Sizes and types of firms (3.1.1)

Why do some firms grow?

• Owners and shareholders desire for higher levels of profit: Apples growth from 1976 has taken the company from its first sales of 50 computers for $400 to £53bn of sales in 2016

• To increase market power: From expanding, Apple managed to gain over 83% of the tablet market in 2010, becoming the dominant tablet producer

• Desire to reduce AC’s by benefiting from economies of scale which occurs when an increase in the scale of output results in a lower cost per unit.

• Easier access to finance: Apple received $90k investment and $250k loan, allowing them to expand their operations.

Why do firms remain small?

• Unable to access finance for expansion: Difficult to raise investments and banks may be unwilling to lend to small firms because there is a higher risk of not paying it back.

• Regulations that prevent a firm from growing too big in order to protect consumer sovereignty: In 2016, 3-mobile aimed to expand by purchasing O2 but was prevented by regulators in risk that they would gain too much market power.

• Niche markets and selling personalised goods. Business who rely on local customers may face market size constraints  Custom made products, tailored to individual preferences market size may be limited due to the time and resources required to create. This means that they may have to charge high average prices to keep profit margins stable but this leads to lower effective demand.

• Rapid growth can cause diseconomies of scale. This could be because of high levels of bureaucracy, low levels of communication and alienation. As a result owners may choose to create smaller businesses to avoid coordination and communication problems.

• Depends on business objectives, some owners may not aim for profit maximisation but rather an acceptable quality of life (Satisficing)

Define the term ‘Divorce of ownership and control’

When shareholders own majority of the business, but professional managers are responsible for running and controlling the day-to-day operations of the firm.

Define the term ‘Principal-agent problem’

When the agent (Managers) makes decisions on behalf of the principal (shareholders), often placing their priorities above the principals.

Exasperated by asymmetric information as the agent often has more information than the principal and are often able to control the flow of information to maximise their own objectives rather than shareholders profits.

Give 2 examples of the Principal-Agent problem

• Former CEO of Apple, Steve Jobs created the Macintosh which increased its costs and lowered its profits. This made shareholders dissatisfied as it costed millions of dollars and didn’t even make significant amounts of sales.

• Anthony Jenkins, instructed to maximise the shareholders of Barclays profits instead increased bonuses paid to himself and other Barclays senior executives. This increased costs and lowered shareholders profits.

Define the term ‘Public Sector firm’.

Organisations owned and controlled by the government, with the objective of providing a service to maximise consumer welfare.

Give an example of a public sector firm.

Network rail: Responsible for operating rail infrastructure in the UK. They do not have shareholders making them a not-for-profit organisation, so their profits are reinvested back into the rail network.

Define the term ‘Private Sector firm’.

Organisations owned and controlled by private individuals, with the primary objective of profit maximisation.

What is a ‘Not-for-profit organisation’

Exists to provide service or need and use their profits to further their objectives.

They are exempt from paying direct taxes and regulated by the UK charity commission