Firms (Copy)

3.5.1 Classification of Firms

• By Sector of Production:
  • Primary sector: Firms engaged in extraction of natural resources (agriculture, mining, fishing).
  • Secondary sector: Firms engaged in manufacturing and processing raw materials into finished goods (factories, construction).
  • Tertiary sector: Firms providing services (banking, retail, transport, education).
• By Ownership:
  • Private sector firms: Owned by individuals or groups of individuals for profit. Examples: sole traders, partnerships, private limited companies, public limited companies.
  • Public sector firms: Owned and controlled by the government for the benefit of society. Examples: public transport companies, state-owned utilities.
• By Size (Relative size of firms):
  • Measured using indicators such as:
    • Number of employees
    • Value of output (sales revenue)
    • Capital employed
    • Market share

Diagram – Classification of Firms by Ownership and Sector

                          Firms
              ┌────────────────────────────┐
              │                            │
       Private Sector                 Public Sector
       │       │                       │       │
   Primary   Secondary             Primary   Secondary
   Tertiary  Industries            Tertiary  Industries

3.5.2 Small Firms

Advantages of Small Firms:

• Closer contact with customers → better customer service.
• Greater flexibility to adapt to changes in demand.
• Specialised or niche products can be supplied.
• Easier communication with employees (flat hierarchy).
• Important for innovation and entrepreneurship.

Disadvantages of Small Firms:

• Limited access to finance → higher borrowing costs.
• Difficult to compete with large firms on price.
• Lower economies of scale → higher average costs.
• Vulnerable to changes in demand and competition.

Reasons for Existence of Small Firms Despite Competition:

• Serving small/niche markets unattractive to large firms.
• Personalised services where trust is important (hairdressers, tutors, local shops).
• New firms starting small before expansion.
• Government support for small businesses (loans, subsidies).

Diagram – Cost Curve Comparison

Cost
 ^
 |       Large firm
 |       
 |      Small firm
 |     
 |     ________________ Output

• Small firms often have higher costs per unit, but they survive in niche markets.

3.5.3 Causes and Forms of Growth of Firms

Internal (Organic) Growth:

• Expansion using firm’s own resources.
• Methods:
  • Increasing output
  • Opening new branches/outlets
  • Expanding product range
  • Increasing market share
• Advantages: steady, less risky, funded by retained profits.
• Disadvantages: slower compared to mergers.

External Growth:

• Expansion by joining with other firms.
• Achieved through mergers or acquisitions.
• Advantages: rapid expansion, instant access to new markets/resources.
• Disadvantages: high cost, cultural clashes.

Diagram – Internal vs External Growth

Internal Growth → Higher sales, profits, branches
External Growth → Mergers, takeovers, alliances

3.5.4 Mergers

• Horizontal Merger: Between firms at the same stage of production (e.g., two car manufacturers).
  • Advantages: larger market share, economies of scale.
  • Disadvantages: risk of monopoly, reduced competition.
• Vertical Merger: Between firms at different stages of production in the same industry.
  • Forward vertical: Manufacturer merges with retailer (e.g., a clothing producer buying shops).
  • Backward vertical: Manufacturer merges with supplier (e.g., a car firm buying a steel factory).
  • Advantages: control over supply chain, reduced costs, guaranteed markets.
  • Disadvantages: possible inefficiency if firms lack experience in new areas.
• Conglomerate Merger: Between firms in different industries (e.g., a food company merging with a media firm).
  • Advantages: diversification, spreading risk.
  • Disadvantages: lack of expertise, harder to manage.

Diagram – Types of Mergers

Horizontal → Firm A + Firm B (same industry, same stage)
Vertical   → Firm A + Firm B (same industry, different stage)
Conglomerate → Firm A + Firm B (different industries)

3.5.5 Economies and Diseconomies of Scale

Economies of Scale (EOS):

• Reduction in average cost as firm size/output increases.

Types of EOS:

1. Internal EOS (within one firm):
   • Purchasing economies (bulk buying).
   • Technical economies (better machinery).
   • Financial economies (cheaper loans).
   • Managerial economies (specialised managers).
   • Marketing economies (spreading advertising costs).
2. External EOS (within industry):
   • Availability of skilled labour in one area.
   • Improved infrastructure.
   • Shared suppliers and services.

Diseconomies of Scale:

• Increase in average cost when firms become too large.

Causes:

• Poor communication in large organisations.
• Low worker motivation (alienation).
• Coordination difficulties between departments.
• Over-specialisation → inflexibility.

Diagram – Economies and Diseconomies of Scale

Cost per unit
 ^
 |                      /
 |                     /
 |                    /
 |                   /
 |       ___________/____________ Output
          EOS       Min AC    DOS

• AC falls with economies of scale, reaches minimum, then rises due to diseconomies.

Summary of 3.5 Firms

• Classification: by sector, ownership, size.
• Small firms: survive due to niche markets and flexibility, though they face cost disadvantages.
• Growth: internal (organic) vs external (mergers).
• Mergers: horizontal, vertical, conglomerate.
• Economies of scale: reduce costs; diseconomies may raise them if firms grow too large.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course