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Constraints on growth, staying small and demergers
Edexcel IAL Economics · WEC13 Business behaviour
Growth is not automatic. Firms meet limits on how big they can become, some owners choose to stay small, and some large firms split themselves up.
Constraints on growth
- Size of the market: a niche product or a small local market limits sales.
- Access to finance: small firms may find loans costly or unavailable and cannot issue shares easily.
- Owner objectives: some owners prefer control, lifestyle or low risk to growth.
- Regulation and bureaucracy: licences, planning permission, employment law and tax paperwork cost relatively more for small firms; competition authorities can block mergers.
Why some firms stay small and others grow
Firms stay small when the market is small or local (hairdressers, plumbers), when customers want a personal service, when there are few economies of scale, when owners choose to, or when finance is limited. Firms grow to exploit economies of scale, gain market power, spread risk, or because managers gain status and pay from running a bigger firm.
Impact of growth
- Businesses: lower average costs, more market power and higher profits; but risk of diseconomies of scale.
- Workers: more jobs and promotion routes, possibly higher pay; but rationalisation after a merger often cuts jobs, and a large firm may have monopsony power over wages.
- Consumers: lower prices if cost savings are passed on, more investment in new products; but less choice and higher prices if market power is abused.
Demergers
A demerger splits a business into two or more separate firms.
- Reasons: diseconomies of scale, a lack of synergy between divisions, to focus on the core business, to raise cash by selling a division, or because the separate parts are worth more to shareholders than the whole; sometimes a competition authority requires it.
- Impacts: firms become more focused and may become more efficient, but lose some economies of scale; workers may face job losses or new employers; consumers may gain from sharper competition.
Worked example
A conglomerate with a food division and an insurance division announces a demerger. Explain two likely reasons.
- The divisions share few costs or skills, so there are no synergies to keep them together.
- Managers find it hard to run unrelated markets well: diseconomies of scale.
- Separate firms can each focus on their own market, and investors may value the two parts more than the combined group.
Answer: Lack of synergy and diseconomies of scale, so focus and shareholder value improve after the split.
Check yourself
- Which constraint on growth affects small firms more than large firms?
- The law of demand
- Diminishing marginal utility
- The level of exports
- Difficulty raising finance
Show answer
Difficulty raising finance. Lenders see small firms as riskier, and small firms cannot easily issue shares.
- Which business is most likely to stay small?
- A car manufacturer
- A local hairdresser offering a personal service
- A steel producer
- A national electricity grid
Show answer
A local hairdresser offering a personal service. Personal service and a local market limit size, and economies of scale are small.
- Which is a reason for a demerger?
- The firm wants more economies of scale
- The firm wants a larger market share
- It wants to buy a supplier
- Divisions have little in common and suffer from diseconomies of scale
Show answer
Divisions have little in common and suffer from diseconomies of scale. Splitting unrelated divisions can improve focus and efficiency.
- After a horizontal merger, which effect on workers is most likely in the short run?
- Some job losses as duplicate roles are removed
- Every worker receives a pay rise
- The number of managers doubles
- Workers become shareholders automatically
Show answer
Some job losses as duplicate roles are removed. Rationalisation removes duplicated head office jobs and overlapping branches.
- How does bureaucracy constrain the growth of small firms in particular?
- It increases demand for their products
- It lowers their wages
- Fixed costs of compliance are spread over fewer units of output
- It allows them to collude
Show answer
Fixed costs of compliance are spread over fewer units of output. Paperwork and licences have a fixed element, so they cost more per unit for a small firm.
- Explain one way that a large firm's growth could benefit consumers.
Show answer
Growth can bring economies of scale, which lower average costs; if the savings are passed on, prices fall. Larger profits may also fund research into new or better products.. Give a chain: growth leads to lower costs or more investment, which leads to lower prices or better products.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.