Goals of the Firm (HSC SSCE Economics): Revision Notes
Goals of the Firm
Overview of business objectives
Firms operate with various objectives that reflect the motives of their owners and managers. These objectives guide the day-to-day decisions that businesses make about production, pricing, and expansion. While economists typically assume that all firms aim to maximise profits, in reality businesses may pursue different goals or balance multiple objectives simultaneously.
The key goals that firms may pursue include:
- Maximising profits
- Meeting shareholder expectations
- Increasing market share
- Maximising growth
- Satisficing behaviour across multiple objectives
Understanding these goals is essential for analysing how businesses behave in different market structures and why they make particular strategic choices.
Economic Assumption: While economists typically assume profit maximisation when analysing market structures, this is a simplifying assumption. In practice, firms often balance multiple competing objectives, and understanding these alternative goals is crucial for explaining real-world business behaviour.
Profit maximisation
Profit maximisation is recognised as the main objective of most business firms. This means making the largest possible profit, or if the firm is loss-making, minimising the size of the loss.
Key Definition: Profit Motive
The profit motive refers to the process by which a business seeks to maximise profit by using the lowest-cost combination of resources and charging the highest possible price.
Calculating profit
Profit is calculated using a straightforward formula:
Where:
- Total Revenue = Output sold Price
- Total Costs = All costs of production
Worked Example: Calculating Profit
If a firm sells 1,000 units at $50 each, its total revenue is $50,000.
If total costs are $35,000, then:
Why profit maximisation matters
Economists generally assume that the desire to maximise profits guides the behaviour of all firms when analysing market structures. This assumption simplifies economic models and reflects the fundamental incentive in a market economy. However, it is important to recognise that this is a theoretical assumption – in practice, firms may have other priorities, as discussed in the following sections.
Exam Tip: Unless a question specifically mentions alternative objectives, you should assume firms are profit maximisers when analysing their behaviour.
Meeting shareholder expectations
Company directors who make decisions for business firms have a legal responsibility to serve the interests of shareholders. This is a fundamental principle governing the operation of corporations in Australia and represents the overriding concern of most business managers.
The role of directors
Directors are chosen to represent shareholder interests on company boards. Their primary duty is to make decisions that benefit shareholders, who are the legal owners of the company. This creates a clear accountability structure where managers must justify their decisions in terms of shareholder value.
Short-term versus long-term tensions
A significant challenge arises because shareholders often focus on short-term returns. There can be a conflict between:
- Short-term actions: Decisions that maximise share price and dividends immediately
- Long-term value: Strategies that build the firm's value over time but may reduce short-term returns
The Trade-off Dilemma
A company might cut research and development spending to boost short-term profits and dividends, but this could harm the firm's competitive position in future years. Directors must balance these competing timeframes while fulfilling their legal duty to shareholders.
For example, a company might cut research and development spending to boost short-term profits and dividends, but this could harm the firm's competitive position in future years. Directors must balance these competing timeframes while fulfilling their legal duty to shareholders.
Exam Guidance: When evaluating business decisions, consider both short-term and long-term impacts on shareholder value. Strong answers will analyse this tension explicitly.
Increasing market share
In larger businesses, the entrepreneurial function is typically split between owners (shareholders) and paid managers. This separation can lead to different priorities emerging.
The shareholder-manager divide
- Shareholders take on the risk function by investing their capital. They seek maximum profit as the reward for bearing this risk.
- Paid managers take on the organisational function. They may seek increased salaries, power, and prestige as their rewards.
Why managers prioritise market share
Managers' perceived ability and personal rewards often depend more on increasing sales volume than on maximising profits. A manager who expands the firm's market share may receive:
- Higher salary and bonuses
- Greater power and status
- Better career prospects
- Recognition within the industry
As a result, there may need to be a compromise between profit maximisation (which benefits shareholders) and increasing market share (which benefits managers). This creates a potential agency problem where managers' interests diverge from shareholders' interests.
Practical Example: Manager vs Shareholder Priorities
A manager might accept lower profit margins to win a larger contract, boosting their reputation and the firm's market position, even though shareholders would prefer higher margins on fewer sales.
Maximising growth
Some firms prioritise maximising the rate of growth of their assets rather than immediate profitability. This objective focuses on expanding the firm's size and capacity over time.
The logic of growth maximisation
Managers may pursue growth maximisation because:
- A larger asset base should enable higher profits in the long run
- Growth brings personal rewards such as higher salaries and prestige
- Bigger firms typically offer more career opportunities and influence
- Expansion can create competitive advantages through economies of scale
The risks of growth strategies
However, focusing on rapid growth rather than profitability can lead to serious problems, including business failure. Firms that expand too quickly may:
- Stretch financial resources too thinly
- Fail to adapt to local market conditions
- Sacrifice quality for speed of expansion
- Underestimate competitive challenges
Warning: Growth Without Profit
Prioritising rapid expansion without careful attention to profitability and market conditions can destroy shareholder value, even for globally successful companies. The following case study demonstrates this critical risk.
Case study: Starbucks in Australia – the perils of maximising growth
Case Study: Starbucks in Australia – The Perils of Maximising Growth
Background: Starbucks is the world's largest coffee chain, with over 27,300 stores across 78 countries and revenue exceeding US$24 billion in 2018. After rapid expansion in the United States during the 1980s, the company went international in the 1990s, opening a new store every single workday throughout the decade.
What Went Wrong in Australia:
Starbucks' aggressive growth strategy worked in many countries but failed dramatically in Australia. The company prioritised rapid expansion over market understanding, which led to significant losses. By focusing on growth rather than profitability, Starbucks failed to recognise that:
- Australia's café market was already highly competitive and mature
- Australian consumers were accustomed to higher-quality coffee than the American market
- Small, sophisticated local operators had strong customer loyalty
- Australian coffee culture differed fundamentally from American preferences
The Outcome:
Starbucks had to close most of its Australian stores. By 2016, only 23 stores remained from a peak of 84 in 2008. The Australian franchise was taken over by the Withers Group (owners of 7-Eleven), who relaunched with a strategy focused on tourist areas and large shopping centres rather than widespread expansion. By 2019, this more targeted approach had grown the chain to 49 stores.
Lessons for Goal-Setting:
This case demonstrates that growth maximisation without attention to profitability and market conditions can destroy shareholder value. Successful firms must balance expansion ambitions with realistic market assessment and financial sustainability.
Exam Application: Use this case study when asked to evaluate the risks of different business objectives or to analyse why firms might fail despite apparent success in other markets.
Satisficing behaviour
Key Definition: Satisficing Behaviour
Satisficing behaviour is the idea that firms will attempt to pursue a satisfactory level in all goals (profit maximisation, sales maximisation etc.) rather than maximising any single goal.
Understanding satisficing
Rather than pursuing one objective to its maximum, firms engaging in satisficing aim to achieve adequate performance across multiple areas simultaneously. For example, a firm might seek:
- A satisfactory level of profit (acceptable rate of return for shareholders)
- Adequate market share
- Reasonable growth rates
- Acceptable employee satisfaction
- Sufficient investment in innovation
Why firms satisfice
There are several rational reasons why a firm might adopt satisficing behaviour:
1. Avoiding competitive threats: Excessive profits may attract new competitors into the industry, eroding the firm's market position in the long run. By earning "reasonable" rather than maximum profits, the firm may maintain a more stable competitive environment.
2. Preventing government intervention: Very high profits might provoke government regulation of the industry or investigations into potential market abuse. Satisficing helps firms avoid unwanted regulatory attention.
3. Non-financial objectives: Some business owners prioritise outcomes beyond profit. For example:
- Newspaper proprietors may seek political influence or social prestige
- Family businesses may prioritise job security for employees
- Lifestyle businesses may balance profit against personal quality of life
4. Social enterprises: A small but growing number of businesses operate with goals of positive social or environmental impact. These include:
- Recycling and green energy businesses
- Companies employing people with disabilities
- Businesses supporting recently arrived refugees
- Organisations helping formerly homeless individuals
Social Enterprises and Satisficing
Social enterprises satisfice by balancing financial sustainability with their social mission, rather than maximising profit alone. They demonstrate that businesses can pursue multiple objectives successfully while remaining economically viable.
Satisficing in economic analysis
While profit maximisation may not be the overriding objective of all firms in reality, economists typically assume this when analysing pricing and output policies under different market structures. This simplifying assumption allows for clear theoretical predictions, even though actual business behaviour may be more complex.
Exam Note: Be prepared to discuss both the profit maximisation assumption that economists use and the alternative objectives that firms may actually pursue. Strong evaluation answers will acknowledge this gap between economic theory and business reality.
Remember!
Key Takeaways:
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Profit maximisation is the main goal of most firms and the standard assumption in economic analysis. Profit equals total revenue minus total costs.
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Shareholder expectations create a legal duty for directors to serve shareholder interests, though tensions arise between short-term returns and long-term value creation.
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Market share objectives may take priority for professional managers whose personal rewards depend on sales growth rather than profit maximisation.
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Growth maximisation focuses on expanding the firm's asset base for long-term benefits, but excessive focus on growth without profitability can lead to failure (e.g., Starbucks in Australia).
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Satisficing behaviour means achieving adequate performance across multiple goals rather than maximising any single objective. This approach can help firms avoid competitive threats, government regulation, or achieve non-financial outcomes like social and environmental impact.
Key Formula:
Where: Total Revenue = Output sold Price