What is Revenue Maximization?

Explanation

  • Each business start-up has a vision of maximizing the wealth of shareholders. To achieve this objective, the major role is handled by Revenue. Increasing revenue leads to profit maximization and ultimately increases the wealth of shareholders. It is very difficult for any organization to increase its revenue in the modern era. It’s a customer-driven market. If a customer is cent percent satisfied, the product/service will get attention and boost revenue.Haphazardly company cannot increase its revenue without thinking about its shutdown/losses. It must stop when Marginal revenue from selling a single unit reaches 0. Even after the company increases its revenue, it will incur losses if the quantity sold is more than revenue maximization. It has increased revenue and maximized the revenue, keeping in mind its sustainability.

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Example of Revenue Maximization

Let us consider an example of a business selling Pens. It is newly launched and wants to maximize its revenue. Here is the table stating its Selling price, Quantity Sold.

Calculate the total revenue and marginal revenue.

Solution:

  • Selling Price = Price at which a pen is sold (It Decreases as an increase in Qty sold)Qty Sold = Qty sold in the market

Now, calculate the total revenue as shown below:

  • = (180-100)/(2-1)= 80

Similarly, calculate the other marginal revenueMarginal RevenueThe marginal revenue formula computes the change in total revenue with more goods and units sold." The value denotes the marginal revenue gained. Marginal revenue = Change in total revenue/Change in quantity sold. read more.

Revenue is maximized at a point where Marginal Revenue = 0

Below is the graph of Revenue maximization. The point at which Marginal Revenue is 0 is when revenue is maximized. In our case, it is when six qty is sold. Total revenue is also high at this point. After this point, even after increasing Qty Sold, Revenue will not be maximized. Marginal revenue will fall.

Benefits

It must clarify that Revenue has not just to be increased but to be Maximized to wealth maximizationWealth MaximizationWealth maximization means the maximization of the shareholder’s wealth as a result of an increase in share price thereby increasing the market capitalization of the company. The share price increase is a direct function of how competitive the company is, its positioning, growth strategy, and how it generates profits.read more. Without determining a point at which revenue is maximized, if blindly targets are set to maximize Sales, things won’t go well. Benefits are listed below-

#1 – Increase in Market Share

When it’s a start-up, it is necessary to build up a strong and large customer base to have a place in the market. i.e., creation/expansion of Market share. As we saw in the above example, the price will fall as the qty sold increases. It will let a product sell at the lowest possible price and gain more customers, eventually increasing market share.

#2  – Creation of Brand Name

A good brand name can be created if products/services are sold at comparatively lower and efficient quality. It will bring loyalty to customers. Customers will retain for a longer period or till forever in some cases.

#3 – Benefit of Economies of Scale

Benefits of high qty sold can be availed which helps in increasing profitability. When a company can sell more qty at a lower price, it has the advantage of producing high qty. For example, it can fully utilize the amount paid for Fixed Costs. The fixed costFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more per unit decreases as the qty sold/produced increases. Rent, Admin Expense, etc., can be fully utilized.

Revenue Maximization vs Profit Maximization

To make it simple, Revenue Maximization is a point at which a business keeps selling until marginal revenue does not fall negative. Profit maximization is when a business sells to a point at which its marginal cost does not increase its marginal revenue.

This has been a guide to what is revenue maximization. Here we discuss examples and benefits of revenue maximization and its differences with profit maximization. You may learn more about financing from the following articles-

  • Normal ProfitMarginal Product of CapitalLaw of Diminishing Marginal UtilityLaw of Diminishing Returns