Economic theory makes a fundamental assumption that maximizing profits is the basic objective of every firm. But in recent years “profit maximization” has been extensively qualified by theorists to refer to the long run; to refer to management’s rather than to owners’ income; to include non-financial income such as increased leisure for high-strung executives and more congenial relations between executive levels within the firm; and to make allowance for special consideration such as restraining competition, maintaining management control, warding off wage demands, and forestalling, anti trust suits. The concept has become so general and hazy that it seems to encompass most of men’s aims in life.
This trends reflect a growing realization by theorists that many firms, and particularly the big ones, do not operate on the principle of profit maximizing in terms of marginal costs and revenues.
Surely a theorem that can be used only when qualified out of existence has ceased to have meaning or usefulness.
This does not mean that profit and profitability are unimportant. It does mean that profitability is not the purpose of business enterprise and business activity, but a limiting factor on it. Profit is not the explanation, cause or rationale of business behavior and business decisions but the test of their validity. If archangels, instead of businessmen, sat in directors’ chairs, they would still have to be concerned with profitability despite their total lack of personal interest in making profits. And this applies with equal force to those far from angelic individuals, the Commissars who run Soviet Russia’s business enterprises. For the problem of any business is not the maximization of profit but the achievement of sufficient profit to cover the risks of economic activity to avoid loss.
The root of the confusion is the mistaken belief that the motive of a person – the so-called “profit motive” of the businessman is an explanation of his behavior or his guide to right action. Whether there is such a thing as a profit motive at all is highly doubtful. It was invented by the classical economists to explain economic behavior that otherwise made otherwise made no sense. Yet there has never been any but negative evidence for the existence of the profit motive. And we have long since found the true explanation of the phenomena of economic change and growth which the profit motive was first put forth to explain.
But it is irrelevant for an understanding of business behavior, including an understanding of profit and profitability, whether there is a profit motive or not. That Jim Smith is in business to make a profit concerns only him and the Recording Angel. It does not tell us what Jim Smith does and how he performs. We do not learn anything about the work of a prospector, hunting for uranium in the Nevada desert, by being told that he is trying to make his fortune. We do not learn anything about the work of a heart specialist by being told that he is trying to make a livelihood or even that he is trying to benefit humanity. The profit motive and its offspring, maximization of profits, are just as irrelevant to the function of a business, the purpose of a business and the job of managing a business.
In fact, the concept is worse than irrelevant. It does harm. It is a major cause for the misunderstanding of the nature of profit in our society and for the deep-seated hostility to profit which are among the most dangerous diseases of an industrial society. It is largely responsible for the work mistakes of public policy in US as well as in Western Europe which are squarely based on a lack of understanding of the nature, function and purpose of business enterprise.