Edith Penrose's theory of the growth of the firm and the strategic management of multinational enterprises.
| Verfasser | Buckley, Peter J. |
Abstract and Key Results
* This paper provides a formal model of Edith Penrose's Theory of the Growth of the Firm which has important implications for the strategy of multinational enterprises.
* The model provides an analysis of the trade-off between product diversification and foreign market penetration. It also can account for the speed of entry into foreign markets.
* Formalizing Penrose's Theory of the Growth of the Firm provides an account of internationalization incorporating geographical expansion patterns, sequential decision making and learning.
Key Words
Internationalization, Multinational Firms, Global Strategic Management, Edith Penrose, Foreign Market Entry, Product Diversification
Introduction
Foss (2002, p. 148) says "Penrose's work is, in the crucial dimensions, at variance with economic orthodoxy ... It should be thought of as a contribution to economic heterodoxy" Penrose and Pitelis (2002, pp. 19 et seq.), in describing Fritz Machlup as "Edith's supervisor" at Johns Hopkins says "A fascinating paradox is how Machlup, a doyen of neo-classical economics, should have been partially responsible for a work so far removed from the mainstream". Penrose has also been claimed as a feminist economist (Best/Humphries 2003). Our argument is that Penrose sought to create a theory of the growth of the firm which was logically consistent and empirically tractable. Her subsequent adoption as grandmother of the resource based view has only limited validity, based on a selective reading of her work and in defiance of its holistic qualities. See the debate between Rugman and Verbeke (2002, 2004) and Kor and Mahoney (2004) and Lockett and Thompson (2004), the latter based on Penrose's (1960) analysis of the Hercules Powder Company.
This paper presents a formalisation of Penrose's model contained in the Theory of the Growth of the Firm (1959) and applies it to the strategic decisions of multinational enterprises (MNEs). Previous research on Penrose and the multinational firm (e.g. Dunning 2003; Pitelis 2002, 2004) has focused on Penrose's overall contributions to strategic decisions in MNEs. This paper focuses solely on her 1959 model and compares it to the model of Buckley and Casson (1976). Interesting contrasts are found and a synthetic approach suggests that this combination is a useful basis for further theorising about the MNE and its strategic decisions.
In contrasting Penrose's theory with that of Buckley and Casson (1976), we shall see that the former's concentration on product diversification can be considered complementary to the latter's emphasis on innovation. Combining the two gives a satisfying model of the strategic management decisions within an MNE and opens up a new research agenda.
A Simple Formal Model of Penrose's Theory of the Growth of the Firm
The key to formalising Penrose's ideas is the recognition that she reformulated the familiar cost functions used in the theory of the firm. She argued that the average cost of output is independent of the scale of production, but increases with respect to the rate of growth. Thus in so far as the average cost curve is U-shaped, it is U-shaped with respect, not to the scale of production, as commonly assumed, but to the rate of growth.
The simplest way to understand this postulate is to recognise that average costs are increased by adjustments in the rate of output. Changing the rate of output has a bigger impact on average cost than setting steady state output at a higher or lower level. Changes in the rate of output dislocate the allocation of resources. This is particularly true for human resources. Employees are usually most productive when they repeat the same routines; furthermore, when their work is repetitive, productivity may improve as a result of learning on the job. As a firm grows, the internal division of labour has to change, and this forces people to change their roles. Their previous learning of job-specific skills becomes obsolete, as they return to the start of the 'learning curve' in their new job.
Change is expensive in other ways too. Plant and machinery have to reallocated to different uses, and this process needs to be managed, creating additional demands on the management team. As the management team grows, new recruits need to be trained. Through leaving their previous employment with another firm, and joining the expanding firm, these recruits incur the same costs of retraining as those who have changed their jobs within the firm. Indeed, their training costs are greater because they know little about the institutional context of their job. To train recruits, experienced managers have to be diverted from their usual work, adding to the dislocation described above.
Costs of change may be related either to the absolute amount of change or the proportional amount of change. A case can be made for both, but in the Penrose model it is the proportional and not the absolute amount of change that matters. In alternative models of growth, however, the absolute amount of change is key.
The formalisation of Penrose's theory is based on Buckley and Casson's (2004) recent interpretation of her major work (Penrose 1959). The model analyses a firm that grows through diversification at a steady rate. The central point of the model is that the firm faces 'costs of growth' which increase, not with the size of the firm, but with its rate of growth. The key to the model is the specification of these costs of growth.
Penrose viewed the firm as a 'bundle of resources' because she saw resources--in particular human resources--as both the key to the firm's success and the principal constraint on its growth. According to her theory, the tacitness of information--on which modern resource-based theory places so much emphasis--not only protects the secrets of the firm's entrepreneurial success, but also inhibits the assimilation of the additional human resources required to sustain its growth. The growth rate of the firm reflects a balance between the entrepreneurial dynamism which drives its diversification, and the difficulty of enlarging the firm's management team to exploit the resultant opportunities.
In the basic model, the profitability of the firm is independent of its size and depends only on its rate of growth. This leads to a simple formula for the value of a growing firm, as determined by the present value of its future profit stream. Managers serving shareholder interests will maximise this value, whilst managers pursuing their own objectives--such as status--may maximise growth instead. Penrose considered both objectives; the differences are small, however, because maximising profits not only maximises shareholder value but also facilitates the internal financing of growth (see also Baumol 1967, Marris 1964).
Penrose's central point is that there is, in principle, no limit to the size to which a firm can grow.
* There are limits to the extent to which a firm can grow within a single market, which are set by the overall size of the market and the existence of competitors within it. But a firm can evade any such market size constraint by diversifying into other markets.
* It is often said that because of U-shaped average cost curves, there is a unique optimal size of firm at which average cost is a minimum. However, the logic of the U-shaped average cost curve applies to physical plant and equipment rather than to a managerial unit such as a firm. A firm that cannot expand beyond optimum plant size can expand by increasing the number of plants it operates, either through replicating plants in the same market (horizontal integration), moving into other stages of production in the same market (vertical integration) or diversifying into different markets.
* Misleading analogies have been employed to suggest that there is a limit to the size of firm. Marshall's metaphor of the firms in an industry resembling the 'trees in a forest' is misleading because it ignores the fact that firms can regenerate themselves through managerial succession. More significant still, firms can merge with each other to sustain their growth, and metamorphose into new forms, as when a small firm with highly-centralised autocratic management merges with other small firms and turns into a large highly-decentralised multi-divisional firm. As a legal and contractual entity, a firm can in principle endure for ever.
* Managerial diseconomies of scale are often said to limit the size of firms, but such limiting factors are more properly regarded as diseconomies of growth. In other words, the costs that limit the size of a firm at any time are costs that limit its continued growth, rather than costs associated with the size to which it has already grown. It is therefore more appropriate to use the concept of an optimum rate of growth of a firm than an optimum size of firm.
* In terms of international expansion, Penrose can be interpreted as considering foreign subsidiaries as autonomous companies. As such, they are beyond the reach of the firm's administrative coordination. The absence of authoritative communication would thus put them beyond the boundary of the firm. There is a potential modification of our formalisation in which the rate of growth of firms of different sizes is the same up to the extent of the reach of coordination and then zero beyond it. This is not a realistic interpretation of modern multinational firms, especially given managerial learning and technological breakthroughs in communication and control of international expansion.
When analysing growth, the natural analogue of a theory of the optimal size of firm is a theory of the optimal growth rate of the firm, and this is essentially what Penrose provides. Because size of firm does not matter, there is no reason to believe that the firm's growth rate will vary systematically over its lifetime, and so it is reasonable to postulate the existence of a steady state rate of growth. The...
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