Profit policies

It is generally held that the main motive of a firm is to make profits. The volume of profit made by it is regarded as a primary measure of its success. Economic theory advocates profit maximisation as the chief policy of a firm. Modem business enterprises do not accept this view and relegate the profit maximisation theory to the back ground. This does not mean that modem firms do not aim at profits. They do aim at maximum profits but aim at other goals as well. All these constitute the profit policy.

(i) Industry Leadership:

Industry leadership may involve either the achievement of the maxi­mum sales volume or the manufacture of the maximum product lines. For the attainment of leadership in the industry, there has to be a satisfactory level of profit consistent with capital invested, labour force employed and volume of output produced.

(ii) Restricting the Entry:

If a firm follows a policy of restricting its profit, no competitors are likely to enter the market. Reasonable profits which guarantee its survival and growth are essential. According to Joel Dean, “Competitors can invade the market as soon as they discover its profitability and find ways to shift the patents and make necessary changes in design, technique, and production plant and market penetration.”

(iii) Political Impact:

High profits are considered to be suicidal for a firm. If the government comes to know that the firms are earning huge returns, it may resort to high taxation or to nationalisa­tion. High profits are often considered as an index of monopoly power and to prevent the govern­ment may introduce price control and profit regulation policies.

(iv) Consumer Goodwill:

Consumer is the foundation of any business. For maintaining con­sumer goodwill, firms have to restrict the profit. By maintaining low profit, the firms may seek the goodwill of the consumers. Consumer goodwill is valued so much these days that firms often make organised efforts through advertisements.

(v) Wage Consideration:

Higher profits may be taken as evidence of the ability to pay higher wages. If the labour associations come to know that the firms are declaring higher dividends to the shareholders, naturally they demand higher wages, bonus, etc. Under these circumstances in the inter­est of harmonious relations with employees, firms keep the profit margin at a reasonable level.

(vi) Liquidity Preference:

Many concerns give greater importance to capital soundness of a firm and hence prefer liquidity to profit maximisation. Liquidity preference means the preference to hold cash to meet the day to day transactions. The first item that attracts one’s attention in the balance sheet is the ratio of current assets to current liabilities. In order to give capital soundness, the business concerns keep less profit and maintain high cash.

(vii) Avoid Risk:

Avoiding risk is another objective of the modem business for which the firms have to restrict the profit. Risk element is high under profit maximisation. Managerial decision involving the setting up of a new venture has to face a number of uncertainties. Very often experienced manage­ments avoid the possibility of such risks. When there is oligopolistic uncertainty, firms may focus attention at minimising losses. The guiding principle of business economics is not maximisation of profit but the avoidance of loss.

1. Alternative Profit Policies:

Economists have suggested different profit policies which business firms may adopt as an alter­native to profit maximisation.

These alternative profit policies are listed below:

Prof. K. Rothschild observes, “Profit maximisation has until now served as the wonderful mar­ket key that opened all doors leading to an understanding of the behaviour of the entrepreneur. It was always realised that family pride, moral and ethical considerations, poor intelligences and similar factors may modify the results built on the maximum profit assumption, but it was right by assuming that these disturbing phenomena are sufficiently exceptional to justify their exclusion from the main body of price theory. But there is another motive which cannot be so lightly dismissed and which is probably a similar order of magnitude as the desire for maximum profits, namely the desire for secure profits”. He has suggested that the primary motive of an enterprise is long run survival.

According to him, the assump­tion of profit maximisation is no doubt valid to the situation of perfect competition or monopolistic competition. Under monopolistic condition, the aim of the firm is to secure monopoly profits. In the case of oligopoly, he says that the assumption of profit maximisation is not sufficient.

W.J. Baumol puts forth the maximisation of sales as the ultimate aim of the firm. He says while maximising sales the producer will not regard costs incurred as output and profits to be made. If the sales of the company increase, it means that the producer is not only covering costs but also making a usual rate of return on investment. Baumol’s theory of sales maximisation as a rational behaviour of the producer is considered as an alternative to the theory of profit maximisation.

Benjamin Higgins, Mekin Reder and Tibor Scitovsky have developed another alternative to the theory of profit maximisation, that of utility maximisation, if the producer is supposed to maximise his satisfaction. In this approach, they have introduced leisure as a variable. Leisure is an essential ingredi­ent of an individual welfare. If more work is put in by the producer, the less leisure he will be able to enjoy. It is said that the producer would get maximum satisfaction where his net profit is optimum.

Donaldson and Lorsch are of the opinion that career managers prefer policies that favour long term stability and growth of their firms which are possible only when they get maximum current profits. For the survival, self sufficiency and success, the top managers strive hard and augment corporate wealth. The more the wealth, the greater the assurance of the means of survival.

1. Aims of Profit Policy:

The firm seeks to achieve many objectives and profit making is the main objective but it is not the only objective. Profit making is no doubt necessary. In addition to adequate profit, the firm often pursues multiple and even contradictory objectives. If a firm makes sufficient profits, it can give good dividends and attractive salaries, etc. The firm can fix a target rate for profits as its investment. There is a problem in determining the target rate of profits.

They are:

(i) Competitive rate of profit

(ii) Historical profit rate

(iii) Rate of profit sufficient enough to protect the equity, and

(iv) Plough back of profit rate.

Competitive rate of profit is the rate earned by other companies in the same industry or of selected companies in other industries working under similar conditions. It may be slightly different from the rate of profit of other companies.

Historical rate of profit is the rate of profit determined as the basis of past earnings in the normal times. The rates should be sufficient enough to attract equity capital, have provided adequate dividend to shareholders and have not encouraged much competition.

Rate of profit sufficient enough to protect the equity is the rate sufficient enough to attract equity capital and the rate of return on investment should protect the interest of present shareholders. Plough back of profit late is that late of profit Which should be such that there is a surplus after paying the dividends to finance further growth of the industry. Cyert and March have focused on five aims which represent main operative organisational goals.

They are:

(i) Production goal

(ii) Inventory goal

(iii) Sales goal

(iv) Marketing share goal and

(v) Profit goal

Production Goal:

The firms want to maintain the production of the product at a stable level to ensure stable employment and growth. The basic requirement is that the production does not fluctuate.

Inventory Goal:

To ensure a complete and convenient stock of inventory throughout the pro­duction, a minimum level of inventory has to be maintained so that the firm can prevent fluctuations in prices.

Sales Goal:

It is considered as very important from the point of view of stability and survival of the firm. Increasing sales mean progress of the firm. Sales strengthen the organisation. The more are the sales, the more is the profit.

Market Share Goal:

Company sales do not reveal how well the company is performing. If the company’s market share goes up, the company is gaining as a competitor, if it goes down the company is losing relative to competitors.

Profit Goal:

Profits are a function of the chosen price, advertising and sales promotion budgets. Normal profit is essential not only to pay dividends but also to ensure additional resources for reinvest­ment.