Definition

The ideal firm size is the theoretically most competitive size for any company, in a given industry, at a given time; which should ideally correspond with the highest possible per-unit profit.

Discussion

If only diseconomies of scale were considered, then the ideal firm size would be one worker. However, economies of scale also apply, which state that large firms can have lower per-unit costs due to buying at bulk discounts (components, insurance, real estate, advertising, etc.) and can also limit competition by buying out competitors, setting proprietary industry standards (like Microsoft Windows), etc. If only these "economies of scale" applied, then the ideal firm size would be infinitely large. However, since both apply, the firm must not be too small or too large, to be an ideal competitor. Economists have long understood economies of scale, the forces which enable larger firms to produce goods and services at reduced per-unit costs. ... ...

Variation in ideal firm size by industry

The "diseconomies of scale" tend not to vary widely by industry, but "economies of scale" do. An auto maker can buy millions of tons of steel for use in forming engine blocks and warehouse it indefinitely, if this will get a better price. A florist can't buy millions of tons of ripe flowers to sell, or they will wither before they are sold. Hence, auto makers tend to be larger firms than florists.

Variation in ideal firm size over time

Note that the ideal size of a firm may also change over time, as industry and market conditions change. If a supplier finds a way to manufacture small batches of a major component at prices comparable to the large batch price, this will help small firms more than large firms. The same "diseconomies of scale" still apply, however, so now the ideal firm size will be smaller.

Effects of agricultural, industrial, and service-based economies on ideal firm size

Also note that the basis of an economy will effect the ideal firm size. An agricultural society will tend to have small firms, as agriculture has a limited economy of scale (especially in the absence of refrigeration and other storage methods that allow for long term storage of large batches). An industrial society will tend to have large firms, as industry has a substantial economy of scale. A service-based economy will again favor smaller firms, as services have a limited economy of scale. There will, of course, be exceptions, such as Microsoft, which is a huge services company. This success may be attributed to getting a "jump start" on the competition with the Windows O/S. One could predict that as Linux and other competing operating systems gain market share, this initial advantage will disappear, and the ideal firm size law will once again apply, causing Microsoft to contract, as industrial giants like GM have in the past. One could also predict that as the US economy shifts to a service-based economy from an industrial one, small and mid-sized firms, like Google, will be more successful than large companies, like Microsoft.

See also

• Economies of scale
• Diseconomies of scale