The concept of the fluidity of the firm dominates the theoretical perspective and practical implications of Penrose (1959) when the aspects of the size of the firms and the growth of the firms are critically analyzed. Penrose believes that a firm should be limitless in size and should be perceived to be a dynamic body and these assumptions are true except when the firm is unsuccessful when it comes to exploiting its resources (Penrose, 1959). This assertion contradicts Coase’s (1937) theories which imply that the firm is static and has a particular optimum size where an entity would stop increasing. The emphasis of this essay would be to critically explore the theoretical perspective and practical implications of the Penrose (1959) theories in terms of size and growth of the firm by applying transaction theory of the firm by Coase (1937), adverse selection by Akerlof (1970), Eisenhardt’s (1989) agency theory, five forces analysis by Porter (1980), the resource-based view of the firm by Barney (1991) vertical integration and diversification.
The size and the Growth of the Firm
Metrics and Indicators of the Firm’s Growth
The firm’s size reflects the capacity of a particular business, and it describes the volume of the operations managed and churns out by a single firm. Realizing the size of an entity is a crucial entrepreneurial decision when it comes to organizing a business since it determines the profitability and the overall success of a firm (Penrose, 1959, p.45). There is a growing acknowledgement that the gap between Penrose’s views on the growth of the firm and the contemporary practices in modern businesses is not a mere transfer of the knowledge and strategies but also a knowledge production problem. One of the current issues that could be linked to the theory is the implication of the size of a firm on its growth or the strategies adopted.
According to the definition provided by the financial dictionary, firm growth is described as the expansion of a particular business in terms of its size over time (financial-dictionary.com) (Morris, Fier, & Liebenberg, 2017). From this lens, financial metrics such as the growth of assets, turnover, profit margins, working capital and number of employees could be applied in measuring the firm growth. Penrose (1959) gave an intriguing theoretical perspective, which elicited viewpoints on firm growth. Penrose portrayed a firm as more than an administrative unit since it is characterized by a collection of the productive resources available to different users and, over time, determined by administrative decisions (p.15). According to these viewpoints, the firm’s growth should be evaluated in terms of its essential function as an economic entity.
For example, a company that pursues an expansion strategy through diversification should evaluate its financial health, the attractiveness of the economic sector, availability of workforce and other external factors such as government regulatory policies (Morris et al., 2017). When the concepts of Penrose’s theory of the firm are examined in the lens of the current global market, it could be deduced that the majority of the firms are striving to increase their size in terms of efficiency, increased volumes of sales and improved influence of their brands. Some of the corporations have embarked on diversifying their brands by exploring various options to deliver their products and services (Samuels, 1995). These outcomes align with Penrose’s argument that excess or unused resources within a firm could be crucial since they can shape the direction and the scope of the activities, which explicitly affect the size of a business (Penrose, 1959, p.43).
It is worth noting that the size of a firm falls under the firm’s management, a concept drawn from Penrose’s arguments on the theory of the growth of the firm. The firm’s resources, including human resources, particularly organizational resources, are crucial to the size and the expansion of a firm. Any growth in terms of the size and functionality of an entity requires planning, which could be completed by the firm’s management (Morris et al., 2017). Firms are expected to be aware of the components that could trigger the growth of the business, thus drawing from Penrose’s suggestion on the strategies of raising capital that could enhance the expansion of a business entity (Samuels, 1995).
How competition shapes the Firm’s Growth
The implication of Penrose’s perspective on the factors affecting the growth of a firm included the increased application of Porter’s five forces framework by entrepreneurs when analyzing the operating microenvironment of competition of the firm. Porter (1980) identified threats of the new entrants, the threat of substitutes, the bargaining power of customers, bargaining power of the suppliers and competitive rivalry as the five forces that could shape the nature of the competition in the market, thus affecting the size and overall growth of a firm.The
Integration of the Management in the Growth of the Firm
Management is portrayed to be a crucial component in managing the growth of a firm. Managers are considered the key architects of the firms’ growth by facilitating the coordination and integration of the resources that propel an entity to desirable expansion outcomes. For example, Penrose (1959) illustrated that firms are organizations that people have developed to serve the interests and purposes of people. The managers are constantly motivated by the prospect of the growth of a firm by enduring the struggles for the business’ struggles and the need for accomplishment and recognition to generate exciting innovations and adaptive reactions through new resource combinations (p.35). From this theoretical perspective, it could be deduced that the firm’s growth is determined by the ability of the managers to facilitate a proper combination of the resources, translating into improved profits, larger working capital, improved turnover and an increase in the number of the employees (Whittington, 1975).
Penrose (1959) also reiterated that the experience of the managers within a particular corporation strongly correlates with the firm’s resources, which in turn affects the brand image of the whole business, thus giving it a valuable asset and unique productive opportunities (p.36). The usefulness of the company’s resources is depicted when managers coordinate and transform them into new products that could facilitate the growth of a firm. Perhaps the pertinent question should be on how managers can leverage their skills, competence and level of expertise to enhance the firm’s growth. From Penrose’s viewpoints, it is deduced that the newly acquired skills enable a manager to combine and allocate resources expertly, which results in innovation and increased dynamism of the firm, thus creating economic value for the business (Penrose, 1959, p.42). Under this scenario, Penrose’s ideology implies that a combination of various resources will elicit a relationship among them that would translate into value creation.
Combination of the Resources to Bolster Firm’s Growth
Nevertheless, it is important to acknowledge resources do not merely exist in a business. Still, they are assembled and combined to create new resources that align with the firm’s growth. This assertion aligns with Barney’s (1991) resource-based view (RBV) conceptualization. Various resources within an entity have an intimate relationship with each other, with the collective knowledge and experience, thus being integral to different aspects of an organization, such as the demand for its products. Under this concept, RBV is portrayed as a managerial guide that identifies the resources that a firm could optimize to accomplish a sustainable competitive advantage (p.101). From the perspective of RBV, it could be deduced that the growth of a firm depends on its managerial effectiveness in utilizing the resources at its disposal to enhance its overall performance. Barney (1991) argues that the approach applied in utilizing and configuring the available resources would enhance a firm’s performance and translate into a distinct competitive advantage, which is vital for the sustainable growth of a firm.
Under the dimension of the RBV, it revealed that the growth of a firm should be explained from the lens of how resources have been managed to improve the overall performance of a business and acquisition of a certain competitive advantage (Barney, 1991, p.102). These views align with Penrose’s argument that a firm’s resources should be specialized and efficient in specific functions and that unutilized resources should be availed to the areas that could potentially facilitate growth within an organization (Penrose, 1959, p.56). It follows that the unused resources are crucial since they affect the direction and the scope of the activities, which in turn impact the firm’s growth. This highlights the role of diversification and vertical integration for a firm that seeks to expand its operational base.
It is important to note that the RBV perspective on the growth of a firm is addressed in terms of the efficiency of the resource utilization, economic profit, competitive advantage and measurable profitable growth. According to Penrose (1959), these are the pillars of the RBV strategic management. They are a significant catalyst for a particular firm’s growth once the management effectively combines them. A link could be drawn between the views of Barney (1991) and Penrose (1959) on the RBV, which could then be applied in the contemporary developments on theorizing the RBV by generating and sustaining the competitive advantages in the current settings of the global business environment. Building on this argument, one could reiterate that firms are seeking to expand their operations vertically or horizontally by exploiting their excess resource capacity as defined by the market frictions (Porter, 1999).
Diversification and Integration as Indicators of Firm’s growth
Diversification is another dimension under which the growth of a firm could be analyzed. The uniqueness of the historical knowledge of a firm sets the precedence for diversification in a direction that optimizes its excess capacity of competencies. From Penrose’s (1959) concept of growth theory of the firm, the emphasis is on the dynamic and path-dependent organization learning. The firm’s knowledge endowment determines the rate and pattern of learning that an organization could accomplish within a particular period. It follows that the company’s distinct capacity to learn, adapt and diversify would set it above the competing firms (p.65). A firm that seeks to grow through diversification should establish knowledge endowments and entrepreneurial insights that would make it difficult for the competitors to imbibe its diversification strategy (Kay, 2012).
The size and the growth of the firm could also be critiqued from the lens of the firm’s ability to use its knowledge of the risk factors involved in the transactions to maximize the outcomes. Akerlof (1970) illustrated the applicability of adverse selection through the principle of lemons. From the theory of the growth of the firm, profit margin is identified as one of the crucial metrics that could be used in measuring the size and viability of a business venture. Akerlof excellently captured this aspect of the growth of the firm by introducing the concept of the profit maximization through adverse selection model. The explanation on the asymmetrical information between key players in the market distorting the market is crucial. For example firms are likely to enter into partnerships to eliminate adverse selection problem in transactions since partnership helps in establishing the trust between groups involved.
Certain instances made Akerlof’s (1970) concept on risk emanating from asymmetrical information on transactions inadequate, particularly on the threats posed by a conflict of interests among the shareholders as an entity grows. However, Eisenhardt (1989) outlined the agency theory offered a framework on how to address the conflicts that could arise from differences in risk aversion. The principle of agency theory has been at the heart of the firms seeking to expand their revenue base primarily through diversification strategy where the risks are spread out to other firm ventures.
The Dynamic and fluidity of the firm
Different theorists agree that the growth of the firm is fluid and dynamic. For instance, from Penrose’s (1959) theoretical perspective, it is illustrated that the growth of a firm is limitless, and it is subject to its capacity to optimize its available resources. Nevertheless, Coase’s (1937) contradicts this assertion by arguing that firms could not grow indefinitely. According to Coase, the firm’s expansion could result in decreasing returns to the owner, attributing to the growing costs of managing the additional transactions and activities within the firm (p.389). The increase in the number of transactions being managed by a firm following its expansion would also increase, increasing the chances of a business failing in optimizing the factors of production.
Coase (1937) also illustrates that a certain growth of a firm could result in underperformance since the entrepreneurs are likely to fail to give their optimum efforts, thus resulting in the limitation of a firm in achieving indefinite growth. This could be attributed to increased workload and pressure on the administration. This explicitly contradicts Penrose’s (1959) argument that the limitation of the firm’s growth is only linked to the limited capacity of its management. It could be deduced that the management of a given entity should not be a limiting factor but rather a catalyst for the overall growth of a firm.
For example, some propositions outlined by Coase (1937) fail are inconclusive when explaining markets contain more than one variety of products and the point at which the production of the new commodity in the market would be less costly than the previous one. Building on the drawbacks of Coase’s propositions and the strengths of Penrose’s ideologies, the firm’s growth involves all aspects of maintaining operational equilibrium and dynamic elements such as changing costs for a firm and the market.
Penrose’s ideologies on the growth of the firm have been crucial and continue being used as a managerial framework for the business entities seeking to expand their ventures. A crucial focus could be on the managerial concepts of the Penrose views on the size and the growth of the firm could be drawn from managerially operated companies which pursue objectives which are different to the short term profit maximization. This is a typical aspect of managerial capitalism which is a driving force to the contemporary businesses.
Akerlof, G.A. (1970) ‘the market for “lemons”: qualitative uncertainty and the market mechanism’, Quarterly Journal of Economics, 84 (3): 488-500.
Barney, J. (1991) ‘Firm Resources and Sustained Competitive Advantage’, Journal of Management, 17 (1): 99-120.
Coase, R. (1937) ‘The nature of the firm’, Economica, 4(16): 386-405.
Eisenhardt, K.M. (1989) ‘Agency Theory: An Assessment and Review’, Academy of Management Review, 14(1): 57-74.
Kay, N. (2012). Competitive Strategy. Edinburgh Business School, 23-78.
Penrose, E. (1959) The theory of the growth of the firm, New York: Oxford University Press.
Morris, B. C., Fier, S. G., & Liebenberg, A. P. (2017). The Effect of Diversification Relatedness on Firm Performance. Journal of Insurance Issues, 125-158. Retrieved from https://www.jstor.org/stable/44464643
Porter, M. (1980) Competitive Strategy, New York: Free Press, Ch1 (pp. 3-32).
Porter, M. (1999). Competitive Strategy: Techniques for Analyzing Industries and Competitors. Chicago: the University of Michigan.
Porter, M. (2004). Competitive Advantage: Creating and Sustaining Superior Performance. New york: Free Press.
Samuels, J. (1995). Size and The Growth of Firms. The Review of Economic Studies, 11-78.
Whittington, G. (1975). The Size and Growth of Firms. Oxford Press, 1-78.