Alternatives to Profit Maximisation
The standard textbook assumption that businesses are driven by the need to maximise
profits and achieve a unique profit maximising equilibrium price and output where
marginal revenue equates with marginal cost is false. Although there are good reasons
to support the argument that private sector businesses must strive to meet commercial
aims and objectives. And that the discipline of the market for corporate control e.g. the
stock market is hugely important for listed companies, especially in a world of private
equity and active hedge funds. Nonetheless we can find many reasons to question the
assumption of profit maximisation.
Questioning profit maximisation
(1) Information failures
o
o
o
Lack of accurate and detailed information to undertake optimal maximising
behaviour
Few firms have the market intelligence to calculate demand curves, marginal
revenue curves or have full information on their marginal costs of production
Most modern businesses are multi-product firms operating in a range of separate
markets in different countries. The amount of information that they have to
handle can be vast.
(2) Behavioural theories of the modern corporation
o
o
o
o
o
o
o
o
Modern businesses / corporations are complex organisations
Frequently shareholders (owners) have little day-to-day control over the
management decisions of the business e.g. decisions on product pricing /
product development / marketing
This is known as the divorce between ownership and control
Managers may have different objectives than the principal shareholders and
may not always work in their best interests i.e. seeking to maximise shareholder
value / profit streams
The owners may not be able to monitor the decisions taken by manager
(principal-agent problem)
Their behaviour may involve pursuing alternative objectives such as
o Satisficing behaviour involves the owners setting minimum acceptable
levels of achievement in terms of business revenue and profit.
o Sales revenue maximisation – at an output where marginal revenue
= zero
Different objectives can lead to different price and output combinations – as
shown in the diagram
Evaluation:
o This has implications for consumer and producer welfare / economic
welfare
o The expansion of private equity and the takeover boom may be placing
businesses under greater pressures to maximise profits and shareholder
returns
o
Profit-related pay and other forms of incentives can also change the
behaviour of managers
(3) Changing objectives at different times
Many profit-driven businesses may opt to depart from pure profit maximisation
strategies at different times
o
o
o
Economic Cycles: During a recession or economic slowdown – when the
priority may be to generate strong cash flow or keep sales volumes high by deep
discounting of prices and lower profit margins
Fresh competition: When a new rival enters the market
Dynamic market conditions: When there is an unexpected cost shock e.g.
higher oil prices and they decide to absorb the cost rise in lower profits
(4) The rise of social entrepreneurs – “not just for profit” businesses
Underneath the surface of an economy dominated by global corporate giants, a new
breed of business is flourishing, where profit is not always the bottom line; these are
entrepreneurs operating for a social purpose not just for profit. A social enterprise is a
business that has social objectives whose surpluses are reinvested for that purpose in
the business or the community, rather than being driven by the need to seek profit to
satisfy investors. Rather than maximise shareholder value and distribute rising
dividends, a social enterprise is looking to achieve social and environmental aims over
the long term.
Examples
o
Café Direct
o
o
o
o
o
o
o
Fair Trade
Traidcraft
Divine Chocolate
The Eden Project
Fifteen Foundation (Jamie Oliver)
Housing Associations
Micro-credit developed by the Grameen Bank and its founder, the Nobel-Prize
winner Muhammad Yunus
An example from India
Devi Prasad Shetty strives to make sophisticated health care in India available to all
irrespective of their economic situation or geographic location. He founded the
Narayana Hrudayalaya Hospital in Bangalore in 2001 and previously co-founded the
Asia Heart Foundation. In addition, Shetty has built a network of 39 telemedicine
centres to reach out to patients in remote rural areas. Together, the network of
hospitals performs 32 heart surgeries a day, making it one of the busiest in the
world. Almost half the patients are children and babies. Sixty percent of the
treatments are provided below cost or for free.
5) Not for Profit Business
Charities, community organisations run on commercial lines - another example is
Network Rail
Network Rail
o Took over the rail network in October 2002
o Stated purpose is to deliver a safe, reliable and efficient railway for Britain.
o It is a company limited by guarantee – whose debts are secured by the
government
o A private company operating as a commercial business and regulated by the
Office of Rail Regulation
o Train operating companies pay Network Rail for use of the rail infrastructure
(6) Businesses required to main a loss-making service on social grounds
A good example here is the Royal Mail which is required to maintain a universal national
postal delivery service throughout the UK for a uniform price. Household mail makes a loss,
cross-subsidised by business mail – although this market is shrinking for the Royal Mail
because of the introduction of fresh competition from Jan 2006. The Post Office Ltd is a
subsidiary of the Royal Mail Group plc – it runs substantial losses on the network or rural
post offices and has been under great pressure to close hundreds of off
Young, gifted and not for profit
By Peter Day
Presenter, BBC Radio 4 and BBC World Service
In the 19th century, it was charities that changed
society, charities responding to the new urban
problems of industrialisation.
In the 21st century
it may be time for
something new:
social
entrepreneurship,
for example.
It means taking a
business eye to the
problems of society,
and then applying a
business imperative
to get things done,
but without the
profit motive.
Ms Young says social entrepreneurs get things done
I think this is terribly important, and so (luckily) do people
with the money to invest in it (unlike me, that is).
Social entrepreneurship is getting a lot of attention.
Even business schools are waking up to it as a subject that
needs to be taught.
At the Said Business School in Oxford the other day, Rowena
Young told me how they are teaching it there, and how keen
people both inside and outside the university are to learn
about it.
She is director of the school's Skoll Centre for Social
Entrepreneurship.
A changing society gives social entrepreneurs new objectives
she says: they may come up with unconventional ways of
addressing the problems of a rapidly ageing population, for
example.
This is different from the charity approach, says Rowena
Young.
They say how do we grow?
Social entrepreneurs ask how to resolve the issue, and move
on to the next one, just like business entrepreneurs.
Social conscience
The Said school is only 10 years old, but it is already
producing its own ex student social entrepreneurs, such as
Clean Start Energy making bio-diesel fuel in India with
founders only one year out of college.
The fuel comes from a weed
which was taking over the land
of poor farmers.
If you want to, half your
Oxford MBA can come from
studying social and
environmental innovation.
Professor Yunus spearheaded
Business students, says Ms
unsecured lending to the poor
Young, want increasingly to
marry their values to their professional careers without
having to make a choice between the two.
She says it is a growing trend for people under 35; big
businesses will ignore it at their peril.
Lending money
The Said School is also where the Skoll Foundation (based in
Silicon Valley USA) has funded this department to study
social entrepreneurship, and where it holds an annual
conference, bringing commentators and entrepreneurs
together from all over the world.
The Skoll in question is Jeff
Skoll, a still young
businessman who made a
fortune as president of Ebay,
but who now devotes himself
to backing films and
encouraging social
entrepreneurs in a hurry to
change the world.
Ms Hale wants to use Big Pharma's
existing discoveries
One of the social
entrepreneurs I met in Oxford as Professor Muhammad
Yunis, founder of the now famous Grameen Bank in
Bangladesh.
He is one of a huddle of new microlenders who are changing
the lives of poor people by lending small sums of money to
them, without the conventional security to lend on: collateral
such as property, which is what most banks require to offset
a loan.
Shelved drugs
The second social entrepreneur I listened to in Oxford was
Victoria Hale.
She is the founder of the Institute for Oneworld Health, a
pharmaceutical company based in San Francisco set up not
to make profits but to do good, perhaps huge good.
She is doing something that the people who run "Big
Pharma", the world's leading drug companies, cannot
imagine ever succeeding.
Ms Hale is trying to create new medicines to treat illnesses
common among poor people in places such as Africa.
And where does a not-for-profit pharmaceutical company find
its new drugs ? Simple, she says on the shelves of Big
Pharma.
Her message to the big companies is: let us have your drugs
that for some reason failed to dazzle the first time around,
drugs stuck in the company vaults.
And they do: the big companies are the ones who are making
the Institute possible.
They have discovered and identified hundreds if not
thousands of new compounds which have failed: not effective
at the task they were produced for, unsuitable side effects,
too small a market place for the huge costs the international
giants have seen become a norm in their particular big lab,
blockbuster drug model of the business.
More needed
Ms Hale, social entrepreneur and pharmacologist, says there
is another model of how to develop drugs.
Oneworld Health can only do its job because Big Pharma is
still profligate in the way it produces potential drugs.
But it also suggests that there are huge inefficiencies in the
way western world drugs are currently devised and
produced.
Challenging the system does not come cheap: among the
backers of Oneworld Health is the Bill and Melinda Gates
Foundation, which has given Victoria Hale $140m to change
the way drugs are produced for the poor.
But we need dozens, no hundreds, more social entrepreneurs
to change the way everything is done: to spot a gap in the
social marketplace and fill it, with a motive other than profit.
They are on their way.
Work in Progress is the title of this exploration of the big
trends reshaping the world of work as we steam further into
the 21st century; and it is a work in progress, influenced and
defined by my encounters as I report on trends in business
and organisations all over the world