A Note on Profit Maximization

What makes a simple argument a good argument? This question has been addressed several times in the history of human thought and now answers have an incredibly long tradition. Just to name one, I believe amongst the first to deal with this problem were Greek philosophers. Aristotle introduced syllogisms to unveil some of the logic behind human reasoning, and to help create sound solid arguments. Is the idea that the one and only goal of business is to maximize their profits a bullet-proof, i.e. sound, consistent, and solid concept? Do its foundations and logic still stand in the face of evidence and theoretical advancements in the management field? This post is an attempt to provide some (not definitive) thoughts on this.

The reasoning is organized as follows. First, I explore the meaning of the concept (profits and maximization), then I try to dig into management theories and see whether they match the idea of a profit-maximizing firm or not. I try to keep this short. Further support to some of the points I discuss can be found in the business literature.

1. What is 'profit'? At its very core, a profit is a positive in the difference between revenues and costs (any type of costs). Translated into common and more practical sense, this means that the higher this positive number, the better. Fine. However, given that families, governments, NGOs, universities, and all organizations and insitutions all have revenues and costs, we may well convene on the fact that they also need to have a positive outcome from that difference. Can you imagine to manage your family with permanent losses over the years? Certainly not. If this is the case, then profit must be a goal for a family too. And to some extent it is so. What I am trying to point out is that a positive balance between costs and revenues is a requirement for almost every organization to survive. Business organizations are no exception. From this perspective, an emphasis on profit (and only on it) is unjustified. A nation State collapses as well if the government does not manage to get the economy right (e.g., Greece, Italy, Spain, etc.).

2. The word 'maximization' is something that comes from the mathematical procedure of optimization, where a max or min is found for a given set of variables. There is nothing wrong with this. The problem start to arise when the procedure is applied to social phenomena. There is no sigle occurrence in the life of a company where the decision makers (e.g., management, executives, employees) know all alternatives (variables) available. Were they to know these variables, they would not be able to process them. These two elements combined describe what is called 'bounded rationality' (Simon, 1955; 1947). Human beings cannot 'optimize' or 'maximize' because of the limits of their cognition and of access to information available. We can only find satisfactory solutions to our problems. Consistently with this, business organizations can only find profit levels that satisfy their needs. No way to 'maximize'.

3. The way profit comes out of an economic statement tells it all about how many goals a company's executive should consider in ordinary business management. The reasoning behind it is that there several other goals and sub-goals in the management of an orgainzation that cannot be treated as simply instrumental. To mention two, for example take customers and employees. An easy way for a business to fail is to treat these two categories of people as means (instruments towards profits) instead of ends per se. To provide a good quality, reliable, sound, functional product or service is a goal that should be considered as a value, that of providing solutions and/or help customers with what they need (or they think they need). Similar approach can be found in how to deal with employees. A receipt for failure is to use people as things (i.e., as means towards an end) instead of taking what everyone has to offer to the company, enriching and expanding employees engagement in the common/shared enterprise. A somewhat detailed account of this is available in an article I published in Business & Society Review as a critique to those that still try to apply the idea of perfect competition as a solution for every problem that appears in the market.
In short, there are multiple goals that can be found in every business organization. The hierarchy or chain of these goals may or may not be clear even to management. But complexity, ambiguity, and uncertainty is what we deal with all the time as human beings. Pretending that there is one only goal for something as complex as a business organization is like staring at the finger when someone is pointing at the moon.

4. Along the lines of this, there is the 'stakeholders vs stockholders' debate. The concept of stakeholders – i.e., individuals and groups that affect and are affected by the company in its business operations – has been introduced in the 1960s and made popular by Freeman (1984). The idea was presented to contrast the idea that the only group the company should be accountable to were stockholders – i.e., those who own shares of the company. After several years, the stakeholder theory is widely accepted among management scholars and amongst most of the business people that operate in large companies. Why? Because it is fairly easy to see how it works in practice: business people deal every day with many different individuals and groups and they should find appropriate ways to cope with their claims. This approach has some limits but it has been particularly successful in debunking the simplistic approach to businesses that reduces everything to stockholders claims. In an article that appeared in the journal Organization Science, Freeman et al (2004) explain why the stakeholder approach has more explanatory power than the other, more traditional, stockholder approach.

5. The modern (social and cognitive) psychology of individual decision making is focuses on biases and heuristics (e.g., Kahneman, 2003). A bias is a misjudgement on a particular topic, problem, or issue that an individual is facing. Heuristics are the mechanisms that make us decide without having to fully analyze all variables of a given problem. Human reasoning leans extensively on these two mechanisms. Someone has suggested that our mind cannot work if we keep heuristics and biases out (Bardone, 2011; see also the review of the book I wrote here). If these approaches to cognition are correct, then we certainly are not capable of predicting a way that aligns all resources in an effort to maximize anything (not to talk about profits). Easy steps towards profit making can be reached via heuristics and biased judgements but, as we stated before, if that is the case, it means that they are not logical. Indeed they are coming out of logical fallacies (see chapter 4 and 5 of my book; Secchi, 2011).

6. The last point I would like to touch on this is the role of passion. As business students we never touch on this but, we have to admit, this is something that exists. And we should be thankful every day for being exposed to it.  The assumption with the goal of profit making is that we forget to distinguish between the company and the actual individual that makes decisions on an every day basis. If we admit this obvious distinction, we can find that even in the case the goal is, say, that of making profits, a company should always lean on single individuals and hope that this goal exactly matches those of individuals that make decisions on a daily basis. Now, this event does not happen very often. Actually, it never happens! Unfortunately for the theorists of profit maximization, individual motives, personal goals, professional ans self-actualization needs, life-work balances, and passions - yes, that too! - vary significantly within an organization. Even the most dedicated employees has multiple goals in his/her life and may or may not have passion for his/her work. When passion gets in the way of work, then the employee may find him- or herself motivated by that, usually forgetting about other objectives. Is this bad for the company? Well… I don't think this should be answered by me here. One thing is for sure: everybody is different and everyone has diverse approaches to work, goals, and interprets similar phenomena differently. How could theorists of profit max be sure that this goal is well received by everyone working in the company?

This is a long post; longer than expected. Anyway, I hope I have given you some food for thoughts!
(I don't have time to read this again; apologies for the many mistakes)

The Next Step in Fair Labor

Apple, Hewlett-Packard, two giant companies working in the electronic computer industry, are taking steps to reduce the number of student workers in their Chinese manufacturing suppliers. Why?

The idea of students working in a manufacturing company to make up some money has never been a bad thing. A period of time spent in a company – i.e., internships, apprenticeship, stages, and the like – is usually good experience for the students as it exposes them to real work, they have a chance to put into practice what they have learned, and could provide a smooth entry to the job market. How could this experience harm students? Why large US companies want Chinese suppliers to reduce student labor?

I know what you may be thinking but we are not concerned with elementary school students. Hence, this is not yet another child labor issue. According to an article that appeared February 7, 2013 in the New York Times, some Chinese factories use temporary, high school student, and vocational school student workers to face high spikes of production. In these cases, students are asked to work long hours on something that is sometimes unrelated to their studies. School principals receive a bonus for sending their students to the factories. Moreover, there have been some issues of forced labor. This is a clear violation of elementary principles of responsible labor set by the International Labor Organization's (ILO) Declaration on Fundamental Principles and Rights at Work, Principle 2.

There are two issues that deal more directly with corporate social responsibility. First, these temp and student workers perform their jobs for free. The assumption is that the work program in the factory helps them learn how to perform a job. What if they don't need that type of job? What if it is unrelated with their studies? What if the job is repetitive and takes just a few hours to be learned? In short, are we talking about a "fair" contract between the company and its unpaid workers? What is the rationale behind the process?

Second, for a company – such as HP or Apple – that proclaims its social responsibility and strongly advocates for it, forced labor is one of the most regrettable events that can happen. Of course, if this manifests in the company on in one of its supplier really makes little difference (do you agree with this?). Forced labor is close to slavery and this is why it is particularly and vehemently opposed by the ILO and companies that make public statements on their social responsible policies.

Now, how could the problem be sold? HP and Apple declared that they are going to inspect the factories of their suppliers to monitor employment of temporary and student workers. Is this enough? Is this a 'rational' step? How can these company make better use of their resources and help their suppliers cope with the problem? While the second definitely is a relevant issue in social responsibility of corporations, is the first topic touched above of real concern? Why is it so?

A multi-billion dollar company has resources to cope with any issue. Why not help schools set up internship programs that actually match student curricula?

A positive note is that it seems that labor issues in international social responsibility are finally moving forward and beyond the usual (unfortunately still unsolved) problem with child labor. This is a fine step in the evolution of the social responsibility of employment relations.