Why do some firms remain small and other firms grow?

Some firms may choose to remain small in order to maintain control. There are also barriers to the growth of firms such as a firm having limited access to financial resources, meaning that some firms may remain small.

Some firms may try to grow to gain market share so that they can gain a more dominant position within a market. Moreover, by growing, firms are likely to gain large economies of scale (which is likely to lead to a fall in long-run costs of production), potentially leading to the firm becoming more profitable.

What is the principal-agent problem?

The principle-agent problem is where the agent (workers/managers) and principal (owners) have differing objectives within the firm. 

The principle-agent problem is more common within larger firms where there is more likely to be a divorce between ownership and control. Usually, in larger firms, owners have little to no part in day-to-day operations. 

In smaller firms, the principle-agent problem is less likely to arise as the owner is likely to also run the firm on a daily basis.

To solve the principal-agent problem, the interests of the agent must be aligned with the principal. 

This is mainly achieved by incentivising management to grow the share price of the firm. For example, by paying managers with shares, or giving managers a bonus based on profit.

What is the distinction between public and private sector organisations?

Public sector organisations aim to provide a service and are owned by the government. Private sector organisations aim to make a profit and are owned by individuals.

What is the distinction between profit and not-for-profit organisations?

Profit organisations aim to generate financial gains or profits. Not-for-profit organisations aim to help society and maximise social welfare.

How do businesses grow and what are the advantages and disadvantages of these methods?

Organic growth is the internal growth and expansion of a firm as a result of the firm increasing its output levels or by other means such as creating new products, without a merger or an acquisition. An advantage of organic growth is that the firm is likely to maintain full control over its business. Another advantage of organic growth is that organic growth may be cheaper than other methods of growth such as integration. A disadvantage of organic growth is that it is likely to lead to slower growth compared to other methods such as integration. Another disadvantage of organic growth could be that organic growth relies solely upon internal resources, rather than leveraging external resources and expertise, which may limit growth.

Vertical integration is where a firm grows as a result of it merging with or gaining ownership of a firm that operates within other areas of the supply chain. Forward vertical integration is where a firm merges with or gains ownership of a firm that is closer to the consumer, for example by merging with or gaining ownership of a firm that has a retail store. Backward vertical integration is where a firm merges or gains ownership of a firm that is further away from the consumer, for example by merging with or gaining ownership of a firm that supplies raw materials. An advantage of vertical integration is that a firm has more control over its costs as they have more control over the production process. Moreover, this increased control over the production process may mean that the firm has improved control over the quality of the goods or services that it may produce. A disadvantage of vertical integration is that some firms may not have much knowledge of the industry that they have vertically integrated with, potentially resulting in the firm making ineffective decisions and strategies. Moreover, another disadvantage of vertical integration is that it may increase operational complexity for the firm.

Horizontal integration is where a firm grows as a result of it merging with or gaining ownership of a firm at the same stage of the supply chain. An advantage of horizontal integration may be that firms can merge with competitors, reducing competitive pressures for the firm. Another advantage of horizontal integration may be that a firm can improve its geographic reach if the firm merges with a firm in the same industry which operates in another geographical area. A potential disadvantage of horizontal integration is that the merged firm may be under increased regulatory scrutiny, and the firm may have to spend more money and resources on complying with regulations. Another potential disadvantage of horizontal is that there may be job losses.

Conglomerate integration is where a firm grows as a result of it merging with or gaining ownership of a firm that may appear unconnected. An advantage of conglomerate integration may be reduced risk due to increased diversification. Moreover, another advantage of conglomerate integration could be that a firm could grow its profits more than it could in its original industry. A disadvantage of conglomerate integration could be that the firm may lack knowledge of the industry that it has integrated with, potentially resulting in the firm making ineffective decisions. Another disadvantage of conglomerate integration could be that the firm may not be focused as it focuses on multiple areas, potentially resulting in inefficiencies.

What are the constraints on business growth?

• Size of the market. If there are not enough consumers in the market, firms don’t have any room to expand. This is particularly the case in niche markets, where profitability is high as suppliers can charge a premium price, but have limited opportunities for economies of scale to be exploited.
• Access to finance. If banks are unwilling to lend it may create difficulties for a firm looking to raise capital for investment, hence limiting growth. 
• Owner objectives. Not every owner will want to grow the firm as they may want to retain control. Other reasons an owner may not want to grow the firm could be due to the fact that they are risk-averse or happy with their level of profit.
• Regulation. Competition laws may prevent a firm from expanding as much as it would want. Moreover, growing businesses which are gaining market share may come under increased scrutiny from competition authorities, leading to increased regulatory pressure.

What are the reasons for a demerger? 

A demerger is a strategy which involves a firm being divided into two or more separate entities. The reasons for a demerger could be:

• Tax advantages. A demerger may mean that the firm becomes more tax efficient, reducing the firm's tax liability, and reducing the costs of production.
• Improved focus. A demerger may mean that a firm will be able to focus more on its core activities. This is likely to lead to improved efficiency levels.
• Regulatory pressure. Some firms may face lots of regulatory pressure which can be reduced by a demerger where the firm is divided into two or more separate entities.

What are the impacts of a demerger on businesses?

• Costs may rise which is likely to lead to a fall in profit.
• Reduced ability to survive in the market due to a loss of market power.
• A fall in efficiency levels due to the loss of economies of scale.

What are the impacts of a demerger on workers?

• Workers may see a fall in their wages as they may now be in a lower level of responsibility within a smaller firm.
• Workers may have a greater chance of promotion within the new smaller firm.
• Workers may have more bargaining power within the smaller firm and may be able to negotiate higher wages.

What are the impacts of a demerger on consumers?

• Prices may rise due to an increase in the smaller firm's average cost.
• The quality of goods and services may fall if the smaller firm's lower profits lead to a fall in investment.
• Reduction in choice of products as the firm focuses on its core products only.