How Small Firms Compete

Why Small Firms Cannot Compete on Price

Large firms have economies of scale (unit 2.1.1), so their average cost is usually lower. A small firm that tries to match their prices will make a loss. To survive, it has to give customers a reason to pay a little more.

The examples follow an independent bike shop competing with a national chain and online sellers.

Product Differentiation and USPs

Unique selling point (USP): a feature of a product or business that customers value and rivals do not offer.

The bike shop builds custom bikes to order and offers a free fitting with every sale. Something customers cannot get elsewhere → fewer close substitutes → demand is less price elastic → it can charge more than the chain without losing many sales → a margin high enough to survive on.

Flexibility in Responding to Customer Needs

A small firm has few layers of management, often just the owner. A customer asks for something unusual → the owner decides on the spot → the order is met within days → sales a large firm's fixed range and procedures would miss.

The same applies to the whole range. If customers start asking for electric bikes, the shop can stock them next month, while the chain waits for a decision from head office.

Customer Service

In a small firm customers often deal with the owner, who knows their names and what they bought last time. Personal service → customers feel valued → they come back and recommend the shop to friends → repeat sales and free word-of-mouth advertising, from customers who are less likely to switch for a lower price.

Targeting Niche Markets

Niche market: a small, clearly defined part of a larger market, with its own particular needs.

Specialising in a niche, such as vintage racing bikes or adapted bikes for disabled riders, lets a small firm become the expert. The niche is often too small for a large firm to bother with → little direct competition → loyal customers willing to pay a premium.

There are two risks. A niche can shrink if tastes change, and a niche that grows can attract a large firm that brings its lower costs with it.

Relationships With Stakeholders

Stakeholder: any person or group with an interest in what a business does (unit 1.1.3).

Close relationships can give a small firm a competitive advantage that size cannot buy:

• Suppliers: a long-standing local supplier → quick deliveries, help in a rush and sometimes longer to pay → lower stock costs and better cash flow.
• Employees: a small team that knows the owner and the customers → higher motivation and fewer staff leaving → lower recruitment costs and better service.
• The local community: the shop sponsors a local cycling club → goodwill and loyalty from people who want to support local businesses → more sales.

Whether these advantages are enough depends on:

• How easily rivals can copy them: a large chain can add free fittings too, but finds personal service and local ties harder to copy.
• The size of the cost gap: customers pay a little more for service, but not much more. If the chain's prices are far lower, many will switch. In trades where economies of scale are small, such as hairdressing, the gap may hardly exist.