OBJECTIVES OF THE BUSINESS FIRM

INTRODUCTION

Economic theory underscores the fact that each firm in the industry operates
under competitive conditions and hence tries to operate more efficiently to
withstand the competition. The indicator of efficiency is profits. The assumption
here is that each firm has one man as the owner and entrepreneur, and that his
sloe aim is to maximise profits.

As time passed, one-man firms were replaced by partnerships and giant

corporations and the structure of the firm changed to include the
owner/entrepreneur/shareholders on the one hand and the managers on the
other. The responsibility of the owners/entrepreneurs/shareholders got
bifurcated. The day to day affairs of the firm were looked after by the managers
and owners/entrepreneurs/shareholders took organisational decisions aimed at
maximising profits.

The goals of the owners/entrepreneurs/shareholders are called Organisational

Goals while the goals of the mangers are referred to as Managerial Goals also
known as Operational Goals.

PROFIT MAXIMIZATION AS BUSINESS OBJECTIVE

Conventional theory of business firm assumes profit maximization, as the sole

objective of a business firm. The real indicator of success of any business
enterprise is the quantum of its profits.

In common man’s language, profit means the excess of income over costs. In
economics and managerial economics profits refer to rewards for entrepreneurial
skills . some economists believe that profit is a reward for entrepreneurial skills,
while others regard it as a remuneration for the entrepreneur and not a reward for
his entrepreneurial skills. In this sense, profit is regarded as income accruing to
equity holders, in the same sense as wages accrue to labour ; rent accrues to
owners of rentable assets ; and interest accrues to money lenders.

Profit is always linked with risk and uncertainty. Therefore profits differs. First, it
is the residue of the income after other factors of production--- namely, land
labour and capital --- have been paid for . Therefore profit does not mean fixed
remuneration--- like rent wages and interest. Profits fluctuate, and, therefore,
they are either positive or negative. Profits fluctuate because of the fact that
business involves speculation, risk, and operations under uncertain conditions,
that is under conditions of uncertainty.

How do profits emerge:

1. Profits emerge primarily because of risk taking. The operation of every

business involves a risk.; every businessman therefore has to take risks . The
risk is of two types--- coverable risks and uncoverable risks. Coverable risks are
risks against fire, theft etc. Because they are covered by insurance. The other
type of risk is purely a business risk.

Example

The dress making industry is highly volatile because fashions change quite often.
Now, if a businessman brings a new fashion into the market, it may click or it may
not click.

This type of risk cannot be covered by insurance. It involves uncertainty. In this

sense, it is said that profits are the result of risks which a businessman takes
and the uncertainty which is involved in business operations.

2. Profits also emerge as a result of innovation. Innovation means that one brings
some new product into the market following laboratory and market research.

Example

Before Nescafe was introduced, coffee drinkers depended upon filters., and it
took some time to prepare the decoction Once Nescafe was introduced, coffee
drinkers ceased to depend upon filters, because coffee powder dissolved
instantaneously in water.

This is what is called innovation . If the company marketing Nescafe is making

enormous profits today, it is because of this innovation.

3. Profits may also from some advantageous conditions. In the present imperfect
competition, Monopolistic conditions have set in. There is heavy product
differentiation. One particular brand may capture the market and drive out
competitors and substitutes as well. Such a situation arises out of some
advantageous or accidental conditions. Again, a firm may enjoy a monopoly; if
does, it rakes in huge profits.

4. Profits arise out of a sudden windfall. The demand for a particular product, for
example may shoot up sky-high; the businessman makes enormous profits
Profit Measurement: Profits are measured over a period of time --- generally a
year. That is from 1st April to 31st March. Profits are measured by accountant in
accordance with accounting methods. But the economists approach is different
from the accountant. While calculating profits, the accountant deducts the
expenses from the revenue of the company. But when expenses are considered
he takes into account only the explicit costs; that is, actual costs. The economist
on the other hand, does not stop at explicit coasts, he takes into account imputed
costs as well. By imputed costs we mean, the costs that would have been
incurred on any item if it had not been owned by the company.

Example:

A firm may be housed in its own building. Now the economist calculates the rent
of the building at the prevailing market rate and treats that as cost. This is known
as imputed cost.

It is evident, then, that the accountant and the economist differ in their approach
to the measurement of profits. The formula may be written as follows:

Accountant’s Formula

Profit = Revenue ˗ Expenses (explicit costs)

Economist’s Formula

Profit = Revenue ˗ Explicit Costs ˗ Imputed Costs.

Economic profits are considered to be more realistic from the managerial point of
view because they project a true financial picture of a company.

ALTERNATIVE OBJECTIVES OF BUSINESS FIRMS

There is no reason to believe that all businessmen pursue the same objective”
Recent research on this issue reveal that the objectives that the business pursue
are more than one. Some important objectives other than profit maximization are
: (a) maximization of sales revenue, (b) maximization of the firm’s growth rate, (c)
maximization of manager’s utility function, (d) making satisfactory of profit,(e)
long-run survival of the firm and (f) entry prevention and risk avoidance

1. Sales revenue Maximization

Baumol has postulated maximization of sales revenue as the alternative to profit

maximization objective. The reason between this objective is the dichotomy
between ownership and management in large business corporations. This
dichotomy gives the managers an opportunity to set their goals other than profit
maximization goal which most owner businessmen pursue. Given the
opportunity, the mangers choose to maximize their own utility function .
According to Baumol, the most plausible facto in manager’s utility function is
maximization of the sales revenue.

The factors which explain the pursuance of this goal by managers are the
following:

First, Salary and other earnings of managers are more closely related to sales
revenue than to profits.

Second, Banks and financial corporations look at sales revenue while financing
the corporations.

Third, Trend in sales revenue is readily available indicator of the performance of

the firm .It helps also in handling the personnel problem .

Fourth, Increasing sales revenue increases the prestige of the managers while
profit goes to the owners.

Fifth, The managers find profit maximization a difficult objective to fulfil

consistently over time and at the same level. Profits may fluctuate with changing
conditions.

Finally, Growing sales strengthen competitive spirit of the firm i n the market and
vice versa.

2. Maximization Of Firms Growth Rate

According to Robin Morris, managers try to maximise the firm’s Balanced

Growth Rate subject to managerial and financial constraints. A firms growth rate
is balanced when the demand for its products and the supply of capital to the firm
increase at the same rate. The two growth rates are translated two utility
functions : (i) Manager’s Utility Function and (ii) Owner’s Utility Function.
Managers try to achieve both the above objectives so as to maximize firms
Balanced Growth Rate. The Manager’s Utility Function and The Owner’s Utility
Function can be specified as follows:

Manager’s Utility Function: Um = ƒ(salary power, job security, prestige and

status)
Owner’s Utility Function Uo = ƒ(output, capital, market share, profit and public
esteem)

According to Morris, by maximizing these two variables, the managers maximize

their own utility function and the owner’s utility function . Maximization of these
two variables, depends upon the maximization of the growth rate of the firm . The
Entry

3. Prevention and Risk Avoidance

Yet another alternative objective of the firms suggested by some economists is to

prevent entry of new firms into the industry. The motive behind entry prevention
may be (a) profit maximisation in the long run, (b) securing constant market
share and (c) avoidance of risk caused by unpredictable behaviour of the new
firms.

4. Satisfying Behaviour

Managers work under conditions of uncertainty and various constraints. Under

such conditions, it is not possible for firms to effectively pursue the processes
required to maximise profits. Instead they seek to achieve a “Satisfactory Profit” ,
a “Satisfactory Growth” and so on . This behaviour of firms is termed as
Satisfactory Behaviour.

Apart fro dealing with the uncertain business world , managers will have to satisfy
a variety of groups of people – managerial staff, labour, shareholders, customers,
financiers, input suppliers accountants, lawyers, authorities, etc. All these
groups have their interests in the firms – often conflicting . The managers
responsibility is to “satisfy” them all. This “Satisfying Behaviour” implies satisfying
various interest groups by sacrificing the firms interests or objectives.

In order to reconcile between the conflicting interests and goals, the managers
form an aspirational level of the firm combining the following goals: (a)
Production goal (b) Sales and market share goals (c) Inventory goal and (d)
Profit goal.

OPERATIONAL GOALS OF BUSINESS FIRMS

 All business firms have undoubtedly some organizational goals to pursue.
Organizational goals are of five kinds, namely, he production goal, the inventory goal,
the sales goal, the market share goal and the profit goal.

Production Goal

The production department is responsible for production of commodities. The

production department prepares a plan of production, which has two aspects. First, how
much to produce ? (that is the volume of production). In how many days will the target
volume be produced (this is the time period).

The production targets is the outcome orders booked by the marketing department.
The marketing department sends its requisition to the production department indicating
the quantity required and the time period within which the quantity is required. To keep
up both the volume of production and deadline, the production department plans its
production schedule. The problems faced by the production department are

(a) availability of labour/manpower

(b) availability of raw materials

(c) breakdown in the plant

(d) machines going out of order

` (e) power failures

Inventory Goals

Inventory could mean stock of raw materials, stock of spare parts and stock of
finished goods. Inventory is expressed in terms its monetary value ; that is in
terms of costs. The cost of holding stocks include

(a) Investment of capital in purchase of raw materials, spare parts, etc.

(b) Interest on capital
(c) The stocks have to be stored involving rent for godown
(d) Administrative expenses like engaging a watchman for

All these expenses have to be incurred, and these are know as inventory costs.
Therefore the higher the level of stocks to be maintained, the higher the cost of
maintaining them. This is known as cost of holding stocks.

Then there is the cost of what is known as stock-out. If the stock-out situation
happens in the case of raw materials, it could cause a interruption in the flow of
production and thereby reduce the availability of the product to the customers.
This will lead to a loss of goodwill in the market and would lead to a loss of
customers.

So a balance has to be struck between high inventory and the resultant inventory
carrying costs and minimum inventory to avoid stock out situations and the
accompanying loss. These can be done by several inventory control methods
and inventory management.

Sales Goal

The sales department generally keeps a target and every year it tries to achieve
the target. Sometimes, the sales department tries to push the sales beyond the
target and as a consequence the firm tries to increase its output. A stage comes
when the output is optimum and that the profits are at their maximum. If a firm
produces beyond this level, it incurs losses. The first stage, that is, when the
profits increase, with an increase in output, in known as increasing returns. The
level of output at which profits are maximum is known as constant returns.
When the output is increased beyond a certain point, resulting a decline in
profits, the process of decreasing returns sets in. In the language of
Managerial Economics, we say that is the sales department pushes sales
beyond the point of constant returns, diminishing returns sets in. Sales, therefore
should not be pushed beyond the profit maximising point.

Market Share Goals

It refers to a the share of a company’s sales of a particular product in the total

sales of that product of all the companies. For example; there are several brands
of toothpaste a in the market. In a particular month, the total sales of toothpastes
on an all-India basis is estimated. Then the sales of the Company’s toothpaste in
the particular month are ascertained. These sales are expressed as a
percentage of the total sales of all the toothpastes. This percentage is known as
the market share of the total sales of all the toothpastes. This percentage is
known as the market share of that company.

Every company constantly strives to increase its market share. Therefore, the
goal of market share is linked with the goals of those persons in a firm who are
interested in increasing the market share, so that their company may occupy a
better position in the market than its competitors.
CONCLUSION

The goals discussed so far --- namely, production goal, inventory goal,
market share goal, and the profit goal are interlinked.

1. An excessive production without a proportionate increase in sales

would result in the piling up of inventory. The production goal and
inventory goal are therefore linked. If the production department goes on
producing and inventory goes on piling up, resulting in tying up of capital.

2. The sale department may not be able to market the entire production and
there might be losses.

3. If however the sales department goes on increasing sales, diseconomies

may set in and the firm might incur losses.

4. The sales department may boost sales and the market share of the firm
may go up but only in terms of cost of diminishing returns.

No shareholder would tolerate losses . Therefore a firm aims at making

profits. In this sense, all the four goal rotate around the profit goal. In
other words, the four goals are subservient to the Profit Goal.

Although profit maximization continues to remain the most popular

hypothesis in economic analysis, there is no reason to believe that profit
maximization is the only objective that firms pursue . Modern Corporations,
inn fact pursue multiple objectives . The economists have postulated a
number of alternative objectives for business firms. The main factor behind
thedn v rms pursue. Modern Corporations in fact, pursue multiple objectives
ynalysis, there is no reason to believe that profit maximization is trhe only
objective that f