A New Form Of Business Organization
Replacing The Public Corporation With A Customer Controlled Company
By David Grace (www.DavidGraceAuthor.com)
The Form Of An Organization Is Shaped By The Society Within Which It Exists
Society, that is the aggregation of political systems, technological tools, levels of education, cultural beliefs and the like that exist at any given point in time and space, dictates what institutions (forms of government, business, education, etc.) it supports and how they work. Or better, a society dictates what kinds of institutions are able to function effectively in that time and in that place.
If you have a low technology, brass-age society – agrarian, no mass communication, no mass education, rigid class structure – what kind of business organization would you be able set up? A stock company? Without literacy, a financial infrastructure, mass communication, a sophisticated banking system, a middle-class with liquid assets? Not likely.
Move forward to the 1600s and those factors have changed. You have upper-middle class people with liquid assets and an interest in investment, an established currency and banking system, wide-spread literacy, and mass communications. People started pooling money and buying shares in new businesses that had received a charter from the government. Most importantly, they had the ability to trade the shares they received. The first corporate business entities were born.
As technology and mass media advanced further we saw the rise of the large public corporation. It became possible for the managers of a company to be separated from the vast majority of the investors. Stock ownership changed from a few entrepreneurs meeting in a coffee house or a primitive exchange to a sophisticated market structure where millions of strangers anonymously bought and sold shares in the same way that gamblers might buy and sell betting slips for next week’s horse race.
The Public Corporation — Control Separate From Ownership
Most investors in today’s public corporations do not exercise significant control over the companies in which they own stock. Sometimes institutional investors band together to remove a company’s CEO but they do not exercise control over its general management decisions.
From time to time institutional investors or hedge-fund managers may mount a proxy fight or demand extra seats on the board or try replace the CEO or institute a major change in company policy but that is a blunt instrument for control, at best.
Certainly small investors who hold a fraction of a percent or less of the stock exercise no control while the large investors are often merely traders buying and selling shares as a short-term investment vehicle and without any interest in the long term success or failure of the company.
Usually, unhappy shareholders utilize the public markets to abandon ship when things start to go bad.
The Public Corporation — Focus On Short-Term Financial Performance
Since executives are customarily compensated with stock options and institutional investors are focused on the daily stock price, management’s incentive in the average public corporation is primarily on short term numbers.
Good short-term numbers increase the stock price which means money in the pockets of the option-holding executives. Whether the policies those executives put in place will destroy the company in five or ten years is not a prime consideration.
Ten years from now the executives and the major investors will all have jumped ship taking their winnings with them and leaving the remains for the mom-and-pop investors and bankruptcy trustees.
In short, the societal environment today – instantaneous trading, complex financials, a highly compensated class of mobile professional executives, part-time boards of directors, stocks as a gambling vehicle – all have had a hand in how today’s public corporations operate, and the overall result is a fixation on short-term metrics.
This is perfectly normal. If the operators of an organization are compensated based on short-term financial results then, of course, they will do whatever they can to improve short-term financial results. Why would we expect them to do anything else?
Essentially, a public-corporation’s executives answer to institutional investors, hedge-fund managers, Wall-Street consultants and investment bankers. That is their constituency. If you expect them to run their companies in any way other than one that will please that constituency then you have no clue how humans work.
With the notable exception of people like Steve Jobs and Jeff Bezos, most CEOs are not directly concerned with product quality or customer satisfaction.
Yes, if the customers think the quality is high and that belief translates into mores sales and the higher sales translate into higher profits and the higher profits cause the stock price to rise, then that’s good but, at most, the executives’ concern with product quality and customer satisfaction is indirect in that it is important only to the extent that it affects the stock price.
Jobs and Bezos didn’t become CEOs because the board hired them from a pool of professional executives. They were the founders who build their companies in the first place.
This is not to say that CEOs whose concerns are market share, increasing market penetration, growing sales, P/E ratios, EBITA, debt to equity ratios and the like are wrong, or right. They are simply doing what the corporate form of organization and the societal system in which it exists expect them to do.
What they are not doing, and generally should not be expected to do, is to be primarily focused on creating the world’s greatest products or having the world’s most satisfied customers.
A company’s customers are not management’s constituency. Stock market traders are their constituency.
The Customer Controlled Company – Focus On Product Quality & Price
If we want business entities to be focused on high quality, reasonably priced products then the principle of incentives tells us that the owners of the company need to be its customers.
If you want to have companies that are dedicated to making the best products and providing the best services you have change the form of the business organization that produces those products to one where the executives’ compensation and continued employment is directly linked to the satisfaction of the company’s customers.
To do that you will have to create a new form of business organization, one that could not have existed fifty years ago anymore than the current form of a public company could have existed six hundred years ago.
Let’s call this new form of business organization a CCC – a Customer Controlled Company.
What makes customers happy? Great products, of course, but if they’re so great that they cost too much (in the customers’ opinion) the customers will buy cheaper products from a competitor. Of course, while low prices are important, if the prices are low because the quality is crap, Customers will avoid those poor-quality products and services for more expensive but better alternatives.
Customers are always looking for the sweet spot, the best combination of quality, service and price.
A CCC would not have been possible before the Internet and before secure communication protocols and before sophisticated financial transaction databases. But today we have all the tools needed to create, if not the successor to the public corporation, at least an alternative to the public corporation – a customer-owned company that is primarily focused on the producing the best products at the lowest price.
For the first time in history we now have the tools needed to create a CCC.
Is this important? Well, as a consumer, which form of entity would you prefer to do business with?
“This is all an Ivory-Tower mental exercise,” I hear you saying. “Give us some specifics.” So, specifically, how would this theoretical organization work?
Form Of CCC Management
A board of directors is a mechanism originally designed to allow investors, often different groups of investors, access the to a company’s strategic decision-making process. Different investors with different interests – founders, executives, lenders, institutional investors, etc. – have different agendas and, as such, each wants an intimate involvement with the company in order to protect their disparate interests.
This committee format necessarily complicates the management of an enterprise and serves to add another layer of bureaucracy to the management process.
This inefficiency becomes worse in a public company where each director is a part-timer who might sit on the boards of five different companies in addition to their “real” job. And, while some have a material economic stake in the companies on whose boards they sit, most do not.
In a standard corporation the shareholders elect a slate of board members whom they know little or nothing about and in no way control.
The Board appoints a CEO and the CEO runs the company. The CEO (or another farther-down-the-chain executive) hires the day-to-day managers.
The millions of individual shareholders have little or no involvement in this process. The big institutional shareholders are almost all focused on short-term numbers.
Essentially, the executives run the company subject to screwing up so badly that even the part-timer board can’t take it any longer.
It’s different for a CCC. The CCC has no disparate interests it needs to cater to through the mechanism of a diverse board. Yes, there are different product lines but giving the customers of different divisions their own separate representatives is an invitation to disaster. The principles of incentive and feedback, in fact, guarantee a disaster if competing product lines are allowed to jockey for management power.
In short, there would be no board of directors in a CCC. How would things work without a board?
General Management Decisions
For most decisions the CEO would be a benevolent dictator who would be elected by the customers and whom the customers could fire at any time.
Customer Powers
There would be a list of actions that would require customer approval, for example, approving initial compensation and changing the already approved compensation of any executive whose salary was in excess of some floor amount.
Selling assets that represented more than a certain percentage of the company’s net worth would be another.
The list of decisions that would require customer approval would be included in the CCC’s articles of organization and those articles could not be changed without the affirmative vote of a majority of the customers.
Information To Customers
All planned activities that were not reasonably required to be kept confidential would be disclosed in a weekly web post available to any customer.
Customer Initiatives
Customers holding 5% or more of the votes could use the Internet to place an initiative up for vote. If a group of customers was upset about some planned action, for example, the plan to build a new facility in Dallas, and they got 5% of the outstanding votes to endorse a proposal to reverse that decision then an Internet vote would be scheduled. If a quorum voted and at least 50% of the votes cast were opposed then the new facility would not be built in Dallas.
For Voting Purposes Who Are the CCC’s Customers?
Direct Customers
If the CCC is a company that sells directly to the customer, e.g. an airline, a telephone company, an insurance company or the like then the identity of the customer is not in question. It’s right there in the company’s records together with the amount each customer has paid to the company.
End Users Of Registered Products
But what if the CCC sells through one or more distribution channels?
Even though an auto manufacturer sells through dealers who then sell and lease cars to the consumer, most people would consider the auto manufacturer’s customer to be the end-users who purchase the vehicle. In this scenario the customer would be the registered owner, the person whose name appears on the product warranty records.
So, we could say that if the CCC sells a product that is customarily registered with the manufacturer for warranty purposes then the customer is the person who holds the warranty.
The number of votes assigned to any customer is the amount spent for company products or services. For end-user customers that amount would be considered to be the suggested retail price for the product purchased.
End Users Of Non-Registered Products – Consumer Goods
But what if the CCC sells consumer products that are not warranted – beer, corn flakes, paper towels, and the like? If Procter & Gamble were a CCC and if it sold Tide detergent to Associated Market Distributors which in turn sold the Tide to Food King which in turn sold a box of Tide to Bill Jones, is the voting customer Associated Market Distributors, Food King, or Bill Jones?
If P&G had records that showed the name of every end user who bought a box of Tide, then the customer would be Bill Jones. But it doesn’t. That means that for consumer products for which there is no warranty registration process the voter is the person whose name appears on the CCC’s sales records. So, in our example the customer is “Associated Market Distributors” because that’s the name that would appear on P&G’s records.
So, the voter-identity rules would be:
- If the product or service is sold directly to the end user, then the seller’s end user records will be used to designate the identity of the voter and the quantity of votes.
- If the product is one for which a warranty applies, e.g. a car, a refrigerator, laptop, then the votes follow the warranty registration records and the number of votes is based on the manufacturer’s suggested retail price.
- If the product or service is one for which there is no warranty registration card and if it is sold through layers of distribution, then the voting customer is the customer who buys the product from the manufacturer and the number of votes is based on the price paid according to the manufacturer’s sales records.
How Many Votes Does Each Customer Get?
In the most simplistic view each dollar spent on a CCC’s products and services over the twelve-month period ending thirty days prior to the closing of voting would entitle the customer to one vote – one dollar equals one vote.
If John Smith purchased $100 worth of Company X’s products and services within that twelve month period then John Smith would have 100 votes. If Acme Inc. purchased $1M worth of Company X’s products and services within that twelve month period then Acme, Inc. would have 1,000,000 votes.
Mechanics Of Voting
Voting would be over the Internet and would take place over a period of seven to ten days. At any time within the voting period any Company X customer could cast his/her/its votes.
As the Company’s customer base changes over time, the votes will follow the customers. Executives who displease the customers could find themselves out of a job. Except for capital accumulation for research, development or expansion, there would be no profits. Look at Amazon as a model.
Where Would CEO Candidates Come From?
The CEO job specs would be published on the Internet – salary, expenses, fringe benefits, duties, etc.
Anyone could fill out a carefully-designed form and apply for the job. The form would include questions such as: “Would you make any major changes to the Company’s products? Services? Structure? Etc. What would they be? What is your philosophy of business? What would your goals be for this Company? Etc.”
All the applications would published on the Internet for access by the voters.
How Would a CEO Be Elected?
The CCC’s customers would get one vote for each dollar they spent on CCC products or services in the last twelve months before the vote.
Each voter could initially cast their Internet votes for up to five applicants. If John Smith had 1,000 votes he could cast 1,000 for Mary Smith, 1,000 for Derek Jones, etc.
The votes would be totaled and the top five candidates would be listed for a second vote. Each voter would list their top three candidates. The first candidate whom John Smith selected would get 3,000 votes. The second candidate John Smith selected would get 2,000 votes and the third one would get 1,000 votes.
All the votes would be totaled and if one candidate got a majority, that would be the new CEO. If not there would be a runoff vote between the top two candidates.
Every six months each customer would receive an email stating the number of votes he/she/it had accrued in the previous twelve months and asking if the customer wanted to register a vote of no-confidence in the CEO.
If 20% of the total eligible votes were “no confidence” then a special election would be held via the Internet to vote “yes” or “no” on firing the CEO.
If at least 50% of all the eligible votes were cast (a quorum) and if at least 50% of those votes were to fire the CEO then the CEO would be fired effective sixty days after the date of the vote.
The office would be open to new applications and the old CEO could apply like everyone else. The newly elected CEO would take office at the end of the sixty day period.
There would be rules about what the CEO could do on his own and what decisions the CEO would need to have approved by the customers. Essentially, the CEO would be a benevolent dictator operating under a written constitution but who could be removed upon the vote of the customers.
How Would A CCC Be Created?
If you want to start a new company as a CCC how do you raise capital without creating a class of shareholders who would expect to remain the owners of the company?
CCC Start-Up Funding
Crowd Sourcing
A company could be designed from the beginning to be a Customer Controlled Company (CCC). For example, the founder(s) might promote the idea of the company on Kickstarter or similar crowd-funded platform to obtain the initial capital with the commitment to the contributors that it would be a CCC.
The founders could remain as highly compensated initial executives unless and until removed by the customers. Also, the CCC’s Articles could provide for a payment to the founders based on profits (tightly defined) over the initial 3 to 5 years of the CCC’s operation.
The contributors would get defined product or services benefits from the company once it produced its products. The company might agree to set aside a certain level of profits for a fixed period of time for distribution to the crowd-source investors under a re-payment with 10% interest plan.
At the end of that set period no more payments would be made and the crowd-sourced contributions would not show on the balance sheet as debt.
Customer Funding
If the company was technology based, the developers of the IP could solicit funding from the industry that would benefit from the technology with the guarantee that it would be a CCC.
For example, if an engineer or a university patented a revolutionary memory-chip technology then, instead of licensing that patent to the various memory chip companies, those same companies might calculate that in the long run it would cost them less to loan the start-up the capital need with the guarantee that it would operate as a CCC.
That would guarantee that as the licensees of the technology they would benefit by receiving low license fees after repayment of their initial capital loans and agreed-in-advance payments to the inventors.
CCCs are intended to operate as break-even enterprises after accumulation of sufficient capital to fund research, development, capital investment and expansion which means that product prices will be lower than those charged by for-profit companies.
Founder Money
If you’re Bill Gates or Warren Buffett and you want to found a CCC with your own money, how do you do it? The easiest way is to loan the company the money and structure a repayment plan with interest based on growth, sales or profits instead of a fixed rate.
Public Funding — Raising CCC Capital With A New Type Of Investment Product — The PPI
I previously proposed a different type of investment security, A Profit Participation Instrument. For more details on how a PPI would work, see my column:
A New Financial Instrument — Not Debt — Not Equity
A CCC could raise capital on the public market through the sale of Profit Participation Instruments.
A PPI — A Different Form Of Investment Product
Profit Participation Instruments (PPIs) would entitle the holders to a fixed level of “profit” participation for a fixed period of time.
PPI holders are neither equity holders nor creditors. They have no voting rights and there is no debt related to their investment on the balance sheet.
The CCC that wants to raise money with the public offering of an investment instrument would agree to act in specific ways with regard to the Profit Participation Instrument.
The corporation (e.g. Acme, Inc.) would offer to sell a fixed number of Profit Participation Instruments (PPIs) to investors at an initial offer price.
Each PPI would give the holder the right to share in a stated percentage (the Payment Percentage (PP)) of the company’s “Profit Equivalent” calculated on a standardized formula.
The PPI would entitle the holder to receive annual payments based on the formula: Payment Percentage (PP) X Profit Equivalent (PE)/Number Of PPIs = Annual Cash Payment Per PPI.
As part of the offering the company would set the time frame (TF) over which payments would be made, e.g. five years, and the cap on payments, e.g. seven times purchase price (CAP). For example, Acme, Inc. might make an offering as follows
Issuer: Acme, Inc.
Number Of Instruments: 500,000 (+/- 2.5%)
Payment Percentage: 25%
Time Frame: 5 years
Payment CAP: 7 times PPI acquisition cost
Initial Offer Price: $10
Acme’s Historical PE Results:
Previous Year: $7M
Two Years Ago: $8M
Three Years Ago: $4M
Four Years Ago: $1M
Converting An Existing Corp To A CCC
A majority of the shareholders in a C corporation could elect to convert all of their shares in the corporation into PPIs under Time Frame, CAP and Profit Percentage terms set prior to the shareholders’ vote.
The CAP amount would be based on the shares’ market price on the date of conversion. The existing shareholders would see their stock converted into PPIs and would receive PPI payments over the set Time Frame. Their PPIs would be tradable on the stock exchange just like any other security.
At the end of the Time Frame the corporation would become a CCC with new management elected by the customers. Prior to the end of the Time Frame the existing shareholders would continue to elect directors and control the company but they could not receive any dividends. The only payments they could receive would be PPI payments.
The Company could redeem PPIs at any time by paying an amount equal to the remaining unpaid CAP amount. For example if the CAP was $100/PPI and the holders had already received $70/PPI the Company could elect to immediately pay $30/PPI and terminate all outstanding PPIs as of the date of the $30 payment. At that point the company would immediately become subject to control by its customers.
Let’s Start The Discussion
None of the above is intended to be a set-in-stone plan. It is intended to be a starting point for a discussion on how a CCC might work.
Obviously, there would need to be state and federal legislation, amendments to the various states’ corporation codes, to the federal securities and taxation laws, etc. Every detail needed to do this or that would need to be evaluated, adjusted and tweaked.
But all new business organizations start with an idea.
The idea of the LLC started in Germany in the late 1800's. The first American legislation establishing the modern form of a Limited Liability Company (LLC) business entity wasn’t adopted until Wyoming passed a comprehensive act in 1977.
Today the LLC is a common form of business organization that exists in all fifty states.
The purpose of this article is to stimulate interest in and a discussion about the creation of another form of business organization that has the power to consistently make better products and provide better services at lower prices – the Customer Controlled Company (CCC).
