Optimal Firm Size

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Optimal Firm Size

Optimal firm size refers to the speed and extent of growth that is ideal for a specific small business. Optimal firm size is dependent on a variety of internal and external factors. For some home-based businesses, the optimal size may be the two founding partners—a husband and wife—if their primary operating goal is simply to bring in enough revenue for a comfortable standard of living, while leaving large blocks of time for family or travel. But most companies are intent on expanding their operations. Growth of some kind, either in revenues, profits, number of employees, or size of facilities, is essential for almost every business. For many companies competing in rapidly changing industries, expansion (of manufacturing capacity, geographic presence, market share, etc.) may be imperative for survival. But smart growth strategies can be elusive, as many entrepreneurs have learned to their chagrin. As James A. Schriner explained in Industry Week, "Growing a company is like blowing up a balloon. Your first few breaths, though difficult, produce immediate results. Subsequent breaths expand the balloon proportionally until it nears capacity. Stop too soon and the balloon never reaches its potential. Stop too late and it bursts."

Successful entrepreneurs and business experts agree that the key to finding the optimal firm size is to grow in a controlled way. In some cases, restraining growth is simply a matter of saying "no," or turning down new business. This is particularly true for service businesses that depend on the personal attention of the founder. When turning down business becomes necessary, the entrepreneur may wish to provide referrals in order to maintain good relations with potential customers. Another strategy in restraining growth involves hiring employees who like working in a small company atmosphere. These people tend to enjoy the diversity of challenges they encounter in a small business, and they often have a strong interest in the product and can provide their expertise to customers. It is important to note, however, that restraining growth does not mean refusing to change. Small businesses are not likely to remain in business long if they cannot be creative and adapt to changes in customer tastes and competitors' tactics.

Schriner noted that one factor influencing the optimal size of a business is the availability of workers and other resources in the surrounding community. In fact, he suggested that it is possible for businesses to outgrow the communities in which they operate, particularly when they are located in a remote area. In this case, it may be difficult to attract talented workers from outside the immediate area, forcing the company to pay sharply higher wages to compete for labor. In addition, some communities cannot afford to provide services to growing companies (or provide top schools, parks, and other quality of life elements that attract high-quality employees necessary for successful business expansion). Finally, Schriner claimed that being too integral a part of a community can make it difficult for a growing company to adapt to a changing business environment. Some factors that may indicate a company has outgrown its community include: employing more than 10 percent of the local work force; growing at a faster rate than the community's labor force; providing more than one-third of the local government's funding through taxes; and being responsible for the death of the community if the company should shut down.

see also Economies of Scale

BIBLIOGRAPHY

Joaquin, Domingo Castelo, and Naveen Khanna. "Investment Timing Decisions Under Threat of Potential Competition: Why Firm Size Matters." Quarterly Review of Economics and Finance. Spring 2001.

Lawler, Edward E. III. "Rethinking Organization Size." Organizational Dynamics. Autumn 1997.

Koretz, Gene. "Little Guys Are Making Plans: Small Businesses Are Set to Expand." Business Week. 2 June 1997.

Orser, Barbara J., Sandy Hogarth-Scott, and Allan L. Riding. "Performance, Firm Size, and Management Problem Solving." Journal of Small Business Management. October 2000.

Rossi-Hansberg, Esteban, and Mark L.J. Wright. Academic Paper. "Firm Size Dynamics and the Aggregate Economy." Stanford University, 10 July 2004.

Schriner, James A. "How Big Is Too Big?" Industry Week. 6 May 1996.

Hillstrom, Northern Lights