Why Do Firms Grow.

Topic: BusinessOrganization
Sample donated:
Last updated: June 15, 2019

The traditional profit maximizing theories of the firm have been criticised for being unrealistic. As a result, alternative theories of the firm were introduced (Sloman & Sutcliffe, 2001). One of the alternative theories of the firm is Growth maximization. Following are the main motives for the firms to grow: ?The cost motive: A growth maximising firm can lower its long run average costs by exploiting economies of scale and economies of scope. Economies of scale come into effect when increasing the scale of production leads to a lower cost per unit of output (Fig. 1).By increasing the range of products produced, a firm reduces the cost of producing each one due to economies of scope (Sloman & Sutcliffe, 2001).

When a firm expands it operation along the stages of production (forward or backward), it can lower its costs by performing complementary stages of production under a single unit. For example, a steel melting plant & a steel rolling plant are operating at a single site. Extremely high temperatures are required to produce steel and roll sheet. With the plants co owned, the hot steel can easily be transferred to rolling plant.This saves transportation and heating costs resulting in lower production costs (Begg & Ward, 2009). An integrated business may gain various financial economies due to its operating size. It will be in a better position to negotiate favourable deals from key suppliers.

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It can also obtain lower borrowing rates from financial institutions due to the additional security feature that accompany a large firm (Sloman & Sutcliffe,2001). (Sloman & Sutcliffe 2001 pp. 185) Figure-1 ?The risk motive: The expansion of business can be through diversification in order to reduce the risks.

If the business performs only in a single market, it is more vulnerable to changes in that market conditions. Consider a company operating in a single market. It might be making good profits.

However the profits can change. The profit of the company can fall due to entry of new competition, or increase in price of raw material. For e. g. sales of Sony corporation PS2 fell after the entry of Xbox game console.

Similarly the profit can rise due to exit of competition or decrease in price of raw material. Profit can rise or fall.But, profits at any point of time can rise for one firm or market and fall for another. By operating in more than one market or industry, falling profits in one area can possibly be offset by rising profits in another part of business. By having a diversified portfolio, business can spread its risk and reduce the variability in overall profits (Begg & Ward, 2009). An example of diversified firm is TATA group.

It operates in automobile, steel manufacturing, consulting services, power, hotels, consumer products, chemicals, financial services and communications sector. The market power motive: Growth will help firms to achieve market dominance resulting in increased pricing power and enabling the firm to erect entry barriers for potential competitors. For example, a firm that grow by backward integration and acquires a key input resource can close the market for potential new entrants either by not supplying or by charging a very high price which makes it difficult for new firms to enter the market (Sloman & Sutcliffe, 2001). A further barrier to entry might be due to increase in minimum efficient size of the business.As the firms become more integrated, they will experience greater economies of scale, so the new entrants will have to operate at the level of integrated firms which may act as cost disadvantage for the new entrants’ and they will become less competitive.

Another motive is to reduce competition and thereby gain greater market share and larger profits. With less competition, the firm will face less elastic demand and will be able to charge a higher percentage above marginal cost. For example, Monopolies can engage in price discrimination (Begg & Ward, 2009). ?The profit motive: Growth depends on profitability.

Profitable firms are likely to be able to finance investment required for growth. Also, growth affects profitability. In the short run, growth above a certain rate may reduce profitability. Some of the finance required for the investment to achieve growth will come from firm’s sales revenue. A firm opting to expand in the existing market will have to spend on advertising and marketing whereas a firm looking to diversify will have to spend on market research and hiring specialists .

Firms will have to sacrifice some of its short run profits for the long run gains which growth might yield (Sloman & Sutcliffe,2001).However, In the long run, a rapidly growing firm may have increasing profits by achieving economies of scale and increased market power. These profits can then be used to finance further growth. (Sloman & Wride, 2009). ?Managerial motives: Managers may take longer term perspective and aim for growth maximization in the size of the firm.

By doing so, they will benefit directly by being a part of expanding firm. Promotion prospects, increased salaries and increased power are the main driving force for managers to select for growth. Hooper, 2011). Means for achieving growth are internal expansion and external expansion.

The table shows various types of growth strategy which can be used by any growth maximising firm. (Sloman & Sutcliffe, 2001, pp. 271) The dynamic competitive nature of the market drives the firms to expand in order to survive. If a firm does not grow, the rivals can benefit from this by securing a greater share of market and reducing profit of the first firm. Thus, business growth is vital for a firm to endure its operations (Sloman & Sutcliffe, 2001).

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