Classification of Firms

Economic Sector

  • Primary Sector: this deals with the extraction of raw materials from the earth. Examples are mining, fishing, farming, etc
  • Secondary Sector: this deals with transforming raw materials into finished good, or the construction of roads, bridges and buildings
  • Tertiary Sector: this deals with firms that provide services to the general public and other firms. Examples are lawyer, teachers, security agencies, doctors, entertainers etc

Private & Public Sector

  • Private Sector: These are firms owned by private individuals and owners, their main aim is to earn profit. This sector involves types of business organisation which includes sole proprietorship, partnership, joint stock companies, multinationals
  • Public Sector: These are firms owned by the government, their aim is to provide a service to the general public. examples are government schools, health centres, water supply, post office etc.

Relative Size of Firms

  • Size of Workforce: A large firm has a tendency to employ more workers than small firms. In some cases, small firms may employ more than large firms if the large firm is largely capital intensive.
  • Market Share: Large firms may dominate sales in the markets they supply. But not all markets are large. Firms serving small or niche markets will tend to remain small.
  • Capital employed: This is the amount of money invested in productive assets that generate revenue. The more capital a firm can invest in productive assets, the more it can produce. But production by some large firms are labour intensive.

Causes of the Growth of Firms

Firms can grow either internally (increasing their market share) or externally (through mergers or acquisitions)

  • Internal Growth: This is when a firm expands its scale of production through the purchase of additional equipment and increasing the size of its premises. This can also be achieved by increasing the number of stores in a particular country or different countries.
  • External Growth: This is when two or more firms join together to form a larger enterprise, this is known as integration. Integration involves the merging of two or more firms or the acquisition of one company by another

Types of merger

  • Horizontal Merger: This occurs between firms engaged in the production of the same type of good or service. Example The Sterling Bank group is made up of Trust Bank of Africa Plc, Magnum Trust Bank, NBM Bank, NAL Bank and Indo-Nigerian Bank who merged together in 2005 in Nigeria.
  • Vertical Merger: This occurs between firms at different stages of production. There are two types of vertical merger: Backward Vertical Merger which occurs when a firm from the secondary sector merges with a firm from the primary sector. example if KFC buys Jenny Farms who supplies them with chicken for the restaurant; Forward Vertical merger which occurs when a firm from the primary sector merges with a firm in the secondary or tertiary sector.
  • Lateral Merger: This occurs between firms in different industries in the same stage or different stages of production. they may form a single company or be part of a large group.

Economies & Diseconomies of Scale

Economies of Scale

Economies of scale are the cost benefits of increasing the scale of production in a firm or industry.

Internal economies of scale are cost savings that arise from within the business as it grows. Examples of internal economies of scale are:

  • Purchasing economies of scale: this occur when the cost of raw materials, components or finished good falls when they are bought in large quantities;
  • Technical economies of scale: this occur when large firms purchase expensive pieces of machinery and automated equipment for the production process. This help large firms increase production thereby reducing the production cost on the long run.
  • Financial economies of scale: This occur as large firms are able to borrow money from banks more easily than small firms because they are perceived by banks to be less risky.
  • Marketing economies of scale: this occurs as large firms tend to have large advertising budgets so that they can spend large amounts of money on promoting their products.
  • Risk-bearing economies of scale: this occurs as large firms produce a range of products and operate in many locations. This diversity spreads the risks as weak sales in one product can be supported by another product through an increase in sales.

External economies of scale are economies that arise due to the location of the firm and are therefore external to the business. Examples of external economies of scale includes:

  • Ancillary Firms: these are firms that develop and locate nearby large firms in other industries to provide them with the specialized equipment and business services they need;
  • Access to Skilled workforce: It is easier for them to employ workers that are trained by other firms in their industry.
  • Joint marketing benefits: new firms locating near to others in the same industry may share their reputation for producing high quality products.
  • Shared infrastructure: growth of an industry may persuade firms in other industries to invest in new infrastructure such as power stations, ports to meet increasing demand for their services.

Diseconomies of Scale

Diseconomies of Scale arises when a firm gets too large, so its average cost of production start to rise as output increases. At this stage the disadvantages starts to outweigh the advantages. Reasons for increased cost of production include the following:

  • A large firm may run out of supplies of parts and materials;
  • A large firm may have to raise wages to attract sufficient numbers of workers;
  • A large firm may find it difficult to attract new customers;
  • A large firm may suffer more industrial disputes because production lines are automated and work tasks are uninteresting;
  • A large firm may suffer from internal communication and coordination problems, especially if it has many locations, many managers and many different activities.

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