Number of Employees

4.
3 The Growth of Firms
In every industry there will be firms of different sizes. Many of today’s largest firms started as
small firms many years ago but have since grown to employ many thousands of employees and
a significant amount of capital.
The size and the market power of a firm can also be measured by its market share
TOTAL EMPLOYEES, CAPITAL EMPLOYED AND MARKET SHARE ARE MEASURES OF FIRM SIZE
• Number of employees: firms with less than 50 employees are often classed as small.
However, some large firms are very capital intensive and may employ relatively few
workers.
• Amount of capital employed: large firms will often invest many millions of dollars in
fixed assets such as premises, fixtures and fittings, machinery and equipment needed
for large-scale production and running business operations, often at many different
locations.
• Market share: the bigger the market demand for a good or service the more potential
there is for firms to grow large. The relative size of firms can be compared according to
their percentage share of the total market supply or total market revenue.
• Organization: large firms may be divided up into many different departments, for
example, finance, sales and marketing, purchasing and production, and have offices,
shops and/or factories spread over many locations with many different levels of
management.
A FIRM CAN GROW THROUGH INTEGRATION WITH OTHER BUSINESS ORGANIZATIONS
Internal growth involves financing business expansion from reinvested profits, loans or share
sales.
Growth by takeover or merger involves integration with other firms.
A takeover occurs when one company acquires ownership and control of another company
through the purchase of its shares.
A merger occurs when two or more firms agree to form a new company and issues new shares
in the combined company replacing those shares held by existing shareholders.
Horizontal integration occurs between firms at the same stage of production, producing similar
products such as integration between the ACE chemical Co and the DELTA chemical Co.
Page 1 of 6
THE ACE
CHEMICAL
CO
Alpha
chemical
THE
Co
DELTA
CHEMICAL
CO
Lateral integration, or conglomerate merger, occurs between firms at the same stage of
production but producing very different products such as integration between the furniture
company, the chocolate company and the paint making company.
Vertical integration occurs between firms at different stages of production.
Forward integration means integration between the juice shop chain and the juice making
company to ensure that there are sufficient outlets or sales.
Backward integration means integration between the juice making company and the grape
plantation farm to ensure an adequate supply of good quality raw materials at reasonable price
LARGE FIRMS CAN ENJOY SIGNIFICANT ECONOMIES OF SCALE
If a firm is supplying a large or expanding market it may be profitable to increase output. A firm
can increase output in the short run by increasing productivity or hiring some more labour, but
it will only be able to increase output significantly by expanding its scale of production. This
means increasing the amount of capital it employs in larger premises, new equipment and
machinery.
Increasing returns to scale-example

Before After
Labour $200 $400
Capital $250 $500
Materials $150 $300
Total costs $600 $1,200
Total output 200 500
Average cost $3.00 $2.40
Page 2 of 6
As firms increase output, market supply will rise and market price will tend to fall. This means
average revenue per unit sold will fall. Increasing the scale of production will increase total
profit as long as average revenue from each unit sold continues to exceed the average cost per
unit.
Advantages of large-scale production Disadvantages of large-scale production

Economies of scale refers to cost saving due Diseconomies of scale refers to rising costs
to increasing the scale of production because a firm has become too large
• Financial economies: larger firms often • Management diseconomies can occur
have access to more and cheaper because larger firms have so many
sources of finance managers of different departments
• Marketing economies: large firms can and in different locations. This makes
buy materials in bulk at discounted communication and decision making
prices, employ specialist buyers to difficult and managers can often
secure the best quality materials at disagree.
best prices, and spread their • Labour diseconomies occur when
advertising costs over larger output. workers become de-motivated and
• Technical economies: larger firms can their productivity falls. This may occur
afford to invest in specialized methods in large firm because many production
of production and equipment, highly processes may be automated and
skilled workers, and research and workers become bored with repetitive
develop new products and process. tasks.
• Risk-bearing economies: the ability to • Agglomeration diseconomies occur if a
spread financial risks over many company takes over or merger with
investors, and reduce market risks by too many other firms producing
selling a wide range of different different products. The business
products in different locations. This is owners and managers may find it
called diversification. difficult to co-operate all the different
• Managerial economies: a large firm activities of merged firms.
can employ specialists and as a result,
efficiency is likely to improve and
average costs fall.
INTERNAL ECONOMIES OF SCALE AND EXTERNAL ECONOMIES OF SCALE
Internal Economies of Scale
Through the growth in size firms are able to enjoy a number of cost advantages over smaller
firms. Average costs can be reduced as a firm grows. It is known as internal economies of scale.
These are the cost savings that result from large-scale production. There are five main types of
internal economies of scale.
Page 3 of 6
Type Benefits to large firms
Purchasing economies Discount when bulk buying raw materials and other resources
Marketing economies Large business may buy or hire their own vehicles to distribute their
goods and services rather than rely on other to do so.
Financial economies More sources to choose from and lower rate of interest from banks
Technical economies Large firms are able to invest in specialized machinery and
equipment, in research and development to develop new product
and process to increase the efficiency of production
Risk-bearing economies Wider product ranges and more markets help to reduce business
risk.
External Economies of Scale
Sometimes all firms in an industry can enjoy falling average costs as the whole industry grows.
This is called external economies of scale. External economies are more likely to raise if an
industry is concentrated in a particular region.
Ancillary firms An established industry in a region will encourage firms which

provide the specialized equipment and services. There is also likely
to be a build up of labour which has the skills and work experience
required by that industry.
Joint marketing Firms in the same industry co-locating together in an area well
benefits known for producing high-quality products may share an enhanced
reputation.
Shared infrastructures The growth of an industry may persuade firms in other industry to
invest in new infrastructure such as new power stations, dock
facilities. Similarly, a government may invest in new road and railway
links to industrialized areas.
Page 4 of 6
DESPITE THE ADVANTAGES OF LARGE-SCALE PRODUCTION, MANY SMALL FIRMS ENJOY
SUCCESS
There are still many small businesses and new start-up all over the world because:
• The size of their market is small or local

• Consumers want to choose between a wide of products and suppliers
• Consumers like personalized services and products
• The owners choose to keep their businesses small
• They cannot raise enough capital to expand their businesses
• Government often provides financial help to new entrepreneurs to start businesses
The vast majority of firms in many countries are small. Government in many countries have
encouraged the development of small businesses. In developed economies, the growth of
tertiary sector has also helped. This is because the provision of many services is more effective
on a small scale.
Advantages of being a small firm Disadvantage of being a small firm

➢ Flexibility: small firms can adapt to ➢ Higher cost: small firms can not take
change more quickly. This is because the advantage of economies of scale.
the owner, who tends to be the main So their average costs will be higher
decision maker is currently involves in than their large rivals.
the business and can react to change. ➢ Lack of finance: small firms often
➢ Personal or customize service: some struggle to raise finance as their
people prefer to deal with the owner sources of finance is limited.
of a firm directly and are prepared to ➢ Difficulty to get skilled labour: small
pay higher price for the benefit. firms may find it difficult to attract
➢ Lower wage costs: many workers in highly skilled labour due to limited
small firms do not belong to trade financial resources.
unions. ➢ Vulnerabllity: small firms might also be
➢ Better communication: since small at risk of takeovers.
firms have fewer employees,
communication tends to be informal
and more rapid than in larger
organizations.
➢ Innovation: one reason for this is that
small firms face competitive pressure
to innovate.
Page 5 of 6
However, large firms are also important for economy as they contribute a large proportion of
national output.
Advantages of being a large firm Disadvantage of being a large firm

Economies of scale: the main advantage to Too bureaucratic: large firms become
large firms is that their average costs are likely overwhelmed by their administrative systems.
to be lower than those of smaller firms. As a result, decision making can be very slow
Because they operate in large-scale and as so many people from different department
exploit economies of scale. have to be contacted before a decision can be
Market domination: large firms can often taken.
dominate a market. They have a higher profile Coordination and control: many employees
in the society than small firms and benefit and plants all over the country and world can
from such recognition that is they can charge make running a very large organization
higher price to make higher profits. demanding. There may also be a need of more
Large-scale contracts: for example, only a supervision that will rise costs.
large firm can win a contract to build a new Poor motivation: the organization may
motorway for the government because they become so large that the effort made by a
have sufficient resources to carry out the individual labour seems insignificant. This can
work. result in poor worker motivation.
Page 6 of 6

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4.

3 The Growth of Firms

A FIRM CAN GROW THROUGH INTEGRATION WITH OTHER BUSINESS ORGANIZATIONS

Growth by takeover or merger involves integration with other firms.

Vertical integration occurs between firms at different stages of production.

LARGE FIRMS CAN ENJOY SIGNIFICANT ECONOMIES OF SCALE

Increasing returns to scale-example

Advantages of large-scale production Disadvantages of large-scale production

INTERNAL ECONOMIES OF SCALE AND EXTERNAL ECONOMIES OF SCALE

Internal Economies of Scale

External Economies of Scale

Ancillary firms An established industry in a region will encourage firms which

• The size of their market is small or local

Advantages of being a small firm Disadvantage of being a small firm

Advantages of being a large firm Disadvantage of being a large firm

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