THE THEORY OF THE GROWTH OF THE FIRM EdithoutsideherhouseinBaltimorearound1956(photo:PerranPenrose). The Theory of the Growth of the Firm With a New Introduction by Christos N. Pitelis Edith Penrose FOURTHEDITION 1 3 GreatClarendonStreet,OxfordOX26DP OxfordUniversityPressisadepartmentoftheUniversityofOxford. ItfurtherstheUniversity’sobjectiveofexcellenceinresearch,scholarship, andeducationbypublishingworldwidein Oxford NewYork Auckland CapeTown DaresSalaam HongKong Karachi KualaLumpur Madrid Melbourne MexicoCity Nairobi NewDelhi Shanghai Taipei Toronto Withofficesin Argentina Austria Brazil Chile CzechRepublic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore SouthKorea Switzerland Thailand Turkey Ukraine Vietnam OxfordisaregisteredtrademarkofOxfordUniversityPress intheUKandincertainothercountries PublishedintheUnitedStates byOxfordUniversityPressInc.,NewYork #TheEstateofEdithPenrose2009 Introduction#ChristosPitelis2009 Themoralrightsoftheauthorhavebeenasserted DatabaserightOxfordUniversityPress(maker) Firstpublished1959 Revisededitionpublished2009 Allrightsreserved.Nopartofthispublicationmaybereproduced, storedinaretrievalsystem,ortransmitted,inanyformorbyanymeans, withoutthepriorpermissioninwritingofOxfordUniversityPress, orasexpresslypermittedbylaw,orundertermsagreedwiththeappropriate reprographicsrightsorganization.Enquiriesconcerningreproduction outsidethescope oftheaboveshouldbesenttotheRightsDepartment, OxfordUniversityPress,attheaddressabove Youmustnotcirculatethisbookinanyotherbindingorcover andyoumustimposethesameconditiononanyacquirer BritishLibraryCataloguinginPublicationData Dataavailable LibraryofCongressCataloginginPublicationData Dataavailable TypesetbySPIPublisherServices,Pondicherry,India PrintedinGreatBritain onacid-freepaperby ClaysLtd.,StIvesplc ISBN 978–0–19–957384–4 1 3 5 7 9 10 8 6 4 2 TABLE OF CONTENTS IntroductionbyChristosN.Pitelis ix Preface xlviii I Introduction 1 II TheFirminTheory 8 TheFirmintheTheoryofPriceandProduction 9 TheLimitstoSize 10 The‘Firm’isnotaFirm 12 TheFirmasanAdministrativeOrganization 13 TheFunctionandNatureoftheIndustrialFirm 13 SizeandAdministrativeCo-Ordination 16 IndustrialFirmsandInvestmentTrusts 17 Continuityinthe‘History’ofaFirm 20 TheFirmasaCollectionofProductiveResources 21 TheMotivationoftheFirm 23 TheProfitMotive 23 Long-RunProfitsandGrowth 26 III TheProductiveOpportunityoftheFirmandthe‘Entrepreneur’ 28 TheRoleofEnterpriseandtheCompetenceofManagement 30 EntrepreneurialversusManagerialCompetence 31 TheQualityofEntrepreneurialServices 32 EntrepreneurialVersatility 32 Fund-RaisingIngenuity 34 EntrepreneurialAmbition 35 EntrepreneurialJudgment 37 TheRoleofExpectationsintheProductiveOpportunity oftheFirm 37 IV ExpansionWithoutMerger:TheRecedingManagerialLimit 39 TheNatureoftheManagerialLimit 40 TheManagement‘Team’ 41 ReleaseofManagerialServices 45 TheGrowthofManagerialServices 46 vi TableofContents TheRecedingLimitandthe‘Static’Approach 49 TheEffectofUncertaintyandRisk 50 UncertaintyandInformation 52 RiskandUnavoidableUncertainty 54 V ‘Inherited’ResourcesandtheDirectionofExpansion 58 TheContinuingAvailabilityofUnusedProductiveServices 60 Indivisibilityandthe‘BalanceofProcesses’ 61 TheSpecializedUseofResources 63 TheHeterogeneityofResources 66 InteractionbetweenMaterialandHumanResources 67 TheCreationofNewProductiveServices 69 ‘Demand’andtheProductiveResourcesoftheFirm 71 WhatistheRelevantDemand? 71 TheDirectionofExpansion 75 VI TheEconomiesofSizeandtheEconomiesofGrowth 78 TheEconomiesofSize 79 TechnologicalEconomies 80 ManagerialEconomies 82 EconomiesinOperationsandEconomicsinExpansion 84 TheEconomiesofGrowth 87 DisappearingversusEnduringEconomies 89 VII TheEconomicsofDiversification 92 MeaningofDiversification 94 ‘AreasofSpecialization’ 97 TheSpecificOpportunitiesforDiversification 98 TheImportanceofIndustrialResearch 99 TheSignificanceofSellingEfforts 102 TheImportanceofaTechnologicalBase 104 SomeExamples 105 TheRoleofA cquisition 112 TheRoleofCompetition 116 TheNecessityofContinuedInvestmentinExistingFields 116 Full-LineDiversification 118 CompetitionandDiversificationintoNewAreas 120 DiversificationasaSolutiontoSpecificProblems 122 TemporaryFluctuationsinDemand 122 PermanentAdverseChangesinDemand 125 TheDirectionofDiversification 125 DiversificationasaGeneralPolicyforGrowth 126 VerticalIntegration 128 TheFirmasaPoolofResources 132 TableofContents vii VIII ExpansionThroughAcquisitionandMerger 135 TheEconomicBasisofAcquisition 138 PersonalConsiderationsandSpecialSituations 139 CriticalPointsintheProcessofExpansion 142 TheCompetitiveExpansionofAlpha 145 WhereBetaBlockstheExpansionofAlpha 148 Combination 151 ThePurchaseandSaleof‘Businesses’thatarenotFirms 152 EconomicBasisfortheSaleofa‘Business’ 154 EffectontheProcessofGrowth 157 TheAppropriatenessofDiversification 158 TheRoleofEntrepreneurialServices 160 EntrepreneurialTemperamentandtheProfitMotive 160 Empire-BuildingandMerger 163 RoleofManagerialServices 166 TheNecessityofAdministrativeIntegration 167 MergerandtheDominantFirm 170 IX TheRateofGrowthofaFirmThroughTime 172 SpecialAssumptions 173 Measurability 173 TheFundamentalRatio 175 ManagerialServicesAvailableforExpansion 176 IncreaseintheAdministrativeTaskwithGrowth 176 ImpactofChangingEnvironmentalConditions 179 ManagerialServicesRequiredforExpansion 180 CharacterofExpansion 181 RelationtoExistingActivitiesandMarketConditions 183 MethodofExpansion 184 ChangesintheRateofGrowthwithIncreasingSize 186 The‘GrowthCurve’ 186 X ThePositionofLargeandSmallFirmsinaGrowingEconomy 189 TheSpecialPositionofSmallFirms 191 CompetitiveHandicaps,EspeciallyFinance 192 TheContinuedExistenceofSmallFirms 193 OpportunitiesforGrowth 194 ‘Interstices’inaGrowingEconomy 196 ThePrincipleofComparativeAdvantage 197 XI GrowingFirmsinaGrowingEconomy:TheProcessof IndustrialConcentrationandthePatternofDominance 201 BarrierstoEntry 202 viii TableofContents GeneralEffectonInvestmentintheEconomyasaWhole 202 TheImportanceof‘BigBusiness’Competition 204 CapitalRequirementsandConsumerLoyalty 206 ArtificialBarriersandtheInterstices 208 MergerinaGrowingEconomy 209 MergerinRelationtoIndicesofBusinessActivity 211 TheEffectontheIntersticesof‘Natural’Limitationson Acquisition 212 IntersticesandtheBusinessCycle 214 TheProcessofIndustrialConcentration 215 MeasurementofConcentration 216 ConcentrationandGrowingFirmsinaGrowingEconomy 217 SomeShakyEvidence 219 ConcentrationWithinIndustries 222 DiversificationandIndustryConcentration 225 ConcentrationandDominance 226 TheContinuedDominanceofLargeFirms 227 Conclusion 229 Appendix:ForewordtotheThirdEdition 234 Index 245 Edith Penrose’s ‘The Theory of the Growth of the Firm’ Fifty Years Later* By Christos N. Pitelis I. Introduction T HEyear2009marksthe50thanniversaryofEdithPenrose’sTheTheoryof the Growth of the Firm (hereafter TGF). In a review of the book in the Economic Journal,RobinMarris(1961)predictedthat TGFwouldproveoneof the most influential of the decade. In his 1987 entry to the New Palgrave he addedthat‘thisprovedanunderstatement’(p.831).Marris’sstatementswere referringmainlytotheeconomictheoryofthefirm,especiallytheliteratureon ‘managerialtheories’,whichwerepopularinthe1960sandtowhichhehimself wasamajorcontributor(Marris1964).NeitherMarrisnorPenroseherselfcould foreseewhatappearstobethecase50yearson;asituationwheretheinfluence ofTGFinmainstreameconomicshasbeenratherlimited(seealsoMarris1987 and below). The managerial theories of the firm turned out to be little more than a footnote in the history of the neoclassical theory of firm, with TGF receivingnomentioninleadingneoclassicalmicroeconomics,IndustrialOrga- nisation(IO),andeconomicsofregulationtextbooks(forexampleKreps1990, Tirole1988,andViscusietal.2001respectively)andeveninleadingEconom- ics, Organization, and Management textbooks, such as Milgrom and Roberts (1992). Thebook’sreceptionineconomicswasanticipatedbythereputableOxford economist P. W. S. Andrews. In his 1961 review of TGF Andrews noted that ‘A theory of the growth of firms surely should involve generalizations about theireconomicenvironment,or,inotherwords,justthosequestionsaboutthe (equilibrium)structuresofindustrieswhichtheauthorrulesoutofcourtatthe start’(p.114). *ThisintroductiondrawsandbuildsuponearlierworkbyPenroseandPitelis(1999) and Pitelis (2004, 2005, 2007a, 2007b). I am grateful to numerous colleagues for comments and discussion on earlier drafts, especially Mie Augier, John Dunning, Joe Mahoney,RobinMarris,PerranPenrose,DavidTeece,andAlainVerbeke.Errorsaremine.