Size & Types of Firms (1)

Reasons Why small Firms exist

• They offer a more personalised service and focus on building relationships with their customers 

• Many small firms operate in mass markets with low barriers to entry

• Unable to access finance for expansion

• Rapid growth can cause diseconomies of scale which are difficult to deal with so many owners choose to these avoid coordination and communication problems

• They provide a product that is in niche market - smaller market size but can be very profitable

• Owners goal is not profit maximisationbut rather an acceptable quality of life (satisficing )

Reason why firm grow ?

• Owners/Shareholders/Managers desire to run a large businessand continually seek growth

• Desire to reduce average costs by benefiting from economies of scale

• Owners/shareholders desire for higherlevels of profit

• Growth provides opportunities for product diversification

• Desire for stronger market power(monopoly) so as to increase profits

• Larger firms often have easier access to finance 

Divorce of Ownership & Control

• As firms grow, the owners (or shareholders) often appoint managersto run the business for them

• There is a separation (divorce) between the owners and the managers who control the day-to-day running of the business

• This divorce gives rise to the Principal - Agent problem :(Occurs when one group (the agent) makes decisions on behalf of another group (the Principal), often placing their priorities above the Principal's)

  • E.g. Shareholders want to maximise their profits, but workers want to maximise their salaries

  • E.g. Shareholders want to maximise their profits, but managers may want to maximise the number of sales over the value of the sales

How is the Principal - Agent problem solved ?

• The problem is exacerbated by information gaps in that the agentshave a lot more information than the owners and are often able to control the flow of that infromation

• One way that Principals attempt to diminish the problem is by granting share options to managers

  • If managers are shareholders, then they will be likely to align their interests more with those of the owners

Public Sector Organisations

• Public sector organisations are owned and controlled by the Government

  • Their goal is not profit maximisation but to provide a service

  • There are a wide variety of government owned organisations in the UK

    • Corporations like the BBC and Channel 4

    • National services such as State Schools and National Health Service Trusts

    • Local services such as Transport for Greater Manchester

    • Civil service departments such as Defence, Police, Education

    • Regulatory bodies such as the General Dental Council

Private Sector Organisations

• Private sector organisations are owned and controlled by private individuals

  • Types of ownership vary from sole trader to partners to company shareholders

  • The goal of most private sector organisations is profit maximisation

    • This often means the private sector is more efficient than the public sector, with higher levels of productivity (output per unit of input used)

Profit Organisations

• Most firms in the private sector exist to make a profit, even if their goal is not profit maximisation

  • If they do not make a profit, then they are likely to go out of business

Not - for - profit organisations

• Exceptions to this are not-for-profit organisations which also operate in the private sector

  • They exist to provide a service or meet a need

  • Many sell goods/services and use the profits they generate to further their objectives, e.g. The British Heart Foundation

  • The government exempts them from paying direct taxes

• All Charities are not-for-profit organisations and are regulated by the UK Charity Commission