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 Lack of accurate and detailed information to undertake optimal maximising behaviour
o Few firms have the market intelligence to calculate demand curves, marginal revenue curves or have full information on their marginal costs of production
o 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 Modern businesses / corporations are complex organisations
o 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
o This is known as the divorce between ownership and control
o 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
o The owners may not be able to monitor the decisions taken by manager (principal-agent problem)
o 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
o Different objectives can lead to different price and output combinations – as shown in the diagram
o 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 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
o Fresh competition: When a new rival enters the market
o 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 Fair Trade
o Traidcraft
o Divine Chocolate
o The Eden Project
o Fifteen Foundation (Jamie Oliver)
o Housing Associations
o 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.
Ms Young says social entrepreneurs get things done
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.
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.
Professor Yunus spearheaded unsecured lending to the poor
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.
Business students, says Ms 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.
Ms Hale wants to use Big Pharma's existing discoveries
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.
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