A firm may fail to survive in any identifiable form without failing in a financial sense at all. A very successful firm may find it more profitable to merge with another firm, and thus lose its identity, than to continue independently. This may be classed as an expansion of the acquiring firm if the latter merely absorbs the former in its own administrative framework and maintains its own identity. Or the merger may be classed as a new firm if the change in the administrative structure of both firms is so extensive that it seems more appropriate to do so. In both cases firms have disappeared without failing. In one case a new firm is created, in the other not.
Survival in this sense is sometimes as much determined by the legal framework within which a firm operates as by the economic ‘viability’ of the firm. The laws regulating bankruptcy and corporate reorganization as well as the attitude of the courts may be decisive in many cases. If the firm is a large one with extensive financial connections, the courts are prone to do everything possible to avert its failure as a going concern, and it may operate for years in an insolvent (‘failed’) condition. Since any particular firm is a legal as well as an economic institution, these considerations should not be ignored; they are of great practical importance for the growth and size of many firms in the economy, but at the same time they make it extremely difficult to use survival as a test of ‘comparative private costs’ or of adaptability to the environment, as some economists have attempted to do.20
Clearly all of these problems must be taken into consideration in any empirical study of the growth of firms. For our present purposes it is not necessary to be more precise; it is enough merely to indicate the nature of the unit with which we are concerned and some of the criteria which should in practice be applied to define its boundaries. I doubt whether any ‘rules’ could be laid down for the application of the criteria which would obviate the necessity of judgment in individual cases, with the consequent differences of opinion. In any event, in most empirical economic investigations the ability of the analyst to adopt a satisfactory definition is severely restricted by the form in which the data appear, and he usually has to make do with a rough approximation of the thing he really wants to measure. Consequently further abstract definition of the firm as an administrative unit would serve no useful purpose here.
The Firm as a Collection of Productive Resources
The cohesive character that an administrative organization imparts to the activities of the people operating within it provides the justification for separating for analytical purposes such a group from all other groups. The activities of the group which we call an industrial firm are further distinguished by their relation to the use of productive resources for the purpose of producing and selling goods and services. Thus, a firm is more than an administrative unit; it is also a collection of productive resources the disposal of which between different uses and over time is determined by administrative decision. When we regard the function of the private business firm from this point of view, the size of the firm is best gauged by some measure of the productive resources it employs.
The physical resources of a firm consist of tangible things—plant, equipment, land and natural resources, raw materials, semi-finished goods, waste products and by-products, and even unsold stocks of finished goods. Some of these are quickly and completely used up in the process of production, some are durable in use and continue to yield substantially the same services for a considerable period of time, some are transformed in production into one or more intermediate products which themselves can be considered as resources of the firm once they are produced, some are acquired directly in the market, and some that are produced within the firm can neither be purchased nor sold outside the firm. All of them are things that the firm buys, leases, or produces, part and parcel of a firm’s operations and with the uses and properties of which the firm is more or less familiar.
There are also human resources available in a firm—unskilled and skilled labour, clerical, administrative, financial, legal, technical, and managerial staff. Some employees are hired on long-term contracts and may represent a substantial investment on the part of the firm. For some purposes these can be treated as more or less fixed or durable resources, like plant or equipment; even though they are not ‘owned’ by the firm, the firm suffers a loss akin to a capital loss when such employees leave the firm at the height of their abilities. Such human resources may well be on the payroll for considerable periods of time even though their services cannot be adequately used at the time. This may sometimes be true also of daily or weekly workers. They, too, may often be considered as a permanent ‘part’ of the firm, as resources the loss of whose services would involve a cost—or lost opportunity—to the firm.
Strictly speaking, it is never resources themselves that are the ‘inputs’ in the production process, but only the services that the resources can render.21 The services yielded by resources are a function of the way in which they are used—exactly the same resource when used for different purposes or in different ways and in combination with different types or amounts of other resources provides a different service or set of services. The important distinction between resources and services is not their relative durability; rather it lies in the fact that resources consist of a bundle of potential services and can, for the most part, be defined independently of their use, while services cannot be so defined, the very word ‘service’ implying a function, an activity. As we shall see, it is largely in this distinction that we find the source of the uniqueness of each individual firm.
Ideally, the size of a firm for our purposes should be measured with respect to the present value of the total of its resources (including its personnel) used for its own productive purposes. This is almost impossible to discover in practice, and in the absence of any really satisfactory measure of size we have a wide choice depending on our purpose. For the most part, though not always, the analysis of the growth of firms that is developed in the following chapters is most directly applicable to their growth measured in terms of fixed assets. This measure has its own disadvantages and there is no overwhelming reason for choosing it rather than another; adaptations of the analysis can be made to meet the requirements of nearly any measure, and at appropriate points in the following pages various problems of measurement will be discussed. As I have indicated, however, the use of total assets may distort the size of the firm as a productive unit because it includes the ‘placements’22 of a firm which may be large simply because the firm is unable to expand its productive operations fast enough to make full use of its cash resources. This point will become clearer as we analyze the process of growth.
The Motivation of the Firm
We cannot leave this discussion of the functions and nature of the firm without making a few remarks about the ‘motivation’ of the firm—why it acts as it does. It is reasonable to assume that the people making decisions on behalf of a firm are acting in the light of some purpose, yet it is notoriously difficult to discover the true purposes of anyone. On the other hand, purposive behaviour cannot be understood if one does not know what the purpose is. Therefore if the economist is to understand the behaviour of firms he must make some assumption about why they do what they do. The more he believes that his assumption corresponds to the true motives, the greater will be his confidence in a theory designed to explain the behaviour of firms. It is possible that his theory may be very useful for analysis and for prediction, even if he is not very happy about the ‘realism’ of his assumption, but the theory will not satisfy his desire to ‘understand’, and his confidence in it will be correspondingly reduced.
Accordingly, a theory purporting to explain the process of growth of firms can be useful on two levels. It can be useful even if it only presents a logical model yielding conclusions which seem to correspond to actual events that can be ‘observed’ in the growth of actual firms. But it will be even better if it helps us to understand the actions behind these events. For this, if we assume that firms act
for a purpose, we must find an acceptable assumption as to why they act. In either case, the usefulness of the theory can only be tested against facts relating to particular firms.23
The Profit Motive
The assumption on which this study is based is simply that the growth of firms can best be explained if we can assume that investment decisions are guided by opportunities to make money; in other words that firms are in search of profits. But then the further question arises, why should a firm, or more accurately the managers of a firm, always want to make more profits? The ‘profit motive’ when applied to individuals is usually based on the psychological assumption that increases in income and wealth have personal advantages for the individual which will spur him to obtain what he reasonably can.24 The profits of a firm do not confer such advantages on individuals unless they are paid out as income to individuals. From this it is often concluded that a firm is interested in making profits in order to pay out dividends to owners. To be sure, some dividends must be paid to maintain the reputation of the firm and, in particular, its attractiveness to investors as the source of future funds, but why should a firm ever want to pay out more than this if owners are not in a position to force it to do so?25
Almost every large firm today is appropriately classed as ‘management controlled’, that is to say, most firms that have grown large (according to any of the commonly accepted criteria of what is large) have reached a size where either the ownership equity is widely shared, or the owners’ control of operations is in practice effectively limited by the managerial bureaucracy.26 Salaried managers have little or nothing to gain by paying out more than is necessary to keep existing shareholders from complaining in force, to attract any additional capital that may be needed, and in general to build up or to maintain the reputation of the firm as a good investment. On the contrary, the managers of a firm have much more to gain if funds can be retained and reinvested in the firm.27 Individuals thereby gain prestige, personal satisfaction in the successful growth of the firm with which they are connected, more responsible and better paid positions, and wider scope for their ambitions and abilities. On this view, dividends would be looked on as a cost to be kept to a level no higher than necessary to keep investors happy; providers of capital, like providers of labour services, must be remunerated, sometimes handsomely, but a desire to remunerate them as handsomely as possible is not a plausible explanation of the behaviour of modern corporations.28 Even owner-managers often seem to be more interested in the growth of their firm than they do in the income they withdraw from it. Small businessmen frequently tend to identify themselves with their firm and to view it as their life’s work, as a constructive creation to which they can point with pride and which they can pass on in full strength to their children. To this end they often prefer to reinvest their profits in the firm rather than outside and to draw only moderately on profits for their personal consumption.
It seems reasonable, therefore, to assume that in general the financial and investment decisions of firms are controlled by a desire to increase total long-run profits.29 Total profits will increase with every increment of investment that yields a positive return, regardless of what happens to the marginal rate of return on investment, and firms will want to expand as fast as they can take advantage of opportunities for expansion that they consider profitable.30 On this assumption, we would expect a marked tendency for firms indefinitely to retain as much profit as possible for reinvestment in the firm; we would also expect that funds that could not be profitably used would be invested instead of being used substantially to raise dividends, unless higher dividends were required to attract further equity capital. In other words, profits would be desired for the sake of the firm itself and in order to make more profit through expansion. The proposition, thus baldly stated, may to some seem to imply extreme and almost irrational behaviour. Yet it is, to my mind, the most plausible of the various possible assumptions.31
Long-Run Profits and Growth
The assumption that the managers of firms wish to maximize long-run profits derived from investment in the enterprise itself has an interesting implication for the relation between the desire to grow and the desire to make profits. If profits are a condition of successful growth, but profits are sought primarily for the sake of the firm, that is, to reinvest in the firm rather than to reimburse owners for the use of their capital or their ‘risk bearing’,32 then, from the point of view of investment policy, growth and profits become equivalent as the criteria for the selection of investment programmes. Firms will never invest in expansion for the sake of growth if the return on the investment is negative, for that would be self-defeating. Firms will never invest outside the firm except eventually to increase the funds available for investment in the firm. To increase total long-run profits of the enterprise in the sense discussed here is therefore equivalent to increasing the long-run rate of growth. Hence, it does not matter whether we speak of ‘growth’ or ‘profits’ as the goal of a firm’s investment activities.
There is no need to deny that other ‘objectives’ are often important—power, prestige, public approval, or the mere love of the game—it need only be recognized that the attainment of these ends more often than not is associated directly with the ability to make profits. There surely can be little doubt that the rate and direction of the growth of a firm depend on the extent to which it is alert to act upon opportunities for profitable investment. It follows that lack of enterprise in a firm will preclude or substantially retard its growth, although ‘enterprise’ is by no means a homogeneous quality, a problem to which we return in the next chapter.
III
The Productive Opportunity of the Firm and the ‘Entrepreneur’
Growth limited by a firm’s ‘productive opportunity’. The role of enterprise and the competence of management. Difference between entrepreneurial and managerial competence. The quality of entrepreneurial services. Entrepreneurial versatility. Fundraising ingenuity. Entrepreneurial ambition. Entrepreneurial judgement. The role of expectations in the productive opportunity of the firm.
THE business firm, as we have defined it, is both an administrative organization and a collection of productive resources; its general purpose is to organize the use of its ‘own’ resources together with other resources acquired from outside the firm for the production and sale of goods and services at a profit; its physical resources yield services essential for the execution of the plans of its personnel, whose activities are bound together by the administrative framework within which they are carried on. The administrative structure of the firm is the creation of the men who run it; the structure may have developed rather haphazardly in response to immediate needs as they arose in the past, or it may have been shaped largely by conscious attempts to achieve a ‘rational’ organization; it may consist of no more than one or two men who divide the task of management; or it may be so elaborate that its complete ramifications cannot even be depicted in the most extensive chart. In any event, there need be nothing ‘fixed’ about it; it can, in principle, always be adapted to there quirements of the firm—expanded, modified, and elaborated as the firm grows and changes.
The productive activities of such a firm are governed by what we shall call its ‘productive opportunity’, which comprises all of the productive possibilities that its ‘entrepreneurs’ see and can take advantage of.33 A theory of the growth of firms is essentially an examination of the changing productive opportunity of firms; in order to find a limit to growth, or a restriction on the rate of growth, the productive opportunity of a firm must be shown to be limited in any period.
It is clear that this opportunity will be restricted to the extent to which a firm does not see opportunities for expansion, is unwilling to act upon them, or is unable to respond to them. We shall examine later the considerations determining the kind of opportunity a given firm will perceive, and determining its ability to take advantage of what it does see; but at the very least we have to assume that the firm
is eager and willing to find opportunities and is not hindered in acting on them by ‘abnormally’ incompetent management. In other words the firms with which we shall be concerned are enterprising and possess competent management; our analysis of the processes, possibilities, and direction of growth proceeds on the assumption that these qualities are present in the firm.
It may be that most firms do not grow, that failure is more common than success, that over the long, long period, firms, like Schumpeter’s lemmings, follow each other in succeeding waves into the sea and drown, or even that ‘death and decay’ are ‘inherent in the structure of organization’.34 These things we do not know. We have neither the facts to disprove them nor convincing theoretical presumptions to support them.
We do know, however, that large numbers of firms have survived for long periods, and that there is at present no conclusive evidence that they have reached or are even near the end of the road—that they will not continue growing indefinitely. We know that other firms have been successfully established since the late 19th century, which, for our purposes, can be considered the beginning of the ‘corporate age’ marking the end of a necessarily close connection between the fortunes of firms and the fortunes of families. Many of the relatively young firms show the same characteristics which mark the successful older firms. These are the types of firms we are concerned with; and the fact that we deal only with enterprising firms possessing or able to attract competent management does not prejudge any part of our argument. It merely provides us with a class of firms which are capable of growing. In the absence of such firms there would be no need for a theory of growth.
Enterprise, or ‘entrepreneurship’ as it is sometimes called, is a slippery concept, not easy to work into formal economic analysis, because it is so closely associated with the temperament or personal qualities of individuals. This extremely personal aspect of the growth of individual firms has undoubtedly been one of the obstacles in the way of the development of a general theory of the growth of firms. It is important, therefore, to examine briefly the nature of ‘enterprise’ and to indicate its significance and the role it will play in our analysis.
Theory of the Growth of the Firm Page 10