Theory of the Growth of the Firm

by Edith Penrose

  Certainly there may be critical periods when administration is not well adjusted to the size of the tasks it must handle, and where the leaders of the firm begin to worry about whether it has become too big to be efficient, especially if the firm has been going through a recent period of very rapid growth.207 But the very purpose of the battery of modern techniques for decentralizing administration, for controlling operations through budgetary and accounting devices, and for the extensive introduction of ‘managerial machinery’ is to ensure that administration is well adapted to the size of its task and that the managerial input does not rise disproportionately. It cannot be concluded, as yet at least, that these techniques have not successfully accomplished their purpose.208 It has, for example, been argued that even though large firms can attract the ‘abler’ men, they also need abler men to handle their administrative problems. Apart from the difficulty of finding a criterion for comparing ability ‘in general’ when different abilities may be needed in the top executives of large firms (for example, ability to ‘deal with people’) than are needed in those of small firms, it is unlikely that extremely rare personal ability is nearly as important for administrative efficiency as is the appropriate adjustment of the administrative framework or administrative organization. Once this adjustment has been effected, the problems of administration relative to the resources for dealing with them do not seem to lead to a general inefficiency in the organization of productive activity nor to the absorption of a significantly larger proportion of the growing total of managerial services.

  Impact of Changing Environmental Conditions

  A large firm necessarily faces an environment different from that of a small firm, 209 and the different environment of different sizes of firms has itself an impact on the nature and difficulty of a firm’s operating problems. A new firm having to exert special efforts to keep its existing footing, let alone expand, may have to devote an extraordinarily high proportion of its existing managerial talent to current operations; once it succeeds in catching the public fancy, in obtaining the confidence of capital suppliers and of consumers, in solidly establishing its trade relations, the operating problems may diminish, growth becomes possible and if growth can take place in the firm’s existing areas of operations, the proportion of total services that must be devoted to operations may remain relatively low. On the other hand, if competition is intense and supply and demand conditions require constant adaptations, the firm may not be able to do much more than keep on its feet and, if it expands at all, can expand only slowly.

  There can be little question that in general the larger and older firm has certain advantages over the smaller and newer firm which ease its operating problems and reduce the managerial services required for operations.210 Some of these advantages will be related to various kinds of market protection the older firm may have been able to erect, others merely to the removal of disadvantages attaching to the unknown and untried, for past success is a powerful aid to future progress. It does not follow, however, that the largest firms have the same types of advantages over large firms. In other words, while a case can be made for the proposition that the managerial services required for operations become proportionately less for the medium-size and moderately large firms than for the very small ones, it is more difficult to make a case for the proposition that the proportion continues to fall, or remains low, as the firm grows larger and larger.

  If growth took place exclusively in fields already familiar to the firm and if the increasing size of the firm implied an increased protection from competition and a decreased compulsion to adapt, innovate, and manoeuvre in order to maintain the firm’s competitive position, then the larger the firm the easier presumably would be the operating problems. But growth in the modern world of competitive capitalism does not very often proceed so simply. The large diversified firms, although undoubtedly wielding much power and occupying strong monopolistic positions in some areas, do not, so far as we can see, hold their position without the expenditure of extensive managerial effort. And it is quite possible that the proportion of total managerial services required to maintain the current operations of a firm will begin to rise when it becomes large enough to get caught up in the kind of competitive innovating struggle with other large firms that was described in Chapter VII; it seems most unlikely that this proportion would fall.

  There is, of course, no way of separating in practice the effect that the increased difficulty of administrative co-ordination has on the managerial services required for operations from the effect of changes in the competitive position of the firm. Most of the discussions of the managerial problems of the large firms have centred on the increased co-ordination problem; a distinction is made here only for the purpose of bringing to the surface the significance of changed competitive relationships. Both changes could be expected to affect the managerial services required for current operations in much the same way, but little can be said with confidence about either. Further speculation would avail but little, and enough has been said, I think, to indicate the difficulties of supporting a presumption. It seems unlikely that the proportion of managerial services available for expansion would increase as firms become very large, more likely that it would decline, if only slightly. But if we had to rely exclusively on speculation about changes in the ratio of managerial services available for expansion to the total of such services we could say little about changes in rate of growth with increasing size of firm, except that we would not expect the availability of managerial services for expansion to increase at a greater rate than that at which total services increase, and thereby provide a pressure for an accelerating rate of growth of firms.

  Managerial Services Required for Expansion

  The other term of the crucial ratio controlling the rate of expansion is the managerial services required per dollar of expansion. Many of the same circumstances that determine the amount of managerial service required to run a firm also determine the amount required to expand it, but their influence is more pronounced on the act of expansion than in the routine of current operations. Here we are not dealing with the size of a going operation, but with the planning and implementing of a change which includes the perfecting of the administrative framework in which current operations can subsequently be conducted.

  The managerial requirements per dollar of expansion depend upon (a) the character of the expansion itself, (b) the relation between the type of expansion, the existing activities of the firm, and the complex of external circumstances that I shall simply call ‘market conditions’, and (c) the method of expansion.

  Character of Expansion

  The more complex the character of an expansion in relation to its size and, with some exceptions, the larger an expansion, the more managerial services we should expect to be required per dollar of expansion. An expansion programme can be considered more complex the more varied the activities contained in it. Consequently, an expansion that involves the production of a variety of different products for different markets will, ceteris paribus, require a proportionately greater input of managerial services than one which involves the increased production of a single product for existing markets. An expansion that involves the establishment of several kinds of plant will be more ‘complex’ in relation to the size of the expansion than one that requires only the duplication of similar plants. In the latter case, much of the basic planning for a single plant can be used, perhaps with small changes, for all the others, and the managerial requirements per unit of expansion will be low. Similarly, a large expansion programme that consists of the creation of a single new plant may require a smaller input of the services of management with experience within the firm than an equally large expansion that consists of the creation of a number of plants (although the total engineering services required may be greater in the former).

  The larger demand for the services of experienced managerial personnel in a complex’ expansion programme arises not only because of the greater variety of
managerial tasks to be performed, and the consequent greater variety of managerial experience required, but also because of the problem of co-ordination. Co-ordination’ includes not only capital budgeting and the working out of the relation of each of the different major activities involved in the expansion to the activities of the rest of the firm, but also the necessary expansion and revision of the firm’s administrative structure and the necessary decisions relating to the scope of responsibility and authority to be entrusted to those concerned with the execution of the expansion and the operation of the expanded activity. Hence, in addition to the administrative task of planning the expansion itself, there is the task of maintaining the necessary integration with the rest of the firm and, at the same time, working out flexible administrative arrangements so that the execution of the expanded programme will not be handicapped by bureaucratic bottle-necks. We have seen that there are times when the difficulty of making the necessary administrative adaptations may result in a very critical period in a firm’s growth during which its continued existence hangs in the balance.

  As the size of a planned expansion increases, whether there will be a more than proportionate increase in the requirements for managerial services or not will depend partly on the extent to which the complexity of the expansion increases pari passu211 Complexity of the kind that demands the services of the limited amount of personnel with experience within the firm need not increase, as I have indicated. A capital-extensive expansion, for example, presumably requires less co-ordinating services per dollar of capital expenditure, and although the engineering aspects of the expansion may be considerable, it seems unlikely that the managerial planning and co-ordinating tasks are increased accordingly212 If this is the case, we have here one, though by no means the only, explanation of why the large firms often prefer a single large, capital-using project to a number of smaller ones; it also throws light on the processes of industrial concentration in industries where the minimum size of a plant is large, for in this case the rate at which expansion can take place is increased, and a given firm in such industries can expand relatively faster than firms in industries where the minimum size of plant is small. But more of this in our discussion of the process of industrial concentration in the following chapter.

  Relation to Existing Activities and Market Conditions

  Where expansion takes place in fields that are closely related to the existing activities of the firm and to the types of knowledge and skills already possessed by the firm’s management, we should expect the managerial effort required per dollar of expansion to be less than a similar amount of expansion into unknown fields; expansion in market areas where the firm is already known and established will require less effort than expansion into markets new to the firm. Here, of course, not only the total supply of managerial services available for expansion but also the particular kind of such services becomes important. But if we assume for present purposes that existing management can always learn new things given sufficient time (or take on people who do), then the fact that a type of service is called for which is not already possessed by the firm merely represents an increase in the total of the managerial services required to effect the expansion. There is little question, as we have shown before, that one of the reasons for the choice of acquisition as the method of expansion into fields new to a firm is precisely that the managerial effort required for the expansion is reduced.

  Clearly the state of competition in both factor and product markets will powerfully influence the managerial services required per dollar of expansion. If a firm has to spend considerable effort attacking the positions of competitors, obtaining the skilled labour or other factors of production required, negotiating for capital supplies because money is ‘tight’, planning and executing extensive advertising campaigns, or organizing unusual selling programmes, both the managerial services directly required for planning the expansion and those required for the administrative organization of it will be accordingly increased. This hardly needs elaboration.

  The new and small firm starting out with the kind of business opportunity that gives it a genuine chance to establish an especially favourable position may, once it is solidly established, enjoy profitable and comfortable growth as a medium-size firm for a considerable period, demand for its product expanding with relatively little effort on its part, particularly if it does not compete directly with larger and financially more powerful firms. With continued expansion, however, the original opportunities may become ‘exhausted’, so to speak, or at least yield less richly, and the firm, though well established, may find that further growth must take place under less favourable market conditions.

  The advantage of the established firms with some degree of ‘market-control’, public acceptance, or, if you like, monopoly, can hardly be questioned, but it is again pertinent to ask whether these advantages reduce the task of expansion for those firms whose expansion must take place in competition with firms of similar strength, position, and size. Only rarely, it seems, does the large firm consider itself free from competitive pressures in those areas in which it produces or contemplates expansion. In fields where expansion depends largely on innovation and improvements which presuppose extensive ‘research and development’ the managerial requirements per dollar of expansion are surely raised; for all of the managerial services required in the organization, co-ordination, and experimentation that are involved in the effort to innovate and in the process of diversification are properly classed as managerial inputs for expansion.

  Method of Expansion

  Finally, we must consider briefly the significance of acquisition and merger. We have already shown that the possibility of acquiring other firms raises enormously the maximum rate of expansion, primarily because it substantially reduces the managerial services required per unit of expansion. But acquisition is open to firms of all sizes, and the point we are interested in here is whether the significance of acquisition for the rate of growth of firms changes as the firm grows larger.

  If we consider merely the managerial problem involved in acquiring other firms, it seems likely that the larger the acquiring firm in relation to the acquired firm, the less the managerial difficulties of integration. Hence for the acquisition of another firm of given size, the larger the size of the acquiring firm, the easier the managerial task of effecting and integrating the acquisition; consequently for a given amount of expansion through acquisition, the smaller the acquiring firm, the greater proportionately the managerial input required. On the other hand, the larger the number of firms acquired in a given period, the greater the average managerial effort necessary to discover and acquire appropriate firms and to incorporate them into the acquiring firm.

  Again, therefore, if we consider the change in external circumstances as a firm grows larger, acquisition as a means of maintaining or increasing a firm’s rate of growth becomes, after a point, less significant. Consider a firm growing entirely through acquisition. The larger the firm, the larger must be the amount of acquisition per unit of time if its rate of growth is not to decline. Therefore it must acquire larger and larger firms (or parts of firms) or more and more smaller firms. So long as larger firms are available, the number of firms acquired does not have to rise as the size of the expansion plans of the acquiring firm increases, and its rate of growth can remain very high. But when the firm reaches a size where few large acquisitions are possible in appropriate fields, then acquisition as a method of maintaining the firm’s growth becomes more and more difficult and the managerial input for a given amount of expansion through acquisition rises sharply because of the increasingly larger numbers of firms that must be acquired to maintain a given rate of growth213

  Occasional mergers of giants with ‘giants’ may take place, but whereas the medium-sized firm may be able almost to double its size every year or so for several years through acquisition, this prospect is simply not open to the giants either through acquisition of other large firms or through the acquisitio
n of larger and larger numbers of small firms. This is partly because of an increasing scarcity of large firms that can be acquired and the consequent difficulties of discovering suitable small firms in sufficient numbers and absorbing them at a rapid rate, which is a question of the size of the growing firm relative to others; and partly because of the administrative difficulties of efficiently absorbing ever-larger additions to its size, which is a question of size alone.

  I am not implying, however, that acquisition is unimportant to the very large firm as a means of breaking into new fields, of reducing annoying competition, or of preventing the rise of new competitors. Acquisition may indeed be almost necessary if the firm is not to suffer a sharp, rather than a gradual, decline in its rate of growth.214 The sole issue here is whether acquisition can be expected to offset the tendencies for the managerial input per dollar of expansion to rise after a point. We can conclude that the prospects of expansion through acquisition may raise the maximum rate of growth for medium-sized and moderately large firms but will probably become less significant for the very large firms simply because acquisition becomes for several reasons quantitatively less significant in their expansion programmes.215

  For the larger firms in competition with each other, therefore, it seems that all of the factors which tend to increase the managerial services required per dollar of expansion are present in an increasing degree; the only significant offsetting factor in the very large firm arises from the possibility of increasing the capital intensity of expansion. But as a firm grows larger it can maintain a given rate of growth only if the absolute increments to its size become ever larger, and there is little reason to believe that this can be accomplished by an indefinite increase in the size of plant. Consequently on all counts we would expect that the managerial requirements per unit of expansion will begin to rise at some point.