Sales Maximization Theory

Sales maximization theory is based on the work of American economist William Jack Baumol. The theory attempts to draw a conceptual framework to better understand the objectives and strategies of corporations operating in a competitive marketplace. Baumol's work helped economists as well as managers make sense of business decisions that often seemed to conflict with a profit maximization model and is an important body of work in microeconomics.

A business can focus on maximizing either revenue or profits, but usually cannot pursue both goals simultaneously. To maximize profits, the company has to sell its products or services at a healthy profit margin; in other words, it has to charge significantly more than what it costs to deliver the product or service. When attempting to maximize sales, however, a business must cut prices to very near costs. In fact, it is not uncommon for a newly-established company to sell at a loss to build a loyal consumer base and gain name recognition in the industry.

Professor Baumol observed that, contrary to prevailing assumptions, most businesses pursued maximum sales, as opposed to maximum profits, and that increasing sales has become the ultimate objective of most businesses. Maximum sales occur when further price cuts result in lower total sales revenue, since the increase in units sold doesn't make up for lower per-unit sales proceeds. Assume you're selling 1,000 bagels a day at $1.25 apiece and lowering prices to $1.20 will increase sales by 40 units. Presently, you're making $1,250, while the lower price will yield 1,040*1.2 = $1248. $1.25 therefore represents your revenue-maximizing price strategy

Although the ultimate long-term goal of a business is maximum profits, a revenue maximizing strategy has various benefits. First, it allows a business to build consumer loyalty. Once a sufficient number of buyers habitually buy the product, prices can be gently raised to increase profits. Secondly, maximum revenue results in higher output levels, which in turn can help reduce costs over the long term. Selling 1,000 instead of 200 bagels a day will allows the baker to buy flour in bulk at lower prices. It can also help move to larger industrial scale ovens to reduce the per-unit manufacturing costs.

In some exceptional cases, the strategy that will yield maximum sales will also maximize, or almost maximize profitability. This occurs when the marginal cost of delivering the product or service is nearly zero. Imagine a software developer that invests into writing the software and then charges end-users per online download. While it costs substantial amounts to produce the software, each extra unit downloaded by consumers costs practically nothing to deliver. Especially if the development occurred well in the past and has already been recognized by the accountants, revenue and profits are almost identical, since practically no costs must be deducted from sales to arrive at gross profit.