- Fixed costs are R15-00 per unit
As can be seen from the above table, MR=MC at an output of 8 units. To produce the ninth unit, marginal cost will exceed marginal revenue. This will result in a reduction in total profits. Profits are therefore maximized on the production of 8 units, which produces the maximum profit of R7-50. Evidently, chasing revenue at all costs will result in a loss of R2-50 after the tenth unit is sold and greater losses with each further sale.
Obviously, my firm will exert all its resources to achieve profit maximization through continued growth and acceptable returns for its shareholders in the current financial year. This is essential for sustained investment by the shareholders and for good media reports (invisible yield). It does, however, appreciate that to continue to grow and be successful in the longer term, it also needs to consider the interests of all its other stakeholders. To this end, the Group’s desired strategic positioning depends on i.a. the following focus areas:
Shareholders:
My firm’s large exposure to the retail market has resulted in a cost base that is higher than the norm. Therefore, to enhance profitability and flexibility, cost growth must be reduced. The focus is on implementing an integrated e-enabled delivery platform and optimizing the value chain.
Customers:
The aim is to ensure the delivery of services either physically or digitally, as preferred by the customer, thus providing a multi-choice delivery solution for the customer.
Staff:
Human talent is becoming an increasingly scarce commodity. It is, therefore, paramount to attract, retain and develop intellectual capital in the Group. There are a number of initiatives underway to achieve this.
Social responsibilities:
The social investment programme, which includes both financial and non-financial resources, consists of donations and grants to civil society organizations, socially responsible sponsorships and commercial ventures. The Group also supports education, HIV/Aids, entrepreneurship and the visual arts.
Special emphasis has been placed on integrating the Group’s black economic empowerment initiatives. The aim is to ensure the achievement of the sustainable social and economic advancement of the South African population, individuals (both staff and customers) and businesses.
Conflict between ownership and management (principal and agent)
Davies et al. (2001) pose the question “Do firms really try to maximize profits?” They point out that the assumption of profit maximization may be unrealistic in a world where ownership and control are in different hands. They also question whether Berle and Means (1932) got it wrong! (See appendix note 1)
In hindsight, after the calamities of Enron, Andersen and Worldcom – not forgetting Leisurenet, Regal and Saambou Bank, we can quite confidently tell Davies et al. (2001) that Berle and Means were spot on.
My firm has taken cognizance of this endemic conflict and the organizational architecture has been established accordingly. The framework suggested by Brickley et al. (2001) i.e. “the three legged stool” is adopted throughout the Group, viz.,
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The assignment of decision rights
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The methods of rewarding individuals See appendix note 2
- Performance evaluation systems
X-inefficiencies
“When people and organizations, for a variety of reasons, normally work neither as hard nor as effectively as they could” is how Leibenstein (1966) described what he called X-inefficiency.
“The conflict between agent and principal is the source of x-inefficiencies” (Kamecke, 1993)
Under the profit-maximizing concept, it is assumed that a firm incurs the minimum costs achievable. Such a firm may be described as being X-efficient. However, this is surely not true in the case of monopolies, and even less so in the case of regulated monopolies. In fact, this could be an anomaly in any principal/agent relationship, where the agent in his “self-interest” may aim at maximizing his personal utility.
How does a firm e.g. a banking firm, that continues to be inefficient, remain economically viable and not get driven out of the market? An empirical study conducted by Kwan et al. (1995) found that smaller banking firms are relatively less efficient than the average large firm, and further, that less efficient banking firms are associated with higher risk taking. This appears to offset the inefficiencies and enable profit-maximization.
Question2
Describe the nature of supply and demand for labour relevant to your firm. Outline as carefully as you can how rates of pay are actually determined. Is the concept of “the internal labour market” relevant? If so, why? If not, why not?
Skills categorized
As can be seen from this table, only a very small percentage of employees, in fact less than 1.2% of the total work force is highly skilled. These highly skilled employees need to be retained, because the cost of losing them far exceeds the cost of retaining them. They are also employed in strategic positions and as such possess information that would be invaluable to our competitors. Also, and I quote from Brickley et al. (2001, pg.339) “Individuals will not participate in an employment relationship unless they expect to receive at least their opportunity cost. If they do not receive their reservation utilities – the utility they could obtain in their next best alternative – they will quit and go to work for another firm (or withdraw from the labour force).”
Retention of highly skilled employees
To “lock in” the highly skilled employees, my firm makes use of various and variable remuneration plans. It also uses the sustainable contributions of employees as the basis for annual reviews.
Several incentive schemes are also in operation at divisional and subsidiary level within the Group, and are custom designed to suit the particular needs and circumstances of these entities. An overriding principle of these schemes is the creation of shareholder value. A further important aspect is that such schemes must be self-funding. Over and above the normal fringe benefits, e.g. housing, car, health, pension/provident funds, etc., a number of additional attractions include share options, profit sharing, study bursaries and general recognition.
Skilled employees
The nature of my firm’s industry, viz., banking, requires a large number of skilled employees. A number of future highly skilled people can emanate from these ranks and as a result it is imperative to ensure that their remuneration is market related. All these employees participate in the various incentive schemes in one way or another. Remuneration is reviewed once a year to ensure that employees, who contribute to the success of the Group and who have the potential to sustain performance, are remunerated competitively.
“Unskilled” workers
It is recognised, i.a. as a social responsibility, within my company that special efforts are required to assist in the development of employees who, through lack of past opportunities, do not possess the necessary skills. These employees are given the opportunity and exposure to grow. A number of promotions from messenger to clerk have taken place. One employee who was initially a messenger is now a supervisor of a relatively large department. Incidentally, even these unskilled workers participate in the profit share scheme.
Determination of rates of pay
- Job value: This is a process whereby the relative worth of various jobs are ranked to achieve internal and external parity, by applying a recognized job evaluation system for internal use.
- Market value: To achieve external parity, comparisons with specific markets are continuously drawn, thereby comparing individual packages and developing remuneration scales for the respective job groups. These remuneration scales establish a realistic and competitive price for labour. Liaison with the remuneration departments of competitors also takes place regularly to obtain remuneration information. During the annual review of package scales, a strategic decision is made regarding the position my firm wishes to occupy in respect of the market. This decision is influenced by labour turnover and losses to competitors; the supply of labour for the company’s specific needs; and affordability.
- Individual value: To compare individual packages and where necessary achieve employee parity, the worth of each employee is determined within the specific job as well as other jobs so that employees can be remunerated equitably. The individual’s outputs, measured by the performance evaluation process, carry the most weight in determining individual remuneration levels. An employee’s potential is also taken into account, as is the product of estimated ability and competence.
The internal labour market
Due to the limited number of highly skilled employees in the group, it is necessary on occasion to utilize the external labour market to fill strategic positions. However, the internal labour market will usually be used to fill most positions. There are certainly a number of employees within the large pool of “skilled” workers, who have been concentrating on their self-development over the years, who now can be classified as highly skilled. By utilising this internal market, these people have a chance to apply for positions and functions to which they aspire. It can also be more cost-efficient for the firm, at least to the extent of learning the culture, branding, training etc. At present the internal labour market has an additional benefit to the group. It facilitates its policy of avoiding retrenchments, by filling vacancies from within and allowing natural attrition to prevail.
Question 3
To what extent do government actions and/or behaviours and /or policies affect your firm, at both macro and micro levels? What seems to you to be the purpose of such government actions/behaviours/policies? Do they seem well conceived to you? Explain your answer carefully.
MACRO POLICY MEASURES
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Monetary Policy: “ Monetary policy consists primarily of decisions rather than actions or the application of measures” (Meijer, J.H.)
The monetary policy decisions that affect the environment in which my firm operates are, i.a. the following:
- Interest rates
An increase in interest rates, particularly from a high base, results in a squeeze on bank margins. This reduces profits and is exacerbated by a reduced demand for credit. Conversely, a reduction in interest rates enhances demand, as consumers consider the opportunity cost to be less than their next best alternative.
2) Inflation
High inflation will push interest rates up, which in the long run will have a negative impact on the economic growth of my firm. Low interest rates will prevail in an environment of low inflation, with the demand for credit increasing as industry can afford the costs of credit. Economic growth
will be evident and my firm will reap the benefits of this growth.
3) Exchange rate
It would be more beneficial for my firm to have low inflation with relatively low and stable interest rates - and hence a stronger Rand. This will fuel economic growth.
4) Employment/Unemployment
Economic growth is essential and paramount to employment. As the economy grows and my firm performs better, as a result of increased business, more employees will be needed to provide the additional products and services demanded.
5) Exchange Control
As the control is delegated to authorised dealers, such as my firm, this has major cost implications, as trained employees are required across the country to exercise the regulatory controls.
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Fiscal Policy: Although fiscal policy may be a macro-economic policy, it also has a micro-policy effect as it impinges directly on the cost curve of my firm. Examples can be taken from the most recent Budget.
- Personal income tax cuts are expected to be positive for growth in the bank’s lending, as the consumer is likely to spend additional income on fixed and movable assets.
- The increase in the interest exemption threshold favours bank deposits, as does the reduction in transfer duty, which should boost home lending.
MICRO POLICY MEASURES
The numerous Acts now in force bear testimony to the fact that there has been considerable transformation of the banking sector, demanding greater equity in terms of corporate governance and transparency.
Explanation
I agree. It ensures responsibility on employers, which otherwise might result in abuse. The costs of implementing requirements of this regulation are far less than for e.g. losing the lives of invaluable employees.
Explanation
Although the 10% capital/risk ratio may be insufficient (e.g. Saambou Bank) I believe it is necessary for the purpose stated. However, it has a negative impact on my firm’s cost curve and a higher requirement expected shortly, will reduce trading capital.
Explanation
One requirement, a banking license, requires a minimum capital requirement of R250 million. This is an entry barrier, which protects Joe Public, but inhibits additional competition, which will benefit my established firm.
Explanation
The Act says it all…”that as a result of apartheid there are disparities in employment, which create such pronounced disadvantages for certain categories of people that they cannot be redressed simply by repealing discriminatory laws.”
I agree! I also do not believe that the firm will suffer a loss of productivity or efficiency as a result of this action. Where candidates are equally qualified, productivity should not be affected and in cases where qualifications do differ, the differences are unlikely to be significant enough to affect productivity.
As regards “Black Economic Empowerment” I believe the latest proposals introduce a welcome direction for the economy. At a recent seminar for British business leaders, Phumzile Mlambo-Ngcuka, minister of mineral and energy affairs, said that companies not prepared to carry the cost of implementing economic empowerment should not do business in South Africa.
“Some companies may be put off but this is the price we have to pay”…”There is a cost in not doing it. You don’t want an unstable country and some of that cost you can’t even quantify”
In the short-term, as we are currently witnessing, firms are incorrectly applying quotas and targets to achieve equity. Job-hopping is occurring as businesses poach the limited supply of skilled blacks from each other. These actions are pushing up the price of labour and proving a costly exercise.
There are also alleged entry barriers: “Banks accused of hampering black empowerment firms”(Business Day, Tuesday, April 1, 2003)
In the long term, future growth can only be guaranteed if gross racial inequality is eliminated. Also significant is the argument that empowerment is also about expanding the production base, and will have strong multiplier effects on economic growth.
In summarising the above three questions we must realise that if firms fail to make profits over time, they will cease to exist. To this end the labour force is incentivised to perform optimally, and government regulations constrain resource misallocations where required, allowing firms to focus on profit maximization. The “three legs of the stool” need to be kept in balance to ensure an efficient organizational architecture, which is driven by the firm’s business strategy, which at the outset is driven by the external business environment, viz., technology, markets and regulation.
APPENDIX
Note 1
Berle and Means (1932) drew the conclusion that shareholders in firms where no shareholder held more than 20% ( for example) would not be able to exert control over the managers. Also because of their relatively small interest (max. 20%) unlikely to monitor the managers.
Baumol (revenue-maximizer) and Williamson (utility-maximizer) were inspired by the work of Berle and Means (1932). Their main discovery was that in large public firms, shareholdings were highly dispersed, with large numbers of small shareholders. Those shareholders, therefore, have relatively little invested compared to a manager and are consequently unlikely to exert much effort monitoring the running of a company.
Note 2
1) The assignment of decision rights
In my firm the ultimate decision rights are bestowed by the shareholders on a board of directors. The Group Chief Executive Officer (CEO) and Group Executive Committee (EXCO) are appointed by the Board to manage the group’s business within an acceptable risk profile and to achieve sustainable profits. The strategic decision rights remain the property of the executive directors and executive management, while the operating decision rights are filtered across the entire spectrum of employees, depending not entirely on seniority, but also to an increasing degree on capabilities.
2) The methods of rewarding individuals
All employees share to a limited extent in the profits of the Group, and can see on a monthly basis how their company is performing, by monitoring their share of such profits. There are various other incentive schemes in place, relevant to the particular area of work. A share option scheme is also utilised to retain especially high-skilled, intellectual capital. A large amount of flexibility is evident in the reward system, which is conducive to the diversification of the group. For example, life assurance sales people that do not earn a basic salary, but are rewarded on a purely commission basis.
3) Performance evaluation systems
With the continuous enhancements in technology, performance evaluation systems are being upgraded year on year, with the ever-increasing demand for more accuracy from the people being evaluated. These systems vary across divisions, according to the particular reward systems and goals of the respective units.