Firm Objectives
firm objectives in the real world
Profit Maximisation - The traditional objective of the firm
Traditionally, firms are assumed to maximise profits. This is because profit is the measure of a firm's welfare. Entrepreneurs take risks in the first place in order to make profits, so it only makes sense that an entrepreneur would want maximum returns on the risks that they take.
When we learned about profit, we learned that firm's maximise profit by setting the quantity at the point where MR=MC.
Other possible objectives
However, a firm may not always choose to maximise profits. Examples of alternatives include:
Revenue maximisation: the firm wants to generate the maximum amount of revenue possible
Revenue is maximised at the point MR=0
Firms continue to increase the quantity up until this point, as each extra unit produced will mean additional gains to total revenue
Read more about revenue here
Sales maximisation: the firm wants to make as many sales as possible
Sales are maximised by reducing the price to the lowest level possible. Price is reduce to the level of normal profit
Therefore, sales are maximised at the point AR=AC
Sacrificing short-run profits for a better future
These strategies are alternatives that a business might use - but why would a business choose these over profit maximisation? The reason is because sometimes the business may be looking to maximise profits over the long run. This may mean that the firm needs to sacrifice profits today in order to survive for a longer period of time and make more profit in the future. If the firm always prices at the point to maximise its profit, then it may even go out of business during hard times e.g. an economic recession.
Firms may choose to produce more and achieve maximum revenue or maximum sales instead, in the interest of its own survival. For example, pricing at the point where you maximise sales may only yield normal profits. However, over time you have delivered your product to many more customers which has strengthened your brand recognition. More people are aware of your brand and its products, and may put their faith in your business. This could give the business an advantage to other businesses in the industry. It could even be a source of monopoly power.
A good example of this would be Amazon.com. They have become extremely popular in recent times, but they haven't always profit maximised. Their business strategy has been one to undercut competitors and deliver a good service to the consumer. However, over time they have developed into the world's largest online retailer. Their CEO (Jeff Bezos) is the richest man in the world today (Jan 2018).
Objectives not directly linked to profit
Some businesses are set up as charities, meaning they are "not for profit" organisations. This means that profit is not paid out to the owners. There may be a reason for this - the money they make may be to benefit society in some way e.g. cancer research.
Some businesses, while not-for-profit, may choose to spend their income on CSR (corporate social responsibility). For example they may replant trees, only use green sources of energy, support local businesses or even pay better than market wages.
You could argue that there may be some sort of hidden agenda here. For example, these positive messages sent out to the public may all be in order to increase the strength of the brand. It gets the firm's name out in the public eye, and it could mean more sales in the future. You could argue that this is to increase profits in the long run.
Sometimes shareholders and managers just don't get along...
When owners and managers are not the same people there is a "divorce of ownership from control".
In today's society, there are huge multinational corporations (MNCs) that provide people goods and services. No longer do we go to the greengrocer to purchase our groceries. We go to big supermarkets which operate all around the country. Chances are you are a stone's throw away from a big supermarket.
This presents a new kind of problem, known as the principal-agent problem. For example, the owner of Tesco, is not physically in the store and running day to day operations. In the case of the local greengrocer, the owner and manager of the store was generally one and the same.
Tesco's owners simply own the shares but they elect directors to manage the business for them and achieve the objectives they want. This leads to a conflict in objectives.
Shareholders always want to achieve maximum profit from their shares
Directors/Managers may have objectives other than profit
They may look to increase revenue or sales
They may sacrifice profit today and instead reinvest into future technology
They may want to create a better working environment for workers e.g. better holidays, company cars, other job perks and pensions
They may offer pay rises to workers or themselves
They may be trying to further their career
What can be done about this problem?
Remember owners can vote out managers who haven't been hitting targets. However, the owners are sometimes missing information because they don't run the business. Managers will have to hold meetings with shareholders to discuss the reasons behind their decisions. Making managers accountable for their decisions should mean they act in the interest of the shareholders.
Also, incentives can be offered to help align objectives. For example, performance related pay like bonuses can incentivise employees to try and make the company more profit. This is why in many sales jobs the company will pay you a base wage (usually not very good), coupled with a sales-related bonus (commission). This means the employee has a greater desire to perform and hit targets.
Another option available is to offer shares to the managers running the business. A share is a store of wealth. If a manager's wealth is stored as company shares, then the manager will want the company to do well because it affects him/her. There are many jobs where people in the top positions are required to hold shares in the company.
Profit Satisficing - The best of both worlds?
Profit satisficing is a strategy where the managers aim to please the shareholders. They are not aiming to maximise anything - they are aiming to satisfy the important people so they get to stay in the job and everybody is happy. It's a way of making life easier in the business and pleasing all stakeholders.
This way, the manager can offer employees satisfactory pay rises when they need to but at the same time they can offer good news to the shareholders too.
Satisficing is a "good enough" mentality.
Real-world objectives
In the real world, it's unlikely that any of these objectives will be used, often because they are too hard to calculate. Going into a meeting and pulling out your MR=MC diagram is probably going to confuse 90% of the people there and it will be difficult to calculate this correctly in the real world. Where do you get your AR, MR, AC, MC curves from?
So it's not very realistic to expect any business to focus on these objectives. The most common real-world objective that's linked to profit will be profit margin.
A profit margin is a percentage-based target where profit is calculated as a percentage of the selling price. For example, if you sell a mug for £5 and your profit margin is 40%, then 40% of the price is profit e.g. £2 will be profit. The remaining £3 will be costs.
Another real-world objective is cost-plus pricing, also known as a mark-up. With this sort of pricing you calculate what your costs are first, and then you add a mark-up as a percentage. For example, if you are selling an Xbox and it costs £100 to produce, then if you add a 70% mark-up then your selling price will be £170. £70 is made as profit.
In summary we have learned:
Objectives of firms: profit max, revenue max, sales max
Long-run profit maximisation
Divorce of ownership from control
Profit satisficing
Profit margin and cost-plus pricing
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