Business Objectives - Alternatives to Profit Maximisation

Author: Jim Riley Last updated: Sunday 23 September, 2012

Introduction

In much of economic theory, it is assumed that a business aims to maximise profits.

In reality, most businesses which are run for “commercial gain” do have profit maximisation as an important objective – since the shareholders have taken a risk investing in the business and require a return (profit) to compensate them for their risk.

There are, however, many other potential financial objectives of a business. The table below summarises three alternative models of business objectives that have attracted popular support:

Sales Maximisation Model (Baumol)

This model argues that businesses try to maximise sales or revenues rather than profits. There are several possible motives for such an objective:

• Grow or sustain market share
• Ensure survival
• Discourage competitors (particularly new entrants to a market)
• Build the prestige of the senior management – who like to be seen running a large rather than a particularly profitable business
• Achieve bonuses – if these are based on revenues rather than profits

Management Discretion Model (Williamson)

In this model, Williamson argues that management act to further their own interests – in other words to achieve personal utility rather than to meet the interests of outside investors. Businesses run with this kind of objectives tend to deliver high levels of remuneration to management rather than the highest possible profits.

Consensus Model (Cyert & March)

The consensus model presents a slightly more complicated model of business objectives. In this case, it is argued that a business is an organisational coalition of shareholders, managers, employees and customers – each with different objectives. Management therefore try to reach a consensus with these different groups – each of which must settle for less than they would otherwise want. Shareholders, therefore have to settle for profits that are less than the theoretical maximum, perhaps to ensure that employees do better.

Wealth Maximisation Model

The theory of corporate finance suggests an alternative financial objective to profit maximisation that can provide a day-to-day focus for management. This theory assumes that management’s main job is to maximise the value or wealth of the business. Within this context, management seek to ensure that investments made by the business earn a return that is satisfactory to shareholders.