Profit maximisation and alternative objectives

Firms pursue various objectives, which can differ based on who controls the business. These goals often involve trade-offs, leading to compromises between competing priorities.

The traditional economic theory assumes that firms primarily aim to maximise profit. However, many businesses prioritise other goals, such as maximising revenue or sales, which may be seen as more important in certain contexts.

How alternative objectives affect profit

Pursuing objectives other than profit maximisation typically reduces profits in the short run. A firm focused on profit maximisation produces at the output level where marginal revenue (MR) equals marginal cost (MC), often denoted as output Q.

In contrast, firms with different objectives operate at alternative output levels.

Revenue maximisation and sales maximisation

Some firms prioritise revenue or sales over pure profit, leading to higher output levels than those seen in profit-focused strategies.

Revenue maximisation

Revenue is maximised at the point where marginal revenue equals zero. This occurs at an output level Q₁, which is greater than the profit-maximising output Q. To achieve this, firms must expand production beyond the profit-maximising point.

Sales maximisation

Sales maximisation involves producing at the output level where average revenue (AR) equals average cost (AC). This represents the maximum sustainable output in the long run, denoted as Q₂, which exceeds both Q and Q₁.

Pushing sales beyond this point would result in losses.

Long-term versus short-term objectives

Firms may distinguish between immediate and future goals, sometimes sacrificing short-term profits to achieve greater long-term success.

Strategies for balancing short-term and long-term goals

• Profit maximisation might be a long-term objective, even if it requires accepting lower profits or losses in the short run.
• A firm could focus on maximising sales or revenue initially to expand market share or establish monopoly power, paving the way for supernormal profits later.
• Other tactics include operating at a loss temporarily to build brand recognition.
• Firms may scale up to benefit from economies of scale that reduce costs over time.
• New firms often prioritise survival by aiming for normal profit in the early stages, before shifting to profit maximisation once established.

Other objectives including corporate social responsibility

Beyond profit, revenue, or sales, firms may pursue goals that align with broader values, while still seeking at least normal profit to remain viable.

Examples of alternative objectives

• Focus on product quality - Some businesses emphasise superior products to build customer loyalty.
• Not-for-profit organisations - These entities do not distribute profits to owners; instead, their primary goal is to deliver public benefits, such as through charities or community services.
• Corporate social responsibility (CSR) - CSR involves operating in ways that benefit society, such as using sustainable resources, supporting local suppliers, or paying wages above market rates. While aiming for supernormal profits, CSR can enhance profits by attracting customers who value ethical practices.

Divorce of ownership from control and the principal-agent problem

As businesses expand, the separation between owners and managers can create conflicts in objectives.

Divorce of ownership from control

In small firms, owners typically manage operations directly. However, larger firms often sell shares to raise finance, creating multiple part-owners (shareholders). Directors are then appointed to run the business on behalf of these shareholders.

This separation, known as the divorce of ownership from control, means directors may prioritise their own goals over those of the owners. Employees and other stakeholders can also influence decisions, adding to potential conflicts.

The principal-agent problem

This issue arises when a principal (such as shareholders) hires an agent (like a managing director) to act in their interests, but the agent pursues self-interest instead.

Examples of principal-agent conflicts:

• If a director's compensation is tied to revenue or sales rather than profits, they might focus on those areas.
• Employees may similarly prioritise personal benefits, such as higher pay, over the firm's profitability.

Mechanisms to control the principal-agent problem

Managers' influence is limited by accountability to owners. Shareholders can vote to remove underperforming directors. However, shareholders often lack full information to act effectively.

Methods to align interests:

• Owners can use incentives like bonuses linked to profits.
• Shares can be offered to managers at discounted rates.
• Accountability requires managers to explain past decisions and outline future strategies.

Satisficing behaviour

Satisficing involves achieving acceptable outcomes for key stakeholders rather than striving for maximum results in any single area.

Characteristics of satisficing

This approach, sometimes called "aiming for an easy life," emerges when stakeholders have conflicting goals. Directors might target sufficient profit to keep shareholders content, while offering wages high enough to retain employees.

Satisficing helps balance diverse interests.