Should maximising profits really be seen as the objective of most firms?

  

A firm is an economic entity engaged in business. Economic theory assumes that the firm, like the consumer, maximises its self-interest. This self interest is however the product of the interplay of market structure, business organisation, and chosen or required objective. So, for instance, some firms might choose to profit-maximise, some to profit satisfy, some to revenue maximise, and some to sales-maximise, or even engage in loss-leading predatory behaviours. Oligopoly firms might take their cue from other firms, and find that price-maximisation is only really possible if they can join a cartel; imperfectly competitive firms might sustain a loss in the short run, covering their variable costs and making a contribution to fixed ones, if they think that this will lead to ultimate survival in a temporarily tough market.

These decisions often relate to the nature of the firms. A sole trader’s objective, for instance, may include the freedom and control that working for oneself can bring. The directors of private limited companies (plcs), who are not under the immediate threat that lower profits will lead to the sale of their shares and who have to give permission for share sales anyway, might choose to maximise status or to profit-satisfy for family or company reasons—for instance wanting to remain associated with a particular area or group of workers. A public limited company would be forced to prioritise profits and profit maximising behaviour (producing where marginal cost equals marginal revenue) or risk takeover.

Technically, firms can accept ‘normal’ profit, which is the profit needed to cover opportunity cost, and evident in perfect competition in the long run. Actually, most firms would want an abnormal profit, in which average revenue exceeded average costs. Whilst this takes from consumer profit and the overall efficiency of production, it provides the incentive for business and entrepreneurial behaviour and is a reward for business effort.

Abnormal profit also indicates to owners that the business is doing well. This can create confidence, encourage purchasing managers to put money into the economy, maintain or increase employment, and provide the funds for investment. Even where normal profit is the norm, in perfect competition, firms have an incentive to develop ideas or to quickly apply cost-savings measures, given that they cannot influence consumers or affect supply or demand, so as to make a temporary abnormal profit in the short run.

Weight needs to be given to the idea of the principal-agent problem in economics. This assumes that there is a split between ownership and control in business, which is most evident in plcs. In such firms, directors need to account to owners. Even in a private limited company (ltd) some directors are more active than others, and sole traders are often accountable to their banks, who are powerful as owners in some ways and who can end the business by withdrawing credit if there is no consistent or credible path to profit.

Revenue maximisation can lead to an abnormal profit, just a lower one than profit-maximisation. Revenue maximising behaviour occurs where a firm wishes to get as much cash as possible and to sell surplus stock for any marginal profit at a price where marginal revenue is at 0. This is not a way of life for firms, but might be a regular choice. So, for instance, a limited company in a recessionary environment, or one in which consumers are under income pressure, might choose to launch sales on a rolling basis or to exploit differences between wholesale sourcing and retail sales in order to move goods off shelves as quickly as possible.

Similarly, larger monopoly companies with complementary products might choose to sell some of them at a point where average cost equals average revenue. This makes for no abnormal profit at all, but does maximise sales in a way which could be intimidatory for firms.

Sometimes, too, firms cannot easily calculate marginal revenue and cost, and will accept a certain level of profit below the maximum. This might also be because the firm is part of a wider supply chain or embedded in practices which require activities that cannot be simply audited or costed. A football club, for instance, is a kind of company, and very much has shareholders and financial requirements. Funds are intimately linked to popularity with fans, which in almost every case is linked to success on the playing field, leading to gate receipts and participation in leagues with lucrative media sales.

If a football firm (or any major sports enterprise) did not invest in players and the culture of training, and in relationships with its supporters beyond merchandise and ticket sales, it would lose support and probably see a decline in marginal revenue productivity of players. This would be true even if the firm had enough money on hand to simply ‘buy’ the best players from anywhere. It follows that a policy of simple profit-maximisation in such circumstances holds the potential to be destructive to the firm.

Many firms are also concerned with their social responsibilities or their relationship with consumers in terms of image. Whole Foods, for instance, and to an extent ‘high end’ supermarkets like Waitrose attract and keep customers on the basis of product differentiation and quality. This requires them to avoid being seen to compete on price, and should discourage them from adopting the profit-maximising behaviours of firms in other parts of the market. If such firms were to become associated with damaging environmental practices or supply chain issues which conflicted with the beliefs of their customers, they might find themselves losing core revenue without adding any customers to compensate.

British markets tend to be marked out by small firms which are barely making above normal profit in imperfect competition, oligopolies such as those in banks, coffee shops, sports companies, and supermarkets, which are operating at a profit-satisficing point somewhere around the ‘kink’ in their AR (‘Demand’) curve, and privatised natural monopolies whose prices and profits have been distorted by government regulations. Although profits are often high, they are not always at a maximum.

This is because of political economy; the government and consumers must be choosing to accept this form of settlement. Should a firm go ‘all-out’ to profit-maximise, it would become subject to calls for a ‘windfall tax’ or to claims upon its social responsibility. Even in American markets, ‘price gouging’ is not fully tolerated, which is why Martin Shkreli is jail despite operating in the infamously price-maximising pharmaceutical industry. Profit-maximisers can often, in Britain and America, attract regulatory or political attention which, oddly, gives agents of the firm, or occasionally principals, an odd potential cost of fines, unpopularity, or jail for profit-maximising.