an understanding of other objectives of firms: survival

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Differing Objectives and Policies of Firms (Cambridge AS/A‑Level)

1. Firm Objectives – Syllabus Overview (Topic 7.8)

The Cambridge syllabus recognises that firms may pursue a range of objectives. For each objective we give a definition, the economic rationale and a typical industry example.

Objective Definition & Rationale Typical Industries / Example
Profit maximisation Maximise \( \pi = TR - TC \). The aim is to obtain the highest possible surplus for owners/shareholders. Manufacturing, retail – e.g., a smartphone maker seeking the greatest profit margin on each model.
Survival Ensure the firm can continue operating in the long run, even if short‑run profits are low or zero. Liquidity and cash‑flow stability become the priority. Small family‑run grocery store during a recession.
Sales‑maximisation Achieve the highest possible output or sales volume, accepting lower profit. Often used to gain market‑share or to exploit economies of scale. Fast‑moving consumer goods (FMCG) firms that run “buy‑one‑get‑one” promotions.
Revenue‑maximisation Maximise total revenue \( TR \) while keeping profit at a normal level (or constrained). Common where profit is not the sole performance measure. State‑owned utilities that aim to cover costs and provide public service.
Market‑share growth Increase the firm’s proportion of total market sales, even at the expense of short‑run profit. The objective is to build a dominant position that can generate future profits. Soft‑drink manufacturers expanding distribution to new retail chains.
Strategic objectives (e.g., limit pricing, predatory pricing, price discrimination) Use pricing or product strategies to achieve a longer‑term goal such as deterring entry, driving rivals out of the market, or extracting consumer surplus. Airline industry employing price discrimination (business vs. economy tickets) to maximise revenue from different consumer groups.

2. Policy Matrix – Linking Objectives to Firm‑Level Policies

Students must be able to associate each objective with the typical set of policies a firm will adopt.

Objective Price‑setting Cost control Product / R&D strategy Advertising & Promotion Financial policy
Profit maximisation Set price where \( MR = MC \) Continuous cost‑reduction, lean production Targeted R&D for high‑margin products Profit‑oriented advertising (focus on ROI) Optimal capital structure, dividend policy
Survival Price ≥ \( AVC \) (cover variable costs); may accept price below \( ATC \) Outsource non‑core activities, close under‑utilised plants Limited R&D – focus on cash‑generating lines Cost‑effective promotions to clear stock Maintain cash reserves, short‑term credit lines
Sales‑maximisation Set price where \( MR \approx 0 \) (maximise quantity) Economies of scale through high output Broad product range, frequent new launches Heavy advertising to stimulate demand Financing to support large inventories
Revenue‑maximisation Price where \( d(TR)/dQ = 0 \) (peak of TR curve) Control variable costs but accept higher fixed costs for capacity Develop differentiated versions to capture different price points Promotions aimed at increasing total sales value Maintain moderate leverage; focus on cash flow
Market‑share growth Often price below marginal cost (penetration pricing) or use loss‑leader tactics Invest in cost efficiencies to sustain low prices Product line extensions, bundling Brand‑building campaigns, loyalty programmes Long‑term financing to support temporary losses
Strategic objectives (limit/predatory pricing, price discrimination) Limit pricing: set price just low enough to deter entry; Predatory pricing: price below cost to drive rivals out; Price discrimination: charge different prices to different consumer groups. Cost‑structure analysis to sustain low‑price periods Innovation to create barriers to entry Targeted advertising for each price segment Financing to absorb short‑run losses (predatory) or to manage multiple price‑setting mechanisms

3. Survival as a Primary Objective

3.1 Why firms may prioritise survival

  • Economic downturns – recessionary falls in demand reduce cash inflows.
  • High entry‑/exit barriers – large sunk costs make leaving the market costly.
  • Rapid technological change – firms must adapt quickly or become obsolete.
  • Financial constraints – limited access to external capital makes cash‑flow management vital.
  • Industry volatility – price swings in commodities or seasonal demand increase risk.

3.2 Key indicators of survival

Indicator Typical target Interpretation for survival
Cash‑flow ratio (operating cash flow ÷ cash outflows) > 1.0 Liquidity – the firm can meet short‑term obligations.
Break‑even output \( Q_{BE} \) ≤ expected sales volume Ensures total revenue covers total cost (\( TR = TC \)).
Debt‑to‑equity ratio < 2.0 Limits financial risk; excessive debt can force closure.
Current ratio (current assets ÷ current liabilities) ≥ 1.5 Another measure of short‑term solvency.
Market‑share trend Stable or rising Protects economies of scale and bargaining power.

3.3 Policies adopted to achieve survival

  1. Cost‑minimisation
    • Outsource non‑core activities (e.g., IT, logistics).
    • Adopt lean production or just‑in‑time inventory systems.
    • Negotiate longer‑term contracts with suppliers for better terms.
    • Review fixed‑cost structure – close under‑utilised plants.
  2. Revenue‑stabilising measures
    • Diversify product lines or services to spread demand risk.
    • Enter new geographic markets or online channels.
    • Use price‑elasticity analysis to set prices that maximise revenue while maintaining volume.
    • Introduce temporary promotions or “clear‑out” sales to free up cash‑tied inventory.
  3. Financial‑management policies
    • Maintain a cash reserve: \( C_{reserve}= \alpha \times C_{operating} \), where \(\alpha\) ≈ 0.2–0.3.
    • Prefer short‑term financing (overdrafts, revolving credit) only when cash‑flow forecasts are positive.
    • Regularly update break‑even analysis:
      \( Q_{BE}= \dfrac{FC}{P - AVC} \), where \(FC\) = fixed costs, \(P\) = price per unit, \(AVC\) = average variable cost.
    • Monitor working‑capital ratios (inventory turnover, receivables days).
  4. Strategic flexibility
    • Maintain adaptable production capacity (e.g., modular plants).
    • Invest in R&D to respond quickly to technological shifts.
    • Form strategic alliances, joint ventures or licensing agreements to share risk.
    • Consider mergers or acquisitions when they provide economies of scale or new capabilities.

4. Linking Objectives to the Cost‑Revenue‑Profit Framework (Topic 7.5)

Key link box
  • Profit maximisation – optimal point where \( MR = MC \); profit is the vertical distance between \( TR \) and \( TC \) at that output.
  • Survival – the firm must at least cover its variable costs: \( P \ge AVC \). If \( P < ATC \) but \( P \ge AVC \), the firm can continue operating in the short run (loss‑covering‑variable‑costs scenario).
  • Sales‑maximisation – occurs where marginal revenue is zero (\( MR = 0 \)); the firm produces the quantity that gives the highest total output.
  • Revenue‑maximisation – the peak of the \( TR \) curve, i.e. where \( d(TR)/dQ = 0 \). Profit may be normal (\( P = ATC \)) or slightly above/below.
  • Market‑share growth – the firm may operate where \( P < MC \) (penetration pricing) to expand output and gain share, accepting short‑run losses.
  • Strategic objectives – limit pricing sets \( P \) just low enough to make entry unattractive; predatory pricing sets \( P < AVC \) temporarily; price discrimination splits the demand curve to extract consumer surplus, moving different parts of the demand curve onto higher marginal revenues.

5. Market‑Structure Influence on Firm Objectives

Structure Entry barriers Price‑setting power Typical efficiency How each objective is pursued
Perfect competition None (free entry/exit) Price‑taker (P = MR = MC) Allocative & productive efficiency in the long run
  • Profit maximisation → normal profit (P = ATC).
  • Survival → shutdown rule: produce only if \( P \ge AVC \).
  • Sales‑maximisation & market‑share growth are irrelevant – firms cannot influence price.
Monopoly High (legal, natural, technological) Price‑setter (MR = MC) Potential X‑inefficiency
  • Profit maximisation – set \( MR = MC \), price > MC.
  • Survival – maintain price above \( AVC \); can sustain losses longer due to barriers.
  • Sales‑maximisation – rarely pursued; would require price close to marginal cost, reducing monopoly rent.
  • Market‑share growth – achieved through limit pricing or product differentiation.
  • Strategic objectives – limit pricing, predatory pricing, price discrimination.
Monopolistic competition Low‑moderate (product differentiation) Some – can set price above MC but below ATC in the short run Excess capacity in the long run
  • Profit maximisation – short‑run profit possible; long‑run normal profit.
  • Survival – rely on advertising and product variety to keep demand above \( AVC \).
  • Sales‑maximisation – heavy advertising to boost quantity even if margin falls.
  • Market‑share growth – frequent product launches and brand loyalty programmes.
  • Strategic objectives – price discrimination (e.g., student discounts) and limited use of limit pricing.
Oligopoly High (economies of scale, strategic interaction) Inter‑dependent – outcomes described by kinked‑demand, collusion or price leadership Often not allocatively efficient
  • Profit maximisation – may be achieved through tacit collusion (price above MC).
  • Survival – capacity coordination, joint R&D, or “price‑leadership” to avoid destructive price wars.
  • Sales‑maximisation – firms may temporarily cut price (penetration) to increase output and deter entry.
  • Market‑share growth – aggressive advertising, product bundling, or loyalty schemes.
  • Strategic objectives – limit pricing to keep potential entrants out; predatory pricing in a price war; price discrimination across regions or customer groups.

6. Growth Strategies and Survival

  • Organic (internal) growth – expanding output, adding product lines, improving processes.
  • External growth – mergers, acquisitions, horizontal/vertical integration, strategic alliances.
  • Cartels – collusive agreements to restrict output and raise prices; illegal in many jurisdictions but sometimes used to stabilise fragile markets.
  • Principal‑agent problem – owners may struggle to ensure managers act in the firm’s survival interest; solutions include performance‑related pay, monitoring, and corporate‑governance mechanisms.

7. Government Intervention that Affects Firm Objectives

  • Taxes & subsidies – lower taxes or production subsidies improve cash‑flow, often shifting a firm’s focus from profit maximisation to survival.
  • Price controls
    • Price floor (e.g., agricultural support) protects firms from prices falling below a survivable level – aids survival.
    • Price ceiling (e.g., rent control) can protect consumers but may force firms to adopt a survival‑oriented strategy or reduce output.
  • Regulation – safety, environmental or licensing rules raise costs; “regulatory relief” packages (tax breaks, compliance subsidies) are introduced to help firms maintain profitability or survive.
  • State bail‑outs / emergency financing – used for systemic firms (banks, airlines) to avoid wider economic fallout; the objective shifts from profit to macro‑economic stability.
  • Trade policy – tariffs or import quotas shield domestic firms, encouraging market‑share growth or survival against foreign competition.

8. Evaluation of Policies (AO2 & AO3)

8.1 Case study – Small clothing retailer in a recession (Survival)

Policy Intended effect Advantages (AO2) Disadvantages / Risks (AO3)
Reduced inventory levels Free up cash tied in stock Improves cash‑flow ratio; lowers holding costs. Risk of stock‑outs if demand recovers quickly; possible loss of customer goodwill.
Negotiated 15 % supplier discount for a longer contract Lower variable cost per unit Raises contribution margin; strengthens supplier relationship. Long‑term commitment may be costly if cheaper suppliers appear later.
“Clear‑out” discount campaign Increase turnover and convert inventory to cash Boosts sales volume; prevents fashion‑stock obsolescence. Reduces average price; may erode brand perception; short‑term profit falls.
Short‑term overdraft facility (3‑month payroll cover) Ensure timely wage payments Maintains employee morale; avoids costly turnover. Interest expense adds to financial burden; higher debt‑to‑equity ratio.

Result: cash‑flow ratio rose to 1.1, the firm avoided shutdown, and the owner retained a viable market position.

8.2 Evaluation of a non‑survival objective – Price discrimination (Revenue‑maximisation)

  • Advantages
    • Extracts more consumer surplus by charging each segment its willingness to pay.
    • Can increase total revenue without raising the average price for any single group.
    • Often feasible for firms with market power (e.g., airlines, utilities).
  • Disadvantages / Risks
    • Requires the ability to segment markets and prevent resale – costly monitoring.
    • May attract regulatory scrutiny for unfair pricing.
    • Can provoke consumer backlash or damage brand image if perceived as exploitative.
    • In highly competitive markets, rivals may undercut the higher‑priced segment, eroding the price‑discrimination advantage.

9. Comparative Summary of Main Firm Objectives

Aspect Profit maximisation Survival Sales‑maximisation Revenue‑maximisation
Primary goal Maximise \( \pi = TR - TC \) Continue operating in the long run Maximise output/sales volume Maximise total revenue \( TR \)
Decision horizon Short‑to‑medium term Long term (avoid exit) Often short‑term (market‑share battles) Medium to long term (especially for public‑sector firms)
Key condition on price \( MR = MC \) \( P \ge AVC \) (may accept \( P < ATC \)) \( MR = 0 \) \( d(TR)/dQ = 0 \) (peak of TR curve)
Typical policy focus Cost reduction, price optimisation, profit‑oriented advertising Liquidity management, cost control, cash‑flow stabilisation High output, aggressive promotion, capacity expansion Segmentation, price discrimination, revenue‑focused marketing

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