Skip to main content

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)

Labels:

Comments

Post a Comment

Popular posts from this blog

Is the existence of different wages a problem for societies, and if so, how can it be remedied?

  Adam Smith, and Karl Marx, both believed that labour value lies at the heart of all economic value. Commodities, goods, and services arise from the interaction of land, labour, and capital. Since Land is fixed until new land is cleared or built by workers, and since capital enhances labour and is invented by people, they both thought that the only people who added value in economic transactions were workers. This theory of labour value was qualified in the second half of the twentieth century by the elevation of entrepreneurialism as a factor of production. The enterprising businesspeople who took on risks, brought factors together, and who were rewarded with profit having been prepared to make losses, were elevated to a ‘fourth factor.’ This idea makes some sense, but also serves to undermine the idea that labour value on its own creates economic value. If labour has value, some argue that the value of time taken from a life to work should be viewed equally. This means t...
Post a Comment
Read more

Inequality, Part One: the greatest market failure?

    Income inequality arises when different consumers have different incomes, and different people have different talents. It could also arise because of the source of income or the value of the talents. For instance, employees might have different incomes from each other because of different marginal labour products, different factor returns to their labour, or different elasticities of labour. People might have different skills for which there is a greater or lesser need and employers, or the purchasers of labour might have different demands. Equally, entrepreneurs often take greater risks than others, and thereby expect and receive greater rewards than those who do not take risks. There might be different factor returns to capital or land, which result in various levels of profit, dividend, or rent, for those who do not live by the return to their labour value. A functional market would bring all these diverse groups together as suppliers and consumers and would matc...
Post a Comment
Read more

How great a challenge does the growth of the People’s Republic of China pose for the world economy?

  The PRC became committed to a policy of managed marketisation and globalisation in 1987, which was termed ‘capitalism with Chinese characteristics.’ In the decades since, economic growth has lifted more people from poverty than at any other time in history, contributed to the development of global growth, and added a third engine to global markets after North America and Europe. As China is resource-poor, its spending of surplus dollars gained in trade on African and South American markets has also lifted those areas for the first time from the dependency and postcolonial malaise identified by the Brandt Commission in 1980. Western Europe, and particularly Britain, have benefitted from Chinese investment and tourism, and have reached a position of trade balance as European and British products have been sold to the Chinese middle classes. The immediate ‘challenges’ of such growth have largely been to western institutions and wages. In the longue durée , China’s growth, and that...
Post a Comment
Read more