Baumol's Theory of Sales Revenue Maximisation?Marris Growth Maximization Model?

Prof. Baumol, in his book 'Business behaviour, Value and Growth' has propounded a theory of Sales Maximisation. Main aim of a firm is to maximise sales. By sales he meant total revenue earned by the sale of goods. That is why this goal is also referred to as Sales Maximisation Goal. According to this theory, once profits reach acceptable levels, the goal of the firms become maximisation of sales revenue rather than maximisation of profits.

In the words of Baumoul, 'The sales maximisation goal says that managers of firms seek to maximise their sales revenue subject to the constraint of earning a satisfactory profits. "


The above definition maintains that when the profits of firms reach a level considered satisfactory by the shareholders then the efforts of the managers are directed to maximise revenue by promoting sales instead of maximising profit. While studying this theory. K must be kept in view that firms do not Ignore profit altogether. They do aspire to attain a general level of profit. But once an acceptable level of profit is obtained their goal shifts to sales maximisation in place of profit maximisation.

Baumol raised serious questions on the validity of profit maximisation as an objective of the firm. He stressed that in competitive markets, firms would rather aim at maximising revenue, through maximisation of sales. According to him, sales volumes, and not profit volumes, determine market leadership in competition. He further stressed that in large organisations, management is separate from owners. Hence there would always be a dichotomy of managers' goals and owners' goals. Manager's salary and other benefits are largely linked with sales volumes, rather than profits.

Baumol hypothesised that managers often attach their personal prestige to the company's revenue or sales; therefore they would rather attempt to maximise the firm's total revenue, instead of profits. Moreover, sales volumes are better indicator of firm's position in the market, and growing sales strengthen the competitive spirit of the firm. Since operations of the firm are in the hands of managers, and managers' performance is measured in terms of achieving sales targets, therefore it follows that management is more interested in maximising sales, with a constraint of minimum profit. Hence the objective is not to maximise profit, but to maximise sales revenue, along with which, firms need to maintain a minimum level of profit to keep shareholder satisfied. This minimum level of profit is regarded as the profit constraint.

However, empirical evidence to support above arguments of Baumol is not sufficient to draw any definite conclusion. Whatever research has been done is based on inadequate data; hence the results are inconclusive.

Arguments in favour of Maximisation of Sales Goal

Following arguments are given in favour of maximisation of sales goal:

i. More Realistic: Goal of maximisation of sales is a more realistic goal- In fact, firms accord more importance to the goal of sales maximisation than profit maximisation. It is so because success of a firm is generally judged from its total sales. According to Ferguson and Krupps, 'Among the various alternatives advanced, Baumoul’s thesis has great advantage — it raises the other models in the direction of reality and plausibility while still permitting a rather general theoretical analysis."

ii. More Practical: Revenue maximisation thesis of Baumol is more practical. It is so because goal of revenue (Sales) maximisation leads to more production which, in turn, leads to fall in price. As a result, consumers' welfare is promoted. They also endorse this goal of the firms.

iii. More Availability of Loans: At the time of sanctioning loan to a firm, financial institutions mainly consider its sales. Prospects of loans are bright for such firms as have large total sales.

iv. Strong Position in the Market: Maximum sales of a firm symbolize its strong position in the market. Sales of a firm will be large only in that situation when consumers like its production, firm has more competitive power and has been expanding. All these features are indicative of the progress of the firm.

v. More Advantageous to the Managers: It is more to the advantage of the managers that the firm should aim at sates maximisation. This way their credibility enhances in the market. Maximum sales is a reflection of the competence of the managers It has a favorable effect on their wages. Firm is in a position to offer higher wages to the employees. Consequently, employer-employee relations become more cordial. II is the constant endeavour of the managers to maximize the sales of the firm after attaining a given level of profit.

Marris Growth Maximization Model:

Working on the principle of segregation of managers from owners, Marris proposed that owners (shareholders) aim at profits and market share, whereas managers aim at better salary, job security and growth. These two sets of goals can be achieved by maximising balanced growth of the firm (G), which is dependent on ihe growth rate of demand for the firm's products (GD) and growth rate of capital supply to the firm (GC). Hence growth rate of the firm is balanced when the demand for its product and the capital supply to the firm grow at the same rate.

Marris further said that firms face two constraints in the objective of maximisation of balanced growth, which are explained below:

i. Managerial Constraint

Among managerial constraints, Marris stressed on the importance of the role of human resource in achieving organisational objectives. According to him, skills, expertise, efficiency and sincerity of team managers are vital to the growth of the firm. Non availability of managerial skill sets in required size creates constraints for growth: organisations on their high levels of growth may face constraint of skill ceiling among the existing employees. New recruitments may be used to increase the size of the managerial pool with desired skills; however new recruits lack experience to make quick decisions, which may pose as another constraint.

ii. Financial Constraint

This relates to the prudence needed in managing financial resources. Marris suggested that a prudent financial policy will be based on at least three financial ratios, which in turn set the limit for the growth of the firm. In order to prove their discretion managers will normally create a tradeoff and prefer a moderate debt equity ratio (rj), moderate liquidity ratio (r2) and moderate retained profit ratio (r3). (Let us mention here that the ratios used in the financial constraint are dealt with in detail in any standard text book on Financial Management and are beyond the scope of this book). However a brief description is given hereunder:

(a) Debt equity ratio (r1) This is the ratio between borrowed capital and owners* capital. High value of debt equity ratio may cause insolvency; hence a low value of this ratio is usually preferred by managers to avoid insolvency. However, a low value of r, may create a constraint to the growth of the firm in terms of dependence on high cost capital, i.e., equity.

(b) Liquidity ratio (r2) This is the ratio between current assets and current liabilities and is an indicator of coverage provided by current assets to current liabilities. According to Marris, a manager would try to operate in a region where there is sufficient liquidity and safety and hence would prefer a high liquidity ratio. But a high r2 would imply low yielding assets, since liquid assets either do not earn at all (like cash and inventory), or earn low returns (like short term securities).

(c) Retention ratio (r3) This is the ratio between retained profits and total profits. In other words, it is the inverse of dividend payout ratio, i.e., the retained profits are that portion of net profit which is not distributed among shareholders. A high retention ratio is good for growth, as retained profits provide internal source of funds. However, a higher r3 would imply greater volume of retained profits, which may antagonise the shareholders. Hence managers cannot afford to keep a very high value of retention ratio.

Williamson’s Managerial Discretionary Theory:

The theory of Managerial Utility Maximisation was developed separately by Berle-Means-Galbralth and Williamson. It is also known as Managerial Discretion Theory. The Theory is based on the concept that shareholders or owners of the firm and managers are (two separate groups. The owners or the shareholders want high dividends and are. therefore, interested In maximising profits, the managers, on the other hand, have different motives other than profit maximisation. Once the managers have achieved a level of profit that will pay satisfactory dividends to shareholders and still ensure growth.

they are free to increase their own emoluments and also the size of their staff and expenditure on them. In the words of Williamson, "7b the extent that the pressure from the capital market and competition in the product market is imperfect, the manager, therefore, has discretion to pursue goals other than profits." Further Berle and Means suggested that "The lack of corporate democracy leaues owners or shareholders with little or no power to change corporation policy."

According to Williamson, "Managerial Utility function may be expressed as follows:

U = f(S, M. ID)

It will be read: Managerial utility is a function (f) of additional expenditure on staff, managerial emoluments and discretionary investment.

(Here, U = managerial utility; S = additional expenditure on staff; M = managerial emoluments and ID = discretionary investment).

Managerial utility function maximises the utility of the managers rather than profits of the firm. The manager is expected to follow policies which maximise the following components of his utility function.

i. Expansion of Staff: The manager will like to increase the quality and number of staff reporting to him. This will lead to an increase in the salary of the staff. More staff are valued because they lead to the manager getting more salary, more prestige and more security.

ii. Increase in Managerial Emoluments: Managerial Utility also depends on managerial emoluments. It includes facilities like entertainment allowance, luxurious office, staff car, company phone, etc. Expenditure of this nature reflects to a large extent the prestige, power and status of the manager.

iii. Discretionary Power of Investment: Managerial utility also depends on the discretion of the manager to undertake investment beyond those required for normal operations. The manager is in a position to invest in advanced technology and modem plants. Such investments may or may not be economically efficient. These investments may be undertaken for the self-satisfaction of the manager.

According to the theory, in a firm, shareholders and managers are two separate groups. The firm tries to get maximum returns on investment and get maximum profit, whereas managers try to maximize profit in their satisfying function.

At last, Williamson’s managerial discretion theory shows the utility function of a manager. In this theory, the firm will try to get maximum returns or maximum profit where as manager try to maximum utility satisfying function. They are in equilibrium when the utility has maximum amount.