The Purpose of Financial Services
In this part, we look at the work to be done in different areas of the financial sector—where it exploits its customers, and where is requires development in order to fulfill its social purpose. I appreciate that I deal in a sentence with some issues that may require a lifetime of work; missing 99 percent of the subtleties and difficulties. My point in raising them is to bring them to your attention—and to indicate my solidarity if you are already working on them! Even if they do not take a virtue ethics approach, the expert authors in John Boatright’s book Finance Ethics cover the subject in more detail if you are interested.
Value for the Customer
You will know that there is an ongoing debate as to whether the sole purpose of business is to make a profit, or whether it has a social purpose in meeting people’s material needs—with profit being one measure of how well it is doing so. Milton Friedman (1970) is perhaps the best-known expression of the former view, Peter Drucker well known for the latter. This section, and the next, outline an approach to management that creates this value in a manner based on service and integrity rather than greed and opportunism. Much of what I say comes from Drucker’s book, Management. I recommend it without reservation: my copy has sat on my desk for 30 years. I used to say it sat between the bible and the dictionary—until the Internet made the latter redundant!
If Friedman is right, there would be nothing much to say about working in the finance or any other sector—as long as you were making a living. I think, however, Drucker’s critique is unanswerable. He says:
Profit is not the explanation, cause, or rationale of business behavior and business decisions, but rather the test of their validity. If archangels instead of businessmen sat in directors’ chairs, they would still have to be concerned with profitability, despite their total lack of personal interest in making profits (1975, 60).
I am attempting here to refute an idea for which Adam Smith is famous:
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages (2005, 19).
Smith was over-pessimistic about human nature in some respects. In particular, he was convinced that corporations would always fail because of the agency problem: managers could not be prevented from looking after their own interests to the exclusion of everyone else’s. In this case, we can perhaps assume that his position in the class system meant that he seldom spoke to his butcher, brewer, or baker. In my world butchers, brewers, and bakers pride themselves on delivering the best possible products. Our local butcher would be genuinely offended if told he chose his cuts to maximize his profits rather than to please his customers!
To return to Drucker’s argument:
It is irrelevant for an understanding of business behavior, profit, and profitability, whether there is a profit motive or not.… We do not learn anything about the work of a heart specialist by being told that he is trying to make a livelihood, or even that he is trying to benefit humanity. The profit motive and its offspring maximisation of profits are just as irrelevant to the function of a business. … (1975, 60).
I confess to have personally fallen into the error of not wanting to make enough profit. The South African government removed small loans from the ambit of the Usury Act in the early 90s. The idea was to attract legal commercial institutions into this market to compete with informal loan sharks. The hope was that credit would be cheaper and it would reduce the violence associated with the informal recovery of bad debts. The main entrants to this new formal market became very profitable, charging interest rates of around 60 percent, which was probably half that previously charged by loan sharks. I became chair of the board of a small not-for-profit that entered the market with interest rates of less than 30 percent, because we felt that anything more was unfair. In retrospect, that was a mistake. We were successful on a small scale but were always strapped for resources, and the organization was wound up a couple of years after I left. We would have been more successful if we had charged more to provide the resources to expand. My thinking was anchored in the idea that capital has to come from investors and not customers. I was also too focused on providing value for existing clients rather than thinking of the wider picture. Creating value in business does mean you have to invest with some enthusiasm, and may need to charge more to do so.
Drucker goes on to address the core strategic task of any business, which he says is to:
To know what a business is, we have to start with its purpose. Its purpose must lie outside of the business itself. In fact, it must lie in society since business enterprise is an organ of society. There is only one valid definition of business purpose: to create a customer … (1975, 61).
He goes on to distinguish between the product and utility gained by the customer, and idea taken up by Theodore Levitt as the marketing concept. This defines marketing as providing for the needs of clients at a profit. We can contrast this with a product orientation, and with a sales orientation, which confuse the means (being the product or sales process) with the ends (the needs of the customer). Levitt’s classic Marketing Myopia shows the dangers of failing to appreciate this contrast. He suggests that the American railroads lost their dominant position in the transport industry in the 19th century—by failing to see that their business was “transport” and not “the running of railways.” With the marketing concept, it is more likely that companies will abandon existing product and sales methods and introduce new products as customers’ needs change. It is to seek to meet your customers’ real needs, which also see as an application of the golden rule, “Do unto others, as you would want them to do to you.” Exploitation of your customer may generate short-term profits, but it is not the action of a virtuous person—nor likely to be profitable in the end.
The first three chapters of this part cover investment management, insurance and pensions, and banking and include some related issues. Those related to corporate governance and reporting seem to fit with investment management; issues around selling and mutual organizations with insurance and pensions, while risk management fits well with Chapter 9. Chapter 10 then covers regulation as it pervasive in all organizations, and relevant to how we encourage each other to ethical behavior. The final chapter is about financial services for the poor. Whatever your particular role, there are challenges and opportunities for you to make a difference.