The setting of profit targets for target oriented divisions

Setting profit targets and striving to achieve them is fundamental to business survival and success. However, there has been little research on modeling profit-target setting. In this paper, we study analytic target setting under a common business scenario where a firm is in control of multiple divisions. Both the firm and the divisions maximize the profit probability, i.e., the probability of achieving some given profit target. The firm sets a profit target for each division which then acts as a price-setting newsvendor. We first obtain the optimal order quantity, the optimal retail price, and the maximal profit probability of a single division given its assigned target. We then derive the firm’s profit probability and focus on two specific cases to gain more managerial insights. In the first case of fair target setting, we show that when each division’s demand distribution has an increasing failure rate, if a division has a relatively high (low) production cost, its assigned profit target decreases (increases) with regard to its price elasticity. In the second case, if the firm is in control of two identical divisions, each division’s optimal profit target is just half of the firm’s profit target when the price elasticity is two or more, regardless of production cost and demand distribution.