Hello Future Business Leader!
Welcome to Topic 1.3: Size of Business. This might seem like a simple concept – "big" or "small" – but in the business world, size determines everything: how a firm operates, how it is financed, and what risks it faces.
Understanding business size is essential for analysis in your exams. You need to know not just how to measure size, but also why small businesses matter and the different ways businesses achieve growth. Let's dive in!
1.3.1 Measurements of Business Size
When we talk about business size, we need objective ways to compare a multinational corporation (MNC) like Apple to a small family bakery. The difficulty is that no single measure works perfectly for every business.
The Four Main Ways to Measure Size
Here are the measures specified in your syllabus, along with the pros and cons of using each one:
1. Number of Employees (Workforce Size)
Definition: The total number of people employed by the business.
- Advantage: This is easy to understand and calculate. It's often used by governments to define "small and medium enterprises" (SMEs).
- Disadvantage: This measure ignores the value of output. A highly automated, capital-intensive factory might have few employees but huge output (e.g., a modern car assembly line).
2. Sales Revenue (Turnover)
Definition: The total value of sales made by the business over a period (usually a year).
- Advantage: This is a very common comparison tool, especially for market share calculations (e.g., "Company X is the biggest in the market by revenue").
- Disadvantage: High revenue doesn't automatically mean high profit. Also, this measure is problematic for service industries (like law firms) compared to manufacturing firms, which naturally have higher turnover.
3. Capital Employed
Definition: The total value of long-term finance invested in the business (e.g., loans plus share capital and reserves). Essentially, the value of assets used to make profit.
- Advantage: This is particularly useful for comparing businesses in capital-intensive industries (where large machinery and equipment are needed).
- Disadvantage: It is a poor measure for labour-intensive industries (like marketing agencies). Also, asset valuations can change due to depreciation or inflation, making comparisons tricky.
4. Market Capitalisation
Definition: The total value of a company’s issued shares. Calculated as: Share Price × Number of Issued Shares.
- Advantage: This is the most accurate reflection of the total value investors place on the business.
- Disadvantage: Only applicable to Public Limited Companies (PLCs) whose shares are traded on a stock exchange. It is highly volatile (changes daily) based on market sentiment.
Quick Review: The Best Measure is...
...the one that is most appropriate for the industry! For a retailer like Tesco, revenue is key. For an airline like Emirates, capital employed (the value of their planes) is very relevant. For a small consulting firm, the number of employees might be most useful.
1.3.2 Significance of Small Businesses
Don't underestimate the power of small businesses! They form the backbone of most economies, yet they operate very differently from large corporations.
Advantages of Being a Small Business
- Flexibility and Adaptability: They can change products, services, or locations quickly in response to market changes. (Analogy: They are speedboats, not oil tankers.)
- Better Communication: Shorter chains of command mean decisions are made faster and messages are less distorted.
- Personalised Customer Service: Owners often deal directly with customers, leading to high loyalty and a better understanding of niche needs.
- Lower Overheads: Less bureaucracy, fewer management layers, and often smaller premises reduce fixed costs.
Disadvantages of Being a Small Business
- Difficulty in Raising Finance: Banks often see small firms as higher risk, making loans harder to secure or more expensive.
- Higher Unit Costs: They cannot benefit from economies of scale (cost savings from increasing scale of output). Purchasing raw materials in small batches is more expensive per unit.
- Risk of Failure: Small firms are highly vulnerable to economic downturns or competition.
- Limited Scope for Diversification: They often focus on a single product or market, increasing their risk if that market fails.
Family Businesses
A family business is owned and often managed by members of the same family. They have unique strengths and weaknesses:
- Strengths: High commitment, long-term perspective (wanting to pass the business to the next generation), and deep-seated trust between owners.
- Weaknesses: Potential for conflicts between family members; succession issues (who takes over when the current owner retires?); reluctance to hire expensive, highly skilled non-family managers.
The Role of Small Businesses in the Economy
Governments love small businesses because they play vital roles:
- Job Creation: They are often the largest employer in aggregate across a country.
- Innovation: They are flexible and often risk-takers, pioneering new products and methods.
- Competition: They keep larger firms competitive by offering alternatives and cheaper/better products.
- Industrial Structure Role: Small businesses often act as specialised suppliers to large businesses (e.g., a small firm supplying custom components to a major car manufacturer). They fill the gaps (niche markets) that large companies ignore.
Did you know? Many of the world’s largest companies, like Ford or Walmart, started as tiny family businesses!
1.3.3 Business Growth
Growth is generally desirable as it can lead to higher profits, better economies of scale, and increased market influence. Businesses can grow in two main ways: internally or externally.
1. Internal Growth (Organic Growth)
Definition: Growth that happens naturally over time, funded by the business’s own resources (retained profit) without merging or taking over another company.
- How it happens: Increasing sales, developing new product lines, opening new stores, or entering new international markets.
- Advantages: It is lower risk, usually financed by retained profits (cheaper), and the firm maintains its original management culture.
- Disadvantages: It is often very slow, and the rate of growth is limited by the size of the market or the amount of profit retained.
2. External Growth (Inorganic Growth)
Definition: Growth achieved by joining with another business, typically through a merger or a takeover.
Mergers and Takeovers (M&T)
A Merger occurs when two firms agree to join together to form a new, single entity (it is a voluntary, "friendly" process). A Takeover (or Acquisition) occurs when one firm buys over 50% of the shares of another firm, gaining control (this can be friendly or hostile).
Types of External Growth (Integration)
The type of merger/takeover depends on the relationship between the two businesses:
- Horizontal Integration: Two businesses at the same stage of production and in the same industry merge.
Example: Two rival supermarket chains merge.
Objective: Gain market share, exploit greater economies of scale. - Vertical Integration: Two businesses at different stages of production but in the same industry merge.
- Backward Vertical: Merging with a business earlier in the supply chain (e.g., a car manufacturer buying a tyre producer). Objective: Control quality and secure raw material supply.
- Forward Vertical: Merging with a business later in the supply chain (e.g., a shoe manufacturer buying a chain of retail shoe shops). Objective: Control distribution and maximise profit margin.
- Conglomerate Diversification: Two businesses in completely unrelated industries merge.
Example: A mining company buying a cinema chain.
Objective: Spread risk across different markets; if one sector is in a recession, the other may be performing well.
Why M&T Succeed or Fail
Mergers are complicated. They may or may not achieve their objectives:
- Success Factors: Achieving planned cost savings (synergies), rapid elimination of excess capacity, accessing new expertise/patents quickly, successfully integrating the two distinct organisational cultures.
- Failure Factors: Culture clash (e.g., strict hierarchy meeting a relaxed startup), high redundancy costs, key employees leaving, overestimating the synergy benefits (paying too much for the target company).
Impact of Mergers/Takeovers on Stakeholders
M&T decisions cause significant consequences for interested groups:
- Employees: Often fear job losses (redundancies) due to duplicate roles (e.g., two Finance Directors are no longer needed).
- Customers: May benefit from lower prices due to economies of scale, but may face less choice if competition is reduced.
- Owners/Shareholders: Expect higher returns, but face greater risk if the takeover fails or management becomes inefficient due to the larger size.
- Suppliers: May face demands for lower prices if the newly merged firm has greater purchasing power.
Joint Ventures (JV) and Strategic Alliances (SA)
These are methods of external growth that involve cooperation rather than outright purchase.
- Joint Venture (JV): Two or more businesses agree to set up a new separate business entity for a specific project or purpose, sharing capital, risk, and profit. (Example: Two airlines create a new separate low-cost carrier.)
- Strategic Alliance (SA): A non-legal agreement where two firms cooperate on a project, such as research, but remain legally independent. (Example: A car company agrees to use a battery manufacturer’s new technology for 5 years.)
Importance of JVs and SAs
They are crucial for external growth because they:
- Share Risk: Large, risky projects (like entering a completely new country) become manageable.
- Access Expertise: One firm might have local knowledge, while the other has necessary technology.
- Overcome Barriers: Necessary when a country restricts foreign ownership (a JV with a local firm is often the only option).
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Quick Review Box: Size and Growth
Size Measurement: No single best measure; depends on the industry (Employees, Revenue, Capital Employed, Market Cap).
Small Firms: Offer flexibility and personal service but face finance limitations and high risk.
Internal Growth: Slow, low risk, maintain culture.
External Growth: Fast, high risk. Types are Horizontal, Backward Vertical, Forward Vertical, and Conglomerate.