CHAPTER 20-

FIRMS

The classification of firms

 There are 3 ways in which firms can be classified, by:
 The economic sector
  Private and public sectors
 The relative size of firms

The economic sector

 One way to classify firms is according to the economic sector is which they
operate; the sectors:
 Primary sector: contains firms that extract raw materials from the earth.
E.g., are fishing, mining and agricultural farming firms.
 Secondary sector: Contains firms that change raw materials into finished
products, e.g., firms that manufacture goods and construct buildings
 Tertiary sector: contains firms that provide services to other firms and
the public. E.g., advertising agencies, retail shops, hospitals, schools,
insurance companies and banks.
 Not in syllabus (use: for internal exams):
some economists identify a quaternary sector [it is more like a sub
section of the tertiary sector]: it is those firms in the tertiary sector
that provide IT services (collection, processing and transmission of
information)
 These 3 sectors are interdependent: depend on each other and cannot
operate independently to produce goods and services.

Private and public sector:

 A second way firms classified is according to whether they operate in the
public or private sector.
 Public sector: refers to economic activity of private individuals and firms.
The private sector firms’ main aim is to earn profit for its owners. Types of
private sector firms:
 Sole traders: business owned and controlled by a single person.
 Partnership: business owned by between two and twenty people, with
shared ownership and risk-taking
 Private limited company: a business owned by shareholders, who are
unable to buy or sell shares until they get the consent of other
shareholders
  Public limited company: a business owned by shareholders, who can
openly and freely buy or sell their shares on a stock exchange.
 Public sector: refers to economic activity directly involving the government,
such as the provision of state education and healthcare services. The public
sector’s main aim is to provide a service. Public sector firms/organizations
are owned by the government, and, therefore, are funded by tax revenues.
E.g., water suppliers, sewerage providers, and utilities (electricity and gas
boards).

The relative size of firms

 Another way firms can be classified is according to their relative size.
 The reason that there’s a difference between business sizes (small
businesses co-exist with multinational companies) is due to the fact that:
 Some businesses start off small and grow over time
 Other prefer to remain small (explained later)
 The relative size of firms is measured in several ways:
 Number of employees: usually, the greater the number of employees
the larger the business. This is because larger businesses have much
more tasks to perform and therefore need more workers.
 Market share: this is a measure of a firm’s sales revenue as a proportion
of the whole industry’s sales revenue. The greater the market share the
larger the business.
 Market capitalization of a firm: this is the stock market value of a
company (calculated by: total number of shares in a business × current share price). The
greater the market capitalization the greater the size of a firm.
 The availability of financial capital: The more financial capital a firm has
to draw on to finance its expansion, the larger it is capable of growing.
 Age of firms: Evidently a firm that’s been set up for 5 years, for instance,
would have had more chances to grow than a business startup. (This
point is variable as some business prefer to remain small and are not
looking for growth opportunities.)

Small Firms
 Small firms co-exist with large firms for the following reasons (the reasons
as to why small business exist):
  Owner’s Decision: The owner (or owners) of a firm may not want it to
grow. This could be due to the fact that they don’t want to handle the
stress of a larger business, may be worried that a larger business could
lead to loss of control and worse product quality or for other motives.
 Location: a small business may be located in a remote area and may be
the only provider of goods (in its industry).
 Specialization: some small businesses provide consumers with goods
and services that cannot be bought in a larger firm.
 Flexibility: many small firms have the ability to adapt to market and
consumer changes faster. E.g., A sole trader is likely to be in regular
touch with his, or her, customers and should be able to pick up on
changes in their demand.
 Consumer demand: if a product’s demand is low the firms supplying
cannot be large. E.g., luxury yachts and designer clothes.
 The most common type of small firms are sole proprietorships.

Advantages and disadvantages/challenges of small firms

» Small businesses are likely to » Largest risk of business failure, for

know their customers on a more
personal level and this can lead to
better relationships. Larger firms
might not have the time to get to
know their customers, so their
services often become impersonal.
» Being your own boss can have
some advantages: not having to take
orders from others and having
flexibility in decision making (such as
dictating your working hours)
» Few legal formalities exist. This
means that small firms, e.g., sole
traders, are easier to set up and
2 reasons:
•intense competition due to the
vast number of small firms that exist
•larger and more established
businesses often poses a huge threat
to the survival of smaller firms.
» Small firms often suffer from a
lack of continuity. The running of the
business can be jeopardised if the
owner is not there, maybe due to
going on holiday, or due to illness.
» Running small firms could be
accompanied with a lot of stress,