A recent Financial Post column relates a real-life counter example of how not to maximize long-term profits, which I think is worth analyzing. To paraphrase the story: some years ago, in a small hamlet in the Canadian Arctic, its only store managed to source a rare treat from the south: a watermelon. Like most foods and other goods, the melon had to be flown in, as the hamlet is only accessible by plane in the summer months. For that reason (and because of the inability to grow much locally), food is very expensive in the far north. For example, the store charged about $8 for a dozen eggs and $6 per pound of apples. A delicacy seldom seen at those latitudes, the watermelon was priced by the storekeeper at $85.
Not surprisingly, there were no takers at that price. Customers asked the grocer to cut up the watermelon and sell it by the slice. The grocer refused. The expensive melon remained unsold and rotted on the shelf. No watermelon for the customers and a loss for the grocer—not a way to maximize profits.
The columnist gives his own explanation of the storekeeper’s behavior (inertia, ego(!), fear), but I suggest it is more helpful to analyze the watermelon case with the help of clear principles on which long-term profit maximization depends. These are the reality principle and its two derivatives: productiveness and trade.
The most fundamental principle that the storekeeper violated was what Martin Puris in his book Comeback about successful company turnarounds called the reality principle. The principle emphasizes staying focused on facts in one’s thinking and action, no matter how unpleasant, or how tempting it might be to evade them. Ayn Rand called this principle rationality which she also considered the primary moral virtue.
Had the storekeeper in the Arctic adhered to the reality principle/rationality, he would not have stopped at recognizing the fact that he had the only store in the hamlet and therefore, a captive market of the residents who had nowhere else to go shopping (without flying out at a great expense).
He would have also recognized the essential fact that the only way he could maximize profits was to create value for his customers,
and that his only regular, long-term customers where the residents in the community. His customers did value watermelons—as their suggestion to sell the pricey melon by the slide suggests—but not enough to be willing to pay the price the storekeeper wanted for the whole watermelon.
The fact that profits (value for the shareholders) are made by first creating value for customers points out another principle guiding long-term profit maximization which Ayn Rand called productiveness: creation of material values through productive work.
Had the shopkeeper adhered to the principle of productiveness, he would have recognized that the material value he could create is the service of sourcing and selling groceries—necessary values to his customers—in his northern community. However, productiveness requires finding ever better ways of doing one’s work, not just complacently depending on a captive market and ignoring customer suggestions for innovative ways of delivering and selling products. A monopoly position cannot be sustained indefinitely (unless protected by government); lack of productiveness will eventually invite competition.
The third principle guiding long-term profit maximization is what Ayn Rand called the Trader Principle, according to which one should trade value for value, by mutual consent for mutual benefit.
The Arctic storekeeper was also violating the Trader Principle: he was trying to sell the watermelon at a price that rendered it a non-value to his customers, with the consequence that he also lost the value (the price he paid for the eventually unsold, rotten melon, and the potential profits he could have made), and nobody benefited.
The story does not end with the loss of the storekeeper’s investment and the wasted watermelon but has longer-term consequences. Apparently, it was the last straw to his customers: they formed they own co-op store, and the grocer went out of business. Had he understood and applied the reality principle (rationality) and its derivatives, productiveness and trade, the ending could be quite different: a watermelon sold by the slice and other values provided to the customers, and long-term profits maximized.