Why Do Firms Grow.

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The traditional profit maximizing theories of the firm have been criticised for being unrealistic. As a result, alternative theories of the firm were introduced (Sloman & Sutcliffe, 2001). One of the alternative theories of the firm is Growth maximization. Following are the main motives for the firms to grow:

The cost motive: A growth maximising firm can lower its long run average costs by exploiting economies of scale and economies of scope. Economies of scale come into effect when increasing the scale of production leads to a lower cost per unit of output (Fig. 1). By increasing the range of products produced, a firm reduces the cost of producing each one due to economies of scope (Sloman & Sutcliffe, 2001).

When a firm expands it operation along the stages of production (forward or backward), it can lower its costs by performing complementary stages of production under a single unit. For example, a steel melting plant & a steel rolling plant are operating at a single site. Extremely high temperatures are required to produce steel and roll sheet. With the plants co owned, the hot steel can easily be transferred to rolling plant. This saves transportation and heating costs resulting in lower production costs (Begg & Ward, 2009).An integrated business may gain various financial economies due to its operating size. It will be in a better position to negotiate favourable deals from key suppliers. It can also obtain lower borrowing rates from financial institutions due to the additional security feature that accompany a large firm (Sloman & Sutcliffe,2001).

(Sloman & Sutcliffe 2001 pp.185) Figure-1

The risk motive: The expansion of business can be through diversification in order to reduce the risks. If the business performs only in a single market, it is more vulnerable to changes in that market conditions. Consider a company operating in a single market. It might be making good profits. However the profits can change. The profit of the company...
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