Profit Is Not The Purpose Of A Business: SeaWorld and Marineland

I subscribe to Peter Drucker's adage that the purpose of a business is to create a customer in a manner that generates a profit. Drucker argued that this was accomplished through marketing and innovation. While a business must earn a profit to remain viable, profit is the reward for creating value, not the purpose of a business per se.

This is an important distinction, because within this specific context, those who set out to run a business and put a focus on earning a profit ahead of how they earn a profit, will have more difficulty succeeding. The reason they will find success more difficult is that a building and sustaining a successful business requires a longer-term perspective, while placing a primary focus on profit tends to drive a short-term perspective. How much did we earn this year? Can we do better next year? Or worse, how much did we earn this month? Can we do better next month?

A major reason for a short-term focus on profits is that investors and managers want to reward themselves too soon, based on an arbitrary temporal measurement. By doing so, they often place themselves in a direct conflict of interest with their managerial responsibilities. Too often short-term incentives create moral hazard because they encourage actions that result in a diminishing value proposition for customers relative to their many alternative choices in the market. Distribution of profits in the form of wages or dividends to serve the short-term desires of employees can strip the business of needed re-investment of capital required to create and retain customers for longer-term success.

I doing research for my soon to be completed book tentatively titled Thinking Like Disney: The 9 Principles of Walt Disney's Business Success (Theme Park Press, www.themeparkpress.com), I came across this story about two Southern California tourist attractions competing for essentially the same market: Marineland and SeaWorld, that drives this point home.

The story comes from Harrison "Buzz" Price, in his book Walt's Revolution! By The Numbers. Price was a research consultant who specialized in theme park feasibility studies, and who got his start in the business working for Walt Disney in the early 1950s. It is a story about what can happen when entrepreneurs and business executives confuse the purpose of a business, and focus on working for and rewarding themselves ahead of working for and rewarding customers.

The biggest lesson I took away from this exposure to the fearless foursome who managed SeaWorld, was its powerful message on the value of aggressive reinvestment. SeaWorld's true competitor is Southern California was Marineland, located on the Palos Verdes peninsula nearby Los Angeles Harbor. Marineland had opened earlier, shortly before Disneyland opened, and with direct access to the huge Los Angeles County market, much larger than the San Diego market, drew 1.6 million in its first year. Marineland's policy, however, was minimum reinvestment, essentially nothing. The investors, a New York syndicate formed by Henry Harris of Harris Upham, had taken a risk and succeeded. Now it was time to pay off the investors with maximum dividend distributions. To misquote an old hymn, "Yield Was The Temptation". Thereafter, without the benefit of new attractions, attendance went steadily down. It was a dumb policy. They had a great running start, a year ahead of Disneyland, and squandered the opportunity of an early lead in the Southern California attractions business.

And then came along George [Millay], Milt [Shedd], Dave [Demotte] and Frank [Powell], working the same extended market with more or less the same kind of project but located in San Diego, a long way from the heart of the rich Los Angeles market. They reinvested every cent available form cash flow: no dividends, no fancy amenities, and no fancy salaries. SeaWorld, which had started out at the 500,000 level in the mid-sixties had grown to over two million attendance by 1975 and it had hit 3.8 million by 1988.

Meanwhile, Marineland went steadily downward to the 800,000 level by 1971. It could not compete with rapidly expanding SeaWorld. Later on, three or four subsequent owners of Marineland could never find the key to turning the park around by investing in later years with "higher cost dollars" (new investment cost more after a decade and a half of inflation). Marineland closed in 1985. Playing catch up with current money after under investing in prior years is not easy. It was a clear demonstration about the importance of reinvestment that would have made a fine Stanford Business School case study (maybe even a Harvard one)....

Walt Disney understood the need to bring his own aspirations in line with those of customers. His ability to always measure his business decisions within the customer framework was one aspect of his entrepreneurial genius. I provide many examples throughout his career in my book.

Don't Confuse A Loyalty Program For Customer Loyalty

In its purest form, a Loyalty Program (LP) is a marketing tool used by companies to bond a small group of its most loyal customers through an exclusive reward or benefit. The concept is to identify one’s most loyal customers and offer them an incentive above and beyond excellent business processes and perceived value as a means of achieving a number of ends:

·      Personal recognition of a loyal customer’s value to the company through a reward

·      Increase sales to existing loyal customers

·      Reduce the risk of attrition of high value customers to competitors

·      Attract and convert high value customers from the competition through additional benefits to garner their loyalty to your brand.

The idea of rewarding loyalty is based on a number of research findings and general beliefs about loyal customers (which may or may not be true in any instance):

• Loyal customers are more profitable to a firm
• Loyal customers are less costly to service
• Loyal customers are less price sensitive
• Loyal customers spend more (80% of revenues come from 20% of customers)
• Loyal customers drive the majority of business profits
• Loyal customers act as consumer advocates to promote the business.

Originally, loyalty programs were developed to identify, personalize relations with, and reward, a small group of highly loyal and profitable customers. Over time, the scope of these programs has widened to influence the behaviour of consumers in general and reward their shopping behaviour. What started off with the requirement of first achieving customer loyalty followed by rewarding loyal customers, has now been transformed into a situation where customers who choose to participate in a rewards program are perceived by businesses as loyal customers.

For the majority of companies with rewards programs, the hard work of earning customer loyalty is no longer on their radar. Instead, the goal is to maximize card holders, which is much easier to measure. Executives often falsely believe and promote the idea that program members are loyal customers. They need to remember that loyalty denotes advocacy and commitment through emotional engagement, not a desire to earn points.

A focus on maximizing customers may in fact be a profit-inhibiting strategy, according to loyalty expert Frederick Reichheld. In his ground-breaking HBR article “Loyalty-Based Management” he argues the case that the road to maximizing profitability includes an understanding of the economics of customer loyalty and the strategy of identifying the benefits and costs of serving different customer segments.

Reichheld identifies and describes four components he sees as foundational to building a loyalty system.

1. Identify the right customers, the loyal customers, who are likely to have long tenure and will be profitable over the longer-term because of personal referrals or willingness to buy at standard prices.
2. Expand offerings to existing customer segments you know well by adding new products and services that anticipate and meet their evolving needs and ensure their retention.
3. Retain the right employees and partners through incentives because they know your customers the best and have build existing bonds of trust and expectations within their relationships.
4. Develop business systems to ensure and understand the long-term economic consequences of changing customer loyalty and the quality of feedback loops that are the foundation of organizational learning and adaptation.

He expounds on the logic of the system as follows:

"The primary mission of a loyalty-based company is to deliver superior value to customers. Success or failure in this mission can be clearly measured by customer loyalty (best quantified by retention rate or share of purchases or both). Customer loyalty has three second-order effects: (1) revenue grows as a result of repeat purchases and referrals, (2) costs decline as a result of lower acquisition expenses and from the efficiencies of serving experienced customers, and (3) employee retention increases because job pride and satisfaction increase, in turn creating a loop that reinforces customer loyalty and further reducing costs as hiring and training costs shrink and productivity rises.

"As costs go down and revenues go up, profits (the third-order effect) increase. Unless managers measure and monitor all of these economic relationships, they will default to their short-term, profit-oriented accounting systems, which tend to focus on only the second- and third-order effects. Focusing on these symptoms––instead of on the primary mission of delivering superior value to customers––often leads to decisions that will eventually reduce value and loyalty."

The loyalty research by Frederick Reichheld supports the old adage that businesses can't be all things to all people. Reichheld's insights into the economics of loyalty mechanisms is a further articulation of Peter Drucker's adage that "the purpose of a business is to create and keep a customer." This is still true,  but the most conscientious executives should focus on the idea that "the purpose of a business is to create a keep loyal customers."