Expanding Operations: Examining Business Sizes, Economies of Scale, and Their Influence on Enterprise Growth
Businesses Rose to Shine
Boosting earnings is the ultimate goal for companies, and they employ various approaches to expand their operations.These expansion strategies usually comprise internal growth or external growth tactics.
As a business expands, it yields multiple advantageous outcomes, including amplified profits. Larger businesses are capable of generating more revenue and decreasing costs due to higher economies of scale, resulting in larger revenues at lower costs.
Size also plays a decisive role in competition. Established corporate giants hold a more robust market position due to their plentiful resources. Conversely, small businesses find it challenging to maintain their presence in the competitive landscape when sizeable companies engage in fierce competition.
The importance of Corporate Size
Business size is characterized by the scale of a company's operations. It can be assessed using several indicators, such as total revenue or production.
The significance of business size lies in the profits it generates. Essentially, a larger business can generate substantial income since it can sell more outputs.
Moreover, business size also impacts a company's competitive capacity in the market. Larger companies have a greater ability to confront competitors compared to their smaller counterparts. Additionally, the structure of ownership (public vs. private) influences competitiveness. Public companies that have access to capital markets may heavily invest in research, marketing, and acquisitions, fueling growth and innovation. Alternatively, private companies, despite lacking easy access to capital, enjoy flexibility and adaptability, empowering them to disrupt larger businesses.
Stakeholder Perspectives
Stakeholders take business size into account when making economic decisions. Some examples include:
Government: On one side, governments encourage small businesses because they generate jobs and absorb unskilled labor, a responsibility large companies usually shun. As such, governments offer perks, like subsidies or tax breaks, to small businesses. On the other hand, the government bails out large financial companies rather than independent, small-scale financial businesses because their impact on the economy is enormous, with the added risk of causing widespread consequences if they fail.
Investors: Some investors opt for large businesses because they are considered safer, and their stock prices tend to be more stable than those of smaller businesses.
Creditors: They favor working with larger businesses due to their stable cash flow and their capacity to borrow large amounts, allowing them to earn higher interest rates.
Consumers: Consumers often engage with large businesses due to their solid reputation. Furthermore, large companies are driven to uphold their image by offering high-quality products and services.
Suppliers: Suppliers are inclined to offer discounts or incentives to larger businesses that order in large quantities, which helps secure long-term contracts.
Economies of Scale
Economies of scale manifest when long-term average costs decline as volume produced increases. There are several reasons for this cost reduction:
- Technical economies of scale: Larger companies can employ efficient production techniques, higher specialization, and automation, resulting in lower costs.
- Managerial economies of scale: They can hire specialized staff to oversee production, thereby reducing management costs per unit and allowing for the distribution of administrative expenses across more outputs.
- Financial economies of scale: With a strong reputation, large companies find it easier to raise capital at a lower cost.
- Marketing economies of scale: Large companies can distribute marketing costs across more output, thereby decreasing marketing costs per unit.
- Purchasing economies of scale: With their high procurement power, large businesses can negotiate lower costs for inputs when buying in large quantities.
Internal economies of scale vs. external economies of scale
Economies of scale are divided into two categories:
- Internal economies of scale
- External economies of scale
The examples given earlier pertain to internal economies of scale, where cost reduction occurs within a single company, with management's control over it. Conversely, external economies of scale are cost reductions caused by external factors affecting multiple companies. Examples include government incentives and agglomeration effects, where businesses in distinct industries congregate in a specific area, sharing resources and opportunities, leading to cost savings.
Diseconomies of Scale
Despite the benefits of economies of scale, they eventually lead to diseconomies of scale as output increases, causing the long-run average cost to rise. Diseconomies of scale signify an increase in long-run average costs when companies extend their output beyond the minimum efficient scale.
Diseconomies of scale can be categorized as:
- Internal diseconomies of scale
- External diseconomies of scale
Internal diseconomies of scale are triggered by factors within the organization, affecting only a single company, such as an overly complex hierarchy, bureaucracy, and slow decision-making due to a lengthy decision-making chain.
External diseconomies of scale are caused by factors outside the company, affecting multiple companies. Reasons may include an increase in corporate profits tax, depletion of resources, and logistics bottlenecks and disruptions due to excessive density.
Economies of Scope
Economies of scope occur when a company produces more than one product while sharing resources for various activities and outputs, such as production machinery, distribution systems, and skilled labor. This allows companies to optimize their use, minimize idle resources, and reduce costs.
Measuring Business Size
Businesses can be classified as small, medium, or large using several indicators, including:
- Number of employees
- Total assets
- Total revenue
- Invested capital
- Production volume
- Sales volume
- Market capitalization
Employees: Small businesses tend to have fewer workers than large businesses because they operate on a limited scale. The number of employees considered small or large varies according to various countries. For instance, the OECD categorizes businesses into four groups based on employee count:
- Micro-sized business: less than 10 employees
- Small business: 10-49 employees
- Medium business: 50-249 employees
- Large business: over 250 employees
Total Assets: The assets owned by a business, expressed in dollars, representing expected future economic benefits, are listed on the balance sheet in the financial statements.
Total Revenue: It is the earnings after adjusting for deductions and is influenced by two factors: price and sales volume. The total revenue is located on the income statement's top line, which is its essential section.
Invested Capital: Business size can also be based on the capital invested, derived from equity capital and debt capital. Equity capital comes from shareholders, while debt capital stems from creditors.
Production Volume: Large businesses boast a high production volume due to sophisticated production techniques, machinery, and equipment, contrasting smaller businesses, which often rely on labor.
Sales Volume: Sales volume represents the quantity of products a company sells. Unlike total revenue, it does not factor in price, so it remains unaffected by various pricing strategies.
Market Capitalization: Market capitalization measures the total worth of shares issued by the company, calculated by multiplying the current share price by the number of outstanding shares. Unlike the variables discussed earlier, classifying businesses by market capitalization applies only to public companies whose shares are traded on stock exchanges.
Small Business vs. Large Business
Small businesses encompass limited operations. The definition varies by country; for example, some consider them businesses with less than 50 employees.
Small businesses are privately owned, usually operated at a single facility, and target local markets. Their operations rely more on labor rather than capital.
Large businesses have extensive operations and high economies of scale, some targeting domestic and international markets in addition to the domestic market. These businesses may possess multiple manufacturing facilities and heavily rely on capital and sophisticated technology and production techniques. They also have better access to financial capital and can attract specialists or professionals.
Benefits and Drawbacks of Large Businesses
Large businesses enjoy several benefits, such as:
- Economies of Scale: Lower costs due to bulk purchasing and efficient production processes.
- Financial Strength: Easier access to investors and financing.
- Market Power: Enhanced bargaining power with suppliers and competitors.
- Organizational Structure: Clear hierarchy, specialization, and delegation of tasks.
- Talent Acquisition: Ability to recruit top talent and professionals.
However, large size also comes with drawbacks:
- Bureaucracy: Slow decision-making due to complex hierarchies and procedures.
- Corporate Culture: Rigid and formal culture that can stifle innovation.
- Customer Service: Difficulty in delivering personalized service at scale.
- Adaptability: Less flexibility to adapt quickly to changing market conditions.
- Growth Challenges: Limited opportunities for significant internal growth within established markets.
- When it comes to personal finance and wealth management, investors often prefer financing large businesses due to their perceived stability and the tendency of their stock prices to be more stable than those of smaller businesses.
- In terms of business operations and wealth-management strategies, larger companies can take advantage of economies of scale in finance, revolutionizing their investing practices and overall wealth management by reducing costs, acquiring capital more easily, and gaining market power to outcompete smaller businesses.
