Towards an Economic Theory of the Multiproduct
Firm by David J. Teece. Journal of Economic Behavior
and Organization (1982) pg. 39-63.
• 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
• Strategic management and corporate governance.
• Human capital and business organization.
• Traditional Perspectives
• Neoclassical firm
• Managerial explanation
• Nature of the Firm
• Individual and organizational knowledge
• Fungible knowledge
• Dynamic Capabilities
• 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
• 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.
• Penrose (1959) noted that the diversification activities of firms are an
• 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).
• Neoclassical Firm:
• Assumes profit maximizing entities operating in competitive products and
capital markets exhibiting zero transactions costs and competitive equilibrium.
• Teece (1982) maintains that under zero transaction cost assumptions one
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.
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
• 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.
• To understand economic scope we posit a 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.
• 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 products due 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
• Market Failure Considerations and Financial Capital
• Information asymmetry and allocation efficiency.
• 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.
Implications and Contributions
• Integrative approach from different theories or perspectives allows
for a better understanding of the phenomenon under review.
• 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.