Firms 1

FIRMS
What is a firm?
A firm is a business entity, also sometimes referred to a business organisation.

Firm and industry
Firms make up industries.

Put another way, an industry consists of several different firms selling similar
products.
Finally, an industry is a subsector of a country's economy.
Firms may be classified in a number of ways:
 Stage of production they produce in
 Who owns the firm
 Size of the firm
THE STAGES OF PRODUCTION
There are four stages of production. Each stage is represented by a sector of firms:
Primary sector – This is the first stage of production which is concerned with the
extraction and collection of natural resources. It includes fishing, farming, mining,
forestry etc.
Secondary sector - The secondary sector includes industries that produce a finished,
usable product or are involved in construction. This sector generally takes the output
of the primary sector and manufactures finished goods and semi-finished goods.
Tertiary sector – The tertiary industry is the segment of the economy that provides
services to its consumers; this includes a wide range of businesses such as financial
institutions, schools and restaurants. It is also known as the tertiary sector or
service industry/sector.
Quaternary sector - The quaternary sector is based on knowledge and skill. It consists of intellectual
industries providing information services, such as:
➢ computing and ICT(information and communication technologies)
➢ consultancy (offering advice to businesses)
➢ R&D (research, particularly in scientific fields)
At its most basic, a quaternary industry is one that is based on new technologies and that requires a high
degree of education. In this field, people are not relying directly on their abilities to collect raw materials
or turn them into a product; instead, they are relying on their education and intelligence to generate and
operate advanced technologies.
Most of the quaternary industries in the United States are those involving computer and information
technologies. Programmers, IT specialists, technology developers, information sharing experts, and even
professional bloggers are part of the national quaternary industry. This sector would also include digital
stockbrokers, financial planners, designers, and educators.
In less developed economies, the primary sector will comprise the biggest part of the
economy. Typically as an economy develops, increased labour productivity will enable
workers to leave the agricultural sector and move to other sectors, such as
manufacturing and the service sector.
OWNERSHIP OF FIRMS
 The private sector is the segment of a national economy that is owned, controlled and managed
by private individuals or enterprises. The private sector has a goal of making money and
employs more workers than the public sector.
 Companies and corporations that are government run are part of what is known as the public
sector, while charities and other nonprofit organizations are part of the voluntary sector.
Size of firms
 How do we measure size of firms?

 No of workers employed
 Value of output produced
 Value of financial capital invested
Factors affecting size of firms
 Age of firms
 Availability of financial capital
 Type of business organisations
 Size of the market
 Economies or diseconomies of scale
SMALL FIRMS
A large proportion of firms in a country are small and want to stay small. The reasons for this are:
• Small size of the market (luxury yachts, designer dresses etc.)
• Preference of consumers - some products require personal service like tailor or hairdresser
• Owner’s preference
• Flexibility - ability to adapt to market changes
• Technical factors - some industries may have a lower capital requirement so a lot of small firms may set up
• Lack of financial capital
• Location
• Cooperation between small firms
• Specialisation
• Government support
Business growth
All owners want their businesses to expand because:

o Higher profits
o More status, power and salary for managers
o Low average costs (economies of scale)
o Higher market share
A business can grow in two ways:
 Internal Growth: Organic growth. Growth paid for by owners capital or retained
profits. It happens when a business expands its own operations rather than relying
on takeovers and mergers. Organic growth can come about from:
 Increasing existing production capacity through investment in new capital
& technology
 Development & launch of new products
 External Growth: External growth (or inorganic growth) strategies are about
increasing output or business through mergers and acquisitions (take over).
Horizontal Integration:
Horizontal merger occurs when one firm merges with another firm or takes over
another one in the same industry and at the same stage of production. Example
Vodafone and Hutch
 Reduces number of competitors in industry
 Economies of scale
 Increase market share
 Rationalisation – getting rid of redundant assets
Vertical Integration:
Vertical integration involves a firm merging with another firm involved with the
production of the same product but at a different stage of production. It involves
acquiring a business in the same industry but at a different stage of the supply chain.
 Backward vertical integration: This is when the firm merges with a firm that is
the source of its supply of raw material, components or products it sells to ensure
adequate supply of good quality raw material.
 Forward vertical integration: This is when a firm merges with or takes over a
market outlet to ensure that there are sufficient outlets and the products are stored
and displayed properly.
Conglomerate Integration:
It is also known as lateral integration. This happens when a firm takes over or merges
with another firm in a completely different industry. example a shoe manufacturer
buys a biscuit producing business.
 Spreads risks through diversification

 Transfer of new ideas from one section of the business to another
Economies of scale
Economies of scale are the factors that lead to a reduction in average costs as a business increases in size.
A bigger company has much lower average cost than a smaller one.
• Internal economies of scale – these are the advantage gained by an individual firm, by increasing its size,
that is having larger or more plants.
• External economies of scale – these are the advantages available to all the firms in an industry, resulting
from the growth of the industry.
Types of internal economies
The reasons responsible for the reduction in average costs are:

 Purchasing or buying economies – larger business can place bigger orders and avail better
discounts.
 Marketing or selling economies – the total cost of processing orders, packing goods and
transporting them does not rise in line with number of orders. Advertising costs remain
same with increased production
 Financial economies – Larger businesses can borrow more money than smaller businesses
and also negotiate a cheaper rate of interest.
 Managerial economies – bigger businesses can employ specialist managers in key posts.
 Technical economies – bigger businesses can invest in better technology and
reduce wastage.
 Labour economies - large firms can engage in division of labour
 Research and development economies – large firms can invest in research and
development. They can reduce average costs by developing more efficient
products.
 Risk bearing economies – large firms generally produce a range of products. This
enables them to spread the risk of trading.
Diseconomies of scale
Diseconomies of scale are the factors that lead to an increase in the average cost as a business grows
beyond a certain size.
 Poor communication – As the business expands it becomes harder to communicate effectively.
 Low morale – As the business grows the staff at the lower level have less contact with higher
management.
 Slow decision making – as there are too many people involved the decision making is a long
process
External
economies and
diseconomies of
scale
Types of external economies
A large industry can also enable a firm to reduce its average costs in a number of ways
such as:
 A skilled labour force – a firm can recruit workers trained by other firms
 A good reputation – an area with a large industry can gain a good reputation ex.
Maldives is popular as a holiday resort
 Specialist suppliers for raw material and capital goods – when an industry
becomes large enough other ancillary industries set up to provide for the needs of
the industry
 Specialist services – universities and collages may run courses and banks and
transport firms can provide special services.
 Specialist markets – some large industries have specialist markets like corn
exchanges, agriculture exhibitions etc.
 Improved infrastructure – the growth of an industry might encourage
government and other private firms to provide better road links, electricity supply,
build new airports and docks etc.
External diseconomies
External diseconomies of scale occur when an industry growing in size causes

negative externalities – and rising long-run average costs. For example, many
financial firms wish to set up in the City of London to benefit from the existing
infrastructure, but as a result, they face very high cost of renting.
External diseconomies refer to factors that occur outside the firm's control. For
example, the local infrastructure may mean employees get stuck in traffic or
suffer from train delays. This may result in staff being late, stressed, and therefore,
unproductive.
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FIRMS

A firm is a business entity, also sometimes referred to a business organisation.

Firms make up industries.

 How do we measure size of firms?

All owners want their businesses to expand because:

 Spreads risks through diversification

The reasons responsible for the reduction in average costs are:

External diseconomies of scale occur when an industry growing in size causes

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