Are large or small companies more successful?

This was a previous Interview Question for Oxbridge Economic Applicants. Here is a sample answer I came up with.

To start with to answer this question it depends on how we are measuring size and successfulness. If we measure both in terms of profit then obviously a large firm (one which has larger profits) will be more successful when we say that large profits = successfulness. Similarly if we measure size in terms of output, labour force or number of shops/factories and successfulness by revenues then we would expect larger firms to have larger revenues (and thus be more successful) because they have the ability to sell more through their stores (which we are assuming they have more of to be considered large) and will be able to produce more due to their larger workforce.

However if we were to still measure size in terms of output, labour force and number of stores but changed the measure of successfulness to profits, then large firms may not necessarily be more successful than smaller firms.This is because larger firms may be more inefficient and have higher costs, smaller firms on the other hand may be more efficient as they have less bureaucracy to deal with. Therefore if the large firm has high costs it may not be very profitable whereas the smaller firm may have low costs and so have high profits.

Although, larger firms may experience greater economies of scale than smaller firms and hence they may therefore have lower costs as they are producing at a greater output level. But economies of scale aren’t guaranteed and just because a firm is large it may not benefit from huge cost savings.

In a smaller firm employees are likely to be more motivated than in larger firms, as they can see the benefits from their output and may not feel as much of a ‘cog in an industrial giant’. A smaller environment may mean workers are more friendly and hence enjoy work more. Smaller firms may also be able to identify hard workers and be able to promote or reward them more easily than larger firms. If this is the case then productivity may be higher in smaller firms than in larger firms. Some economists may believe that this means that smaller firms (with higher productivity) are more successful.

Another measurement we could use for success is profit or revenue in terms of growth (year-on-year) or profit as a percentage of revenue. With these measurements large firms may not necessarily have an advantage over smaller firms. As a share of revenue smaller firms (with smaller revenues and profits) may have a higher share than a larger firm (with larger revenues and profits). However if this is the case, and small firms are more successful in terms of these measurements, why are they still small? Surely the product they have, or their business strategy, or perhaps even their CEO is so successful that the firm should have grown dramatically (at least in terms of revenues). This may be the case in the long run for the company. However the reason it may be so successful is because it is small and benefits from knowing its customers more, and being able to offer a better, more customised and friendly service to them. Maybe it is more friendly with its suppliers, and although (unlike a large firm) it may not have monopsony power, it may still be able to get favourable conditions because of its size and relationship with its suppliers. For example a local butcher may get better terms on its meat from the local farmer because they are friends, rather than a large supermarket who demands a price.

I conclude that large firms aren’t necessarily more successful than smaller firms and how we define both successful and size is based on the measurement used, and this has varying conclusions on the statement.

One thought on “Are large or small companies more successful?

  1. Another reason small firms which are successful are not large, may be due to low investment. They may not re-invest in much of their profit. Subsequently they may find it hard to acquire new funds to promote growth. Currently it is very hard for small firms to get loans and borrow from banks. Even if they managed to source these funds it may be very expensive and hence reduce the profitability of such firms. Furthermore small firms, unlike large firms, can’t use other methods of sourcing investment like public listings on the stock market or issuing bonds. Therefore they may find it harder to grow into a large company. Conversely large firms may be able to grow even larger (even if they are not as successful as small firms) because they can source finance a lot easier.

    Another plausible reason for why small firms may be more successful than larger firms is due to the principal agent problem. Smaller firms are likely to be owned by the person running the firm and so any profits are likely to go to him. Therefore he is inclined to make sure the business is operating efficiently and will try to minimise costs and maximise revenues to ensure he (or she!) makes a nice profit. For a large firm, the CEO, is unlikely to own the business (however he may hold some shares in it) and hence wouldn’t be as bothered by some waste and inefficiency hence profits may not be maximised in this situation. Similarly in a large firm small costs like stationary don’t take up as much of the budget as they may do for small firms and so large firms may not be as bothered about them, whereas smaller firms may shop around in order to minimise these costs (because they take up a greater proportion of costs than for a larger firm) and hence become more profitable.

    Following on from the motivation theory for workers in a small firm being more productive, their wages may also be more directly linked to their output and hence they may be more productive and create more revenue for a firm. In a large firm workers may get lost in the corporate tides and may not sufficiently be rewarded and hence not operate at their maximum potential.

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