THE CONCEPT OF SUPER PROFIT

Abstract

The general profit equation which considers cost and price as the determinants of profit has led to many business heavily relying on it to make unsustainable projection of profit making false assumptions which sometimes turns catastrophic for them in many cases ending in business failures. The failure of some managers to properly isolate super profit from normal profit has contributed to them making decisions which is not sustainable.

Full text

THE CONCEPT OF SUPER PROFIT
INTRODUCTION
The general profit equation which considers cost and price as the determinants of profit
has led to many business heavily relying on it to make unsustainable projection of profit
making false assumptions which sometimes turns catastrophic for them in many cases
ending in business failures. The failure of some managers to properly isolate super profit
from normal profit has contributed to them making decisions which is not sustainable.
This has led many scholars to reconsider profit as main bench mark of business success
and hence develop another theory which tends to shift the attention of managers from
profit maximization to shareholder wealth maximization, however profit remain the main
incentives for doing business and the only way to maximize shareholders wealth is
making a sustainable profit. The problem here is therefore not the reliance of profit by
managers but reliance of super profit which is as a result of information asymmetry in
favour of managers to the disadvantage of the other market players especially during the
early stages of product life cycle.
This article tries to properly define profit and properly isolate super profit from normal
profit especially during the initial stages of a product life cycle and propose a prudent
attitude to managers on proper utilization of supper profit in order to promote business
sustainability and curtail avoidable business failures.
DEFINITION OF PROFIT
The concept of profitability is very controversial, many disciplines have used their
terminologies to define profit. But a simple dictionary definition of profit is a financial

gain especially the deference between the amounts earned and the amount spent in
buying, operating or producing something (oxford dictionary) in general terms profit is
considered as the ability to have more income than expenses. Example a company invest
GHC300 into operations and sell it products for GHC350, the total profit for the company
is GHC50 that is (300-350) this is a very simplistic way of calculating profit.
This concept is very simplistic because it relies on only two variables that is cost and
price. Because this calculation rely on cost and price and price is just cost plus margin
managers focus is normally the margins that they will put on the cost rather than
reduction of inefficiencies on their cost structure which also can have impact on the level
of profitability.
Economist see profit differently from accountants, while economists introduce one
additional aspect into the profit equation.
In economics profit is positive difference between the revenue received from the sales of
an output and the cost of all inputs used as well as any opportunity cost. Example if a
company invest GHC 300 into the production of a good or services this cost is termed as
an explicit cost. assuming the company was producing another good or service and as a
result of limited resources it has to forgo the production of that goods in order to produce
the current good which was giving the company a profit of say GHC10, and sells the new
product for GHC350 then the total economic profit will be equals to (350-300-10= 40)
GHC40.

TYPES OF PROFIT
The three major types of profit includes gross profit, operating profit and net profit all
these profit can be found in the income statement. (www.investopedia.com) another type
of profit which is normally not seen in the income statement but very important in
business survival is super profit.
Gross profit is the profit a company makes after deducting the costs associated with
making and selling its products or services (www.invetopedia.com). In the other words is
the profit that is directly generated by a product or service. The formula for calculating
gross profit is GP= sales-cost of sales.
Operating profit refers to an accounting metric measuring the profits a company
generates from its core business functions where the deduction of interest and taxes are
excluded from the calculation. Operating profit is equal to operating revenue-cost of
goods sold- operating expenses-depreciation-amortization
Net profit refers to profit after deduction all expenses incurred by the company during the
production and sale of the goods which includes both direct and indirect cost. It is
calculated by deducting total expenses from total revenue.
SUPPER PROFIT
Another aspect of profit which has been underestimated is super profit. In general supper
profit is defined as profit over and above normal profit. In business there is an acceptable
calculation which define super profit as total profit less an average profit. An average

profit is also term as a normal profit. This can be calculated by picking normal profit of a
company for a particular product of a company and calculate its average. This concept is
problematic as it is difficult to identify whether or not those period selected does not itself
contain abnormal profit. The best way to calculate a super profit base on the above
formula is to extract the average profit from selected companies and strike out the
average and then compare it to a company’s profit to see whether or not there is a super
profit. For example the following are the average profit of some companies in an
industry. (320,300,318,298,309) the average profit of the above companies is
320+300+318+298+309/5 =309
If the current profit of a company is 350 then the supper profit will be equal to (350-309)
41. The concept of super profit which is very important in long time going concern of
businesses has been undervalued and this is causing rather financially healthy companies
to collapse unexpectedly. For example many microfinance companies sprigged out
between the early nineties and a close look at their books in the early stages indicates
massive profit with such massive profit it was surprising that many of these companies
began to collapse beginning in the late 2000s leaving in their wake near collapse industry.
Eventhough industry watchers believe this was caused by reckless managers but this
managers were embolden by the prospect of continue high profit which a higher
percentage was supper profit which should not be used when making a long term
projections. The long term sustenance of a super profit depend on how successful a
manager is able to reduce it inefficiencies in the long term by applying some if the super
profit on reducing both production and operating inefficiencies in it production system,
this will be able to compensate the reduction of profit as market players begin to get more

information on product the market begin to collect itself which in most cases will lead to
price reduction.
PRICE AND COST RELATIONSHIP IN PROFIT DETERMINATION
For us to fully understand profit we have to fully understand price which is a major
determinant of profit, Cost is an amount invested into a production of goods or service.
Price is however the total revenue generated from the sales of a product or service. Price
is the subset of cost in the other words price is cost plus producer’s margin. So if cost is
high it will influence the price of a product. For example if the expected margin of a
product is equal to 20 percentage of a product cost and the product cost 100 Ghana cedis
to produce, the product is expected to be price at 120 Ghana cedis.
. A careful look at price curve of a product or service life circle will show a higher price
from the product inception and begin to fall during its growing period and then stabilize
for the rest of the product life circle. The behaviour of a price curve of normal product or
service life circle indicates that during the initial stages of a product life, the producers
have control on the price in order words the producers may have their way of setting the
price that is favourable to them due to information asymmetry, however in the long-term
when information becomes available to the market players the producers monopoly on
price determination become limited and hence price is determine by proper negotiation
between all the market players where none of them will be able to manipulate
information to their advantage price will begin to fall until it reaches normal level below

which it may not fall again. The length between the period of abnormal price and the
normal price is determined by how well the company can manage the product
information and the uniqueness of the product. This law will apply to all product whether
or not it is unique in the long-term. For instance, the price between the current IPhone
and the previous model is not necessary the difference between the value added but how
the company is able to manipulate information to their advantage, as soon as consumers
are able to have the actual access to the information through other users of the products
the market begins to correct itself and price will fall closer to real level.it is therefore
paramount for the producers to determine the actual value between the old and the new
iPhone and the expected margin which constitute the super profit. This profit will be
eroded when the market receive the actual information about the real value of the new
brand of iPhone they are buying compared to the most recent one. But the company may
be able to slow down the erosion by taking measures to entrench information asymmetry
or increasing cost efficiency of the product in question. The earlier strategy is meant to
prolong the super profit but the latter is meant to compensate for the anticipated erosion
of the super profit when the market begin to correct itself. It is therefore very important to
isolate the super profit from the total profit figure to know the percentage of your profit
which is super profit. Because the long term sustainability of super profit is not
guaranteed managers should only make long term projection with only the normal profit.
THE PROFIT FORMULA
Arm with this idea the concept of profit should now be calculated using the following
formula.
Profit= P-IC+CI

Where P is price of the product or services, IC is the input cost of the product or service
and CI is the cost of inefficiency of the product or service in question. The cost of
inefficiency of the product is calculated as a percentage of the input cost. All things being
equal the input cost will remain constant in the short term. Because we are not able to
isolate the cost of inefficiency from the input cost it portrays wrong signal to managers
that they don’t have much control over the input cost but rather they focus much attention
on pricing thereby pushing all the cost of the inefficiencies to the consumers. Because
information is limited to market players in the initial stages consumers may be force to
buy the product at higher price but producers should be able to reduce the price when
information becomes available to the market players as consumers will not be prepare to
absorb the inefficiencies of the producers.
The input cost of product A is equal to GHC 50 per unit. Assuming that this GHC 50
includes 15 percent inefficiency and the product expected return on capital is equal to 20
percent the total price of the product will be equal to GHC 60 which will bring the total
profit to GHC 10 per unit. ie. 20% (50) +50 however this profit will include the 15
percent share of the inefficiency which is embedded in the pricing mechanism. The super
profit embedded in this profit is therefore equal to 20 %( 15/115X50) = 1.3 so GH 1.3 of
the GHC 10 is super profit and the remaining GHC8.7 is the normal profit. If the
inefficiencies included in the input cost increases to say 20 percent the super profit will
increase from GHC 1.3 to GHC 1.7. So the higher the inefficiencies the higher the super
profit and vice versa.
because the old idea of calculation of profit ignores inefficiencies this makes the
managers to put much emphasis on revenue maximization instead of expenditure

minimization, This led managers to find ways to use information asymmetry to the
disadvantage of consumers to make supper profits, this is mainly achieve by aggressive
advertisation which is aim at embellishing the actual value the product or services offers
to consumers.in the initial stages of a product life cycle producers should always target on
ways to reduce inefficiencies associated with input cost of the product. Another name for
supper profits is consumer credits they will ultimately come for it when markets
conditions normalize.
COST OF INEFFICIENCY
According to Webster dictionary, inefficiency is the lack of ability to do something or
produce something without wasting materials, time, or energy.
Cost of inefficiency is the cost associated with a product which can be reduced if
managers adopt more appropriate and efficient cost savings method in the short to
medium term of a product life. In a book written by Mariana Martin business efficiency
for dummies it state that inefficiencies cost organisations as much as 20 to 30 percent of
their revenues every year. This includes cost of raw materials wastages, labour hour
wastages, cost of packaging, cost of advertisement and others. In the initial stages of a
product life mostly managers’ attention is the introduction of the product in the market
successfully. Therefore this stage is normally characterized with high cost of inefficiency
and since super profit is directly proportional to cost of inefficiency this stage is also
characterize by high level of super profit. Rule of thumb is that 5 percent inefficiency is
acceptable in the initial stages of product life cycle. In the initial stage of product life
cycle the managers are able to manipulate information to their advantage and hence are
able to hide inefficiencies and hid it as part of input cost and transfer it as price to the

consumer thereby making huge profit but as soon as the consumers begin to be aware of
the dynamics of the product they will not be prepare to allowed the producers to transfer
it to them in a form of price. This is the time that the profit begin to fall. however if the
producers are able to improve efficiency to compensate for the fall of price eventhough
price may fall but profit will remain same hence the producers will continue to enjoy the
super profit, the situation will not be the same if producers are not able to improve on
their efficiency in this case profit will decline proportionately with price which will lead
to erosion of the super profit. For example if information becomes available to the maket
prayers and hence bargain the above price from GHC 60 to GHC58.5 it will reduce the
profit margin from 20% to 17% which is will be below the acceptable margin, however if
the company is able to reduce the inefficiency from 20% to 5% then the new price will be
equal to GHC 47.7(20) + 47.7= GHC 57.2. which is lower than the market bargain this
means that the reduction of the inefficiency from 20% to 5% have more than compensate
for the reduction in price which was forced by market players. In the hand if managers
wait for the market to bargain for the new price it will force the managers to generate
profit which is below the investors’ threshold of 20% and make 17% which can cause
going concern problems.

CONCLUSION
It is not wrong for businesses to make super profit in the short term but it is suicidal for a
business to expect supper profit in the long term, it is therefore imperative for managers
to adopt strategies aim at reducing inefficiencies within short to medium term to improve
going concern status of the organisation.
It is very important to isolate the inefficiency cost from the actual input cost this will help
the managers to adopt strategies to reduce it the barest minimum as soon as possible so
that it can withstand the shocks presented by the market correction in the short to medium
term. As demonstrated above, the higher the inefficiency cost the higher the super profit.
If managers are interested in the long term viability of a business unit or a product they
should make conscious effort to invest parts of it supper profit on activities and areas
which will lead to reduction of inefficiency cost in the short to medium term so that when
prices begin to fall as a result of market correction the reduction in inefficiency cost could
compensate for the price reduction the them to mentain the acceptable profit margin.