Peter f. drucker delivering value to customers

Q U A L I T Y P R O G R E S S I M A Y 2 0 0 2 I 55
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
D E L I V E R I N G VA L U E T O C U S T O M E R S
56 I M A Y 2 0 0 2 I W W W . A S Q . O R G
“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
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
30books, 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 (Cp).
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
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.
58 I M A Y 2 0 0 2 I W W W . A S Q . O R G
“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
“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?
60 I M A Y 2 0 0 2 I W W W . A S Q . O R G
“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).
IF YOU WOULD LIKE to comment on this article,
please post your remarks on the Quality Progress
Discussion Board at www.asqnet.org, or e-mail
them to editor@asq.org.
QP

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