We usually don’t think about why firms grow to be so large. It is a common assumption that bigger means more profitable, but is this true? And if it is true than why is it true? My simple answer is economies of scale. What does this mean? Tutor2U.net defines economies of scale as, “advantages that arise for a firm because of its larger size, or scale of operations,” So economies of scale just means the benefits for having a big company. Here are some of the most important highlights.
If a firm is large it theoretically should be buying in bulk. This begs a lower price, quality demands, transportation discounts, and other advantages. Very large firms can go past the retail supplier and go directly to the producer so that they can receive a lower price.
Large firms can attract the best and the brightest to work as specialist managers, which makes each specialized group more efficient. When firms have more people working for them they can hire people that are specialized instead of having a few employees that have general knowledge about everything. The specialized work force is much more efficient. These firms can also offer benefits that smaller firms could not. This enables the firm to keep the best and attract those that would otherwise go elsewhere.
Larger firms have a much easier time marketing. They have the capital to give their marketing department the money they need for a national television ad or a featured tweet. This opportunity cost would make it illogical for a small firm to nationally advertise.
As a larger firm you have the ability to produce at lower cost. This means you could theoretically lower price to drive out competitors. But the Bertrand Model argues that the competition would drive the price down to marginal cost (MC) anyway. So this point is debatable.
In summary, big companies have more capital available which is crucial in having advantages over smaller firms. Everything stems from access to capital.