Unlimited Growth: How to Sustain Success (18 February 2003)

The rise and fall of the fortunes of corporations suggests that they have natural life-cycles. It seems there are pre-determined limits to the level of an organisation's sustainable growth. If so, how do organizations move beyond these limitations to ensure ongoing success?

Fundamentally all biological systems follow the same pattern. They start slowly, have a period of rapid evolution, then slow down, reach an equilibrium and plateau until they decline. Organizations also seem to follow this same cycle. Comparisons can be made between the growth of organizations and the growth of biological systems. In doing so there may be a useful parallel for business management in biology.

If we look to population theory for a guide to organizational growth, the starting point is the model developed by Thomas R. Malthus (1766-1834). In The Principle of Population essay that he published in 1798, Malthus explained in simple terms his theories of human population growth and the connection between overpopulation and misery. When ideal conditions exist, unlimited (and unchecked) growth occurs. This is the familiar exponential growth graph - the so called 'J curve'. For example, rabbits introduced on to an island with available food will grow in number exponentially. Eventually they will, however, reach an unsustainable population density and the unlimited growth stops. So what limits this normal growth and how does this apply to organizations?

For any biological system that is constantly expanding, the ultimate limiting factor will be the inherent limitations of the system. In biological terms these limiting factors are either internal (biotic) or external (abiotic). Like the rabbits on an island with a ready supply of food, the population density increases until either the food runs out, the climate changes, predators emerge in greater numbers or other natural limiting factors occur.

Organizations seem to follow the same pattern. During a growth phase with steady sales an organization may expand by replicating the basic structure, but eventually the volume of business activity reaches a size when the existing system cannot cope with the level of complexity required for the expanded business. The organization must then morph into something new and more complex if it is to survive. In population theory, logistic difference equations are used to determine the upper limit of population growth. This limit is called the 'K factor'. If organizations also have a 'K factor', we could use the same principles to predict the limits of their growth.

Pierre Francois Verhulst, a scientist interested in population growth, showed in 1846 that the rate of growth of a biological system depends on how much progress has been made towards the upper limit of the system's potential. What happens is that growth increases exponentially, and when it reaches a point half way to the limit of the system's potential for growth, the growth rate then rapidly and exponentially declines. The second half of the graph is a mirror of the first half. The result is a classic Sigmoid curve - a sideways 'S' shape of slow initial development, rapid growth, followed by a rapid slow down and a plateau. What then results is a prolonged equilibrium period of static growth at the same level as the K factor. This is possibly followed by decline as the system, being sustained at an unsustainable level, eventually breaks down.

Most organisations appear to follow these same growth cycles as if they were biological systems. When the rate of organisational growth begins to slow it is therefore likely that the organisation has also reached a mid-point on the growth curve and is approaching its K factor - the limit of its potential. The question is: Why does this happen and what can be done prior to decline?

The answer was discovered by Edith Penrose, who looked deeply into this question and published in 1959 an overlooked book called 'The Theory of the Growth of the Firm' (1.). Edith Penrose was not a biologist, or in management, but an international economist. Born in California, Penrose graduated from Berkley and gained her PhD. from John Hopkins University in the economics of knowledge. She worked for the ILO in Geneva, at the ANU in Canberra, lived in Baghdad and Beirut, and held positions at the London School of Economics and INSEAD in Paris (2.). Penrose's unique perspective allowed her to see past the industry-based market competition theories of the day (that still dominate our thinking) and look to the limiting factors that exist within individual organisations.

Penrose examined the parallels that have been drawn on by business management theorists from the biological world. She concluded that parallels with biological theory, while useful illustrative metaphors to assist our thinking, had no sound basis in common with management theory(3.).

The reason for this is that biological systems are not conscious agents, while (more often than not) individual organisations have the ability to consciously think about their internal structure and can understand and react consciously to their changing environments. Organisations do not rely merely on long-term processes of evolution to improve their prospects of survival. Penrose provided a detailed analysis of how organisations instigate mergers, acquisitions, diversification and divestment to sustain growth. What may explain population decline does not help in organisational growth predictions, although they appear to follow similar dynamics. Biological theory, while similar, is not helpful. A different model applies when growth is consciously managed.

This is in fact a good thing and a bit of a relief. While biological systems seem condemned to go through the predictable Sigmoid curve of growth, plateau and decline, conscious organisations, that can determine their own limiting factors, may not be pre-destined to the same fate (even though this is what appears to happen). This led Penrose to consider a different question.

As biological theory provided no direct answers, and market economic theory ignored the dynamics relevant to individual organisations, Penrose sought the reason for the limitation of the growth of the firm elsewhere. She developed from her observations a theory that organisational potential is linked to the capabilities the firm develops from its resources. To actualize this potential you must realise these capabilities. Having unique resources (such as expert knowledge) is not in itself useful in creating growth unless they are translated into capabilities that are used to their full potential. As organisations grow and learn they develop new opportunities to build new capabilities. What intrigued Penrose was why these opportunities were not acted on and why the potential growth didn't eventuate.

The answer she found was that managerial capability to realize potential does not necessarily develop at the same rate as the potential being created in the growing resources. It seems that the ability for us to understand and react to the increasingly complex management issues that arise during exponential growth can eventually become an ultimate limiting factor to the growth of the firm. This seems to be the 'K factor' for all organisations. We know this to be true and see it every day. When growth occurs and the volume of business increases, management systems rarely change to keep pace with potential. We just keep doing more of what was working before. However, at a critical point half way to the maximum potential able to be achieved using the existing systems, growth begins to decline, even though our effort is maintained.

At this point the system has become sufficiently complex so as to require a different dynamic to sustain it. But now being very busy, and also under pressure in a system under tension, there is no capacity for management to slow down and create the necessary capability to manage the expanding system. Improvements are needed to create less pressure, but management is now too pressured to make the improvements. The rate of growth has created an unsustainable dynamic. Being at the steepest part of the curve our organisation then locks into its self-limiting level, and the natural cycle of plateau, equilibrium and possibly decline just follows its biologically determined path.

However, this biological life-cycle need not be the only path. Penrose discovered that sustainable growth was possible 'based on complex and cumulative processes which achieve a balance between innovation and implementation'(3.). These theories explain the basis of strategic development: where both strategy and organizational development are linked into a conscious integrated picture that balances growth in a complete and expanding system. Once we have out-grown our capacity to know our own system dynamics a more holistic perspective is required. In re-negotiating the K factor, growth then becomes more like a three-dimensional spiral than a one-dimensional line.

Penrose knew what needed to be done, but did not work out how to bring the theory into practice. But that's ok, because now we have (4). The good part is that you can begin the process at any point on the curve, including equilibrium, provided it is before the period of decline starts. By escaping the Sigmoid curve of eventual demise sustainable development is then easily achieved. All that is really required is the decision to begin.

By William Varey

1. Penrose, E. (1980) The Theory of the Growth of the Firm, 2nd Ed. Basil Blackwell, Oxford.
2. Best, M., Garnsey, E. (1998) Edith Penrose www.uml.edu/centers/CIC/pdf/bestpaper2.pdf
3. Knudsen, K. 'Strategic Management and the Knowledge Based Theory of the Firm', In Falkenberg, J. and Haugland S. (1990) Rethinking the Boundaries of Strategy, Munksgaard, Copenhagen.
4. Varey, W. (2003) Sustainable Development: Integrating Theory and Practice for Generative Growth

William Varey
Forsyth Consulting Group
www.fcg.com.au

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