| In economic theories, it is assumed that maximizing profits is the basic objective of every firm. The volume of profit is regarded as the primary measure of the success of a business. But in recent days, it has been realized that many firms, particularly big one do not operate on the principle of profit maximization in terms of marginal costs and revenues. Instead, the firms set standards or targets of reasonable profits. |
This is because of so many reasons. The firms may limit profit or aim at only reasonable profits due to following reasons:
- Discourage potential competitors: When a firm earns large profit under profit maximizing objective. It is likely to attract potential competitors to enter the field and capture the market share enjoyed by it. They adopt the practices such as infringement of patent rights, copying of product designs, encroachment upon the firm’s sources of raw materials, etc. To discourage such tendency, a firm may adopt the policy of limiting profits rather than maximization. The danger of potential competition is more serious when the firm enjoys a weak monopoly situation. However, there is no guarantee that limiting profits may prevent potential competition.
- Project a favorable image to the public and government: The earning of high profits shows the enjoying of monopoly power. It may create an impression that the firm is exploiting the consumers. Hence, the public may appeal the government for nationalization of the firm or to exercise some sort of regulation of prices, profits and dividends. Therefore, the firms may aim at only reasonable profit. Restraining demand for wage hike. When there is high profit the labors may demand higher wages. This is particularly true in the industries having strong trade unions. Hence, such industries may not like to maximize profits. Because, this may lead to wage price spiral.
- Maintaining consumer goodwill: The consumer goodwill is of great importance to the industries. The consumers show their resentment and think that they are being exploited when prices are set too high. The consumers expect a fair price in terms of cost of production. Similarly, if a firm exploits a short-term situation, it may seriously damage its image, reputation and long-run interests. Hence, the profit restraint is adopted to maintain consumer goodwill.
- Keeping internal control: Another reason for restraining profits is management’s desire to maintain control of the firm. The management gives strong preference to liquidity, abhors debt and may not like expansion. Because maximizing profits may require entering new areas of production involving heavy investments and thus, reducing liquidity and losing control.
- Maintaining congenial working conditions: Profit restraint is also adopted to maintain congenial working conditions within a firm. There is growing awareness about the social responsibilities of management. There is increasing concern with the direct effects of management’s decision upon workers, consumers and the business cycle.
- Attainment of industry leadership: If a firm aims at achieving industry leadership, the firm may try for maximum sales or manufacturer of maximum product lines. Hence, profit maximization will not get the priority. The entrepreneur may merely seek to earn a satisfactory profit level so as to maintain certain share of market or a certain level of sales.
- Avoiding risk: Profit maximization may require setting up new ventures, which may have number of uncertainties. The project appeared profitable at the outset may turn out to be unprofitable.
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