Theory of the Growth of the Firm

by Edith Penrose

  THE THEORY OF THE GROWTH OF THE FIRM

  Edith outside her house in Baltimore around 1956 (photo: Perran Penrose).

  The Theory of

  the Growth of

  the Firm

  With a New Introduction by

  Christos N. Pitelis

  Edith Penrose

  FOURTH EDITION

  Great Clarendon Street, Oxford OX2 6DP

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  © The Estate of Edith Penrose 2009

  Introduction © Christos Pitelis 2009

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  First published 1959

  Revised edition published 2009

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  ISBN 978–0–19–957384–4

  1 3 5 7 9 10 8 6 4 2

  TABLE OF CONTENTS

  Introduction by Christos N. Pitelis

  Preface

  I Introduction

  II The Firm in Theory

  The Firm in the Theory of Price and Production

  The Limits to Size

  The ‘Firm’ is not a Firm

  The Firm as an Administrative Organization

  The Function and Nature of the Industrial Firm

  Size and Administrative Co-Ordination

  Industrial Firms and Investment Trusts

  Continuity in the ‘History’ of a Firm

  The Firm as a Collection of Productive Resources

  The Motivation of the Firm

  The Profit Motive

  Long-Run Profits and Growth

  III The Productive Opportunity of the Firm and the ‘Entrepreneur’

  The Role of Enterprise and the Competence of Management

  Entrepreneurial versus Managerial Competence

  The Quality of Entrepreneurial Services

  Entrepreneurial Versatility

  Fund-Raising Ingenuity

  Entrepreneurial Ambition

  Entrepreneurial Judgment

  The Role of Expectations in the Productive Opportunity of the Firm

  IV Expansion Without Merger: The Receding Managerial Limit

  The Nature of the Managerial Limit

  The Management ‘Team’

  Release of Managerial Services

  The Growth of Managerial Services

  The Receding Limit and the ‘Static’ Approach

  The Effect of Uncertainty and Risk

  Uncertainty and Information

  Risk and Unavoidable Uncertainty

  V ‘Inherited’ Resources and the Direction of Expansion

  The Continuing Availability of Unused Productive Services

  Indivisibility and the ‘Balance of Processes’

  The Specialized Use of Resources

  The Heterogeneity of Resources

  Interaction between Material and Human Resources

  The Creation of New Productive Services

  ‘Demand’ and the Productive Resources of the Firm

  What is the Relevant Demand?

  The Direction of Expansion

  VI The Economies of Size and the Economies of Growth

  The Economies of Size

  Technological Economies

  Managerial Economies

  Economies in Operations and Economics in Expansion

  The Economies of Growth

  Disappearing versus Enduring Economies

  VII The Economics of Diversification

  Meaning of Diversification

  ‘Areas of Specialization’

  The Specific Opportunities for Diversification

  The Importance of Industrial Research

  The Significance of Selling Efforts

  The Importance of a Technological Base

  Some Examples

  The Role of Acquisition

  The Role of Competition

  The Necessity of Continued Investment in Existing Fields

  Full-Line Diversification

  Competition and Diversification into New Areas

  Diversification as a Solution to Specific Problems

  Temporary Fluctuations in Demand

  Permanent Adverse Changes in Demand

  The Direction of Diversification

  Diversification as a General Policy for Growth

  Vertical Integration

  The Firm as a Pool of Resources

  VIII Expansion Through Acquisition and Merger

  The Economic Basis of Acquisition

  Personal Considerations and Special Situations

  Critical Points in the Process of Expansion

  The Competitive Expansion of Alpha

  Where Beta Blocks the Expansion of Alpha

  Combination

  The Purchase and Sale of ‘Businesses’ that are not Firms

  Economic Basis for the Sale of a ‘Business’

  Effect on the Process of Growth

  The Appropriateness of Diversification

  The Role of Entrepreneurial Services

  Entrepreneurial Temperament and the Profit Motive

  Empire-Building and Merger

  Role of Managerial Services

  The Necessity of Administrative Integration

  Merger and the Dominant Firm

  IX The Rate of Growth of a Firm Through Time

  Special Assumptions

  Measurability

  The Fundamental Ratio

  Managerial Services Available for Expansion

  Increase in the Administrative Task with Growth

  Impact of Changing Environmental Conditions

  Managerial Services Required for Expansion

  Character of Expansion

  Relation to Existing Activities and Market Conditions

  Method of Expansion

  Changes in the Rate of Growth with Increasing Size

  The ‘Gro
wth Curve’

  X The Position of Large and Small Firms in a Growing Economy

  The Special Position of Small Firms

  Competitive Handicaps, Especially Finance

  The Continued Existence of Small Firms

  Opportunities for Growth

  ‘Interstices’ in a Growing Economy

  The Principle of Comparative Advantage

  XI Growing Firms in a Growing Economy: The Process of Industrial Concentration and the Pattern of Dominance

  Barriers to Entry

  General Effect on Investment in the Economy as a Whole

  The Importance of ‘Big Business’ Competition

  Capital Requirements and Consumer Loyalty

  Artificial Barriers and the Interstices

  Merger in a Growing Economy

  Merger in Relation to Indices of Business Activity

  The Effect on the Interstices of ‘Natural’ Limitations on Acquisition

  Interstices and the Business Cycle

  The Process of Industrial Concentration

  Measurement of Concentration

  Concentration and Growing Firms in a Growing Economy

  Some Shaky Evidence

  Concentration Within Industries

  Diversification and Industry Concentration

  Concentration and Dominance

  The Continued Dominance of Large Firms

  Conclusion

  Appendix: Foreword to the Third Edition

  Index

  Edith Penrose’s ‘The Theory of the Growth of the Firm’ Fifty Years Later*

  By Christos N. Pitelis

  I. Introduction

  THE year 2009 marks the 50th anniversary of Edith Penrose’s The Theory of the Growth of the Firm (hereafter TGF). In a review of the book in the Economic Journal, Robin Marris (1961) predicted that TGF would prove one of the most influential of the decade. In his 1987 entry to the New Palgrave he added that ‘this proved an understatement’ (p. 831). Marris’s statements were referring mainly to the economic theory of the firm, especially the literature on ‘managerial theories’, which were popular in the 1960s and to which he himself was a major contributor (Marris 1964). Neither Marris nor Penrose herself could foresee what appears to be the case 50 years on; a situation where the influence of TGF in mainstream economics has been rather limited (see also Marris 1987 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 receiving no mention in leading neoclassical microeconomics, Industrial Organisation (IO), and economics of regulation textbooks (for example Kreps 1990, Tirole 1988, and Viscusi et al. 2001 respectively) and even in leading Economics, Organization, and Management textbooks, such as Milgrom and Roberts (1992).

  The book’s reception in economics was anticipated by the reputable Oxford 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 their economic environment, or, in other words, just those questions about the (equilibrium) structures of industries which the author rules out of court at the start’ (p. 114).

  Andrews’s criticisms and predictions proved to be in line with economists’ continued focus upon a market-based analysis of the equilibrium structure of industries. Early inroads from economics to management by Porter (1980, 1985) retained this focus. TGF helped change this spectacularly, albeit so far mainly outside mainstream economics. Whether the apparent failure of TGF to make significant inroads in neoclassical economics says something about the quality of the book, or instead about the state of economics, however, only history will tell. This introduction reveals, at least, where the present author stands on this.

  TGF’s influence outside mainstream economics, gradually exceeded by far Marris’s apparently optimistic assessment. Over the past 25 years or so, TGF has become a canonical reference to the currently dominant resource-, knowledge-, and (dynamic) capabilities-based approaches to business strategy, and to a lesser extent to the theory of the multinational enterprise (MNE) and International Business (IB) scholarship. TGF is also seen as seminal in (strategic) human resource management (SHRM). Of late, the book has been used as the basis of integrating and extending the now flourishing literature on strategic entrepreneurship. TGF is also employed in order to explain the nature of the firm and its ability to create and capture value, which are at the heart of the theory of the firm, business strategy, and organization scholarship. It is virtually impossible to predict where else and how much further the book’s ideas will branch out. Today TGF is one of the leading books on the theory of the firm with more than 7,800 citations in Google Scholar. This compares with, for example, around 1,600 for Chandler’s (1962) Strategy and Structure and 7,500 for Cyert and March’s (1963) A Behavioral Theory of the Firm.1

  Although we will attempt some speculative predictions towards the end of this introduction, our main focus will be to present TGF’s ideas and assess them critically. In so doing, we will aim to understand the book’s phenomenal success that motivated the present fourth edition on the occasion of its 50th anniversary, while celebrating the book’s and Penrose’s lasting influence. In particular, the aim of this introduction to the fourth edition is to briefly discuss Penrose’s life and the background to the writing of the book; the early contributions of the book to economics; subsequent ideas in economics which are related to, but do not appear to have drawn on, the book; the book’s contribution to organizational economics, (international) business strategy, SHRM, strategic entrepreneurship, and recent debates on value creation and capture. We will also touch upon Penrose’s epistemology. Following on from the above, we will outline possible ways in which TGF can be generalized, critiqued, and integrated with other theories, extant and emergent.

  Clearly the above is a rather tall order, both imperfect by its nature and reliant on earlier work by the present author, including joint work with colleagues. These are all recognized in the text. However, special mention is due here to Perran Penrose, Edith’s son, who has authored the biography, printed below with little input from the present author.

  II. Edith Penrose’s Life2

  Edith Elura Tilton was born on 29 November 1914 on Sunset Boulevard in Los Angeles. Her father, George Tilton, was a road engineer for the Department of Public Works, and was descended from early immigrants to the United States. Edith had two brothers, Harvey and Jack. It was a close and supportive family, living in a small-town community. For much of the time, the family followed George as he surveyed the new Californian road network (he headed the party that surveyed Highway 1 along the Pacific coast). As a child Edith spent much of her time in road camps, packing along narrow trails, receiving a basic education in small shacks that served as classrooms. For a child the life was exciting and not without danger: she was about to engage in a close dialogue with a rattlesnake when her mother shot the snake through the head.

  The family settled eventually in San Luis Obispo, where she went to school. She went on to graduate at the top of her class in San Luis Obispo High, and entered the University of California at Berkeley. She gained a scholarship after her first semester, and more or less by accident decided to study economics. While still a student she met David Denhardt, who was slightly older than she was, and married him. She completed her studies in Berkeley in 1936 with a BA in economics, and the couple moved to Northern California where Edith took a job as a social worker with a depression relief agency. The first tragedy in a life that was to see more tragedy came when David, who was a lawyer and an aspirant district attorney, was killed in a hunting accident when Edith was four months pregnant. Circumstances surrounding the incident suggest the possibility that it might not have been an accident, but the mystery was never resolved.

  One of her teachers at Berkeley was the economist E. F. Penrose (‘Pen’), who was born of Cornish parents in Plymouth, UK, in 1896. Like Edith, Pen came from a relatively humble background. He had served in the tr
enches in the First World War, managed to finance himself through Cambridge after the war (assisted by his tutor W. S. Thatcher), and had come to Berkeley via Japan and the Stanford Food Research Institute. Edith acted as an assistant to Pen, who was 20 years her senior, and attended his summer extension classes in economics.

  In 1939 Pen moved to the International Labour Office (ILO) in Geneva at the suggestion of John Winant, who was at the ILO and who was later to become US Ambassador to Britain. Edith took a job as a researcher in the Economics and Statistics Section of the ILO, and travelled to Geneva. Life there was tense during this period, and Pen and Edith were involved in assisting Jews to escape from Germany through Switzerland amid real uncertainty whether Germany would invade Switzerland.3 The ILO then moved to Montreal, and Pen and Edith made the first part of the journey by bus across France in front of the German invasion. During this period she wrote Food Control in Great Britain, published in 1940, which analysed the problems of production, distribution, and consumption of food in wartime Britain.4

  When Winant was appointed to London, Pen went with him as Economic Adviser, and Edith served on his staff as a researcher. Pen was deeply involved in the negotiations between the United Kingdom and the United States, including those between John Maynard Keynes and Harry Dexter White, over the postwar economic order. Edith’s association with Pen, who was in a web of economists working on post-war planning, had brought her into contact with many of the most prominent economists of the day. She had been greatly influenced by Schumpeter, whom she met once (Pen knew him and worked with Elizabeth Boody Schumpeter (1940)), and as a young woman came into contact with Keynes, Meade, D. H. Robertson, Austin Robinson, H. D. Henderson, Robbins, Jewkes, all before, as she used to say later, seriously taking up economics!

  In 1945 another tragedy occurred: Edith’s brother Jack, a pilot in the US Air Force in Italy, was shot down and killed. Her other brother, Harvey, was also an Air Force pilot. In 1952 his plane went down over Alaska and he perished before help could arrive. In 1945 Pen and Edith married. Immediately after the war Edith and Pen joined the US delegation to the United Nations, again following Winant, who died in 1947. Pen spent a year at the Institute of Advanced Studies in Princeton, and in late 1947 moved to Johns Hopkins University in Baltimore where he took a chair in Human Geography. In 1946 Edith bore a son, Trevan. Trevan died in 1947 at the age of 18 months, and is buried in Baltimore. Edith bore two further sons (1947 and 1948).