Peter Drucker called this one many years ago. His definition for profits proves to be more important now than ever.
First, Drucker asserted that profits are an accounting illusion. In reality, profits are the cost of staying in business today, i.e. today's cost deferred to future payment. It is the seed corn, or surplus that must be planted for later growth. To consume it in the form of executive bonuses and shareholder dividends without first calculating the true and necessary needs of staying in business drains the vitality of capital formation and wealth-producing economic activity. At the very least, since profit is capital, and capital is a resource, and there are no free resources, the cost of capital plus inflation have to be deducted from any distribution of surplus just to avert creating an immediate deficit. But even that short changes the investment of capital needed for future job creation.
The auto industry and the newspaper industry are two good examples of ascribing a past tense value to profits. (In another post I named a few of the other problems that have plagued the newspaper industry in creating a new business model.)
Take a look at newspapers. Incredibly profitable up until the past five years, right? Great investment in the last twenty years, right? Wrong.
The fall of newspapers was inevitable and was apparent for many years before the internet or mobile technology. The fact that newspapers continued to be profitable long after they began their decline is evidence that profit, as defined by most businesses, is not a true measure of a business' health and a prosperous future. The average business has a life cycle of about thirty years before it encounters either obsolescence or major restructuring. Newspapers and by relation magazines have been in existence for over two hundred years (not counting some of the earlier, isolated ventures). The longer a business survives beyond the thirty year cycle, the higher the risk of future cyclical adjustments to prosper and extend into the next period. Newspapers have responded to several such cycles of technological innovations over the two hundred year run, and benefited tremendously from the late 19th and early 20th century changes.
The advent of radio and television first dented newspapers' reign as media giants. As I've illustrated in previous posts on the topic, newspapers and magazines decline became most obvious after 1955, but was obscured by the accelerated growth of advertising, local retail and service industries and continued profits of the industry. The digital revolution which began around that time signaled that newspapers should have begun their investment in that new technology then. But they didn't and it has made all the difference in the world toward their current predicament.
The next generation of businesses as well as any sovereign economy will have to tap into Drucker's definition of profits in order to remake our economy into a wealth-producing one instead of a deficit-producing one. As we surely have learned by now, their is no future in mounting deficits.
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