S11

IGCSE®/O Level Economics

4.3 The growth of firms

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 The size of firms
It is useful to group firms together according to whether they are large enterprises or small
and medium-sized enterprises (SMEs).
The size of firms can be measured in different ways. They provide useful clues about the
reasons why some firms grow into very large organizations while others remain small.

Wal-Mart Stores Nyeko Plumbing

Multinational serving global market Sole trader serving local households

Workforce: 2.1 million employees Workforce: 1 owner/employee

Capital employed: $170 billion Capital employed: $5,250

Annual revenue: $405 billion Annual revenue: $23,700

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 But which is the largest?

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 Measuring the size of firms

There are a number of ways to measure and compare the size of firms:

•SIZE OF WORKFORCE But some large firms are capital intensive and
employ relatively few workers.

•INTERNAL ORGANIZATION Larger firms are divided up into different

departments each specializing in a particular function, such as purchasing,
sales and marketing, finance and production. In smaller firms, the owners and
employees all tend to carry out all these functions.

•CAPITAL EMPLOYED This is the amount of money invested in productive

assets that generate revenue. The more capital a firm can invest in
productive assets, the more it can produce. But production by some large
firms is labour intensive.

•MARKET SHARE Large firms may dominate sales in the markets they
supply. But not all markets are large. Firms serving small or niche markets
will tend to remain small.
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 How firms grow

Internal growth or organic growth is when a firm

expands its scale of production through the purchase
of additional equipment and increasing the size of its
premises
This will increase its fixed costs

External growth is when two or more firms join

together to form a larger enterprise
This is known as integration
Integration involves the merger of two or more firms
or the takeover of one company by another

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 Growth through merger or takeover
Horizontal integration occurs between firms engaged Vertical integration occurs between
in the production of the same type of good or service firms at different stages of production

Lateral integration occurs between firms in different

industries in the same stage or different stages of
production

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 What are economies of scale?
They are cost savings from increasing the scale of production in a firm or industry

Internal economies of scale

Increasing the size of a firm provides an

opportunity to change the way it is
organized, run and financed to reduce the
average or unit cost of production

External economies of scale

These are cost savings enjoyed by firms
in large industries compared to firms in
smaller industries

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 Internal economies of scale

PURCHASING ECONOMIES e.g. discounts for bulk purchases

MARKETING ECONOMIES e.g. mass advertising; own distribution network

FINANCIAL ECONOMIES e.g. ability to borrow more at lower interest rates

TECHNICAL ECONOMIES e.g. ability to afford and employ advanced equipment

RISK-BEARING ECONOMIES e.g. offering a range of different products

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 External economies of scale

These are cost savings enjoyed by firms in a large industry

These may be:

•Access to a skilled workforce because firms can recruit workers trained by

other firms in their industry

•Ancillary firms that develop and locate nearby large firms in other industries to
provide them with the specialized equipment and business services they need

•Joint marketing benefits: for example, new firms locating near to others in the
same industry may share their reputation for producing high-quality products

•Shared infrastructure: for example, the growth of an industry may persuade

firms in other industries to invest in new infrastructure such as power stations,
dock facilities and airports to meet increasing demand for these services

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 Can firms grow too large?
Firms can experience problems if they expand scale too much and too quickly
Falling productivity and rising average costs result from diseconomies of scale

•A large firm may run out of supplies of parts and materials

•A large firm may have to raise wages to attract sufficient numbers of workers
•A large firm may find it difficult to attract new customers
•A large firm may suffer more industrial disputes because production lines are
automated and work tasks are uninteresting

•A large firm may suffer from internal communication and coordination problems,
especially if it has many locations, many managers and many different activities

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 Returns to scale

Increasing returns to scale Constant returns to scale Decreasing returns to scale

A firm doubles all its inputs A firm doubles all its inputs A firm doubles all its inputs

Output more than doubles Output doubles Output fails to double

Therefore, cost per unit falls Cost per unit is unchanged Cost per unit rises

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 Why do some firms remain small?

• It may be because the market is a small,

local or specialized niche market

• A small firm may be unable to raise enough

capital to expand

• New technology may have reduced the

scale of production needed in some sectors

• The owner may prefer keep the business

small

▲ Smaller firms can often provide more

personalized goods and services than many
larger firms

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