optimum size of firm and factors affecting the size of firm

OPTIMUM FIRM SIZE

A business unit may be launched in a small scale and then expanded gradually. With the increase in the scale of operation, it can enjoy various economies in regard to prosecution, marketing, financing and management.

But it must not be presumed that these economies will be available in increasing measure with every growth n the scale of operations. The law of diminishing return applies after a certain level of production. In other words, a point will come beyond which further expansion of business operations may lead to inefficiency. This point indicated the optimum size of firm.

To optimum size denotes the size of a firm at which there is maximum efficiency in operations. Efficiency will be reduced whenever the size is reduced below the optimum level or expanded beyond the optimum level. The concept of optimum firm was developed by E.A.G. Robinson.  By the optimum firm, we must mean that firm which in existing conditions of technique and organizing ability has the lowest average cost of production per unit when all those cost which must be covered in the long-run are included.

FACTORS AFFACTING THE SIZE OF FIRM

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FACTORS FOR DETERMINING THE OPTIMUM SIZE OF A BUSINESS UNIt

The size of an average firm varies from country to country. We have, on the one hand, giant concerns in the United States and Germany and tiny businesses in small Indian towns. Why is it so? There are a number of factors which determine the size of a business unit in a country.

Ø  Types of Industry: The nature of industry determines the size of the firm. The size of the firm will be large in those industries in which the product or the productive machinery is physically very large as in steel-making and ship-building and in those in which final product is highly complex as in the manufacture of typewriters, watches, cash registers, etc. The size of firms in an industry will be small where the product is both small and simple as in the case of manufacture of cutlery, weaving of standard cloths or the baking of bread.

Ø  Nature of Product: When a complex and large product is to be manufactured, the size of the firm will be higher. Size of a firm producing less standard and more fashionable products will be smaller.

Ø  Size of Market: It the size of market is sufficiently large, large firm may come into being to ha the benefit to large scale production and distribution.

Ø  Capital. The needs of capital and the ability of the management to raise capital also influence the size of a firm. If the management of a company can raise capital conveniently, there will be a tendency towards large scale operations. 

Ø  Attitude of Promoters and Management. The ability and attitude of the promoters and the management also influence the size of a business firm. If they are intelligent, foresighted, enterprising and ambitious, the size of the firm will tend to grow as the time passes.

Ø  Entrepreneurial Skill. The most important factor of comes is the skill, initiative and resourcefulness of the entrepreneur. Everything depends on his judgment and ability. An entrepreneur of outstanding ability will be able to procure as much finance as he may need, hire the requisite labor force and build up a huge business. But an entrepreneur of moderate ability will run business on a moderate scale and a man of limited entrepreneurial skill will be content with a small business.

Ø  Managerial Ability

For running the routine part of the business, managers are appointed. If a firm is lucky enough to have a manager of great ability, the size of the firm will grow to considerable dimensions. On the other hand, a mediocre manager will have a small-sized firm to manage.

Ø  Availability of Labour

Another factor on which the size of the firm depends is the availability of labour of requisite skill. After all, what can the entrepreneur even with large capital do, if the labour to man the business is not available? What is required is efficient and skilled labour.

Ø  Number of Employees

The number of employees employed by any business determines its size. This is done by comparing the wages paid to employees with other businesses. This factor is used where firms produce similar goods. If you use it in comparing firms that are producing differentiated products, then you end up with false results.

Ø  Power Used

The amount of power used determines the size of business. Don’t rely on this factor as it is inaccurate because the amount of power used by any business maybe more or less.

Ø  Raw Materials Used

The annual consumption of raw materials of any firm determines its size. It used only on those firms that are producing similar products. 

Ø  Volume of the Output

This factor is used on those firms that are producing homogeneous goods.

Ø  Total Assets

The total assets of any business determine its size. The value of all assets (current and fixed) is taken as a means of measure. It is used in both similar and differentiated firms.

Professor Robinson has grouped the factors determining the optimum size of a business unit into five classes. They are: 1. Technical factors, 2. Financial factors, 3. Managerial factors, 4. Risk factors and 5. Marketing factors:

Each class of factors decides the optimum size of unit. The optimum depending upon the group of factors is known as the optimum technical unit, optimum financial unit, optimum managerial unit, together may give the optimum size.

1. Optimum technical unit:

Technical factors are concerned with methods of production. They may include specialization, division of labor, mechanization and the like. Production methods become economical when these steps are taken. Technical forces decide the minimum and the maximum limits to size.

2. Optimum Financial unit:

Generally, the size of a unit depends upon the volume or size of capital and, in turn, the volume of capital depends on its size. Larger the size of a unit, larger the volume of capital required and easier to obtain capital because large volume of production and operational efficiency insure adequate return on capital. The optimum financial unit is governed by the volume of funds.

3. Optimum managerial unit:

Management expenses may vary with size. If the size is small it may be relatively costly to manage its affairs whereas with the growth of size there is an economy in such expenses. The growth of size may bring in complexities of organization and management. But in a larger unit the advantages of specialization and division of labor may be obtained and managerial efficiency improved.

4. Optimum survival unit:

The production of a commodity depends upon its demand in the market. Since demand may fluctuate from time to time, there is risk and uncertainty before the firm. Therefore, conditions of demand may influence the size of a unit because the risk or uncertainty is influenced by such conditions.

The changes in demand may be permanent cyclical and seasonal. Changes in demand due to the development of a substitute or a change in the taste and habits of the consumers may be taken as a permanent change.

The firm should reorganize its activities to adjust to the changed conditions. Cyclical variations are those which are concerned with depressions and booms. The firm has to meet both these situations and make adjustments. Seasonal variations are governed by change situations the firm has to adjust its size to keep it optimum in a particular situation, in seasons and the subsequent change in the demand for a commodity. In all these, however, changes in the size of a unit are difficult to make.

5. Optimum marketing unit:

Marketing optimum has to seek a balance between large scale marketing operations with a view to having some economies in selling and buying and better quality of commodities and services by limiting the size to a manageable limit. Demand estimates are to be prepared to decide the size of marketing operations.