Profit Maximization in an Organisation - Essay Example

Organizations must respond to multiple stakeholders if they have to survive and prosper. While s, owners, employers and suppliers are the primary stakeholders, the company has to fight competition. Any organization has to constantly look ahead, build on their strengths and reach for new goals. Profit is one of the core values of the company. Very few organizations identify profits as their mission although every corporation wants to maximize profits. Profit has been defined as the metaphorical equivalent of oxygen, food and water that the body requires (Gregory, Lumpkin & Taylor, 2005). They are not the point of life but without them there is no life. This paper will prove that the maximization of profit is a common objective in most organizations. The primary goal of financial management is to determine where to make investments, how to finance them and how to manage the existing resources in a way that will accomplish the given financial objectives (AEC, n.d.). The strategic management process helps in mission development, objective formulation, SWOT analysis, strategy development, strategy implementation and performance evaluation. Before developing the strategy, the manager needs to understand the strengths and weaknesses of the firm. The opportunities and threats posed by the micro and macro environment have to be considered. The firma can then take corrective steps and better position itself. Financial management plays a key role in the entire process. Figure 1 demonstrates the SWOT analysis: Source: AEC, Chapter 1 The management goal of any firm is to maximize profit for the firm and the profit is the difference between the value of the goods and services produced and the cost of resources used in their production. Profit thus equals to total revenue minus total cost. Profit today is viewed in much deeper sense and is not limited to cash surplus. Globalization and internationalization has caused fluctuations in currency and the value differs from time to time. Hence profit is related to time-value of money (TMV) concept. Maximizing the value of the firm is the same as maximizing the value of all the future cash generated by the firm. Wilson (2004) adds that “profit” is sometimes elaborated as “maximize profitability” or in the modern language “create shareowner value”. Today profit is the key motivator for any organization to seek out new ventures. Profit provides the means for investment in research, new product development, plant expansion. Profit is the measure of the corporation’s success or failure in performing its social role of meeting economic needs. Thus to attain profits, firms need to take strategic decisions. All strategies aim to create and sustain competitive advantage. Porter does not explicitly discuss the objectives of the firm but he assumes it to be the maximization of long-term return on investments. Competitive advantage can be attained by lowering the cost or by creating more value for the customer (Sorensen, 1996). Porter’s generic strategies for low-cost, differentiation, focus, and combination strategies are generally accepted by organizations (Allen & Helms, 2006). According to Porter, an effective competitive strategy provides the firm the industry niche and it learns about its customers. An organization can choose any of the three and focus on maximizing profits. Some authors suggest that a combination of the three factors may give the company best chance to attain competitive advantage. Source: Miler & Dess, 1993 The choice of generic decisions drives other strategic decisions and it integrates all the strategic decision into a coherent whole thereby creating internal consistency among decisions (Tang & Thomas, 1994). Thus to fully exploit the concept of generic strategy it is necessary to determine the context in which a certain generic strategy can maximize a firm’s market value. The profit potential and the strategy of the firms is determined by five forces, commonly known as Porter’s five forces model (Sorensen, 1996): Source: Sorensen, 1996 To use the five forces model the specific value chain has to be analyzed. According to Porter, ‘every firm is a collection of activities that are performed to design, produce, market, deliver and support its product. All these activities can be represented using a value chain’. The porter’s model of value chain (Table I) describes generic activities undertaken by the firm to procure, transform and add value to the products and services delivered to the customer. These activities can be primary or support activities where the primary activities are concerned with the transformation of the input into output as services or after sales service. Support activities include procurement, HRM, technology and infrastructure. Table I Source: Hales & Barker, 2003 A firm’s value chain reflects its history, strategy, the approach to implementing the strategy and the economics of the activities themselves. In this traditional value chain each activity is an independent process and each activity sequentially adds value to the final outcome. Creating a value chain is with the objective to create a process or product that will lead to profits. Thus value chain analysis studies each link of the chain to ensure that economic value is added to it. According to Porter, adding value is a strategic means to maximize profit and competitive advantage. Traditionally different business functions perceived and created value differently but with Porter’s model each activity can be analyzed individually or collectively to asses their contribution to the enterprise. An analysis helps to eliminate the inefficient processes and add value. Ryanair entered the market as pioneers in the budget airline industry and adopted a classical airline business model focusing on customer service. They were distinctive as they offered air route for the Irish immigrants working in England whose status was elevated from ferrying across to air travel (Bhagavan Ertekin, Geijerman & Kuznetsov, 2003). Their strategy was not just to divert other airlines’ passengers to them but to convert passengers of other modes of service to air travel. This required low prices to sustain competition, which in turn meant offering no frills, introduced direct sales, increased the number of seats and reduced staff. They adopted the cost-leadership according to Porter’s generic strategies. Ryanair uses online booking and ticketing system to lower brokerage fees and ticketing costs (O’Toole, 2003). E-relationships help to automate the service functions. This automation helps in cost reduction and increasing reliability of services. All these efforts by Ryanair were only to maximize profits although they tried to lay stress on efficient delivery of services. Another strategic direction has been shown by Ansoff. Tang and Thomas further elaborate Ansoff’s four components of strategy, the cost leadership strategy generally determines the product-market scope (mass market), competitive advantages (cost), growth vector (market penetration), and synergy (production technology). This strategy is used by marketers who have objectives for growth. The firm can adopt any of the four strategies – market penetration, product development (as Pizza Hut has done by adding salads to the main menu), market development (like McDonald’s) or unrelated diversification strategy (Bourgeis, n.d.). Ansoff determined that there must be a relationship between present and future market products. Market penetration can be determined either through straight expansion or takeover of existing products. Straight expansion would involve increasing advertising budgets, expanding production or enlarging the size of the purchases (Pecotich & Purdie, 2003). Takeover strategies involve acquiring competitors known as horizontal acquisition. Any strategy is designed to transform the firm from the present position to the position described by the objectives. The components of the strategy include defining the objectives and the strategy itself. The strategy includes the growth vector matrix which determines the direction in which the firm is heading (Cipher, n.d.). This would enable outsiders to see where the firm is going and allow guidance. Growth is always determined in terms of profits. Mainland China has modified its foreign direct investment (FDI) policies to attract foreign investment in the country. Having multinationals invest in China leads to development of the economy and technology transfer. A motivation for FDI is the lower production costs through the utilization of low cost factors of production in the country (Chen, 1996). FDI is hence an attempt by profit-maximizing firms to lower their cost of production. Foreign investors prefer to invest in high productivity regions. They also like to take advantage of mineral and energy resource abundance even though its efficiency level may be low. Firms analyze through the growth matrix and decide whether to takeover an existing firm in China or indulge in market penetration. Air China carried out a SWOT analysis when it wanted to expand. It tried to build a strategy on genuine understanding of the customers’ true needs (Ahmed, Zairi & Almarri, 2006). It identified the key customer satisfaction areas and used this as a foundation to develop strategies and innovations. All efforts are for optimum utilization of resources for efficient service delivery, the ultimate motive is maximizing profits for the airline. Cornell-Morgan (2004) cites three models of Richard Caves which explains why firms expand to become MNCs. In horizontal integration they produce the same goods in international markets as they do in domestic market. Vertical integration occurs if a company manufactures some parts of the computer monitor in South Korea and the final assembly takes place in Mexico. There are also companies with diversified foreign investments that produce entirely unrelated and different products in different countries. The reasons for expansion in each may be different but in all three cases the primary goal is to maximize profits. The mode of invest may differ and they try to impress that low wages is not the only consideration but the according to Cornell-Morgan decisions are based primarily on the expected marginal profit that can be obtained. Again, to maximize profits an MNC may be forced to invest in local production facilities if exports from its home country are restricted. Since Japan has unofficial barriers preventing foreigners from competing locally, the inward FDI is low. The mission to maximize profits becomes such a primary concern that companies even compromise on human safety and resort to unethical working conditions. Union Carbide in Bhopal highlights the difficulty of controlling global corporations when there is an over-riding desire to reduce costs and maximize profits (Kakabadse & Kakabadse, 2003). Locational determinants affect how corporate facilities are spread through out the world. Nike, based in Oregon has more than 22,000 employees and over 800 contract suppliers in more than 52 countries across the world. While it always endeavoured to deliver high-quality goods at affordable costs, it pays extremely low wages and stresses on anti-union efforts throughout Indonesia, China and Vietnam were reported (O’Rourke, 1997). Nike focuses on countries where wages are low and derives economies of scale to maximize profits. Wal-Mart is another example which cuts corners both with vendors and employees to maximize profits. Wal-Mart also adopted the cost-leadership approach according to Porter’s generic strategy. Wal-Mart has 3,400 stores in the US and is largest employer in US second only to the Federal Government. It is sheer size, growth and profitability of Wal-Mart that it is in a position to define corporate trends (Bianchi & Swinney, 2004). Wal-Mart squeezes profits at each point in its supply chain and uses these to negotiate deals with the vendors. Wal-Mart keeps a tight rein on finances right from the beginning and its managers too know that they were working on low margins. Because of bulk purchases they are in a position to dictate terms to the suppliers. They pick up goods from countries with low-cost labour. Wal-Mart serves as a vast pipe-line that gives non-US companies direct access to the American market. According to Paul Krugman, the Princeton University economist, "Wal-Mart is so big and so centralized that it can all at once hook Chinese and other suppliers into its digital system” (Fishman, 2003). Employee wages at Wal-Mart are as much as 31% lower than competitors (Nester, 2006). Wal-Mart employs immigrant workers so labour is cheap. It pays practically no benefits and very often employees have to work overtime without any additional compensation. It discriminates employees based on gender and disabilities. It pays a wage on which people cannot survive but the bottom line is that by cost-leadership approach they have been able to introduce innovative technology in its procurement and selling process and thereby maximize profits. In multi-period facilities location problem (MFLP) profit maximization is the objective when selecting a location (Canel & Das, 1999). The manager has to set a set of locations from a number of potential location sites for opening facilities. Profit maximization becomes important when prices and costs in various demand centres are dissimilar, which implies that profits can vary depending upon where a facility is located. The logistics manager conducts sensitivity analysis and uses variations in pricing, demand, transportation costs, production costs, or incorporate trends and seasonality into the problem formulation. Inventories are also integrated into the formulation and the purpose of the entire exercise is to maximize profits. The last 15 years in US has been a scene of layoffs, downsizing, urge for reengineering and eventually outsourcing. Salaries being the largest expenditures for any organization, these were the first to be cut. Just when layoffs and ‘pay-for-performance’ was taking place, educated and eager workforce emerged in countries like India, China, Malaysia and Vietnam (Johnson, 1999). These led to outsourcing of business processes from US to the developing nations. Based on the transactional theory, cost has been a major driver for outsourcing business processes. According to NASSCOM, American banking, financial services and insurance (BFSI) companies have saved $6 billion in the last four years by offshoring to India (Bandi & Srinivasan, 2005). This has resulted in quality and productivity gains of 15-20% and customer satisfaction of almost 85%. Apart from this, The McKinsey Global Institute estimates cost savings on factor costs up to 45-50% and 30-40% savings on task and process level improvements. Overall outsourcing to India has led to savings of 25-60%. Thus we see that even in outsourcing profit maximization is the common objective. Thus, a study of the various strategies suggested by various researchers and authors suggests that the ultimate mission of the firm is maximization of profits. While different names may be given to it, the common objective is increasing the shareowner value of the firm. Some firms may use the growth matrix and involve product development but ultimately the objective is to maximize profits by adding value to the existing product. Selecting locations based on costs like low wages, is also a strategy of cost-leadership as per Porter’s generic model. Product differentiation is used when high price can be charged and locational advantage also benefits the firm. The idea of undertaking the SWOT analysis is also with a view to take a strategic decision about investments, product development, marketing strategies but all these strategies are with a view to maximize profits. Even the purpose of outsourcing despite political barriers was to reduce costs and leverage the economies of scale without compromising on customer services. Mode of investment may differ across products, nation and industries but the maximisation of profits remains the common objective with most firms. 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