Revenue Maximization

What is Revenue Maximization?

Revenue Maximization is the maximization of sales of a business using measures such as advertisement, sales promotion, demos and test samples, campaign, references, etc to increase revenue and capturing higher market share in an industry. Technically Revenue is maximized at a point where MR (Marginal Revenue) equals 0.

Explanation

  • Each business start-up has a vision of maximizing the wealth of shareholders. In order to achieve this objective, the major role is handled by Revenue. Increasing revenue leads to profit maximization and ultimately increase the wealth of shareholder. In the modern era, it is very difficult for any organization to increase its revenue. It’s a customer-driven market. If a customer is cent percent satisfied, the product/service will get attention and will boost up the revenue.
  • Haphazardly company cannot increase its revenue without thinking about its shutdown/losses. It must stop at a point where Marginal revenue derived 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 to point of revenue maximization. It has not to just increase Revenue but to Maximize the revenue keeping into mind its sustainability.

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Source: Revenue Maximization (wallstreetmojo.com)

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.

Revenue Maximization Example 1

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:

Total Revenue = Selling Price * Qty Sold
Revenue Maximization Example 1-1
Marginal Revenue= Change in Total Revenue/Change in Qty Sold
Example 1-2
  • = (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 the point at which revenue is maximized. In our case, it is when 6 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.

Revenue Maximization graph

Benefits

It must make clear in mind that Revenue has not just to be increased but to be Maximized in order 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 very necessary to build up a strong and large customer base to have place into the market. i.e. creation/expansion of Market share. As we saw in the above example, the price will fall as the qty sold is increased. This lets selling a product at the lowest possible price and gaining more customers eventually leading an increase in market share.

#2  – Creation of Brand Name

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

#3 – Benefit of Economies of Scale

When a company can sell more qty at a lower price, it has the advantage to produce 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 gets decrease as the qty sold/produce increases. Rent, Admin Expense, etc can be fully utilized. Benefits of high qty sold can be availed which helps in increasing profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more

Revenue Maximization vs Profit Maximization

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

Revenue MaximizationProfit Maximization
Qty sold to a point at which MR=0Qty sold to a point at which MR=MC
Where MR= Marginal RevenueWhere MR= Marginal Revenue, MC= Marginal Cost
The aim is to increase the customer base and capture high market shareAim to increase the profitability of a business
It is suitable for a new entrant to a market or existing business expanding into new product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more eg. Reliance JioIt is suitable for an existing business whose reputation is maintained in the market and has a well-established client base who is more concerned of the better quality of product/ service and not cutting down the price.
It is a long term objectiveIt is short term objective
Business having this strategy is capable to take up any new opportunity into the market and take up its utmost advantageBusiness becomes a bit rigid and has to lose a few new customers in non-flexibility of cutting down prices.

Recommended Articles

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

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