Historically, profit maximization has been given quite a lot of importance as the main objective of any business. But, in a practical scenario, revenue maximization holds true. Profit maximization as an objective has a number of limitations. Revenue maximization passes all those tests to become a rational objective for any business.
Revenue maximization or profit maximization, what to choose as a strategy to managing the business? It has been a difficult situation for managers in any for-profit business. Managers need to keep all the stakeholders satisfied. Shareholders want appreciation in the value of their capital and regular dividends which calls for profit maximization. On the other hand, everything is driven by sales including the profits and performance of managers which calls for revenue maximization or sales maximization.
It is a fact that profits are the lifeblood of any business but at the same time, profits are a byproduct of revenues. There seems a strong and direct link between revenue and profits. The differences begin with the introduction of price and output.
It is because all levels of output cannot be achieved at a fixed price. So, the correlation between profits and revenues may not show direct relation because higher sales or revenue with lower product prices will result in dip in profits. Here, an increase in sales is not leading to increasing in profits.
It is completely agreed that profits are the final goals to be achieved by the business or the managers as they can satisfy all of the stakeholders. Major stakeholders include the capital provider i.e. the shareholders. But the limitation is that profits are not a physical activity which can be conducted. Profits are derived from other activity like selling and producing. Practically, a manager can focus on revenue maximization rather than profit maximization. Let us understand the reasons for details.
Limitations of Profit Maximization
Why Revenue (Sales) Maximization and not Profit maximization? First of all, profit maximization is not a physical activity which can be performed. The other activities which can possibly and practically be performed are selling and production of the product. Production is under the control and can be influenced easily. Managerial efforts are required in generating revenues and therefore revenue maximization can be the strategy to run the business.
Secondly, we know that profits are a function of revenues and costs. Factually, the revenue generation and costs incurrence are not a simultaneous activity. Costs are incurred first to do the production activity and then the selling of the product is initiated. Prices also are not known when the product is being produced. After the cost incurrence which may be considered sunk cost, the only objective left is to maximize the revenues as the cost are no more controllable by the managers.
To further understand the situation, let us take an example. The sales of Air Conditioners (AC) in the market are dependent on the summer season. If it is too hot, the sales would be too high and vice-versa. The decision to produce the AC cannot be taken once the full summer has arrived but it has to be taken at the time of winters on the basis of some assumption and perception of a profitable venture. Profit maximizing objective cannot be pursued because one of the factors (i.e. cost) is not under control anymore and therefore the objective left is of sales maximization.
To add to it, the profit maximization objective is vague. There can be many interpretations of the term. Does it actually mean maximizing profits or minimizing costs? If maximizing profits, in relation to what?
Considering the limitations as discussed the profit maximization as an objective, can we not safely conclude that revenue or sales maximization is a better or obvious choice for the managers.