Simple Profit Maximizing Perspective - Essay Example

Simple Profit Maximizing Perspective Simple Profit- Maximizing Perspective Introduction Profit maximization by firms is the process by which firms create an optimum level of output and price that offers profitable returns. Profit making is the main aim of several firms, and adopting a profit maximization strategy is one step towards their goal. Firms adopt different approaches and perspectives towards profit maximization and the most common are the total revenue-cost and marginal revenue-cost perspectives. Firms use these strategies as the spring board for their activities towards profit realization. These strategies introduce both positive and negative results to the organization. Positivity arises when the firm meets its targets and rewards employees and shareholders. Negative results arise when managers concentrate on personal development instead of the firm’s goals. The firm may also engage in unethical practices in order to achieve its profit goals. Therefore, there is need for strategic management of the firm’s profit strategies to prevent the workers from going overboard to introduce negative impacts to the firm. Profit maximization perspectives Total revenue- total cost Total revenues are derived from the amount a firm receives from the sale of its output. Total costs include all expenses incurred by a firm in buying the inputs required in the production process (Grant, 2002). This perspective begins with determining the optimum quantity of output that will maximize profits. The quality of the output is also considered in the planning stage. Firms processing high quality products attract several customers, which increases their revenue. A firm is considered profitable when the total revenues exceed the total costs. As illustrated in the diagram below, the curve illustrates profit maximization point for a firm in a perfect competition market. The optimal level of output at which the firm should operate to maximize profits is point C. At this point, the total profit curve is also at its maximum; therefore the firm can maximize its profits. Figure 1.0 Total revenue-total cost curve Source: Journal of Political Economy, 108 (3): 604-631. Marginal revenue- marginal cost This perspective holds that for each unit sold, a deduction of marginal cost from the marginal revenue will result to a marginal profit. At a certain level of output, the marginal profit becomes positive when marginal revenue exceeds marginal cost (Smith, Ferrier & Ndofor, 2001). This firm can adopt this level as the optimum level of production and the number of units produced should not fall below this level. Where the marginal cost exceeds the marginal revenue, the firm is making marginal losses, and this is an indication that the firm should produce fewer units of output. When the marginal cost is equal to the marginal revenue, the marginal profit is zero and the firm is considered to be maximizing profits. The goals of a firm are crucial as they are the elements that lay a foundation for understanding, predicting and interpreting different profit behaviors experienced by different firms. Some profit maximization strategies may have a conflict with the employees of the firm leading to negative impacts. Profit maximization perspectives limit the ability to understand how the firms utilize different methods and techniques to achieve their goals and objectives. The agency theory gives the relationship between the ownership structure of a firm and the profit maximization objective. The theory demarcates ownership from control of corporate organizations (Berle, & Means, 2006). This leads to a nonprofit maximizing behavior if managerial and individual needs have a mismatch with the profit goal of the organizational. This is common in firms where the managers have different goals from those governing the entire firm. The managers strife to achieve and maximize personal utility and they end up compromising the profit targets of the firm (Gupta et al., 2004). In microeconomic theory, it is argued that only the firms and businesses managed by the owner resemble an ideal profit maximization production unit. The profit maximization perspectives adopted by an organization may ignore the time value of money. In the two perspectives of profit maximization, a business is considered to be making profits at a certain level of output or revenue without considering their time. The firms may take several years to realize these profits or reach the optimum levels of production where there is maximum profit. In the financial time value of money concept, there is no equivalence between a dollar earned now and that to be earned later (Baum, & Mezias, 2002). The profit maximization perspectives ignore this concept and the firms may fail to reap the benefits of these perspectives within a short period. On the other hand, the investors are not compensated for the funds earned later. Firms that make profits within a short period increase their investments, which in turn increase their market share (Byrd, Parrino & Pritsch, 1998). These investments increase the interest and revenue for the organization. In addition, there are no standards that give a clear definition of the profit concept. Different organizations have different perceptions and ways of viewing profits. For instance, firms can recognize profits in terms of their gross figure, net figure or even before deduction of tax. These variations exist due to lack of a clear rule defining profit maximization for these categories of profit (Elsayed and Paton, 2005). This makes firms adopt different ways of disclosing their profits. For instance, some firms report profits as gross figures in their financial statements while others disclose the net figures. This creates difficulties when market and financial analysts try to compare different organizations competing in the same region or field. Comparison is an important factor in investment since it helps investors make informed decisions before investing in the organizations. Most firms that base their goals on profit maximization do not operate ethically (Mojonnier, 2012). This is because such firms have to adopt strategies that enable them make a lot of money in order to maximize their profits. Some shareholders believe that companies where they have invested should not give back to the security. For instance, when Chicago Booth faculty initiated the goal of maximizing profits, all its employees worked hard towards achieving this goal (Cappelen and Kolstad, 2006). When Environ Corporation paid attention to maximizing profits on a quarterly basis, the company collapsed. This is because the company focused on inflating its prices and fraudulent profits and assets. Goldman Sachs created and allowed a client to pick a mortgage security product without disclosing that another client had used the product and failed. The company had sold this product at a high price; therefore making a onetime profit but a substantial loss of ethics. Currently, unethical practices of profit maximization are manifested in financial services. According to New York Times, many financial services firms are manipulating their financial statements to display false financial images (Craig, 2012). Profit maximizes introduces financial risks to the company, which are mostly ignored or half-mitigated. Managers prefer organizations with profit maximization strategies due to monetary benefits in the organization regardless of the risks involved (Hoetker, 2007). The decision making process in these firms may create unforeseeable risks as the managers pursue maximum profits. These risks may paralyze survival of the business when they occur in the decision implementation process. These risks may have the effect of overshadowing the profit goals in the firm. For instance, managers of Lehmen Brothers loaded billions of dollars in a risky mortgage portfolio. To shield the shareholders and stockholders from knowing this, they wrote off these securities from their financial books (Mojonnier, 2012). This was in line with the anticipation that the stock prices would be affected negatively reducing bonuses for the executives. This reduces the profit margin of the firm due to the unforeseen risk. Profit maximizing perspectives undermine the quality of both products and services offered by a firm. Firms that center their operations on profit maximization ignore intangible benefits such as quality, image of the firm and its products, and advancement in technology (Amit, MacCrimmon & Zietsma, 2001). These benefits indirectly create intangible assets that are important for increasing the profit margin. For instance, the image of Goldman Sachs was affected after the government charged it for defrauding its clients. This made the firm lose some of its customers and suffer from financial losses. On the other hand, most firms operating as monopolies may fail to implement advanced technology. This is because they lack competition from other firms and, therefore; they have no reason for improving their technology. These firms have poor services and low quality products for their customers. However, there are benefits that a firm is likely to reap from adopting simple profit maximizing perspectives. Most firms start up with an aim of making profits and adopting these strategies helps them survive in the market. These firms have continuous innovation and invention as a way of attracting a market share and increasing their profit margins. Continuous profit realization determines the survival of the business. Firms experiencing continuous losses are forced to halt their operations due to lack of investors. An example of the effects of small profit margins is the bankruptcy facing General Motors (Craig, 2012). The shares of General Motors have declined for several years creating financial hardships for the company. Currently, the company’s shares have lost approximately 49% of their value relative to Dow. Economists observing the financial and market trends of GM foresee a possible closure of the company in the near future. For the first seven months of this year 2012, the company’s market share has dropped by 18 to 20 percent compared to the same period in 2011. Therefore, profit maximization perspectives ensure the economic viability and sustainability of a company. Profit maximization serves as the standard measure of business or project viability. Businesses making maximum profits have a strong command in the market and are unlikely to collapse. Investors have to evaluate the previous, current, and future profit projections before undertaking investments in an organization (Benz and Frey, 2008). Investors may have several organizations to consider for their investments, and they are mostly attracted to organizations with high standards such as high profit margins. This makes them conduct a viability test of the organization and settle for the business organization with a promising market value and profitability. Investors require an assurance that they will accrue profits after undertaking an investment. The previous profit margins and profit maximization strategies serve as an assurance of return on investment (Vroom & Gimeno, 2007). In some cases, investors compete to pump their money in an organization with high economic standards. The company executives exploit the competition and extract the highest amount of money from the competing investors. This helps the organization increase its assets in order expand the business activities. Firms that adopt simple profit maximizing perspectives cater for the social wellbeing of their employees. The employees are rewarded after the organization generates profits. The profit margin realized in an organization is an indication of the hard work and effective resource utilization by the employees. In return, the company rewards its employees for the good performance (Darnall, Jolley, Ytterhus and Johnstone, 2004). In an organization, the profits are shared among the factors of production that include land, labor, capital and entrepreneurship. Through these payments, the firm takes care of the needs of the employees and investors. Some organizations pay bonuses to employees who have exhibited exemplary performance over a given period. This acts as an incentive to employees who refine their work ethics and processes to increase their bonuses. This in turn favors the production processes for the organization leading to high profit margins. Through this process of profit maximization, earnings per share of the firm are increased, and the company valuation improves. Profit maximization perspectives practiced traditionally, lead to oversimplified models of competitive interaction. This helps the business owners improve the firm’s utility by reinvesting part of the profits. The strategic management strategies adopted in an organization are closely tied to its profit margins. According to Barney and Arikan (2001) involving work culture in the strategy would help respond to competition arising from strategic management. According to neoclassic economists, a firm is a profit maximizing entity when production function transforms inputs into outputs (Barney & Hesterley, 2006; Hamilton, 2000). Complete transformation depends on the strategies governing the organization. The utility of the company is improved by reaching the optimum output based on marginal costs and marginal revenues. Conversely, a large percentage of the resources are consumed by the firm in the production process. The firm generates its utility from this consumption and optimum consumption improves the profitability of the business. Production driven by profit maximization improves the utility of the firm. This helps the business owners capitalize on production and service provision in order to improve the business utilities and profitability. The profit maximization process has to strike a balance between the cost of production and the optimum price. According to Boeker et al (1997) pricing is a determining factor in competitiveness of a business. This has to be synchronized with the quality of services offered for a given price set (Cappelen, 2004). Some high levels of profit maximization introduce risks that may drive customers away, leaving the firm at a worse position than it was before initiating the profit maximizing perspective. Returns on investment determine the next production lifecycle for the firm. Firms plan their activities for the next year depending on the targets met during the previous lifecycle and the amount of profits realized. Investors are likely to increase their investments when the company makes encouraging profits. This gives the managers enough resources to plan and execute their production activities in the coming production period (Vroom & Gimeno, 2007). However, this may have a negative impact if the firm fails to increase its profit after heavy investment. The investors may encounter heavy losses if the managers fail to produce higher profits than those recorded in the previous lifecycle. Businesses with internal ownership, where managers are also the owners of the business, have autonomous activities (Birley and Westhead, 1994). This is because the firms are utilized for both consumption and production purposes. This could happen when possibilities of consumption offered do not match the production possibilities. It can also be the case when the cost of utility received is lower than consumption necessary in the household. These firms provide their owners with income by eliminating the need for a salaried executive (Cappelen, 2004). These firms are mostly associated with provision of general leadership and ability to deploy resources that suite ones preferences. Conclusion Simple profit maximization perspectives are the right ways of implementing optimum prices for products and services while at the same time fulfilling the firm’s goals and objectives. This has to be implemented without compromising some of the business activities such as the quality of products and services. The firm needs a delicate approach so as to avoid negative effects of profit maximizations such as unethical practices and disoriented managers. Profits originate from the costs, marginal and total costs accrued by the firm. These costs originate from the business activities of the firm, which are mostly centered on the customer. Companies are exposed to financial risks since managers are attracted by benefits from the organization. They may result to decisions that increase profits, but place the company at risk. Companies with profit maximization perspectives have a competitive advantage due to strategic measures that increase their sales. 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