Why Firms Grow or Stay Small

1. Firms grow to spread fixed costs over more units, capturing economies of scale that cut average cost and let them undercut rivals on price.
2. Greater scale also brings market power, so the firm can hold price above marginal cost and earn larger supernormal profit.
3. Widening the product range diversifies revenue, spreading risk so a downturn in one market does not threaten survival.
4. Many firms stay small because they serve a niche where total demand is too limited to justify extra capacity.
5. Small firms often cannot fund expansion, since they hold little retained profit and lenders treat them as higher risk.
6. Owners may choose to stay small to keep personal control, protect a bespoke service, or avoid the diseconomies of scale that would raise average cost.

Divorce of Ownership from Control

1. Shareholders, the principals, want maximum profit and dividends, while managers, the agents, may prefer growth, status or an easier life.
2. Because managers run daily operations, they hold information owners cannot observe, so owners struggle to check whether each decision serves them.
3. This asymmetric information lets managers pursue their own aims at owners' expense, for example empire-building through unprofitable expansion.
4. The divorce therefore explains why large firms may adopt objectives other than pure profit maximisation.
5. At a listed plc such as Unilever, ownership is spread across thousands of dispersed shareholders who cannot monitor the board day to day, so the principal-agent problem is especially acute.

Public and Private Sector

1. Private sector firms answer to their owners, so profit and shareholder returns usually drive decisions, as at Tesco or Greggs.
2. Public sector bodies answer to government, so social welfare and universal provision shape decisions, as in the NHS.
3. Ownership therefore decides whose interests come first: private returns or public benefit.

Profit and Not-for-Profit Organisations

1. Most private firms are profit-making and use profit to reward owners and fund reinvestment.
2. Not-for-profit bodies such as the British Red Cross, social enterprises and housing associations channel any surplus back into their purpose.
3. The distinction lies in what happens to any surplus, not in whether the organisation can earn one.

Is growth always in the owners' best interests?

1. It can be, because scale delivers economies of scale and market power that lift profit and the dividends shareholders receive.
2. But manager-led growth can reflect the principal-agent problem, where empire-building raises managers' status while diseconomies of scale erode profit.
3. Rapid growth can also overstretch finance and management, so a smaller, focused firm may earn a higher return on capital.
4. On balance it depends on whether growth is pursued to cut average cost and raise profit, or simply to serve managers' own objectives.