Towards an Economic Theory of the Multiproduct Firm by David J. Teece. Journal of Economic Behavior and Organization (

1. Education • BA, MComm, University of Canterbury • MA, University of Pennsylvania • PhD, Economics, University of Pennsylvania • Current Research and Interests • Role of product and process development, and intellectual property in the competitive performance of the business enterprise. • Competitive performance of firms in the global marketplace. • Innovation and the organization of industry. • Technology and intellectual property policy, telecommunications policy, antitrust policy, and energy policy at the national and international levels. • Strategic management and corporate governance. • Human capital and business organization. Towards an Economic Theory of the Multiproduct Firm by David J. Teece. Journal of Economic Behavior and Organization (1982) pg. 39-63. Cited 1585

2. Paper Outline • Introduction • Traditional Perspectives • Neoclassical firm • Managerial explanation • Nature of the Firm • Individual and organizational knowledge • Fungible knowledge • Dynamic Capabilities • General • Learning, teaching, and ‘Penrose-effects’ • Demand conditions • Market failure considerations: Physical and human capital • Related Issues • Slack and managerial discretion • De novo entry vs. acquisition or merger • Lateral vs. conglomerate diversification • Some historical observations • Implications and Conclusions

3. Introduction • Purpose: • Outline a theory of the multiproduct firm by considering the properties of (1) organizational knowledge and (2) transactions cost properties neglected by the neoclassical theory of the firm. • Motivation: • Penrose (1959) noted that the diversification activities of firms are an understudied phenomenon. • According to Penrose (1959), “firm diversification is often based on a firm’s competencies that can lead to a sustainable competitive advantage” (Kor and Mahoney, 2000). • Key Building Blocks Discussed: • Excess capacity and its creation, market imperfections, and the characteristics of organizational capabilities, including its fungible and tacit character (Mahoney, 2005).

4. Traditional Perspectives • Neoclassical Firm: • Assumes profit maximizing entities operating in competitive products and capital markets exhibiting zero transactions costs and competitive equilibrium. • Teece(1982) maintainsthat under zero transaction cost assumptionsone cannot derive a theory of the multiproduct firm (e.g., “economies of scope” may explain joint production but not the “scope of the firm”) • Reducing the variance in cash flows need not reduce stockholder risk since stockholders can hold a diversified portfolio of stocks. • Managerial Explanation: • Marris (1966) suggests that in order for firms to grow faster than the market firms must diversify. • Mueller (1969) suggests that managers have an incentive to increase the size of their firm, which may be a basic motivation for managers to diversify. • Teece (1982) suggests that neither argument is well supported (e.g., managerial compensation is more related to profit rather than firm size). • Main Argument: • Teece (1982) points out that diversification can be driven by efficiency (e.g., gains obtained from internal learning, etc.)and therefore the author seeks to derive an efficiency-based theory.

5. Nature of the Firm • Individual and Organizational Knowledge: • Management theory, unlike traditional microeconomic theory, suggests that individual knowledge can be tacit (Polanyi, 1958) and not easily codified. • Nelson and Winter (1982) suggest that routines can serve as organizational memory. • Fungible Knowledge: • Organization knowledge is often fungible. • Main Points: • Based on logic from Penrose (1959), Teece suggests that “a firm’s capability lies upstream from the end product -- it lies in a generalizable capability which might well find a variety of final product applications” (pg. 45). • This view departs from the neoclassical view as the organizational view, presented by Teece (1982), suggests that the firm has both technological choices and end product choices to make based on the capabilities and organizational knowledge developed within the firm.

6. Dynamic Capabilities • General: • To understand economic scope we posita dynamic market environment and not just consider individual and organizational knowledge. • Learning, Teaching and ‘Penrose-Effect’: • Growth exists because of unused productive services. Unused services exist because of learning and routines, not just because of indivisibilities, that require less managerial oversight. However, the increment to total managerial services provided by each additional manager is assumed to decrease the faster the rate at which they are reoriented (Penrose Effect) • Demand Conditions: • Firms confront the issue to either (1) use the market to sell the services of unused assets or (2) diversify via acquisition or de novo. • Teece (1982( suggests that firms will diversify when transactions cost problems are likely to confound efficient transfer.

7. Dynamic Capabilities • Market Failure Considerations: • Class 1:Indivisible but non-specialized physical capital as a common input into two or more products. • Recommendation: The market • Class 2: Indivisible specialized physical capital as a common input to two or more products: bilateral monopoly (hold-up) problems • Recommendation: Multiproduct diversification • Class 3: Human capital as a common input to two or more productsdue to tacit knowledge and Arrow’s fundamental paradox of information: “its value to the purchaser is not known until he has the information, but then he has in effect acquired it without cost” (1971: 152) • Recommendation: Multiproduct diversification • Class 4: External economies • Recommendation: Multiproduct diversification if there are high transaction costs. • Market Failure Considerations and Financial Capital • Information asymmetry and allocation efficiency.

8. Related Issues • Slack and Managerial Discretion: • Excess resources refers to excess factor services over and above what is needed to meet managers requirements for organizational slack. Thus, excess resources and organizational slack are different concepts. • De Novo Entry vs. Acquisition or Merger: • The current paper does not distinguish between entry mode. The author notes the potential importance of complementary assets and slack as influencing the entry mode decision, among others. • Lateral vs. Conglomerate Diversification: • Teece (1982) suggests that the efficiency based theory provided in this paper aligns more with lateral diversification but offers suggestions on how the internal capital market efficiencies of firms may shed light into conglomerate diversification based on Williamson (1975). • Some Historical Observations: • Depression trigged diversification by generating excess capacity. • WWII created significant demand for military products. Firms used capabilities for new civilian products after the war.

9. Implications and Contributions • Implications: • Integrative approach from different theories or perspectives allows for a better understanding of the phenomenon under review. • Contributions: • This paper advances ideas from Penrose (1959) coupled with transaction cost economics to predict when firms may choose to diversify or sell the services of its unused assets in the market. • The building blocks of generating a theory of the multiproduct firm used in this paper include “excess capacity and its creation, market imperfections, and the peculiarities of organizational knowledge, particularly its fungibility and tacit character” (pg. 61). • Further Research: • Consider how these building blocks interact and can be empirically tested to advance the resource-based/dynamic capabilities approach.