Strategy - Chapter 7 “The Firm as an Administrative Organization T. Penrose

Introduction This chapter considered a theory of the firm that has as its focus the internal organization of the firm and the growth of firms through new products and techniques of productions

Introduction The main idea is that competitive advantage in an originations is derived from its unique mix of human and physical resources, and that the interaction between theses amounts to more than the sum of the individual parts. Each organization has its own unique bundle of resources which yield competitive advantage if they are difficult to substitute, replicate or imitate by other firms.

Firms in Penrose view are social organizations that produce products and services via planning, administration & organization. This is important because whereas traditional economic theory mainly considers the quantity of inputs that a firm owns. This approach considers how two firms that own the same inputs might differ greatly in their performance owing to differences in the ways that they organize, administer & plan the functioning of these inputs. How these physical & human resources are used depends on the internal dynamics of the org.

Resources consist of a bundle of potential services Resources consist of a bundle of potential services. The potential is discovered (and emerges) through the ways in which the resources are used. How they are used depends on managers` mental images, which define the possibilities and restrictions that are faced. These images determine a manager's view of his or her competitors and potential consumers, and the environment in general. The interaction between the manager's mental images and the physical resources at the manager's disposal determines the dynamic of firm growth or contraction

Penrose`s perspective is dynamic: services represent the transformation of resources over time. Penrose considers the difference between thinking of a firm In terms of the assets that it owns and thinking of a firm as an administrative org. which creates value by combining resources in specific ways. She suggests viewing the firm as a 'pool of resources' where resources include not just tangible resources (i.e. machinery & labs), but also intangible ones embodied in HR, like skills, knowledge & the ability to interact effectively.

The term 'growth' is used in ordinary discourse with two different connotations: Means increase in amount (i.e. growth in output, exports & sales). Some times used in its primary meaning implying an increase in size or an improvement in quality as a result of a process of development, processes in which an interacting series of internal changes leads to increases in size accompanied by changes in the characteristics of the growing object. Here it has the connotation of natural or normal – a process that will occur whenever condition are favorable because of the nature of the 'organism'; size becomes a more or less incidental result of a continuous on-going or unfolding process

'economic growth' and 'economic development' The term 'economic growth' and 'economic development' are often used interchangeably where 'growth' implies not only an increase in the national product but also a progressive changing of the economy.

The firm in theory In a private enterprise industrial economy the business firm is the basic unit for the organization of production. The greater part of economic activity is channeled through firms. The patterns of economic life, including the patterns of consumption as well as of production, are largely shaped by the multitude of individual decisions made by the businessmen who guide the actions of the business units we call firms.

Firm It is complex institution, impinging of economic and social life in many directions, comprising numerous and diverse activities, making a large variety of significant decisions. Influenced by miscellaneous and unpredictable human whims, yet generally directed in the light of human reason. The 'theory of the firm' determines the different uses of prices and allocation of resources, in order to be able to solve problems related to economic analysis.

The limits to 'size' The conditions of equilibrium analysis require that there be something to prevent the indefinite expansion of output of the individual 'firm'.

firm in 'pure' competition The limit to output is found only in the assumption that the cost of producing the individual product must arise after a point as additional quantities of its are produced.

firm in 'monopolistic' competition The limit is partly found in falling revenue as additional quantities of the product are sold. Without some such limit to the output of a given product (which means to the size of the firm) no determinate equilibrium position can be posited in static theory

The limits to 'size' The limitation of management (causing increasing long-run costs of production) The limitation market (causing decreasing revenue from sales) The limitation to uncertainty about future prospects (causing both increasing cost of larger outputs and decreasing revenue from larger sales because of the necessity of making allowance for risk) to provide a limit to the size of firm .

Penrose argues that the limits to growth lie in the internal dynamics of a firm, not in the structure of costs or market demand. The traditional theory claims that a firm's size is limited whether by falling market demand and/or by the presence of decreasing returns to scale. Traditional economic theory holds that a firm's size is limited by the eventual rise in unit costs that a firm incurs when its surpasses its optimal or 'equilibrium' size (where size is measured by quantity produced in a given time period). Decreasing returns may arise because after surpassing a certain size firms are less able to efficiently co-ordinate production (perhaps because managerial talent is scarce and larger size requires more managerial co-ordination). Penrose claims that the assumption of decreasing returns presumes a static environment where large firms are not able to decentralize their administrative structure in order to deal with management problems. Also, it argues that since firms can adapt to changing environments, there is no reason to think that decreasing returns will necessarily occur

What does limit growth? The answer lies in the internal structure of the firm, which dependent on the way in which tangible and intangible resources interact. This interaction is not something that can be bought but that is learned over time. Some firms and characterized by efficient and productive interaction between employees, while others are characterized by tense and not very efficient interaction. It is through experience that people learn to work together, to be a team (there is no blueprint or job description that describes how this is done). Employees` ability to function efficiently as a team: to administer, plan and organize production in such a way that the physical and human resources interact in an efficient and flexible manner.

Why should a firm's ability to administer, plan and organize be endangered when it expands Large firms become so bureaucratic that information is processed slowly. It is not possible to buy managerial ability, only managers. New managers do not have the level of experience and understanding of the internal organization possessed by existing managers. Working relationships can't be defined in a blueprint or job description.