13 April 2007

Profits are Environmentally Friendly

This is a posting in praise of profits.

Profits have, rather oddly, gotten a bad rap. One reason for this is because they are misunderstood.

Profit is what is left over after you've paid the factors their due. Labor gets wages. Capital gets interest. Resources are purchased. What is left over after various inputs are paid is profit. Profit is the difference between the market value of the output and the market value of the inputs.

In an ideal world, the inputs of labor, capital, and resources would be minimal and the outputs of products and services would be maximized. You'd only have to work about 4 hours, buy a guitar for $500 (your capital), rent a studio for an hour, and create millions in value, collecting royalities for decades. In an ideal world. The beautiful thing about profits is that it signals that you've created more value than was there when you started. You've orchestrated inputs like resources, capital, and labor into lots of value.

Every community ought to have the goal of maximizing profits. If you can create a million dollars worth of value with thousands of dollars of input, you're creating quality of life with minimal impact on people's personal time and scarce resources. Among other things, minimal input suggests little environmental impact. If a community could create value without using any labor or resources, why wouldn't it?

One other reason that profits have gotten a bad rap is because they have been associated with capital and returns to an elite few. But we've made our largest companies public - literally spread their ownership across the public. And the really smart companies have made their employees owners - sharing ownership through outright grants of stock and stock options.

Historically, ownership has been very concentrated. Even today, "the typical big company distributes 75 percent of its stock options to only its top five executives." Because of this, the average person has tended to see profits as something that come at the expense of the little guy, something that simply make the rich richer. But this is not an indictment of profits. This is an indictment of how profits are shared.

One reason to popularize entrepreneurship is to transform the role of employee from a wage earner to someone who shares profit. Profits are a great thing. Hoarding profits into the pockets of a half dozen executives is not.

We need to change our values and expectations. We need to show more appreciation for profits, need to see them more as something of great economic value. And we need to change our expectations of how profits in publicly held companies are shared. Corporate profits are going to continue to increase. We need to make sure that this increase is widely felt.


exskindiver said...

Who really wants negatives outweighing the positives?
People that disdain profit are not being truthful to themselves.
The opposite of profit is loss--and loss is usually undesirable.

Life Hiker said...

Ron, I agree that the increase in profits should be "wildly" felt, and also widely felt. The incredible growth of the U.S. has been due to profits, "wildly felt", although workers didn't have much participation in them.

Today's news included coverage of Home Depot's recently-dismissed CEO getting $130 million in his last year on the job. Guys like him are "wildly" overpaid, and over-optioned as well.

My top MBA school professor asked us on our first day of class, "What is the primary purpose of the corporation?" Of course we answered, "To reward shareholders for their investment." He replied, "Wrong! The primary purpose of the corporation is to reward senior management. If you understand that culture, you will know how to perform a management job in a large company." Sad, but true.

But back to profits. China is growing at an incredible rate due to profits. If we don't continue to have a lot of profit in the U.S. economy, we are toast. As you say, it's time people start to understand this simple fact and work to get their share.

Ron Davison said...

To the point and well said.

LOL. Good catch (now corrected) and great point about how profits levels also determine business formation.