Critically Evaluate the Management Model of Baumol

Under the traditional economic understanding, it is perpetually sour that loot maximisation is treated as the main goal or objective for holler outinges, subject to perfect knowledge, single entity and coherent logic. However, as illustrated by the principal-agency problem, managers do not usually make rational decision wholly analogous owners who take fellowship interest as their sole behind for their decisions. Past examples have shown that managers do take their own personal goals and satisfactions as consideration in their decision-making.In addition, information gathering is not always perfect as managers do make decision by relying altogether on the implicit knowledge step-uped from past experiences, without referencing to the macro-economic environment and the current grocery qualifys. Combining all these factors, it is therefore understandable that businesses do not always work toward make headway maximization, at least in the short term, and opposite(a) ob jectives like financial objective, market sh are, executive power, etc. do complicate in business decision making.However, as pointed out by mingled academics (Baumol, 1962 Marris, 1964 Williamson, 1963), realise maximization does not always serve as the just now correct objective for a firm, e exceptionally at unhomogeneous phrases of the business on a timeline scale. A point-in-hand is Baumol amaze. As an alternative to profit maximization homunculus, Baumol place works on the correlation between scathe and rig decision with the objective of maximise sales tax receipts, subjected to minimum profit diffidence by shareholders.In profit maximization sit down, profit is maximized at the resultion where Marginal Revenue (MR) is equaled to Marginal Cost (MC) whereas Baumol Model emphasizes on maximizing sales gross (TR) and may miss the MC = MR point to get finished its goal. This gravel argues that businesses try to maximize sales revenues rather than profits with the feasible motives such as growing or sustaining market share, to content up spare capacity, discourage new entrants, management performance and etc.In addition, Baumol model provides a platform to understand some of the set strategies follow by certain industries, which usually share common characteristics of having huge drop down hail and low variable equal. In such industries where founded appeal or sunk apostrophize takes up a huge infract of the total cost, producing a single unit and its utmost allowable siding (without expanding its capacity in the short term) does not have any material impact to the total cost.In such instances, profit maximization model is neither practical nor feasible as a focus of the model relies on seeking the product point where MC=MR. In the exercise of Walt Disney, the operational cost does not differ much whether there is matchless patronage or maximum allowable patronages as a write up park has to be fully functional during it s operation hours, which render the MC at zero or near zero level. The objective of the smart set to seek sales revenue maximization for the day rather than focussing its effort to achieve the output point where MC=MR to maximize its profit does make sense.This explains the two-part pricing strategy aggrandiseed by Walt Disney where a fix signization fee per entry is charged and allows the patronage to have as many free rides as they wish. Another example is the telecom industry, where the initial enthronization/fixed cost (for example launching the satellite and reach up the infrastructure) is huge, and the variable cost per call is insignifi pott to the total cost. In such industry, firms will focus on maximizing sales revenue (with diffidences to maximum capacity/output) by use strategies like expense difference strategy.In this strategy, the firms charge a different unit price to extreme and off-peak hours, as there is plenty of spare capacity at off-peak hours. Sin ce MC of output is low, any excess revenue that can be generated from this prodigality capacity will be profit to the firms. As such instance, it is rational for telecommunication industrial to adopt sales maximization model like Baumol. In addition, as short term capacity is always constraint and expressage, telecommunication industries would not want to experience loss sales collectable to their inability to meet customer choose, especially during peak hour usage.As service providers, consistent and frequent service failure could prove to be fatal in term of their survival and their long-term brand reputation. and then it would make sense for telecommunication firms to divert the peak-hours traffic into non-peak hours by using a price discrimination strategy which segments the users based upon their unstrainedness and abilities to pay. For instance, business-users are will to pay higher price for peak-hours usage collectable to their inelastic demand whereas in contrast, lei sure-users demand is elastic and are willing to make call during off-peak hours in return for lower price.By adopting the price discrimination strategy, telecommunication firms are able to maximize sales revenue during peak and off-peak hours by balancing the air-time traffic based upon different market segment of users. At this point, it is also noticeable that one of the characteristics of Baumol firms lies in the perishable products/ operate offered which cannot be inventoried. The loss sale of the day on the un holdd capacity/outputs is an opportunity cost to the firms.Baumol model is not only applicable to huge/large corporations, only if also to small retailers like bakery shop or moisture market, which explains the reason why some bakery shops offer a special discount one hour before the shop closed to maximize the revenue. The rationales applied similarly to the low cost carriers (LCC) where price discrimination is utilise as a strategy to maximize revenue. LCCs sell a ch eaper price to early booking passengers and a higher price for last little passengers to increase the revenue.LCCs used the cosmos of multiple segments to serve and the opportunity to utilize surplus capacities to generate additional revenue. The adoption of sales revenue maximization model is also used as an efficacious way of securing additional market share within a regulated market with limited players where market dominance is vital. In related to pricing, add-on product/ run like travel insurance, priority boarding and choosing-a-seat are used as bundled offering to the customer to gain extra profit.Firms are willing to win a smaller profit if it means that they are able to gain a competitive advantage from their rival firms. As an illustration, fittingness club is a good example to elaborate how Baumol model is applied through adopting different pricing strategies. The reasons behind seaworthiness Club in adopting Baumol model include penetration to new market segments, retaining existing customer and to fill up spare capacity. True Fitness, which is a chained fitness centre, is in effect using Baumol model by offering different pricing strategies to detain different market egments, for instance, offering periodic fees to uncertain-customer and periodical/lifetime rank and file to certain-customer. Two types of pricing strategies are used by True Fitness to maximum its sales revenue, which are- i)Two part pricing ( lifetime social station) The lodge offers a lifetime membership at ? 1. 5K as one-off payment and charges a minimal price of ? 20 yearly as administration/subscription fee. By paying a lifetime membership fees as fixed price, the customers are able to enjoy the facilities for life for as low as ? . 67 per month, which no other rivals is able to compete with this low price. As per other industries discussed above, fitness clubs have the similar characteristic like high initial set up cost and low marginal cost to adopt the Baumol m odel. The company charges an upfront fee to gain maximum consumer surplus and utilizes the yearly subscription fees, which is equaled to the marginal cost/average variable cost, to cover its yearly course costs.In addition, in order to adopt the two-part pricing strategy to maximize sales revenue, the company needs to have a minimum output (also known as critical mass), so that the full consumer surplus can be derived from the fixed fees. For example, if the yearly running cost (without considering the depreciation cost of the initial set up) is ? 200,000, in order to offer a yearly subscription fee of ? 20, the company needs to have a minimum membership of 10,000 in order to reduce the average variable cost/marginal cost to this level.By adopting Baumol model, which gives a higher output with lower price, this is achievable. This pricing strategy is also applicable to other chained-companies where the firms can derive the maximum profit from the fixed fee and use it as capital/inv estment to set up a new chain store. At the alike time, individual chain store is able to run by itself from the revenue derived from the minimal pricing. ii) toll discrimination ( monthly membership vs. lifetime membership) True Fitness segments their customers into certain and uncertain customer by ffering different pricing to monthly and lifetime membership. The club is willing to offer a lower price to customers who are willing to commit, in comparison to uncertain customers. As illustrated in earlier examples, fitness clubs need to fill up spare capacities as any unutilized capacity carried an opportunity cost. With customers commitment, they are able to secure their stability in term of both volume and sales revenue. For those uncertain customers, the company charges a higher price, which customer willing to pay due to the flexibility and short-term commitment.From the above illustrations, it is discernible that a key characteristic of the Baumol model hinges on the elasti city of demand. As shown, Baumol model uses pricing strategies as a mean to achieve revenue maximization, and is therefore heavily dependent on the price elasticity to achieve the objective of the model If the demand is inelastic, Baumol model will not work as the demand of the product/services will not increase proportionately and therefore the sales revenue will not maximize from the reduction in price.In addition, advertizement effect has not been considered in the above examples, which is a common tactical maneuver used to increase the inelasticity of demand. The psychological effect of advertising has been proven effective in occupying the mindset of consumers through brand image building, which increase the connexion of the consumers to certain products/services, thus the inelasticity of the demand. The pointers from the last paragraph are well-illustrated by the memoranda 1 example in Baye text book.In this example, it is shown that the price change does not correlate with the demand. By reducing the price from the current, $10. 50 to $10, the subscribers drops from 881 subscribers to 842, causation the revenue to drop from $9251 to $8240 and therefore a profit drop of $614. 5. (Appendix 1). In reverse, the firm should increase the price to $11. 5 to maximize the revenue at $11282 and a price of $12. 5 to maximize the profit at $4734. whiz of the reasons is due to the advertising and promotional effort from the company which increases the inelasticity of the demand.Secondly, since a liege group of subscribers has already been amassed, STARZ network functions more as an add-on product to the existing subscribers. The combination of these two factors explained the reason why sales revenues and profit actually increases with price increases. In addition, from the data on STARZ network (Appendix 1), it is apparent that STARZ network does not share the same characteristics of high fixed cost or excess capacity to apply Baumol model. Instead, it seems l ike advertising or bundled pricing works better for STARZ network rather then price reduction.Further to the points above, Baumol model players are highly susceptible to the price reception from their rivals, which could easily result in a price-war especially in an oligopolistic market. The existence of a floor triggering price in Baumol model constrained the players from displace the price too much which will defeat the purpose of revenue maximization. Thus, it is highly unfavorable for Baumol model players to induce a price-cutting reaction from their rivals when they taste to lower the price.This explained why certain Baumol model players used noise as disguise to their rivals when lowering the price to achieve revenue maximization. To summarize, long-term profit pursuance remains as the ultimate objective for any business. However, due to dissimilar characteristics of different industries, there are various models that can be used to achieve this long-term objective, which e xplains why certain firms are willing to sacrifice profit today in exchange for profit tomorrow.As illustrated through various examples in this assignment, the application of the correct model for the decline industries and at the correct phrase of the company life-cycle becomes an even more distinguished decision for managers to make. With the understanding and knowledge gained through the detailed analysis and review article of Baumol model, an useful insight to the economic rationale adopted by various industries, like Walt Disney, LCC and telecommunication firms is achieved. Bibliography Mercuro, N. , Haralambos, S. Gerald, W. , 1992. Ownership Structure, Value of the Firm and the Bargaining military unit of the Manager. Southern Economic daybook, 59(2), pp. 273-83. Baumol, W. J. , 1996. 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