Firms : Concept & Objectives
By:
Akshat.D.Yadav
What is a firm?
• A “Firm” is an entity & an Input- Output System.
• Firms use different types of factors of production & a technical process to convert
those inputs into the useful products.
• There are following factors which are used by firms during the process grouped as
“Inputs”.
Land Labor Capital enterprise & Organization
• The process of identifying the factors of production, identifying & selecting an
appropriate technology and process & converting these inputs into a desirable
output is done by the enterprise on behalf of firm.
• The person who takes risk & start the business for the entity “Firm” is called
entrepreneur.
Forms of Ownership of “Firm”
• Business Firms can be categorized as follows:
Private Sector:- (wholly owned by individuals or by group of individuals)
Public Sector :- (Owned, managed & controlled by Government)
Joint Sector :- (Owned and managed jointly by individual & Government)
• Private Sector can be of following types:
Private sector
Individual Collective /group
Proprietorship Partnership Company Cooperative
Objectives of a FIRM
• Why do people do Business?
• What motivates individuals or groups to take that big Risk?
• Is “Profit maximization “ the only objective of the firm?
“Profit maximization” had been the sole objective for a long time. Objective of a
firm also took various dimensions with the change in time. Many other objectves
have come out with the time & progress.
• There can be following Objectives of any firm:-
Profit Maximization theory
Baumol ’s Theory of Sales Revenue Maximization.
Marrim’s hypothesis of Maximization of Growth rate.
William’s Model of Marginal utility theory.
Behavioral theories
Profit Maximization Theory
• This is most widely accepted objective of a firm. “ Generation of the largest amount of Absolute profit
over a period of time” is the sole objective of a firm as per this theory.
• According to this theory
” efficiency of a firm is measured in terms of its profit generating capacity”.
“Market value of a firm is largely dependent upon profits earned.
“ Profit is must for long term survival of a firm
“Profit is the only source of Internal Fund”.
• This theory can be represented as : Profit = Total revenue – Total Cost
• Acceptance of this theory raises some important issues e.g
Which measure of profit should be considered?( G.P or N.P or NP before tax)
NP after Tax)
Which time period to be taken into consideration ?
In the present era when market is very competitive, is it possible to calculate &
reach the profit maximization level.?
• It is clear that accepting maximization of profit as the objective, leaves many questions un answered &
give rise to another objective of a FIRM.
Baumol’s Theory Of Sales Revenue Maximization
• Mr. Baumol opined that in a competitive market, Firms aim at maximizing
revenue, through maximization of sales.
• According to him, Sales Volume & not the profit volumes determine market
leadership in competition.
• In large organizations, Management is separate than owners.Hence Owners goals &
managers goals would be different. Manager’s salary & other benefits are generally
linked with Sales Volumes rather than on profit.
• Mr.Baumal formed following hypothesis & tested:-
Managers attach their personal prestige to the company’s Sales. Hence they try
to maximize Sales.
Sales Volumes are better indicators of Firm’s position in market.
Growing sales strengthen the Firm’s competitive spirit.
As manager’s performance is evaluated in terms of achieving sales targets,
Managers are more interested to maximize their sales volumes.
• Hence According to Mr.Baumol , Objective of Firm is to maximize the sales
revenue keeping in view the firm’s Profit constarint i.e (a minimum level of profit
to satisfy the shareholders
Marri’s Maximization Of Growth Rates
• Marri’s theory depends upon two assumptions:
1) Owners aim at profits & market share where as
2) Managers aim at better salary , job security and personal growth.
• These two sets of goals can only be achieved by maximizing the Balanced Growth
of Firm say “G”.
• “G” will depend upon following two components:-
Growth rate of Demand for the Firm’s Products say “GD” &
Growth rate of Capital Supply to the firm say “GC”
• Hence Growth rate of Firm will be balanced only when GD & GC grows at the
same rate.
• Firms face two types of constraints if they keep this as Firm’s Objective.
a) Managerial Constraint:- According to him “ Skills, expertise, efficiency and
sincerity of managers are vital to the firm’s growth. Non availability of these pose
Managerial Constarints
b) Financial Constraints:- Lack of appropriate finance also poses a constraint.These
are generally reflected by 1) Debt-Equity ratio 2) Liquidity ratio & 3) retained profit
ratio.
Williamson’s Marginal utility function objective
• It is a combination of 1) Profit maximization objective & 2) Growth Masximization
objective.
• According to this theory, modern managers have discretionary powers to set the
goals of the firms. They set the goals so as to maximize their own “Utility Function”
within the constraint of minimum profit required to satisfy the stake holders.
• “Utility Function” of manager will depend upon two factors:-
Measurable Factors :- Manager’s Salary
Non- Measurable Factors :- Job security, power, status & professional
satisfaction.
• Following mathematical model represents the objective of utility function:
Um = f( S, M.Id) Um is manager’s utility, S is salary, M is Managerial
emoluments & Id is power of discretionary investment
Id =∏d where Pye D is Diuscretionary profit
Discretionary profit = Actual Profit- Minimum profit-Tax
Therefore it can be said that
Utility function of managers Um= f( S, ∏d ), Change in one will affect the
other. Increase in one will lead to decrease in other.
Behavioral Theories
• These theories propose that Firms aim at Satisfactory behavior rather than
maximization of something. Two most important behavioral theories are :-
Simon’s Satisficing Model :- This model says that modern business faces a big
challenge because of lack of information & uncertain future. Because of this
challenge, maximization of profit, sales or growth is not possible. They operate
under “Bounded Rationality” & can only achieve satisfactory level of profit, sales or
growth.
According to Simon, Manager set an aspiration level & then try to achieve it. If their
performance exceeds the aspiration level, the target is increased and vice versa to
achieve a satisfying level of sales, profit or growth.
Cyert & March Model:- According to this model, Firms need to have Multi Goal
& Multi faced activities.
Apart from dealing with inadequate information & uncertain future, they also
have to satisfy all stakeholders. Stake holders quite often have conflicting goals
hence a firm can not have a single Goal
Principal Agent Problem
• In an organizational set up Owners are Principle & Managers are Agent. Conflict of
interests between the owners and the managers of the Firm is one example of
Principal Agent Problem.
• Agents have generally more information's about the market in which they work.
Difference between two parties in any situation or transaction is termed as “ STATE
OF ASYMETRIC INFORMATION”
• Principle has to depend upon agent because of this asymmetric information
situation.
Let us discuss a caselette on Dabur India Limited….
Likely and Important questions
• Explain Baumol’s sales maximization model of a Firm’s Behavior.How is it different
from Profit maximization model? 2009
• On a critical note which one among the Firm’s theories, do you think is the most
relevant in present business scenario in India?
----------------------------------------The End----------------------------------------------------
