20. Firms
Firms are classified by industry (primary to quaternary) and ownership (private, public, mixed). Firm size depends on market niche, capital access, or strategic goals. Growth occurs internally (expanding operations) or externally (mergers, takeovers). Integrations may be horizontal, vertical, or conglomerate, each with unique advantages and risks. Larger firms benefit from economies of scale (lower costs via efficiency), but may face diseconomies (higher costs from complexity). Mergers can boost market power and efficiency but risk job loss and price increases. Stakeholders—owners, workers, customers, suppliers, and the government—are all affected differently depending on the success and consequences of firm growth.
- Classification of Firms
Firms can be classified based on sector and ownership:
➤ By Sector of Industry (Based on Production Stages):
- Primary Sector: Involves extraction of raw materials from nature (e.g., agriculture, fishing, mining).
- Secondary Sector: Concerned with manufacturing and construction using raw materials (e.g., car factories, textile industries).
- Tertiary Sector: Provides services to consumers and businesses (e.g., education, healthcare, transport, retail).
- Quaternary Sector: Focuses on knowledge-based activities like IT, R&D, and data management.
➤ By Sector of Ownership:
- Private Sector: Owned and controlled by private individuals or companies (e.g., sole traders, partnerships, private limited companies).
- Public Sector: Owned and operated by the government, providing essential services (e.g., police, public transport).
- Mixed Economy: Combines both sectors; some services are publicly owned, others privately (e.g., NHS in the UK vs. private hospitals).
- Firm Size and Influencing Factors
➤ Why Some Firms Remain Small:
- Owner’s choice: Desire to retain control or work-life balance.
- Niche markets: Serving small, specialised markets.
- Flexibility and speed: Small firms can adapt quicker to changes.
- Limited access to capital: Smaller businesses may struggle to secure loans or investors.
- Regulatory or legal constraints
➤ Why Some Firms Grow Large:
- Access to larger markets
- Greater financial resources
- Government support schemes
- Skilled workforce availability
- Strategic locations
- Partnerships and alliances
- Growth of Firms
Firms can grow through two main strategies:
➤ Internal Growth (Organic):
- Expansion using the firm’s own resources.
- Methods include opening new branches, increasing product range, or entering new markets.
- Slower but often more controlled and less risky.
➤ External Growth (Inorganic):
- Merger: Two firms agree to join and form a new entity.
- Takeover (Acquisition): One firm buys another.
- Types of Integration
Firms may merge or acquire others in various ways:
- Horizontal Integration: Merging with a competitor at the same stage of production (e.g., two car manufacturers).
- Advantage: Market share increase, economies of scale.
- Risk: Reduced competition may lead to inefficiency.
- Vertical Integration:
- Forward Vertical: Acquiring a firm closer to the consumer (e.g., manufacturer buying a retailer).
- Backward Vertical: Acquiring a supplier (e.g., carmaker buying a parts supplier).
- Advantages: More control over supply chain, cost savings.
- Risks: High cost, lack of expertise in new area.
- Conglomerate Integration: Firms from unrelated industries merge (e.g., a food company buying a media firm).
- Advantages: Diversification, risk spread.
- Risks: Management complexity, lack of synergy.
- Economies of Scale (EOS)
As firms grow, average costs can fall due to economies of scale.
➤ Internal Economies of Scale:
- Technical: Efficient use of capital equipment and automation.
- Managerial: Specialised managers improve efficiency.
- Marketing: Lower cost per unit of advertising.
- Financial: Easier to get loans at better rates.
- Risk-bearing: Can spread risks over a wider product range.
- Purchasing: Bulk buying reduces input costs.
➤ External Economies of Scale:
- Occur outside the firm but within an industry.
- Examples: skilled local workforce, improved infrastructure, availability of component suppliers nearby.
- Diseconomies of Scale
Beyond a point, further growth can increase average costs.
➤ Internal Diseconomies:
- Coordination issues: Harder to manage larger operations.
- Communication breakdowns: Delays and inefficiency.
- Motivation loss: Workers may feel less valued in large firms.
- ‘X’ Inefficiency: Lack of competitive pressure causes complacency.
- Principal-Agent Problem: Separation between ownership and control can lead to conflicting goals.
➤ External Diseconomies:
- Overcrowding: Too many firms in one area causes congestion.
- Skilled labor shortages: Harder to find qualified staff.
- Rising costs: Land prices and input costs may rise.
- Impact of Mergers and Takeovers
➤ Advantages:
- Increased market share and power.
- Greater efficiency and cost savings.
- Access to new markets and technologies.
- Can eliminate competition and duplication.
➤ Disadvantages:
- Loss of jobs due to duplication of roles.
- Higher prices due to reduced competition.
- Risk of diseconomies of scale.
- Cultural clashes or poor integration.
- Stakeholder Impacts
- Owners/Shareholders: Potential for higher profits or risk of loss if integration fails.
- Employees: May benefit from growth or face job cuts.
- Customers: Might enjoy better products or suffer from higher prices.
- Suppliers: Could gain more business or be squeezed on prices.
- Government: Monitors for anti-competitive behavior (e.g., via Competition Authorities).
Internal vs. External GrowthÂ
Internal Growth: Expansion using a firm's own resources (e.g., new outlets). External Growth: Expansion via mergers or takeovers of other firms.
Types of Integration
1. Horizontal: Same industry & stage 2. Vertical Forward: Toward consumer 3. Vertical Backward: Toward supplier 4. Conglomerate: Different industry
Economies of Scale (EOS)
Cost savings as firms grow: Internal: Technical, managerial, marketing, financial External: Industry-level benefits (e.g., skilled labor, local suppliers)