Theory of the Growth of the Firm

by Edith Penrose

  12 Penrose goes on to point out the ‘central managerial direction’ within firms which she calls a ‘court of last resort’, much in line with subsequent arguments by Masten (1996) and Williamson (1996).

  13 Despite glowing references to G. B. Richardson’s 1972 ‘splendid and pioneering article’ (p. ix) in which ‘[h]e challenges the whole notion of a firm/market dichotomy, pointing out that there are three means of co-ordination: direction, co-operation, and market coordination and that firm networking blurs the boundaries of firms; that the firm in reality is not the island in a sea of market transactions, but itself part of a network ,…’ (p. xvi), Penrose maintained that ‘firms and markets are both, in their different ways, networks of activity, but the difference between them is crucial to an understanding of the nature of the economy as a whole’ (1996, p. 1717).

  14 Importantly, ‘the unused services thus created, do not ordinarily exist in the visible form of idle man-hours but in the concealed form of unused abilities’ (1955, p. 538).

  15 See also Demsetz (1995) for a critique of the idea of managerial diseconomies of scale.

  16 In the entry to the New Palgrave, Penrose also comments on Coase (1937) and Hymer (1976) to the effect that their theories do not distinguish the multinational from domestic firms.

  17 Penrose recognizes this in a letter to Slater, on 10 April 1979, where she points out that ‘I came across references to my 1956 paper in the EJ of Foreign Investment and the Growth of the Firm. This paper is widely cited and I do not deal with the subject in the book. I am wondering if it would not be useful somewhere in your introduction to refer to this offshoot of the “‘Theory of the Growth of the Firm”. We pursue this literature below.

  18 The nearest she comes in TGF to discussing the MNE is the following: ‘Often the large firms organize their various types of business in separate divisions or subsidiaries’ (1959, p. 156).

  19 In private discussions. Note that Richardson (1972) also took this view.

  20 Being capabilities-based and quite Penrosean in nature, this contribution has acquired prominence. Yet both the Penrosean view of vertical integration and Kogut and Zander’s view of the MNE, suffer from a failure to appreciate that differential firm capabilities are tantamount to relative firm superiority vis-á-vis the market (i.e. relative market failure). (See Pitelis and Teece 2009). It is interesting to note that in her case study of the Hercules Powder Company (Penrose 1960) she provides a reason for non-vertical integration of Hercules’ customers and of Hercules itself, not only in terms of oligopolistic interaction’, but also in terms of the superior advantages of specialization (not integration) of Hercules.

  21 In his own unparalleled way, Marris (2002) describes his first encounter with Penrose’s ideas as follows: ‘my administrative task was carried out after teaching hours in the department office, which was then located in Downing Street. Naturally it was my habit to read any other interesting documents concerning faculty affairs which might happen to be lying around. In 1958 one such was a full set of the galley proofs of The Growth of the Firm. Obviously I was immediately attracted, I took all the sheets home for the night and by the time I had surreptitiously replaced them the next day, I had read every one. It turned out that the reason the proofs were in the office was the departmental appointments committee had decided to offer Edith a Cambridge lectureship, subject to interview. The interview duly occurred; there is no record of what transpired, except that no appointment was made. A bad day for Cambridge but in my opinion a good day for Edith, who I think would have been suffocated there’ (in Pitelis 2002, p. 62).

  22 It is also interesting to read the follow-up to this statement: ‘That I adopt a “‘weak” form of the profit-maximizing hypothesis is only a recognition of the fact that even in the strong form, maximum profits cannot be uniquely determined ex-ante in the face of uncertainty; that no ex-post outcome can be unequivocally identified as the maximum that would have been obtained; and that managerial and entrepreneurial attitudes towards uncertainty differ greatly among firms. The problem of “‘testability” and “‘refutability” I leave to others, who have long been puzzling over it, (p. 12).

  23 In reviewing a paper, which was building explicitly on her work (thus helping to revive it), Penrose recommended rejection (thankfully the paper was later published in another journal, went on to become very influential, and helped Penrose’s work to be recognized and acknowledged). She also discouraged attempts to formalize her work considering the ‘path’ more interesting than the equilibrium position (letter to M. Slater 16 July 1977). It is arguable that, despite its limitations, formalization would have made her ideas easier to be fathomed by economists.

  24 Even two book reviews of TGF more recently appeared, almost 50years on (Volpe and Biferali 2008; Nair, Trendowski, and Judge 2008).

  25 Resource allocation and creation are related. For example, a change in resource allocation can lead to resource creation. Yet, there is a difference in focus between the two perspectives (see below).

  26 Porter does not refer to Penrose and it is unlikely he has read her book. Williamson’s critique seems to be reinforcing Porter’s.

  1 See my ‘Biological Analogies in the Theory of the Firm’, American Economic Review, Vol. XLII, No. 5 (Dec. 1952), pp. 804–19.

  2 Indeed, after having laboriously worked out for myself what I took to be an important and ‘original’ idea, I have often had the disconcerting experience of subsequently finding the same idea better expressed by some other writer. I try always to mention such earlier expositions; I am sure that there are many I have overlooked, for which I offer advance apology.

  3 I am much impressed by Mrs. Joan Robinson’s insistence that ‘There is no advantage (and much error) in making definitions of words more precise than the subject matter they refer to’. ‘The Industry and The Market’, Economic Journal, Vol. LXVI, No. 262 (June 1956), p. 361.

  4 Charles H. Wilson’s History of Unilever (London: Cassell, 1954) is a model of what good firm histories can be. I have leaned heavily on this type of work (and there are some others), as well as on direct discussions with businessmen, for insight into the processes of firm growth.

  5 There is, incidentally, a great deal of useful information available in the ‘managerial’ literature which has, I think, been sadly neglected by economists who, however, are gradually beginning to take more seriously the literature of ‘management’, and of the businessman generally, largely owing, I suppose, to the insistent hammering of those empirically-minded economists who have a foot in each discipline.

  6 These lines were written in a slightly different form before Kenneth Boulding’s imaginative little book appeared. ‘Image’ is so apt a word for my purposes that I promptly appropriated it. See Kenneth E. Boulding, The Image (Ann Arbor: University of Michigan Press, 1956).

  7 I hope I shall be forgiven if, on occasion, I endow the firm itself with human attributes, considering it, not as a ‘legal person’, but, by analogy, as an ‘economic person’ (although not necessarily as the ‘economic man’). This fiction permits me to speak of the ‘firm’, rather than its managers or executives, acting in this way or that, and facilitates exposition in those cases where no distinction is required between the firm and the men who run it.

  8 Consequently the various attacks on the theory of the firm, whether they come from theorists emphasizing the effect of uncertainty or from investigators of the actual behaviour of firms, have failed to dislodge it from its key position in economic theory. To do so, even for the competitive case, would, as Hicks has pointed out, involve the ‘wreckage’ of ‘the greater part of general equilibrium theory’, which can hardly be accepted until something better has been evolved to take its place. J. R. Hicks, Value and Capital (Oxford: Clarendon Press, 2nd edn., 1946), p. 84.

  9 It is not surprising, therefore, that this firm is ‘. . . a strange bloodless creature without a balance sheet, without any visible capital structure, without debts, and engaged apparently
in the simultaneous purchase of inputs and sale of outputs at constant rates’. Kenneth Boulding, Reconstruction in Economics (New York: Wiley, 1950), p. 34.

  10 The effect of uncertainty is not always put in these terms—see, for example, M. Kalecki, ‘The Principle of Increasing Risk,’ Economica, Vol. IV (New Series) Nov. 1937, pp. 440–7—but most formulations can usually be expressed in terms of ‘corrected’ cost and revenue estimates. See Chapter IV for further discussion of this point.

  11 Chamberlin attempted to meet the problem by abandoning entirely the principle of a fixed factor and argued that mere increased complexity of organization would lead to the requisite rise in costs as the firm expanded. E. H. Chamberlin, ‘Proportionality, Divisibility and Economies of Scale’, Quarterly Journal of Economics, Vol. LXII, No. 2 (Feb. 1948), pp. 229–62. This does not get to the root of the matter, however, since complexity is a problem only if the capacity of men to deal with complexity is limited. Hence we are again back to the same point.

  12 Kaldor, for example, has defined the firm as a ‘productive combination possessing a given unit of co-ordinating ability’, and holds that ‘all the theoretically relevant characteristics of a firm change with changes in coordinating ability. It might as well be treated, therefore, as a different firm’. N. Kaldor, ‘The Equilibrium of the Firm’, Economic Journal, Vol. XLIV, No. 173 (March 1934), pp. 69–70. And Triffin explicitly states that for (his) theoretical purposes it is ‘better to say that a new firm has been created’ when the producer’s appraisal of cost and revenue conditions changes. Furthermore ‘each innovation modifies the level of profit opportunities attached to a firm or rather creates a new firm, provided with profit opportunities of its own. .. ’. Robert Triffin, Monopolistic Competition and General Equilibrium Theory (Cambridge: Harvard University Press, 1940), pp. 169–71.

  13 It is for this reason that I would reject the attempt of Andreas G. Papandreou to construct a concept of the firm which takes into account the firm as an organization without ‘doing violence to [the economist’s] main conceptual schema’. He holds that ‘organization theory and the economist’s theory of the firm are seen to converge, in fact, as soon as we introduce organizational techniques as data into the latter, side by side with the technological data’. Andreas G. Papandreou, ‘Some Basic Problems in the Theory of the Firm’, in Survey of Contemporary Economics, Vol. II, B. F. Haley, Editor (Homewood: Irwin, 1952), pp. 187–8.

  The economist’s ‘main conceptual schema’ is designed for the theory of price determination and resource allocation, and it is unnecessary and inappropriate to try to reconcile this theory with ‘organization theory’. E. S. Mason in his Comment (Ibid., pp. 221–2) is justified in confessing a ‘lack of confidence in the marked superiority, for purposes of economic analysis, of this newer concept of the firm, over the older conception of the entrepreneur’. If the study of the process of growth of firms is a legitimate purpose of economic analysis, however, then I think it can be shown that the ‘newer concept of the firm’ is of importance, but it should be clearly defined as a concept to be used for a different purpose from that of the traditional one.

  14 The concept of autonomy must not be taken too rigidly. It certainly can never mean complete independence of any external forces nor that there are not areas in which a firm is forced to adopt certain policies against its will. Furthermore, a firm can voluntarily give up its autonomy in certain respects, for example when it joins a price cartel, without becoming any the less a firm thereby.

  15 The brief discussion here of the nature of the firm’s administrative organization is not intended to contribute anything to the extensive literature on business organization nor to discuss the important issues in organizational theory or the significant problems connected with determining the functions of different groups within the firm. I am concerned only with those aspects of these large and complex subjects which will be of use in the theory of the growth of the firm to be developed later. However, the general view of the administrative functioning of a firm set forth here does not differ fundamentally from the concepts underlying the analyses of Simon, Barnard, Papandreou, and similar ‘organization theorists’, nor is it at variance with the findings of Gordon. Cf. H. A. Simon, Administrative Behavior (New York: Macmillan, 1945), Chester Barnard, The Functions of the Executive (Cambridge: Harvard University Press, 1938), Andreas G. Papandreou, ‘Some Basic Problems in the Theory of the Firm’, op. cit., and R. A. Gordon, Business Leadership in the Large Corporation (Washington D.C.: Brookings Institution, 1945).

  16 Compare the views, for example, of analysts as different as Nicholas Kaldor and Chester Barnard. Although Kaldor’s frame of reference is that of the ‘theory of the firm’ and thus fundamentally different from ours, nevertheless his conclusion, that ‘the technically optimum size of the individual firm becomes infinite or indeterminate’ in equilibrium, rests on essentially the same conception of the administrative task as that set forth here. Op. cit., p. 71. Barnard on the other hand, points out that ‘Systems of cooperation are never stable, because of changes in the environment and the evolution of new purposes. . . adjustment of cooperative systems to changing conditions or new purposes known as executives or executive organizations’. Chester Barnard, op. cit., p. 37 (Italics added).implies special management processes and, in complex cooperation, special organs

  17 The term is that of Chester Barnard, and is peculiarly appropriate because it leaves room for informal as well as formal ‘communications’ which are accepted as ‘authoritative’.

  18 See, for example, Papandreou’s discussion, op. cit., pp. 194–5.

  19 The National Resources Committee distinguished eight more or less clearly defined interest groups on the basis of interrelations between the corporations included in the group through interlocking directorates, minority stockholding, financial connections, etc. The largest, for example, it called the ‘Morgan-First National group’, ‘not because the separate companies are controlled by either J. P. Morgan and Co., or by the First National Bank of New York or by these two institutions in combination but rather because much of the interrelation between the separate corporations allocated to this group is brought about through these two institutions’. The eight interest groups included 106 of the 250 largest corporations and nearly two-thirds of their combined assets. See National Resources Committee, The Structure of the American Economy, Part I (Washington, D.C., 1939), pp. 160 ff.

  20 See, for example, George Stigler, ‘The comparative private costs of firms of various sizes can be measured in only one way; by ascertaining whether firms of the various sizes are able to survive in the industry.’ George J. Stigler, ‘Monopoly and Oligopoly by Merger’, American Economic Review, Vol. XL, No. 2 (May 1950), p. 26.

  21 I am avoiding the use of the term ‘factor of production’ precisely because it makes no distinction between resources and services, sometimes meaning the one and sometimes the other in economic literature.

  22 This ingenious term was proposed by Joan Robinson to denote ‘the purchase of titles to debts or shares’, and is used here to mean investments outside the firm which, though perhaps conferring some power to influence the behaviour of other firms, do not bring the other firms into the administrative orbit of the investing firm. See Joan Robinson, The Accumulation of Capital (London: Macmillan, 1956), p. 8.

  23 In this it differs fundamentally from the ‘theory of the firm’, the primary usefulness of which lies in the extent to which it explains the response in the economy as a whole to those types of change which the theory leads us to believe will affect the price and output decisions of firms. The usefulness of this type of theory is not dependent upon whether or not it helps to explain the behaviour of any particular firm (although it may do so); consequently the appropriate test of its usefulness does not lie in its applicability to particular firms.

  24 For this reason, it has sometimes been held that the ‘profit motive’ is weaker in the large corporations than in the small firm becau
se the various managers of the former have less personal ‘stake’ in the firm’s profits. There may be some truth in this, but the extensive use of impersonal accounting records with which to judge the performance of the individual business executives in charge of the various operations of the large firms may have exactly the opposite effect; the ‘profit motive’ may be sharpened simply because the personal preferences of the businessmen are more rigidly controlled in the interests of the firm.

  25 ‘. . . the distribution of dividends. . . is a problem in the theory of the firm analogous to the problem of the distribution of a consumer’s income between consumption and saving, and it presents similar analytical difficulties. From the point of view of the balance sheet a cash dividend represents a simple destruction of liquid assets. It is not an exchange, for no asset is created to correspond to the assets destroyed; it is, from the firm’s point of view, an act of more or less voluntary consumption. It may be asked, therefore, why should the firm ever perform such an act?’ Kenneth E. Boulding, A Reconstruction of Economics (New York: Wiley, 1950), p. 113.