensation. And they are perhaps even taking, if they manage to get the consumer to pay more than the product is credibly worth. What could have been an act of giving instead becomes an act of unfeeling transaction at best, or cold exploitation at worst, from which both parties leave hardened, their relation and their dignity unimproved, and perhaps worsened. No one sees the other in these transactions, because both parties are too busy being oriented towards themselves. The result is that, regardless of the economic picture, the society itself is worse off, each transaction ever-so-slightly loosening the social bonds that hold it together.¹

Economic welfare is not equivalent to social welfare. A society which teaches itself capitalism — which insists that it is economically necessary to maximize what we can take rather than what we can give — ultimately leads itself to social disarray, regardless of the economic robustness of the capitalist position.

Maximizing Profit Hurts the Economy

That said, it is still worth emphasizing that the capitalist position is not economically robust. The problem with profit maximization extends beyond our dignity and humanity — it is also an economically suboptimal business strategy. By capturing as much excess value as possible, the capitalist business actively limits the generative economic potential of its own capital.

To understand this, let’s put on, for a moment, a “purely economic” lens — putting aside all the talk of dignity, holistic welfare, and social good — and delve a bit further into the boring stuff: economic theory.

From a purely economic perspective, the core problem with the capitalist argument is that it under-appreciates the consumer’s role in economic markets. In reality, the consumer is just as important to economic markets as the producer. By choosing how and where to spend their money, the consumer guides businesses to make products that better meet their needs.

In other words, the consumer’s buying power is what creates economic competition. It is what incentivizes businesses to create better products — so that the consumer will choose to spend money on their products rather than those of their competitors.

Because the consumer’s buying power is capital, it is fungible — this means that it can be used to buy a wide variety of different types of goods and services that a person might need or want. When consumers have a lot of buying power, they spread that buying power all across the economy — increasing competition in groceries, car manufacturing, housing, movie-making, pottery, video game development, and so on and so forth. As a diversity of consumers employ their buying power across the economy, every industry gets a small slice of this benefit, and the whole of the economy improves, making the quality of goods increase over time. Everyone in the economy, even the business owners, benefits from this wholesale economic improvement.

But the inverse is also true. When consumers have less buying power, they do less to generate economic improvement. When consumers can’t afford much more than their basic needs (housing, groceries, transportation, etc.), they become less quality-conscious and more price-conscious — rather than seeking the best product, they begin to seek the lowest price. This changes the incentives for businesses, as they find that the penny-pinching consumer actually prefers a worse product if they can get it for dirt cheap. So, output remains high, but the quality of goods and services decreases over time. And just as the benefit of strong consumer buying power is spread across every industry, so is the impact of weak consumer buying power. Everyone in the economy, even the business owners, lives in a society that is increasingly populated with worse stuff.

Here’s where we begin to see the problem with the profit maximization strategy. A business’s profit doesn’t come from nowhere — it comes directly from the consumer.² The economic relationship between the business and the consumer is (again, from a restricted economic viewpoint) zero-sum. Every dollar above cost that the business takes from the consumer (economic rent) is one less dollar of buying power that the consumer is left with. That is, it is one less dollar leading to the overall economic improvement of society.

At this point, anyone who has ever run a business will likely have a host of concerns with this line of thinking, and may already be preparing counter-arguments: Don’t businesses need to make a profit to improve their product and to outperform their competitors? Don’t business leaders need to make a profit in order to be incentivized to keep innovating? Aren’t business owners also consumers whose buying power can stimulate the economy? Don’t businesses re-invest some of their earnings back into the economy by paying their employees?

The contributist answer to all of these questions is: actually, yes!

The difference between the contributist business and the capitalist business is not that the capitalist seeks to make a profit and the contributist avoids making one. Rather, what distinguishes the contributist business leader is that they are oriented towards giving. When they do seek a profit, they do it in service of their goal of providing further value with the resources they take. This means that a contributist business leader aims not to take a single dollar from a consumer except that they are confident that the dollar will go to good use.

Note that Jim Sinegal didn’t set Costco’s margins to zero. He set them to 14 to 15% — a number significantly lower than his competitors, but presumably, the number that he believed best accounted for all of the questions above.

This is an entirely different orientation than the capitalist’s orientation, which seeks to maximize profits. The capitalist doesn’t ask the questions above — at least not in good faith. They’re not truly interested in performing a cost-benefit analysis about whether this or that amount of profit really provides the best value to society. Strategically, they’re working in the opposite direction — they’ll provide only as much value as will allow them to make the maximum profit.

The difference is that contributists enrich their communities, while capitalists accelerate their decay.

Maximizing Profit Hurts the Business

But still, isn’t it in the best economic interest of the capitalist’s business to seek to maximize profits, even if it is not in the best interest of society? Even if society is worse off overall, can’t the shrewd capitalist business leader extract enough benefit for herself and her company that she still comes out ahead?

This perspective is short-sighted for multiple reasons. First, we must remember that the economic lens is itself limited. Even when a business leader comes out ahead economically using the capitalist business model, they generally do so at the cost of their own dignity, and they usually find that they have sacrificed much of what they valued most along the way.

Second, the economic benefit of the capitalist business model is always precarious, because any effort to help oneself at the expense of society is inherently a product of short-term thinking. Despite their endless efforts at shoring up personal economic security, the capitalist can never truly insulate themselves from their detrimental impact on broader society. Economic gluttony ultimately catches up to all of us. Our global economic system has experienced multiple severe crashes due to the profit maximization model, and it will happen again. Meanwhile, humanity faces the existential crisis of climate change as a direct result of the capitalist business model, and instead of helping to solve this problem, the wealthiest capitalist businesses continue to lead us headlong into it by investing billions into technological cold wars with worrisome impacts on our climate. And lest our government regulate us into a better trajectory, these same billionaire capitalists are now “shrewdly” working to turn it into an oligarchy that can be expected to serve only their short-term interests, even to the long-term detriment of the survivability of their own planet.

Finally, profit maximization is simply less effective than value maximization, because it is less attractive to consumers. As Costco shows, contributist businesses can outperform capitalist competitors because consumers simply prefer to buy from businesses that provide them with great value while aligning with their values. At the time of that article’s publication twenty years ago, it was the fifth-largest retailer in the world — now it’s the third, while maintaining its strict limit on profit margins.

It is worth noting that Costco exists in as free a market as any of its competitors. There is no regulation forcing Costco to restrict its profit margin to 15%. It chooses to do this not because its freedom is restricted, but exactly the opposite: because its leaders realize that they have the freedom to do so.

Conclusion

So why, then, does it seem that the most successful businesses today are not the most contributist ones, but actually the ones that are the most ruthlessly capitalist, sacrificing the consumer’s interest whenever profit and product are in conflict? Fully explaining this phenomenon is beyond the scope of this article, but there are multiple reasons which are worth mentioning.

First, as discussed in our 800lb companies piece, our society has adopted a distorted view of what it means to be successful. Perhaps if we scrutinized our criteria a bit more, we would notice that many of the businesses we see as successful are actually in a state of constant crisis — plagued with mistrust and discord internally, and fighting tooth-and-nail to maintain their narrow competitive advantage externally — while many that we see as less successful are actually highly productive and secure.

Second, consider the role that education (both cultural and formal) plays in the development of new businesses. The most authoritative voices in our culture tend to assert that the capitalist mindset leads to the best overall economic growth and efficiency. But they usually assert this without having first seriously considered the alternative that contributism provides. There are no contributist business schools. (At least not yet!) If we teach our business leaders that the only way to succeed is to become capitalists, then we should not be surprised when the vast majority of them do, even if it isn’t true.

Finally, capitalist companies have long held control of government policy, giving themselves unfair advantages in markets in which they cannot naturally win. This is touched upon in The Capitalist’s Secret from our intro series, and even more effectively described by Katherina Pistor in The Code of Capital: How the Law Creates Wealth and Inequality (and in this excellent podcast episode, for those who prefer to listen).

All of this has led us to the position we are now in. But the fact that capitalism dominates the business world now does not mean that this will always be the case. Societies do not simply develop into the best versions of themselves on their own; they become so when we choose to make them so. And since our business leaders are the social leaders of our society, they play a more critical role in its direction than we tend to acknowledge. To a large extent, the orientation of our business leaders becomes, over time, the orientation of our society. Let us hope that more of them choose to be oriented towards giving.

“Principle 3: Ownership by Giving” will be out next week.

1. For a more detailed dive into this phenomenon, check out Lou Keep’s excellent review of Karl Polanyi’s The Great Transformation.

2. This is true even in the case of ad-supported “free” products; it just becomes much more complex. The company offering the free product is paid by the advertiser, who builds the cost of the advertising into the price of the advertised product, which is ultimately paid by the consumer. Although this is often a different consumer than the one watching the ad, it is usually one of a similar profile. On the whole, we are more susceptible to advertising than we think; otherwise, businesses wouldn’t spend so much money on it.