Home > other > How Maximizing Profits is Making Life Worse for Everyone

How Maximizing Profits is Making Life Worse for Everyone

“we end up with schools that don’t work, planes that only young children fit comfortably in, hotels that are too dark to see if your clothes match, phone menus from hell, long lines to buy food, burdensome workweeks, and so forth”

It is well known that people are generally sensitive only to big relative changes, and tend not to care about, or even notice, small ones. This is why three shots of vodka is much more than one, but if you add two shots of milk to a gallon of milk, you still have about a gallon. They’re both a 3-ounce addition, but the vodka increased 200%, the milk only about 2.5%, and we notice the percentage, not the absolute amount. Similarly, a fifteen minute car ride feels longer than a five minute one, but seven hours and 15 minutes on a flight doesn’t seem different than only seven hours and five minutes. A child who grows from four feet to five has shot up, while a mountain in the Rockies that goes from 8,200 feet to 8,300 looks the same.

“maximizing profits is a bad idea in the long run”

This can be a problem when small changes yield big profits. If, for example, you could earn a million dollars by making your house only 5% darker, you’d do it. You wouldn’t even notice the 5% reduction in light. But here’s the rub. If you’d do it once, you’d do it again and again. Pretty soon you’ll end up rich but living in the dark.

Worse, you won’t even know what went wrong. You’ll try in vain to isolate which 5% decrease did you in, and you’ll conclude that every step of the way seemed like a good one. Each time you got a lot of money for a difference you couldn’t even notice.

This dilemma is especially pronounced when big organizations get involved. Most of us can’t earn a million dollars by making changes to the lighting, but hotel chains can, and they do, which is why hotel rooms are so dark. Of course, it’s not just lighting. That same chain makes the soap bars just a little smaller, and gathers up the tiny profit from each bar of soap for a huge increase in the bottom line. Airlines put the seats in their planes just a little closer together to augment revenue. Oil companies raise the price of fuel by just a cent or two every so often. Call-center managers reduce staff just a tad. Supermarkets provide slightly fewer cashiers. Managers demand just five more minutes out of each employee’s workweek.

And it’s not just the corporate world. Municipalities suffer the same kind of fate when they cut the number of police just a bit. So do school districts that reduce each teacher’s training only a little. And at the federal level, a decision is made from time to time to spend just 1% less on some important program.

What we end up with, though, is schools that don’t work, planes that only young children fit comfortably in, hotels that are too dark to see if your clothes match, phone menus from hell, long lines to buy food, burdensome workweeks, and so forth.

The problem comes from the seemingly desirable goal of maximizing profits combined with the human tendency not to notice small changes.

The only solution I can think of is to agree that maximizing profits is a bad idea in the long run.

To look at another example, imagine a swimming pool. With so much water, it’s hard to imagine that giving away a single cup could make any difference. Yet a pool can be emptied one cup at a time. If you think you can sell one cup and not impact the pool, you’ll end up with lots of money and nowhere to swim.

At first glance, it might seem as though the same mechanism that prevents us from noticing slightly darker rooms also means that a huge hotel chain won’t care about slightly higher earnings. For example, Marriott International had gross revenue of over 12 billion dollars in 2011. That’s over 12,000 million dollars. Does it really matter if it’s 12,321 million or 12,322? Sometimes, maybe not, though other things being equal any CEO or board member will opt for more money instead of less, no matter how small the difference. But other times, even a tiny amount can make a huge difference: if saving just a thousand dollars means not going over budget, even a huge hotel chain might need that $1,000. Or if a bonus for some employee is tied to meeting a certain goal, that $1,000 might be the final step toward getting the bonus.

The overhead cost of making any change might also seem important. Even if smaller bars of soap are cheaper, for example, the one or two cents saved on each bar is offset by the costs of putting someone in charge, of changing the specs, etc. But even though this may mitigate the tendency for our lives to get worse, it doesn’t eliminate it. Furthermore, as companies grow larger, the overhead costs become less significant compared to the potential savings.

Similarly, eventually the soap will be so small, the lighting so dark, the teachers so poorly trained, that a 5% reduction doesn’t net much profit. For example, if a bar of soap weighs 3.5 ounces, cutting 5% means not having to pay for 1/6 of an ounce of soap. Multiplied by over half a million Marriott rooms and 365 days/year (potentially over 180 million guests, but probably closer to 100 million), that’s up to almost 1,000 tons of soap each year saved by that 5% cut. But once the bar is whittled down to only 1 ounce, the same 5% cut saves less than 200 tons. It might not be worth it. Unfortunately, this pattern just means that there might be a lower limit to how bad things can get. Even more unfortunately, as companies grow larger, this limit goes down.

So, again, the only solution I can think of is to agree that maximizing profits is a bad idea in the long run.

Advertisements
Categories: other
  1. April 9, 2012 at 3:46 pm

    An interestingly presented premise, and I agree that a simple focus on maximizing short-term profits is not in the best interest of anyone other than those who may wrongly have incentives tied to short-term, i.e. myopic, goals. That is not to say that it is bad for corporations to maximize profits in the long term, if it is part of an approach which maximizes long-term stakeholder wealth. It must be understood, however, that the stakeholders include not only the holders of the corporation’s equity, but also of its debt, its employees, its customers, its suppliers, and its community, increasingly the global community. The business should be built with the values and integrity which honor its people and the universe at large.

  2. Colleen Harper
    April 10, 2012 at 2:11 am

    Thank you Joel.

    As I read this article, I kept thinking of people who know the price of everything and the value of nothing. Surely there comes a point where the commodity being offered loses all value, and then no price can be made off it.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: