3.2.1 Business Objectives

Spec:

Different business objectives and reasons for them:

  • profit maximisation

  • revenue maximisation

  • sales maximisation

  • satisficing

  • b) Diagrams and formulae to illustrate the different business objectives:

  • profit maximisation

  • revenue maximisation

  • sales maximisation

Profit Maximisation

  • An assumption in classical economics is that firms seek to maximise profits.

  • Profit = Total Revenue (TR) – Total Costs (TC).

  • Therefore, profit maximisation occurs at the biggest gap between total revenue and total costs.

  • A firm can maximise profits if it produces at an output where marginal revenue (MR) = marginal cost (MC)

Why 😀 :

  1. Re-investment in R and D - i.e. new capital, innovation

  2. Dividends for shareholders - rewards

  3. Lowers costs - more competitive when prices are lower

  4. Reward entrepreneurship

  5. Usually the aim for monopolies and oligopolies due to lack of competition

But

  1. It is hard to know when MC=MR

  2. Principle agent problem - easier to revenue maximise

  3. Avoid scrutiny from competitions authorities - i.e. too low standards/ competitive pricing

  4. Key stakeholders are harmed

Profit satisficing

= Sacrificing profit to satisfy as many key stakeholders as possible

Can any of these shareholders lose out from profit maximising ?

  • Shareholders - Not really as simply higher dividends

  • Managers - Not really as usually higher wages

  • Consumers - Yes as potentially higher prices than if productively efficient so decreases consumer surplus

  • Workers/TU - Yes as may be sacked due to cost cutting affects in order to increase profit magins

  • Govt. - If prices are high and wages are low govt. doesn’t like this and investigate and punish

  • Environment - Cost cutting i.e. dumping waste and can tarnish reputation - may lose out on investors or market share

Revenue Maximisation

= Where MR = 0 on diagram

Why?

  1. Economies of scale - Greater quantity than profit max point - Lower AC then lower prices

  2. Predatory pricing - due to lower prices than profit max - aim to drive out competitors

  3. Principle agent problem - agents might revenue max to ‘impress’ their principles ( shareholders ) for benefits i.e. bonuses or pay rises

Sales Maximisation

= Where AR meets AC

( Break even ) = normal profit

Used for the most growth

Why ?

  1. Economies of scale

  2. Limit pricing - essentially ‘breaking even’ which deters other firms entering the market which limits competition - not classed as predatory pricing as still covering costs - still illegal

  3. Principle agent problems - using growth this time

  4. Flood the market - Loads of consumers are aware of your product which increases consumer loyalty and then later down the line can change objective to prof max i.e Netflix

  5. Contestable markets will use this

What are other business objectives ?

  1. Survival - In short run in a very competitive market - increase brand awareness and then loyalty

  2. Public Organisations - not for profit - just produces to maximise societies welfare ( P=MC )

  3. Corporate Social Responsibility ( CSR ) - i.e. the Body Shop not testing on animals

‘Revenue maximisation is a more realistic business objective than profit maximisation for many businesses.’

Para one KAA

K - Revenue maximisation may be a more realistic option for firms operating in monopolistic competition. Monopolistic competition is a market where barriers to entry are fairly low, market concentration is dilutes and products are near homogenous - however, there is not perfect knowledge in this market

Firms in monopolistic competition include:

  • Coffee shops

  • Hair salons

A - Firms in these markets may choose to revenue max because this may increase their market share - due to high levels of competition.

  • This is because when firms revenue max - MR = 0 in comparison to profit max where MR=MC because of this giving lower prices to consumers

  • As a result of this, increasing consumer surplus and allows the coffee shop to build their consumer base which is more inelastic - increasing retention

  • Despite, if they were to profit max in the LR they would make larger proportions of SNP, by revenue max, they are still making a substantial profit whilst building their consumer base

  • Furthermore, the small proportion of SNP made by the coffee shop may reduce entry of new firms into the market - market price mechanism

  • Therefore, by focusing on revenue max, coffee shops are preventing new entrants, to an extent and increasing consumer retention

E - However, in evaluation, this is highly dependent on the contestability of the market.

By revenue maximising, firms are still making a substantial SNP - whuch may still in turn attract new entrants - due to the low barriers to entry of monopolistic competition

This may be furthered by the differing degrees of sunk costs per market - i.e. in the coffee market if an entrepeneur already has a building, he may only then need to invest in coffee machines and staff - little/no permits/qualifications needed - LOW sunk costs

Therefore, by even a smaller degree of SNP, this will not deter some entrants in monopolistic competition

Because of this, the coffee shop may be better profit maximising and making a high degree of SNP in the long run in which they can reinvest in the LR - dynamically efficient - differentiate their products and increase market share

K - In turn, profit maximisation may be the objective for firms operating in a monopoly or oligopoly market - this is due to their high concentration ratios

  • High concentration ratios meaning they won’t have large degrees of competition - definitely not in a monopoly - especially dominant of 40% i.e. Railway

  • Because of this, there will be little to no price competition - esp in oligopolies as this wouldn’t be rational due to the interconnected nature - Kinked Demand Curve

  • I.e. Parmaceutical companies may want to profit maximise so they can achieve dynamic efficiency and therefore compete on non price - i.e. quality

  • Or, perhaps they could utilise dynamic efficiency by exploiting technological economies of scale

  • This will make they more productively efficient and because of this TC will fall proportionately faster than the rise in total output

  • Therefore, firms such as Pfizer can move closer to minimum efficient scale where costs are lowest and output is highest

  • This can then be translated into lower prices for the consumer, increasing consumer surplus and increasing market share - this may be beneficial in a fairly competitive market i.e. Supermarkets

E - However, if firms become too big as a result of profit max - they may suffer from dis economies of scale - where LRAC exceed TQ

  • This can happen via poor coordination/communication - this reduces this efficiency of firms - reducing productivity - increasing unit labour costs and not benefitng

  • Therefore, firms may want to operate at a profit saticficing level - this is where shareholders are simply satisfied with the amount of profit aquired i.e. CF drug is actually sold at a loss

  • This may improve cosnumer welfare due to lower prices and in a roundabout way actually increase market share and therefore profit margains

  • As well as this, avoid attention from the CMA - i.e. blocked mergers Asda Sainsburies - who may impose profit restrictions - windfall taxation

OR revenue max to satisfy principles in PA problem !