About a year ago, we sat in the lecture room at the philosophy department at Wits. It was 10 am. Our professor always began the class by writing a question on the board and asking us to write a short essay about it. She gave us about 20 minutes, after which debate ensued. On one occasion, the question was, “Should businesses seek to maximise profit?”
The knee-jerk answer is yes. After all, without surplus value, a business cannot invest in future products and services, nor can it absorb unfavourable market conditions. In its simplest form: if you buy tomatoes to resell them, you do so to accrue residual value from which you make a living. In other words, you factor in the time it took to buy the stock, take it to a more convenient spot for your customer, and handle all the administration. The sale price therefore reflects all of this, plus a premium for taking the risk. Framed this way, a tomato bought for R1 can be sold for R1.50 — or is R10 also justifiable? That is the nub of the question; should we seek to maximise profit?
Economists and philosophers have debated this topic for years, albeit on different grounds. Before I explain profit maximisation, it is important to distinguish price-takers from price-setters. In most competitive markets, companies are price-takers and customers are price-setters. Even in monopolies where it seems like companies set prices, they are likely controlling supply and taking a favourable price. A good example is De Beers, which consolidated the market by buying diamond mines and then stockpiling the diamonds until prices stabilised. The government often operates on the other side of the coin; it sets prices. For instance, the price of electricity in South Africa is set by the National Energy Regulator, and the markets respond. I will discuss profit maximisation from the price-taking point of view.
So, back to tomatoes. Suppose you bought tomatoes for R1 and sold them for R1.50. In each transaction, your business would make a 50c profit, and it would make sense to increase sales volumes. However, the more units sold, the more complicated the business would become. It would incur greater transport costs, payroll, spoilage, and attract competitors. At the same time, it would gain other advantages, like buying power and reputation, which reduce marginal costs and affect demand respectively. The CEO’s role would be to work out the number of tomatoes to sell at a given price point without making a marginal loss. This is profit maximisation.
The technical terms used are marginal revenue (MR) and marginal cost (MC). Marginal refers to the changes in cost/revenue. That is to say, what conditions necessitate selling 1 million tomatoes per day compared to 10? And at what point on that continuum does it no longer make sense to sell more, i.e. at what point is profit maximised? Economists say that point is where MR = MC. Framed this way, in a competitive market, businesses should aim to maximise profit.
By way of example, is Apple profit-maximal? The answer is complicated, but if we narrow it down to iPhones only, then the answer is that Apple is profit-maximising under monopolistic conditions. We know, for instance, that it makes up to a 60% margin on some of its iPhones. This means its marginal cost is significantly lower than the price. Therefore, it has room to produce and sell more phones at a lower price point. This is, in fact, what Apple has done; it has introduced lower-cost phones like the iPhone SE range. However, for the most part, Apple is like De Beers in its iPhone niche in that it has chosen to produce a lower quantity at a higher price. This position is not profit-maximal because Apple is likely leaving money on the table. But as I said, this is a complicated question because we do not know the extent to which Apple subsidises other services or invests in research and development with its marginal surplus.
It creates anticompetitive behaviour, as the courts have found, which causes users to overlook Bing, DuckDuckGo and other free search providers. Moreover, it concentrates search traffic, raises advertising prices and therefore reduces market participation in highly competitive niches because larger companies always outbid smaller ones. Moreover, we do not know Google’s marginal cost for serving ads. But one could expect it is significantly lower than the bid price; otherwise, it would not spend so much on distribution and, at the same time, invest in other products like Gemini and self-driving cars. Therefore, Google’s ads business is plausibly profit-maximal for Google, but not for the market since it excludes alternative search providers and potential advertisers.
What does all this mean for practitioners? A few years ago, Uber launched in South Africa. The drivers who pounced on the opportunity early made good money. Some introduced additional cars and paid them off quickly, all while smiling to the bank. Over time, more and more drivers joined Uber and competition rose. Some cars were burnt as taxi associations and metered taxis protested Uber. Moreover, other areas were prohibited for Uber drivers. Meanwhile, Uber was also enforcing its standards by discontinuing older cars and, in financial terms, forcing drivers to operate at higher marginal costs. In other words, the Uber market reached “profit maximisation”, but many Uber drivers, to this day, add more vehicles.
The point of profit maximisation is to look beyond unit economics, i.e. the net effect of one unit sold, and examine the extent to which market conditions remain conducive. The business leader, in other words, must ask, “What are the market conditions, and how are they changing?” Given these considerations, does it make sense to invest in more infrastructure to increase sales? Is it better to increase margins and sit on the cash to buy patience in an uncertain future, as Apple did? Is it better to buy and merge with other companies, as Sibanye-Stillwater did? Is it better to exit and pivot to another market, as Jaguar has done since 2021?
All these questions weigh on CEOs. If answered incorrectly, hundreds and sometimes thousands of people lose their jobs and suffer when the business shuts down. The upside is also true: correctly answered, scores of people enjoy improved quality of life as the business thrives. But the answers come from analysing profit (and perhaps more accurately, profit potential), not to drool over the prospect of making more money, but to ascertain market conditions and work out the most appropriate response.
Until next week,
Vusi.
P.S. There might be a phrase you missed earlier. I argued that profit maximisation is morally compelling, “at least according to this view.” I was hinting at another view that finds profit by definition morally problematic. I happen to find that view compelling and therefore struggle to reconcile it with my profit-seeking motives. But this is a topic for next week: Are there necessary evils in profit?
P.S. Many readers ask for my permission to share these articles with friends. The answer is an emphatic no! Do not share. Rather, keep these articles as a secret weapon to apply when needed. I joke. Please feel free to share.
