We judge most companies by their profitability. Recent tech IPOs notwithstanding, an unprofitable enterprise is generally an oxymoron; businesses exist to make money. But make money for whom?
When Snap Inc. went public last month, there was a lot for potential investors to be excited about. More than 158 million people use the company’s photo-sharing app, Snapchat, an average of 18 times every day. Snap’s revenue, which comes from advertising, leapt seven-fold in a single year, to more than $400 million in 2016.
On the other hand, the company also lost $500 million last year alone. For every dollar of revenue it earned, it lost a dollar twenty.
Most of that money went to people. Snap paid nearly $475 million to its employees in salary and benefits in 2016. So the company is both generating and losing hundreds of millions of dollars.
Is it profitable? First, we have to return to the question: Profitable for whom?
Traditional Measures of Profitability
Traditionally, to determine if your company is profitable, you add up its revenue, subtract its expenses, and see what remains. The amount left over is what you, the business owner, earned. In other words, we talk about profitability from the point of view of the owner and other investors backing the venture.
It's no accident that traditional methods for calculating profitability are oriented toward investors. “It takes money to make money” may be the most fundamental adage in finance, and investors need to know how much they’ve made.
When 15th-century Franciscan Friar Luca Pacioli published the first book on accounting, he introduced double-entry bookkeeping (a practice that Goethe somewhat inexplicably called “among the finest inventions of the human mind”). Double-entry bookkeeping is notable in that it does not just record the company's assets, but also records where the money to acquire those assets came from. These two entries make up the two sides of the balance sheet. As the business grows in value, every dollar of that value is allocated to a specific investor. The focus, for Fra Pacioli and the Venetian merchants who adopted his system, was how wealth accrued to the investor. And that still holds today.
In the United States, the Financial Accounting Standards Bureau sets the accounting standards for the financial information that companies like Snap have to make public. The organization’s explicit mission is to help “investors, lenders, and other users of financial reporting … make decisions about how to allocate their capital.” Meaning the financial reporting that companies make public is not for the public. It's for their investors.
There's nothing wrong with that. For financial markets to function well, it’s necessary that potential investors know exactly what they’re getting into. But we should recognize that this focus on a single audience, the investor, leads to a very narrow definition of profitability.
Choosing the Right Perspective
We all inhabit many roles—not only investor, but also customer, citizen, public official, human. From these other vantage points, it doesn’t make sense to use traditional measures of profitability to judge a company.
Traditional measures of profitability would say a dollar earned by the company’s owners is prosperity created, while a dollar paid in wages is prosperity lost. This system of accounting treats wages no differently than it treats raw material costs or interest expenses.
But for employees, wages are income. And traditional accounting fails to capture that we, as citizens, should care about the wealth and wellbeing an enterprise provides to its employees. So when we judge a company, we should look not only at its profit to investors, but also its profit to people—all people.
Profit to People
A simple way to do this is to calculate profitability using traditional methods, and then add to this result the salaries and benefits that the company pays to employees.
For example, if a company makes $5 million in profits and pays $5 million in salaries, its profit to people would be $10 million. If salaries increased 10 percent, traditional measures would say profitability declined, as $500,000 that had been going to investors now would go to employees. But profit to people would stay constant. Only different groups’ relative shares of the profit would change.
Profit to people can diverge widely from traditional measures. Some companies, like Verizon, have seen large gains in reported profitability without growth in profit to people. Others, like Amazon, have seen growth in profit to people far outpace gains in reported profitability.
This way of calculating profit to people is most natural for employee-owned companies, such as Publix Super Markets or New Belgium Brewing. When the employees own the company, higher wages directly offset making less as owners, and vice versa. So instead of trying to maximize one slice of the pie, they focus on maximizing the size of the pie itself.
At companies like New Belgium Brewing, where the employees are also the owners, there is less tension between wages and owner earnings and more emphasis on growing the total profit to people.
But socially conscious executives, government officials, and other stakeholders can also use this measure of profit to assess a company’s full financial impact. The “profit to people” metric would allow them to calculate all the wealth they create and compare themselves to their competitors.
Consider the Ford Motor Company during the Great Recession. From 2007 through 2009, Ford reported a total loss of nearly $15 billion as revenue dropped by a third. But over this same period, Ford’s profit to people totaled over $18 billion. The survival of car companies during the Great Recession was important to so many Americans, because they never stopped being massive generators of income for workers, even if their reported profitability didn’t reflect that fact.
Consider also Walmart’s recent history. Since 2010, the company’s profitability as measured by traditional means has been roughly flat. But as salaries have increased, profit to people has grown by 18 percent in that time, to $112 billion today. Given that its workforce is twice the size of the US Army, Walmart should be singing from the mountaintops about this creation of wealth.
While Walmart’s reported profitability was nearly flat from 2010 to 2016, its profit to people increased at a 2.9 percent annual growth rate.
Capturing What We Care About
In 1968, Robert F. Kennedy lamented that gross national product was an insufficient measure by which to judge the United States. It “counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage ... yet [it] does not allow for the health of our children, the quality of their education, or the joy of their play.” He concluded, “It measures everything, in short, except that which makes life worthwhile.”
Experts in the burgeoning field of socially responsible investing are racing to form an alternative set of metrics that capture far more about a company than just its financials. The Global Impact Investing Network, with support from traditional accounting firms like Deloitte and PricewaterhouseCoopers, for example, launched the Impact Reporting and Investment Standards. This framework attempts to provide a standardized set of social and environmental metrics for companies to report. B Lab certifies companies as B Corporations, which have to meet certain social and environmental standards. Others focus on a single issue, as the CDP (formerly the Carbon Disclosure Project) does with carbon emissions.
Profit to people can show the full financial impact a company has. It is, however, an admittedly blunt measure. For Walmart, it captures the increase in wages but not the value of the company’s new employee-training program or the benefit of lower turnover. It also doesn’t account for the distribution of incomes in a company where the CEO earns 1,133 times the median employee’s salary.
Profit to people also cannot tell you about the financial health of a company. A company that does not provide a fair return to its investors cannot survive. We cared about Ford because of its profit to people, but it survived the Great Recession by focusing on its profit to investors.
So: We care about investors. We also care about employees. At the end of the day, we care about people. We should use a more inclusive measure of profitability to reflect that.
And Snap? Currently, if we look at the company in terms of profit to people, it still lost $41 million. Given its current trajectory, though, it may end up like Twitter or other, more mature tech companies. Twitter reported a $457 million loss last year, but its profit to people was well over a billion dollars. As investors, this may give us pause. But as citizens, it’s a cause for praise.