POM L7:

Penrose’s theory of the growth of the firm (2)

I. Expansion without merger: the receding managerial limit

1. Managerial ability as a barrier to firms’ expansion

Managerial ability refers to conditions within the firm

2. The nature of the managerial limit

 Firm cannot immediately increase the effective management team simply
by hiring more managers from outside the firm
“It is impossible for a firm to expand efficiently beyond a certain point
merely by drawing up a management ‘blueprint’ for an extensive
organization and then proceeding to hire people to fill the various positions
and carry out the functions laid down in detailed ‘job descriptions’.”
 A team can only learn to work together by actual experience, and this can
take considerable time
“Extensive planning requires the co-operation of many individuals who
have confidence in each other, and this, in general, requires knowledge of
each other. Individuals with experience it takes time for them to achieve
the requisite experience”
 Dynamics of the growth of managerial services
“Many of the productive services created through an increase in knowledge
that occurs as a result of experience gained in the operation of the firm as
time passes will remain unused if the firm fails to expand. Thus, they
provide an internal inducement to expansion as well as new possibilities for
it”
 The receding limit and the ‘static’ approach
 The tradition static assumption  “They (traditional static assumptions)
guarantee that increasing costs of production of all products produced by
the firm must at some point set in. So-called managerial diseconomies must
eventually come into play if it is assumed that there is no change in
 knowledge and hence no change in the quality and type of managerial
service”
 DIAGRAM IN NOTEBOOK
 The Penrose’s Firm
Once each increment of growth was completed, managerial resources
became available for further expansion. This was because activities could
be routinized, economising on cognitive effort and allowing managers to
consider new possibilities  Dynamic View on Firm’s Productive Resources.

II. ‘Inherited’ resources and the direction of expansion

Key Q: “Can we say that a firm will ever reach an ‘equilibrium position’ in which
there is no further internal incentive to expand?” Penrose’s answer is NO.

1. The continuing availability of unused productive services

 Indivisibility of resources
“Even though a firm may not need a full-time salesman, engineer, or
‘trouble shooter’, it is often impossible…….to acquire a part-time one, and
for a given scale of operations it may be preferable to acquire a resource
and use it only partly than to do without it”
“Every time we make something, we have something left over, and have to
find something to do with that. And then find something to do with it we
usually find that leaves us with something else. It is an endless process.”
 Specialized use of resources
 “The extent to which a firm can employ the most advantageous division of
labor (The separation of a work process into a number of tasks, with each
task performed by a separate person or group of persons) depends on the
scale of its operations; the smaller its output the less can resources be used
in a specialized manner”
 The heterogeneity of resources
Homogeneity of the services per unit of any given resource: ‘man-hours’,
‘machine-hours’, ‘bales of cotton’ or ‘tons of coal’
However,…
 Entrepreneurial service
“Not only can the personnel of a firm render a heterogeneous variety of unique
services, but also the material resources of the firm can be used different ways,
which means that they can provide different kinds of services”
 The creation of new productive service
“The services that resources will yield depend on the capacities of the men
using them, but the development of the capacities of men is partly shaped
by the resources men deal with. The two together create the special
productive opportunity of a particular firm”
 Key Summary
“As long as expansion can provide a way of using the services of its
resources more profitably than they are being used, a firm has an incentive
to expand”
“So long as any resources are not used fully in current operations, there is
an incentive for a firm to find a way of using them more fully (through an
expansion)”

2. The direction of expansion

 “If there are profitable opportunities for increased production anywhere in
the economy, they will provide for some firm an external inducement to
expand”  But this alone tells us nothing about their significance for any
given firm
 “New inventions, changes in consumers’ tastes, growing demand for
particular products are external inducements to expand only for what
might be termed ‘qualified’ firms – firms whose internal resources are of a
kind either to give them a special advantage in the ‘profitable’ areas or at
least not to impose serious obstacles”

III. The economies of size and the economies of growth

1. The economies of size

 Penrose’s view on traditional theory of the economies of size:
 “Management has often been treated as the ‘fixed factor’ giving rise to
increasing costs; while this may be legitimate for many particular firms, it’s
is not appropriate for all firms.”
“We have rejected the proposition that there is for every firm some
optimum size beyond which it will run into diseconomies. Only for firm’s
incapable of adapting their managerial structure to the requirements of
larger operations can one postulate an optimum size.”

2. The concept of economies of growth proposed by Penrose

 “Economies of growth are the internal economies available to an individual
firm which make expansion profitable in particular direction.”
 “The availability of economies of growth is the result of the process by
which unused productive services are continually created within the firm”

IV. Concluding Remarks

 Penrose introduced a radically different understanding of growth, which
was predicated on the idea that organisational factors could reduce the
inherent managerial limit on the growth rate of an individual firm
 Unused and under-utilized productive services of resources are a key
source of firm expansion, learning, innovation, and profitable growth
 Firms operate in a disequilibrium model of firm growth
 “After the completion of an optimum plan for expansion, a new
‘disequilibrium’ has been created in which a firm has new inducements to
expand further even if all external conditions have remained unchanged”
 “As management tries to make the best use of the resources available, a
truly ‘dynamic’ interacting process occurs which encourages continuous
growth but limits the rate of growth”