6 The Growth of Firms

Methods of Comparing Size of Firms

6. The Growth of Firms

Motives for Growth

Methods of Growth
Optimum Size of Firms
Existence of Small Firms

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Measure

Stock Measures

Capital Stock

Number of Employees

Other Measures

Concentration Ratio

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Comparing Apple and Microsoft

65.2 billion (USD)

Capital Stock*

75.2 billion (USD)

86.1 billion (USD)

Number of employees

49,400

89,000

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2.15 billion (SGD)

0.457

0.30

Capital Stock*

37.9 billion (SGD)

1.73 billion (SGD)

Number of employees

4000

2702

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62.5 billion (USD)

Exploit
economies of scale
more fully
(reduce cost)

2010 figures
*Estimated

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16.8 billion (SGD)

Concentration Ratio
(mobile phone market only)

6.2 Motives for growth

Motives for growth

Measure

Sales Turnover

Sales Turnover

2010 figures
*Estimated

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Comparing SingTel and StarHub

6.1 Measurement of Size of Firms

Flow Measures

Quantity of Output
(theoretical)

Sales Turnover
(Total Revenue)

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Market
domination
(increase price)
Reduce risk

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Exploit (Internal) Economies of

Scale

Market Dominance

Assume flour is the only ingredient in bread

and no fixed cost
80  10  $3x10=$30  ATC = $0.375

8000 1000$2x1000=$2000ATC=$0.25
[bulk-buying]

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Reduce Risk

6.2

Methods of growth

Market risk includes risk of market demand falling

Internal Growth

External Growth

Increased market valuation reduce risk of

take-over



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Market Valuation = Share Price x No. of shares

Take-over = Change of ownership where another
firm buys up the target firms shares and becomes
the majority shareholder
High share price = High market valuation = More
difficult to be taken over
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Take-over/

1. Horizontal integration Acquisition

2. Vertical integration
- Forward
- Backward
3. Conglomeration
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Take-over/ Acquisition

Build up productive capacity



Merger

External Growth

Internal Growth

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Diversification reduces market risk



Increase market
share
Increase market
power
Increase price

Build a bigger plant (or more plants)

Merger

One firm buying another

firm

Two firms forming one

entity

Formed in 2000, when

Chase Manhattan
Corporation merged with
J.P. Morgan & Co.

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External Growth: M&A

Vertical Integration

External Growth: M&A

Vertical Integration

Backward

Forward

Firms extend into previous

stage of production

Firms moves into succeeding

stage of production

=news
producer
=news
distributor

VIMAL
A RELIANCE PRODUCT

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External Growth: M&A

Horizontal Integration

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External Growth: M&A

Conglomeration

Firm takes
over/merges with
another firm at the
same stage of
production
E.g.
Daimler-Benz +
Chrysler =
DaimlerChrysler
[1998]

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6.4 The Optimum Size of the Firm

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Neither vertical nor

horizontal
Combination of firms
not directly related
E.g.
Google bought over
YouTube (2006)

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The minimum efficient scale and market

demand

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It all depends on the amount of IEOS

available relative to market demand

The minimum efficient scale (mes) is the output at

which a firms long-run average cost curve stops
falling.
The size of the mes relative to market demand has a
strong influence on market structure

LAC2

LAC3

LAC1

Output
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10.18

The minimum efficient scale and market

demand

The minimum efficient scale and market

demand

The minimum efficient scale (mes) is the output at

which a firms long-run average cost curve stops
falling.
The size of the mes relative to market demand has a
strong influence on market structure

If market demand is Q1 = 1000

The firms LRAC is LAC1 and its MES is q1=10,
Then there will be 100 firms in the industry that
achieves MES???


Many firms relative to market demand

LAC2

LAC2

LAC3

LAC1

P1=C1
q1

LAC3

D
q2

Q2 q3

Q1

LAC1

P1=C1

D
Q1=1000 Output

q1=10

Output
10.19

The minimum efficient scale and market

demand

10.20

The minimum efficient scale and market

demand

If market demand is Q2 = 700

The firms LRAC is LAC3 and its MES is q3=800,
Then the industry can support 1 firm ??

If market demand is Q2 = 700

The firms LRAC is LAC2 and its MES is q2=350,
Then the industry will achieve 2 firms MES???

A few large firms relative to industrys demand

LAC2

LAC2

LAC3

LAC1

LAC3

LAC1

D
Q2=700 q3=800

Output

D
Q2=350

Q2=700

Output

10.21

The minimum efficient scale and market

demand

The minimum efficient scale and market

demand

The minimum efficient scale (mes) is the output at

which a firms long-run average cost curve stops
falling.
The size of the mes relative to market demand has a
strong influence on market structure

10.22

The minimum efficient scale (mes) is the output at

which a firms long-run average cost curve stops
falling.
The size of the mes relative to market demand has a
strong influence on market structure

LAC2

LAC2

LAC3

LAC1

P1=C1
q1

LAC3

D
q2

Q2 q3

Q1

LAC1

P1=C1

Output
10.23

q1

D
q2

Q2 q3

Q1

Output
10.24

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6.5 Existence of Small Firms

Supply side factors

1) Internal diseconomies of scale

Supply Side

Factors

E.g. Hair
dressing, dental
clinic

LAC

Demand Side
Q

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Output

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Supply side factors

Supply side factors

2) Banding

3) Vertical disintegration
Small firms emerge when an entire
production process is broken into a series of
separate processes
Examples: Hollywood firms
Studios used to handle everything from
production to theatrical presentation
Now, with lighting companies, postproduction companies, props and editing
industries, etc.

Group of firms band together to gain the

advantages of bulk buying
Examples: Market cooperatives such
as iEcon

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Supply side factors

Supply side factors

4) Low barriers to entry

5) Managerial Attitudes

Costs
($)

Risk-averse
Desire to keep firms under family control
Example:
Lim Chee Guan prior to 2009

LRAC1
LRAC2

Quantity
Q1

Q3

Q2

Examples: Foot wear, accessories stores

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Demand side factors

Demand side factors

1) Nature of the product

1) Nature of the product

BULKY, eg. Bricks & fresh fish

Demand for Variety, e.g. Rolex watches, Mont Blanc Pen

Perishable eg. Grocery/fruit

stalls

Personalised services, e.g. custom-made to order

furniture/clothes
Specialised products, e.g. lab equipment
Prestige markets, e.g. Vertu,

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Demand side factors

Demand side factors

2) Niche markets

3) Geographical limitations

A subset of the market which a firm carves out for itself

Examples:
Educational travel industry/eco-tourism
Organic food products
Gaming mouse

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Bulky products where transport costs will be high relative

to total production costs.
Examples:
Supermarkets operating in Russia
Not feasible for them to cater to the whole market
due to poor transport infrastructure

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6.5 Existence of Small Firms

Supply Side

Food for thought:

 How do small firms survive?

Demand Side

1. Internal economies of
scale limited relative to
market demand

1. Nature of the product

 Why do small firms exist?

Bulky, perishable

Demand for variety

2. Banding

Personal services

3. Vertical disintegration

Specialised products

Prestige markets

4. Barriers to entry low

5. Managerial attitudes
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 Why do firms choose to remain small?

 What are the factors that encourage the
existence of small firms?
 Why do firms merge?

2. Niche markets
3. Geographical limitations
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