SM139 The Objectives of Organisations Kevin Hinde 1 What are organisations? “Even in the most libertarian of free-market economies, individuals voluntarily surrender their freedom of action in order to form and join organisations.” – Bruce Lyons in Hargreaves Heap et al (1993) The Theory of Choice. A critical guide, Blackwell, London. p155. They transform inputs into outputs with some aim in mind. Types of organisations Private sector Small business, partnerships, cooperatives, Limited Companies (including large multinationals. Public sector Local government, Central Government, schools, hospitals Quasi-Governmental Regulators such as OFTEL, OFT Charitable Sector What about churches, trade unions? Public sector Public Interest Theory – Civil Servants and politicians seen as maximisers of social welfare. – acting in pursuit of the public rather than private interests, e.g. where markets fail. – Civil servant seen to be trustworthy and a disinterested expert. Criticism of Public interest theory difficulties in defining the public interest. Institutions seen as political instruments Regulators are usually politicians or civil servants and critics argue that they have their own agendas. regulatory capture. competition for power between interest groups which provides the various forms of regulation. Alternative views – Niskanen (1971) emphasises the propensity of bureaucrats to maximise agency budgets. – Dunleavy (1991) notes how agents of regulation engage in „bureau-shaping‟ to create job satisfaction. – Majone (1996) points out how regulators seek to maximise the scope of their political influence across activities and space However…… Civil servants and politicians are accountable to parliaments parliamentary bodies and independent scrutinisers – (e.g. the National Audit Office and the Media). Civil servants can act in the public interest if appropriate incentive schemes are in place. – the existence of a competitive managerial labour market as well as remuneration packages. There has also been a greater emphasis on competition in recent times, e.g privatisation, liberalisation, compulsory competitive tendering, Best Value. Private sector firms Objectives are varied but the dominant one is profit maximisation. But what is profit maximisation? This occurs at the output level where the organisation's Total revenue (TR) most greatly exceeds its Total Cost (TC ) Normal profit and economic profit Economists definition of cost The opportunity cost of an input. I.e. the cost of putting that input to its next best alternative use. However, economists include normal profit in their analysis of costs. „normal profit‟, i.e. a return to the investors /entrepreneurs that reflects the risk associated with their investment and which just keeps them from exiting that activity. Economic profit (Sometimes called abnormal or supernormal profit) is profit from market power. In perfect competition firms can only earn a normal return in the long run. A simple example Assume a linear demand and constant marginal (and so average) costs. We will use a numerical example. Total Revenue Price Quantity Total Revenue 6 0 0 5 1 5 4 2 8 3 3 9 2 4 8 1 5 5 0 6 0 TR Demand and Total Revenue Graph A 9 TR 0 3 6 Q Price 6 D Graph B 3 AR = D 0 3 6 Q Marginal Revenue TR C A Graph A B TR 0 Q P,MR Graph B A C X AR = D 0 Q1 Q2 Q MR Costs and profit TC Graph A TC 0 Q MC Graph B MC=AC 0 Q Profit maximisation under perfect competition: TR, TC ‘Break even’? TC Graph A X TR 0 Q P,MR, MC Graph B Y MC=AC AR = D 0 Qpc Q MR Profit maximisation with market power TR,TC C Graph A TC TR 0 Q P,MR, MC Graph B X MC=AC AR = D 0 Qm Qpc Q MR Profit maximisation with market power TR,TC C Graph A TC TR 0 Q P,MR, MC Graph B Pm Ppc MC=AC AR = D 0 Qm Qpc Q MR Alternatives to profit maximisation: the divorce of ownership from control Sales maximisation (Baumol 1959) Growth maximisation (Marris 1964) Utility maximisation (Williamson 1959) Satisficing (Cyert and March 1963). Emphasis on managers with bounded rationality. However, profit maximisation bounces back. “The Firm is a legal fiction that serves as a nexus of contracts” Jensen M. C and Meckling W. H (1976). Principal Agent analysis stresses the role of incentives to encourage errant managers to maximise profits rather than their own objectives.