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Why do some firms choose to remain small?

  

Defining a large business is not easy. Vladimir Lenin, who is not usually viewed as a business guru, did it by default when he wrote that a small business employed five people or fewer.[1] Most economists would point to a variety of metrics, including market share, capitalisation, the overall value of assets or profits, or both, or turnover.

Economists argue that businesses want to grow however. This is because larger businesses benefit from economies of scale, either physically, internally, or externally. Larger businesses are thought able to lower long run average costs (LRAC) to their lowest point, the minimum efficient scale (MES), and can hold them there across a range of output. This means that they can ‘stretch out’ the moment of lowest LRAC.

Eventually, diseconomies of scale set in as the business gets too big. There are too many managers, or company structures are too complicated, or the business is complacent and develops x-inefficiency and y-inefficiency, failing to hold down costs or to develop new products and markets. Economists argue that this point is not reached quickly in most businesses, and that therefore companies maximising their own profits should grow at least until LRAC starts to rise.

Many industries do not operate on this basis, however. Small companies focussed on outsourcing, or some ‘tech’ companies, are best when they are compact, and reach MES at quite a small scale. In addition, the objectives of the owners need to be accounted for, as well as their business model. For instance, an individual might maximise their own utility by being free of any bosses as a sole trader or director of a limited company, and might measure their success by their ability to maintain the employment of their workers, property for themselves and their family, and a modest but comfortable lifestyle. This does not require them to be as big as possible and to be striving for growth all the time. Of course, a company may also wish to remain small so as not to attract attention from regulators or potential bidders, though some firms in the tech and education industries, for example, establish themselves with the aim of being bought out by a global oligopoly or monopoly.

Firms that gain market share gain price making power. This allows them to maximise consumer surplus, sometimes at the cost of the allocative efficiency of the whole economy.

Large firms with market power can also engage more easily in price discrimination, and on attempts to make consumer demand inelastic with advertising or marketing, or the development of a suite of complementary goods which raise barriers to entry. Apple, for instance, maintained a market share of the mobile telephone and computer market of above 35% as late as 2018 by linking a variety of products, including charging cables, closely together. A smaller firm with consumers who were more focussed on price and functionality would not have been able to do so.

Firms are sometimes best understood in terms of behavioural analysis. A smaller private limited firm may wish to continue with a profit-satisfying level of earnings, in a particular location or in association with a particular set of families. In odd markets, such firms can swell in size—the Korean chaebol and Japanese Keiretsu were largely family-based, for instance—and then decline with little appreciable change to family or managerial behaviours above a certain minimum income level. Sometimes firms are affected by endogenous factors, such as the global reach of the economy they are located in and the extent of its markets, such as Imperial Chemical Industries in Britain (ICI) which rose and fell in parallel with British captive markets and investment. Over time, directors may also be aware of the way that technology and products can change, and prefer to offer a guaranteed level of quality within a particular niche over time, rather than to pursue rapid growth and then a high probability of decline.

It is not therefore obvious that businesses would want to grow; some would actively wish to stay small.


[1] Vladimir Lenin, Imperialism the Highest Stage of Capitalism (1917)

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