Where do profits come from?

We have stressed value creation as the main reason for firms to exist in the previous chapter. However, firms do not engage in business for the sake of value creation for their customers, but generally as the necessary condition to grow and obtain larger profits that they appropriate for their resources and owners. While value creation is, therefore, a precondition to value capture, it is the latter that firms ultimately pursue. We will now analyze how firms appropriate value.

It has been widely accepted since Adam Smith that the self-interest of two parties drives any voluntary economic exchange between them. The total value created in an exchange with a firm is divided between the customer and the producer's internal and external resources. Presumably, it is the search for producer's surplus (i.e., profits) that motivates the firm's managers in their business decisions. Profit maximization has become one of the cornerstones of economics, though it has received numerous criticisms regarding the extent to which it realistically describes firm behavior. Despite its centrality in economics, there is no agreement about the origin of profits, which have frequently been considered a nuisance for economic theory in the models of general equilibrium. In this section, let us briefly discuss the three most prominent approaches to profit theory in economics. In the rest of the chapter we will build on these ideas to understand the emergence and sustainability of profits from a strategy perspective.