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PROFIT AND BUSINESS PROBLEMS
Profit, Money, and Prices.-Profit, viewed concretely, is a matter of money and prices. It is a matter of money, in that it is always a sum of dollars, pounds, francs, marks, or other financial units. Making profit is making money. The only way in which a business can get profits is to get dollars. Nothing else counts. Goods do not enter into profits unless they can be converted into money. Property does not enter into profits unless it can be sold for a sum of money. In modern business, profit is a purely pecuniary factor.
Money profits are obtainable because of a certain price relationship. This relationship is a spread between cost prices and selling prices. The margin between the prices which make up business receipts and the prices which make up business expenses is the profit margin. The only way known to a modern business man of gaining profit is to sell something for a price higher than the price paid for it. Modern business resolves itself into a series of price contracts for the purchase and sale of goods and services in terms of money. It is a connected mass of purchases and sales, and the margins between different prices within the system hold out the hope of pecuniary profit. The width of the price margin is counted in terms of money, and in no other terms.. The decisive consideration at every link in the chain of price bargains is the spread between cost and selling price. Business is dominated by the quest for profit, and profit is always a sum of money, and this sum of money is always a price spread created
by buying low and selling
high. This is all there is to gain or loss as modern business reckons the matter. The last term of all transactions is the money profit derived from the price spread.
Producing Goods versus Producing Profits.- Production involves not merely the creating of goods and services but also the creating of money profits.
Physical production of commodities is simply one form and aspect of production. From the standpoint of the community at large, economic welfare is served in proportion as the output of goods is great or small. Emphasis here upon production as a source of welfare is not to be taken as a neglect of other equally important sources, such as wise consumption, or equitable distribution of wealth. At this stage of the analysis, production is the indispensable factor in welfare. In later stages of analysis, the other factors will receive due consideration.
Physical production is an industrial process, and includes the processes of the farm, the mine, the factory, the railroad, and the warehouse. It employs the physical sciences and the technique of engineering in order to make its processes effective. The measurement of its volume reads in terms of pounds, yards, bushels, carloads. Its capital equipment is tangible machinery, buildings, rolling stock. The criterion of its effectiveness is the making of material goods and commodities for the use of society.
From the viewpoint of the welfare of society, maximum physical production is a primary desideratum. But in modern economic life, the pecuniary aspect of production has intervened. It has come to dominate the whole process of physical production. The point of view is business profit. Production is the making of money profit. Incidentally, more or less goods may have to be made in order to make money profit, but always the making of the goods is an incidental thing. The real nature of production, as business views the matter, is the pursuit of profits. Business welfare is served in proportion as the piling up of profits is great or small. Business production is a pecuniary process, and includes the strategies of cutting costs, of calculating price movements, of salesmanship, and of financing. It employs statistics, accounting, and the technique of pricing, borrowing and lending, and buying and selling, in order to make its processes effective. The measurement of its volume runs in terms of dollars and cents. Its capital is stocks, bonds, and valuable property rights. The criterion of its effectiveness is dividends, surplus, and undivided profits. The balance sheet and the profit and loss statements are its cardinal documents. Pecuniary profit dominates physical production. Business lets physical production go forward just in so far as, by so doing, it expects increased monetary profits, but holds physical production back in so far as that may seem necessary to prevent a falling off of monetary profits.
“Making goods and making money are both objective processes, at some points quite distinct from or even opposed to each other; at most points running side by side, concerned with the same objects and supervised by the same men. We need clearer insight into the industrial process of making goods and the business process of making money, and the way in which both sets of activities are related to each other and to the individual's inner life.” 1
Consequences of the Dominance of Pecuniary Profits.—There is no single and simple law governing the relation between production and profits. Production affects profit in a wide variety of ways. The only trait common to all these ways is that they affect profits by first affecting price changes of some sort. The various ways by which production, through affecting price changes, affects profit, cannot here be enumerated in detail, but certain of the more important ways can be stated in brief form.
1 Wesley C. Mitchell, American Economic Review Supplement, 1916, Volume VI, p. 158.
(a) Profit Making by Increased Production of Goods. If a shoe manufacturer can make fifty cents on each pair of shoes produced, obviously the more shoes manufactured, the more total profit made. As long as a given price spread on each unit of product can be maintained, the greater the number of units produced, the greater the total pecuniary profit. The rate of profit on each unit of product remaining constant, the greater the number of units, the greater the total profit. What makes the profit is the price spread, not the existence of the goods as such. Goods as such have no claim to profit. Goods with a price spread automatically yield profit. What leads to profit is not the making of the goods, but the pricing of the goods so as to maintain a fixed price spread between unit costs and unit selling prices. The profit making is due to the price making relationships, and only incidentally to the commodity making that is carried on. With a given and fixed price spread, increased production of goods gives increased profit.
Increased production may affect profits by widening the price spread. Large scale business commonly tends to decrease the unit costs of production. Full time operation of plant tends to decrease unit costs of production. When unit costs fall, the spread between costs and selling prices widens, and profit increases. When increased production takes place under these conditions, it creates increased profit. If these conditions disappear, further production of goods fails to yield further profit. The price conditions and relationships are everything. The output of the goods themselves is purely incidental to the price factors involved. Consequently, under conditions of either constant unit costs or decreasing unit costs, selling prices remaining the same, profit making requires the increased production of goods.
(b) Profit Losing by the Increased Production of Goods. Increased production leads to the losing of profits by two main results upon price making. First, production on a large scale eventually reaches a point of diminishing returns, that is, of increasing unit costs. Thereafter, each unit of product bears a cost price so high that the margin between cost and selling price tends to disappear. Increased production, which increases the pricing of costs without increasing the pricing of sales, leads toward loss. Second, production eventually reaches a point where an over-supply of goods causes a slump in selling prices. Over-production occurs only when the volume of goods has this depressing effect upon prices. Increased production which leads to decreased prices tends toward a loss of profit by the business man.
Increased production which results in rising costs or in falling sale3 prices threatens a reduction in profits. It is the price relationship which governs losses as well as gains. The making of goods, essential and indispensable though it may be, bears upon the making of money in and through its effect upon the making of prices.
2 Even under increasing unit costs it often pays to expand production, because an increased quantity of sales more than offsets the diminishing profit per unit of product. Total profits may be increasing although unit profits are decreasing.
(c) Profit Making Without Producing Any Goods. Between the factory, the farm, the mine, on the one hand, and the consumer on the other hand lie a mass of traders, distributors, brokers, speculators, middlemen. Much of the work of this group is essential in getting goods into the hands of consumers. It is essential to modern distribution. But much of the work of this group can also be classed as a waste of distribution. Countless traders are constantly on the alert for an opportunity to buy something low and sell it high. They reap a profit. In pecuniary terms, they have made a gain. In business terms, they are successful. The profit, however, rests upon no added production of goods as a result of their effort. Goods are neither more nor less after they are through, but profits are more. Profit making without goods making, or without performing an indispensable function in goods distributing, is a commonplace of the modern business world. Almost every business follows out the strategy to some extent, and many business men depend solely upon such a strategy. Taking advantage of price fluctuations is the essence of profit making, regardless of whether commodity production changes or not. The tactics of pure business center upon the requirements of this great game of price differentials. The ups and downs of prices yield the ups and downs of profits. How much goods shall be produced is a wholly subordinate matter. Wherever and whenever more profit can be made without making more goods, the goods will not be made.
(d) Profit Making by Decreasing the Production of Goods. The essence of monopoly is the ability to raise prices by arbitrary lessening of supply. The increase of prices follows from a decrease of goods. The less the goods, the higher the prices, and the more the profits.
But the strategy of restricted production is no longer confined to monopolistic business. Competitive business in the modern era copies the same strategy. By following the statistics of output and of stocks on hand, the individual competitive producer calculates when the time has arrived for running his factory or mine on a part time basis. His calculation is based upon knowledge of the fact that unless he does curtail his individual production, he will find himself confronted with a saturated market and will be unable to sell his product at a profit. Throughout the industrial world we find productive equipment being run at only a fraction of its full capacity. No matter how free and perfect competition may be, the individual firm decreases its production from time to time in order to avoid a glutted market. It decreases production to avoid the calamity of overproduction. This calamity is purely a price calamity. Overproduction is overproduction at prices which would make possible a desired profit. Decreased production is a policy of individual competitors as a means of maintaining fair and profitable prices. It has no other justification and needs no other. This justification is imperative and compelling. When lessened production is the one true pathway to maintenance of prices and of profits, then lessened production is the orthodox and standard business policy. Any other would be foolhardy. This alone would be discretion.
(e) Profit Making by Destroying Goods Already Produced. Occasionally, it is necessary in the name of profit to let apples rot on the ground, to dump milk into the gutters, to burn tobacco in the barns, to throw manufactures in the junk heap, in order to hold prices up to a profitable level. Such devices are the exception and not the rule, but they are resorted to just enough to make them a significant part of the technique of profit making.
(f) Profit Making by Intangible Production. Modern business contains a mass of values which are not material at all. Although intangible, they are nevertheless unsurpassed in importance in the technique of profit making. Here belong all those intangibles included in the sweeping term, “good will." Here belong the creation of and traffic in franchises, rights, patents, copyrights, advantages of location, advertising reputation. All such items possess pecuniary value. They can be bought low and sold high. They provide opportunity for a price spread between cost value and selling value. They offer a favorite means of making a profit. They exist everywhere and in abundance in the business world. They surround at all stages the physical process of production, but are separate from it. They are a traffic in immaterial property rights and values, and an integral part of the modern business profit régime.
(g) Differences in Profit not Proportionate to Differences in Production. A small difference in production may make an enormous difference in profits. There are times and places where a decline of production by 5 per cent would wipe out profit altogether. On the other hand a wide difference in production may make a slight difference in profit. There are times and places when a doubling of production would increase profits only slightly, if at all. Moreover, there are other times and places when production of the same amount of goods would make much, little, or no profit. One concern may make a profit by selling the same goods at a higher price than the average. Another may make a profit by producing the same goods at a lower cost than the average. Production bears no direct proportion to profit. Production always affects profits, but how it will affect profit varies with each particular price relationship. The bridge uniting production and profit is the price spread. Price relations are the central uniting factor between making goods and making money. Pecuniary production is profit making by virtue of favorable price relationships. Pecuniary production dominates physical production. It is well, therefore, as a next step to examine some of the methods by which this domination is made effective. We have analyzed how production affects profit. We may next analyze how profit affects production.
How Profit Affects Production.— Profit is the actuating force in business, production of goods is incidental. Making money is the real incentive to business effort, making goods is one means toward that end.