Business Size, Small Businesses, and Business Growth
Measurements of Business Size
It is useful to measure business size for several reasons:
Governments may want to assist small firms and need to identify them.
Investors may want to compare the size and growth rate of a business with its competitors.
Customers may prefer larger businesses for greater security of supply.
Some workers prefer small business workplaces.
Problems with measuring business size:
Different methods of measurement can give different results.
There is no internationally agreed definition of small, medium, or large business, but the number of employees is often used.
Different Measures of Business Size
Various measures are used to determine the size of businesses:
Number of employees
This is the simplest measure and is easy to understand.
However, some businesses need few employees despite high capital investment and sales (e.g., automated computer chip manufacturing).
Example: A soft drinks firm using traditional methods might employ 100 people to make 300,000 liters a week, while an automated rival makes 1 million liters a week with 10 workers.
Revenue (or sales turnover)
Often used to compare businesses in the same industry.
Less effective when comparing businesses in different industries due to variations in value production.
Revenue is needed to calculate market share.
Revenue: The total value of sales made during the trading period, calculated as selling price × quantity sold.
Capital employed
Larger businesses generally require greater capital for long-term investment.
Comparisons between firms in different industries can be misleading.
Example: A hairdresser and an optician may employ the same number of workers but have different capital equipment needs.
Capital employed: The total value of all long-term finance invested in the business.
Market Capitalization
Can only be used for businesses with shares on the stock exchange (public limited companies).
Calculated as: market \ capitalisation = current \ share \ price \times total \ number \ of \ shares \ issued
Market capitalization: The total value of a company's issued shares.
Share prices change daily, making this measure unstable.
A temporary drop in share price can make a company appear smaller even with the same number of workers.
Market Share
A relative measure; a high market share indicates a leading firm in the industry.
If the total market size is small, a high market share may not indicate a very large firm.
Calculated as: market \ share = \frac{total \ sales \ of \ business}{total \ sales \ of \ industry} \times 100
Market share: Sales of the business as a proportion of total market sales.
Other measures
These depend on the industry.
Examples: number of guest beds for hotels, number of shops for retailers, total floor sales space for retailers, number of units sold for businesses in the same industry.
Profit should not be used as a measure of business size; it assesses business performance.
Which form of measurement is best?
There is no single best measure; it depends on what needs to be established.
Consider absolute size versus comparative size within an industry.
For an absolute measure, assess business size on at least two criteria.
Remember that conclusions about relative size might differ if another measure were used.
Significance of Small Businesses
Small businesses are important to the economy and can play a significant role within their industry.
What is a Small Business?
Small businesses employ few people and have relatively low annual revenue.
Micro-enterprises are very small businesses.
EU classifications of business size:
Micro: 10 or fewer employees, up to €2m revenue, up to €2m capital employed.
Small: 11-50 employees, over €2m to €10m revenue, over €2m to €10m capital employed.
Medium: 51-250 employees, over €10m to €50m revenue, over €10m to €34m capital employed.
Importance of Small Firms
Small firms (including micro-enterprises) are very important to all economies and the industry in which they operate.
Small businesses have many economic benefits:
They create employment, collectively employing a high proportion of the working population.
They are often run by dynamic entrepreneurs with new ideas, creating variety and consumer choice.
They create competition for larger businesses, preventing exploitation of consumers.
They often supply specialist goods and services to important industries.
They can be important suppliers to larger businesses, adapting quickly to changing needs.
All great businesses were small at one time (e.g., The Body Shop, Hewlett-Packard).
They might have lower average costs than larger ones due to lower wage rates and administration costs.
Governments encourage and assist business start-ups and existing small businesses.
Advantages and Disadvantages of Being a Small Business
Some owners choose to keep their business small, while others have no choice due to the market size.
Advantages of small businesses:
Can be managed and controlled by the owner(s) with little risk of losing control.
Often able to adapt quickly to meet changing customer needs, especially with direct owner-customer interaction.
Offer personal service to customers, helping to build customer loyalty.
Easy to know each worker; many people prefer small business workplaces.
Family-owned businesses often have an informal culture, with well-motivated employees performing multiple roles.
Can usually be started up and operated with low capital investment.
Disadvantages of small businesses:
May have limited access to sources of finance.
The owner carries a large burden of responsibility and may be unable to afford specialist managers.
If the owner or important workers are absent/ill, other employees may lack necessary skills.
May not be diversified, increasing the risk of external changes having a negative impact.
Few opportunities for economies of scale, potentially leading to high average costs.
Strengths and Weaknesses of Family Businesses
Family-owned businesses are actively owned and managed by at least two family members.
They are very important in nearly all economies, especially newly industrializing ones (e.g., 80% of businesses in South Africa are family-owned).
Many family businesses are small (e.g., 65% of small businesses in Malaysia are family-owned).
In Asia, family businesses make up 50% of all public limited companies (67% in India), with founding families retaining a controlling interest.
Strengths of family businesses:
Commitment: Family owners are dedicated to seeing the business grow and be passed on to future generations.
Reliability and pride: The family name is associated with the products, so they strive to increase quality and maintain good stakeholder relationships.
Knowledge continuity: Families prioritize passing accumulated knowledge, experience, and skills to the next generation.
Weaknesses of family businesses:
Succession/continuity problem: Many fail to be sustainable in the long term (only around 15% continue into the third generation).
Informality: Lack of clear and formal business practices can lead to inefficiencies and internal conflicts.
Tradition: Reluctance to change systems and procedures can lead to a lack of innovation.
Conflict: Problems within the family may reflect on the management of the business.
Importance of Small Businesses in the Economy
The economies of most countries are heavily reliant on small businesses.
Small businesses help generate economic growth and can be particularly important in regions without large companies.
Globally, small businesses account for up to 90% of all employers.
In the USA, 60 million people work for small businesses.
In Pakistan, over 80% of manufacturing jobs are created by small businesses.
An estimated 80% of all new jobs in developing countries are created by small businesses.
Small businesses are often innovative and can develop new products and services, creating competition.
Role of Small Businesses in Some Industries
Some industries are almost completely dominated by small businesses (e.g., personal care, hairdressing, house-decorating, and gardening).
In contrast, small businesses produce zero output in the nuclear power generation industry.
Small supplying businesses may offer:
Specialist services such as research, technical support, repair, and maintenance facilities.
Functions that larger businesses want to buy in, such as recruitment, training, and transport.
Business Growth
Reasons for Seeking Growth
Some business owners want their firms to remain small, while others seek growth for various reasons:
Increased profits: Expanding the business and achieving higher sales.
Increased market share: Giving the business a higher market profile and greater bargaining power.
Increased economies of scale.
Increased power and status of the owners and directors.
Reduced risk of being a takeover target.
Types of Business Growth
Business growth can be achieved through organic (internal) growth and external growth.
Organic (internal) growth:
Organic growth: Expansion of a business by means of opening new branches, shops, or factories.
Example: A retail business opening more shops in new locations.
This growth can be slow but avoids problems of excessively fast growth.
Inadequate capital (overtrading).
Management problems associated with integrating businesses with different attitudes and cultures.
External growth:
External growth: Business expansion achieved by integrating with another business through merger or takeover.
Merger: An agreement by owners and managers of two businesses to bring them together in a new combined business (friendly merger).
Takeover: When a company buys more than 50% of the shares of another company and becomes its controlling owner (acquisition).
This can lead to rapid expansion but often leads to management problems:
Different management systems.
Conflict between managers.
Conflicts of culture and business ethics.
Types of External Growth
Types of Integration:
Horizontal Integration
Horizontal integration: Integration with a business in the same industry and at the same stage of production.
Advantages
It eliminates one competitor and increases market share and power.
Potential economies of scale.
Scope for rationalizing production, concentrating output on one site as opposed to two.
Increased power over suppliers to obtain lower prices.
Disadvantages
Rationalization may bring bad publicity and redundancies.
There may be customer opposition to less competition and less choice.
It may lead to a monopoly investigation if the combined business exceeds certain market share limits.
Vertical Integration
Vertical integration: Integration with a business in the same industry.
Forward Vertical Integration
Forward vertical integration: Vertical integration with a customer business.
Advantages
The business is now able to control the promotion and pricing of its own products.
It gives a secure outlet for the products of the business and may now exclude competitors' products from retail outlets.
Disadvantages
The business may lack experience in this sector of the industry-a successful manufacturer does not necessarily make a good retailer.
Suppliers may have to offer lower prices to the bigger integrated business.
Backward Vertical Integration
Backward vertical integration: Vertical integration with a supplier business.
Advantages
It gives control over quality, price, and delivery times of supplies.
It encourages joint research and development into improved quality of components.
The business may now control supplies of materials to competitors.
Disadvantages
The business may lack experience of managing a supplying company-a successful steel producer will not necessarily make a good manager of a coal mine.
The supplying business may become complacent due to having a guaranteed customer.
Conglomerate Integration
Conglomerate integration: Integration with a business in a different industry.
Advantages
It diversifies the business away from its original industry and markets.
This should spread risk and may take the business into a faster-growing market.
Disadvantages
There may be lack of management experience in the acquired business sector.
There could be a lack of clear focus and direction now that the business is spread across more than one industry.
Why a Merger or Takeover Might Fail to Achieve Objectives
The objectives of mergers and takeovers are to increase efficiency and profitability.
The integrated businesses will be able to share research facilities and pool ideas that achieve better results than the two separate businesses.
The economies of operating a larger scale of business, such as buying supplies in large quantities, should cut average costs and increase efficiency.
The larger combined business can save on marketing costs and distribution costs by using the same sales outlets and sales teams.
Rationalization of property and other assets will reduce duplication and costs.
The record of many mergers and takeovers is mixed.
In practice, many mergers and takeovers fail to gain true synergy.
Synergy: The whole is greater than the sum of parts.
The most common reasons for a merger or takeover to fail to achieve its objectives are:
The integrated firm is too big to manage and control effectively (diseconomy of scale).
A different business and management culture.
There may be little benefit from combined research departments or marketing/distribution facilities if the original businesses produced different products.
The rate of growth is too rapid for the directors to manage effectively.
Problems of Growth Through Mergers/Takeovers
Financial problems:
Takeovers can be very costly, stretching the financial resources of the business.
Additional fixed capital and working capital will be required quickly.
A merger/takeover could lead to negative cash flow and an increase in long-term borrowing and interest payments.
Possible strategies to overcome:
Use internal sources of finance when possible, for example retained earnings.
Raise finance from share issues.
Offer shares, not cash, to pay for a takeover.
Managerial problems:
Existing management may be unable to cope with problems of controlling an operation which may have doubled in size overnight.
There may be a lack of coordination between the divisions of an expanding business-a real problem for integrating businesses.
The culture clash between the two management teams may be very great.
Possible strategies to overcome:
New management systems and structures are required: a policy of delegation and employee empowerment should reduce the pressure on senior managers.
A decentralisation policy could provide motivated managers with a clear local focus.
A new management culture needs to be put in place rapidly.
Joint Ventures and Strategic Alliances
Joint ventures and strategic alliances are further forms of external growth.
Strategic alliance: Agreement between two organizations to commit resources to achieving a specific objective while remaining independent.
Strategic alliances can be made between a wide variety of businesses/organizations.
A university, providing finance to provide new specialist training courses that will increase the supply of suitably trained employees for the business
A supplier, to design and produce components and materials that will be used in a new range of products.
A competitor, to reduce the risks of entering a market that neither firm currently operates in.
The best strategic alliances benefit both businesses or organizations.
Once the objective of the alliance has been reached, it is often ended.
The most successful strategic alliances bring together businesses with different skills and strengths so that the combination of these achieves the planned objectives.