The Continued Dominance of Large Firms
In spite of the weakness of the data, there can be little doubt that the place of the large firms over the last fifty years has been remarkably secure and seems in many ways to become more secure as they grow bigger. Even a slow decrease in concentration need not substantially undermine their importance, and, potentially at least, they are in a powerful position to impose serious restrictions on the entry of smaller firms into the interstices. In a recent study the identity of the 100 largest industrial firms (measured in terms of total assets) were compared for every decade from 1909 to 1948.265 If the list of firms in 1909 is taken as it is presented (unfortunately it includes a number of large merger-created ‘firms’ which were primarily financial structures and not at any time fully established as industrial firms, and which disappeared very soon after their creation) and if allowance is made for merger and acquisition within the group of largest firms, it appears that some 48 per cent of the largest firms in 1909 can be found among the 250 largest manufacturing firms as listed by the Federal Trade Commission 30 years later, and 60 per cent among the first 500.266 Again making allowance for merger, only five of the first 50 in 1919 were not listed among the 100 largest in 1948, and of the 100 largest in 1919, 80 percent were among the 200 largest as listed by the F.T.C. in 1948.267
The process of deconcentration, if it has set in the United States, is clearly very slow, although it might be greater than appears if one measured it excluding the purely financial assets of firms. Fluctuations in economic activity may retard it in the future and may even reverse it for significant periods of time. But the more important consideration governing the course of concentration is likely to be found in the extent to which large firms will be able to set up ‘artificial’ barriers against expansion of smaller firms into the interstices. As we have seen, some of the competitive disadvantages of the smaller firms are part and parcel of the very conditions which account for the superior ability of the larger firms, in particular their apparent superiority in research, their easier access to capital, and their ability to attract and hold the confidence of consumers. These advantages of large firms will not necessarily promote further increases in concentration in a growing economy; for if the large firms are to maintain their position in the various fields in which they operate, their performance must be acceptable to consumers. This, together with ‘big business’ competition, will restrict their ability to take advantage of all the opportunities for profitable investment that open up in a changing and growing economy. In the absence of artificial barriers to their expansion, the smaller firms have a chance to grow until they too achieve positions in which their growth is no longer handicapped by their size.
Conclusion
A strong case can be made for the big firm and for ‘big business’ competition, especially with respect to the rate of development of new technology and new and improved products, and it may be that economists have been slow to recognize some of its advantages.268Part of the reason for this, I think, can be traced to the influence on economic analysis of the so-called ‘theory of the firm’, which has tended to confine the theoretical approach to the firm within the frame of reference provided by the traditional categories of monopoly and competiton and by the problems of price and output determination. In consequence, this part of economic theory has attained a high state of refinement, but, as we saw in Chapter II, it does not provide suitable tools for the analysis of the growth and, in particular, of the innovating activities of firms treated as administrative organizations free to produce any kind of product they find profitable.
We have been concerned in this study with questions that the traditional ‘theory of the firm’ was not designed to answer, and from our analysis, in particular from the distinction between the economies of size and the economies of growth, have come a number of propositions which are relevant for the appraisal of the place of large and growing firms in the modern world. Let us briefly review some of the conclusions we have reached.
1. There is no evidence to support the proposition often advanced that ‘diseconomies of size’ will arise at some point in a firm’s growth and that the large firms will eventually become inefficient. They may reach a stage where their structure and behaviour become more akin to those of financial holding companies than of industrial firms, thus raising the question whether the two types of firm should be examined with the same type of analysis, but the efficiency of their productive activities need not suffer because of the change in organizational form.
2. Equally there is no evidence, and indeed there is a presumption to the contrary, that the largest firms enjoy economies in the production and distribution of their existing products that would disappear if these operations were carried on in a smaller administrative framework. Economies of large-scale operation are indeed important up to a point, and the minimum size of firm which can take full advantage of them in particular types of economic activity may be fairly large, but it is likely that this minimum is far below the size of the largest firms in the United States, as well as in many other industrial economies today.
3. On the other hand, no matter how large a firm becomes, economies of growth are still available to it. Up to a point economies of growth may be of a kind that give large firms an advantage in expansion over smaller firms; these are properly treated as economies of size, as well as economies of growth; but they differ greatly from the traditional economies of large-scale production and operation. They often make it possible for large firms to expand more efficiently than smaller firms, but by their very nature, particular economies of growth disappear once an expansion based on them has been completed; they facilitate expansion, but they do not endure throughout the subsequent operations. Any continuing advantages the large firm may have in subsequent operating activities will not rest on the economies of growth that gave it the initial advantage but, unless other economies of size are present, merely on the advantages normally possessed by any established producer with the appropriate type of resources.269 The great prestige of the large firm rests on its ability to explore, to experiment, and to innovate; it is this ability, together with the market position (carefully cultivated by advertising) that its reputation, and the reputation of its products, can command, which give rise to many of its economies in expansion.270 Again, however, there is no evidence that the largest firms have appreciably greater economies of growth, even of this kind, than do the smaller of the large firms.
4. Economies of growth exist for all sizes of firm, and therefore growth for any size of firm may be an efficient use of resources both from the point of view of the firm and from the point of view of the economy as a whole.
5. To the extent that the economies of size available to the large firms are primarily economies of growth, no loss in efficiency would result if those activities that are already established and run more or less as separate ‘businesses’, were divorced from the parent firm and permitted to operate as independent businesses. There is every reason to presume that the ‘new’ firms thus created would continue growing, taking advantage of their own economies of growth, without any reduction in the efficiency of production or distribution of either the original firm or the new ones created. The decentralized type of organization that is becoming increasingly characteristic of the large firm facilitates the severance of a particular business from the rest; this is shown in the growing numbers of such ‘businesses’ that are bought and sold by the large firms.
To be sure, attempts of the government to force large firms to divest themselves of any of their operations would meet political, legal, and psychological objections—in particular, the incentive of the large firms to create and to take advantage of opportunities for growth would probably be impaired if the procedure were frequent and widespread. To restrict the innovating, competitive expansion of the big firms could possibly reduce the rate of technological advance both in the process of production and in the kind and quality of end products produced.
The diversification of these firms is itself a response to changing economic opportunities and is made possible by extensive innovations in administrative organization. In both respects big firms have led the way in experimentation.271
6. There is a limit to the rate at which any firm can grow, a limit provided by the capacities of its existing management. Although the large firms may continue to undertake very large amounts of expansion, their rate of growth will, after a point, begin to fall, especially under the impact of big business competition. In a progressive and expanding economy, the reduction in the rate of growth of the largest firms will retard the process of industrial concentration, and may eventually lead to a decline in concentration—provided that the interstices in the economy are not artificially closed against the smaller firms.
7. To the extent that small firms are prevented from taking advantage of economies of growth by artificial restrictions on their ability to expand into those areas not occupied by the larger firms (which we have called the ‘interstices’), resources in the economy will be inefficiently used.
8. It cannot be too forcefully emphasized that the whole case made by the advocates of big business rests on the insistence that competition in a very real and pressing form is constantly and powerfully in evidence. Hence, the case as presented breaks down if a few big firms get so big or so powerful that they are in a position substantially to restrict competition among themselves. It has recently been suggested that the largest firms in the United States today are not yet big enough to take full advantage of the opportunities for continued research and discovery, and that some form of ‘super cartel’ will be required272 At the same time it is argued, and quite reasonably, that the fruits of extensive research and development must be protected from competition, and must accrue to those who make the investments required to produce them.
Here is the basic dilemma: competition is the essence of the struggle among the large firms that induces and almost forces the extensive research and innovation in which they engage and provides the justification for the whole system; at the same time the large firms expect reward for their efforts, but this expectation is held precisely because competition can be restrained.
9. Because there is a limit to the amount of expansion any firm, no matter how large, can undertake in a given period, there is no reason to assume that the large firms as a group can effectively exploit all of the opportunities for profitable investment that they themselves create in the economy. They may be expected to insist on retaining the power to protect themselves against competition, but so far as they get such protection by means other than their superior ability to produce, to innovate, and to attract consumers, the interstices in the economy are reduced ‘artificially’, and not only will their dominant position be maintained, but the growth of the economy itself may be kept down.
If the case for big firms, and for big-business competition, is a strong one, its strength rests on conditions that are not self-perpetuating, but may themselves be destroyed by collusion, by the extension of financial control, and by the struggle to resolve the contradictions in a system where competition is at once the god and the devil, where the growth of firms may be efficient but where their consequent size, though not in itself inefficient, may create an industrial structure which impedes its own continued growth.
APPENDIX
Foreword to the Third Edition
By Edith Penrose
There has long been much discussion of the behaviour, growth, organizational structures, and managerial problems of firms. One of the earliest and most important was the work of Alfred Marshall both in his Principles and his Industry and Trade. In 1937 Coase published his classic article in Economica on ‘The Nature of the Firm’, which was little noticed for some years. In the few years after the publication of The Theory of the Growth of the Firm in 1959, a number of important works came out in which similar ideas to many of my own were independently developed by others. Two early books dealing with the factors determining the growth of firms, Chandler’s Strategy and Structure and Marris’s Economic Theory of Managerial Capitalism were published in 1962 and 1964 respectively. Chandler’s book was finished before The Theory of the Growth of the Firm appeared, but the analytical structure within which its historical analysis was cast was remarkably congruent with my own work, using much the same concepts and very nearly the same terminology at many points. Although Marris did take account of my work, with generous acknowledgement, his own research and basic arguments had been well developed earlier and constituted a significant advance in the role of firms in ‘managerial capitalism’ generally consistent with, but adopting a very different approach, extending and modifying my own. It is not feasible here to attempt to refer to much of the work that quickly followed but I should like to mention a relatively neglected but splendid pioneering article by G. B. Richardson. ‘The Organization of Industry’, published in 1972 in the Economic Journal, which anticipated much that was to follow.
By the middle of this century the neoclassical ‘theory of the firm’, that is to say, the theory of perfectly competitive markets, relative prices and Pareto optimal resource allocation, could reasonably be looked on as a ‘mature science’ in the Kuhnian sense of a set of received propositions, the practitioners of which were trained in a rigorous traditional theory embodying well-established mathematical and verbal techniques; but they did not deal with institutions. They still form a particularly vigorous culture in economic science, dominating the teaching of economic theory but using a definition of economics very different from that of Alfred Marshall’s ‘study of mankind in the ordinary business of life’ in the opening words of Book I (8th edition 1920).
Students of industrial economics existed in a kind of border area of ‘applied’ economics. Sociologists, institutionalists, behavioural psychologists, business analysts (and especially business school teachers) dealing with economic matters were clearly of lesser ‘scientific’ standing. They had no ‘hard’ integrated theoretical foundation for their type of economics. The occasional free-thinking economists were treated with respect and interest (provided that they had already earned their spurs), but it was difficult to see what could be ‘done’ with their ideas, what use could be made of them for the real problems of theoretical economics, which had largely to do with building models of market equilibrium, resource allocation, prices and welfare maximization. In the United States there was often much argument about, and resistance to, the acceptance of business studies in a good department of economics. Traces of this attitude still exist today, but now it almost seems at times as if ‘business studies’ with their appropriate models and statistical tests are taking over the analysis of the firm almost entirely, leaving the traditional microeconomics to concentrate on perhaps its most useful function as the theoretical foundation of the theory of the macroeconomic behaviour of the economy, for which the ‘firm’ as an organization is thought to be irrelevant.
Nevertheless, the ‘firm’ in the traditional ‘theory of the firm’ has been a source of constant theoretical trouble partly because it was extremely difficult to see why at its profit maximizing equilibrium it should not be of a size that destroyed the very foundations of the theoretical model of a perfectly competitive economy. Without a conceptual equilibrium economists could not predict the direction of the response of an economy to exogenous disturbances, and without the assumed perfect competition they could not assert the superior welfare efficiency of competitive markets. Few economists thought it necessary to enquire what happened inside the firm—and indeed their ‘firm’ had no ‘insides’ so to speak. I do not say they were wrong, only that, being theoretical economists, they saw reality differently from other people and asked different questions about it. It is not in my opinion useful to attempt to ‘integrate’ the different approaches.
The neoclassical aspect of the subject continued to dominate theoretical economics until the last quarter of this century, and still seems to have the highest prestige. B
ut along side it has come a literal explosion of new literature on the behaviour, management, theories, and policies of business firms as organizations. There are many reasons for this: the rise of business schools, the rapid increase in PhDs relating to management and business in Universities and the consequent increase in applied economic studies of firms, the clear need for new ways of thinking about the emerging nature of a different type of industrial society, including the development of new forms of firm organization, which was often stimulated by a burst of interest in the Japanese firms and their success, and perhaps more recently the growth of evolutionary thinking in economics generally and the increasingly perceived limitations of the explanatory efficacy of ‘static’ neoclassical economics in the modern world. (See for example the works of Nelson and Winter (1982) and Geoffrey Hodgson (1988).)
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