Sizes and Types of Firms

Reasons Why Firms Grow

Ultimately, all firms have an incentive to grow in order to increase profits. Below are some of the main reasons why firms may seek to expand in size.

• Economies of scale: Larger firms can reduce average costs through bulk buying, specialisation, and spreading fixed costs.
• Market power: Larger firms may have more influence over prices and suppliers, allowing them to increase profits.
• Access to finance: Larger firms may find it easier to raise capital through loans or issuing shares.
• Brand recognition: Larger firms may benefit from stronger brand loyalty and customer trust.

Reasons Why Firms Remain Small

• Diseconomies of scale: As firms grow, they may face higher average costs due to management inefficiencies, communication problems, and bureaucracy.
• Market conditions: Some markets may lack demand or be highly competitive, making it difficult for firms to grow significantly.
• Owner preferences: Some owners may prefer to maintain control and keep the business small for personal or lifestyle reasons.
• Regulatory constraints: Some industries may have strict regulations that limit growth opportunities.

Divorce of Ownership and Control

In large firms, especially PLCs, owner's typically do not run the business on a day-to-day basis. Instead, owners employ professional managers to run the business. Owners/shareholders are the principals and managers are the agents who run the business on their behalf.

The principal-agent problem: Managers may pursue their own objectives, such as higher salaries, sales maximisation, or perks, instead of the owners' goal of profit maximisation.

Cause: The separation of ownership and control means that managers may not have the same incentives as owners, leading to potential conflicts of interest. For example, the owner wants to maximise profits, while the manager may want to increase their own salary or job security/salary, which may not align with profit maximisation.

Possible solutions: Solutions must ensure that managers are incentivised to maximise profits for the owners. This can be achieved through performance-related pay, such as bonuses or stock options.

Public Sector and Private Sector Organisations

Public sector: Public sector organisations are owned and funded by the government. Their main purpose is usually to provide a service, such as the NHS, state schools, or the BBC, and they are funded mainly through taxation.

Private sector: Private sector organisations are owned by private individuals or shareholders. Their main objective is usually profit, and they include sole traders, partnerships, and companies.

Profit and Not-for-Profit Organisations

Profit organisations: These aim to generate financial returns for owners. Most private sector firms fall into this category.

Not-for-profit organisations: These aim to achieve a social, environmental, or charitable mission. Any surplus is reinvested into the cause rather than distributed as profit.

Not-for-profit organisations can operate in both the public and private sectors, such as charities and some social enterprises, and they may receive tax advantages.