The Nature and Functions of Profits

Business Profit – the revenue of the firm minus the explicit and

accounting costs of the firm.

Economic Profit – revenue of the firm minus its explicit and

implicit cost

• Explicit costs – the actual out of pocket expenditures of the

firm to purchase or hire the inputs required in

production

• Implicit costs – value of the inputs owned and used by the

in its own production processes.

Theories of Profit

• Risk-Bearing Theories of Profit – above normal returns are required by firms to enter in such
field with above average risks.

• Frictional Theory of Profit – profits arise as result of friction or disturbances from long-run
equilibrium.

• Monopoly Theory of Profit – monopoly power can restrict output and charge higher prices than
under perfect competition, thereby earning profit.

• Innovation Theory of Profit – profit is the reward for the introduction of successful innovations.

• Managerial Efficiency Theory of Profit – if the average firm tends to earn only a normal return
on investment in the long-run, firms that are more efficient than the average would earn above
normal returns and profits.

Business Ethics – seeks to proscribe behavior that businesses, firm managers, and workers should not
engage in.

Management Tools for Optimization

• Benchmarking – the finding out, in an open and aboveboard way, how other firms may be doing
something better.

• Total Quality Management –refers to constantly improving the quality of products and the firm’s
processes so as to constantly deliver increasing value to customers. (ex. Harley Davidson, Ford)

Five rules determine the success of a TQM Program

1. The CEO must strongly support it with words and actions.

 2. The TQM program must clearly show how it benefits customers and creates value for the firm.

3. The TQM program must have a few clear strategic goals; it must ask, What is the firm trying to
accomplish?

4. The TQM program must provide quick financial returns and compensation.

5. The TQM program should be tailored to a particular firm.

• Reengineering – involves the radical redesign of all the firm’s processes to achieve major gains
in speed, quality, service, and profitability.

• Learning Organization – values continuing learning, both individual and collective, and believe
that competitive advantage derives from and requires continuous learning in the information age.

LO is Based on 5 Basic Ingredients:

1. New Mental Model – people must put aside old ways of thinking and be willing to change.

2. Personal Mastery – firm employees must learn to be open with others and listen rather than
telling others what to do.

3. System thinking – everyone in the organization must have an understanding of how the firm really
works.

4. Shared vision – all firm’s employees must share the same strategy.

5. Team Learning- all the firm’s employees can be made to work and learn together to realize the shared
vision and carry out the strategy of the firm.

Other Management Tools:

1. Broadbanding – the elimination of multiple salary grades to foster movement among jobs within
the firm, thus increasing flexibility and lowering costs.

2. Direct business model – firm deals directly deal with consumers , thus eliminating the time and
cost of third party distribution.

3. Networking – the forming of temporary strategic alliances where each firm contributes its
competency.

4. Pricing power – ability of a firm to raise prices faster than the rise in its costs or to lower its costs
faster than the fall in prices at which the firm sells – resulting to increase in profit.

5. Process management – the coordination or integration under single umbrella of all the firm’s
performance management initiatives- benchmarking, reengineering, TQM and Six Sigma.

6. Virtual management – the ability of manager to simulate consumer behavior using computer models
based on the emerging science or theory of complexity.