3.1 - Size and types of firms Flashcards
Business growth
What are the advantages of large firms?
1) Can exploit economies of scale
- decreases costs of production
- increases output - more revenue
> increases profit (many firms are profit
maximisers)
2) Gain market power
- larger firms hold greater shares of
market
- greater ability to influence prices
- greater ability to restrict other firms
from entering the market
> able to make profit in long run
3) Increases financial security
- able to build up assets and cash
> can be used in financial difficulties
- able to sell a larger range of goods in
more than one local/national market
> less impacted by changes in market (
due to place/product)
What factors affect whether firms remain small or grow?
1) Market demand
- Firms may remain small if there is low
market demand for their good/service
- However some firms may grow if their
goods/services are in higher demand in
order to meet it
2) Access to capital
- Availability of funds
- Eg: small startup businesses may
struggle to secure investment whereas
companies with proven track records
easily raise funds to expand
3) Managerial capacity
- entrepreneurs may
lack resources/skills
required to manage a
large organisation
efficiently
4) Government
regulations
- regulatory barriers can
hinder or promote
growth in specific
industries
5) Economies of scale
- cost advantages a
firm can achieve as it
increases its level of
output
- however rapid growth
cause diseconomies of
scale
What are some reasons as to why some firms remain small?
1) Offer a more personalised service and focus on building relationships with their customers
2) Unable to access finance for expansion
3) Provide a product that is in a niche market - smaller market size but can be very profitable
4) Many small firms operate in mass markets with low barriers to entry
5) Rapid growth can cause diseconomies of scale which are difficult to deal with so many owners choose to avoid these
6) Owners goal is not profit maximisation but rather an acceptable quality of life (satisficing)
What is the divorce of ownership and control?
- As firms grow, the owners (or shareholders) often appoint managers to run the business for them
- There is a separation (divorce) between the owners and the managers who control the day-to-day running of the business
- This divorce gives rise to the Principal-Agent problem
What is the principle agent problem?
This problem arises when the interests of the owner (principal) and the manager (agent) of a firm do not align, leading to conflicts.
What are some examples of the principle agent problem?
1) Misaligned Incentives:
Point: Managers may prioritise personal gain over maximising shareholder wealth.
Example: CEOs receiving large bonuses even if company performance declines, leading to shareholders losing value.
- Risk Aversion:
Explanation: Managers may avoid taking risks that could benefit the firm but endanger their job security.
Example: Managers may resist long-term investments in research and development due to the uncertainty involved.
How is the principle agent problem exacerbated?
- The problem is exacerbated by information gaps in that the agents have a lot more information than the owners and are often able to control the flow of that information.
What are some solutions to the principle agent problem?
Various mechanisms:
- performance-based pay, monitoring
- corporate governance
- granting share options to managers
> are used to align interests.
What is a public sector organisation?
- Public sector organisations are owned and controlled by the Government
- Their goal is not profit maximisation but to provide a service
What is a private sector organisation?
- Private sector organisations are owned and controlled by private individuals
> Types of ownership vary from sole trader to partners to company shareholders - The goal of most private sector organisations is profit maximisation
> often means the private sector is more efficient than the public sector, with higher levels of productivity
What is the difference in ownership and control between private and public sector organisations?
Public sector organisations are owned and controlled by the government, while private sector organisations are owned by private individuals or entities.
What is the difference in motives between public and private sector organisations?
Private sector firms aim to generate profits, while public sector organisations aim to provide services
What is the difference in funding sources between public and private sector organisations?
Public sector organisations are funded through taxes and government budgets, while private sector organisations rely on investments, loans, and revenue.
What are not-for-profit organisations?
-Operate in the private sector
- They exist to provide a service or meet a need
- Many sell goods/services and use the profits they generate to further their objectives, e.g. The British Heart Foundation
- The government exempts them from paying direct taxes
What is the difference in profit orientation between profit and not-for-profit organisations?
Profit organisations aim to generate income that exceeds their expenses, while not-for-profit organisations prioritise their mission over profit.
What is the difference in revenue sources between profit and not-for-profit organisations?
Profit organisations primarily rely on sales and investments for revenue, while not-for-profit organisations may depend on donations and grants.
What is the difference in distribution of surplus between profit and not-for-profit organisations?
Profit organisations distribute surplus (profits) to shareholders or reinvest it, whereas not-for-profits reinvest surplus in their mission.
