Penrose Effect Penrose Stated That "Firm Knowledge

Penrose Effect Penrose stated that "firm knowledge and experience gives rise to excess resources that can be redeployed" towards other opportunities in the marketplace. It is by this means that firms grow (Goerzen & Beamish, 2007). This growth, however, was not sustainable internally, because in firms characterized by predominantly internal management did not growth their knowledge and experience quickly enough to sustain a high level of growth.

The Penrose Effect, therefore, is that firms will deliberately slow down their rate of growth in order to maintain operational effectiveness following a period of rapid growth (Tan & Mahoney, 2005). The Penrose Effect can affect everyday management decision making by calling attention to managers the need to management growth carefully in order to retain efficiency. Many firms today compete on a cost leadership platform. This necessitates cost control on the back end. One of the ways to achieve cost control is through high levels of operating efficiency.

The Penrose Effect argues that success and rapid growth will allow firms to acquire excess resources that can be redeployed, but there are two concerns with this. The first is that until those resources are redeployed, they will be a drag on the firm's level of efficiency. The second is that redeployment should only come if the marginal opportunity of that redeployment is superior to the firm's current business. If it is not, the firm could find its returns reduced.

In order to constantly redeploy assets into useful situations, the firm would most likely need to continually expand its core business, and do so into businesses just as lucrative as the present one. The implication of this is that firms should constrain their rate of growth at a level where these excess resources are not acquired.

This level is most likely lower than the level at which a highly successful firm would normally grow, but the underlying theory is that the firm would be able to sustain its growth rate over the long run, whereas without any constraints on growth the firm would grow at a rapid rate but then see its growth rate decline significantly. One of the modern management concepts that flows from the Penrose Effect is that of sustainable growth.

Growth remains an objective, but at a level that can be sustained over the long-term. The negative impacts of the Penrose Effect, therefore, are not felt, and the company is able to maintain a high level of organizational efficiency and effectiveness during the entire growth trajectory. An example of a firm that failed to take heed of the lessons of the Penrose Effect was Starbucks. The company's rapid pace of expansion ultimately led it to a glut of assets that dragged down firm efficiency.

While the company remained profitable, its balance sheet and margins took a hit. The firm responded by shedding some of its assets, in particular new assets that were less effective than others (600+ underperforming stores). The company has since restored its margins, balance sheet health and growth trajectory as a result of placing this constraint on growth until organizational resources could be deployed more effectively. The Penrose Effect also dovetails with the managerial concept of human resources management as a source of strength.

Managerial knowledge and expertise -- the foundations of success in the knowledge economy, must be cultivated in order to maximize the rate at which the firm can sustainably grow.