Important forces that determines the optimum size of the firm

Financial forces: As compared to smaller firms, large firms enjoy certain financial advantages. They possess a good credit standing. They can raise the long term and short term funds easily and economically. Due to their financial position and greater profitability there is always a warm welcome to the issue of shares and debentures. Commercial banks also provide working capital on moderate terms. They command huge assets which can be offered as security. They are in a position to retain greater profits for investing them back in the business.

However, sometimes huge financial resources are diverted to less remunerative channels which affect the profitability of the firm adversely. If the firm is engaged is only single line of product, it will expose the firm greatly to business risk. If it depends excessively on borrowed funds (i.e. greater debt-equity ratio) it will be exposed to the financial risk of liquidation. If it depends more on equity capital, it will dilute the controlling interest of original shareholders.

Marketing forces: Large firms are in an advantageous position to tap certain economies which are attached to bulk buying and selling. In bulk buying they can bargain effectively, can economize in transportation, and can avail of the services of an expert. Similarly in bulk selling they can arrange effective distribution channel, can employ effective sales force, can advertise effectively, can use services of experts etc.

If it is a multi- product firm, the selling cost per unit will be less because the same salesmen will manage to promote the sales of all products at a time. However, a large firm is sometimes exposed to certain typical unfavorable situations like wrong buying of raw material. This will amount to huge financial losses as it is not easy to rectify the mistake. Similarly under unfavorable business conditions, it shall have to maintain costly distribution machinery and allied costs.

Forces of risk and fluctuations: There always exists a business risk of demand fluctuations. The fluctuations in the demand arise due to four factors: changes in taste and fashions, seasonal requirements, cyclical occurrence of booms and depression, and secular changes caused by change in culture and tradition.

The business risk of demand fluctuations is relatively greater in large firms. Due to huge investment in fixed assets and long term commitments, they are highly inflexible to the changing conditions. Such business risk will be greater for firms having only single product line. In multi-product units, the production strategy can be developed in such a way that the decline of one product can be compensated by the growth in the other product.

Firms intending to attain the optimum size should try to spell out the various types of economies enjoyable by them. They should attempt to arrive at such a size where the advantages of all the factors reduce the average unit cost to the minimum.