Measuring business size and why businesses grow or stay small

Last time

Before we start: last time, in Entrepreneurs, business plans and why businesses fail, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Big and small

A corner shop and a national supermarket chain both sell food. But how do we say one is bigger, and by how much? And why does one stay small while another grows? This lesson answers both.

Ways to measure size

Number of employees: the simplest measure. But a highly automated firm may be large with few workers. Value of output, or revenue: how much it produces or sells. But this depends on the price of the product. Capital employed: the money invested in the business. And market share: its sales as a percentage of the market.

Why not profit?

Profit is not a good measure of size. A small, efficient business can make more profit than a large, badly run one. No single measure is perfect, so businesses are often compared using more than one. And the best measure depends on the industry: workers for a labour-intensive firm, capital for a capital-intensive one.

Why owners want to grow

Larger businesses gain economies of scale, so their average costs fall. They gain a bigger market share, so more power over prices and suppliers, and a stronger brand. Growth also spreads risk across more products or markets, and can mean higher profits and status for owners.

Internal growth

Internal growth, or organic growth, is when a business expands its own activities: new products, new branches, more workers. It is usually financed from retained profits, so it is slow but low-risk. The owners keep control, and the business culture stays the same.

External growth

External growth is when a business joins with another: a merger, by agreement, or a takeover, when one buys the other. A horizontal merger joins firms in the same industry at the same stage. A vertical merger joins firms at different stages, backward towards suppliers or forward towards customers. A conglomerate merger joins firms in different industries, to spread risk.

Types of merger

Here are the types of merger with a Pakistani-style example of each, and the main benefit.

Problems of growth

Growth needs finance, and borrowing adds interest costs. Communication and coordination become harder: diseconomies of scale. After a merger, different cultures may clash, and jobs may be cut, lowering motivation.

Why some businesses stay small

The market is small: a specialist product or a local service, such as a village barber, has few customers. The owner chooses to stay small, to keep control, avoid risk and stress, or keep a personal service. Lack of finance to expand, or the type of product, such as hand-made goods, limits growth.

Advantages of being small

Small businesses can give personal service and know their customers well. They are flexible: decisions are fast, and they can change quickly. They can serve niche markets that large firms find too small to bother with.

Judging the most important reason

Six-mark questions often end: which reason is likely to be the most important? Justify your answer. A good judgement compares the two: it says why one matters more for this business, using the case. For example: the owner's wish to keep control matters most, because even with finance he would not expand.

Mistakes that lose marks

Mistake one: using profit to measure the size of a business. Mistake two: mixing up horizontal and vertical mergers. Mistake three: a judgement that just repeats one point without comparing it with the other. The fix: correct measures, correct merger, and a compared judgement.

The full-marks tip

The full-marks tip: measure size with employees, output, capital employed or market share, never profit. In the judgement, say why one reason matters more than the other for this business.

On one card

So, on one card: business size and growth. Keep it for revision.