Alternative Theories of the Firm

Sales Maximisation
Sales maximisation is achieved when:

AC = AR or TC = TR

In other words, a business is selling as much as they can without making a loss. At the sales
maximisation output, there are normal profits only and no supernormal profits/loss.

Businesses choose a sales maximisation objective to achieve a rapid growth of market

share (subject to the constraint that they need to achieve a minimum rate of profit (normal profit)
to justify staying in the market in the long run).

Sales maximisation typically involves businesses charging lower prices for their products contrasted
with profit maximisation. This can be good news for consumer welfare in the short run as the level of
consumer surplus increases.

Baumol's Theory of Sales Revenue Maximisation

Baumol's theory of sales revenue maximization was created by American economist William
Jack Baumol. According to Baumol, sales revenue maximization is the most important goal of
managers. W. J. Baumol suggested sales revenue maximisation as an alternative goal to profit
maximisation. He presented two basic models: the first is a static single-period model, the
second is a multi-period dynamic model of growth of sales revenue maximisation.

Sales maximization theory is based on the work of American economist William Jack Baumol.
The theory attempts to draw a conceptual framework to better understand the objectives and
strategies of corporations operating in a competitive marketplace. Baumol's work helped
economists as well as managers make sense of business decisions that often seemed to conflict
with a profit maximization model and is an important body of work in microeconomics.
Professor Baumol observed that, contrary to prevailing assumptions, most businesses pursued
maximum sales, as opposed to maximum profits, and that increasing sales has become the
ultimate objective of most businesses. Maximum sales occur when further price cuts result in
lower total sales revenue, since the increase in units sold doesn't make up for lower per-unit
sales proceeds.

Management Utility Maximization

Economics concept that, when making a purchase decision, a consumer attempts to get the greatest
value possible from expenditure of least amount of money. His or her objective is to maximize the
total value derived from the available money.

Williamson’s Utility Maximisation Theory

Williamson has developed managerial-utility-maximisation theory as against profit maximisation. It
is also known as the ‘managerial discretion theory’. In large modem firms, shareholders and
managers are two separate groups. The shareholders want the maximum return on their investment
and hence the maximisation of profits. The managers, on the other hand, have consideration other
than profit maximisation in their utility functions. Thus the managers are interested not only in their
own emoluments but also in the size of their staff and expenditure on them.
Thus Williamson’s theory is related to the maximisation of the manager’s utility which is a function
of the expenditure on staff and emoluments and discretionary funds. “To the extent that pressure
from the capital market and competition in the product market is imperfect, the manager, therefore,
has discretion to pursue goals other than profits.”

The managers derive utility from a wide range of variables. For this Williamson introduces the
concept of expense preferences. It means “that managers get satisfaction from using some of the
firm’s potential profits for unnecessary spending on items from which they personally benefit.”

Satisficing Behaviour
Satisficing behaviour is an alternative business objective to maximising profits. It means a business is
making enough profit to keep shareholders happy or it's sufficient for investors to maintain
confidence in the management they appoint.

The management may have other objectives, or a decision been made to sacrifice some short-run
profits may mean long run profit maximisation.

The idea that businesses depart from pure profit maximisation is linked to the existence of
a divorce of ownership from control and the principal agent problem.
 Theories of Profit
1. Risk and Uncertainty Bearing Theory of Profit
This theory explains that profits are a necessary reward of the entrepreneur for bearing risk and
uncertainty in a changing economy. So this is functional theory of profits. Profits arise as a result of
uncertainty of future.

2. Frictional Theory of Profits

According to this theory there exists a normal rate of profit which is a return on capital that must be
paid to the owners of capital as a reward for saving and investment of their funds rather than to
consume all their income or hoard them.

3. Monopoly Theory of Profits

Another explanation of above-normal profits attributes them to the monopoly power enjoyed by
firms. Firms with monopoly power restrict output and charge higher prices than under perfect
competition. This causes above-normal profits to be earned by the monopolistic firms.

4. Innovations Theory of Profits

This theory of profits explains that economic profits arise because of successful innovations
introduced by the entrepreneurs. It has been held by Joseph Schumpeter that the main function of
the entrepreneur is to introduce innovations in the economy and profits are reward for his
performing this function.

5. Managerial Efficiency Theory of Profits

Lastly, this theory recognizes that some firms are more efficient than others in terms of
management of productive operations and successfully meeting the needs of consumers. Firms with
average level of efficiency earns average rate of return. Firms with higher managerial skills and
production efficiency are required to be compensated by above-normal profits (i.e. economic
profits). Therefore, this theory is also called compensatory theory of profits.