Essay/Term paper: Optimal size of a firm

Essay, term paper, research paper:  Society Term Papers

Optimal Size Of A Firm


The optimum size of a firm is a very subjective idea. The ways in which
size can help or hinder a firm vary from which angle you a looking at the
situation from. Size can have its benefits and its drawbacks, and each firm will
have its own benefits and drawbacks that come from either increasing in size, or
remaining small, and these will depend on the market in which the firm is in,
the current economy, and in some cases the preferences of the manager(s).

For example a small firm may be small for many reasons. It may be small
because it has just started out in business, and still has relatively little
funds, so although the owner/manager may have aspirations of the business
growing, at the present time, his main concern would be keeping the business
afloat. Another small business may stay small due to the preference of the
manager/owner, for example a corner newsagent's shop may remain a small retail
business as the owner is making a profit from the business that he finds
acceptable, and does not want the hassle of either expanding his current
business, setting up new shops, or taking over another business.

The size of a business does however depend a great deal on the market
which it is in. For example a business which makes specialist goods, or caters
to only a very small number of people, will not be able to grow beyond the
capacity of that market. This means that the optimum size for a business in a
market with little growth and only a small number of prospective customers would
be large enough to serve as many customers as it had market share for, but small
enough to ensure that they don't over produce.

If there is a fairly large market for the product/service that a company
is providing, then there is likely to be a large amount of competition in the
market. This means that it would be fairly hard for the company to grow in that
market unless they did one of three things. Firstly they could come up with a
better and cheaper product then the rest of their competitors, if their
customers noticed this then the customers would choose their product over their
competitors, leading to growth in the company (although internal growth can be
one of the slowest, and sometimes one of the most costly methods of growth).
Secondly the company could invest money into giving themselves a recognisable
brand name, although this can be a costly procedure, and can take a great deal
of time, one customers recognise a brand name they will choose the product over
a less swell known branded product. Thirdly the company could take over, merge
with or enter into a joint venture with another company in their market.

If the company were to horizontally integrate with another company in
their market, they would take on all of that company's knowledge an expertise in
that area. The company could also utilise and pre-existing brand names which the
other company had established. They could sell off any assets from the other
company which they did not require (assets stripping) and utilise economies of
scale.

Economies of scale are one of the reasons why companies choose to expand.
Economies of Scale are where when a company grows, it can take advantage of its
size in bulk discounts, machine utilisation etc. However once a company reaches
a certain size than diseconomies of scale start to predominate over economies of
scale. Diseconomies of scale can be caused by thing such as administrative waste,
and break down of communications. This balance between the predomination of
economies of scale and the predomination of diseconomies of scale is what some
people consider to be the optimum size of a firm, however this is only one view
point.

For example in a small retail outlet (such as a corner shop) it is the
manager's personal preference to keep the business the size that it currently is,
therefore in this situation for the owner of the small business it is the
optimum size of the firm for him, but a more analytical approach would suggest
otherwise. For many small businesses the optimum size is small, sometimes this
is because of the VAT threshold, as if a company's profits are greater than £
40,000 VAT must be paid on all sales, thus if the company were to slightly
increase in size so it made more than £40,000 in profit, it would have to pay
VAT leaving it worse off than before it grew (even though economies of scale etc.
would be achieved, and after expanding more the firm would be better off, the
period of reduced profits due to the VAT may endanger the company).

Therefore in conclusion I would say that there are many different
factors that might determine the optimum size of a firm, and many different
point of view of what the optimum size of a firm really is. It varies from
company to company and from person to person as to what they think the optimum
size for a firm really is.