CHAPTER 2 : SIZE AND LOCATION OF A FIRM

1. Meaning of firm and industry

A firm is an individual enterprise or business unit under one control an 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 sop industry consists of all those firms producing soap while an insurance industry consists of all these 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 KCC and Brookside. In some cases where we have 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 would yield maximum profit.

• Level of competition

In order to survive in a competitive market, firms must come up with products with products that consumers prefer. A firm may therefore develop products that are not currently available or copy rivals ideals 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

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 which are favored by the government policy e.g. low taxation and subsidies. Firms should not produce goods that are illegal as it will be breaking the law.

3. Determining the size of the firm

The following are some of the ways/factors 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 large scale, while a small firm will produce on small scale.

• Number of employs in the firm

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

• Floor area covered by the premises

A firm with 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 only control a small size 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 most often adopt capital intensive methods of technology, where operations will be highly mechanized while small firms use more labour then machinery.

• Sales of volume

Small firms have low levels of sales with 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 would be established. The management has to make appropriate decisions concerning the location of the firm since a good location would lead to success while a bad location would lead 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 locations of a firm. Firms should be located near the source of raw material when:

1. The raw materials are heavy and bulky so as to avoid high transport as cost to the firm.
2. The raw materials are perishable so as to ensure they get the firm in fresh.

• The competition for the raw materials is high should be located near their source so as to ensure that it gets all the raw materials it requires at all times.

          Advantages of locating a firm near the source of raw materials

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

 

Labour (human resources)

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

1. The market

Reasons for locating near market

1. If the finished product is perishable, then the firm should be located near the market so as to ensure that it gets to the market in fresh state.
2. If the finished product is bulky, the firm should be located near the market so as to avoid high cost of transport to the market.

• If the final product is fragile, the firm should be located near the market so as to avoid losses that may result from breakages as the product is transported to the market.

1. If there is high completion, the firm should be located near the market as this will make it easy to get to the customers fast.
2. Where a product is made as per customers’ specification, the firm should be located near the market.

 

Transport and communication

A firm should be located in an area that is well served by means of transport. This ensures that both raw materials and finished products can be transported with ease.

A firm should be located in an area that is well served by means of communication. This ensures that the firm is able to communicate with its customers and suppliers, and vice versa.

Poor developed transport and communication facilities may lead to:

1. High transport cost especially where raw material or the finished products are bulky.
2. Delays in receiving the raw materials and distributing the finished products.

• Where communication network is poor, business people will not able to give or get information in time.

1. Availability of power

Industries require electric power to operate. They should, therefore be located where electricity is readily available.

1. Security

Industries should be located in areas with adequate security .

1. Auxiliary services

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

1. Water

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

1. Government policy

The government may formulate policies that may have implications on the location of the firms, especially with regard to physical planning. Such planning may be aimed at checking rural-urban migration, environmental degradation or for strategic concerns.

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

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

 

LOCALISATION AND DELOCALISATION

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

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

Advantages of localization

1. Firms will benefit from already from established skilled labour pool from which they can recruit their employees.
2. Firms will benefit from already established infrastructure such as transportation and communication.

• Firms will benefit from auxiliary services firms that may already have been established.

1. Such areas have social amenities such as hospitals and schools.
2. Employment is created in such areas.
3. Joint management of wastes can be carried out by all firms.

• Firms may benefit from already established markets.
• Firms may be able to get raw materials easily, as they may use the by-products produced by other industries as their 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.

• Congestion and traffic jams are a common problem in such areas.

1. In case of war such areas can become a target of attacks.
2. Leads to rural-urban migration leaving the old and the young in the rural areas.
3. A lot of environmental degradation through pollution by many cars, deforestation, discharges of waste and mining in the area.

• Social problems such as crime, prostitution and illegal drugs are a common problem in such areas.

Advantages of delocalization

1. It ensures that all areas are developed.
2. To ensure that employment opportunities are evenly distributed all over the country.

• It reduces rural-urban migration since people can get jobs in the rural areas once industries are delocalized.

1. It promotes the development of infrastructure all over the country.
2. It leads to the establishment of auxiliary services e.g. banks and insurance firms, in rural areas for the benefit of the residents.
3. It enhances the development of social amenities such as schools and hospitals in all areas of the country.

• It lessens losses in case of attack by enemies during war.
• People in rural areas are provided with goods and services closer to where they are.

Disadvantages of delocalization 

1. Pollution is spread to the rural areas.
2. The 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 in such areas.
5. Incentives offered by the government to industries in order to delocalize add to public expenditure, which is an added burden to tax payers.
6. Industries may not enjoy the benefits that accrue from concentration of industries e.g. developed infrastructure.

 

 

Ways in which the government may motivate industries to delocalize

1. By giving entrepreneurs free of cheap land to construct their factories.
2. By giving tax incentives to those who locate their industries in the delocalized area.

• By giving cheap loans to entrepreneurs wishing to establish industries in areas with few industries.

1. By providing security in the new industrial areas.
2. By providing subsidies to those industrialists who are willing to delocalize.
3. By providing the appropriate infrastructure in the area.

• By providing social amenities e.g. schools and hospitals in areas where the delocalized industries are to be established.
• By offering financial assistance to the delocalized industries.

ECONOMIES OF SCALE

Economies of scale are the benefits the firm or industry derives from expanding its scale of production/the advantages of operating on 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 the other firms in the industry.

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

The internal economies of scale may be achieved by a single plant of the firm or they may arise from an increase in the number of plants.

The internal economies of scale include;

1. Marketing economies (Buying and selling economies)

These are the benefits which a firm derives from large purchases of inputs or factors of production due to the discounts offered in the process e.g. trade and quantity discounts

The firms may also incur less cost per unit in transportation of the goods bought

Selling economies of scale arise from the distribution and sale of the finished product as the scale of production increases, i.e it is likely to incur less cost per unit in areas such as advertising, distribution e.t.c

1. Financial economies; As a firm grows, its assets also increase. These assets can be used as security to borrow money/loan from financial institutions at low interest rates.

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

• Risk bearing economies; Large firms can reduce risks involved in the market failure through diversification of products or markets.

Diversification of markets or products can be done so that;

1. Failure of one product is offset by the success of other products
2. A failure of a product in one part of the market may be offset by the success of the same product in another part of the market

-Large scale firms are also able to obtain supplies from alternative sources so that failure in one does not significantly affect the activities of the firm.

1. iv) Managerial economies/staff economies

Large firms are able to hire/employ specialized staff and management. This increases the firms efficiency and productivity i.e.

1. The staff is able to make viable decisions that can go along way in increasing the firms output.
2. The firm/management is also able to put in place better organizational structures which allow for departmentalization and subsequent division of labour.Division of labour leads to specialization and hence the overall increase in the firms output.

-the costs of hiring/employing the specialized staff/management are spread over a large number of units of output of variable cost of production.Thus,the cost of labour is minimized when production increases leading to increased profits.

1. v) Technical economies;

These are benefits that accrue to a firm from the use of specialized labour and machinery. Large firms have access to large capital which they utilize to obtain those machines and hire the specialized labour. The machines use the latest technology and are put to full use, making the firm production more efficient i.e. cost of the machines and labour are spread over many units of output hence less costly but giving higher profits.

 

1. vi) Research economies;

Large firms can afford to carry out research into better methods of production and marketing.(Research is necessary because of the increased competition in the business world today) This improves the quality of the products and increases the sales and profits made by the firm.

1. Staff welfare economies;

Large firms can easily provide social amenities to their employees including recreations, housing, education, canteens and wide range of allowances. These amenities work as incentives to boost the morale of the employees to work harder and increase the quality and quantity of output. This leads to higher sales and profits.

1. Inventory economies

A large sized firm can establish warehouses to stock raw materials and therefore enjoy large stocks of raw materials for use when the raw materials are in short supply.Thus, the firm can avoid production stoppages that can be occasioned by shortages of the raw materials. The suppliers of such material may be sold at a higher price to realize profit.

External economies of scale;

External economies of scale are those benefits which accrue to a firm as a result of growth of the whole industry. They are realized by a firm due to its location near other firms. They include;

1. Easier access to labour; Where many firms are located in one area a pool of labour of various skills is usually available. Therefore firms relocating to the area find it easy to obtain.
2. Improved/efficient infrastructure; Usually where many firms are located, infrastructure would be highly developed e.g. roads, power, water and communication facilities. Firms relocating in that area thus enjoy the services of infrastructure already in place.
3. Firms may be able to dispose off their waste product easily
4. Ready market may be available from the surrounding firms
5. Readily available services such as banking, insurance and medical care
6. Adequate supply of power due to large volume of consumption e.t.c

 

 

Diseconomies of scale

A firm cannot continue to expand indefinitely or without a limit.As a firm grows or industry expands, the benefits the firm can reap or get from such growth or expansion have a limit.

Any further expansion in the scale of production beyond the limit will actually create negative which would increase the cost of production.

The negative effects to a firm due to its size or scale of production are referred to as diseconomies of scale.

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

Sources of diseconomies of scale

Diseconomies of scale may arise from;

1. Managerial functions which become increasingly difficult to perform as the firm expands. Communication and consultations take more time than before.
2. Changing consumer tastes which may not be fulfilled immediately because decision-making may take too long.
3. Increase in the costs of transporting raw materials, components and finished products.
4. Labour unrest or disputes and lack of commitment from the employees because they are not involved in decision making
5. Stoppage of production process when disputes arise since all production stages are interdependent and labour specialized.
6. Lack of adequate finances for further expansion of the firm.

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

 

Internal diseconomies of scale

These are the problems a firm experiences as a result of large scale production due to its persistant growth. They include;

1. Managerial diseconomies of scale

These are the losses which may arise due to the failure of management to supervise and control the operations properly. This may be because the firm is large resulting into;

1. Difficulties in controlling and coordinating the departments leading to laxity among employees.
2. Difficult in decision making and communication and co-ordination between management and workers. Delays in decision making means lost opportunities.
3. Impersonal relationship between management and workers, and staff problems not easily established which could lead to low morale, disputes, unrests/skills.
4. An increase in management tasks leading to increase in number and impact of risks i.e. any error in judgement on the part of management may lead to big losses.

 

1. Marketing diseconomies of scale

These are losses which may arise due to changes in consumer tastes. These may be as a result of;

1. A change in tastes leading to fall in demand for the firms products. A large firm may find it difficult to immediately adjust to the changes in the tastes of consumers, hence it will experience fall in its scale.
2. An increase in the scale of production, which leads to higher demand for factor of production such as labour, raw materials and capital. This will result into higher prices for them. This will push up the prices of the goods and services produced, which will cause a fall in sales.

 

• High overhead costs

When the output of a firm increases beyond a certain limit, some factors may set in to increase the average costs.e.g the overhead costs incurred in production and marketing activities may increase. This is because firms may intensify their promotional campaign, incur heavy transport expenses and be forced to offer generous discounts in an effort to attract more clients. All these are factors that may increase overheads without any corresponding increase in real benefits to the firm.

1. Financial diseconomies of scale

These are losses which may arise due to a firm’s inability to acquire adequate finances for its expansion. This will prevent the firm from expanding further thereby limiting its capacity to increase the volume of its output.

External diseconomies of scale

These are demerits that affirm experiences as a result of growth of the entire industry. These include;

-scramble for raw materials

-Unavailability of land for expansion

-scramble for available labour

-competition for available market

-easy targets especially in times of war.

Existence of small firms in an economy

As the firm grows in size, its scale of production increases. However, many firms remain small even though they face stiff competition from larger firms. Some of the reasons for existence of small scale firms include;

1. Size of the market

Large scale production can only be sustained by a high demand for a product. If the demand for a product is low, it may not be advisable for a firm to produce on a large scale, hence it will remain small.

1. Nature of the product;

The nature of the product sometimes makes it impossible to produce in large quantities e.g. personal services e.g. hairdressing, painting or nursing can only be provided by an individual or a small firm.

1. Simplicity of organization

Small firms have the considerable advantage of simplicity in organization. They avoid bureaucracy, wastage and managerial complexity associated with large scale organizations.

Where a firm intends to take advantage of simplicity, the proprietor may maintain its small firm.

 

1. Flexibility of small firms

Small firms are flexible i.e. one can easily switch from one business to another where an owner of a business wishes to maintain flexibility so as to take advantage of any new opportunity, he/she may have to maintain a small firm.

1. Quick decision making

In a situation where proprietors want to avoid delay in decision-making, they may opt to maintain a small business as this would involve less consultation.

1. Belief that a small firm is more manageable

Many small businesses have the potential of expansion, yet their owners prefer to have them remain small believing that big businesses are difficult to run.

1. Rising costs of production

In situations where production costs rise too fast, such that diseconomies of scale set is very early, the firm has to remain small.

1. Need to retain control

In order to retain control and independence, the owners of the firm may wish to keep it small.

1. Legal constraints/Government policy

In some situations, the laws may restrict the growth of a firm. In such circumstances the existing firms remain small.

1. Small capital requirements

As opposed to large scale firms, small firms require little amounts of capital to start and operate.

Implication of production activities on environmental and community health

As production activities take place in a given area, the environment and the health of the community around may be adversely affected by these activities. Some of these effects include;

1. Air pollution

This is caused by waste which is discharged into the atmosphere leading to contamination of the air. Such waste may be in funs of industrial emissions and toxic chemicals from the firms. These pollutants cause air-borne diseases. Acid rain due to such emission may also affect plants.