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Use examples to evaluate the optimum size of a firm

The optimum size of a firm is a very subjective idea. The ways in which size can help or hinder a firm vary from which angle you a looking at the situation from. Size can have its benefits and its drawbacks, and each firm will have its own benefits and drawbacks that come from either increasing in size, or remaining small, and these will depend on the market in which the firm is in, the current economy, and in some cases the preferences of the manager(s).

For example a small firm may be small for many reasons. It may be small because it has just started out in business, and still has relatively little funds, so although the owner/manager may have aspirations of the business growing, at the present time, his main concern would be keeping the business afloat. Another small business may stay small due to the preference of the manager/owner, for example a corner newsagent's shop may remain a small retail business as the owner is making a profit from the business that he finds acceptable, and does not want the hassle of either expanding his current business, setting up new shops, or taking over another business.

The size of a business does however depend a great deal on the market which it is in. For example a business which makes specialist goods, or caters to only a very small number of people, will not be able to grow beyond the capacity of that market. This means that the optimum size for a business in a market with little growth and only a small number of prospective customers would be large enough to serve as many customers as it had market share for, but small enough to ensure that they don't over produce.

If there is a fairly large market for the product/service that a company is providing, then there is likely to be a large amount of competition in the market. This means that it would be fairly hard for the company to grow in that market unless they did one of three things. Firstly they could come up with a better and cheaper product then the rest of their competitors, if their customers noticed this then the customers would choose their product over their competitors, leading to growth in the company (although internal growth can be one of the slowest, and sometimes one of the most costly methods of growth). Secondly the company could invest money into giving themselves a recognisable brand name, although this can be a costly procedure, and can take a great deal of time, one customers recognise a brand name they will choose the product over a less swell known branded product. Thirdly the company could take over, merge with or enter into a joint venture with another company in their market.

If the company were to horizontally integrate with another company in their market, they would take on all of that company's knowledge an expertise in that area. The company could also utilise and pre-existing brand names which the other company had established. They could sell off any assets from the other company which they did not require (assets stripping) and utilise economies of scale.

Economies of scale are one of the reasons why companies choose to expand. Economies of Scale are where when a company grows, it can take advantage of its size in bulk discounts, machine utilisation etc. However once a company reaches a certain size than diseconomies of scale start to predominate over economies of scale. Diseconomies of scale can be caused by thing such as administrative waste, and break down of communications. This balance between the predomination of economies of scale and the predomination of diseconomies of scale is what some people consider to be the optimum size of a firm, however this is only one view point.

For example in a small retail outlet (such as a corner shop) it is the manager's personal preference to keep the business the size that it currently is, therefore in this situation for the owner of the small business it is the optimum size of the firm for him, but a more analytical approach would suggest otherwise. For many small businesses the optimum size is small, sometimes this is because of the VAT threshold, as if a company's profits are greater than £40,000 VAT must be paid on all sales, thus if the company were to slightly increase in size so it made more than £40,000 in profit, it would have to pay VAT leaving it worse off than before it grew (even though economies of scale etc. would be achieved, and after expanding more the firm would be better off, the period of reduced profits due to the VAT may endanger the company).

Therefore in conclusion I would say that there are many different factors that might determine the optimum size of a firm, and many different point of view of what the optimum size of a firm really is. It varies from company to company and from person to person as to what they think the optimum size for a firm really is.

Source: Essay UK -

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