The behavioural theories of the firm started developing in the early 1950s. Some of the seminal work may be traced in Simon’s article ‘A Behavioural Model of Rational Choice’, published in the Quarterly Journal of Economics in 1955.
The theory has subsequently been elaborated by Cyert and March, with whose names it has been connected to this day. The writers founded their theory on four case studies and two ‘laboratory’- experimental studies.
We will develop the model of Cyert and March in the following sequence:
1. The firm as a coalition of groups with conflicting interests.
2. Process of formation of demand-goals of the different groups within the firm.
3. Definition of the goals of the firm by the top management. Satisfying behaviour of the firm.
4. Means for the resolution of the conflicting demands and interests of the various groups of the firm-coalition.
5. The process of decision-making for the implementation of the goals set by the management.
6. The environment of the firm and the treatment of uncertainty in the behavioural theory.
7. A simple model of behaviourism.
8. Comparison of the behavioural theory with the traditional theory of the firm.
9. Summary and conclusions.
The Firm as a Coalition of Groups:
With Conflicting Goals:
The behavioural theory of the firm, as developed by Cyert and March, focuses on the decision-making process of the ‘large multiproduct firm under uncertainty in an imperfect market. Cyert and March deal with the large corporate managerial business in which ownership is divorced from management.
Their theory originated from the concern about the organisational problems which the internal structure of such firms creates and from the need to investigate their effect on the decision-making process in these large organisations. Such internal organisational factors may well explain the difference in the reactions of firms to the same external stimuli, that is, to the same change in their economic environment.
The assumptions underlying the behavioural theories about the complex nature of the firm introduces an element of realism into the theory of the firm. The firm is not treated as a single-goal single-decision unit, as in the traditional theory, but as a multi- goal, multi-decision organisational coalition. The firm is conceived as a coalition of different groups which are connected with its activity in various ways managers, workers, shareholders, customers, suppliers, bankers, tax inspectors and so on.
Each group has its own set of goals or demands. For example, workers want high wages, good pension schemes, good conditions of work. The managers want high salaries, power, prestige. The shareholders want high profits, growing capital and market size.
The customers want low prices and good quality and service. The suppliers want steady contracts for the materials they sell to the firm, and so on. The most important groups, however, within the framework of the behavioural theories are those most directly and actively connected with the firm, namely the managers, the workers and the shareholders. Our next step is to examine the process by which the demand-goals of the different groups are formed.
The Concept of the ‘Aspiration Level’:
The behavioural theory recognizes explicitly that there exists a basic dichotomy in the firm. On the one side there are the individual members of the coalition-firm, and on the other side there is the organisation-coalition called ‘the firm’. The consequence of this dichotomy is a conflict of goals individuals may have (and usually have) different goals to those of the organisation-firm.
Process of Goal-Formation:
The purpose of the behavioural theory is to determine the key variables in the decision-making process in the firm. It is not interested in the goals of the firm as such, but rather in their origin and the decision process which leads to their formation.
Cyert and March argue that the goals of the firm depend on (are determined by) the demands of the members of the coalition, while the demands of these members are determined by various factors, such as the aspirations of the members, their success in the past in pursuing their demands (past achievement), their expectations, the achievements of other groups in the same or other firms, the information available to them and so on.
Goals of the Firm: Satisficing Behaviour:
The goals of the firm are set ultimately by the top management.
There are five main goals of the firm:
(a) Production goal.
(b) Inventory goal.
(c) Sales goal.
(d) Share-of-the- market goal.
(e) Profit goal.
The production goal originates from the production department. The main goal of the production manager is the smooth running of the production process. Production should be distributed evenly over time, irrespective of possible seasonal fluctuations of demand, so as to avoid excess capacity and lay-off of workers at some periods, and overworking the plant and resorting to rush recruitment of workers at other times, with the consequence of higher costs, due to excess capacity and dismissal payments or too frequent breakdowns of machinery and wastes of raw materials in period of ‘rush’ production.
The inventory goal originates mainly from the inventory department, if such a department exists, or from the sales and production departments. The sales department wants an adequate stock of output for the customers, while the production department requires adequate stocks of raw materials and other items necessary for a smooth flow of the output process. The sales goal and possibly the share-of-the-market goal originate from the sales department. The same department will also normally set the ‘sales strategy,’ that is, decide on the advertising campaigns, the market research programmes, and so on.
The profit goal is set by the top management so as to satisfy the demands of share- holders and the expectations of bankers and other finance institutions; and also to create funds with which they can accomplish their own goals and projects, or satisfy the other goals of the firm. What we said earlier about the dynamic changes in the goals of individuals or groups, holds also for the goals of the firm these goals change over time depending on the past history of the firm (past aspiration levels relative to past attainments), as well as on the conditions of the external environment and on the changes of aspirations of groups within the organisation.
The number of goals of the firm may be increased, but the decision-making process becomes increasingly complex. The efficiency of decision-making decreases as the number of goals increases. The law of diminishing returns holds for managerial work as for all other types of labour. The goals of the firm are ultimately decided by the top management, through continuous bargaining between the groups of the coalition. In the process of goal formation the top management attempts to satisfy as many as possible of the demands with which it is confronted by the various members of the coalition.
Some of the above goals may be desirable to (and consequently acceptable by) all members of the coalition. For example, the sales goal is directly desirable to the sales manager and his department, to the top management and most probably to the shareholders. But this goal is also indirectly desirable to all the other members of the coalition, since all groups know that unless the firm sells whatever it produces no one will be able to attain his own individual goals.
Other goals are desirable to only some of the groups. For example, profits are the concern of the shareholders and the top management, but not of the employees in lower administrative levels or of the workers ‘on the floor.’ The conflicts arising in the process of goal-setting at the level of top management are resolved by various means which are examined in section IV below.
The goals of the firm, like the goals of the individual members or particular groups of the coalition, take the form of aspiration levels rather than strict maximising constraints. The firm in the behavioural theories seeks to satisfice, that is, to attain a ‘satisfactory’ overall performance, as defined by the set aspiration goals, rather than maximise profits, sales or other magnitudes. The firm is a satisficing organisation rather than a maximising entrepreneur.
The top management, responsible for the coordination of the activities of the various members of the firm, wishes to attain a ‘satisfactory’ level of production, to attain a ‘satisfactory’ share of the market, to earn a ‘satisfactory’ level of profit, to divert a ‘satisfactory’ percentage of their total receipts to research and development or to advertising, to acquire a ‘satisfactory’ public image, and so on. However, it is not clear in the behavioural theories what is a satisfactory and what is an unsatisfactory attainment.
Some objectives may even take the form of sheer wishful thinking, that is, they are unquantifiable goals, of a non-operational form; for example, the goal of ‘serving best the public’, or ‘keeping a good public image’, or ‘being progressive and pioneering’, and so on. Such goals do not necessarily lead to specific actions.
However, they may indirectly affect other goals in that they may lead to appointment of personnel or other policy commitments. What is important about such goals is that they may be used as an excuse by the top management for justifying particular projects or expenses, given that such goals are consistent with virtually any other set of goals of particular members or groups of the coalition.
Cyert and March argue that satisficing behaviour is rational given the limitations, internal and external, within which the operation of the firm is confined. Simon introduced the concept of ‘bounded rationality to justify the satisficing behaviour of the large corporate firms. The goals, irrespective of where they originate, are finally decided by the top management and approved, normally, by the board of directors.
They take the form of aspiration levels, and, if attained, the performance of the firm is considered as “satisfactory”. The goals-targets do not normally take the form of maximisation of the relevant magnitudes. The firm is not a maximising but rather a satisficing organisation.
This behaviour is characterised by Simon. As a behaviour of ‘limited’ or ‘bounded’ rationality, as opposed to ‘global’ rationality of the entrepreneur-firm of the traditional theory. Traditional theory conceived of the entrepreneur as a person with unlimited and costless information, unlimited computational ability and with unlimited time at his disposal.
Such a rational entrepreneur could afford the luxury of pursuing maximisation of his profit by comparing diligently all possible alternative actions facing him at any one time. ‘Global’ rationality implies that the firm has a clearly defined ordering of preferences for the various goals, each of which has been set after the scrutiny of all possible alternatives, and has been assigned a definite weight, possibly in terms of probabilities.
The behavioral theory recognizes explicitly the fact that in the modern real world the entrepreneurial work is executed by the group of top management. These are people with limited time at their disposal, have limited and imperfect information and limited computational ability. Hence it is impossible for them to examine all possible alternatives open to them and choose the one that maximizes profits (or anything else). Instead they examine only a small number of alternatives and choose the ‘best’ given their limited time, information and computational abilities. Thus the top management (the firm) acts with ‘bounded’ rationality.
It should be obvious that the behaviorists redefine rationality. Traditional theory defined the rational firm as the firm that maximizes profit (short-run and long-run). The behaviorist school is the only theory that postulates a satisficing behavior of the firm, which is rationed given the limited information and limited computational abilities of the managers
DYNAMIC MODEL OF SALES MAXIMISATION
- The objective of the firm is to maximise the rate of growth of sales revenue over its lifetime. Sales revenue (R) grows at the rate of ‘g’ percent.
- Profit is not taken as a given exogenous variable, which acts like a constraint in the static.
- Demand and cost curves have traditional shapes as in the static model.
- The growth function is derived from profit function, as growth of firm is mainly financed by retained profits.
- Highest attainable growth rate is achieved when profit is maximised.