Profit Comparisons: One of the Least Important Uses of the Concept of Profit

One of the most distracting uses of the concept of profit in this country is our tendency to place too much emphasis on profit comparisons between companies or between industries. What does it mean to say that the oil industry makes more profit than the chemical industry? Usually, when this kind of discussion evolves, we talk about technical efficiencies, cost efficiencies, productivities, or differences in management. However, when all is said and done, when all of the technical analysis of profit is written and discussed, the bottom line is this: What does profit mean for the community? What does profit mean for people?

Profit Maximization and Ethics

When businesspeople profit-maximize, that is, allocate scarce resources efficiently, people have more of the things they want, and that is good. When they do not profit-maximize, that is, allocate scarce resources inefficiently, people have less of the things they want, and that is bad. This is especially true if the things they want are food, health care, education, and other necessities of life.

Since ethics is basically the study of what is good and what is bad, then the decision to profit-maximize or not to profit-maximize becomes an ethical decision. Therefore, those resource allocators who try to use resources efficiently are ethical managers. Those resource allocators who do not try to use resources efficiently are not ethical managers.

There is more to profit maximization and ethics than the decision to use or not use resources efficiently. However, that discussion falls outside the scope of this book.

Profit Maximization and the Bottom Line

The behavior of profit maximization as it relates to the bottom line will result in one of two outcomes. If the bottom line of the company shows a profit, it will be the most profit the company can receive for using its resources efficiently. If the bottom line of the company shows a loss, it will be the minimum loss the, company can incur by using its resources efficiently.

The only thing the behavior of profit maximization will ever guarantee is the efficient use of scarce resources. When resources are allocated efficiently, we all have more of the things we want.

The Behavior That Maximizes Profit

I define profit maximization in behavioral terms as the act of producing the right kind and the right amount of the goods and services the consumer wants at the lowest possible cost.

Businesses know they are producing the right kind of goods and services if consumers are willing to buy them. Let me emphasize again that businesses that produce goods and services illegally have no place in this discussion because they are performing criminal acts.

Businesses also know when they are producing the right amount of goods and services. It is that level of output where marginal revenue is equal to marginal cost, as previously discussed. To produce less would mean the company would not bring units to the marketplace that, when sold, would result in revenues greater than the cost of producing them, and this kind of behavior is inefficient. To produce more would mean the company would bring units to the marketplace that, when sold, would result in revenues less than the cost of producing them, and this kind of behavior is also inefficient.

Producing at the lowest possible cost is probably the most recognizable tenet of business behavior. Lower costs give the company a competitive advantage in the marketplace. Higher costs put it at a competitive disadvantage and reduce its ability to survive.

The Real World of Profit Maximization

Assume you make cars. You produce a car and take it to the marketplace. As long as you can sell the car for more than it costs you to make it, you will sell it. In the technical language of profit maximization, one would say that you would bring the car to market as long as the marginal revenue from the sale of the 'car is greater than the marginal cost of producing the car.

In fact, you will continue to bring additional cars to the market until the revenue from the sale of the car is equal to the cost of producing the car (marginal revenue equals marginal cost). Once your cost exceeds your revenue (marginal revenue is less than marginal cost), you will no longer bring cars to the marketplace because you will lose money on these additional units.

The Technical Definition of Profit Maximization

From a technical perspective, profit maximization is defined as the set of conditions in which marginal revenue is equal to marginal cost and the marginal-cost curve intersects the marginal-revenue curve from below. At this point, and only this point, the company is operating at a level of efficiency that guarantees the community the maximum amount of goods and services that can be produced from a given set of scarce resources. These efficiencies are usually calculated mathematically and are rarely translated into behavior.

What Is Profit Maximization? Or If Profit Maximization Is Not Merely Making the Bottom line as Large as Possible, Then What Is It?

Any analysis of profit maximization begins and ends with the people who are involved in business: What is it that these people do? They engage in the human behavior of allocating the scarce resources that produce the goods and services the community wants. Stated another way, businesspeople are resource allocators. That is their profession; that is their mandate.

There is a directive that comes with this responsibility of being a resource allocator. Businesspeople must allocate scarce resources efficiently! And how do businesspeople allocate scarce resources efficiently? They do it by adhering to the principles inherent in profit maximization, also referred to as profit maximizing.

Rather than concentrating on the bottom line, profit maximization focuses on the behavior that leads directly to bottom-line profits and losses. Rather than concentrating on numbers, profit maximization focuses on all of those human activities that generate these numbers.

When I use the phrase H profit maximization" or "profit maximizing," I am referring to everything and anything that goes into good business. Stated another way, profit maximization refers to everything that goes into converting scarce resources into what people want and doing it efficiently.

A Lecture by a Well-Intentioned Scientist

About ten years ago, a faculty member from one of the science departments attended a business school faculty meeting at the university where I was working. He asked to address our group and proceeded to berate us for teaching our students to maximize the bottom line (accounting profit) by using business strategies that were destroying the planet Earth.

He accused us of teaching students that, in the interest of profit, it was good business to pollute our rivers and streams, foul our air, contaminate the soil, and destroy the ozone layer. The shocking part of his diatribe was that he believed what he was saying.

At the time, I thought to myself that the arrogance and conceit of this well intentioned, grossly ignorant man were reprehensible. He had never attended a single lecture by any professor in the school of business. He assumed that my colleagues and I were teaching this kind of drivel. His conclusions were based on anecdotal data about a few businesspeople, out of tens of millions, who were abusing the system.

Profit VS. Profit Maximization

We have already said that accounting profit is equal to total revenue minus total fixed cost and total variable cost. Economic profit is equal to accounting profit minus opportunity cost. We also know that profit, whether accounting profit or economic profit, is an event or happening that occurs when people engage in those kinds of human activities that generate revenues and produce goods and services.

Profit maximization is a different kind of animal. Most men and women in business probably think of it as maximizing their bottom line or accounting profit. Essentially, this perception is an accounting perspective. It is not an economic perspective. And it is not the meaning of profit maximization.

There are those who believe that profit maximization implies that companies can and will do anything to make the most profit they can, regardless of the means. They accuse business of raping the land, polluting the environment, destroying our institutions, and so on. This perspective on profit maximization is usually advanced by those who have never run a business.