Peter F. Drucker: Delivering Value to Customers



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Peter F. Drucker:

Delivering Value to Customers



You have to manage for results, do the right thing right

and make serving the customer the center of everything

by 

Gregory H. Watson

M A N A G E M E N T

ETER F. DRUCKER is

widely credited

with creating management as a formal

discipline. In 1954, he published the

first book that defined business man-

agement,  The Practice of Management.

Before this book, there was no coher-

ent body of management knowledge, and only two

or three books even addressed management issues.

When it comes to the quality aspects of manage-

ment, Drucker has established several ideas of

importance to quality professionals. His concepts

span from defining the purpose of a business to

challenging leadership to manage information

more effectively.

Throughout his career, Drucker has presented an

idea toolkit to create profound knowledge and

stimulate business improvement. This article,

based on the lifelong writings of Drucker and an

interview I conducted with him in summer 2001,

traces the ideas behind his strategic architecture for

delivering value and quality to customers.

Drucker almost always begins his discussions

with a question like what is a business? To him the

usual answer—the purpose of an organization is to

make a profit—“is not only false, but it is totally

irrelevant.”

After rejecting this most obvious definition,

Drucker then describes his basic concept as a start-

ing point: If you want to know what a business is,

you have to start with its purpose, which must be

found outside the business itself—in society, since

a business enterprise is an organ of society. “There

is only one valid definition of business purpose: to

create a customer.”

From a quality perspective, Drucker develops the

more traditional emphasis on financial return—that

a business is an organization that “adds value and

creates wealth.” Value is created for customers, and

wealth is generated for owners. While this is a sim-

ple statement, Drucker observes traditional man-

agement methods often mask this basic business 

P



purpose. Throughout his body of work, Drucker gives

quality professionals many lessons in economics, busi-

ness, finance and accounting.

Traditional measurements inadequate

Consider how Drucker takes on some of the main-

stream thinking in business. “Enterprises are paid to

create wealth, not control costs. But that obvious fact

is not reflected in traditional measurements. First-year

accounting students are taught the balance sheet por-

trays the liquidation value of the enterprise and pro-

vides creditors with worst-case information. But

enterprises are not normally run to be liquidated.

They have to be managed as going concerns, that is,

for wealth creation. To do that requires information

that enables executives to make informed judgments.”

One theme in all of Drucker’s work emphasizes the

inadequacy of traditional cost

accounting methods that cre-

ate a short-term decision bias

due to the need to regularly

deliver a quarterly profit and

assure investors their capital

can be returned if the business

is liquidated. This bias runs counter to the long-term

need for organizational strength that delivers sus-

tained success, increases customer loyalty and grows

the wealth of the investors.

Drucker commented in our interview, “Financial

people believe businesses make money.” In reality,

businesses make products for customers. Money is a

result earned by products delivering value that cus-

tomers are willing to purchase. “In a business you

earn your money; in a nonprofit organization you

deserve your money,” he added.

“Because there is no bottom line in a nonprofit, per-

formance is actually more important,” Drucker contin-

ued. “Many nonprofits are not concerned with

performance because they believe good intentions are

enough. ‘We are in a good cause. Therefore, the fact

that we are totally ineffectual is unimportant.’ I’m

exaggerating, but not too much, I’m afraid.”

All organizations must consider their priorities, he

insists. “What results are we expecting? What are we

trying to accomplish? Why are we here? We must

remember, managing volunteers is much more chal-

lenging than managing employees because there is no

paycheck!”

To achieve long-term business success, an organiza-

tion must have a purpose that elicits the dedication of

its people. This may be defined in a mission state-

ment, vision or purpose that aligns the people with

their organization.  As Drucker stated in his book



Managing for Results: “Businesses exist to produce

results on the outside, in the market and in the econo-

my.” This statement introduces one of Drucker’s pre-

mier ideas: management by objectives, or focusing the

organization to achieve a set of results by aligning the

work of its people to a shared set of objectives.  

Measuring business results

Managing by objectives changes the job of the man-

ager. Instead of supervising employees in their work,

the manager elicits agreement on objectives, measures

and goals and leaves the employees to define the

means by which they will accomplish these objectives.

To  know the objective of a business, you must have

impartial measurements of its performance. But it is

not profit that is most important. Drucker sees eco-

nomic value added (EVA) as a superior measure.

“EVA is based on what we have known for a long

time: What we generally

call profits, the money left

to service equity, is usually

not profit at all,” he says.

“Until a business returns a

profit that is greater than its

cost of capital, it operates at

a loss. Never mind that it pays taxes as if it had a gen-

uine profit. The enterprise still returns less to the econ-

omy than it devours in resources. It does not cover its

full costs unless the reported profit exceeds the cost of

capital. Until then, it does not create wealth; it

destroys it.”

Drucker continues, “By measuring the value added

over all costs, including the cost of capital, EVA mea-

sures, in effect, the productivity of all factors of pro-

duction. It does not, by itself, tell us why a certain

product or service does not add value or what to do

about it. But it shows us what we need to find out and

whether we need to take remedial action.”

Cost of capital is the return an investor could

achieve by making an alternative choice for his or her

investment. If this return is not generated, then the

investor is having his or her investment diluted and

principal destroyed. This concept differs from the tra-

ditional definition of profit (revenue minus costs).

Confusing profit margin with profit

Why is there such confusion over profit? “One rea-

son is the common management mistake of identify-

ing profit margin with profit, which is always profit

margin multiplied by turnover,” Drucker says.

The short-term view of cost accounting misses a key

distinction between a static measure of the profit con-

tribution potential (or the margin contribution of a

product as defined by its standard cost) and the sales

activity in the market that produces a revenue

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“There is only one valid definition of

business purpose: to create a customer.”




stream—or as the language of

finance calls it, turnover. 

Drucker made the following

observation in 1973: “The essential

thing about profit is there is no such

thing. There are only costs … costs

of doing business and costs of stay-

ing in business; costs of labor and

costs of capital; costs of today’s jobs

and tomorrow’s pensions.”

Business can survive only when

its profit is able to meet the

demands of its future. In consider-

ing the cost structure of an organi-

zation, Drucker notes people are a

resource, not a cost—a theme con-

sistent from his General Motors

study in the book The Concept of the



Corporation (originally published in

1946) to his most recent article in

the  Harvard Business Review (Jan-

uary/February 2002).

Perhaps one of the most provoca-

tive quality related comments

Drucker makes is when he defines

the meaning of a profit center within

an organization: “Inside an organiza-

tion there are only cost centers. The

only profit center is the customer

whose check has not bounced.”

Drucker ’s complaints against

cost accounting are manifold. “The

oldest and most widely used diag-

nostic management tools are cash

flow and liquidity projections and

such standard measurements as

[financial] ratios. … If these read-

ings are normal, they do not tell us

much. If they are abnormal, they

indicate a problem that needs to be

identified and treated,” he says.

These standard financial measures

do not tell managers where the

problem is or what caused it.

Further analysis and diagnosis are

required to find a root cause.

While accounting separates oper-

ating expenses and capital assets in

analyzing business performance,

this separation actually distorts the

effect of the cost of these assets. As

Drucker comments, “For manage-

ment purposes, there are no ‘cost-

less assets.’ There are only ‘sunk

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Insights Into Peter F. Drucker

Peter Ferdinand Drucker was born in 1909 in Vienna, Austria. His early

life was rich from the intellectual influence of his father, a senior civil servant

in the Austro-Hungarian Ministry of Economics, and his mother, a medical

doctor. These formative years were a product of both World War I and the

Great Depression.

Drucker received his degrees courtesy of the European education sys-

tem, which allowed him to read and study on his own and take examina-

tions to demonstrate subject mastery. This learning style is the basis for

his lifelong thirst for knowledge.

While Drucker pursued a doctorate degree in public law and internation-

al relations at Frankfurt University, he was also senior editor for finance

with the Frankfurter General Anzeiger newspaper. He wrote a pamphlet on

Friedrich Joseph Stahl (1802-1861), a legal philosopher and Jew, in 1933,

just two months after the Nazis took power in Germany. The pamphlet

was subsequently banned and burned by the new administration.

Drucker moved to London, and during the early years of Hitler’s rise to

power, he began work on his first book, The End of Economic Man: The Rise



of Totalitarianism, an analysis of the irrationalism and nihilism of fascism that

was ultimately published in 1939.

With his wife, Doris, Drucker immigrated to the United States in 1937,

serving as a correspondent for the newspaper now called the Financial



Times. His first American teaching job, at Sarah Lawrence College in

Bronxville, NY, was terminated when he refused to support a faculty peti-

tion that supported communism.

He moved on to a successful career teaching at

Bennington College in Bennington, VT. Then, in

1949 at New York University (NYU), Drucker

founded the third formal management

education program in the world (after

ones at Harvard and the Massachusetts

Institute of Technology).

The world owes Drucker a debt for

his influence on global quality: When

he formed the NYU management pro-

gram, he hired both Joseph M. Juran

and W. Edwards Deming for the faculty.

Together these three men had a strong

influence on exporting quality management

thinking to Japan.

Drucker’s final career stop has been at Claremont (CA)

Graduate University, where the graduate school of management has since

been named in his honor. He is currently the Clarke Professor of Social

Science and Management.

Although he has been a journalist and educator all his life, Drucker

considers himself primarily a writer. The author of 30 books, whenever he

is asked which he considers the best, he smiles and says, “The next one.”

The author of 

30

books,


whenever he is

asked which he considers

the

best,


he 

smiles


and says,

“The next one.”




costs,’ the economist’s term for buildings and other

fixed investments. The question is never, ‘What have

they cost?’ The question is, ‘What will they produce?’

And assets that no longer produce, except in account-

ing terms—assets that produce only because they

appear not to ‘cost’ anything—are not assets, they are

only sunk costs.”

Playing games with measurement

“There is no better way to improve an organiza-

tion’s performance than to measure the results of capi-

tal appropriations against the promises and

expectations that led to their authorization.” What

does Drucker mean by this suggestion?

Capital acquisition decisions are made based on the

expectation for performance of a piece of equipment

and its cost to the organization. This cost-benefit deci-

sion is based on the design performance of the equip-

ment. Business leaders calculate the decision criteria

using the ratio of the performance specification to the

inherent variation contained in the design for this per-

formance. In quality we call this ratio process capabili-

ty (C


p

).

Thus, decisions to buy equipment are based on a



promise or expected performance value. The reality is

often that when this equipment is installed, it operates

less efficiently than the expectation at the time of its

authorization; however, management changes the

basis for measuring its true efficiency to evaluating its

productivity using standard cost analysis. In this

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Encouraging a Leader To Improve Quality

During my interview with Peter Drucker, I asked him a question on the minds of many quality profession-

als: How can a CEO be convinced to focus attention on quality improvement as a method to drive productivi-

ty and profitability?

“Only if you can show the profitability of quality in your reports. Preaching only gets you converts on

Sunday, but they are sinners again on Monday,” he responded. “Don’t try to convince a CEO. It is not your

job as a manager to educate your boss. It is much too difficult.

“Give him [or her] information in the form management is used to seeing—the effects of policies and pro-

cedures—but also report it in a form you can use to demonstrate to those difficult, but important, outsiders,

the security analysts and the institutional investors,” Drucker continued. “They are financial people and

know nothing about business. I’m an old financial person, and I can say no financial person has ever under-

stood business. Financial people believe businesses make money. Business makes shoes!”

What is this report Drucker encourages us to provide? His writings amplify his comments. He observes

managers are accustomed to receiving regular reports describing the performance of their organizations.

Though he criticizes the measurement systems used for business and the lack of information contained in

these data, he also offers sound advice on how to improve these reports.

While most reports focus on the problems of the organizations—gaps between planned and actual perfor-

mance—Drucker believes, “It is important for the change leader to have reports focusing on the areas in

which the enterprise does better than expected, the areas of unexpected success and therefore the areas of

potential opportunity.”

It is the obligation of the worker to communicate clearly to the boss—to put

“information in a form in which they operate and think”—so management can

“translate it into action. And, in fact, top management cannot know these

things because they were not put into a form that gave a convincing

argument of the impact of polices and procedures on losing or gain-

ing sales,” Drucker asserts.

In the end business is about making products and deliver-

ing service—the shoes—to customers, not just about

making money. The challenge for organizations is to

design their business reports to clearly communi-

cate the inherent status of their organizations.

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“Preaching 

only gets

you 

converts 



on

Sunday, 


but they are 

sinners


again

on 


Monday.”


method the expected real-world performance (a stan-

dard operating cost based on an average performance

attained and not related in any way to the design

capacity) is directly compared with the production

plan to establish a yield or production output.

This method would provide a very different result if

the basis of comparison were not the production plan

but the original, or “nameplate,” capacity used during

the capital authorization. If the original capacity were

used, many business process yields that currently

average in the 80 to 95% range

would drop by more than half.

Good measurement of business

results doesn’t play games by

changing the basis for analysis

halfway through its execution—

unfortunately, that is exactly

what most capital acquisition

decisions do!

Quantifying quality

In our interview Drucker observed that you can

present quality quantitatively in several ways. One is

the cost of poor quality; another is the profit of good

quality as shown in additional purchases; and a third

is the long-term gain in brand image, consumer loyal-

ty and repeat purchases. You’re building a constituen-

cy among your customers, he says.

In this brief listing, Drucker helps us bridge our

thinking about quality performance measurement

from the viewpoint of the customer to the internally

focused viewpoint of quality costs. He moves us to go

beyond EVA to perform organizational diagnosis that

will allow us to find the root cause of operational

problems and improve the organization’s value to its

customers.

Assessing performance effectiveness

Drucker is not satisfied with traditional ways of

analyzing the financial performance of business.

“Traditional cost accounting postulates that total man-

ufacturing cost is the sum of the costs of all individual

operations,” he states. “Yet the cost that matters most

for competitiveness and profitability is the cost of the

total process, and that is what the new activity based

costing records and makes manageable.”

The basic premise of activity based costing is this:

“Manufacturing is an integrated process that starts

when supplies, materials and parts arrive at the

plant’s loading dock and continues even after the fin-

ished product reaches the end user. Service is still a

cost of the product, and so is installation, even if the

customer pays.

“Traditional cost accounting measures what it costs

to do something—for example, to cut a screw thread,”

Drucker continues. “Activity based costing also

records the costs of not doing, such as the cost of

machine downtime, the cost of waiting for a needed

part or tool, the cost of inventory waiting to be

shipped and the cost of reworking or scrapping a

defective part. The costs of not doing, which tradition-

al cost accounting cannot and does not record, often

equal and sometimes even exceed the costs of doing.”

In assessing the benefits of activity based costing,

Drucker returns to three of his

consistent themes: managing

for results, the duality of doing

things right while doing the

right thing and the importance

of the customer.

• “Activity based costing

therefore gives not only

much better cost control, but

increasingly, it also gives

result control.”

• “Traditional cost accounting assumes that a certain

operation … has to be done and has to be done

where it is being done now. Activity based costing

asks, does it have to be done? If so, where is it best

done? Activity based costing integrates what were

once several activities—value analysis, process

analysis, quality management and costing—into

one analysis.”

• “Which one activity is at the center of costs and of

results? The answer: serving the customer.”

Better product pricing

While activity based costing provides a basis for

understanding the true costs of doing business, it also

provides the foundation for determining better prices

for products. “Knowing the cost of your operations,

however, is not enough,” Drucker comments. “To

compete successfully in an increasingly competitive

global market, a company has to know the costs of its

entire economic chain and work with other members

of the chain to manage costs and maximize yield.

Companies … shift from costing only what goes on

inside their own organizations to costing the entire

economic process.”

In economic chain costing, legal entities become an

“economic fiction. What matters in the marketplace is

the economic reality, the costs of the entire process,

regardless of who owns what.” While traditional

accounting features cost based pricing as the approach

to establishing market prices, “a powerful force dri-

ving companies toward economic chain costing will

be … price led costing,” Drucker asserts.

“Traditionally, Western companies have started

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“Inside an organization there are

only cost centers. The only profit

center is the customer whose

check has not bounced.”




with costs, put a desired profit margin on top and

arrived at a price,” he continues. In price led costing a

different scenario occurs: “The price the customer is

willing to pay determines the allowable costs, begin-

ning with the design stage. … Companies can practice

price led costing, however, only if they know and

manage the entire cost of the economic chain,”

Drucker says.

While this accounting practice is fully consistent

with the theory and application of supply chain man-

agement and partnerships with key suppliers, it is dif-

ficult to put into action in a pragmatic sense. “It will

be painful for most businesses to convert to economic

chain costing. Doing so requires uniform or at least

compatible accounting systems at companies along

the entire chain,” Drucker explains. “Yet each compa-

ny does its accounting its own way, and each is con-

vinced its system is the only possible one. Moreover,

economic chain costing

requires information sharing

across companies, yet even

within the same company, peo-

ple tend to resist information

sharing.”

Determining competitive standing

Even when an organization

applies EVA to focus its efforts

on delivering value to its cus-

tomers and uses activity based

costing to improve manage-

ment of process costs and

product pricing, there is still

the need for external valida-

tion of performance through

the active gathering and analysis of competitive infor-

mation.


Drucker states, “What a business needs most for its

decisions—especially its strategic ones—are data

about what goes on outside it. Only outside a business

are there results, opportunities and threats.”

“Together, EVA and benchmarking provide the

diagnostic tools to measure total factor productivity

and to manage it,” he adds. EVA provides the wake-

up call that says the organization’s performance is not

delivering the value desired by customers, and bench-

marking provides a rapid learning opportunity for

what to do about it.

“Benchmarking assumes correctly that what an

organization does, any organization can do as well.

And it assumes, also correctly, that being at least as

good as the leader is a prerequisite to being competi-

tive,” Drucker continues. Benchmarking assists busi-

ness leaders by forcing them to look outside

themselves and consider opportunities for learning

from external sources—opportunities that may allow

them to innovate within their industries.

Innovation for business sustainability

To  sustain success in a business—delivering long-

term strength—a business must emphasize its require-

ments for innovation and entrepreneurship.

Innovation is a significant theme in much of Drucker’s

writing. His perspective is defined by this observa-

tion: “Yet no matter how powerful a company is in its

industry, noncustomers almost always outnumber

customers.”

Consider Six Sigma. Drucker believes its most

important contributions will support innovation once

organizations learn what their noncustomers need.

“The most valuable aspect is Six Sigma builds quality

into the design. Six Sigma says you design it so it can

be made. It puts quality and

productivity into the design

from the beginning.” As

always with Drucker’s ideas,

the beginning begins with the

customer!

Delivering more value

Throughout his life Druck-

er has demonstrated his agile

thinking and ability to forge

new trends. He stays ahead

of other management think-

ers because of his commit-

ment to lifelong learning,

which causes him to keep

well-informed in many areas.

Interestingly, he believes many top executives have

business problems because they are poorly informed

about the fundamentals of the business’s performance

and don’t really know how to interpret business infor-

mation. “Not many executives are information-liter-

ate. They know how to get data. But most still have

yet to learn how to use data,” Drucker says.

To meet this information challenge, executives must

remove a serious cause of business failure: “the com-

mon assumption that conditions must be what we

think they are or at least what we think they should

be. An adequate information system has to include

information that makes executives question that

assumption,” Drucker adds.

He applies the Socratic method to stimulate top

management to think about how it is running the

organization. Three of his basic questions are formu-

lated around the results of the organization:

• What is our business today?

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“Activity based costing also records

the costs of not doing, such as the cost

of machine downtime, the cost of

waiting for a needed part or tool, the

cost of inventory waiting to be shipped

and the cost of reworking or scrapping

a defective part.”




• What will be our business?

• What should be our business?

Management’s job is to discover the answer to these

questions and implement solutions that deliver

results. It is our job as quality professionals to report

the necessary data. We must also ask ourselves these

same critical questions:

• What information do we owe?

• To whom do we owe it?

• When should we give them this information? 

• In what form should we present it?

Learning the language of business is the next per-

sonal growth opportunity for many quality profes-

sionals. Let’s hope Drucker ’s ideas will provide a

foundation for our continuous learning about how to

deliver more value to customers.

BIBLIOGRAPHY

Drucker, Peter F., Management Challenges for the 21st Century

(New York: HarperBusiness, 1999).

Drucker, Peter F., Managing for Results, second edition (New

York: HarperBusiness, 1986).

Drucker, Peter F., Managing in a Time of Great Change (New

York: Penguin Putnam, 1995).

Drucker, Peter F., The Concept of the Corporation (New

Brunswick, NJ: Transaction Publishers, 1993).

Drucker, Peter F., The Practice of Management (New York:

HarperBusiness, 1993).

Drucker, Peter F., “They’re Not Employees, They’re People,”



Harvard Business Review, January/February 2002.

GREGORY H. WATSON

is chairman of ASQ’s Board of Directors,

managing partner of Business Systems Solutions Inc. and an aca-

demician in the International Academy of Quality. He holds mas-

ter’s degrees from the University of Southern California (in

systems engineering) and the law school at Antioch University,

Seattle (in legal analysis).

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Discussion Board at www.asqnet.org, or e-mail

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