Business objectives

A business objective is an outcome that the owners of a business wish to achieve.

Setting an objective will enable scarce resources to be organised in a way that best achieves the chosen objective. Many businesses have more than one objective, but some are conflicting, and decisions must be made in terms of choosing which objective to prioritise.

Objectives will vary from firm to firm, and a single firm may change its objectives over time. Here we consider the dominant objectives that shape the behaviour of firms.

Profit maximisation

Profit maximisation is often regarded as the key metric by which a firm's performance is evaluated, and it is the starting point for an analysis of business objectives.

Profits are the rewards available to business owners once production costs have been paid. Profits are seen as the reward to risk taking given that costs are incurred before any revenue is earned, and because of the uncertainty as to whether revenue will exceed costs.

Profit maximisation is best looked at through marginal analysis, which indicates that maximum profits will be earned when:

Marginal revenue (MR) = Marginal cost (MC)

Hence, the condition for profit maximisation is for a firm to produce up to the point where marginal revenue equals marginal cost.

Normal profits

Normal profits occur when entrepreneurs achieve a reward that is just sufficient to keep them supplying their enterprise. Normal profits are seen as efficient in that an entrepreneur will supply their enterprise for this reward, and although a greater reward would be beneficial, in terms of economic theory a reward above normal profit is not required to enable scarce resources to be used.

To the economist (but not the accountant) the reward to the entrepreneur to keep them supplying their enterprise is included in the firm's costs of production. This is because, in a legal sense, a business is independent from the entrepreneur. Hence, in order to produce and supply goods to market the business must reward all the factors - land, labour, capital and enterprise - with at least the minimum reward they are prepared to accept - which will just cover their opportunity cost.

Hence, when total revenue equals total cost, normal profit is being made.

Supernormal profit

Supernormal profit is derived when total revenue (TR) is greater than total costs (TC).

Example of profit maximisation

If we take the cost and revenue calculations for a hypothetical business, we can present them in a cost and revenue schedule, as shown below:

Cost schedule

A cost and revenue schedule to show profit maximisation

Here we can see that profit maximisation (shown directly in the last column) occurs at output 7, and at price 80, and with total profits of 320. However, we can derive profit maximisation simply by looking at the output where the marginal cost of producing one extra unit (MC) exactly equals the marginal revenue derived from selling one extra unit (MR). At output 7, and price 80, MR=50 and MC = 50.

So why is MC=MR the profit maximisation rule?

At profit maximisation output, the marginal profit (MR-MC) is zero. In other words, at profit maximisation output the marginal unit produced does not contribute to further profit. However, if the firm stops 'one unit short' of profit maximisation, at 6 units, MR is 60 and MC is 28, so the 6th unit contributes 32 to marginal profit. Hence, stopping production (or supply) at 6 units would present a considerable opportunity cost - profits could have been higher.

If the firm produces 'one unit beyond' profit maximisation, at 8 units, MR is 40 and MC is 68, creating a marginal loss of 28. This would reduce the total profit from its maximum point (from 320 to 292).

In conclusion, profit is maximised when MR=MC (which is shown graphically below.) If we plot the total profit function (as shown below) - which is derived from the total revenue and total costs functions, the profit function has a gradient of zero when MC=MR.

Graph to show profit maximisation using MC and MR

A cost and revenue diagram to show profit maximisation

We can show the total revenue, cost and profit using the marginal and average curve graph - where a total measure (TR and TC) is the area under the relevant 'average' curve. So, at profit maximisation output, total revenue is the area under the average revenue curve (at MC=MR), and total cost is the area under the average cost curve.

A cost and revenue diagram to show total revenue, cost and profit

Here, TR is the area mnrt (at 560); TC is the area mxyt (240); leaving profits as the area nryx (320).

Graph to show profit maximisation using TR and TC

Profit maximisation point can also be illustrated by using total cost and revenue. This will occur at the widest vertical gap between the two curves.

Unless we are informed to the contrary, the basic assumption regarding the dominant business objective is to assume profit maximisation. However, other objectives are entirely possible.

Showing profit maximisation using a graph for a profit function

Sales maximisation

Sales maximisation as a business objective that is concerned with sales rather than profits. Sales maximisation is defined as:

Where the firm sells as much as possible without making a loss

In the schedule and diagram below for the hypothetical firm, we can see that the firm would make a loss if sold 12 units, hence it would stop at 11 units, which is where average costs (AC) equals average revenue (AR) which is also 'break-even' output.

A sales maximisation schedule
A sales maximisation diagram

This may be a rational objective if the firm is looking to clear its current stock, perhaps in a sales promotion. It may also be rational if it is impossible to make more detailed calculations of marginal cost and revenue.

Revenue maximisation

Firms may also try to maximise the revenue coming into a business, where revenue = price x quantity.

Total revenue is maximised when:

The firm produces up to the point where MR = 0

In the schedule and diagram below, we can see that our hypothetical firm will maximise revenue when it sells 12 units and earns a total revenue of 660. Although it would also earn this at one less unit, the 'turning point' is beyond 12, and the assumption is that it will go up to the output where the marginal revenue from selling another unit does not contribute any more to total revenue.

A revenue maximisation schedule
A revenue maximisation diagram

Maximising revenue may be a rational strategy for managers, and this objective is often referred to as a managerial objective. This is because managers derive their income from sales revenue rather than profit. Hence, large businesses where decision making is primarily taken by managers are more likely to be revenue maximisers than profit maximisers. It should be noted that, in the case we have considered the firm would make a loss if it pursued a revenue maximisation strategy.

The divorce of ownership and control

The firms most likely to pursue the alternative objectives of maximising sales or revenue are likely to be larger firms where ownership of the business has been divorced from the management and control of the business.

In larger corporations, the owners are the shareholders who receive their income as a dividend derived from profits. The shareholders appoint managers to undertake the running of the business, and hence give them the power to make operational and strategic decisions. As the roles of shareholders and managers have become increasingly divorced, alternative business objectives have become more dominant.

Conclusion

The maximisation of profits, sales, and revenue all occur at different outputs (for this hypothetical example) - hence they are mutually exclusive. This means that they cannot be achieved at the same time, and entrepreneurs (or managers) must choose between them. In our example, profit maximisation occurs at the lowest output, and sales maximisation at the highest output, with revenue maximisation occurring somewhere between the two. In the absence of any other real-world data, we assume that this pattern applies to all types of firm.

Other objectives

Market share

In markets with a few large firms [that is, oligopolies] firms may keep a close eye on market share as, with only a few rivals, market share is often an indication of how well they are doing in their market.

Ethical objectives

Increasingly, firms adopt corporate social responsibility (CSR) as a business objective. Most large organisations have a CSR policy, which outlines how they deal with different stakeholders, including employees, the environment and their local community. Check out the CSR initiatives at Netflix.

While this is unlikely to be a dominant objective, many large corporations see this objective as an important one.

Some organisations operate on a not-for-profit basis, such as charities and 'social businesses'. In these cases, the objective of the organisation depends upon its specific goal, which might include specific ethical, employment or environmental objectives.

Survival

For various reasons businesses may simply aim to survive - either because they are new start-ups, or because market conditions threaten their survival.

For example, the COVID-19 pandemic and lockdowns threatened the existence of many firms and survival became the most important objective.

Conflicts of objectives

It should be clear that the simultaneous satisfaction of several of these objectives is impossible as they are mutually exclusive. Unless by an unlikely quirk of numbers, profit maximisation - at least in the short run - conflicts with sales maximisation and ethical objectives, to name two.

If an oligopolist wishes to increase market share it may well have to accept lower profits - if a price reduction is the tool to increase market share.

Satisficing

It is for this reason that many firms adopt a satisficing strategy - a concept first introduced by Herbert Simon in the 1950s.

Satisficing (from satisfy and suffice) starts from the position that maximising several objectives at any one time is impossible, and so the rational firm sets a minimum level of expectation regarding several objectives.

Profit satisficing is where profit is still the major objective, but the aim is not to maximise profit but to achieve an 'acceptable' minimum level of profit.

The reason for the inability to maximise anything is more a practical issue with lack of relevant information being a major constraint. Simon thought that trying to calculate and achieve any kind of maximisation was beyond most people, and there was a 'cognitive' limit to individual's decision making in the face of complex choices. It would be less cognitively challenging to set a series of smaller, more achievable objectives.

For example, a large firm may set a minimum level of turnover (sales revenue) and profits along with certain ethical targets. it may well exceed these, but by setting a minimum it is able to allocate resources to a range of competing objectives.

Long run profit maximisation

It is still possible to have more than one objective if we separate the short run and the long run. While the long-term objective of a business might be to maximise profits over an extended period of time, in the short run profits may be sacrificed to achieve other objectives.

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