Sizes and Types of Firms

Sizes and Types of Firms

There are nearly 6 million private businesses in the U.K. Some of these are vast multi-national businesses, employing many thousands of people. But the large majority of businesses are classified as SMEs (small and medium-sized enterprises). An SME is defined as a business with fewer than 250 people.

In the UK SMEs make up 99% of all private businesses, but only employ 60% of all workers in the private sector and account for just 51% of turnover (output) of the private sector.

Over 75% of SMEs are self employed-people who do not have any other employees.

Larger firms tend to dominate industries where:

  1. Economies of scale are important – eg. the car industry
  2. The market is large (national or global) – eg. oil, cars, or mobile phones
  3. There are barriers to entry

Small firms survive (and often prosper) for the following reasons:

  1. Economies of scale are not important – in a personal service like hairdressing for instance, there are few advantages for large firms. The minimum efficient scale can be reached by small firms.
  2. The market is small- some goods or services have a small number of potential customers, who want a very specific good or service. These are called niche markets. Big companies which aim at a mass market may not have the expertise or interest in pursuing these customers; holiday companies offering ‘extreme sports’ for instance
  3. The market is very local – a village shop, for instance offers convenience that a supermarket in town can’t match. For small purchases, consumers may be unwilling to travel far.

entry barriers may be low _– _the growth of the internet, for instance has made it much easier for people to set up small businesses that operate from home.

Separation of Ownership and Control

In small businesses, the owner(s) are usually also involved in running and managing the business. But in a large company, which is usually a plc (public limited company), the ownership and control of a business can become separated. This means the function of enterprise (or entrepreneurship) is divided between shareholders, who bear the risks, and senior managers (directors) who organise and run the company.

This separation of risk bearing from control is an example of what economists call the principal-agent problem. The interests of the principal group (shareholders) is in the hands of the agents (the directors). The shareholders appoint the directors to maximise their financial returns from owning the business (in the form of profits and increase in the value of the shares).

This can create a conflict of interests, as directors may seek to maximise their benefits (such as salaries, expenses and bonuses) rather than the interests of shareholders. They may also be more interested in increasing the size of the company (the turnover or number of employees) rather than profit, since their status and influence is more dependent on the former.

Directors may also be more concerned with the short term performance of the company rather than the long term, since their salaries and bonuses are often linked to the annual profits or share price. This can give them an incentive to cut costs or reduce expenditure on things like investment, which boost short term profits but may harm the company’s long run competitiveness.

The Private Sector, Public Sector and Voluntary Sector

Businesses in the private sector are owned by individuals. In the case of the smallest enterprises (sole traders), there is just one owner. A large plc may have many thousands of owners (the shareholders).

For private businesses, making a profit is a very important aim. Profit is the reward for risk taking, innovation and organisation.

Public sector organisations exist mainly to provide a service to the community. They are state-owned and managed by the government or local authorities. Examples include the NHS, the BBC, police forces, state schools and the Department for Transport (which builds and maintains major roads).

Some public sector businesses (eg a council owned sports centre) may generate a surplus, but this usually goes to pay for other services. It is not the primary aim of the organisation.

The voluntary sector comprises organisations that are not owned by the state or individuals. They are run on a not-for-profit basis. They mostly have a board of trustees who are responsible for managing the organisation. Any surpluses have to be used to further the aims of the organisation. Many of them are registered charities and are regulated by the Charities Commission. Some of them are awarded contracts by the government or local authorities to provide services to the community. For instance, many care homes are run by charities.