Subject content
3.1.1 Sizes and types of firms
a) Reasons why some firms tend to remain small and why others grow
Firms grow for a number of reasons:
● to make more money
● to gain monopoly power
● for greater security
By growing, a firm will be able to experience economies of scale which helps them to decrease
their costs of production. They will also be able to sell more goods and therefore make more
revenue. Together, these will help a firm to make a larger profit; and many firms are motivated
by profit.
A larger firm will hold a greater share of their market. This will give them the ability to influence
prices and restrict the ability of other firms to enter the market, helping them to make profits in
the long run. Monopoly power often means firms have monopsony power, and so will be able to
reduce their costs by driving down the prices of their raw materials.
A larger firm will have more security as they will be able to build up assets and cash which can
be used in financial difficulties. Moreover, they are likely to sell a bigger range of goods in more
than one local/national market and so they will be less affected by changes to individual
products or places.
However, not all firms grow. Some remain small because of constraints on growth: the size of
the market, access to finance, owner objectives and regulation. Not all firms want to grow.
Constraints of business growth:
● Size of the market
A market is limited to a certain size and so not all businesses are able to mass produce
because their goods would not be bought by consumers. This can happen no matter
how big the market is, and there will always be limits on growth. In particular, niche
markets (specific products that few people want) and markets for luxury items or
restricted prestige markets make it difficult for businesses to grow.
● Access to finance
Firms use two main ways to finance growth: retained profits and loans. If firms do not
make enough profit or have to give out too much to shareholders, they will not be able to
, use retained profits to grow. Banks may be unwilling to lend firms money, particularly
smaller businesses that they see as high risk. As a result, firms will be unable to grow as
they can't finance it.
● Owner objectives
Some owners may not want their business to grow any further as they are happy with
their current profits and do not want the extra risk or work that comes with growth.
● Regulation
In some markets, the government may introduce regulation which prevents businesses
from growing. For example, the UK government regulates the number of pharmacies in a
local area and an existing pharmacy can only expand by buying another company.
Competition law, which prevents monopolies, can restrict growth as any merger which
creates a company with more than a 25% market share can be forbidden from taking
place.
b) Significance of the divorce of ownership from control: the principal-agent problem
In many large firms, there is separation of ownership and control:
● Firms are owned by their shareholders, who play no part in the day to day running of the
business.
● The chief executive and senior managers work for the company and control day-to-day
decision making.
● Shareholders are represented by a Board of Directors, who oversee the way the
business is run. They are able to vote directors onto and off the Board of Directors at the
AGM. However, this often makes little difference and shareholders have more power
through buying and selling shares: if share prices drop significantly, the board may be
encouraged to change their strategy.
This separation causes problems due to the differing aims of the two stakeholders:
● The owners will want to maximise the returns on their investment so will want to short
run profit maximise.
However, directors and managers are unlikely to want the same thing: as employees, they will
want to maximise their own benefits.
This is the principal agent problem, where one group, the agent, makes decisions on behalf of
another group, the principal. In theory, the agent should maximise the benefits for those whom
they are looking after but in practice agents have the temptation to maximise their own benefits.
It is for this reason that many firms are not run to profit-maximise but to profit satisfice. The
issue could be overcome by giving managers shares in the business or linking their bonuses to
profits, this will mean that they personally will gain from higher profits.
,An extreme example of this problem is the Enron Scandal (2001). The executives used
loopholes to hide billions of dollars in debt from the Board of Directors. The shareholders filed a
lawsuit to the firm and the executives when share prices fell from nearly $100 to less than $1 in
just over a year.
thomas cook collapse 2019
Who were the principals?
● Shareholders and investors who wanted long-term sustainable growth and returns.
🎯 Who were the agents?
● Senior management and executives, responsible for day-to-day decisions.
💣 What went wrong?
● Executives continued to pay themselves large bonuses and salaries, even while the
company was underperforming and burdened with debt.
● They pushed aggressive expansion and acquisitions, which made the firm highly
leveraged.
● Took on risky business decisions, moral hazard, to boost short-term revenues and
look good in quarterly reports, despite weakening fundamentals.
🔻 Result:
● Massive debt (£1.6 billion).
● Poor financial health ignored for years.
● The company collapsed in 2019, stranding around 600,000 holidaymakers globally.
📉 How it shows Principal-Agent Problem:
● Executives (agents) acted in self-interest (bonuses, growth image).
● Shareholders (principals) suffered the ultimate loss — total collapse, loss of
investment.
● No proper checks, accountability, or aligning of incentives (like performance-linked
pay).
c) Distinction between public and private sector organisations
In the UK, the economy is split into private and public sectors.
, The private sector refers to that part of the economy that is owned and run by individuals or
groups of individuals, including sole traders and PLCs. The public sector refers to that part of
the economy which is owned or controlled by the local or central government. The purpose of
these organisations is to provide a service for UK citizens and profit making is not their main
aim, some may even make a loss which is funded for by the taxpayer.
d) Distinction between profit and not-for-profit organisations
The private sector can be split into for profit and not-for-profit organisations:
Almost all private sector organisations are run to make a profit and to maximise the financial
benefits for their shareholders. They may not necessarily profit-maximise, but their long term
goal is to make money. Some private sector organisations are not-for-profit. Any profit they do
make is used to support their aim of maximising social welfare and helping individuals and
groups. These organisations include charities and smaller organisations who aren't large
enough to be classified as charities.
3.1.2 Business growth
a) How businesses grow:
● organic growth
There are two main types of growth: internal/organic growth and integration. Organic
growth is where the firm grows by increasing their output, for example increased
investment or more labour. They may open new stores, increase their range of products
etc. Almost all growth of firms is organic.
An example of a firm who grew through organic growth is LEGO. They introduced new
products such as Lego Friends and board games to expand their customer base.
● forward and backward (vertical) integration
Integration is growth through amalgamation, merger or takeover. A merger or
amalgamation is where two or more firms join under common ownership whilst a
takeover is when one firm buys another. Vertical integration is of firms in the same
industry but at different stages in the production process.
Forward integration secures retail outlets and can restrict access to these outlets for
competitors. If the merger takes the firm back towards the supplier of a good, it is
backwards integration. Forward integration is when the firm is moving towards the
eventual consumer of a good.
Tesco's £3.7bn takeover of Booker in 2018 is an example of vertical integration. It has
led to an increase in sales for Tesco.
3.1.1 Sizes and types of firms
a) Reasons why some firms tend to remain small and why others grow
Firms grow for a number of reasons:
● to make more money
● to gain monopoly power
● for greater security
By growing, a firm will be able to experience economies of scale which helps them to decrease
their costs of production. They will also be able to sell more goods and therefore make more
revenue. Together, these will help a firm to make a larger profit; and many firms are motivated
by profit.
A larger firm will hold a greater share of their market. This will give them the ability to influence
prices and restrict the ability of other firms to enter the market, helping them to make profits in
the long run. Monopoly power often means firms have monopsony power, and so will be able to
reduce their costs by driving down the prices of their raw materials.
A larger firm will have more security as they will be able to build up assets and cash which can
be used in financial difficulties. Moreover, they are likely to sell a bigger range of goods in more
than one local/national market and so they will be less affected by changes to individual
products or places.
However, not all firms grow. Some remain small because of constraints on growth: the size of
the market, access to finance, owner objectives and regulation. Not all firms want to grow.
Constraints of business growth:
● Size of the market
A market is limited to a certain size and so not all businesses are able to mass produce
because their goods would not be bought by consumers. This can happen no matter
how big the market is, and there will always be limits on growth. In particular, niche
markets (specific products that few people want) and markets for luxury items or
restricted prestige markets make it difficult for businesses to grow.
● Access to finance
Firms use two main ways to finance growth: retained profits and loans. If firms do not
make enough profit or have to give out too much to shareholders, they will not be able to
, use retained profits to grow. Banks may be unwilling to lend firms money, particularly
smaller businesses that they see as high risk. As a result, firms will be unable to grow as
they can't finance it.
● Owner objectives
Some owners may not want their business to grow any further as they are happy with
their current profits and do not want the extra risk or work that comes with growth.
● Regulation
In some markets, the government may introduce regulation which prevents businesses
from growing. For example, the UK government regulates the number of pharmacies in a
local area and an existing pharmacy can only expand by buying another company.
Competition law, which prevents monopolies, can restrict growth as any merger which
creates a company with more than a 25% market share can be forbidden from taking
place.
b) Significance of the divorce of ownership from control: the principal-agent problem
In many large firms, there is separation of ownership and control:
● Firms are owned by their shareholders, who play no part in the day to day running of the
business.
● The chief executive and senior managers work for the company and control day-to-day
decision making.
● Shareholders are represented by a Board of Directors, who oversee the way the
business is run. They are able to vote directors onto and off the Board of Directors at the
AGM. However, this often makes little difference and shareholders have more power
through buying and selling shares: if share prices drop significantly, the board may be
encouraged to change their strategy.
This separation causes problems due to the differing aims of the two stakeholders:
● The owners will want to maximise the returns on their investment so will want to short
run profit maximise.
However, directors and managers are unlikely to want the same thing: as employees, they will
want to maximise their own benefits.
This is the principal agent problem, where one group, the agent, makes decisions on behalf of
another group, the principal. In theory, the agent should maximise the benefits for those whom
they are looking after but in practice agents have the temptation to maximise their own benefits.
It is for this reason that many firms are not run to profit-maximise but to profit satisfice. The
issue could be overcome by giving managers shares in the business or linking their bonuses to
profits, this will mean that they personally will gain from higher profits.
,An extreme example of this problem is the Enron Scandal (2001). The executives used
loopholes to hide billions of dollars in debt from the Board of Directors. The shareholders filed a
lawsuit to the firm and the executives when share prices fell from nearly $100 to less than $1 in
just over a year.
thomas cook collapse 2019
Who were the principals?
● Shareholders and investors who wanted long-term sustainable growth and returns.
🎯 Who were the agents?
● Senior management and executives, responsible for day-to-day decisions.
💣 What went wrong?
● Executives continued to pay themselves large bonuses and salaries, even while the
company was underperforming and burdened with debt.
● They pushed aggressive expansion and acquisitions, which made the firm highly
leveraged.
● Took on risky business decisions, moral hazard, to boost short-term revenues and
look good in quarterly reports, despite weakening fundamentals.
🔻 Result:
● Massive debt (£1.6 billion).
● Poor financial health ignored for years.
● The company collapsed in 2019, stranding around 600,000 holidaymakers globally.
📉 How it shows Principal-Agent Problem:
● Executives (agents) acted in self-interest (bonuses, growth image).
● Shareholders (principals) suffered the ultimate loss — total collapse, loss of
investment.
● No proper checks, accountability, or aligning of incentives (like performance-linked
pay).
c) Distinction between public and private sector organisations
In the UK, the economy is split into private and public sectors.
, The private sector refers to that part of the economy that is owned and run by individuals or
groups of individuals, including sole traders and PLCs. The public sector refers to that part of
the economy which is owned or controlled by the local or central government. The purpose of
these organisations is to provide a service for UK citizens and profit making is not their main
aim, some may even make a loss which is funded for by the taxpayer.
d) Distinction between profit and not-for-profit organisations
The private sector can be split into for profit and not-for-profit organisations:
Almost all private sector organisations are run to make a profit and to maximise the financial
benefits for their shareholders. They may not necessarily profit-maximise, but their long term
goal is to make money. Some private sector organisations are not-for-profit. Any profit they do
make is used to support their aim of maximising social welfare and helping individuals and
groups. These organisations include charities and smaller organisations who aren't large
enough to be classified as charities.
3.1.2 Business growth
a) How businesses grow:
● organic growth
There are two main types of growth: internal/organic growth and integration. Organic
growth is where the firm grows by increasing their output, for example increased
investment or more labour. They may open new stores, increase their range of products
etc. Almost all growth of firms is organic.
An example of a firm who grew through organic growth is LEGO. They introduced new
products such as Lego Friends and board games to expand their customer base.
● forward and backward (vertical) integration
Integration is growth through amalgamation, merger or takeover. A merger or
amalgamation is where two or more firms join under common ownership whilst a
takeover is when one firm buys another. Vertical integration is of firms in the same
industry but at different stages in the production process.
Forward integration secures retail outlets and can restrict access to these outlets for
competitors. If the merger takes the firm back towards the supplier of a good, it is
backwards integration. Forward integration is when the firm is moving towards the
eventual consumer of a good.
Tesco's £3.7bn takeover of Booker in 2018 is an example of vertical integration. It has
led to an increase in sales for Tesco.
