Traditional and alternative business objectives

Business objectives guide a firm's decisions and strategies, but they can vary based on who controls the organisation. Often, firms must balance multiple goals, leading to compromises to satisfy different stakeholders.

Traditional economic theory assumptions

Traditional economic theory assumes that firms primarily aim to maximise profit, as this is seen as the key driver of business behaviour. However, firms may pursue other objectives, such as maximising revenue or sales, depending on their circumstances and leadership.

Alternative objectives beyond profit

Some firms prioritise goals that are not directly tied to profit, revenue, or sales, though they usually aim to achieve at least normal profit to survive.

Examples of alternative objectives:

• Not-for-profit organisations - These do not distribute profits to owners; instead, their main goal is to benefit the public, such as through charities or community services.
• High-quality production - Firms may focus on delivering superior products to build customer loyalty and a strong reputation.
• Corporate social responsibility (CSR) - This involves operating in ways that positively impact society, such as:
  • Investing in renewable energy sources.
  • Sourcing fair trade goods.
  • Paying employees wages above the industry minimum to promote fairness.

Profit, revenue, and sales maximisation

Firms may choose different objectives, which affect their output levels and short-term profitability. Pursuing revenue or sales maximisation typically leads to lower profits in the short run compared to profit maximisation.

Profit maximisation

A firm aiming to maximise profit produces at the output level where marginal revenue (MR) equals marginal cost (MC). This is often labelled as output Q in economic models.

Revenue maximisation

Revenue is maximised at the point where MR equals zero. This occurs at a higher output level, often called Q₁, which exceeds the profit-maximising output Q. Firms continue expanding production beyond Q as long as additional output increases total revenue.

Sales maximisation

Sales are maximised where average revenue (AR) equals average cost (AC). This is the highest sustainable output in the long run, labelled as Q₂, which is greater than both Q and Q₁. Increasing sales beyond this point would result in losses, making it unsustainable.

Short-run versus long-run objectives

Firms may prioritise different goals in the short run to achieve greater profits over the long term. This often involves accepting reduced profits or even losses temporarily.

Strategies for long-run profit maximisation

• Building market share - Firms might maximise sales or revenue in the short run to gain a larger market presence or monopoly power, enabling supernormal profits later.
• Operating at a loss - Some businesses accept short-run losses, expecting future revenue growth from increased brand awareness.
• Achieving economies of scale - Higher short-run output can lower costs per unit in the long run through efficiencies gained from larger-scale production.
• Survival focus - In challenging periods, the objective may simply be to achieve normal profit to stay in operation.

Divorce of ownership from control and the principal-agent problem

As businesses expand, the separation between owners and managers can lead to conflicting objectives, creating challenges in aligning interests.

How divorce of ownership from control occurs

• In small firms, owners typically handle daily management.
• As firms grow, they sell shares to raise finance, making shareholders part-owners.
• Directors are then appointed to run the business on behalf of shareholders, who no longer control day-to-day operations.
• Stakeholders, including owners, employees, and others affected by the firm, may have varying interests.

The principal-agent problem

This arises when agents (e.g., directors) pursue their own interests rather than those of principals (e.g., shareholders).

Examples include:

• Directors prioritising revenue or sales if their pay is linked to these metrics, rather than profits.
• Managers seeking firm growth for personal benefits, such as career advancement or the prestige of leading a large organisation.
• Employees focusing on their own wages and benefits over the firm's profitability.

Retaining control through accountability and incentives

Owners can maintain influence by making managers accountable and providing incentives:

• Accountability measures - Shareholders can vote to remove underperforming directors, though they often lack full information. Managers must justify past decisions and outline future plans.
• Incentive structures - Bonuses tied to profit levels or shares in the company encourage directors to focus on maximising profits.

Satisficing as a business approach

When stakeholders have conflicting objectives, firms may opt for satisficing rather than maximising a single goal. This approach simplifies decision-making by aiming for acceptable outcomes.

Key features of satisficing

• Satisficing involves achieving just enough to meet the needs of key stakeholders, often described as seeking an "easy life."
• It occurs in situations with competing demands, such as from shareholders and employees.
• Examples include targeting sufficient profit to keep owners satisfied and adequate wages to retain staff, avoiding extreme efforts to maximise any one area.