Today’s post promises to be “profitic.” 🙂 We are exploring the concept of profit. What is profit?  What is its role in business and the economy?

 

Unlike most economies of the past, most of us earn income by engaging in a narrow range of work that contributes to the production of goods and services. We use our income in exchange for goods and services others provide. Exchange is central to market economies. But let’s look closely at the nature exchange.

 

I go to the store and pay $3.00 for a gallon of milk. What is really happening? I surrender $3.00 for the milk because I value it more than keeping my $3.00. The store values my $3.00 more than keeping the milk. We both win … we both walk away with something of greater value. When both parties exchange without coercion, they each intend to achieve a benefit from the transaction (though either party can be mistaken due to poor information or deception.) 

Because the store ends up with more money and the buyer ends up with less, some falsely conclude the store has increased its wealth at the buyer’s expense. Wealth is falsely equated with cash. Cash is just a medium of exchange while wealth is the economic value of all the assets we possess … which now includes a gallon of milk. Each party increases their wealth because each party now has something they value more than they offered in exchange. It is a win-win game, not a win-lose game.

But where do
the goods we purchase come from? Matter, energy, and data must somehow be transformed
from less useful forms into more useful forms. Firms fulfill this need. (Firms
can be self-employed individuals or massive corporations.) They amass and
organize resources (materials, energy, labor, plant and equipment, etc.) to do
this transformative work. 

Here is where profit comes in. Profit is a firm’s total sales minus all the expenses and taxes in
running the business … technically, “net profit”. If expenses are more than
sales, then there is a net loss. Profit is what tells firms how many of
which things to produce. Consider what profit and loss communicates:

 

1. Profit – If
the cost of inputs is less than the sales of the final products, then the firm
is creating value. Buyers are signaling they value the firm’s use of resources
more than if the resources had not been used in this way.

 

2. Loss – If
the cost of inputs is greater than or equal to the sales of the final products,
then a firm is actually destroying value. Buyers are signaling they value the
firm’s use of resources less than if they had not used the resources at all.
Where sales and costs are equal, the market is communicating that it is
indifferent.

 

If a firm
continually operates at a loss or at a minimal profit, then the firm either has
to improve its performance or eventually close. If a firm is making
exceptionally high profits, then other firms are drawn into that market and the
profit tends to fall toward an average return. (The U. S. after-tax profit as a
percentage of Gross National Product in non-recession years over recent decades
has been 5.0-7.5%.)

 

What does
profit mean for the firm? It has three implications:

 

1. Profit is
a reward to the owners for delaying personal gratification and investing wealth
in something productive. Money in hand now is always worth more than a promise
of the same amount in the future. The longer the distance between now and the
date of a future payment, the less valuable the future money becomes. Profit
rewards investors for delaying the consumption of their wealth.

 

2. Profit is
a reward for taking risks. Some investments in business will fail and a few
will be wildly successful. Most will fall somewhere in between. Profit tends to
reward investors relative to the risk they took with their investment in
productive enterprises

 

3. Profit
serves as a reward for innovation. Some firms rise above the norm in the value
they bring to customers, or in providing better solutions to needs that have
not been met. Profit rewards entrepreneurs for innovation and motivates others
to be innovative.

 

Non-Profit
Firms

 

What about
“non-profit” firms? Non-profit firms are like profit businesses except for two
key differences: The surplus funds are never distributed to shareholders/
owners, and when a non-profit firm dissolves the assets must go either to
another non-profit or to the state. The non-profit must still make a “profit” …
excess of income over expenses … but  the “profit” always stays with the firm. (Government entities
have essentially the same qualities.)

 

Non-profits
play a critical role but a pervasive challenge for non-profit organizations is
their inability to measure impact. Non-profits usually have two customers: Clients
who receive services and the donors who contribute funds. When a conflict over service
and mission emerges, the donors win.  While customers of profit businesses give direct feedback
through sales, non-profits lack a direct feedback loop for clients that
directly motivate responsiveness. Some social entrepreneurs are now
experimenting with what are called social businesses where non-profit restrictions
exist on the distributions of profits but investors can get their investment
back and the social business focuses on making a profit in conjunction with pursued
social aims.

 

The critical
point is that non-profit enterprises are not substitutes for profit making
businesses. The primary source of revenue for non-profit enterprises is
contributions from wealth created by profit making businesses. (Taxes for
government are the same thing.) Without the diligent intentional effort of
firms to organize resources and labor in a way that creates value … earns a
profit … there would be no surplus wealth from which to make donations and pay
taxes.

 

Concluding
Thoughts

 

I want to be
clear about what I have not said.
Just because a business earns a profit, it does not mean the business is doing
good for society as we measured by the Kingdom of God. It simply means that it
is producing something that is valued in society. Change what people value and what
is profitable changes. 

Furthermore, I have not said that everything done in
effort to reduce costs or promote sales is legitimized because it achieves a
profit. Profit is to be sought within certain ethical constraints. The problem
is that in many cases it is difficult to discern the balance of positive and
negative effects of particular actions. Legitimate disagreement about how to
address problems created by profit maximization should be expected. 

Finally,
the way I’ve framed this conversation it might give the impression that
business is only about profit. That
is not my intent. Most businesses come into existence because there is passion
around providing some type of goods or services. Profits are to business what
food is to the human body: essential but not the central mission. Businesses
that lose sight of their mission in pursuit of profit usually die.

 

I see two
challenges in the church that relate to profit. One is uncritical praise for
economically successful people (more common in conservative churches.) Just
because someone has been economically successful tells us nothing about their
spiritual maturity and wisdom. The other challenge is vilification of profit
and those who pursue it. There is a zero-sum game mindset where distribution
and consumption are the only economic questions. Exchange is a win-lose game.
Profit is understood as extraction of someone else’s wealth. We should share
instead of seeking profit.

 

Clearly in
the context of family and close community … and in terms of aiding others in
need … we are to be generous. But without profit and the wealth it creates
there would be nothing to be generous with. Goods do not appear in optimal
quantities out of thin air. I’d suggest that to the degree that they operate
within just parameters, profitable firms are major contributors to the shalom of society. They effectively
organize resources for the production of wealth. The critic of profit is
compelled to offer an alternative for how businesses will know how much of
which things to produce and how to optimally distribute them through society.

 

So was this a profitic post? 🙂 What
impresses or concerns you about profit?