Baumol's Theory of Sales Revenue Maximisation

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.

Baumol’s Model of Sales Revenue maximisation.ppt