The blogosphere is aflutter with talk on Apple’s recent customer satisfaction issues linked to the new iPhone 4’s antenna design. A quiet whisper turned into thunderous noise once Consumer Reports decided to not recommend the phone because calls are dropped if the antenna is covered while in use (for example, by the user’s hand holding the phone).

Much of the on-line conversation centers on public relations lessons and a debate about the sensitivity issues of the iPhone versus competitive products. (For a good assessment of the PR lessons for Apple, see The Leadership Playlist blog.)

There is more to this lesson than public relations.  I think in terms of business model and strategic leadership, and I believe Jobs ignored Apple’s business model in resolving an internal debate about the antenna, a product design decision that I’m confident Jobs now regrets.

Apple’s value promise includes two key benefits for which customers are willing to pay a price premium. One is an owner appearing “cool” or “savvy,” as the company’s products offer among the most elegant looks on the market for technology products (for most products, as a matter of fact). But a key driver of Apple’s recent financial success has been growing adoption of Apple products for business (as opposed to school or home) use. And in the business world, the benefit promise that converted PC and Blackberry users to the Apple brand is that the company’s products “save you time and minimize frustration.”

Genius ergonomics make Apple products effortless to use. I recently cared for my 87-year old mother, a woman who quickly mastered the iPAD, without prior experience with Apple products. (Try teaching your elderly Mom to use a Blackberry.)  Apple’s effortless products also enable users to better manage more digital information, making Apple products time-savers in our lives. I’ve argued before that Apple moved into Applications faster than its competitors because saving time and minimizing frustration are the essence of Apple’s brand promise.

Jobs placed “cool, elegant design” before “saves you time and minimizes frustration” in deciding on the antenna design, and that was a mistake.

When your business model value promise is multifaceted, it’s vitally important that leaders not advance one element of the promise at the expense of another. Rather, strategic leaders force their team to find the collaborative break-through solution that advances both elements and therefore overall value.

Apple’s first solution to the problem–offering a free bumper case to all owners–contradicts both value promises.  Early adopters now have to take time to order a bumper case or get a refund for one they’ve already purchased and the iPhone looks considerably less sleek with the requisite case.  Eventually Apple will figure out the antenna solution that delivers effortless time savings, while retaining the look of the thin iPhone 4. Apple’s delay in doing this wasted its customers’ time and increased frustration, costs that could have been avoided if Apple had acted more proactively.

A leader steeped in business model innovation can avoid the costly issues Jobs had to leave his vacation early to resolve. Keep your value promise front and center at all times and train teams to align their decisions to meet or exceed this promise. Unlike Jobs, you’ll be able to finish your vacation.

I am spending two weeks, mostly in Austria, exploring the Eastern Alps and biking along the Donau (Danube) River, before seeing Wein (Vienna) and Prague in The Czech Republic.  Austria is exquisite. The majestic views here make Wisconsin’s landscapes look like a table model for the real thing. (And I love Wisconsin’s land.)

In Saltzburg, an imposing castle stands atop the city. (The photo is an IPhone shot I took in Salzburg.) Indeed in most significant Austrian cities there are castles or grand churches hundreds of years old, each so stately it defines the character of the community.

I can’t help but wonder how the imposing presence of the past impacts those who live in Austria today.  Unlike the US which grew steadily, the Austrian-Hungarian empire significantly shrunk following World Wars. How does this affect the cultural norms passed from generation to generation?

Yet in many ways Austria is far more modern than the US. Austria has the highest production and consumption of organic food within Europe according to Fodor’s.  By the end of our trip, Nick and I will  have biked over 210 miles, 90%+ on bike paths safe from road traffic. And there are hundreds of more miles we will not cover. Hallways in hotels old and new have motion sensitive lighting, while solar panels cover far more roofs than I’ve seen covered in the US. (The roofs by the way are tile-built for life.) The Danube River is dammed at many points to capture its current for electricity, but boats and fish still travel downstream and upstream thanks to large locks built into every dam.

Linz is an old industrial city that has reinvented its business model (yes, cities have a parallel to business models) as a European Cultural Capital, with tourists filling its lively streets and performances.  The industrial base has also reinvented itself according to the Linz write-up I read. Milwaukee could learn something from Linz just as Wisconsin could learn a lot from Austria’s tourism approaches, so friendly to bikers, hikers and motorcyclists alike.

Austrians’ love for their land is visible even to tourists.  Edelweiss, the Sound of Music’s  closing number in which the Austrian Von Trapp family leaves Austria to avoid the father becoming part of Hitler’s army, sounds even more sad as I recall it. A tour of Mauthausen’s prison camp where 123,000 innocent Jewish people, Russian prisoners of war and Austrian resistance fighters were killed reminds visitors (many of them Austrian students on the day we visited) of an ugly part of the country’s past.

The best cultures are ones that honor values from the past vital to success going forward. Values that no longer serve the greater good are weeded out. Strong cultures, like that in Linz,  are not just open to changes required by the times, they proactively capitalize on the need to change in ways that create a stronger future.

Great leaders astutely identify the values that must be left to history while reinforcing the values that will create tomorrow’s works of art – the outcome of our collective efforts.

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For insight on business model strategy, read my recently released book, Beyond Price.

I spoke with Robert Finfrock this week. His company, Finfrock Enterprises, is featured in the introduction to my book, Beyond Price, for how it escaped the ruthless construction industry competition. Bob transformed what had become a commoditized business into a one-of-a-kind business selling its services at a premium. The financial and enjoyment returns have been remarkable and enviable.

Years after his business model innovation, Bob’s firm finds itself in the toughest macro conditions of its lifetime. (Bob’s firm serves real estate developers and building owners in Orlando, Florida–a market very hard hit by the recent recession). Yet his company is still making money.

What about Bob’s industry peers? About 10% of the 275 US plants in his industry have already shut down, unlikely to ever open again. Furthermore, Bob and his team have stayed out of the nasty bid market in which contractors and subcontractors win business, only to squeeze out little or no profit.

I keep thinking about the other companies in the precast-prestressed concrete industry. I worked with forty companies for about two years and stay in touch with some of them. Most know of Finfrock Industries remarkable story of transformation, yet none have followed fully in Bob’s footprints. “Why?” I ask. “Because we’re precast firms, not contractors,” they answer. They thought the risk of competing against their customers (general contractors) was too high relative to the return of becoming the general contractor on projects.

I find this situation very sad. An entire industry could and should have been transformed. Instead, just one leader discovered the promised land of competing with a new business model.

One of the most important strategy decisions you make as a leadership team is: What business are we in? Don’t leave the answer to this question to history, your competition, or serendipity.

What business are you in? Find an answer that uniquely addresses an important issue facing a target market with the ability to pay for that answer. Bob redefined his business to give owners and developers more build features for their dollar, in a shorter period of time, and with less schedule risk. No wonder he’s succeeded on every measure.

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For insight on business model strategy, read my recently released book, Beyond Price.

The best products and businesses solve problems otherwise left unaddressed. Customers and owners win as a result. Vidalias onions provide this week’s example of a business model innovation with the potential to solve an important problem.

Any mother can speak eloquently about the challenges of getting her child to eat healthy foods, with vegetables the most daunting. Yet, sales of Vidalias onions are way ahead of last year’s numbers – because of kids.

A savvy campaign involving Shrek, a beloved ogre staring in Dreamworks’ films of the same name, deserves the credit. The onions are displayed with pictures and a giant blow-up of Shrek in the grocery store, complete with recipes like Swampy Joes. Kids, according to the June 28, 2010 Wall Street Journal, are clamoring for Moms to buy Vidalias onions and cook the meals that Shrek and his friends enjoy.

What’s good for kids is good for the onion business. Victory, at last, exclaims this Mom.

I hope Kraft and other packaged goods companies are paying attention. Packaged food companies are facing enormous pricing pressures from a consolidating customer base (Walmart, Target and regional chain grocers). Furthermore, retailers can easily backward integrate into copycat versions of branded goods products thanks to the existence of private label food manufacturers. Net result: Kraft and its competitors are stuck in commodity-market quicksand. They keep cutting costs to maintain earnings expectations, a non-sustainable business situation.

The food companies that help parents raise kids with healthy eating habits will build brands that matter to parents. More and more parents are willing to switch purchases (from other food to onions) and pay a premium price (Vidalia versus generic onions) for this value-add. When will companies wake up?

What can your business do to solve an important social or environmental problem otherwise unaddressed?
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For insight on business model strategy, read my recently released book, Beyond Price.

For decades, corporate social responsibility has been managed by most CEOs as a Pubic Relations activity, financed through philanthropy and Marketing Department budgets, rather than as a core principle guiding decision-making. What a loss to companies, consumers, the environment and communities. Those few companies who were early adopters of sustainability as a business practice versus messaging opportunity gained attractive financial and market position advantages.

Fortunately, “The times, they are a changing.”

A recent Accenture-UN Global Compact report states that sustainability is moving from the sidelines into senior leadership team meetings where sustainability issues will influence corporate decisions on capabilities, processes, systems, in fact the entire supply chain. “According to the survey, A New Era of Sustainability – UN Global Compact-Accenture CEO Study, 2010, the global economic downturn did little to dampen corporate commitment to sustainability, in fact it seems to have done the opposite: 80% of the CEOs say the downturn has raised the importance of sustainability.” Concern about sustainability is at an all time high, with climate change and education among the top areas of concern.

Small wonder. For companies competing in maturing industries with flat to falling demand, the best new business opportunities are unsolved problems. Environmental health and community well-being are areas ripe with unsolved problems. Other top drivers of company’s commitment to sustainability, according to the study, include brand, trust and reputation (three forces that are highly interdependent). Sadly, consumer demand and employee engagement ranked lower in advancing the sustainability agenda. With a stronger economy, consumers and employees may become more important factors.

So what does this all mean for business model innovation?

With sustainability concerns on the sidelines, environmental footprint considerations and advancing local communities’ well-being didn’t even enter business model considerations, except indirectly as drivers of cost and perhaps workforce availability and quality. Now, decisions about target market, business scope, value promise, advantages and profit drivers (the five strategy decision areas of the business model) will increasingly take sustainability goals into account.

The UN Global Compact is but one of multiple groups in which companies committed to sustainability make commitments to which they are then help accountable. Business for Social Responsibility and CERES are two groups I also admire. I encourage you to look at these organizations’ websites and see example after example of member companies changing their business models to advance sustainability goals.

My sense is that sustainability concerns will follow the pattern of PCs – a lot of hype, slow uptake at first and then zooming demand driven by successive waves of expanded technical capabilities, with adoption rates steadily rising.

Don’t be a laggard in sustainability practices, therefore, if you want to ride a wave to better performance and if your want to seize opportunities to attract and retain today’s young talent.

At a time when economists are exploring broader notions of national well-being than Gross National Product, companies are being compelled by external risks and opportunities to move beyond financial performance to a Triple Bottom Line (profits + people + environment) focus. CEO feedback in the Accenture-UN Global Compact survey reflects CEOs’ deep appreciation that there is no way to hit all three targets until sustainability moves from a lower-level staff responsibility to a leadership imperative, affecting how leaders are judged and company performance is measured. Going forward, commercial decisions will increasingly be shaped by a desire to leave more than just investors and customers better off by the company’s actions.

What are you doing differently to advance your Triple Bottom Line?
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For insight on business model strategy, read my recently released book, Beyond Price.

I’d never have bet that the US Security and Exchange Commission, the team fooled needlessly by Ponzi-scheme artist Madoff and others, would become the brave kid in the crowd to scream, “The Emperor is naked!”

In accusing Dell and its CEO of negligence-based fraud, the reality of Dell’s broken business model becomes clear to all. Apparently Dell’s profits were significantly enhanced by rebates from Intel, so much so that Dell would have otherwise reported a loss in at least one year.

Investors should have been told about the role of rebates in Dell’s financial performance. The information reveals much about the financial risks Dell faced. The information also casts a spot light on a poorly-conceived business model that left Dell’s products competing as commodities.

I’ve criticized Dell before. Owner/leader Michael Dell failed to evolve a once-unique business model in ways that retained a compelling, hard-to-copy value promise. Dell was the first personal computer company to sell directly to businesses, bypassing traditional channels of distribution. Rather than capitalize on this advantage and build advantages that differentiated its offerings to business users, Dell chased dollars by entering the retail market without any advantages.

Today, Dell finds itself caught between a rock and a hard place. Dell’s a distant follower behind IBM and HP in building a strong service-focused B2B offering. In retail markets, Dell lacks any benefit or cost advantage. (In a brilliant move, IBM exited the PC business and tied Dell’s socks in knots by selling IBM’s PC Group to Lenovo.) Price is, as a result, Dell’s competitive weapon of choice and profits reflect this.

Dell leaders should have spent more time thinking strategically and less time negotiating exclusive contracts with Intel whose rebates enabled leaders to report better numbers.

If you want better financial numbers, build a unique business model anchored in hard-to-copy advantages.

What short-term financial moves are keeping you from feeling the performance pain that points leaders towards business model innovation?
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For insight on business model strategy, read my recently released book, Beyond Price.

Borders Group, the struggling bookseller, has a new Chairman of the Board, Bennett LeBow. LeBow’s a member of Vector Group Ltd., the investor group that recently acquired 15% of Borders (35% if warrants are exercised).

According to interim Borders CEO Mike Edwards, LeBow “will play an extremely important role in helping us redefine the Borders brand.” Will a new brand image change the landscape? Perhaps on the margin, but Borders needs more than marginal change.

Borders needs a new business model not just a new brand. Otherwise, change will consist solely of the smoke and mirrors of advertising rather than the real transformation required to win a profitable share of the market. As a Borders lover, I’d hate to see LeBow follow in the footsteps of other leaders who foolishly and tragically banked their hopes on a new brand alone.

Let’s face it. Amazon.com owns on-line book sales, a position so strong that it’s broadened its scope into all kinds of other categories sold on line beyond books. Barnes and Noble Booksellers won the retail store war. Which leaves Borders with higher relative costs per book sold, lower profits and therefore a new controlling investor.

Borders is stuck with a high cost position in what has become a commodity market—the selling of books. While a book itself may be differentiated, when its available in all kinds of physical and virtual places, the seller of that book is essentially selling a commodity. No wonder on-line book sales are growing so rapidly (they have a lower cost structure) and Kindle, IPad, etc., are disrupting the printed book industry (by offering a lower cost structure and more convenient experience than the printed book).

My advice to Borders leaders is to redefine the business Borders is in, broadening far beyond bookseller while still remaining focused on book lovers. (In most commodity situations, expanding the scope of the business is a key way to remain in a market of one.)

How might this broadening play out over the next five years? Imagine…

• Borders librarians (versus store clerks) help you locate the exact information you want, whether it’s a book that reads like those of another author you love, or takes you to the perfect hidden places in a faraway country because the author of the articles shares your tastes in travel. Media not available in the store arrives in your home on line or via express mail.
• To meet the needs of businesses, Borders acquires 800-CEO-Read, a service organization that selects and offers the best selection of books and videos to advance a business customer’s learning and development goals. Business coaches, Corporate VPs of Learning, professionals, entrepreneurs, sole proprietors, non-profits and business educators turn to this Borders’ subsidiary for advice and resources.
• Book lovers travel together on trips designed around a shared interest, be it an author, a period in time or a place. The synergy between pre-travel reading and discussions while traveling creates a winning combination that retirees love and come back to buy again and again.
• Borders stores are redesigned (with loads of customer input) to become the place where readers and authors convene or work in isolation. “I’m Bordering” today becomes codeword for a common shared experience that readers and writers highly value.
• Borders solves parents’ dilemma of raising children who love to read.
• Borders creates a tailored offering of books, courses and peer groups for educated immigrants who want to advance their mastery of English through reading and discussing US authors.
• Membership and event fees are growing shares of Borders’ revenue.
• Authors line up to be part of the Borders’ Tours (virtual and real), connecting authors to current and potential fans.

In essence, Borders purpose becomes infusing books and reading deeper into our lives, not just selling us books. In the process, Borders becomes a trusted and highly valued resource for individuals overwhelmed with information. Borders new value promise becomes better lives (better businesses) which would make for a great re-branding. Border’s new scope is far broader than a retail box store or an on-line marketer, yet still highly synergistic with books.

Creating these changes will require far more challenging work than developing communications for a new brand concept. Which path would you pursue as a leader – a new brand alone or a new business model that truly differentiates Borders from Amazon.com and Barnes and Noble?
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For insight on business model strategy, read my recently released book, Beyond Price.

Media provides a great case study of creative destruction, to coin Joseph Schumpeter’s term for capitalism’s ability to destroy while creating anew. Yet even massive creative destruction will not reverse the basic economic principal that customers buy based on highest perceived value, where value is perceived benefits less the perceived costs to acquire those benefits.

Newspapers, for example, were highly profitable when they held the unique advantage of cost-effectively and frequently reaching customers with an advertiser’s message. Editors focused first and foremost on readers, with the publisher paying most attention to advertisers. The symbiotic relationship worked …

… until Cable TV and the Internet fragmented markets and provided alternative and less costly routes for commercial advertisers and classified ad purchasers to reach their target markets and paying readers to find news. The monopoly position of the newspaper as a frequent advertising vehicle was lost. With declining ad revenues, newsrooms have been downsized to the point where every Sunday New York Times feels like an Easter Sunday version, historically the thinnest of the year.

With less content and free content available on the web, paid circulation further declined. In the interim, Google who creates absolutely zero content becomes, in the words of Atlantic Magazine writer James Fallows, “the world’s most important media organization.” Fallows is writing about how Google is working to help news publications in “How to Save the News.”

Why then has the Wall Street Journal flourished? And why, with Newsweek bankrupt and on the auction block, is The Economist thriving?

Both of the winning publications know their target markets and have designed their publications to uniquely meet their target market’s needs. The publications exist for the reader, not the advertiser. The advertiser comes along because these media examples have a growing customer base that is paying attention to the page.

The Wall Street Journal has been very savvy in both moving upscale—giving professional readers even more content with Wall Street Journal Pro—while giving the every-day reader interested in financial and business news enough sports, arts and style to reduce the emotional switching costs of canceling a New York Times or local daily subscription.

Both publications also remind me of the savvy direct mail companies like Lands End. It realized before its peers that the internet is the channel, the printed catalog a direct mail marketing tactic to attract new customers and prompt existing ones to buy more.

Where else for example but The Economist’s on-line homepage can I find top-notch, professionally produced global coverage of economics and politics? (Goggle News is an alternative, but I like supporting journalists!) The Economist print magazine on the other hand offers items like a10-page in depth coverage of an issue, coverage that I prefer reading off-line.

Advice for local newspapers

Fallows suggests that eventually newspapers will flourish once again, albeit on line. While Fallows offers some interesting innovations (most advanced by Google who will lose content and therefore ad revenue if all the other media go out of business), he’s missed a few.

Publishers of local papers should recognize that they still have advantages that benefit advertisers, but to capitalize on them they must expand their advertising scope beyond newspaper print and webpage. Imagine if Lee Enterprises (owner of many local newspapers in my region) acquired Hiebing, a successful regional marketing communications agency and secured attractive rates from local radio stations and printers. Lee could offer cost-effective integrated marketing solutions to local companies in need of getting their message out across multiple channels. There’s more value in that than on-line paid ads.

Second, local newspapers must stop treating their target market on the reader side as one market. Identify the key segments and create focused publications that meet their unique needs. Biz Times in Milwaukee and In Business in Madison are creating communities of small business leaders through their events, on-line and print publications; with these audiences come advertising dollars the Milwaukee Journal-Sentinel and Wisconsin State Journal have respectively lost. Why Lee Enterprise let the (from what I understand profitable) Capital Region Business Journal languish into a poorly advertised on-line only offering is beyond my comprehension. (Disclosure: I write a column for the CRBJ.)

Without change here is where local newspapers may be headed in the very near term: There is now a software program that writes sports articles automatically from internet-feeds of local game scores. A local start-up could use this software to create an on-line local sports publication. ESPN is also eying local sports news as a business opportunity.

Without sports readers I do fear local papers are doomed, well before Google’s innovations for news sources save the day.

The lesson

Technology changes transform industries. The winners are those companies that stop holding onto an obsolete business model. Winners innovate their business model to uniquely benefit a well-defined target market.

(Image Credit: FreeFoto.com)
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For insight on business model strategy, read my recently released book, Beyond Price.

I spoke a number of months ago to an audience composed largely of machining companies. (Machining companies transform metal and other hard materials into parts used in transportation equipment, packaging machinery and other manufactured goods.) Like many CEOs in mature manufacturing markets, the leaders felt their companies’ offerings had become commoditized. Quality and service, once differentiators, were now requirements to even be considered. Once considered, a customer’s (usually a purchasing agent) final selection of a part supplier was driven largely by prices quoted on bids.

Many leaders were angry and frustrated at the Herculean power price (and purchasing agents) acquired during the recession. All signs point to price remaining important into the distant future as well. If companies are doing their best work ever, why were they being treated like a commodity versus a truly valued partner and supplier?

A comparison of websites reveals the answer.

To win an INC 500 spot, innovate your business model

In looking at the websites of the companies whose leaders I would meet with, I noted a very typical pattern – a company describing itself from an inside perspective:
• Years in business
• Types of parts
• Types of equipment
• Quality systems
• Value-added services
In essence, each company had the same business model: manufacturing component parts designed by an OEM to the OEM’s specifications. (OEM=original equipment manufacturer) Once qualified on quality, reliability and capacity, price drives which machining company offers the most value. Why? Because the process of qualifying suppliers ensures that each company can provide the desired benefits. When perceived benefits are the same, price differences between suppliers are value differences as well.

A commodity market requires only two qualified suppliers

The companies were different in terms of the part sizes and tolerances they could best manufacture, a reflection of how the industry had fragmented along lines defined largely by types of machine tools in use. But other than two companies dealing with exotic materials and one meeting an incredibly tight tolerance level, it was clear there’d likely be at least two competitors for any size/tolerance need. And this was just Illinois! Two suppliers meeting requirements is all that a buyer needs to position one supplier against another in order to extract the lowest possible price.

One website was different. Fusion Systems, Inc., an Illinois machining company has a uniquely different business model. In lieu of making parts, Fusion manufactures and distributes its customers’ older products, products that themselves have a lot of machined parts. Fusion promises to increase profitability on its customers’ legacy products while increasing customers’ time to work on new products, products that are more strategic to a company’s success.

Like any great business model, Fusion’s model is built on a strategic insight – there’s untapped profit opportunity in legacy products, but companies are too busy doing more work with fewer staff or too constrained by established parts protocols to realize the profit opportunity contained in redesigning older product lines. And oftentimes, it’s the legacy products that create a lot of complexity in a manufacturing or distribution site (e.g., repair parts are ordered erratically).

On Fusion’s homepage President Craig Zoberis describes today’s manufacturing challenge, effectively communicating that Fusion is here to help relieve the load on manufacturing and engineering leaders and their staffs and improve its customers’ bottom line in the process. This graph visually explains the FUSION financial benefit.

A strategic insight plus the courage to build a different business earns the young company a spot on the INC 500. Fusion is one of only 13 companies on the 2009 list making components used in final manufacturing goods.

Unlike other machining companies, Fusion sets prices to earn its desired return, using an open-book pricing model with its customers. Open-book is a good signal to send potential customers if your aim is replace their manufacturing operations in making their legacy parts. Fusion negotiates to reach a profitable price, while competitors compete on (oftentimes unprofitable) price, because Fusion competes as a one-of-a-kind business, versus a me-too business.

Feeling uncomfortable? Find the strategic insight that will enable you to innovate your business model. The Inc 500 is within reach if you reach for it.
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For insight on business model strategy, read my recently released book, Beyond Price.

A new Schwab advertising campaign states, “Ask not what you should do for your broker.” What a great way to successfully communicate Schwab ‘s value promise given what’s happened with the “too big to fail” banks – Schwab will always act to benefit its clients. The company has built it’s business model around this value promise.

Not so Goldman Sachs. The SEC charged the investment bank with fraud for selling an asset to banks whose return depended upon a group of home mortgages being repaid by the home loan borrowers. The alleged fraud arises because Goldman Sachs did not tell the banks that the specific sub-prime mortgages in the group were recommended by another Goldman Sachs customer who planned to bet against these same mortgages ever being repaid by the home loan borrowers. (The fact that Goldman Sachs is selling bets and banks are buying them is a topic in itself, but hey, this is how we set up our regulatory frameworks thanks to Greenspan.)

Would you host a poker game for your friends knowing the dealer was bringing stacked cards and not at least inform your friends of the dealer’s intention? It’s not hard therefore to wonder, “Who is Goldman Sachs’ target customer?”

“Who is your target market?” – the group you will design your company around to benefit – is one of five core business model questions. Goldman Sach’s behavior suggests it is changing its business model. Is this a wise thing?

In the good old days

Goldman Sachs traditionally served both investors and businesses seeking capital outside traditional depository banks (the banks with our checking accounts). This intermediary role was good for both sides of the exchange and good for the economy, as investment banks traditionally channeled capital to the best uses for society, according to economic theory. As an economist, I think the theory pretty much got it right. The US became the wealthiest nation in the world in large measure because free markets and democracy moved capital to the right places. Until recently, that is.

“Too big to fail” bank interests stopped being aligned with Main Street’s best interests

On Wall Street today, President Obama spoke to financial industry leaders. According to an early release of the speech, he said, “A free market was never meant to be a free license to take whatever you can get, however you can get it.” I disagree with Obama. Free license to maximize one’s well-being is what a free market does. In other words, capitalism is devoid of a moral code. The moral behavior of a business therefore depends upon who is leading the business. With most leaders, behavior benefits the business, its customers and society. But not with all leaders. That is why we need a strong (note that I did not say big) government – to establish laws and incentives to best align business interests with society’s best interests.

Which brings us to the SEC filing a case against Goldman Sachs. Our courts will decide if the SEC is reading the law correctly.

An issue irrespective of guilt or innocence

Goldman Sachs may not have broken the law. After all, as the firm claims, they were selling the bet to highly informed professional investors. Was it Goldman Sach’s role to point out the risks? Well, it used to be.

So who is Goldman Sachs’ strategic customer – the one leaders design their firm to serve? If it’s the investor, Goldman Sachs’ omission of facts from its prospectus broke the firm’s commitment to its investors. If Goldman Sachs’ strategic customer is the man influencing the selection of the mortgages (a hedge fund manager) then Goldman Sachs should hang a huge sign outside their new building for investors to read stating, “Buyer Beware.” I think Goldman Sachs’ strategic customer was itself – profit for the sheer purpose of profit, at anyone’s expense.

Lawyers must argue a case for their client, whatever the lawyer’s belief about guilt and innocence. This principle and professional commitment creates our nation’s a stellar legal system. Goldman Sachs will say the same thing – their role is merely to make markets. OK, I get that, especially for derivative contracts that help airlines manage fuel costs and new issues of stock that enable a high potential company to grow. But the market maker must be fair, not someone who’s knowingly allowed the game to be stacked in one person’s favor not because of economic trends but because facts are omitted by the market maker.

My vote

Were I a Goldman Sachs partner, I would vote to plead guilty to fraud. Yes, it would be expensive for the firm to do so. But it would communicate that Goldman Sachs:

• Understands its true value to society
• Works according to its publicly-stated principles
• Will get back to this important work as soon as it gets rid of the leaders who forgot why the firm really exists.

Another way to look at the situation

Goldman Sachs’ was known for hiring the “smartest guys on the block.” Instead of using these smarts to create deals like the one for which they are in trouble, imagine if they used their smarts to fulfill the purpose the firm was initially created to advance: channeling capital to build societal wealth. The smart guys could have helped the US Treasury and Federal Reserve Board understand the leverage risk we were facing. The firm’s truth telling could have averted the 2008 economic calamity that so hurt businesses and investors.

If only ...
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For insight on business model strategy, read my recently released book, Beyond Price.