Profit Maximization Strategies For Managers
The main objective, and indeed, the primary motivation of a business come from the need to make profits. This is true, of course, unless one is running a non-profit organization. In which case, the company must still make some profit, and it could be in terms of the social health of the society they are serving. This means no matter what, every business must have a goal, which upon achieving, the organization can count a profit.
A profit calculated as what remains after expenses and cost of production has been deducted from the overall income. Expenses, in this case, include taxes. For the case of a non-profit organization, they don’t pay taxes, and they don’t make monetary profits, but their success is seen through the results of their input. If, for instance, an organization is created to feed a starving community, they profit when the community receives all the necessary items for survival. Their focus is not on gaining monetary value but in creating a more conducive environment for human existence.
Whatever the case, the organization has to reap maximum benefits. And many factors determine how a company reaches these objectives. For a start, it will depend on the size of the company, the industry, the profit margin, and the volume of sales, factors that vary from business to business. Business owners and managers, regardless of their individual situations, share the desire to utilize the available resources with optimum efficiency. They all strive to improve their business’ performance. And for this to happen, there are two important competing methods: profit maximization and revenue maximization.
Profit maximizers include strategies that companies following to build more net income as much as possible utilizing the resources and market share currently available. In other words, the company will use every weapon in their arsenal to reap as many profits as possible from an investment. To many, it is the goal of every company to make profits. It is logical. However, if a company focuses only on profit maximization, chances are they will lose on the opportunities that don’t offer and immediate financial gain. They may, for instance, fail to establish a good relationship with consumers, which is critical for long-term benefits.
Revenue maximization is where a company may put its primary focus on maximizing their revenues. Such companies do not care much about the current profit margin from their sales. Instead, they focus more on controlling market share. This is a behavior, for instance, of a company entering a new market and is trying to market a new product before focusing on sales. This is a good strategy for large and competitive markets where consumers are highly sensitive to prices. Companies that use this strategy mostly focus on long-term profits from the business. Chances are they will not be making any profits currently, but they know sooner or later ways will open.
What is profit maximization?
In economics, every company, small or large, seeks to make a profit. They will do everything possible to ensure there is proper market capitalization, and the available resources are being utilized in the desired manner. In this case, profit maximization can be defined in terms of short-run or long-run processes through which a firm sets its price, input, and output levels that bring in the highest profits. And mainstream view normal theorizes the firm as profit maximization.
Understanding profit maximization may not be as straightforward as you may have imagined. It is a subject that takes different forms with a number of perspectives. And this is why there are many approaches that one can use to determine this issue. For instance, considering that profit is equal to revenue less cost, you can draw a graph, where revenue and cost variable stand as the extent of output than produces a maximum difference.
Or, taking that there are known specific functional forms for the output of revenue and cost, one can apply calculus to bring out maximum profits based on how far the output goes. The third approach includes using equations of marginal revenue and marginal cost; in which case, the first order for maximization is equal to the two variables, if marginal revenue and minimal costs are available as functions where output is involved.
Another method would include the firm having input cost functions to determine the price of getting any amount of outputs, as opposed to a function allocation production for each possible output level. In this case, the function works hand in hand with production functions, and the reveal the output results are a combination of the output process. Here, a person can maximize profit in relation to input using calculus. The input cost and production functions are used to determine the outcome.
We have already seen how profit maximizers differ from revenue maximizers in the previous section. If a firm operates in a greatly competitive market, its revenue will be equal to its market price multiplied by the number of products made and sold. But in the case of a monopolist market, the level of output is calculated simultaneously with the selling price. In this case, the revenue function considers that high output levels demand reduced prices for consumers to get the products.
What are the perspectives of profit maximization?
The cost of any firm can be classified as a fixed cost and variable costs. Fixed costs occur only in the short-term and are what the business spends at am level of output, even at zero. They include things like maintenance of equipment, rent, and employee wages. They include figures that cannot be increased or decreased without proper channels. Variable costs, on the other hand, change as the output changes. They include things like materials used during production. Consider, for instance, wages paid to outsourced employees who are hired and laid-off in a short time. Fixed cost plus the variable cost is equal to the total cost.
Revenue is the money that comes from normal business operations. It normally comes from the sale of goods and services. Every shilling that comes in becomes revenue. Marginal costs and marginal revenue can be defined in terms of change in cost or revenue. But this depends on whether one uses the calculus method or not.
Following this definition, maximizing profits can be looked at from different perspectives;
- Total revenue – total cost approach.
One must start by identifying that profit is equal to total revenue less total cost to get out the quantity for profit maximization. There should be a table of costs and revenues at each quantity. Using these, one can either calculate equations or draw a graph using the data directly. You get the profit-maximizing output where this difference is maximum.
- Marginal revenue vs. marginal cost.
This is a perspective that relies on the fact that marginal profit is equal to the marginal revenue less marginal cost for each unit sold. Marginal benefits are positive, where marginal revenue is above marginal cost. Such a situation will call for an increase in production. And the opposite causes a negative marginal cost, hence, less input in production. Maximized profit is zero, where the level of output is the same as the marginal cost.
How can a firm increase profits?
Cracking the profitability codes is one of the hardest things a company has to do. However, they must do it because that is the main objective of opening the firm. Hence, when it comes to increasing profits, there are things, including universal laws of profitability and the peculiar element a company must look at. We can put them into two simple options:
1. Sell more to increase revenue
Increasing revenue is the most basic way to see better profits. And there are several ways to do this. For instance, one can increase the number of sales. They can invest more in marketing the product and or improving its quality, with a focus on where more money is coming from. Second. A company can up-sell to existing customers. The firm can, for example, convince them to but improved products and services. Another way is by diversifying their sales into a wider range of products. A firm can opt to manufacture many different products so that it seems they have invested in different areas. Also, revising pricing to achieve balance is another great way of getting more revenues. But this should be according to the current market situation.
2. Cut costs
There are also several ways a company can use to cut costs. When you want to maximize profits, consider the following suggestion:
Have a system of analyzing where the money is being spent more. For instance, overheads are among the highest costs for many companies. Things like rental and energy costs may be eating more of the profits. Hence, check out for better deals.
Outsourcing can be another great option. In this case, a firm can find strategic partners who offer outsourcing services on a pay-as-you-go strategy. Such items, like design projects, press releases, and website content, are all things you can assign to freelancing.
Look for suppliers with suppliers, especially when buying in bulk. Apart from this, consider making more efficient processes. A good example would be to break down each task and set up a production line system. With an improved busing process, you can cut costs by a great margin.
Another approach would be to buy your own equipment. If you are using leased equipment, chances are you are spending more than you would need to, and that means you will not acquire maximum profits. Have an assessment of your cost structure, which offers a long-term solution. Here, you can:
- Review your cost structure.
Ensure the markup price on your goods is sufficient. In cases where the raw materials cost high, increase the related cost in the selling price. A regular cost structure review helps you keep track of expenses that come before things become overwhelming.
- Research from others.
You don’t have to look directly at competitors. Apart from such, you can also look at what is working for other companies. There is nothing wrong with having a similar business module as another company. Besides, you can take these ideas and transform them into your best methods.
- Improve your online presence.
The internet has become a critical tool for companies today. Hence, one must ensure people about their company across markets. A good website and an excellent social profile can do this for you.
Profit maximization simply means the level where a company reaches an equilibrium output for the best profits. It is, therefore, crucial for a business to work its profit maximization strategies.
What are the benefits and drawbacks of profit maximization?
Profit maximization comes with several benefits as well as drawbacks. Consider the following:
- Maximizing profits is equal to economic existence. The main aim of starting a business is economic power. Profit maximization theory is founded on profit, which is a must for any company to exist economically.
- Profits determine the standard output of any firm. If a company fails to meet its main target risking its existence, such may be a result of its inability to make a profit.
- For the economic and social well-being of the business. Profit maximization has a role to play in economic and social being. When a business makes profits, it reduces the burden of costs by paying for capital, fixed assets, labor, and other things that need settling.
There are also drawbacks to business maximization that one must be aware of. Consider the following:
- Vague profit concept. People have different ideas about profits. For instance, some call it EPS, EPS, gross profit, net profit, profit ration, e.t.c. Looking at this, we can say no defined rule defines profit maximization.
- Profit maximization does not consider the risk. In most cases, business decisions on profit maximization models ignore the risk factor. If a business fails to handle high risks, it’s survival will be very hard.
Most businesses exist because they make profits. If there are profits, a company can afford to pay for costs and have something for expansion. As such, they tap into profit-maximization models to get the best from their input. It is all about a business assuring its survival in the market.
Author: James Hamilton