Modern Oligopolistic firms typically seek to maximize their sales subject to minimum profit constraints.
| Boumol’s theory of sales maximization is an alternative theory of firm’s behavior. The basic premise of this theory is that sales maximization, rather than profit maximization, is the plausible goal of the firm. As pointed by him, there is no reason to believe that all firms seek to maximize their profits. |
Business firms pursue a number of incompatible objectives and it is not easy to single out one as the most common objective pursued by the firms. His observation shows that more managers seek to maximize sales revenue rather than profits. He argues that in modern business management is separated from ownership, and managers enjoy the discretion to pursue goals other than profit maximization. According to Boumol, business managers pursue the goal of sales maximization for the following reasons:
Under sales maximizing objective, output is greater and price is lower under the objective of profit maximization. Hence, Boumol has described two types of equilibrium under sales maximization objective which are;
- Financial institutions consider sales as an index of performance of the firm and willing to finance to the firm with growing sales.
- Profit figures are available only annually, sales figures can be obtained easily and more frequently to assess the performance of the management. Maximization of sales is more satisfying for the managers than the maximization of profits which go to the pockets of the shareholders.
- Salaries and slack earnings of the top managers linked more closely to sales than to profit.
- The routine personal problems are more easily handled with growing sales. Higher payments may be offered to employees. Sales figure indicate better performance. Profits are generally known after a year.
- If profit maximization is the goal and it rises in one period to an unusually high level, this becomes the standard profit target for the shareholders which managers find very difficult to maintain in the long-run.
- Sales growing more than proportionately to market expansion indicate growing market share and a greater competitive strength and bargaining power of a firm in a collective oligopoly.
- Without profit constraint to sales maximization, &
- There is profit constraint to sales maximization
In the figure, total profit curve (TP) measures the vertical distance between the total revenue and that cost at various levels of output. At first, total profit rises and after a profit falls downwards.
If the firm is a profit maximizer, it would produce the level of output OA. However, in Boumol’s model, the firm is sales maximizer, but it must also earn a minimum level of profit. The acceptable level of profit is OM. The firm will produce the level of output OB which maximizes its sales revenue. The firm earns profit BE, which is less than the maximum attainable profit AH. At this point, output OB total revenue is BR1. The figure shows that sales or total revenue maximizing output OB is larger than profit maximizing output OA.
The firm aims at sales maximization subject to a profit constraint as Boumol contended. If OM is the minimum total profit, which firm wants, then ML is the minimum profit line. This minimum profit line ML cuts TP curve at point E. There, the firm produces and sells OB output.
At output OB, the firm will have total revenue equal to BR1, which has less maximum possible total revenue of CR2. It should be noted that the firm can earn minimum profit ON even by producing ON output. But total revenue at output OH is much less than at output OB. In summary, two types of equilibrium appear to be possible. One in which the constraint provides no effective barrier to sales maximization. The firm is assumed to be able to pursue an independent price policy that is to set its price so as to achieve its goal of sales maximization (given the profit constraint) without being concerned about the reactions of competitors.
A profit maximizer produces the output OB defined by the equilibrium
If the firm is a profit maximizer, it would produce the level of output OA. However, in Boumol’s model, the firm is sales maximizer, but it must also earn a minimum level of profit. The acceptable level of profit is OM. The firm will produce the level of output OB which maximizes its sales revenue. The firm earns profit BE, which is less than the maximum attainable profit AH. At this point, output OB total revenue is BR1. The figure shows that sales or total revenue maximizing output OB is larger than profit maximizing output OA.
The firm aims at sales maximization subject to a profit constraint as Boumol contended. If OM is the minimum total profit, which firm wants, then ML is the minimum profit line. This minimum profit line ML cuts TP curve at point E. There, the firm produces and sells OB output.
At output OB, the firm will have total revenue equal to BR1, which has less maximum possible total revenue of CR2. It should be noted that the firm can earn minimum profit ON even by producing ON output. But total revenue at output OH is much less than at output OB. In summary, two types of equilibrium appear to be possible. One in which the constraint provides no effective barrier to sales maximization. The firm is assumed to be able to pursue an independent price policy that is to set its price so as to achieve its goal of sales maximization (given the profit constraint) without being concerned about the reactions of competitors.
A profit maximizer produces the output OB defined by the equilibrium
The sales maximize sells at a price lower than profit maximize. The price at any level of output is the slope of the line through the origin to the relevant point of the total revenue curve (corresponding to the particular level of output).
Criticisms of Boumol's Theory of Sales Maximization
This model is not also free from certain weaknesses as below:
- As pointed by Boumol, sales maximize will in general produce and advertise more than a profit maximize, which is invalid. Hawkins comments that a sales-maximizer may choose a higher, lower or identical output and a higher, lower or advertising budget. It depends on the responsiveness of demand to advertising rather than price cuts.
- In case of multi-products, Baumol has argued that revenue and profit maximization yield the same results. But Williamson has shown that sales maximization yields different results from profit maximization.
- This model fails to explain observed market situations in which price are kept for considerable time periods in the range of inelastic demand.
- This model ignores the interdependence of the price of oligopolistic firms.
- It ignores not only actual competition, but also the threat of potential competition from rival oligopolistic firms.
- This model does not show how equilibrium in an industry in which all firms are sales maximizers, will be attained. Baumol does not establish the relationship between the firms and industry.
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