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The Third Capital

Maurice, the baker, had turned sixty-five and the entire D’Souza family was in attendance at his fifth floor apartment for the celebration. He stood up, looking at his family, whose tradition he had tried so hard to uphold for the last fifty years or so. Everyone knew what was coming, yet they sat in rapt attention to hear it from the man himself.

‘It won’t be easy for me to retire,’ he said, looking at the family with tired eyes that denoted the five decades that he had spent working and the imminent retirement.

Bakery was not just a business for him, it was his heritage, his legacy. Hailing from a family that had, over countless generations, produced and served bakery products, being a good baker could win instant applause from this otherwise praise-stingy family. Such was Maurice’s commitment to baking, and his excellence at it, that he was unarguably the D’Souza mascot, someone the youngsters looked up to.  

‘Of course, it won’t be easy for her,’ continued Maurice, smiling and pointing the glass towards his lovely wife Stella, ‘my retirement will be a full time job for her. Anyway, Stella and I have decided that we want to serve the community. God has been very kind to us, and perhaps now is the time for us to help those who were not so lucky.’

James, tall, with attractive eyes and a lean physique, was at his mother’s side, holding her hand. His, ill-kempt curly brown hair and a warm smile indicated an approachability that was a deep contrast to his brother Fernandes’s. He noticed that his mother had tears in her eyes.

Fernandes had a stocky build, jet black hair and dark eyes that mean business. Slightly shorter than his brother, he sat without any expression, determined to continue his father’s legacy, twiddling his thumbs on his smartphone.

Since their teenage years, James and Fernandes had helped their father in the bakery. Though their father had been the baker himself, they had focused more on managing the business.  While James had seen his father’s struggling years, Fernandes, two years younger, had seen his father when he was already half way up the ladder of success. James had seen the journey and Fernandes, the destination. 

James, calm, composed, with an easy demeanour, and Fernandes, fidgety and impatient to prove himself, knew that in keeping with the family tradition, at the sixty-fifth birthday, their father would hand over the reins to them.

They were wrong.

‘Just as I set up this bakery forty years ago, after working in my father’s bakery, I want my sons to follow suit,’ Maurice said, looking at his two sons who were more than a little confused.  ‘The old must make way for the new. In fact, the old must finish to make room for the new. Anyway, I have decided to sell my bakery.’

Silence descended on the table. Many eyes darted here and there with disbelief. Yet, this doyen of the D’Souza family would not be asked any questions. He had earned the right to do as he pleased.

Maurice had decided that after selling his bakery, he would create three capital pools. One each to be given to his sons, which would help them start their own bakeries. The third pool, to be invested in the bakery that did better at the end of two years.

That was the deal. In one brilliant stroke, Maurice had not only ensured that the brothers would not step on each other’s toes, but also dangled a prize before them to encourage them to focus on building their businesses. 

The growing economy held out the new hope for the brothers to dream of not just one bakery, but a chain of bakeries. James and Fernandes, armed with starting capital, set out on the adventurous journey of opening their own bakeries. Both decided to hire chefs to do the baking so that they could focus more on managing and growing the bakery business. To avoid coming in each other’s way, they opened their bakeries in different neighbourhoods of Mumbai.

Fernandes, business-like and straightforward, brimming with energy, knew what he had to achieve. Profit is the difference between the revenues and the cost. All he needed to do was maximise revenue and minimise cost. That was going to be his mantra for the next two years.  

Being experienced in this business, Fernandes also did a survey of the prices of various competing products in the market. That helped him set the prices of his own produce. He interviewed suppliers and the cost of products was the overarching criterion that he focused on. If convinced with the quality, he would choose the supplier who offered the minimum cost. After talking to a few people in the neighbourhood, he finalised a chef. Very soon, the other people came too. Fernandes’s Bakery took off within three months.

James, experienced as he was, took similar steps towards setting up his bakery as his brother. He got suppliers, employees and a chef. He did a survey and set the prices too, like Fernandes. A month after Fernandes opened his bakery’s doors, James followed suit.

With their sons in the driving seat at their bakeries, for Maurice and Stella, busy enjoying themselves and coping with Maurice’s retirement, two years went by rather quickly. With not just experience, but a rich tradition of baking, both James and Fernandes had no problems in making a mark in their respective areas. They were head to head in almost all departments of the business except one: profit. Fernandes made a tad more profit than James.

At the end of two years, both the brothers looked set to clinch the deal that their father had struck with them. Beating the other would not just mean winning the third capital resource, but would also feel like winning the D’Souza family cup.

Fernandes, generating a tad more profit than James, was confident that he was going to get a fresh infusion of capital. In fact, true to his nature, he had already drawn up plans on how to use it efficiently.

Late in the afternoon one day, as usual, Maurice was tending the modest garden in his balcony, when James and Fernandes walked up to him with concealed excitement. Fernandes knew that the capital was his. He had made more profit.

Maurice looked up towards his sons and they exchanged the usual short pleasantries. Then they followed their father as he walked slowly towards the cane chairs at the centre of the balcony that looked out on the busy Joggers Park at the edge of the Arabian Sea.  

Easing himself into the cane chair, he stared at the sea. His reflexes had slowed down a little during the last two years. At the horizon, there were dark shapes of some ships making their way to the Mumbai harbour. Of course, there were also the small fishing boats that had ventured out only to return at night with their catch.

A certain amount of melancholy had claimed Maurice since he took retirement two years ago. Yet, his brilliance remained untouched.

‘I am growing old, boys. What I wanted to say to you is ... that the world is changing. Simpler times are a faint memory now. What worked for me will not work for you. It seems to me that your future expansion will depend upon your ability to raise capital from other sources than the family. With this in mind, I wanted to make this investment like a professional, and therefore, neutral investor, so that you can get a first taste of what investors look for.’

James and Fernandes were aware that due diligence was going on in their bakeries. They looked at Stella with impatience. Both wanted to hear the news. Stella smiled back, sensing their impatience and yet aware that they would have to wait.

Pausing to take a sip of the tea, Maurice said, ‘With this aim in mind, I followed a procedure that I thought any neutral investor would follow. Mr Gupta, our chartered accountant, suggested that I conduct a due diligence on your bakeries.’

‘So, I hired a company to do it. They gave me some numbers. As you know, though important, numbers are not enough to judge a bakery, so I spoke to the people working at your bakeries. After these discussions and much deliberation, I have now reached a decision.’

He looked at James and then at Fernandes. ‘I would like to give this fresh capital to James.’

Fernandes couldn’t believe his ears. He had never imagined that despite making more profit, an investor would choose James’s bakery over his. He was curious. He was a consummate businessman, like his father, and not prone to unnecessary emotional anguish. He just wanted to learn from his mistakes.

Fernandes shook hands with James, before turning towards his father. ‘I respect your decision, and I know you must have acted, as is your habit, without any bias. However, I must admit I am a little confused. Please tell me why you decided to give your capital to James despite my bakery making more profit.’

The father, admiring his son’s grace in defeat said, ‘Son, for the past two years, this capital, was kept in a fixed deposit at a bank. There was no risk to the capital and I got a return of nine per cent per annum. As an investor, who is looking to invest in a business, my number one priority was to know the risk that I am taking and the reward if I succeed. If I adopt additional risk and get only a nine per cent return every year, wouldn’t it be a bad investment?’

‘Sure. I agree. You will take a greater risk only if the return is greater than nine per cent,’ said Fernandes. Even James, who had won the capital, listened on.

‘So, clearly, I wanted to find out the level of risk associated with the reward. The reward here, for me as an investor, is your profit. The risk, then, is basically the certainty or uncertainty surrounding those profit.

Though I was concerned with the profits both of you are making today, I was even more concerned about the consistency and certainty of these profits in the years to come. The greater the certainty of these profits, the better for me as an investor. Do you understand me so far?’

After getting satisfactory nods from both his sons, he continued, ‘Given my five decades experience in the bakery business, it was easy for me to estimate the reward, to forecast your levels of profits based on your performance during the last two years. Risk was a challenge. As I focused on the consistency of these profits, year after year, I was drawn to factors which would ensure a steady long-term growth. I looked for factors that could offer the business more predictable profit streams in the years to come.’

Fernandes was getting some idea of what his father was trying to convey. ‘So you are saying that you do value the profit that I made this year, but you are more concerned about my long-term profits?’

‘I think it is a little like measuring a child’s potential only by this year’s report card. While it is important, it is more important whether the child continues to show improvement in the years to come,’ said Stella, surprising everyone with her common sense approach.

‘Exactly,’ said Maurice, turning to admire the intelligence of his wife.

‘I could sense your relentless profit focus that was single-mindedly reducing costs and increasing revenues. I met your suppliers and felt that they were a little stretched-out to provide you with the lowest cost. They confessed to me that often they felt short-changed. I concluded that they were vulnerable to compromising the quality at some point to protect their profits. A definite risk to your long-term profitability.’

‘Next, I looked at your employees. I sensed a lack of belonging, a lack of motivation. They felt that the only thing they were a part of was making money. Perhaps, due to your profit motive, even their reason for existence was money. In all my years of baking, I have always liked to believe that I have worked for a higher cause: to serve my customers. Money was secondary. However, your employees felt that they were spending a good ten hours of their life making money for the bakery and receiving money in return. In many cases they admitted that they had overbilled or under-delivered to unsuspecting customers to report better profits. Since there was no higher cause, there was nothing that bound them all together. The result: a cut-throat competition among your employees.’

‘I get your point about working for higher cause, but isn’t competition healthy?’ Fernandes countered.

‘Sure. It is. Competition is healthy, but too much internal competition can pull the business apart. It can be the medicine that treated the ailment but killed the patient,’ continued the father. ‘Also, competition for what? Serving your customers, or making money? It makes all the difference, son.’

The logic was incontrovertible. Fernandes was always impressed by his father’s unique way of explaining things. 

‘Fernandes, you have focused well on something and achieved what you set out to achieve: profit. However, there are many other things you need to take care of. I have no doubt that you will. Now, I must come to James’s bakery,’ said the father.

Stella looked at Fernandes to make sure he was not hurt by all this. She and Maurice made a perfect couple. He taught his children the tricks of the trade; she provided them emotional support. After having raised two fine boys, she knew the importance of both.

‘I must say his bakery inspired me. It brought back a lot of old memories for me. I am no expert on how the best businesses are run, but as an investor, I felt that my money was safer with James. Remember, I am not a gambler, and the protection of my capital is my main concern, even before I can think of returns,’ said the father.

‘When I met the people working for James, I could see them not as five different people working for money, or their own self-interests; I saw them as people who believed in something -- a common cause. They were together, cohesive as a team, working not towards money but towards a higher objective:  providing delicious bakery products to the neighbourhood. They drew immense satisfaction from seeing their customers smile and return for more purchases. They helped each other because they were a team. In the process, they earned more money too. The due diligence confirmed that James’s employees take home 20 per cent more money than Fernandes’s employees.’

‘Next, I met the suppliers. They felt they belonged. They felt like they had a stake in the bakery. James would have lunch with all his suppliers every Tuesday, and discuss their problems as well as voice his concerns. Though James paid his suppliers slightly more, what he lost in profits today would pay dividends in the long term. The suppliers would make more money and treat James’s bakery as one of their preferred customers. They were encouraged to provide him the best service compared to other bakeries in the area. This allowed James to deliver to his customers what other bakeries could not. A competitive advantage.’

‘Though, overall, Fernandes has made more profit in the last two years, I feel that, as an investor, James has created more value for all the stakeholders in his bakery.

Fernandes, you have won in the profit maximisation department, but James is the clear winner in the value creation department.’

‘I can understand what you say, and I have learnt much. But, please tell me clearly, what is the difference between value creation and profit maximisation?’ asked a contemplative Fernandes, who was beginning to understand what James was doing differently, and how it benefited him.

Stella raised her hands, smiling, as if in a classroom. ‘I think, it is perhaps the same as between learning and scoring. If you study to learn, you will score. If you study to score, you may not learn. Learning stays with you and helps you in the long term.’

‘Beautifully put, dear! I am no business guru, but it seems to me that profit maximisation can lead you to run your business in a ruthlessly opportunistic way. It can, perhaps, generate profits quickly. That can be a handicap in the long run. Value creation, on the other hand, is a more holistic and comprehensive approach that can ensure how, through efficient business practices, you can set the business on a path of long-term value creation for all its stakeholders: the investors, employees, suppliers and so on.’

‘As an investor I am more interested in seeing where you will be five years from now than where you are right now. A business that has practices that create value for all stakeholders has a better chance of sustained growth.’

Most of the people in the park nearby had left. The people who counted, doing the rounds of the park, burning calories, and people who experienced sunset and, sunrise, the sounds of the sea and the swish-swoosh of the palm trees. 

Already, the irresistible aroma of sumptuous dinner wafted out to the balcony. In a few minutes, the entire D’Souza family would get together again to celebrate the 67th birthday of its mascot, Maurice.


What is the aim of business? Why do companies run businesses at all? Is the aim of business to make more profits?

As the preceding parable shows, profit maximisation could be a very short-sighted aim.

Businesses need an ecosystem to thrive, and the various stakeholders are integral parts of that ecosystem. Businesses have a larger responsibility to preserve the ecosystem from where they generate value. A profit motive, while not wrong per se, can lead the business into areas where it starts to take advantage of the ecosystem in a way that creates profit today but harms its future prospects.

Therefore, the aim of any business that wants to grow in a sustainable way has to be value creation for all its stakeholders.

What is value? Is it another business jargon to replace profit? Why don’t we just say that all stakeholders should make money? Why do we say that they should be able to create value?

Value is a multidimensional concept. Profit is one-dimensional. Value is a more holistic concept. A business that creates value surely makes profit, but the converse may not be true. A business can grow sustainably only if it can repeatedly attract resources like capital, labour and goodwill. The ability to continuously attract these resources will depend upon how much value it is able to deliver to all its stakeholders.

While value creation may seem like a romantic, even utopian concept, it is very real and absolutely quantifiable. A firm that marches on the path of value creation for all its stakeholders, takes decisions that increase the certainty of the firm’s future growth.

As we saw in the previous example, Fernandes, driven purely by maximising the profit, ended up squeezing his suppliers and making his bakery vulnerable to quality issues. His employees were dissatisfied. They might have left him. Further, he could have had trouble finding new high-quality manpower.

James, on the other hand, proved that he had his eyes set on the long term. He talked to his suppliers and engaged with them, instead of squeezing every last penny out of them. No doubt, it affected his profit at that time, but it prepared him for the long term. He is creating those critical relationships in the ecosystem that would ultimately ensure his continued growth. The same for his employees. In fact, in a way he sacrificed some immediate profits with an eye on the future.

When an investor tries to value a firm, he looks at the future cash flows and their certainty and predictability. Therefore, he would be interested in characteristics of the business that can create sustainable cash flows rather than a one-off profit performance. Not just as investors, even as employees, as consumers, and as vendors, wouldn’t we would prefer a company that has a long-term value creation potential?

Most of the successful companies that we see today create value, not just profits. That ensures their uninterrupted growth. There are many examples of firms that have taken the value creation concept to the communities they operate in. Not just for their employees, they run innovative programs for their families, enabling them to find livelihood and dignity.

In its annual report (12-13 FY), Tata Motors lists the value created and the value distributed. It is a new way of looking at business. A business is an entity that creates value and then distributes that value to its stakeholders. This is exactly what the balance sheet depicts. It shows the value created as the revenue for that year. Then, it states the value distributed (to the stakeholders) to employees, providers of capital and the government amongst others.

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