Lakhasly

Alternative theories of the firm Problems with traditional theory The traditional profits maximising theories of the firm have been criticised being unrealistic.Such theories fall into two categories: first those theories that assume that firms attempt to maximise some other aim, provided that sufficient profits are achieved f: these are examined in section 14.7); and second, those theories that assume that firms pursue a number of potentially conflicting aims, of which sufficient profit is merely, one 'these theories are examined in section 14.3 Alternative maximising theories Long-run profit maximisation The traditional theory of the firm is based on the assumption of short-run profit maximisation.In an attempt to capture new markets and lead the field in gaming technology innovation, the three main protagonists are locked in battles not only to produce new and improved consoles, but also to develop new and improved consoles, but also to develop online gaming and mobile gaming - two major growth areas.Williamson argued that, provided satisfactory levels of profit are achieved, managers often have the discretion to choose what policies to pursue.Microsoft in particular intends to develop its Xbox live online service, into a 'digital entertainment centre', through which to distribute a range of entertainment content, including films and music.The criticisms are mainly of two parts: (a) that firms wish to maximise profits, but for some reason or other are unable to do so; or (b) that firms have aims other than profit maximisation.Thus the picture of firms making precise calculations of long-run profit-maximising prices and outputs is a false one.It may be useful, however, simply to observe that firms, when making current price, output and investment decisions, try to judge the approximate effect on new entrants, consumer demand, future costs, etc., and try to avoid decisions that would appear to conflict with long-run profits.In search of long-run profits The video games war Traditional economic theory argues that firms will seek to maximise their short-run profits, and therefore adopt a range of strategies to achieve this goal.One way of doing this is to examine managers' expenditure on various items, and in particular on staff on perks (such as a company car and a plush office) and on discretionary investment.Both Microsoft and Sony have invested heavily in developing an online gaming capability.Nokia, the mobile phone manufacturer, entered the market in October 2003 with its Ngage hybrid phone, which has gaming capability.This may be true, but firms could still arrive at maximum profit by trial and error adjustment of price, or by finding the output where TR and TC are furthest apart.Collusion between oligopolists or price leadership would help, but there will still be a considerable area of uncertainty, especially if the firm faces competition from abroad or from other industries.Game theory may help a firm decide its price and output strategy: it may choose to sacrifice the chance of getting the absolute maximum profit (the high-risk, maximum option), and instead go for the safe strategy of getting probably at least reasonable profits (maximin.) But even this assumes that it knows the consequences for its profits of each of the possible reactions of its rivals.The shareholders are the owners and presumably will want the firm to maximise profits so as to increase their dividends and the value of their shares.The greater the level of expenditure by managers On these items, the greater is likely to be their status, power, prestige, professional excellence and job security, and hence utility.Mobile gaming, a gaming niche dominated by Nintendo and its Gameboy, is also facing new competitive pressure.Having identified the factors that influence a manager's utility, Williamson developed several models in which managers seek to maximise their utility.He used these models to predict managerial behaviour under various conditions and argued that they performed better than traditional profit-maximising theory.Difficulties in maximising profit One criticism of traditional theory sometimes put forward is that firms do not use MR and MC concepts.More importantly, firms are unlikely to know precisely (or even approximately) their demand curves and hence their AIR curves.Some of these shifts occur as a result of factors outside the firm's control, such as changes in competitors' prices and products, or changes in technology.Alternative aims An even more fundamental attack on the traditional theory of firm is that firms do not even aim to maximise profits (even if they could).Mangers will still have to ensure that sufficient profits are made to keep shareholders happy, but that may be very different from maximising profits.The market for game consoles is an interesting one, as it appears to have its own cycle that is quite distinct from the broader economic cycle of the economy.It also increases the player's average age: according to the interactive digital software association, the average American gamer is 28.Managerial utility maximisation One of the most influential of the alternative theories of the firm has been that developed by O.E Williamson' in the 1.960s.To maximise their own utility, argued Williamson Williamson identified a number of factors that affect a manager's utility.Provided they end up maximising profits, they will be equating MC and AIR, even if they do not know it!In reality, it will not even have this information to any degree of certainty, because it simply will not be able to predict just how consumers will respond to each of its rivals alternative reactions.The firm is not, therefore, faced with static cost and revenue curves from which it can read off its profit-maximising price and output.If it chooses a price and an output that maximise profits this year, it may as a result jeopardise profits in the future.Given these extreme problems in deciding profit-maximising price and out-put, firms may adopt simple rules of thumb for pricing.Directors in turn employ professional managers, who are often given considerable discretion in making decisions.For example, policies to increase the size of the firm or the firm's share of the market may involve heavy advertising or low prices to the detriment of short-run profits.But if this results in the firm becoming larger, with a larger share of the market, the resulting economic power may enable the firm to make larger profits in the long run.A claim by managers that they were attempting to maximise long-run profits could be an excuse for virtually any policy.When challenged as to why the firm had say, undertaken expensive research, or high-cost investment, or engaged in damaging price war, the managers could reply, yes but in the long run it will pay off.'Quite apart from this, the actions of competitors, sup-pliers, unions and so on are difficult to predict.In joint second place, and launched at about the same time are Microsoft's Xbox and Nintendo's Game Cube.Console purchases are strongly linked to new console developments, which occur every few years.However, even with such aggressive price-cutting, Xbox's market share has remained largely unaffected.The growth in online gaming is heavily dependent on the development and spread of broadband internet connections.All three companies- Sony, Microsoft and Nintendo- know that, to be successful in the gaming industry, you must look to the long term and constantly seek to innovate.Time period Finally, there is the problem in deciding the time period over which the firm should be seeking to maximise profits.Some, however, change as a direct result of a firm's policies, such as an advertising campaign, the development of a new improved product, or the installation of new equipment.It is reasonable to assume that owners will want to maximise profits: this much most of the critics of the traditional theory accept.In Chapter 3 we saw that in public limited companies there is generally a separation of ownership and control.They may, for example, pursue higher salaries, greater power or prestige, better working conditions, greater sales, etc.Alternative theories of the firm to those of profit maximisation, therefore, tend to assume that Large firms are profit satisficers.Many actions of firms may be seen to conflict with this aim and yet could be consistent with the aim of long-run profit maximisation.The firm will need a plan of action for prices, output, investment, etc., stretching from now into the future.These shifts in demand and cost curves will be very difficult to estimate with any precision.This would explain why sales of gaming hardware and software continue to expand.The four main ones were salary, job security, dominance (including status, power and prestige) and professional excellence.Sony is set to enter the market in 2004 with its own mobile gaming handset.It would be a poor business strategy not to look to the future in this ever changing market, and so long as competition remains, and products need replacing over a period of time, then long-run profits are likely to be the goal rather than the maximisation of profits over short-run.One important conclusion was that average costs are likely to be higher when managers have the discretion to pursue their own utility.For example, perks and unnecessarily high staffing levels add to costs.In this case, traditional models will still be useful in predicting price and output.Lack of information The main difficulty in trying to maximise profits is a lack of information.Firms may well use accountants' cost concepts not based on opportunity cost.If it is thereby impossible to measure true profit, a -firm will not be able to maximise profit except by chance.In order to make even an informed guess about marginal revenue, they must have some idea of how responsive demand will be to a change in price.The biggest problem in estimating the firm's demand curve is in estimating the actions and reactions of other firms and their effects.Also variable costs are likely to decrease if the new equipment is more efficient.The traditional theory of the firm assumes that it is the owners of the firm that make price and output decisions.Shareholders elect directors.Will they want to maximise profits, or will they have some other aim?Managers may be assumed to want to maximise their own utility.Different managers in the same firm may well pursue different aims.That is, managers strive hard for a minimum target level of profit, but are less interested in profits above this level.Even if long-run profit maximisation is the prime aim, the means of achieving it are extremely complex.Often this will simply involve avoiding making decisions (e.g. cutting price) that may, stimulate an unfavourable reaction from rivals (e.g. rivals cutting their price).One example, is the long-running video games war between Sony, Nintendo and, most recently, Microsoft.Older players tend to have more disposable income to spend on games than do teenagers.In 2002 it reached an all-time high in the UK of 2.1m, an 8 per cent increase on the previous year.Product development has also been influenced by this trend towards older gamers.Even given the market's staggering growth, it has proved to be fiercely competitive.Until the next generation of consoles appear in these two market areas are likely to be the Source of most competition between the gaming industry's major players.But how are they to estimate this price elasticity?But even this is frequently very unreliable.Instead it is faced with a changing (and often highly unpredictable) set of curves.If it does, its costs will rise in the short run and thus short-run profits will fall.On the other hand, if the quality of the product thereby increases, demand is likely to increase over the longer run.But what are the objectives of managers?This may well involve pursuits that conflict with profit maximisation.At first sight, a theory of long-run profit maximisation would seem to be a realistic alternative to the traditional short-run profit-maximisation theory.In practice, however, the theory is not a very useful predictor of firms' behaviour and is very difficult to test.But today's prices and marketing decisions affect tomorrow's demand.Similarly, today's investment decisions \yin affect tomorrow's costs.There are, however, plenty of examples from the world of business to suggest that firms often take a longer-term perspective.The industry is dominated by Sony and its Play station 2.Mature-rated games now account for 13 per cent of the American market, up 6 per cent on 2001.The launch price of Microsoft's Xbox in March 2002 was GBP299.Of these only salary is directly measurable.The rest have to be measured indirectly.Let us examine each in turn.Even though (presumably) they will know how much they are selling at the moment, this only gives them one point on their demand curve and no point at all on their MR curve.Firms operate in a changing environment.Demand curves shift; supply curves shift.The firm may be considering whether to invest in new expensive equipment.In other words, long-run profit is likely to increase, but probably by a highly uncertain amount.The question is, however, whether the owners do in fact make the decisions.This is very difficult to refute (until it is too late!).Therefore, future demand curves cannot be taken as given.Therefore, future cost curves cannot be taken as given.Since 2001 they have both sold about 10 million consoles.In addition Each gaming boom is bigger than the last.Children who have grown up with games keep on playing, which expands the market....Just one year later it was GBP129.99 - a fall of 56 per cent.In other words, they are free to pursue their own interests.And what are the managers' interests?Market research may help.Take a simple example.By the end of 2002 it had sold over 50 million units since its launch in March 2000.

Alternative theories of the firm
Problems with traditional theory
The traditional profits maximising theories of the firm have been criticised being unrealistic. The criticisms are mainly of two parts: (a) that firms wish to maximise profits, but for some reason or other are unable to do so; or (b) that firms have aims other than profit maximisation. Let us examine each in turn.
Difficulties in maximising profit
One criticism of traditional theory sometimes put forward is that firms do not use MR and MC concepts. This may be true, but firms could still arrive at maximum profit by trial and error adjustment of price, or by finding the output where TR and TC are furthest apart. Provided they end up maximising profits, they will be equating MC and AIR, even if they do not know it! In this case, traditional models will still be useful in predicting price and output.
Lack of information
The main difficulty in trying to maximise profits is a lack of information. Firms may well use accountants' cost concepts not based on opportunity cost. If it is thereby impossible to measure true profit, a -firm will not be able to maximise profit except by chance.
More importantly, firms are unlikely to know precisely (or even approximately) their demand curves and hence their AIR curves. Even though (presumably) they will know how much they are selling at the moment, this only gives them one point on their demand curve and no point at all on their MR curve. In order to make even an informed guess about marginal revenue, they must have some idea of how responsive demand will be to a change in price. But how are they to estimate this price elasticity? Market research may help. But even this is frequently very unreliable.
The biggest problem in estimating the firm's demand curve is in estimating the actions and reactions of other firms and their effects. Collusion between oligopolists or price leadership would help, but there will still be a considerable area of uncertainty, especially if the firm faces competition from abroad or from other industries.
Game theory may help a firm decide its price and output strategy: it may choose to sacrifice the chance of getting the absolute maximum profit (the high-risk, maximum option), and instead go for the safe strategy of getting probably at least reasonable profits (maximin.) But even this assumes that it knows the consequences for its profits of each of the possible reactions of its rivals. In reality, it will not even have this information to any degree of certainty, because it simply will not be able to predict just how consumers will respond to each of its rivals alternative reactions.
Time period
Finally, there is the problem in deciding the time period over which the firm should be seeking to maximise profits. Firms operate in a changing environment. Demand curves shift; supply curves shift. Some of these shifts occur as a result of factors outside the firm's control, such as changes in competitors' prices and products, or changes in technology. Some, however, change as a direct result of a firm’s policies, such as an advertising campaign, the development of a new improved product, or the installation of new equipment. The firm is not, therefore, faced with static cost and revenue curves from which it can read off its profit-maximising price and output. Instead it is faced with a changing (and often highly unpredictable) set of curves. If it chooses a price and an output that maximise profits this year, it may as a result jeopardise profits in the future.
Take a simple example. The firm may be considering whether to invest in new expensive equipment. If it does, its costs will rise in the short run and thus short-run profits will fall. On the other hand, if the quality of the product thereby increases, demand is likely to increase over the longer run. Also variable costs are likely to decrease if the new equipment is more efficient. In other words, long-run profit is likely to increase, but probably by a highly uncertain amount. Given these extreme problems in deciding profit-maximising price and out-put, firms may adopt simple rules of thumb for pricing.
Alternative aims
An even more fundamental attack on the traditional theory of firm is that firms do not even aim to maximise profits (even if they could).
The traditional theory of the firm assumes that it is the owners of the firm that make price and output decisions. It is reasonable to assume that owners will want to maximise profits: this much most of the critics of the traditional theory accept. The question is, however, whether the owners do in fact make the decisions.
In Chapter 3 we saw that in public limited companies there is generally a separation of ownership and control. The shareholders are the owners and presumably will want the firm to maximise profits so as to increase their dividends and the value of their shares. Shareholders elect directors. Directors in turn employ professional managers, who are often given considerable discretion in making decisions. But what are the objectives of managers? Will they want to maximise profits, or will they have some other aim?
Managers may be assumed to want to maximise their own utility. This may well involve pursuits that conflict with profit maximisation. They may, for example, pursue higher salaries, greater power or prestige, better working conditions, greater sales, etc. Different managers in the same firm may well pursue different aims.
Mangers will still have to ensure that sufficient profits are made to keep shareholders happy, but that may be very different from maximising profits.
Alternative theories of the firm to those of profit maximisation, therefore, tend to assume that Large firms are profit satisficers. That is, managers strive hard for a minimum target level of profit, but are less interested in profits above this level.
Such theories fall into two categories: first those theories that assume that firms attempt to maximise some other aim, provided that sufficient profits are achieved f: these are examined in section 14.7); and second, those theories that assume that firms pursue a number of potentially conflicting aims, of which sufficient profit is merely, one 'these theories are examined in section 14.3
Alternative maximising theories
Long-run profit maximisation
The traditional theory of the firm is based on the assumption of short-run profit maximisation. Many actions of firms may be seen to conflict with this aim and yet could be consistent with the aim of long-run profit maximisation. For example, policies to increase the size of the firm or the firm's share of the market may involve heavy advertising or low prices to the detriment of short-run profits. But if this results in the firm becoming larger, with a larger share of the market, the resulting economic power may enable the firm to make larger profits in the long run.
At first sight, a theory of long-run profit maximisation would seem to be a realistic alternative to the traditional short-run profit-maximisation theory. In practice, however, the theory is not a very useful predictor of firms' behaviour and is very difficult to test. A claim by managers that they were attempting to maximise long-run profits could be an excuse for virtually any policy. When challenged as to why the firm had say, undertaken expensive research, or high-cost investment, or engaged in damaging price war, the managers could reply, yes but in the long run it will pay off.' This is very difficult to refute (until it is too late!).
Even if long-run profit maximisation is the prime aim, the means of achieving it are extremely complex. The firm will need a plan of action for prices, output, investment, etc., stretching from now into the future. But today's prices and marketing decisions affect tomorrow's demand. Therefore, future demand curves cannot be taken as given. Similarly, today's investment decisions \yin affect tomorrow's costs. Therefore, future cost curves cannot be taken as given. These shifts in demand and cost curves will be very difficult to estimate with any precision. Quite apart from this, the actions of competitors, sup-pliers, unions and so on are difficult to predict. Thus the picture of firms making precise calculations of long-run profit-maximising prices and outputs is a false one.
It may be useful, however, simply to observe that firms, when making current price, output and investment decisions, try to judge the approximate effect on new entrants, consumer demand, future costs, etc., and try to avoid decisions that would appear to conflict with long-run profits. Often this will simply involve avoiding making decisions (e.g. cutting price) that may, stimulate an unfavourable reaction from rivals (e.g. rivals cutting their price).
In search of long-run profits
The video games war
Traditional economic theory argues that firms will seek to maximise their short-run profits, and therefore adopt a range of strategies to achieve this goal. There are, however, plenty of examples from the world of business to suggest that firms often take a longer-term perspective. One example, is the long-running video games war between Sony, Nintendo and, most recently, Microsoft.
The industry is dominated by Sony and its Play station 2. By the end of 2002 it had sold over 50 million units since its launch in March 2000. In joint second place, and launched at about the same time are Microsoft's Xbox and Nintendo's Game Cube. Since 2001 they have both sold about 10 million consoles.
The market for game consoles is an interesting one, as it appears to have its own cycle that is quite distinct from the broader economic cycle of the economy. Console purchases are strongly linked to new console developments, which occur every few years. In addition
Each gaming boom is bigger than the last. Children who have grown up with games keep on playing, which expands the market.... It also increases the player’s average age: according to the interactive digital software association, the average American gamer is 28. Older players tend to have more disposable income to spend on games than do teenagers.
This would explain why sales of gaming hardware and software continue to expand. In 2002 it reached an all-time high in the UK of 2.1m, an 8 per cent increase on the previous year. Product development has also been influenced by this trend towards older gamers. Mature-rated games now account for 13 per cent of the American market, up 6 per cent on 2001.
Even given the market's staggering growth, it has proved to be fiercely competitive. The launch price of Microsoft's Xbox in March 2002 was £299. Just one year later it was £129.99 - a fall of 56 per cent. However, even with such aggressive price-cutting, Xbox’s market share has remained largely unaffected.
Managerial utility maximisation
One of the most influential of the alternative theories of the firm has been that developed by O.E Williamson' in the 1.960s. Williamson argued that, provided satisfactory levels of profit are achieved, managers often have the discretion to choose what policies to pursue. In other words, they are free to pursue their own interests. And what are the managers' interests? To maximise their own utility, argued Williamson
Williamson identified a number of factors that affect a manager's utility. The four main ones were salary, job security, dominance (including status, power and prestige) and professional excellence.
Of these only salary is directly measurable. The rest have to be measured indirectly. One way of doing this is to examine managers' expenditure on various items, and in particular on staff on perks (such as a company car and a plush office) and on discretionary investment. The greater the level of expenditure by managers On these items, the greater is likely to be their status, power, prestige, professional excellence and job security, and hence utility.
In an attempt to capture new markets and lead the field in gaming technology innovation, the three main protagonists are locked in battles not only to produce new and improved consoles, but also to develop new and improved consoles, but also to develop online gaming and mobile gaming - two major growth areas.
The growth in online gaming is heavily dependent on the development and spread of broadband internet connections. Both Microsoft and Sony have invested heavily in developing an online gaming capability. Microsoft in particular intends to develop its Xbox live online service, into a 'digital entertainment centre', through which to distribute a range of entertainment content, including films and music.
Mobile gaming, a gaming niche dominated by Nintendo and its Gameboy, is also facing new competitive pressure. Sony is set to enter the market in 2004 with its own mobile gaming handset. Nokia, the mobile phone manufacturer, entered the market in October 2003 with its Ngage hybrid phone, which has gaming capability.
Until the next generation of consoles appear in these two market areas are likely to be the
Source of most competition between the gaming industry’s major players. All three companies- Sony, Microsoft and Nintendo- know that, to be successful in the gaming industry, you must look to the long term and constantly seek to innovate.
It would be a poor business strategy not to look to the future in this ever changing market, and so long as competition remains, and products need replacing over a period of time, then long-run profits are likely to be the goal rather than the maximisation of profits over short-run.
Having identified the factors that influence a manager's utility, Williamson developed several models in which managers seek to maximise their utility. He used these models to predict managerial behaviour under various conditions and argued that they performed better than traditional profit-maximising theory.
One important conclusion was that average costs are likely to be higher when managers have the discretion to pursue their own utility. For example, perks and unnecessarily high staffing levels add to costs. On the other hand, the resulting 'slack" allows managers to rein in these costs in times of low demand. This enables them to maintain their profit levels. To support these claims he conducted 'a number of case studies. These did indeed show that staff and perks were cur during recessions and expanded during booms, and that 'Any managers were, frequently able to cut staff without influencing the productivity of firms.
Sales revenue maximisation (short run)
Perhaps the most famous of all alternative theories of the firm is that developed by William Baumol in the late I 950s. This is the theory of sales revenue maximisation. Unlike the theories of long-run profit maximisation and managerial utility maximisation, it is easy to identify the price and output that meet this aim - at least in the short run. So why should managers want to maximise their firm's sales revenue? The answer is that the success of managers, and especially sales managers, may be judged according to the level of the firm's sales. Sales figures are an obvious barometer of the firm's health. Managers' salaries, power and prestige may depend directly on sales revenue. The firm's sales representatives may be paid commission on their sales. Thus sales revenue maximisation may be a more dominant aim in the firm than profit maximisation, particularly if it has a dominant sales department.
Sales revenue will be maximised at the top of the TR curve at output Q, in Figure 14.1. Profits, by contrast, would be maximised at Q. Thus, for given total revenue and total cost curves, sales revenue maximisation will tend to lead to a higher, output and a lower price than profit maximisation.
The firm will still have to make sufficient profits, however, to keep the share-holders happy. Thus firms can be seen to be operating with a profit constraint. They are profit satisficers.
The effect of this profit constraint is illustrated in Figure 14.2. The diagram shows a total profit curve. (This is found by simply taking the difference between TR and TC at each output.) Assume that the minimum acceptable profit is ƞ (whatever the output). Any output greater than Q, will give a profit less than ƞ. Thus the sales revenue maximiser who is also a profit satisficer will produce Q, not Q1. Note, however, that this output is still greater than the profit-maximising output Q2.
If the firm could maximise sales revenue and still make more than the minimum acceptable profit, it would probably spend this surplus profit on advertising to increase revenue further. This would have the effect of shifting the TR curve upward and also the TC curve (since advertising costs money).
Sales revenue maximisation will tend to involve more advertising than profit maximisation. Ideally the profit-maximising firm will advertise up to the point where the marginal revenue of advertising equals the marginal cost of advertising (assuming diminishing returns to advertising). The firm aiming to maximise. Sales revenue will go beyond this, since further advertising, although costing more than it earns the firm, will still add to total revenue. The firm will continue advertising until surplus profits above the minimum have been used up.
Growth maximisation
Rather than aiming to maximise short-run revenue, managers may take a longer-term perspective and aim for growth maximisation in the size of the firm, They may gain utility directly from being part of a rapidly growing 'dynamic' organisation; promotion prospects are greater in an expanding organisation, since new posts tend to he created; large firms may pay higher salaries; mash may obtain greater power in a large firm.
Growth is probably best measured in terms of a growth in sales revenue, since sales revenue (or 'turnover') is the simplest way of measuring the size of a business. An alternative would be to measure the capital value of a firm, but this will depend on the ups and downs of the stock market and is thus a rather unreliable method.

If a firm is to maximise growth, it needs to be clear about the time period over which it is setting itself this objective. For example, maximum growth over the next two or three years might be obtained by running factories to absolute maximum capacity, cramming in as many machines and workers as possible, and backing this up with massive advertising campaigns and price cuts. Such policies, however, may not be sustainable in the longer run. The firm may simply not be able to finance them. A longer-term perspective (say, 5-10 years) may therefore require the firm to 'pace' itself, and perhaps to direct resources away from current production and sales into the development of new products that have potentially high and growing long-term demand.
Equilibrium for a growth-maximising firm
What will a growth-maximising firm's price and output be? Unfortunately, there is no simple formula for predicting this. In the short run, the firm may choose the profit-maxims mg price and output - so as to provide the greatest funds for investment. On the other hand it may be prepared to sacrifice some short-term profits in order to mount an advertising campaign, It all depends on the strategy it considers most suitable to achieve growth.
In the long run, prediction is more difficult still. The policies that a firm adopts will depend crucially on the assessments of market opportunities made by managers. But this involves judgement, not fine calculation. Different managers will judge a situation differently. One prediction can be made. Growth-maximising firms are likely to diversify into different products, especially as they approach the limits to expansion in existing markets. Alternative growth strategies are considered in Chapter 15.
Alternative maximising theories and the consumer
It is difficult to draw firm conclusions about how the behaviour of firms in these alternative maximising theories will affect the consumer's interest.
In the case of sales revenue maximisation, a higher output will be produced than under profit maximisation, but the consumer will not necessarily benefit from tower prices, since more will be spent on advertising - costs that will be passed on to the consumer.
In the case of growth and long-run profit maximisation, there are many possible policies that a firm could pursue. To the extent that a concern for the long run encourages firms to look to improved products, new products and new techniques, the consumer may benefit from such a concern. To the extent, however, that growth encourages a greater level of industrial concentration through merger, so the consumer may lose from the resulting greater level of monopoly power.
As with the traditional theory of the firm, the degree of competition that a firm faces is a crucial factor in deter-mining just how responsive it will be to the wishes of the maximising firms benefit the consumer.
Multiple aims
Satisficing and the setting of targets
Firms may have more than one aim. For example, they may try to achieve increased sales revenue and increased profit. The problem with this is that, if two aims conflict, it will not be possible to maximise both of them. For example, sales revenue will probably be maximised at a different price and output from that at which profits are maximised. Where firms have two or more aims, a compromise may be for targets to be set for individual aims which are low enough to achieve simultaneously, and yet which are sufficient to satisfy the interested parties. Such target setting is also likely when the maximum value of a particular aim is unknown. If, for example, the maximum achievable profit is unknown, the firm may well set a target for profit which it feels is both satisfactory and achievable.
Behavioural theories of the firm: the setting of targets
A major advance in alternative theories of the firm has been the development behavioural theories. Rather than setting up a model to show how various objectives could in theory be achieved, behavioural theories of the firm are based on observations of how firms actually behave.
Large firm are often complex institutions with several departments (salts, production, design, purchasing, personnel, finance, etc.). Each department is likely to have its own specific set of aims and objectives, which may possibly come into conflict with those of other departments. These aims in turn will be constrained by the interests of shareholders, workers, customers and creditors (collectively known as stakeholders), who will need to be kept sufficiently happy.
Behavioural theories do not lay down, rules of how to achieve these aims, but rather examine what these aims are, the motivations underlying them, the conflicts that can arise between aims, and how these conflicts are resolved. It is assumed that targets will be set for production, sales, profit, stock holding, etc. If in practice, target levels are not achieved, a search procedure will be started to find what went wrong and how to rectify it. If the problem cannot be rectified, managers will probably adjust the target downwards. If, on the other hand, targets are easily achieved, managers may adjust them upwards. Thus the targets to which managers aspire depend to a large extent on the success in achieving previous targets. Targets are also influenced by expectations of demand and costs, by the achievements of competitors and by expectations of competitors' future behaviour. For example, if it is expected that the economy is likely to move into recession, sales and profit targets may be adjusted downwards.
If targets conflict, the conflict will be settled by a bargaining process between managers. The outcome of the bargaining, however, will depend on the power and ability of the individual managers concerned. Thus a similar set of conflicting targets may be resolved differently in different firms.
Behavioural theories of the firm: organisational slack
Since changing targets often involves search procedures and- bargaining cusses and is therefore time consuming, and since many managers prefer to avoid conflict, targets tend to be changed fairly infrequently. Business conditions, however, often change rapidly. To avoid the need to change targets, therefore, managers will tend to be fairly conservative in their aspirations. This leads to the phenomenon known as organisational slack.
When the firm does better than planned, it will allow slack to develop. This slack can then be taken up it the firm does worse than planned. For example, if the firm produces more than it planned, it will build up stocks of finished goods and draw on them if production subsequently falls. It would not in the meantime, increase its sales target or reduce its production target. If it did, and production then fell below target, the production department might not be able to supply the sales department with its full requirement.
Thus keeping targets fairly low and allowing slack to develop allows all targets to be met with minimum conflict.
Stakeholder power?
Who governs the firm?
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Organisational slack, however, adds to a firm's costs. If firms are operating in a competitive environment, they may be forced to cut slack in order to survive. In the 1970s, many Japanese firms succeeded in cutting slack by using just-in-time methods of production. These involve keeping stocks to a minimum and ensuring that inputs are delivered as required. Clearly, this requires that production is rightly controlled and that suppliers are reliable. Many firms today have successfully cut their warehouse costs by using such methods. These methods are examined in section 1.8.7.
Multiple goals: predictions of behaviour
Conservatism
Some firms may be wary of unnecessary change. Change is a risky. They may prefer to stick with tried and tested practices. If it works, stick with it. This could apply to pricing policies, marketing techniques, product design and range, internal organisation the firm, etc.
If something does not work, however, managers will probably change it, but again they may be conservative and only try a cautious change: perhaps imitating successful competitors.
This safe, satisficing approach makes prediction of an, given firm's behaviour relatively easy. You simply examine its pair behaviour. Making generalisations about all such cautious firms, however, is more difficult. Different firms are likely to have established different rules of behaviour depending on their own particular experiences of their market.
Comparison with other firms
Managers may judge their success by comparing their firm's performance with that of rival firms. For example, growing market share may be seen as a more important indicator of 'success' than simple growth in sales. Similarly, they may compare their profits, their product design, their technology or their industrial relations with those of rivals. To many managers it is relative performance that matters, rather than absolute performance.
What predictions can be made if this is how managers behave? The answer is that it depends on the nature of competition in the industry. The more profitable, innovative and efficient are the competitors, the more profitable, innovative and efficient will managers try to make their particular firm.
The further ahead of their rivals that firms try to stay, the more likely it is that there will be a 'snowballing' effect: each firm trying to outdo the other.
Satisficing and the consumer's interest
Firms with multiple goals will be satisficers. The greater the number of goals of the different managers, the greater is the chance of conflict and the more likely it is that organisational slack will develop. Satisficing firms are therefore likely to be less responsive to changes in consumer demand and changes in costs than profit-maximising firms. They may thus be less efficient.
On the other hand, such firms may be less eager to exploit their economic power by charging high prices, or to use aggressive advertising, or to nay low Wages.
The extent to which satisficing firms do act in the public interest will as in the case of other types of firm, depend to a large extent on the amount and type of competition they face, and their attitudes towards this Competition. Firms that compare their performance with that of their rivals are more likely to be responsive to consumer wishes than firms that prefer to stick to welt-established practices. On the other hand, they may be more concerned to 'manipulate' consumer tastes than the more traditional Firm.