A Simple Profit Maximization - Case Study Example

Adopting a Simple Profit-Maximising Perspective Can Have Positive Impacts for a Firm College: Introduction Profit maximisation is the basic goal of any business owner irrespective of the size and type of business. Every business owner takes a risk to introduce products or services in the market with an aim of making profits. Thus, profit is the reward for taking a risk to enter a certain market. Without this reward, an entrepreneur or business owner is likely to withdrawal from the market. Organisations utilise different strategies to increase their level of profits. Profit maximisation is a basic perspective but not the only perspective in organisations. The perspective that an organisation adopts will depend on its goals, objectives, and vision among other things. For instance, an organisation may choose to focus of customer satisfaction instead of profit maximisation. Consequently, the organisation will invest its resource in ensuring that all its customers receive quality services and products. Its resources will be directed to building good relations with customers. In addition, an organisation may choose to focus on cost minimisation, product development and branding or building the image of the organisation. Thus, perspectives vary across organisation. Adopting a profit maximisation perspective implies that all decisions in an organisation are aimed at maximising profits. Thus, the management has to evaluate every decision and determine how the organisation will benefit if a decision is implemented. Therefore, any decision that does not lead to an increase in profits is eliminated. For this reason, the profit maximisation perspective has received much criticism over the years. Although it is the primary and tradition goal of all businesses, critics argue that it is not the only reason why businesses exist and adopting such a perspective is selfish. Critics argue that businesses with a profit maximisation goal ignore the interests of other stakeholders such as communities, suppliers and employees. Despite the criticism, business owners have continued to adopt profit maximisation as their major objective. This paper will discuss in detail whether adopting a simple profit maximisation perspective can have positive impacts in a firm. Body Arguments against Profit Maximisation Every business has a unique combination of factors that contribute to its competitiveness in the market. A business will allocate most of its resources in optimising these factors to remain competitive in the industry and expand its market share. The management team in an organisation bears the responsibility of developing effective strategies that ensure that the organisation beats its rivals in the market. Shareholders have high expectations that managers will undertake the responsibility efficiently. A business is considered to have a competitive advantage over its rivals if its level of profitability is higher than the average profitability level in the industry. Thus, profitability is a major source of a competitive advantage in organisations. For this reason, managers may choose to adopt profit maximisation as the main strategy for gaining a competitive advantage. Competitiveness can be sustained by ensuring that profitability strategies have both short-term and long-term perspectives. If the management decides to use profitability as the main source of a competitive advantage, its major perspective in operations becomes profit maximisation (Barney & Hesterley 2006; Hills & Jones 2009). The basic assumption in economic theory is that businesses aim at maximising profits. Thus, businesses will ensure that they operate at a level where benefits exceed costs. Businesses may incur losses in some production process but such financial should not be recurrent if a business is to survive in an industry (Nicholson & Snyder 2011). Critics of the profit maximisation perspective give various reasons why businesses should adopt other perspectives rather than profit maximisation. One argument against profit maximisation is that businesses may ignore the risks involved in profit maximisation strategies. The management may adopt idea simply because of the high profits that it bring to company and ignore the risks involved. Most of the strategies that lead to large profits are associated with high levels of risks. Ignoring such risks may have negative effects on a firm’s future profitability (Shim & Siegel 2009 Another shortcoming of a profit maximisation perspective is that organisations sometimes ignore important aspects such as quality of products of services, efficiency, reputation and customer satisfaction that contribute to the long-term success. This implies that a profit maximisation goal consider the short-term benefits to a firm and ignores the long-term viability of profit maximising strategies. Profit maximisation sometimes creates a bad image of an organisation in its customers and suppliers. This is because such a perspective focuses on prices of products and raw materials. A firm with a profit maximisation perspective may insist of changing suppliers to get the lowest prices for raw materials and raising the prices of where possible (Shim & Siegel 2009; Moyer, McGuigan & Kretlow 2008) Jagels and Ralston (2006) argue that a profit maximisation goal may cause an organisation to ignore its shareholders in the process. This may damage the relations between shareholders and the management team. An organisation may chose not to pay dividends to its shareholders or consider this requirement as a minor objective in pursuit of higher profits. A rift between the management and shareholders is a threat to an organisation’s future success and stability. In this case, profit maximisation is only beneficial if it is a short-term goal. Profit maximisation ignores the timing of expected returns and requires that an organisation uses its current resources or invests in all necessary resources in the short term. It is difficult to compare the short-term profits and long-term profits since the perspective has no time dimension. Profit maximisation does not differentiate between getting money now and getting the same amount of money in future. In addition, the definition of profits is unclear and this discredits profit maximisation as a viable goal in an organisation (Parrino & Kidwell 2009; Moyer, McGuigan & Kretlow 2008). The Positive Impacts of a Profit Maximisation Perspective in a Firm Despite the shortcomings of a profit maximisation goal listed above, firms can still benefit from this perspective. Kolstad (2007) indicates that businesses adopt different strategies to enhance their competitiveness in the market. For example, Coca Cola maintains its competitiveness in the soft drinks industry by developing its brands and offering high quality products. However, each of those strategies is attached to a long-term goal of maximising profits. This means that in the end, the main goal in firms is to maximise profits and maintain an upward trend in the level of profits. Many critics use social responsibility as a reason why businesses should not focus on profit maximisation. Friedman (1970) argues that profit maximization is the social responsibility of all firms. This implies that firms fulfil their social responsibility by adopting a profit maximisation strategy. One benefit of this approach is that an organisation is able to survive in the market and industry. Survival for businesses largely depends on whether a business is profitable or not. New entrants in an industry sometimes aim at pushing out small firms or firms with low profits out of the industry by adopting strategies that lead to losses in their competitors. For instance, a large company may decide to lower its prices to a level that a small firm or a firm earning low profits cannot adopt. Adopting the low prices would mean that competitors incur losses and hence they are pushed of the market. Apart from the price wars, large competitors sometimes acquire small firms with low profit margins. Such a firm loses full control over its operations because the larger firm has more powers in decision-making processes. However, focusing profit maximisation can help such organisations to increase their level of profits and develop strategies of ensuring every decision on investment is profitable. Consequently, organisations are able to withstand competition from new entrants and existing firms in the market (Cabral, 2000; Kolstad 2007). Keown (2003) indicates that profits are used to measure the viability of a business venture and thus cannot be ignored. If a business is not making profits, then the primary objective is not achieved and such a business cannot survive in the market. High levels of profits partly result from efficient allocation of resources in a firm. A firm is able to pay for its inputs including human resources easily with increasing profits. Lack of enough resources limits firms in their efforts to cater for the welfare of communities. However, profit maximisation sometimes translates to more funds that can be used for such programs. Profit maximisation increases the amount of cash in a firm, which can be reinvested for additional returns in future or used to expand the business. This implies that a profit maximising perspective can be beneficial to a new or small firm that intends to expand its operations. Additional cash from profit maximisation strategies can also be used to clear debts and this improves an organisation’s financial credibility (Keown 2003; Hall & Lieberman 2009). Investors require a report on a firm’s profitability to make decisions on whether to invest their funds in an organisation or not. For instance, private investors consider the profitability of an organisation before buying the organisation’s stocks. Financiers such as banks consider the profitability of a firm before issuing funds or loans for expansion. A profit maximising approach will ensure that an organisation’s profits record an increasing trend and this will attract many financiers and investors. Shareholders expect returns for their investment and may use profits to make decisions on selling or retaining a company’s shares. If profits are low, shareholders dispose their shares and this lowers their prices in the stock market. Such an instance has a negative effect on the image of a company to other potential investors and this can be avoided if a firm focuses on its profitability (Keown 2003; Hall & Lieberman 2009). It is easy to predict the behaviour and course of a firm with a profit maximisation goal compared to firms with other goals. The behaviour of such an organisation is based on the objective to make profits. A profit maximisation perspective ensures that limited resources in an organisation are allocated to the most profitable operations or products. For instance, product development strategies, labour, and capital can be allocated to the product that records the highest level of sales. An organisation can use profits to determine the viable operations and eliminate wastage of resources. One common strategy to maximise profits is to minimise production costs. Cost leadership is a major source of a competitive advantage for an organisation. Low costs allow firms to reduce their prices and thus the demand for their products increases. A competitive advantage may help an organisation to increase its market share, which translates to higher profits in future (Keown 2003; Hall & Lieberman 2009). As indicated earlier, higher profits increase the amount of available cash in an organisation. As profits increase, an organisation’s capacity to invest in its employees is improved. Thus, an organisation may improve its compensation schemes and pay better wages to its employees. Consequently, the level of employee motivation and satisfaction will increase. Satisfied employees are more productive and committed to an organisation’s success. The higher levels of employee productivity will lead to higher returns in future. This implies that if an organisation invests additional cash from higher profits wisely, it can maintain an upward trend in profits in future. Similarly, an organisation may chose to invest extra cash from higher profits in paying higher dividends to shareholders. The shareholders may be motivated to invest more funds and this is increases the amount of capital available to a firm. Investing a share of profits in corporate social responsibility helps in building an organisation’s image and may attract more potential customers (Jain & Khanna 2009). Firms require funds to grow through acquisition and profits provide part of these funds. Additional funds from higher profits can be used to repurchasing shares from the stock market. This means that an organisation can use its profits wisely to control the price of its shares in the market. Companies with an increasing flow of income can improve their operations including customer service, quality of products and investing in advance technology that makes production faster. Such companies are likely to record better performance in the stock market and this enhances their competitiveness in the market. They are likely to survive in the market longer than relative to their competitors especially if the management is competent in decision-making. A corporate performance is in most cases measured by their level of profits. Profits are a reward to business owners for taking risks. An upward trend in profits may encourage entrepreneurs or business to take higher risks, which may lead to higher levels of profitability and competitiveness in the long term (Jain & Khanna 2009). One of the major challenges in organisations is contentions between shareholders and managers. This is because these parties in most cases have different opinions on what should be the main goal in an organisation. For instance, business managers may argue that corporate social responsibility or customer satisfaction should be the main perspective in an organisation. However, shareholders are concerned about profitability since the level of profits determines the reward they get for investing their funds in a business. Profits are important to shareholders because of the dividends they enjoy and the possibility of selling their shares at a higher price. The contentions between managers and shareholder sometimes slow down the operations in an organisation until an agreement is reached. One way of avoiding such contentions is adopting a simple profit maximisation perspective that includes the interests of shareholders. Adopting this perspective does not necessarily mean that a firm will only focus on satisfying shareholders. Other stakeholders benefits as well. For instance, consumers may benefits from improved products and employees from better wages (Hall & Lieberman 2009; Sekhar 2009). From the literatures analysed in this section, it is clear that a simple profit maximisation model has positive impacts on firms. One of the firm’s that seek to maximise profits is a U.S based agricultural firm called Stevia Corporation. Other companies with profit maximisation goals include Dell, Google, Amazon, Macdonald, and DaimlerChrysler. Although their strategies differ, their main objective is to maximise profits. Consequently, these companies have experienced tremendous growth in profits and some of these profits are used to expand their operations to different parts or the world (Warren & Leeve 2006). Conclusion Organisations adopt different strategies of gaining a competitive advantage over their rivals. One of these strategies is profit maximisation, which has faced sharp criticism over the years. Critics argue that a profit maximisation goal has not time dimension, is vague and that firms ignore the risks involved in the process of maximising profits. Profit maximisation has also been viewed as a short-term goal that may not be feasible in the long-term. In spite of these criticisms, firms adopt a profit maximisation perspective and enjoy various benefits. These benefits include a competitive advantage over rivals, sustainability in the markets and improved financial credibility. A profit maximising approach will ensure that an organisation’s profits record an increasing trend and this will attract many financiers and investors. Profit maximisation increases the amount of cash in a firm, which can be reinvested for additional returns in future or expanding operations to new markets. The additional cash can also be used to clear debts, pay higher dividends to shareholders, increase wages, improve products and customer services as well as in corporate social responsibility programs. A profit maximisation perspective allows an organisation to allocate its resources efficiently and eliminate contentions between managers and shareholders. Every strategic plan in an organisation contributes to the ultimate goal of profit maximisation. Although profit maximisation is not the only reason why businesses exist, profits guarantee the survival of a firm in the market. A profit maximisation perspective has various benefits for firms and thus it should be ignored. However, firms should consider the long-term and short-term effects of each profit maximisation strategy. 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