What this lesson teaches
I can classify firms by sector and ownership, and weigh the advantages of small and large firms.
Syllabus K343, 3.4.1. Different types of firms: primary/secondary/tertiary sector firms; private sector/public sector firms; advantages and disadvantages of small and large firms
Make a guess
A large chain and a hawker both want to borrow $50,000. Who usually pays the lower interest rate?
- Both pay the same, because the loan is the same size.
- The large chain, because banks see it as safer.
- The hawker, because the loan is small for a bank.
Show the answer
The large chain, because banks see it as safer.
Banks expect large firms to repay more reliably, so they lend to them more cheaply. This is a financial economy of scale.
Large firms gain lower costs and easier finance but can become slow; small firms are flexible and personal but find it harder to borrow and to cut costs.
Advantages of large firms. A large firm buys materials in bulk, so it pays less per unit. It can afford specialist machines and staff, which raise output per worker. These lower costs let it charge lower prices or earn more profit. Banks see it as a safer borrower, so it raises money more cheaply. Selling many products in many countries spreads its risk: a fall in one market does not sink the whole firm.
Disadvantages of large firms. With many layers of managers, decisions are slow and messages get lost. Workers may feel like a small part of a big machine and lose motivation. Head office can be far from customers and miss what they want. These problems can push costs per unit back up. A very large firm may also face little competition and so feel less pressure to keep prices low.
Advantages of small firms. The owner usually knows customers by name and can give a personal service. Decisions are quick, so a small firm can change its products in days. It can serve a small, specialised market that is too small to interest a large firm, such as repairing antique clocks.
Disadvantages of small firms. A small firm buys in small amounts, so it pays more per unit. Banks see it as risky, so loans are harder to get and cost more. One bad year, or the loss of one big customer, can close it. This is why many governments, including Singapore's, offer grants and loan schemes to small and medium-sized enterprises (SMEs).
- Large firm advantages
- Bulk buying, specialist machines and staff, cheaper finance, risk spread across products.
- Large firm disadvantages
- Slow decisions, poor communication, demotivated workers, distance from customers.
- Small firm trade-off
- Personal, flexible service but higher costs per unit and harder borrowing.
Worked example: A hawker stall and a supermarket chain
Compare a single hawker stall with a large supermarket chain in Singapore.
- The chain buys rice and cooking oil in huge amounts, so it pays less per kilogram than the hawker does.
- The chain can borrow from banks easily to open new outlets; the hawker relies mainly on savings.
- The hawker knows regular customers, cooks to order and can change the menu tomorrow; the chain changes its range more slowly.
- Who gains: shoppers get low prices from the chain and personal service from the hawker, so both kinds of firm survive.
Watch out for this
Large firms always have lower costs per unit than small firms.
Large firms often do, because of bulk buying and specialisation. But if a firm grows too big, slow decisions and poor communication can push its costs per unit back up.
Check your understanding
Why might a bank charge a small firm a higher interest rate than a large firm?
- Small firms are more likely to fail and not repay
- Small firms always borrow larger amounts than large firms
- The law requires banks to charge small firms more
Show the answer
Small firms are more likely to fail and not repay
Right. Lenders charge more when the risk of not being repaid is higher.
Check your understanding
Which is an advantage that a small firm usually has over a large firm?
- It can change its products quickly
- It spreads its risk across many markets
- It buys materials more cheaply in bulk
- Banks lend to it at lower interest rates
Show the answer
It can change its products quickly
Right. With few managers, a small firm can decide and act fast.