Friday, March 9, 2007

Of Profits and Growth

I run a company. So I could be called a capitalist. However I am also a consumer. So I play on both sides of the court. There is one core question that has started playing in my minds ever since I started my company. What is a fair margin that I should charge on my products and services?

There are some auxiliary questions here. Will the customer have any idea of the margin that I take and if not then what is the issue about the margin if the customer is happy with the final price? Even if the customer is aware of the margin and he is happy with the price that is being paid why bother? If I offer the lowest price in the market then what is the issue with the margins? The market I am talking about is not a mature market in its steady state stage but rather a growing market with transient trends. But then most markets are not mature markets and some of the arguments should hold true in such cases too.

By free market theory the market should ultimately fine tune the margins until all players start charging the same margins. But we don’t have a perfect market, we don’t have information symmetry, we don’t even have educated consumers - so there is a scope for exploitation in terms of margins. And capitalists, being opportunists, will keep overcharging consistently without any kind of formal or informal agreement between them. In spite of the absence of a price cartel or a centralized decision, capitalists will charge high margins to a limit where small players start controlling the margins by lowering the prices but not as much as to crash the market. Here the customer does not have too much of a control because the demand

Now the question is whether there is anything as a fair margin from the business owners perspective. If I run a business I should expect to get some return on investment on the money I put in. If there is no competition and there is infinite (or at least a huge) demand for my product I should theoretically be able to sell at any margin I like. But from a third party perspective I should charge a margin corresponding to the value I create to the end consumer. This should include a reasonable margin for growth of the company. So suppose you reach upon a fair margin. What does that make me - a fair capitalist. Consumers would want me rather than an exploiting capitalist to meet their needs. The society would expect me to cater to more and more people. This demand to serve more would put a requirement to grow more, and for high growth rates you need high margins. So how you work that out.

Now you figure out. I am still confused


  1. For the sake of argument, let's assume that you're the CEO of a public company(as opposed to running your own business). I see your dilemma as being essentially a conflict between the following two goals that affect two groups of people-

    1. Maximise the profits of the company's owners.
    2. Maximise the value of goods and services delivered to it's customers.

    You can do both by letting the markets be the arbiter of the price of goods and services. What if this leads to a monopoly and price gouging? Ultimately, that fine dynamic by which all market economies create and distribute wealth, namely creative destruction, will prevail for the good of all the players involved. History is ample proof for this but a case in point in the oil crisis of 73. Even though oil prices initially skyrocketed because of supply restrictions by OPEC, they had the effect of tempering demand and forcing the players involved to look for alternate, efficient sources of energy.

    So to answer your question what a fair margin is? I think it is one that is
    1. Fair to both groups of people above. 2. Is competitive in the market.

  2. I agree to all your points mk. But my problem is to find what is my fair share when the market forces are not working properly. I can always deceive an uninformed customer and make exorbitant profits from that deal. So what should be my margins in such a case, that is the question.

  3. In that case(when market forces are not functioning as it should), defining what is fair and unfair is more subjective. Every society should strive to avoid such a state, one that hinders progress.