Firms: size, growth, mergers and economies of scale

Last time

Before we start: last time, in Money, commercial banks and the central bank, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Small shops and giant firms

On one street in Pakistan you can find a small family shop and, next to it, a branch of a huge national chain. Why do some firms grow so large, while others stay small? This lesson covers the types of firm, how they grow, and why being big can cut costs, or raise them.

Private and public sector firms

Private sector firms are owned by individuals or shareholders and usually aim for profit: sole traders, partnerships and companies. Public sector organisations are owned by the government, and aim to provide a service, such as electricity, water or railways. The examiner asks you to explain the difference, so always compare ownership and aims.

Measuring the size of a firm

Number of employees: how many people the firm employs. Output or sales revenue: how much it produces or sells in a year. Market share: its sales as a percentage of all sales in the market. And capital employed: the value of its machines and buildings.

Why small firms survive

Some markets are small, or local: a village shop or a specialist tailor cannot grow much. Small firms can give personal service, react quickly, and serve a niche, a small group of customers that big firms ignore. Some owners prefer to stay small to keep control. And governments often help small firms with loans and advice.

How firms grow

Internal growth: the firm grows by itself, using its profits to buy more machines, open new branches and hire more workers. External growth: the firm grows by joining with another firm, through a merger or a takeover. External growth is quicker, but joining two different businesses can cause problems.

Three kinds of merger

A horizontal merger joins two firms in the same industry at the same stage of production, such as two toothpaste makers. A vertical merger joins firms at different stages of the same industry, such as a cotton grower and a textile mill. Backward towards supplies, forward towards customers. A conglomerate merger joins firms in unrelated industries, such as a cement maker and a bank.

Who gains from a merger?

The new firm may gain economies of scale, a larger market share, and more power over suppliers. Consumers may gain lower prices if costs fall. But with less competition, prices may rise and choice may fall. Workers may lose jobs where the two firms did the same work, such as two head offices.

Internal economies of scale

Economies of scale are the falls in average cost that come from producing on a larger scale. Purchasing: big firms buy in bulk and get discounts. Technical: they can use large, efficient machines. Financial: banks lend to them more cheaply. Marketing: advertising costs are spread over many units. Managerial: they can employ specialist managers.

External economies of scale

External economies of scale come from the growth of the whole industry in an area, not from one firm. When many textile firms gather in one city, there is a pool of skilled workers, specialist suppliers nearby, and good transport. Every firm in that area gains lower costs.

Diseconomies of scale

Diseconomies of scale are rises in average cost when a firm grows too large. Communication becomes slow, decisions take longer, and managers lose control of what is happening. Workers may feel unimportant, so motivation falls and absence rises.

Economies of scale at a glance

Here are the economies of scale you can name, with an example of each. Questions usually ask for two, explained.

Mistakes that lose marks

Mistake one: describing how a merger happens at length. The examiner said many answers did this, and it earned no marks. Mistake two: defining economies of scale as lower total costs. It is lower average cost. Mistake three: in a discuss question on mergers, forgetting consumers and workers. The fix: average cost, named economies, and every group affected.

The full-marks tip

The full-marks tip: define economies of scale as a fall in average cost as output rises, and name the type. For a merger, cover the firm, the consumers and the workers, then judge.

On one card

So, on one card: firms and economies of scale. Keep it for revision.