In classical economics, firms are assumed to be profit maximisation seekers. However, firms may have alternative business objectives:
- Corporate social responsibility.
- Market share.
- Satisficing.
- Growth.
Try to memorise case studies that can be applied to more than one concept!
Profit maximisation: the traditional objective
Rational Producer Behaviour
The act of aiming to maximise profits. The goal of firms, according to the standard theory of the firm.
Profit as factor payment
Payments, per unit time, made to the owners of entrepreneurship (one of the factors of production)
Profits can also be understood as the difference between the total revenue and costs of a firm.
- Profits can be understood as the difference between the total revenue and costs of a firm.
- Hence, profit maximising firms try and maximise how much they earn while minimising how much they spend.
- The idea that firms seek for profit maximisation is a key assumption in traditional economic models.
- However, real-world firms often pursue other objectives.
Profit maximisation in action
Suppose a firm produces 10,000 units of a product $X$ that
- Costed $\$ 50,000$ in total.
- Sold 9000 units for $\$ 10$ each.
Then the total revenue earned is
$$ 9000 \times \$ 10 = \$ 90000 $$
So the profit is
$$ Revenue - Cost = \$ 90000 - \$ 50000 = \$ 40000 $$
Alternative Business Objectives
Corporate social responsibility
Corporate social responsibility involves firms adopting ethical practices that benefit society as a whole, rather than focusing solely on profits. Firms may make business choices with their corporate social responsibility in mind due to:
- Reputation and brand loyalty: a firm’s image, attracting socially conscious consumers.
- Long-term profitability.
- Employee satisfaction.
- Regulatory Compliance.
- Lowers the chance of stricter government intervention.
Due to the increasing environmental and ethical awareness of consumers, firms find the impact of corporate social responsibility to be higher nowadays.
Case studyPatagonia. Prioritizing Environmental Sustainability Over Profit Maximization
Patagonia, the outdoor clothing and gear company, is renowned for its commitment to environmental sustainability. Instead of focusing solely on profit maximization, the company prioritizes environmental and social goals. For example, Patagonia encourages customers to repair and reuse their clothing rather than purchase new items, even offering free repair services and guidance. This approach deliberately limits sales growth to align with its sustainability mission.
Non-Profit Maximizing Objectives:
- Patagonia donates 1% of its sales to environmental causes and reinvests in sustainable materials and ethical labor practices.
- By focusing on sustainability, Patagonia builds strong customer loyalty, which can have long-term benefits even if it reduces short-term profits.
Outcomes:
- The company's "Don't Buy This Jacket" campaign, encouraging mindful consumption, resulted in increased brand loyalty but also paradoxically led to higher sales due to strong brand alignment with customer values.
- Patagonia’s practices demonstrate that prioritizing environmental sustainability can coexist with financial success, even if it doesn’t strictly maximize short-term profits.
Market share
Market share
The percentage of total sales in the market, which a firm is part of, that the firm generates.
For an industry that had total sales of $\$ 10$, if a company in that industry had sales worth $\$ 5$ then its market share is $50\%$
There are several reasons why a firm may choose to prioritise market share over sharing profit:
- Competitive advantage to achieve economies of scale (section 2.11).
- Brand recognition to attract more customers.
- Showcases to consumers the competitiveness of the firm within its market, and how well it's doing above its competitors
Amazon's Market Share Strategy
Amazon has consistently prioritized gaining market share over immediate profitability. This is evident in its aggressive pricing strategies, extensive investments in logistics, and expansion into various markets, from e-commerce to cloud computing.
- Competitive Advantage: By achieving economies of scale, Amazon reduces per-unit costs through bulk purchasing and efficient supply chain management, making it harder for competitors to match its low prices.
- Brand Recognition: Amazon's dominance has made it synonymous with online shopping, drawing more customers and increasing loyalty through programs like Prime Membership.
- Long-term Market Position: By reinvesting profits into innovation and expansion, Amazon showcases its competitiveness, which further solidifies its position as a market leader and deters new entrants.
This approach has led Amazon to dominate markets globally, even at the cost of reduced short-term profits, demonstrating how market share gains can translate into sustained competitive advantage.
In order to prioritise market share, firms may sometimes employ strategies that lead to lower profits (lowering prices, investing in more thorough research and development...).
Satisficing
Satisficing, introduced by Herbert Simon, refers to achieving an acceptable level of profit rather than maximising it. Firms who choose to satisfice over maximising their profits may do so because:
- They face constraints such as limited information, time, or resources.
- They may have a hierarchy of objectives where profit maximization, while important, is not the first. Such objectives could be:
- Balancing stakeholder interests.
- Employee satisfaction.
- Work-life balance.
Case Study: Patagonia's Satisficing Approach
Patagonia, a sustainable outdoor clothing and gear company, exemplifies the concept of satisficing. The company prioritizes environmental sustainability and ethical practices over profit maximization.
- Balancing Objectives:
- Patagonia actively allocates resources to reduce environmental impact, such as using recycled materials and minimizing waste, even if it increases production costs.
- They have implemented the "Worn Wear" program, encouraging customers to repair, reuse, and recycle their clothing, reducing new sales but fostering long-term customer loyalty.
- Stakeholder Interests:
- The company aligns its goals with the values of environmentally conscious customers and invests heavily in community initiatives, donating 1% of its sales to environmental causes.
- Patagonia supports its employees through generous benefits, flexible working conditions, and a culture that promotes work-life balance.
- Satisficing Over Maximizing:
- Despite the potential to scale production and boost profits significantly, Patagonia limits its growth to ensure it adheres to its sustainability and ethical goals.
- The firm’s hierarchy of objectives prioritizes environmental stewardship and employee welfare, demonstrating that acceptable profitability aligns with long-term brand trust and customer loyalty.
This approach highlights how satisficing allows firms to fulfill broader objectives while still maintaining profitability and competitive advantage.
Growth
Growth maximisation involves increasing the size and scale of a firm’s operations. Firms may prioritise growth over profit maximisation because:
- Larger firms can reduce average costs through bulk purchasing, specialised labour, and financial advantages (section 2.11).
- Growth can increase a firm’s influence over pricing and supply chains.
- Larger firms are often better equipped to withstand economic downturns or competitive pressures.
- Satisfy investors.
Through diversification (focussing on more than just one market/industry) Amazon started as an online bookstore but has since diversified into cloud computing (AWS), streaming services (Prime Video), and smart devices (Alexa).
Now it is one of the largest companies.
Similarly to market share maximisation, growth strategies involve trade-offs with profits, since maximising growth usually:
- Requires a greater cost of investing for expansion.
- Firms may decide to expand into new markets, even though here is a greater risk when joining new markets.
- Dealing with diseconomies of scale (2.11)
Amazon's Growth Maximisation Strategy
Amazon is a prime example of a firm that prioritised growth maximisation over immediate profit maximisation.
- Aggressive Expansion:
- Amazon reinvested significant portions of its revenue into expanding its operations, logistics, and technological capabilities.
- The company entered new markets such as cloud computing (AWS), streaming (Prime Video), and grocery retail (Whole Foods).
- Economies of Scale:
- By growing its scale, Amazon reduced average costs through bulk purchasing and innovations in supply chain management.
- This also allowed Amazon to offer competitive pricing, further driving growth.
- Long-Term Strategy:
- Despite operating at minimal or no profit margins in its early years, Amazon gained market dominance across multiple industries.
- Its investor-focused growth strategy satisfied shareholders with the promise of long-term returns, evidenced by surging stock prices over the years.
- Withstanding Competition:
- Amazon's growth has enabled it to outcompete smaller retailers and withstand competitive pressures, ensuring resilience during economic challenges.
Trade-offs: Amazon's growth came with substantial risks, such as initial financial losses, higher costs for expansion, and navigating challenges like potential diseconomies of scale in its vast global operations. However, this growth-first strategy positioned Amazon as a leader in e-commerce and beyond.
Theory of KnowledgeDo firms that prioritise corporate social responsibility only in the hope of attracting more consumers and profits? If so, is this ethical?
