When a small business is first getting started, its goal may appear relatively straight forward: to make as much money as possible for its owners. But for a business to be successful long term, a new enterprise needs to balance the most basic goal of making money with the more immediate requirement of winning over customers. These two motivations are the basic difference between profit and revenue maximization and illustrates the difficulty in choosing the appropriate strategy for a small business just starting out.
Revenue is essentially another word for sales, or how much of the good or service that your business produces is sold to consumers. Revenue does not take into consideration the costs necessary to produce or market your business’s product, so it does not reflect what the owners ultimately receive. A revenue maximization strategy dictates that a business should do whatever is required to sell as much of its product as possible.
Profit is the amount of value that remains after you subtract the expenses your business incurs during the year from the amount of revenue it produces. In addition to additional cash, profit could be defined as a decrease in liabilities, an increase in assets, or an increase in the owners’ value in the company.
Profit maximization describes when a business can sell a product so that the marginal revenue equals the marginal cost when the value of marginal cost is increasing. What this means is that the production and sale of the business’s product reach a point that if the business were to sell one more unit, it would begin to lose money because the costs of producing that unit would exceed the unit’s price on the market. Achieving this goal with precision in the real world is difficult, but it illustrates the overall strategy of maximizing the owners’ annual return, even if that means not making sales that could have been made if the business produced more.
Profit vs. Revenue Maximization
The long-term strategy of any business is to maximize profits because maximizing personal profit is why people start businesses. However, when a small business begins, it may choose to maximize revenue to the detriment of short-term profits so it can build market share and a reputation in the market. Market share is the portion of total sales volume a company controls in a given market.
After a business generates a reputation in the market, it can then shift to profit maximization. Part of this strategy will invariably involve decreasing expenses, which more established and experienced businesses can do by acting on the lessons they have learned in their earlier years and improving bargaining positions with their suppliers. But another part may involve raising the price, which will probably alienate some customers, decreasing revenue. However, profit would still increase.
The difficulty for any business is determining when to shift strategy from revenue maximization to profit maximization or vice versa. A lot of this decision has to do with decisions of entering into new markets. While your business may have a reputation in one region, your business may need to cultivate that image when you enter into a new region, requiring you to take a revenue maximization approach. Consult with an experienced financial consultant when making these decisions. While every effort has been taken to ensure that this article is complete and accurate, it is not intended to be legal advice.
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