Business objectives can only be fully understood by considering the interests of the different groups of people that influence a firm’s behaviour and decisions. These groups are called stakeholders. They have interests in common, but also some that conflict with the interests of other stakeholders. The relative power and influence of each group will determine a business’s main priorities. The principal stakeholders in a business are:
Owners – In small businesses (sole traders, partnerships or family owned private limited companies), the owners are also the people who manage the business. But in large businesses, which are usually public limited companies, ownership is in the hands of shareholders, of whom there may be many thousands, who take little or no part in the decision making and running of the business. Shareholders may be mainly focused on profit, but there are investors who take an active interest in the way the company is run, and they may, for instance have ethical concerns about how employees are rewarded or the company’s environmental policies.
Senior managers – In large businesses the shareholders appoint a board of directors to run the company. These are the most senior managers. Their interests are not identical to those of owners. Apart from their salaries they may seek other rewards that increase their status and power. Increasing the size of the business (revenue, sales or number of employees) may be more important to them than profit.
Workers __– They will want to maximise their rewards in terms of wages, pensions and holidays, but will have other concerns too, such as working conditions and job security. In businesses where workers are represented by __trade unions, and negotiations are carried out by collective bargaining on behalf of all workers, they may have considerable influence on a company’s policies and decisions. In some countries, such as Germany, the law requires workers to be represented (usually by a trade union official) on the board of directors and makes it compulsory for the company to consult the workforce over
Customers – They may have considerable power and influence, depending on how much competition there is in the market and how well organised they are. The increased use of the internet and social media makes it easier for customers to organise and put pressure on companies to address their concerns.
Suppliers – The power a supplier has over a firm it sells to is likely to depend on the extent to which the firm can easily switch to another supplier, and the proportion of the supplier’s sales that go to the firm. A small farm supplying a supermarket with vegetables will not have much power, but a multinational food company, like Kelloggs or Cadbury’s is in a much stronger bargaining position.
The government – The government raises revenue from corporation tax and other taxes on business. It also regulates business activity (eg. environmental and health & safety laws). Its ability to control and regulate multinational businesses is more limited than for small firms. This is because large businesses may have the choice of relocating to another country and can afford lawyers and public relations consultants to help oppose regulations they don’t like.
Possible Business Objectives
Short-run profit maximisation – Neo-classical theory of the firm is based on the assumption that firms aim to maximise their short-run profit. This is achieved by producing at an output and price where marginal cost = marginal revenue (mc = mr). This theory assumes that a firm will adjust their price and output whenever market conditions change. (see notes on 3.3.4)
Long-run profit maximisation – Keynesian economists argue that the neo-classical view is unrealistic. Firms that frequently change their prices or output levels when market conditions change may experience problems:
- If they raise prices when there is a temporary shortage of the good, it may alienate customers who believe the company is ‘profiteering’. The firm may lose the loyalty of its customers and suffer a fall in its long-run profits.
- If prices are reduced because of a downturn in sales, customers may see this as a sign of distress. This might cause them to avoid the business if they think it might fail and not provide after sales service. Alternatively they may ‘smell blood’ and try to drive an even harder bargain with the firm.
- Frequent price changes also mean the firm will incur additional costs, such as producing new price lists, changes to advertising and packaging and informing sales teams and customers
Keynesians argue that instead firms use cost-plus pricing. This is based on calculating the long run average total cost and adding a mark-up to achieve the desired profit margin. For example, if the average total cost of making a widget is £5.00 and a 20% profit margin is required, the price will be £6.00.
This does not mean that prices don’t change at all; but there is more price stability than suggested by the neo-classical model. Many firms work to an annual budgeting cycle, when they try to predict their costs for the year ahead, factoring into their calculations anticipated changes in wage rates, costs of materials and so on. So prices may be reviewed annually as part of this cycle.
Revenue maximisation – A revenue maximising goal would involve producing at an output where marginal revenue (MR) is zero. MR declines as output increases (see notes on 3.3.1). If MR is positive, a further increase in output will raise total revenue (TR). But if output increases beyond the level where MR is zero, MR will be negative and hence TR will fall.
Sales volume maximisation – Another possible objective is to maximise the quantity (volume) of sales, rather than the revenue. This is likely to be subject to a constraint that normal profit is earned. (It would clearly be against the interest of the firm to maximise sales by giving the product away free!).
__Profit satisficing __– This means aiming at a profit that is sufficient to satisfy the owners (shareholders), rather than trying to maximise profit. It may arise in large firms where there is a separation of ownership from control (see 3.1.1). Senior managers may aim at a level of profit that makes it unlikely that shareholders will seek to remove them from their jobs, leaving the managers free to pursue other objectives, such as revenue or sales maximisation, that enhance their power and status. The satisficing level of profit is likely to be above normal profit, but below the profit that could be achieved by a maximising strategy. Behavioural economists argue that a profit maximising strategy requires accurate information that is difficult to obtain. Measuring marginal cost and marginal revenue with precision is not easy. Therefore it is not easy to identify accurately the profit maximising price and output. Managers may also want a relatively easy life and avoid conflict with other stakeholders, such as employees, customers or suppliers. It may be tempting, for instance to concede a demand for a wage increase rather than provoke a strike. It may be easier to renew a contract with an existing supplier rather than look for a cheaper one.
The pursuit of alternative objectives can be represented using cost and revenue diagrams:
In Fig 1 (below) the diagram shows the revenue and cost per unit at different levels of output.
Profit maximisation is achieved at output Q1, where MC=MR. The total profit is shown by area BEIH
Revenue maximisation is reached at output Q2, where MR = 0. Total profit is ADGF
Sales volume maximisation occurs at output Q3. The firm makes normal profit only (ATC = AR). The firm could increase output further, but would then make a loss.
In Fig 2 (below) the diagram shows total revenue and total cost at different levels of output.
The total profit at any output is shown by the vertical height between the Total Cost (TC) and Total Revenue (TR). At outputs Q1 and 6 we can see that in both cases TC=TR. Normal profit only (which is counted as a cost) is earned. Between Q1 and Q6 abnormal profit is earned.
Abnormal profit is also shown by the curve which starts at Q1 and finishes at Q6. At any output it shows the vertical height between TC and TR.
The level of profit associated with profit satisficing is OP.
Profit maximising takes place at output Q3.
Revenue maximisation takes place at output Q4.
Sales volume maximisation takes place at output Q6.
Profit satisficing can be achieved at either an output of Q2 or Q5. (Directors who are more concerned with the size of the business will go for Q5; if they are less ambitious and want an easier life, they may go for Q2).
- Briefly explain why a firm may pursue an objective of profit satisficing rather than profit maximising.
- Your answer should include: profit satisficing / stakeholders / trade unions / trade union / principal-agent problem
Explanation: Your answer should make the point that profit satisficing is most likely to take place in large firms where there is a separation of ownership and control, where the interests of directors are not the same as those of the owners. The principal/agent problem arises (as discussed in 3.1.1). Owners may want to maximise profit, but directors want to maximise their salaries, power and status. They may also want an 'easy life', avoiding conflict with other powerful stakeholders, such as trade unions or suppliers, so may not always seek to minimise costs in order to boost profit. Directors status and power may be more dependent on the size of the business rather than profit, (as measured by revenue or volume). However, owners can try to focus directors concerns on profit through financial incentives such as giving them shares in the company, or linking salary to profit.