MANAGERIAL
THEORIES
BAUMOL THEORY
• According
to
Baumol,
sales
revenue
maximization is the most important goal of
managers.
Models
Static Model of Sales
Maximization
Without
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Dynamic Model of
Sales Maximization
With
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STATIC MODEL OF SALES
MAXIMISATION
• Given minimum acceptable level of profit, the basic
assumptions of the model are :-The time horizon of the firm is a single period.
-The firm is aiming for only that particular period it
ignores what will happen in the subsequent periods as a
result of decision taken in current period.
-The certain minimum profit constraint is determined by
the market conditions.
-Demand curve is downward sloping curve and average
unit curve is U-shape.
STATIC MODEL WITHOUT
ADVERTISEMENT
• In figure TC – Total Cost, TR – Total Revenue ∏- Profit. X1 –
Output level where profit level is maximum.X2 – Output level
where profit is less than at X1 but sales are more.
• Sales maximiser sells at price lower than
profit maximiser.
• Firm will not increase its sales beyond X2,
because if profit is less than ∏ SM , It will
not be acceptable to share holder and other
lending Institutions and Managers.
STATIC MODEL WITH
ADVERTISMENT
• We assume that sales revenue increases with
advertising expenses.
• An Oligopolistic firm will prefer to go for sales
maximization via an increase in advertisement
rather than a price cut.
• The sales maximiser decides on optimum
advertisement by examining its impact on sales
revenue.
• TC – Total cost (CC1+AC), BC – Production cost, TR – Total
Revenue, ∏ - Profit (TR-TC), ∏max - Maximum Profit, ∏SM =Sales
maximization profit, A ∏ = Advertisement expenditure incurred
by a profit maximiser, AS = Advertisement expenditure incurred
by a sales maximiser.
• This implies that with increase in advertisement
expenditure, total cost, sales revenue and hence profit,
all increase proportionately.
• Production cost shown by BC line is assumed to be
independent of advertising cost.
• If price is such as to enable the firm to sell an output
yielding profit above the minimum acceptable profit
level, firms will go for higher advertisement
expenditure and yield greater revenue.
• However, if profit falls below ∏ SM , the firms cost
become too high and firm will cut back on
advertisement.
• Thus sales maximiser will spend more on advertisement
than a profit maximiser.
LIMITATIONS OF STATIC
MODEL
• Assumption of constant price for all product is not
realistic.
• Production cost is assumed to be independent of
advertising expenditure. However with advertisement,
the sales increase and physical volume of output
increases leading to economies of sale, a firm already
producing at maximum possible efficiency may face
diseconomies of sale. This will effect the production
cost of the firm, whether it strives for sales
maximisation or profit maximisation.
DYNAMIC MODEL OF SALES
MAXIMISATION
• Assumption:The objective of the firm is to maximise the rate
of growth of sales revenue over its lifetime.
Sales revenue (R) grows at the rate of ‘g’
percent.
Profit is not taken as a given exogenous variable,
which acts like a constraint in the static.
Demand and cost curves have traditional shapes
as in the static model.
• R,R(1+g), R(1+g)2, ----R (1+g)n
The present value of this stream of future revenue is
estimated by discount formula.
 1 g   1 g 
1 g 
R, R
,
R
,



R
 



 1 i   1 i 
 1 i 
2
n
Where i is rate of discount. The total present
(discounted) value of all future revenue is
n
S 
t 0
1 g 
R
 (n  0,1,2,-- - - n)
 1 i 
t
S = Future stream of sale
• The growth function is derived from profit
function, as growth of firm is mainly financed
by retained profits.
• Highest attainable growth rate is achieved when
profit is maximised.
• To find equilibrium a firm, we will use iso present value
curve, which shows all present value of g & R which
yield same value of S.
S  a1 g  a 2 R
a2
1
g SR
a1
a1
1
a1
R S g
a2
a2
• Point E in the figure represents the point of tangency of iso
present value curve to the growth curve . Thus firm will choose
ge & Re to get the highest possible level of S subject to the
growth constraint.
LIMITATIONS
• It try to explain long run behaviour of sales
maximising firm. However in long run market
demand, prices of factors of production etc.
change. This model does not take these changes
into account.
MARRIS MODEL OF
MANAGERIAL ECONOMICS
• Aim – firm’s aim at balanced rate of growth (G)
• This can be achieved by maximization of rate of
growth of demand for the product of firm (GD)
and the rate of growth of capital supply (GS)
• To achieve the above growth management faces
two types of constraint on its growthManagerial Constraint
Financial constraint
Managerial Constraint
• Decision making and planning skills of the
manager
• Co-ordination, cooperation and good team work
– this requires experience
• Research and development
Financial Constraint
• Job security
• Fear of takeover and merger
To avoid these risk, manager should choose a prudent financial
policy consisting of three financial ratios –
 Debt equity ratio – value of debts to total assets
Lower the value better it is
 Liquidity ratio – total liquid assets to total assets
ratio is too low – risk of insolvency
ratio is too high – risk of take over
 Retention ratio – retained profit to total profit
important source of finance for growth of capital, but firms
needs to distribute a part to satisfy the shareholders
Equilibrium of firm
• U managers = f(GD)
• U owners = f(GS)
• Condition of equilibrium is
GD = GS = G
Where GD = f(d,k)
and GS = r(∏)
d= diversification / differentiation of product
k= success rate of new product
r= financial security ratio assumed to be constant
proportion of profit(∏)
Critical Evaluation
• Marris assumes cost structure and price to be given,
thus profit as given which is not true
• Marris theory does not account for the
interdependence in firm’s decision making
• During industrial slowdown the manager’s aim will be
to retain the existing power in the market rather than a
balanced rate of growth
• During industrial slowdown process firm may not be
doing well not because of managerial inefficiency but
because the overall atmosphere is not conducive to
business
• Marris talks about only two constraint. In real life –
firm face social, cultural, environmental etc
BEHAVIOURAL MODEL
• Behavioral theory view business firm engaging
in non- maximizing behavior. Firm emerges as a
satisfier rather than maxi miser.
• Simaon Satisfying Model
• Cyert and March Model
Simon Satisfying Model
• Constraint of incomplete information, imperfect data
and uncertainty about future creates difficulty for
managers to get to optimum decision
• Thus managers look for the second best situation,
which is called the satisfying behavior.
• Thus manager look for satisfactory level of profit
rather than profit maximizing behavior and satisfactory
level of cost rather than cost minimizing behavior.
Critical Evaluation
• Simon assumed that organizational behavior and
individual behavior are comparable.
• Model is not concrete – talks about incomplete
knowledge and information but doesn’t specify
the kind of information
• Model talks about satisfactory level – subjective
concept
Model of Cyert and March
• They have stressed on decision making process of
multi product firm under uncertainty in an imperfect
market
• Assumptions –
 In a firm there are many groups with conflicting
behavior on interest.
 One has to develop the goals of various groups
 One has to develop the overall environment of the firm
 There has to be treatment of uncertainty
Goals of individual group
• Firm is considered to have multi- goal
• Organization comprises of workers, managers,
shareholders, suppliers, customers, bankers, tax
collectors each having different goals.
• To know the goals one needs to know the
origin and decision making process which leads
to their formation
Goal of the firm
Demand of the members of the coalition
Factors such as aspirations of the members, past
achievements,
their
expectations,
the
achievements of other groups in same or other
firms, the information available to them.
• The demand of the different groups are competing for
the given resources of the firm, and there is a
continuous conflict
• The relationship between demand (aspirations ) and the
past achievements depends on the performance of the
firm and the changes in the environment
 Steady situation – aspirations tend to be equal to past
achievements.
 Dynamic situation – aspirations lag behind
achievements excess profit / surpluses.
 Recession situation - aspirations are larger than past
achievements
Goal of the firm
• The five main goal set by the firm are –
Production goal
Inventory goal
respective dept.
Market share goal
Profit goal
top management
Resolution of conflict
•
•
•
•
•
Money payments
Side payments
monetary
Slack payments
Sequential hearing to demand
Decentralizing decision making
qualitative
Treatment of uncertainty
• Market uncertainty
Due to - incomplete information about changing
taste & preferences, changes in methods
of production.
Minimize -market survey and R& D
• Uncertainty about competitor’s reaction
Minimize – by forming collusion with rivals
Critical Evaluation
• The model fails to address as to how
interdependence of firms will influence the
action taken by top management to solve
various conflicting situations.
• Cyert and March deal with one form of slack i.e.
the managerial slack. Other important forms of
organizational slacks were ignored by them.
WILLIAMSON MODEL
• Managers have discretion in pursuing policies
which maximise their utility rather than that of
owner shareholder.
• Profit acts as a constraint to this exercise.
• The utility function includes one measurable
variable namely, salary and other nonmeasurable ones like security, power, status,
prestige, professional excellence.
• To formalize the model, one has to take proxy
variables to these non-measurable ones.
WILLIAMSON MODEL
• These proxy variables taken are emoluments of managers or
slack in the form of luxury offices, company car, etc. or the
expenditure which are incurred at the discretion of the
managers. This reflect their power, status, prestige, professional
excellence.
• These remunerations have their own advantage (comparison to
salaries), as the person getting these will get tax benefits.
• Such payments catch less attention from the shareholders and
labour force.
• Also, status & power of managers is associated with the
discretion they have in undertaking investment. Discretionary
investment expenditure gives satisfaction to manager because it
allows them to materialize their personal favorite projects.
WILLIAMSON MODEL
The model can be written as follows:
Um ~f (s,m,i).
s = staff expenditure, including managerial salary.
m = managerial remunerations (slack).
i = discretionary investment.
The aim is to maximize the value of Um.
Critical Evaluation
• Model is valid for large firms where there is
scope of product differentiation an discretionary
investment
• This model doesn’t talk about the managerial
behavior of firm in relation to the rival firms
and its impact on utility function