Objectives of Firms

Objectives of Firms

Profit maximisation
Profit is the difference between total revenue and total cost. Profit maximisation occurs when the total revenue exceeds the total cost by the largest amount. It is widely accepted to be the primary business objective. The firm maximises profit when the quantity of the product is  70 in Table 1 below. This is when the highest amount of profit, £100, is made. 

Table 1: Numerical example of profit maximisation

QuantityPrice(£5)Total Revenue (Quantity x Price)Total CostProfit      (Total Revenue -Total Cost)
05030-30
10550100-50
205100140-40
3051501500
405200170+30
505250200+50
605300220+80
705350250+100
805400330+70
905450400+50


In Figure 1 below, the profit maximising quantity is Q1 because that is where the gap between the total revenue curve and the total cost curve is the largest (a-b). It corresponds to the maximum point on the profit curve (point c).

Figure 1: Graph showing total revenue, total cost and profit

Graph showing total revenue, total cost and profit

The maximum profit can also be achieved by producing at the level where marginal revenue and marginal cost are equal (MR=MC). This is Q in Figure 2 below.

Figure 2: Profit maximisation using marginal revenue and marginal cost curves

Profit maximisation using marginal revenue and marginal cost curves

Why profit maximisation may be abandoned

Interests of other stakeholders
The performance of the business is of interest to other parties apart from the shareholders. The stakeholders include the government, workers, customers and the community. If they are not happy, the business can only maximise profit in the short run. They must be kept happy for the business to be able to maximise profit in the long run. The workers demand good pay and favourable working conditions; managers want handsome salaries and bonuses which may be in conflict with the profit maximisation objective of the shareholders; the government wants taxes form the business and reduction of environmental degradation; the community wants the business to use green technology and pollute less; the customers want value for money. The firm has to sacrifice profit maximisation objective in order to satisfy these other stakeholders.

To hide the existence of  high abnormal profit
A business may jettison profit maximisation in order to ward off potential entrants into the industry. A large amount of profit will always attract new industry entrants in the short run and such profit will disappear in the long run as a result of intense competition. Also, the firm may want to discourage its competitors from taking over its business by concealing the lucrativeness of the firm. It may be a ploy to distract regulators from investigating whether the firm is using its size to restrict competition.

Profit maximising output may be difficult to determine
In reality, the firm may not find it easy to ascertain the marginal revenue and marginal cost in order to arrive at the profit maximising output.  Estimating costs and demand are prone to errors because the past data used may not represent future conditions that are constantly changing. Therefore, determining the output where marginal revenue and marginal cots are equal could pose a challenge. In practice, businesses normally add a predetermined profit percentage to the unit cost to arrive at the selling price. 

Survival
If the priority of the business is to ensure the business continues to exist rather than shut down, it may have to abandon the profit maximisation objective. It is applicable to a new company, a  firm in an unfamiliar business terrain or an established business going through rough times as a result of internal or external factors such as a recession. 

To increase market share
A firm that wants to increase the percentage of the total market it controls may have to reduce its price in order to attract more customers. A large market share will ensure that the company enjoys low cost per unit emanating from the high output. This will lead to more profits in the future.

 

Alternative objectives

Revenue maximisation

A revenue maximising firm ensures that the highest amount of revenue is obtained. This occurs at the maximum point on the total revenue curve (see point e in Figure 1 above). The marginal revenue is zero when the total revenue is at the highest level. Therefore, the revenue maximising quantity is Q2; the marginal revenue is zero at this point. In Figure 3 below, the output that maximises sales revenue is Q. The firm still makes an abnormal profit represented by rectangle PRUT even though it is less than the amount made if it were to maximise profit (see PRST in Figure 2 above). One reason why revenue maximisation results in lower profit than profit maximisation is that the business may have to lower its price in order to sell more. And this reduces the difference between total revenue (price times quantity) and total cost. 

Figure 3: Graph showing revenue maximisation objective

Figure 3: Graph showing revenue maximisation objective

Sales volume maximisation
This involves selling the highest quantity of the product. It is different from profit maximisation because the firm wants to increase its market share by selling as many units of the product as possible. In this case, the business can only make a normal profit but not an abnormal profit. In other words, sales maximisation will only be possible where total revenue is equal to total cost (Q3 in Figure 1 above) or average revenue is equal to average cost (see Q in Figure 4 below).

Figure 4: Graph showing sales volume maximisation objectiveFigure 4: Graph showing sales volume maximisation objective

Profit satisficing
This occurs when the firm seeks to achieve a satisfactory level of profit that is enough to meet the demands all stakeholders. It is worthy of note that the business is an alliance of different stakeholders such as workers, community, government and customers. They are all vital for the business to survive. So, their aims and aspirations must be met by the business for continuity purposes. Meeting the needs or demands of these stakeholders come at a cost and profit will be reduced as a result. The amount of profit made is shown by the rectangle P2NOQ for profit satisficing as against the rectangle P1LMK for profit maximisation (see Figure 5 below).

Figure 5: Graph showing profit satisficing objective

Figure 5: Graph showing profit satisficing objective

Ethical objective
An ethical firm adheres to moral rules in the conduct of its affairs. A business must adopt fair business practices in order to have a good reputation and avoid protests from pressure groups. Apart from economic objective, the firm must be concerned about the society and other parties in its business environment. Many businesses are committed to reducing the carbon footprint of their operations. For example, it is immoral for firms to exploit their bargaining power to pay unreasonably low prices to their suppliers or low wages to their workers. But there is no law against reducing costs in order to make more profit. Fairtrade is a movement that ensures that the relationship between producers and suppliers is equitable. It helps commodities producers in developing countries to get better prices from their exports to developed countries. Companies with the fairtrade label are known for adhering to ethical standards.