Powered by Leeds Metropolitan University
Economics Resources Economics revision notesEconomics revision quizzes Popular resources on the Economics blog Resource tags for the blog RSS Feed for the blog Twitter feed for the Economics blog Teacher Email Resource Newsletter Category listing for this blog AS / A2 Economics Blog Home Page

Objectives of Firms

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Introduction to Business Objectives

  • Standard theory assumes that businesses have sufficient information, market power and (importantly) motivation to set prices for their products that maximise profits
  • This assumption is now heavily criticised by economists who have studied the organisation and objectives of modern-day corporations.
  • Not only do most businesses frequently move away from pure profit-seeking behaviour, many are organised and operated in a way where profit is not the only objective.

Key Point: There will always be a range of business objectives:

  1. Profit maximisation (where MR=MC)
  2. Revenue maximisation (sales revenue) – where MR=zero
  3. Increasing and protecting market share
  4. Surviving an economic downturn / recession
  5. Pursuing ethical business objectives (corporate social responsibility)
  6. Providing a public service – see later sections on nationalised (state-owned) industries

Why might a business depart from profit maximisation?
Some explanations relate to the lack of accurate information required to set profit maximising prices. Others concentrate on the alternative objectives of businesses.

  • Imperfect information:
    • It might be hard for a business to pinpoint their profit maximising output, as they cannot accurately calculate marginal revenue & cost.
    • Day-to-day pricing decisions are taken on the basis of “estimated demand” or “rules of thumb”.
    • A business might look to add a profit margin on top of average cost – “cost-plus pricing”.
  • Multi-product businesses:
    • Most businesses are multi-product firms operating in a range of markets across countries and continents – the volume of information that they have to handle can be vast. And they must keep track of the ever-changing preferences of consumers.
    • The idea that there is a neat, single profit maximising price is redundant.

Behavioural Theories of the Firm

Behavioural economists believe that large-scale businesses are complex organizations made up of various stakeholders – i.e. groups who have a vested interest in the activity of a business. Examples include:

  • Managers employed by a business and other employees
  • Shareholders – people who have an equity stake in a business
  • Customers
  • The government and it’s agencies including local government

Each group is likely to have different objectives or goals at points in time. The dominant group at any moment can give greater emphasis to their own objectives – for example price and output decisions may be taken at a local level by managers – with shareholders taking only a distant and imperfectly informed view of the company’s performance and strategy.
If firms are likely to move away from pure profit maximising behaviour, what are the alternatives?

  1. Satisficing behaviour is a term first coined by economist Hugo Simon – when faced with a decision where the cost of identifying and pursuing the optimal choice is high.  For business owners this might mean moving away from pure profit maximisation and choosing instead to aim for minimum acceptable levels of achievement in terms of revenue and profit.
  2. Sales Revenue Maximisation
  • The objective of maximising sales revenue rather than profits was developed by William Baumol whose work focused on the behaviour of manager-controlled businesses.
  • Baumol argued that annual salaries and perks are linked to total sales revenue rather than profits.
  • Companies geared towards maximising revenue are likely to make extensive use of price discrimination to extract extra revenue and profit from consumers. A firm might also aim to maximise sales revenue rather than profits because it wishes to deter the entry of new firms.
  • If a firm decides to aim to maximise sales revenue rather than profits, one of the consequences might be a reduction in the price of the firm’s shares
  1. Managerial Satisfaction model

An alternative view was put forward by Oliver Williamson (1981), who developed the concept of managerial satisfaction (or managerial utility). This can be enhanced by raising sales revenue.

Managerial Satisfaction model

  • Assuming that the firm’s costs remain the same, a firm will choose a lower price and supply a higher output when sales revenue maximisation is the main objective.
  • The profit maximising price is P1 at output Q1, the revenue maximising price is P2 at output Q2
  • Consumer surplus is higher with sales revenue maximisation because output is higher and price is lower. Producer surplus is greater when profits are maximised.

Social Entrepreneurs

Michael Porter - Shared Value and the Limitations of CSR
Narrow views about how to create profit has created disconnect between businesses and society and needs to change according to Harvard Business School Professor Michael Porter.

“A growing number of companies known for their hard-nosed approach to business—such as GE, Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart—have already embarked on efforts to create shared value by looking again at  the intersection between society and corporate performance.”
Shared value is creating economic value by creating social value

In recent times, creating value has tended to focus on short-termist thinking - Businesses have been long on driving huge sales and output volumes, downsize and de-layering inefficient management and generally responding to pressure from financial markets to deliver immediate results through cost-cutting, dynamic pricing and increasingly tough marketing that can often persuade people to buy things that are not good for them.

This involves a recalibration and a rethinking about what a product really is and what needs a business is meeting, for example in the food industry, products that are nutritious and healthy rather than focus on volume, lower unit costs and higher profits. He notes to increasing prominence of social entrepreneurs with revenue generating business models.

Consumers looking at the world differently and expressing their preferences in strong ways - this is already having a direct effect on supermarket behaviour.

  • A social enterprise is a business that has social objectives whose profits are reinvested for that purpose in the business or the community, rather than being driven by the need to seek profit to satisfy investors.
  • Social entrepreneurs are looking to achieve social and environmental aims

Not for Profit Businesses

These are charities, community organisations that are run on commercial lines e.g. Network Rail:
  • Network Rail: Their stated purpose is to deliver a safe, reliable and efficient railway for Britain
  • They employ over 35,000 people with annual staff costs in excess of £1.6bn
  • It is a company limited by guarantee – whose debts are secured by the government
  • Network Rail operates as a commercial business and regulated by the Office of Rail Regulation
  • Network Rail is a "not-for-dividend" company - profits are invested in the railway network.
  • Train operating companies (TOCs) pay Network Rail for use of the rail infrastructure
  • They are given targets for punctuality and safety
  • In 2011 Network Rail made profits of £750 million. It receives an annual subsidy from the UK government in excess of £5 billion.

Businesses required to main a loss-making service

A good example here is the Royal Mail which is required to maintain a universal national postal delivery service throughout the UK for a uniform price.

Household mail makes a loss, cross-subsidised by business mail – although this market is shrinking for the Royal Mail because of the introduction of fresh competition from 2006. The Post Office Ltd is a subsidiary of the Royal Mail Group plc – it runs substantial losses on the network or rural post offices and has been under great pressure to close hundreds of offices to stem losses.





Add your comments and share this study note:

blog comments powered by Disqus

 

Search tutor2u






Order by 


Related study notes

Buy your personal copy of our Economics revision guides

tutor2u Economics Revision Guides

Agriculture
Behavioural Economics
Network Economics
Game Theory
Business Economics
Economics of Utilities
Contestable Markets
Competitive Markets
Economies of Scale
Management Issues
Monopolistic Competition
Monopoly
Oligopoly
Price Discrimination
Competition Policy
Commodities Markets
Emerging Economies
Human Development
African Economy
South African Economy
Kenyan Economy
Development Economics
Brazil Economy
China Economy
Indian economy
Russia Economy
Cost Benefit Analysis
Cycles and Shocks
Aggregate Demand
Capital Investment
Consumer Spending
Saving
Aggregate Supply
Demography
Economic History
Economic Growth
Competitiveness
Innovation
Economics of Technology
Environmental Economics
European Economy
EU Enlargement
EU Farming and Fishing
Single Market
The Euro
Exchange Rates
Money and Finance
Monetarism
Global Economy
IMF
Balance of Payments
Credit Crunch
International Trade
Housing Economics
Government Intervention
Buffer Stocks
Government Failure
Indirect Taxes
Maximum Prices
Minimum Prices
Regulation
Subsidies
Health Economics
Inflation and Deflation
Labour Market
Trade Unions
Introductory Economics
Macroeconomic Policies
Fiscal Policy
Monetary Policy
Supply-side policies
Trade Policies
Keynesian Economics
Market Failure
Externalities
Factor Immobility
Information Failure
Merit & De-Merit Goods
Public Goods
Manufacturing Industry
Oil and Gas
OECD Economies
Australia Economy
French Economy
German Economy
Greece Economy
Ireland Economy
Japan Economy
Poland
Spain Economy
US Economy
Poverty and Inequality
Market Equilibrium and Price
Elasticity of Demand
Elasticity of Supply
Nature of Demand
Nature of Supply
Price Mechanism in Action
Price Volatility
Inter-related Markets
Standard of Living
Transport Economics
UK Economy
Regional Economics
London Economy
Recession Watch
Unemployment

 


tutor2u

Tutor2u support for students
Teaching support and resources
Search for resources on tutor2u

Law



Refine Search by Subject
A Level Economics
Business Studies
Geography Give It A Go!
History Law
IB Diploma Politics
Religious Studies Sociology

Order Search Results By


Follow tutor2u on Twitter
   
   

tutor2u Home Page | Online Store | About tutor2u | Copyright Info | Your Privacy | Terms of Use

tutor2u

Working with Our Partners

 Zondle - Games for LearningVue Cinemas | Moneypenny | Nexcess | Really Simple Systems 

Boston House | 214 High Street | Boston Spa | West Yorkshire | LS23 6AD | Tel +44 0844 800 0085 | Fax +44 01937 529236

Company Registration Number: 04489574 | VAT Reg No 816865400

tutor2u is proud to sponsor TABS Cricket Club and the Wetherby Cricket League as part of its commitment to invest in local junior sport