Sales Maximization

William J. Boumol (Economic Theory and operations Analysis, 1970) has postulated maximization of sales revenue model as an alternative to profit maximization objective. The separation of ownership from management, characteristic of the modern firm, gives discretion to the managers to pursue goals which maximize their own utility and deviate from profit maximization, which is the desirable goal of owners. Given this discretion, Baumol argues that sales maximization seems the most plausible goal of managers. From his experience as a consultant to large firms, he found that manager’s are preoccupied with maximization of the sales rather than profits. The reasons which explain the pursuance of this attitude of the top management are following.
? There is evidence that salaries and other slack (payments above minimum necessary) earnings of top managers are correlated more closely with sales than with profits.
? The banks and other financial institutions keeps a close eye on the sales of firms and are more willing to finance firms with large and growing sales.
? Personnel problems can be handled more satisfactorily when sales are growing. Generally there is positive relations growing sales, higher earnings and better terms of work there of.
? Larger sales, growing over time, give prestige to the manager’s, while large profits go into the pockets of share-holders.
? Managers find profit maximization a difficult objective to fulfill consistently over time and at the same level. Profits may fluctuate with changing conditions.
? Large, growing sales strengthen the power to adopt competitive tactics, while a low or declining share of the market weakens the competitive position of the firm and its bargaining power vis-a-vis its rivals.
Baumol’s Static Models: The basic assumptions of the static model are as follows:
? The time-horizon of a firm is a single period.
? During these period the firm attempts to maximize its total sales revenue (not physical volume of output) subject to a profit constraint.
? The minimum profit constraint is exogenously determined by the demands and expectations of the shareholders, the banks and other financial institutions.
? ‘Conventional’ cost and revenue functions are assumed. That is, Baumol accepts that cost curves are U-shaped and the demand curve of the firm is of downward sloping.
A Single Product Model, without Advertising
The total revenue and total cost curves under the above assumptions are shown is figure 1.3 below. Total sales revenue is at its maximum level at the highest point of the TR curve, where the price elasticity of demand is unity the slope of this TR.
If the firm is a profit maximize, it would produce OXpm level of output (See figure 1.1). However, as it stands this argument is incomplete. Baumol argued that there is some minimum level of profit, a profit constraints, which must be earned. This level is determined by a firm’s desire to keep its dividends and share prices sufficiently high to keep existing shareholder’s desire and to enable it to raise new capital at a future date.
The prediction is contrary to the traditional hypothesis of p maximization. A p maximizer will not change his equilibrium position is the short-run, since fixed costs do not enter into the determination of the equilibrium of the firm. So long as the fixed costs do not vary with the level of output (provided that the increase in TFC does not lead the firm to close down altogether) the change in the TFC will not lead the profit maximize to change his price and output in the short-run.
Baumol claims that firms in the real world do in fact change their output and price whenever their overhead costs increase. Thus, he says that the sales maximization hypothesis has a better predictive performance than the traditional profit maximization hypothesis.
The imposition of a lump-sum tax will have similar type of effects which is shown in fig 1.6 that the imposition of specific tax will shift the profit curve downwards from p to p1 (fig. 1.6). Given profit constraint line p, the sales maximizer will reduce his output from Xs to X1s and will raise his price, passing the tax to the buyers. The profit maximize will also reduce his output from Xp to Xp and raise his price. However, the decrease in output of sales maximize will larger than the decrease of the output of a profit maximize.