Economic Foundations of Strategy Chapter 5: Dynamic ResourceBased Theory: Resources

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Economic Foundations of StrategyChapter
5Dynamic Resource-Based Theory Resources

• Joe Mahoney
• University of Illinois at Urbana-Champaign

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Resource-Based Theory Dynamic Capabilities

• Penrose (1959)
  The Theory of
  the Growth of the Firm
• Chandler (1990)
  Scale and Scope
  The Dynamics of Capitalism

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Penrose (1959) The Theory of the Growth of
the Firm

• Penrose (1959) is concerned with the growth of
  firms and only incidentally with their size.
• The focus is on an internal process of
  development leading to cumulative movements of
  the firm in a particular direction.
• The emphasis is on the internal resources of
  a firm --- on the productive services available
  to a firm from its own resources, particularly
  the productive services available from management
  with experience within the firm.

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Penrose (1959) The Theory of the Growth of
the Firm

• Experience of management will affect the
  productive services that all its other resources
  are capable of rendering.
• As management tries to make the best use of the
  resources available, a truly dynamic
  interacting process occurs which encourages
  continuous growth but limits the rate of growth.
• The environment is treated as an image in the
  entrepreneurs mind.

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Penrose (1959) The Theory of the Growth of
the Firm

• A firm is more than an administrative unit a
  firm is also a collection of productive resources
  where the choice of different resources uses is
  made by managerial decision.
• Subjective productive opportunity set of the firm
  is determined by the resources and experiences of
  the management team and this perceived
  opportunity set is unique for each firm.

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Penrose (1959) The Theory of the Growth of
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.
• The capacities of the existing managerial
  personnel of the firm necessarily set a limit to
  the expansion of that firm in any given period of
  time, for it is self-evident that such management
  cannot be hired in the marketplace.

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Penrose (1959) The Theory of the Growth of
the Firm

• An administrative group is something more than a
  collection of individuals it is a collection of
  individuals who have experience in working
  together, for only in this way can teamwork
  develop.
• Experience that these managers gain from working
  within the firm and with each other enables them
  to provide services that are uniquely valuable
  for the operations of the particular group with
  which they are associated.

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Penrose (1959) The Theory of the Growth of
the Firm

• Existing management limit the amount of new
  management that can be hired (after all the
  services of existing management are required even
  to greet, let alone to install and instruct, the
  new personnel).
• Individuals cannot be hired from outside the
  group, and it takes time to achieve the requisite
  experience.

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Penrose (1959) The Theory of the Growth of
the Firm

• If a firm deliberately or inadvertently expands
  its organization more rapidly than the
  individuals in the expanding organization can
  obtain the experience with each other and with
  the firm that is necessary for the effective
  operation of the group, the efficiency of the
  firm will suffer.
• Since the services from the inherited
  managerial resources control the amount of
  new managerial resources that can be absorbed,
  they create a fundamental and inescapable limit
  to the amount of expansion a firm can undertake
  at any time.

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Penrose (1959) The Theory of the Growth of
the Firm

• The Penrose Effect
• The amount of activity that can be planned at a
  given time limits the amount of new personnel
  that can be profitably absorbed in the next
  period.
• Though learning, managerial services absorbed in
  the planning processes will be gradually released
  and become available for future projects.

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Penrose (1959) The Theory of the Growth of
the Firm

• Through experience comes excess capacity in
  firm-specific knowledge and resources that are
  subject to market frictions. Therefore, the
  firm seeks to expand in directions that will
  allow the utilization of these excess resources.
  Management is then confronted with a jig saw
  puzzle of how to utilize these resources.
• The limits to the rate of the growth of the firm
  are due to the The Penrose Effect where the
  current supply of managers with firm-specific
  knowledge cannot be spread too thin otherwise
  inefficiencies will result (i.e., there are
  dynamic adjustment costs).

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Penrose (1959) The Theory of the Growth of
the Firm

• Unused productive services of resources shape the
  scope and direction of the search for knowledge.
• If resources were completely non-specific, a firm
  could in principle produce anything.
• The selection of the relevant product-markets is
  necessarily determined by the inherited
  resources of the firm --- the productive services
  it already has.
• This search leads to new combinations of
  resources.

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Penrose (1959) The Theory of the Growth of
the Firm

• The concept of market imperfections is an
  important explanation for explaining firm-level
  diversification.
• Diversification and expansion based on a high
  degree of competence and technical knowledge in
  specialized areas of manufacture are
  characteristic of many of the largest firms in
  the economy. This type of competence together
  with the market position it ensures is the
  strongest and most enduring position a firm can
  develop.

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Penrose (1959) Key Ideas

• Firm growth can be studied as a dynamic process
  of management interacting with resources.
• Firms are institutions by people to serve the
  purposes of people.
• Services of resources are drivers of firm-level
  heterogeneity.

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Penrose (1959) Key Ideas

• Services that material resources will yield
  depend on the knowledge possessed by human
  resources. The two together create a subjective
  opportunity set that is unique for each firm.
• Firm-level growth is a function of firm-specific
  experiences in teams.
• Managerial capability is the binding constraint
  that limits the rate of the growth of the firm
  --- the so-called Penrose Effect

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Penrose (1959) Key Ideas

• Excess capacity of productive services of
  resources is a driver of firm-level growth.
• Unused productive services of resources can be a
  source of innovation.
• Firm-level diversification is often based on a
  firms competencies that can lead to sustained
  competitive advantage.
• An important component of the competitive process
  is experimentation.

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Chandler (1990) Scale and Scope The Dynamics
of Capitalism

• In the last half of the 19th century a new
  form of capitalism appeared in the United
  States and Europe.
• The building of the rail and telegraph systems
  called for the creation of a new type of business
  enterprise. The massive investment required to
  construct those systems and the complexities of
  their operations brought the separation of
  ownership from management. The enlarged
  enterprises came to be operated by team of
  salaried managers who had little or no equity in
  the firm.

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Chandler (1990) Scale and Scope The Dynamics
of Capitalism

• The new forms of transportation and
  communication, in turn, permitted the rise of
  modern mass marketing and mass production. The
  unprecedented increase in the volume of
  production and in the number of transactions led
  the entrepreneurs who established the new
  mass-producing and mass-distributing enterprises
  like the railroad personnel before them --- to
  recruit teams of salaried managers.

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Chandler (1990) Scale and Scope The Dynamics
of Capitalism

• Once modern transportation and communication
  systems were in place, the new institution and
  the new type of managerial personnel provided a
  central dynamic for continuous economic growth
  and transformation.

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Chandler (1990) Scale and Scope The Dynamics
of Capitalism

• Examines the beginnings and growth of the modern
  industrial enterprise in the worlds three
  leading industrial nations United States, Great
  Britain and Germany.
• Maintains that as a result of the regularity,
  increased volume, and greater speed of the flows
  of goods and materials made possible by the new
  transportation and communication systems, new and
  improved processes of production developed that
  for the first time in economic history achieved
  substantial economies of scale and scope.

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Chandler (1990) Scale and Scope The Dynamics
of Capitalism

• In order to benefit from economies of scale and
  scope, entrepreneurs had to make three sets of
  inter-related investments for achieving
  organizational capabilities
• Investment in production facilities large enough
  to utilize a technologys potential economies
• Investment in national and international
  marketing and distribution networks and
• Investment in managerial recruitment and
  training

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Chandler (1990) Scale and Scope The Dynamics
of Capitalism

• Organizational capabilities, in turn, provided an
  internal dynamic for the continuing growth of the
  enterprise.
• In particular, organizational capabilities
  stimulated its owners and managers to expand into
  more distant markets in their own country and
  then to become multinational by moving abroad.
  They also encouraged the firm to diversify by
  developing products competitive in markets other
  than the original one and so to become a
  multi-product enterprise.