Within the unknowable limits placed by the environment on successful action there is a wide scope for judgment. We shall be interested in the environment as an ‘image’ in the entrepreneur’s mind, for we want, among other things, to discover what economic considerations, as contrasted with ‘temperamental’ considerations, determine entrepreneurial judgments about the environment. The factors affecting the relation between the ‘image’ and ‘reality’ are not being ignored, but for an analysis of the growth of firms it is appropriate to start from an analysis of the firm rather than of the environment and then proceed to a discussion of the effect of certain types of environmental conditions. If we can discover what determines entrepreneurial ideas about what the firm can and cannot do, that is, what determines the nature and extent of the ‘subjective’ productive opportunity of the firm, we can at least know where to look if we want to explain or to predict the actions of particular firms. If we can further establish that there are significant factors expanding the productive opportunity of a firm and causing it to change in a systematic way over time with the operation of the firm, we are on the trail of a theory of the growth of firms.
IV
Expansion Without Merger: The Receding Managerial Limit
Two basic assumptions: Some elasticity in supply of management, capital, and labour to the firm; some opportunities for profitable investment in the economy. The nature of the managerial limit on expansion. The management ‘team’. Release of managerial services. Growth of managerial services. The receding limit and the ‘static’ approach. The effect of uncertainty. Uncertainty and information. Risk and unavoidable uncertainty.
OF the three classes of explanation why there may be a limit to the growth of firms—managerial ability, product or factor markets, and uncertainty and risk—the first refers to conditions within the firm, the second to conditions outside the firm, and the third is a combination of internal attitudes and external conditions. In this chapter we shall be concerned with the analysis of the fundamental and inescapable limits to the amount of expansion a firm can undertake at a given time when there is no rigid external barrier to its expansion, but we shall temporarily ignore expansion through acquisition and merger, reserving that for separate discussion.42
External barriers to expansion can be ruled out if we make two basic assumptions: First, that the supply to the firm of capital, labour, or management is not absolutely fixed—that there is not an effective limit to the amount of any kind of productive resource that the firm can obtain at a price; second, that there are opportunities for profitable investment open somewhere in the economy at existing prices and interest rates. These assumptions are, in general, fairly reasonable for many firms. In essence all they do is to ensure that the individual firm is not subject to the same restraints in the same degree as is the economy as a whole. It is reasonable enough to suppose that at any given time in any given economy the amounts of labour, managerial services, and capital, and the opportunities for profitable investment are more or less fixed and not readily expansible, although they may increase over time. But one of the reasons for treating the individual firm differently from the economy as a whole is precisely that it is not constrained by the same supply or demand functions as is the economy. Different firms will be faced with different supply and demand conditions, and the profitability of investment in different directions will be affected accordingly.
A firm’s managers may believe that they can acquire all the resources they want and can sell all the product they can produce at existing prices; alternatively they may recognize that some resources will be available in larger amounts only at higher prices and that some products can be sold in larger amounts only at lower prices or with higher selling costs. Increasing costs of some resources or declining average revenue for some products may make further expansion unprofitable in particular locations and in particular products. But a firm is not confined to particular products or locations by the supply of resources or the demand for products in the market, and provided that there are profitable opportunities open for the use of further or different resources obtainable in the market, the fundamental limit to the productive opportunity of the firm cannot be found in external supply and demand conditions; we must look within the firm itself.
We have to separate three problems: (1) the nature of the factors restricting expansion under the assumed conditions; (2) the influence of these restricting factors on the actual amount of expansion planned under different or changing conditions; and (3) the closely related problem of the composition of the expansion programme of a firm. Only the first of these will be dealt with in this chapter; consequently, while we shall deal with the factors limiting the rate of growth of a firm, we do not yet deal with changes in the rate of growth as the firm grows larger or as conditions change.
The Nature of the Managerial Limit
Expansion does not take place automatically; on the contrary, the composition and extent of an expansion programme, as well as its execution, must be planned. Planning implies on the one hand a purpose, and on the other, the organization of resources to accomplish this purpose in some desired manner. Specifically, the creation of an ‘optimum’ plan for expansion requires that the resources available to a firm, whether already acquired by the firm or obtainable in the market, be used to ‘best’ advantage.43 It is obvious that if all necessary productive services, including managerial and entrepreneurial services, were available in unlimited amounts at constant prices, and if demand for products were infinitely elastic, no ‘best’ plan could be constructed: a larger plan would always be better than a smaller one. It follows that there must be some limiting consideration to which the plan is anchored.
The assumption that a firm can obtain in the market any type of resource or quality of management implies that the specialized resources or managerial abilities it may need to take advantage of market opportunities are available to it. We assume that there are numerous opportunities for profitable production open to the individual firm. Nevertheless, the firm cannot, and in general will not attempt to, extend its expansion plans, and with them its ‘management team’, in an effort to take advantage of all such opportunities. It cannot do so because the very nature of a firm as an administrative and planning organization requires that the existing responsible officials of the firm at least know and approve, even if they do not in detail control all aspects of, the plans and operations of the firm; it will not even try to do so if the officials of the firm are themselves concerned to maintain its character as an organized unit.
The Management ‘Team’
Since there is plainly a physical maximum to the number of things any individual or group of individuals can do, there is clearly some sort of limit to the rate at which even the financial transactions of individuals or groups can be expanded. In the present discussion, however, we are dealing with the rate of expansion of the firm as an administrative and planning organization. It follows that the existing officials of such an organization must have something to do with any operations that are to be treated as an expansion of that organization’s operations; for to call a group of activities which are unconnected with a given organization an expansion of that organization is a contradiction in terms. This being so, the capacities of the existing managerial personnel of the firm necessarily set a limit to the expansion of that firm in any given period of time, for it is self-evident that such management cannot be hired in the market-place.
Businessmen commonly refer to the managerial group as a ‘team’, and the use of this word implies that management in some sense works as a unit. An administrative group is something more than a collection of individuals; it is a collection of individuals who have had experience in working together, for only in this way can ‘teamwork’ be developed. Existing managerial personnel provide services that cannot be provided by personnel newly hired from outside the firm, not only because they make up the administrative organization which cannot be expanded except by their own act
ions, but also because the experience they gain from working within the firm and with each other enables them to provide services that are uniquely valuable for the operations of the particular group with which they are associated.
These are services which make possible a working relationship between particular individuals making decisions and taking action in a particular environment, and they determine the efficiency and confidence with which action can be taken by the group as a whole. Unless such services are provided by its members, the group cannot function as a unit. It is for this reason that 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’.44
If a group is to gain experience in working together, it must have work to do. The total amount of work to be done at any time in a firm depends on the size of the firm’s operations, which is in turn limited by the plans and actions of the past and thus by the managerial resources existing at the time the plans were made. Hence not only does existing management limit the amount of new management that can be hired (after all the services of existing management are required even to greet, let alone to install and instruct, the new personnel) but the plans put into effect by past management limit the rate at which newly hired personnel can gain the requisite experience.45 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 within a given group cannot be hired from outside the group, and it takes time for them to achieve the requisite experience.46 It follows, therefore, that if a firm deliberately or inadvertently expands its organization more rapidly than the individuals in the expanding organization can obtain the experience with each other and with the firm that is necessary for the effective operation of the group, the efficiency of the firm will suffer, even if optimum adjustments are made in the administrative structure; in extreme cases this may lead to such disorganization that the firm will be unable to compete efficiently in the market with other firms, and a period of ‘stagnation’ may follow.47
There is nothing novel about the suggestion that there are difficulties attendant upon the rapid expansion of the activities of a group of individuals bound together by intricate and delicate relationships. In a general way the notion has frequently been put forward in the literature.48 I am giving so much attention to it in order to emphasize the significance of the experience gained by the personnel of a firm operating in a particular environment. In one form or another the experience of a firm’s managerial group plays a crucial role in the whole process of expansion, for the process by which experience is gained is properly treated as a process creating new productive services available to the firm.
In Chapter II a distinction was made between resources and productive services. Managerial services of the type described here are as much productive services in a firm as are the services of engineers in the physical production process; and they are a necessary part of the ‘inputs’ of which the productive activities of a firm are composed. Of all the various kinds of productive services, managerial services are the only type which every firm, because of its very nature as an administrative organization, must make use of. Since the services from ‘inherited’ managerial resources control the amount of new managerial resources that can be absorbed, they create a fundamental and inescapable limit to the amount of expansion a firm can undertake at any time.49 It is this as much as anything else that forces new firms to start on a small organizational scale unless they are built on existing firms or unless market conditions are such that they can afford to operate relatively inefficiently for some time.50
There are thus two aspects of the nature of the managerial limit on the rate of expansion of a firm: First, the services available from the existing managerial group limit the amount of expansion that can be planned at any time because all plans for expansion absorb some of the services available from this group, and the larger and more complex the plans the more services will be required to digest and approve them on behalf of the firm. Regardless of the extent to which a firm may use managerial and industrial engineering consultants and similar advisory services to improve its organization, to test markets, and to suggest possible avenues of expansion, all advice and proposed plans have to be considered and approved somewhere within the firm’s own managerial hierarchy before action is taken. Secondly, the amount of activity that can be planned at a given time limits the amount of new personnel that can profitably be absorbed in the ‘next period’.51
Release of Managerial Services
If the argument is accepted that a firm will expand only in accordance with plans for expansion and that the extent of these plans will be limited by the size of the experienced managerial group, then it is evident that as plans are completed and put into operation, managerial services absorbed in the planning processes will be gradually released and become available for further planning.
In practice, the planning of expansion, and expansion itself, takes place in a variety of different ways. In small firms where managerial services are supplied by from one to a half-dozen men who are fully occupied in running the firm, expansion sometimes depends on ‘overtime’ spurts of activity which can only occur periodically. It may be necessary that each expansion programme be fully completed, the operating problems solved and the expanded firm as a whole running smoothly before managerial services again become available for further planning, even on an ‘overtime’ basis.
In the larger firm, on the other hand, the planning and execution of expansion is not a discrete ‘step-by-step’ process, but a continuous one not always clearly separable from current operating activities. Plans are made and then revised as events command, and revision also absorbs managerial services. Small projects are constantly being created and executed, some of which are never considered in the higher reaches of management. Large programmes may be worked over by numerous committees for long periods of time and then put into effect gradually and revised in the process. The services of individual men, or all of the services of entire groups of men, are often used entirely in planning for expansion. Whole departments may be devoted exclusively to research into new products, new methods, new uses for old products, and new markets, envisaging the possibility that the firm might expand in new directions. On the other hand, a rapid obsolescence of methods, products, and materials, often forces firms not only to try to keep abreast of all new research, but if possible to lead in the introduction of new things, and the line between planning for expansion and planning ‘defensive’ adjustments becomes difficult to draw. Since either type of planning requires that some productive services be free from current productive operations, a kind of ‘vertical’ specialization is often effected, in the sense that planning and expansion at all levels are in the hands of personnel largely free of operating duties and more or less continuously occupied with planning.52
In any case, it is clear that the creation and execution of plans for expansion absorb managerial services, and that as these services are released they become available for still further planning of expansion if they are not needed to operate the expanded concern. If the amount of managerial services remains constant over time (or decreases) it might be possible for a firm so to organize their use that some ‘equilibrium’ point could be reached in which all managerial services were used in the operation of the firm and none was available for expansion. A very slow rate of expansion with an increasing proportion of existing services devoted to operations and less to planning could conceivably reach this result.53 Increments of expansion would deliberately have to be reduced as planning services could be absorbed into operating functions. It is not clear why any firm should adopt such a policy, especially if its actions are influenced by the considerations set forth in Chapter II. On the other hand, in small firms wh
ose owner-managers want to substitute leisure for work, excess managerial services can easily be withdrawn from the firm if there is no desire to use them.
The Growth of Managerial Services
In most circumstances one would expect new managerial services to be created in the process of expansion and to remain available to the firm. Any substantial expansion normally involves both acquisition of new personnel and promotion and redistribution of the old. Not infrequently a new subdivision of managerial organization is effected and a further decentralization of managerial functions takes place.
As growth proceeds, the administrative structure of a firm changes—more and more authority becomes delegated ‘down the line’ and an increasing number of responsible officials with authority to act in defined areas is created. Delegation of authority may be virtually ‘final’ in the sense that the decisions of subordinates in their defined fields are rarely overruled, the officials being transferred if their decisions are not acceptable while the authority attaching to their old positions remains unchanged. But ‘final’ delegation of responsibility is impossible. Responsibility is cumulative in a firm—the very notion of a hierarchy of officials implies this—and must always accumulate in full measure at the ‘top’, even if in fact responsibility becomes divorced from effective ‘authority’ in the process.54 This progressive decentralization of authority and of subordinate responsibility which leaves untouched the cumulation of ultimate responsibility is a necessary condition for continued growth beyond a relatively small size of firm. Its success depends upon a gradual building up of a group of officials experienced in working together. Although administrative ‘organization charts’ and other formal statements of the ‘lines’ of authority are doubtless an important adjunct to the process, they are, as we have seen, by no means sufficient to create a working team that can proceed efficiently and with confidence.
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