Leaders damage their prospects for profitable, sustainable organic growth when they send signals to their organization that maximizing stockholder value is their chief goal.

Customers are the true source of increasing value for a firm… so shareholders are rewarded more when a firm focuses on customers than shareholders.

1. Why stock price poorly reflects a firm’s real value

Your company’s stock price is only a weak shadow of its true value. Just as shadows change with passing clouds and the sun’s position, so a company’s stock price is a fleeting and distorted glimpse of what is real. If a stock’s price-to-earnings ratio is 20-to-1, then only 5 percent of the company’s value is driven by this year’s earnings. The real value—the other 95%--is driven by expectations of the company’s future performance. (See Roger Martin’s article, The Age of Customer Capitalism, HBR January 2010.)

When Apple launched its first iPhone in mid-2007, its market capitalization was about the same as Nokia’s. Five years later, Apple’s market capitalization was nearly twenty times Nokia’s. Why did the market fail to reflect the true value of each company in 2007? First, the long-term future performance of a company is relatively opaque to outside investors. The safeguards that prevent competitors from understanding value-creating initiatives also blind investors. (This is less true of pharmaceutical companies, because regulated clinical trials provide transparency to their new product pipelines.)

Second, there are few share-holders, but many share-handlers. The pension funds, mutual funds and hedge funds owning a company’s stock this year are unlikely to own it next year. (See Christensen, et al, Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things, HBR January 2008.) They care about what others think the value is in the short term (the shadow), not what the true value is in the long-term (the sun). So Wall Street lacks both the insight and inclination to properly value a company.

2. Why maximizing shareholder value is a poor organizational goal

When executives dance to the tune of Wall Street analysts, they are distracted from the job of building the company’s true value. This distraction is wicked when “maximizing shareholder value” becomes the goal of the organization. Maximizing long-term shareholder value is a good result, but a lousy goal. Finishing a marathon is a worthy goal. The recognition you receive afterwards is the result of achieving your goal… but it should not be the goal. If you focus on “recognition” as a goal—instead of running 26 miles—you will fail. You’ll be unprepared, exhausted, frustrated… and fall short of your goal of recognition. By confusing the result with the goal, you’ll miss both.

When a business leader makes shareholder value the “goal,” unpleasant things happen among employees—those who can actually make the “result” happen. Employees become cynical, believing this is all about executive stock options. They feel detached, seeing little connecting their day-to-day performance with the organization’s Wall Street goals. And they feel their future is being mortgaged, as long-term growth is subordinated to this quarter’s earnings per share.

3. A better goal for B2B suppliers

A much better goal for the B2B supplier intent on long-term, sustainable growth is this: “Understand and meet the needs of customers.” This goal 1) points to the only well-spring of profitable, sustainable organic growth, 2) lets employees see how they can directly contribute to the goal, and 3) focuses on closing the enormous “customer insight gap” that exists today, between what is known and knowable for B2B suppliers.

To be clear, it’s not misguided to seek increases in long-term shareholder value. In fact, that’s what the application of this article is intended to do. But to accomplish this result, the B2B supplier must focus its employees’ attention on creating customer value.

B2B Organic Growth Newsletter, Jan-Feb, 2012, “Why Maximizing Shareholder Value Is a Flawed Goal”

Q1. Isn’t it radical to propose not focusing on maximizing shareholder value?

Not really. Peter Drucker claimed the primary purpose of a business is to acquire and keep customers. “Maximizing shareholder wealth” has only been broadly accepted since 1976, when Jensen and Meckling published the most-cited academic business article of all time, “Theory of the Firm.” Increasingly, thought leaders are now questioning this logic.

Q2. Is our situation hopeless… when management is pressured by short-term share-handlers?

This is tough, but not hopeless. In fact, you could argue it may become a competitive advantage since many of your competitors face the same dilemma. Many shareholders will actually applaud the work your firm does to create value for its customers, so make this your clear message to them.

Q3. Where do we start?

Nature abhors a vacuum. So instead of tearing down the goal, “maximize shareholder value,” erect the goal, “understand and meet the needs of customers.” As your organization makes this its north star, you’ll see less organizational preoccupation with quarterly earnings-per-share.