Business Studies Form 3 Notes : SIZE AND LOCATION OF A FIRM

SIZE AND LOCATION OF A FIRM

1. Meaning of firm and industry

   A firm is an individual enterprise or business unit under one control and ownership, e.g., a business unit carrying the production of a good or service such as production of soap or a legal service firm.

   A firm is a single business unit or enterprise under one ownership, management, and control, e.g., KCC, Brookside, etc.

   An industry consists of all those firms producing the same type of products in the same line of production. A soap industry consists of all those firms producing soap, while an insurance industry consists of all those firms providing insurance services.

   An industry refers to a group of firms producing the same products for a given market, e.g., the milk industry which includes firms such as KCC and Brookside. In some cases where there is a single firm, the firm becomes the industry.

2. Factors which influence the decision on what goods and services to produce
   • Profitability

     Businesses tend to provide goods and services that yield maximum profit.

   • Level of competition

     To survive in a competitive market, firms must develop products that consumers prefer. A firm may develop products not currently available or copy rivals’ ideas and improve on them.

   • Cost of production

     A firm would produce commodities for which production costs are low.

   • Demand/market

     A firm will produce commodities that have the highest demand since demand leads to high sales volume.

   • Availability of resources
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     A firm can only produce commodities for which the necessary resources are available. Such resources include raw materials, labor, equipment, adequate space, and appropriate technology.

   • Government policy

     A firm should produce goods favored by government policy, e.g., low taxation and subsidies. Firms should not produce illegal goods as it breaks the law.

3. Determining the size of the firm

   The following are some ways/factors by which the size of a firm may be determined:

   • Level of output/volume of output

     A firm’s size may be judged by the level of output. A large firm will produce on a large scale, while a small firm will produce on a small scale.

   • Number of employees in the firm

     A small firm is likely to employ only a few employees, while a large firm will often employ many workers.

   • Floor area covered by the premises

     A firm with a large floor area covered by premises may be said to be large.

   • Size of the market controlled by the firm

     Large firms control large proportions of the total market of a particular product. Small firms may control only a small part of the market.

   • Capital invested

     The larger the capital of the firm in terms of assets, the larger the firm and vice versa.

   • Methods of production adopted

     A large firm will often adopt capital-intensive methods of technology, where operations are highly mechanized, while small firms use more labor than machinery.

   • Sales volume

     Small firms have low levels of sales within a given period, while large firms have huge levels of sales.

4. Location of the firm

   Location is the site or place from which the business operations/firms are established. Management must make appropriate decisions concerning the location of the firm since a good location leads to success while a bad location leads to failure of the business enterprise.

Factors that influence the location of a firm

1. Raw materials

   The availability of raw materials is one of the factors that determine the location of a firm. Firms should be located near the source of raw materials when:

   1. The raw materials are heavy and bulky to avoid high transport costs to the firm.
   2. The raw materials are perishable to ensure they get to the firm fresh.
   3. Competition for the raw materials is high; firms should be located near their source to ensure they get all the raw materials they require at all times.

Advantages of locating a firm near the source of raw materials

1. Transport cost of raw materials is minimized.
2. Storage cost of raw materials is minimized.
3. It is easier for the firm to select the quality of raw materials required.
4. Easier to get fresh and undamaged raw materials.
5. Production process can run uninterrupted because of constant supply of raw materials, thus continuous production.

1. Labour (human resources)

   Labour is a basic factor of production. It can be skilled, unskilled, or semi-skilled. It is important for firms to be located in an area where there is a large supply of labour to ensure adequate supply. Location near the source of labour reduces the cost of transporting labour to factories and reduces time wasted in transporting labour from far.

2. The market

   Reasons for locating near the market

   1. If the finished product is perishable, the firm should be located near the market to ensure it gets there fresh.
   2. If the finished product is bulky, the firm should be located near the market to avoid high transport costs.
   3. If the final product is fragile, the firm should be located near the market to avoid losses from breakages during transport.
   4. If there is high competition, the firm should be located near the market to reach customers quickly.
   5. Where a product is made as per customers’ specifications, the firm should be located near the market.
3. Transport and communication

   A firm should be located in an area well served by means of transport to ensure raw materials and finished products can be transported easily.

   A firm should be located in an area well served by means of communication to ensure effective communication with customers and suppliers.

Poorly developed transport and communication facilities may lead to:

1. High transport costs, especially where raw materials or finished products are bulky.
2. Delays in receiving raw materials and distributing finished products.
3. Poor communication networks prevent timely exchange of information.

1. Availability of power

   Industries require electric power to operate and should be located where electricity is readily available.

2. Security

   Industries should be located in areas with adequate security.

3. Auxiliary services

   Firms should be located where auxiliary services such as insurance, banking, and warehousing are available.

4. Water

   Many firms require water in one or more processes and should be located where water is readily available.

5. Government policy

   The government may formulate policies affecting the location of firms, especially regarding physical planning aimed at checking rural-urban migration, environmental degradation, or strategic concerns.

   The government may encourage development of firms in some areas by offering concessions such as:

   1. Offering free land
   2. Reduction of taxes
   3. Offering subsidies
   4. Improvement of infrastructure
   5. Offering direct financial assistance

LOCALISATION AND DELOCALISATION

Localization of firms is a situation where many firms are concentrated in a particular area.

Delocalization of firms describes a situation where the location of firms is spread across different regions to minimize the problems of localization.

Advantages of localization

1. Firms benefit from an already established skilled labour pool for recruitment.
2. Firms benefit from established infrastructure such as transportation and communication.
3. Firms benefit from auxiliary service firms that may already be established.
4. Such areas have social amenities such as hospitals and schools.
5. Employment is created in such areas.
6. Joint management of wastes can be carried out by all firms.
7. Firms may benefit from established markets.
8. Firms may easily get raw materials, possibly using by-products produced by other industries as raw materials.

Disadvantages of localization

1. As many people move to such areas in search of jobs, slums may be created.
2. Land becomes very expensive in such areas.
3. Congestion and traffic jams are common problems.
4. Such areas can become targets of attacks in case of war.
5. Leads to rural-urban migration, leaving the old and young in rural areas.
6. Environmental degradation through pollution, deforestation, waste discharge, and mining.
7. Social problems such as crime, prostitution, and illegal drugs are common.

Advantages of delocalization

1. Ensures that all areas are developed.
2. Ensures employment opportunities are evenly distributed across the country.
3. Reduces rural-urban migration by providing jobs in rural areas.
4. Promotes development of infrastructure nationwide.
5. Leads to establishment of auxiliary services like banks and insurance firms in rural areas.
6. Enhances development of social amenities such as schools and hospitals countrywide.
7. Lessens losses in case of attacks during war.
8. Provides goods and services closer to rural residents.

Disadvantages of delocalization

1. Pollution is spread to rural areas.
2. Security in such areas may not be guaranteed.
3. It might be expensive to hire and attract appropriate labour.
4. Auxiliary services such as banks and postal services may be lacking.
5. Government incentives to delocalize add to public expenditure, burdening taxpayers.
6. Industries may not enjoy benefits from concentration, e.g., developed infrastructure.

Ways in which the government may motivate industries to delocalize

1. By giving entrepreneurs free or cheap land to construct factories.
2. By giving tax incentives to those locating industries in delocalized areas.
3. By giving cheap loans to entrepreneurs wishing to establish industries in areas with few industries.
4. By providing security in new industrial areas.
5. By providing subsidies to industrialists willing to delocalize.
6. By providing appropriate infrastructure in the area.
7. By providing social amenities such as schools and hospitals in areas where delocalized industries are established.
8. By offering financial assistance to delocalized industries.

ECONOMIES OF SCALE

Economies of scale are the benefits a firm or industry derives from expanding its scale of production—the advantages of operating on a large scale.

There are two types of economies of scale:

1. Internal economies of scale
2. External economies of scale

Internal economies of scale

These are advantages that accrue to a single firm as its production increases, independent of what happens in other firms in the industry.

Internal economies of scale result from an increase in output and cannot be realized unless output increases.

They may be achieved by a single plant or from an increase in the number of plants.

Internal economies of scale include:

1. Marketing economies (Buying and selling economies)

These are benefits from large purchases of inputs due to discounts offered, e.g., trade and quantity discounts.

Firms may also incur less cost per unit in transportation of goods bought.

Selling economies arise from distribution and sale of finished products as production scale increases, reducing costs per unit in advertising, distribution, etc.

1. Financial economies

   As a firm grows, its assets increase and can be used as security to borrow money at low interest rates.

   Large firms can raise more funds through selling and buying shares and debentures.

2. Risk bearing economies

   Large firms can reduce risks of market failure through diversification of products or markets.

   Diversification means:

   1. Failure of one product is offset by success of others.
   2. Failure of a product in one market part may be offset by success in another part.

   Large firms can obtain supplies from alternative sources so failure in one does not significantly affect operations.

iv) Managerial economies/staff economies

Large firms can hire specialized staff and management, increasing efficiency and productivity:

1. Staff can make viable decisions increasing output.
2. Management can establish better organizational structures allowing departmentalization and division of labour, leading to specialization and increased output.

Costs of specialized staff are spread over many units of output, minimizing labour costs and increasing profits.

v) Technical economies

These benefits arise from using specialized labour and machinery. Large firms have capital to obtain advanced machines and specialized labour. Machines use latest technology and are fully utilized, making production more efficient and less costly per unit, increasing profits.

vi) Research economies

Large firms can afford research into better production and marketing methods, improving product quality and increasing sales and profits.

1. Staff welfare economies

Large firms can provide social amenities to employees such as recreation, housing, education, canteens, and allowances. These incentives boost morale, increasing quality and quantity of output, leading to higher sales and profits.

1. Inventory economies

Large firms can establish warehouses to stock raw materials, ensuring availability during shortages and avoiding production stoppages. Suppliers may sell at higher prices to realize profit.

External economies of scale

These benefits accrue to a firm due to growth of the whole industry, realized by location near other firms. They include:

1. Easier access to labour; a pool of labour with various skills is available where many firms are located.
2. Improved/efficient infrastructure; roads, power, water, and communication facilities are highly developed.
3. Firms may dispose of waste products easily.
4. Ready market may be available from surrounding firms.
5. Available services such as banking, insurance, and medical care.
6. Adequate power supply due to large consumption volume.

Diseconomies of scale

A firm cannot expand indefinitely. Beyond a certain limit, further expansion increases production costs.

Negative effects due to size or scale of production are called diseconomies of scale.

Diseconomies of scale are problems a firm experiences due to expansion.

Sources of diseconomies of scale

Diseconomies of scale may arise from:

1. Managerial functions becoming difficult as the firm expands; communication and consultation take more time.
2. Changing consumer tastes not fulfilled immediately due to slow decision-making.
3. Increased costs of transporting raw materials, components, and finished products.
4. Labour unrest or disputes and lack of employee commitment due to exclusion from decision-making.
5. Production stoppages when disputes arise, as production stages are interdependent and labour specialized.
6. Lack of adequate finances for further expansion.

There are two forms of diseconomies of scale: internal and external.

Internal diseconomies of scale

Problems a firm experiences due to large scale production and persistent growth include:

1. Managerial diseconomies of scale

Losses arising from failure of management to supervise and control operations properly due to firm size, resulting in:

1. Difficulties in controlling and coordinating departments, leading to laxity among employees.
2. Difficulty in decision-making, communication, and coordination between management and workers, causing delays and lost opportunities.
3. Impersonal relationships and staff problems leading to low morale, disputes, unrest, or strikes.
4. Increased management tasks and risks; errors in judgment may cause big losses.

1. Marketing diseconomies of scale

Losses due to changes in consumer tastes, including:

1. Difficulty adjusting immediately to changes, causing demand fall.
2. Higher demand for factors of production pushing up prices, causing sales to fall.

1. High overhead costs

When output increases beyond a limit, overhead costs may rise due to intensified promotion, heavy transport expenses, and generous discounts, increasing costs without corresponding benefits.

1. Financial diseconomies of scale

Losses due to inability to acquire adequate finances for expansion, limiting output growth.

External diseconomies of scale

Demerits experienced due to growth of the entire industry include:

• Scramble for raw materials
• Unavailability of land for expansion
• Scramble for available labour
• Competition for available market
• Easy targets during war

Existence of small firms in an economy

Despite growth opportunities, many firms remain small due to:

1. Size of the market

Large scale production requires high demand. Low demand discourages large scale production, keeping firms small.

1. Nature of the product

Some products, like personal services (hairdressing, painting, nursing), can only be provided by individuals or small firms.

1. Simplicity of organization

Small firms avoid bureaucracy, wastage, and managerial complexity associated with large organizations. Owners may prefer to keep firms small to maintain simplicity.

1. Flexibility of small firms

Small firms are flexible and can easily switch businesses. Owners may keep firms small to take advantage of new opportunities.

1. Quick decision making

Small firms involve less consultation, enabling faster decisions.

1. Belief that a small firm is more manageable

Some owners prefer small firms believing large businesses are difficult to run.

1. Rising costs of production

If production costs rise quickly and diseconomies of scale set in early, firms remain small.

1. Need to retain control

Owners may keep firms small to retain control and independence.

1. Legal constraints/Government policy

Laws may restrict firm growth, causing firms to remain small.

1. Small capital requirements

Small firms require less capital to start and operate compared to large firms.

Implication of production activities on environmental and community health

Production activities may adversely affect the environment and community health. Effects include:

1. Air pollution

Caused by waste discharged into the atmosphere, including industrial emissions and toxic chemicals. These pollutants cause airborne diseases. Acid rain from emissions may also harm plants.