Benefits of small firms

Readers Question: Why do some firms prefer to remain small?

In recent times, the tendency is for product markets to be dominated by large multinational corporations who can benefit from various economies of scale. However, despite this general trend, there are still advantages to being a small firm.

Benefits of being a small firm

Concentrate on niche markets

Small niche markets may have less competition and therefore be more profitable. Moving into a mass market may make competition more intense. Niche markets such as handmade products can have a more price inelastic demand; therefore firms can charge a bigger markup on the marginal cost of production. This enables the firm to be more profitable, despite lower volume.

Small can be a selling point

In some goods like clothes, there could be an advantage to small firms selling top end clothes ranges. A big firm like Primark and M&S may be able to sell clothes cheaper, but, small firms can target the customer who wants an exclusive deal – somebody who wants to stand out from the crowd. Some people prefer a local small coffee shop, rather than visiting a ‘bland’ multinational like Starbucks.

Local profile

Related to the previous point, small local firms can take advantage of their local knowledge and local profile. Consumers gain utility from supporting ‘local small businesses’

Economies of scale are limited in some industries.

In the car industry, there are a small number of relatively big firms as economies of scale are very significant. But, in some industries like coffee shops, economies of scale are relatively insignificant. There may be dis-economies of scale in expanding production. Therefore, it is not a competitive disadvantage to retain low output.

Different business objectives.

Not all firms aim at profit maximisation and increasing market share. Some owners may prefer a business that is manageable and easy to retain control. Expansion may involve listing on the stock exchange which makes you liable to shareholders. If people work in small firms, they may get more joy because they feel in control and have a close connection with customers. Owners may create a business that is also a hobby. Therefore, they would prefer to keep the firm small and avoid spending their time on management and paperwork.

Tax advantages

In the UK there is a VAT threshold of £83,000. Once firms increase turnover above this, they are liable to paying VAT and filing in VAT returns. This can be a disincentive for a firm to grow. Also, as firms grow and employ more workers, it leads to national insurance contributions. For some small business owners, the cost and time of filing tax returns can be as cumbersome as the tax.

Avoid principal-agent problem

In a large firm, owners have to delegate control to managers and workers who may not share the same motivation and goals of maximising interests of the firms. Managers and workers may engage in profit-satisficing – do enough to keep owners happy but then maximise other objectives, such as sales maximisation

Benefits to consumer of using small firms

  • Personal touch. A small firm can give greater personal contact with customers.
  • Individuality. Multinationals tend to standardise service and types of goods. This is more efficient and cost-effective but can lead to feelings of similarity. For example, a local coffee shop can express a greater individuality than a Starbucks; the Starbucks layout and drinks will follow a tried and tested formula. But, consumers can grow tired of ‘another chain-store’ experience.
  • New ideas. New innovative ideas often start with small businesses just beginning to start. Google and Microsoft both started as small enterprises in someone’s garden. Working for themselves, entrepreneurs are able to think outside the box.
  • Avoid paying VAT. Using a small firm to erect a fence, can lead to a lower price than a large firm who have to charge VAT on top of their bill.
  • Small firms will need to impress. With a small firm, the person you deal with is likely to be the owner and therefore, they have a vested interest in offering you the best service. In a large firm, there can be a separation of ownership and control. WIth owners employing workers and managers who may not share the same ideals.

Disadvantages of small firms

  • Less efficient than big firms. Big firms can benefit from economies of scale in production and sell at lower cost
  • Lack of resources. Small firms do not have resources to invest in research and development and bring to market
  • Small firms may lack access to supply chains and retail outlets. For example, big supermarkets may not want to deal with small suppliers.
  • Lack brand awareness. Consumers may prefer to use a well-known brand as they can be sure of the quality and not worry about getting an unexpected experience

See also: