Firms vary in size and purpose depending on a wide range of internal and external factors. This section explores why firms remain small or choose to grow, how ownership and control are separated in large businesses, and the distinctions between public and private, as well as profit and not-for-profit organisations.
Why some firms remain small
Not all firms aim to grow. Some deliberately choose to remain small, or are limited by circumstances. These small firms often form a key part of the economy, particularly in specialised sectors.
Niche markets
Niche markets refer to small, specific segments of a broader market that cater to unique customer needs or preferences.
Firms operating in niche markets provide highly specialised goods or services that may not have mass appeal but attract a loyal customer base.
Larger firms may not find it profitable to enter these markets due to the limited scale and low overall demand.
For example, a local artisan who handcrafts musical instruments for professional musicians is unlikely to face competition from large multinational corporations.
Niche firms can build strong customer relationships and a reputation for quality and personal service, allowing them to thrive without expanding.
Flexibility
Small firms are often more agile and responsive than larger ones due to fewer layers of management and simpler communication channels.
This flexibility enables them to quickly adapt to changes in consumer preferences, economic conditions, or technology.
They can easily introduce or modify products and services without the bureaucracy and time lags that typically affect larger organisations.
For example, a small bakery can trial a new type of bread based on local customer demand within days, while a national chain may require months of testing and approval.
Low start-up costs
Certain industries require relatively minimal capital investment to enter, such as online retail, tutoring, freelance design, or cleaning services.
These low barriers to entry allow individuals or small groups to start businesses with limited savings or personal loans.
Operating costs are often low, and many such businesses can be run from home or in small, inexpensive premises.
This makes it possible for firms to operate on a small scale and still be financially viable without the need to expand.
Personal preference of owners
Some business owners prioritise lifestyle objectives over profit maximisation.
These “lifestyle businesses” are set up to generate a comfortable income while providing flexibility and independence.
Owners may value autonomy, reduced stress, or a better work-life balance over growth and the responsibilities that come with managing a larger enterprise.
This is common in sectors such as crafts, coaching, or consultancy, where the owner’s involvement is central to the business.
Why other firms grow
Other businesses choose to grow for a variety of strategic and financial reasons. Growth can bring with it significant benefits, but also presents challenges that firms must manage carefully.
Economies of scale
One of the primary motives for business growth is to achieve economies of scale, which reduce the average cost per unit as output increases.
There are several types of economies of scale:
Technical economies: Larger firms can invest in more efficient machinery and production processes.
Managerial economies: Specialised managers can improve productivity and decision-making.
Financial economies: Large firms often have better access to finance and can borrow at lower interest rates.
Marketing economies: Advertising and promotional costs can be spread over a larger output.
Purchasing economies: Bulk buying of raw materials can lead to discounts and better terms.
These cost reductions can lead to higher profits, increased competitiveness, and the ability to lower prices for consumers.
Increased market share
Growing firms often aim to increase their market share—the proportion of total sales within a market that they control.
A larger market share can provide greater pricing power, improve brand recognition, and make it harder for new competitors to enter the market.
Firms with significant market share can benefit from customer loyalty, economies of scale, and greater influence over suppliers and distribution channels.
Diversification
Growth allows firms to diversify into new markets, products, or industries, which helps reduce risk.
If one area of the business suffers losses, others may remain profitable, stabilising the firm’s overall performance.
Diversification can be:
Product-based: A firm starts offering new types of products or services.
Market-based: A firm enters new geographical or demographic markets.
Industry-based: A firm moves into entirely different industries.
For instance, a food manufacturer might diversify into health supplements or ready-made meals to tap into new demand.
Profit maximisation
Larger firms often aim to maximise profits as a core objective.
Growth can enable firms to increase revenue, reduce average costs, and expand profit margins.
Profits provide the means to reinvest in the business, fund innovation, attract investors, and increase dividends to shareholders.
For shareholders and senior managers, profit growth is often seen as a measure of success and competitiveness.
Divorce of ownership from control in large firms
As firms grow, it becomes less practical for owners to manage daily operations directly. This separation of ownership and control introduces potential issues.
The principal-agent problem
In large firms, the owners (known as principals) are typically shareholders who provide capital but do not manage the business.
Managers (known as agents) are employed to run the business on behalf of the owners.
The principal-agent problem occurs when managers pursue their own objectives, which may differ from those of the owners.
For example, managers may seek to grow the business to increase their prestige or job security, even if such growth does not maximise shareholder value.
This problem arises due to information asymmetry, where managers have more knowledge about the firm's operations than the shareholders.
Implications of the principal-agent problem
Agency costs
These are costs incurred to monitor and align the behaviour of managers with the goals of the owners.
They include:
Monitoring expenses (e.g. audits, performance evaluations)
Incentive schemes (e.g. bonuses, stock options)
Opportunity costs from inefficiencies or poor decisions made by managers
Agency costs can reduce overall profitability and require careful management.
Need for incentives
To mitigate the principal-agent problem, firms must design effective incentive structures:
Performance-related pay aligns managers’ income with firm success.
Stock options give managers a personal stake in share price performance.
Promotion opportunities and recognition programmes can also motivate desired behaviours.
These incentives aim to ensure that managers act in the best interests of the shareholders.
Oversight and governance
Corporate governance mechanisms are essential for ensuring accountability.
Key components include:
Board of directors: Provides strategic direction and supervises management.
External audits: Offer independent assessments of financial health.
Regulatory oversight: Ensures firms comply with legal and ethical standards.
Effective governance reduces the risk of fraud, mismanagement, and inefficiency.
Public vs private sector organisations
Firms can also be categorised by who owns and controls them—either the government or private individuals and entities.
Public sector organisations
These are owned and operated by the government, either centrally or locally.
Their primary objective is public service, not profit.
Examples include the National Health Service (NHS), state schools, and public transport authorities.
They aim to provide universal access to essential services, regardless of income or social status.
Funding typically comes from tax revenue, and pricing is often subsidised or free.
Public sector bodies may also aim to support employment, promote regional development, or achieve social equity.
Private sector firms
These are owned by individuals, partners, or shareholders, and operate with the goal of making a profit.
They include a wide range of business types—from sole traders and partnerships to large corporations.
Objectives include:
Maximising profit
Expanding market share
Achieving growth and innovation
Funding sources include:
Private savings
Retained profits
Bank loans
Issuance of shares or bonds
Decision-making is driven by market forces and competitive pressures rather than political or social considerations.
Profit vs not-for-profit organisations
Another key distinction is between firms that aim to generate profit and those with a social or community focus.
Profit-making organisations
These firms aim to generate financial returns for owners or shareholders.
Profits may be reinvested into the business or distributed as dividends.
Success is typically measured by financial performance, such as:
Total profit = Total revenue - Total costs
Return on capital employed (ROCE) = Operating profit / Capital employed
Common examples include supermarkets, banks, manufacturers, and tech companies.
Not-for-profit organisations
These entities aim to achieve social, charitable, or community-based goals.
They reinvest any surplus back into their operations rather than distributing profits.
Objectives include:
Alleviating poverty
Promoting education or health
Supporting community development
Examples:
Charities like Oxfam or Cancer Research UK
Co-operatives that serve member interests (e.g. The Co-operative Group)
Social enterprises that sell products to fund social initiatives
Funding sources include:
Donations
Government grants
Membership fees
Revenue from goods and services
Governance structures often involve a board of trustees responsible for ensuring compliance with ethical and legal standards.
FAQ
Lifestyle businesses are primarily established to support the personal goals and lifestyle preferences of their owners rather than to achieve high levels of profit or rapid growth. Strategic decisions in lifestyle businesses are typically influenced by non-financial objectives such as maintaining work-life balance, flexibility, independence, and reduced stress. These firms are more likely to avoid expansion, complex operations, or external investment if it compromises the owner's autonomy. In contrast, profit-driven firms often make decisions based on achieving economies of scale, increasing shareholder value, and maximising market share. This can involve aggressive marketing, high reinvestment of profits, or mergers and acquisitions. Lifestyle firms may turn down opportunities that would involve hiring large teams or operating in multiple locations, even if these would be financially rewarding. As a result, their decision-making tends to be more risk-averse, long-term personal-goal oriented, and focused on maintaining stability over maximising profit margins.
Not-for-profit organisations frequently adopt business-like practices to ensure efficiency, sustainability, and accountability. While their primary aim is not to generate profit, they still require sound financial management to operate effectively and achieve their social objectives. Using business principles—such as budgeting, strategic planning, marketing, and performance measurement—helps these organisations to maximise the impact of limited resources. For example, a charity running a health programme must ensure that donations are spent effectively, which involves minimising waste and monitoring outcomes. Moreover, many not-for-profits engage in revenue-generating activities, such as selling products or services, to supplement donations and grants. In such cases, they must manage costs, price competitively, and maintain customer satisfaction just like commercial firms. Adopting these practices also improves transparency and builds trust with stakeholders, including donors, regulators, and beneficiaries. Ultimately, behaving like a well-run business allows not-for-profits to scale their operations, attract funding, and deliver better results without compromising their core mission.
Co-operatives are unique business entities that are owned and controlled by their members, who may be customers, employees, or producers. Unlike conventional private sector firms, where ownership and control typically rest with external shareholders, co-operatives operate on a democratic basis—often following the principle of “one member, one vote” regardless of capital contribution. Their objectives focus not only on profitability but also on serving the mutual interests of their members, such as fair pricing, ethical sourcing, or shared economic benefit. Profits in a co-operative are usually reinvested in the business or distributed among members in the form of dividends or improved services. Decision-making in co-operatives tends to be more inclusive and consensus-based, which can slow down processes but fosters stronger stakeholder commitment. Furthermore, co-operatives are more likely to adopt ethical practices, local sourcing, and sustainable operations. Their structure prioritises long-term member welfare over short-term profits, differentiating them from shareholder-centric private firms.
Government regulations can significantly influence the strategic choices and operational conduct of private sector firms. Regulations may set boundaries on pricing, product safety, employment practices, environmental impact, and competition. For instance, competition laws prevent monopolistic behaviour and promote fair market access, potentially limiting a firm’s ability to expand aggressively or merge with competitors. Employment regulations ensure fair wages and working conditions, increasing labour costs and influencing HR policies. Environmental regulations might compel firms to invest in cleaner technologies or reduce emissions, affecting production methods and cost structures. Compliance with these rules may constrain profit maximisation in the short term, but non-compliance can result in penalties, reputational damage, or legal action. In some cases, regulation encourages innovation; for example, green regulations may spur investment in sustainable products. Thus, firms must adapt their objectives to operate within legal frameworks while balancing profitability, competitiveness, and regulatory compliance.
A firm might avoid external investment—such as issuing shares or taking on venture capital—to retain control, minimise risk, and maintain strategic autonomy. Accepting external investment often comes with strings attached: investors may demand a share of ownership, decision-making influence, or short-term returns, which can conflict with the founder’s vision or long-term strategy. For many firms, especially family-run or lifestyle businesses, maintaining control is more important than rapid growth. Using internal sources like retained profits allows them to expand gradually without dilution of ownership or added obligations. Additionally, external investors may push for more aggressive growth, cost-cutting, or exit strategies like public flotation, which may not align with the firm’s culture or values. Avoiding external investment also protects the firm from debt-related risk, especially during economic downturns or market uncertainty. This approach supports sustainable, organic growth and ensures that the business evolves on the founder’s terms, even if progress is slower.
Practice Questions
Explain two reasons why a firm might choose to remain small.
Firms may choose to remain small due to operating in a niche market, where demand is limited and products are highly specialised. Expanding could dilute the firm’s uniqueness or increase costs beyond viable levels. Another reason is owner preference; some entrepreneurs prioritise lifestyle over profit maximisation. Remaining small allows greater control, work-life balance, and lower managerial burden. These firms may avoid external finance and growth risks, aiming instead for stable income and independence. In both cases, the decision reflects strategic or personal motives rather than an inability to grow, and can be entirely rational within the firm’s context.
Evaluate the impact of the principal-agent problem on the objectives of large firms.
The principal-agent problem can significantly affect a firm’s objectives. In large firms, managers (agents) may pursue goals such as revenue growth, empire-building, or job security, which conflict with the owners’ (principals’) aim of profit maximisation. This misalignment can result in inefficiencies, misallocation of resources, and higher agency costs. However, performance-related incentives like bonuses or share options can realign interests, motivating managers to act in shareholders’ best interests. Effective corporate governance, including independent boards and transparency, can further reduce the impact. While the problem poses a risk, firms with strong oversight mechanisms can mitigate its adverse effects on strategic goals.
