Evolution of Organizational Scale and Scope

Tinbergen Institute Working Paper No. 2002-060/2

37 Pages Posted: 11 Nov 2002

See all articles by Arnoud W. A. Boot

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School

Date Written: April 16, 2002

Abstract

This paper examines the determinants of organizational scale and scope, with applications to various industries, including financial services. We build a model in which new opportunities arise for firms, but the skills needed to exploit them effectively are unknown. Early investments in these new opportunities expand scope and allow firms to learn the skills needed to make more efficient production decisions later on. The value of early scope expansion is thus increasing in the strategic uncertainty about the skills needed for future success in exploiting new opportunities. The disadvantage of early scope expansion is that it requires irreversible investments before actual demand is known. This demand uncertainty means potential losses since the investment cannot be recovered when demand does not materialize. Thus, early entry into a new activity involves a tradeoff, and this tradeoff works in favor of early entry under two conditions. First, there must be sufficiently high strategic uncertainty about the skills needed for success in the new activity. Second, the firm's existing operations must be sufficiently profitable to give it the necessary "deep pockets" to absorb the potential loss of the capital invested early if there is no demand. This perspective allows us to link the optimality of scope expansion to the degrees of competition in the firm's existing activities as well as the new activity, and the development of the capital market. Moreover, to the extent that a scale-expanding merger "deepens" the firm's pockets, scale expansion will facilitate scope expansion and thus precede it.

Keywords: Organizational scale and scope

JEL Classification: G34, L20

Suggested Citation

Boot, Arnoud W. A. and Thakor, Anjan V. and Milbourn, Todd T., Evolution of Organizational Scale and Scope (April 16, 2002). Tinbergen Institute Working Paper No. 2002-060/2, Available at SSRN: https://ssrn.com/abstract=321621 or http://dx.doi.org/10.2139/ssrn.321621

Arnoud W. A. Boot (Contact Author)

University of Amsterdam - Amsterdam Business School ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Tinbergen Institute ( email )

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Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business ( email )

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St. Louis, MO 63130-4899
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European Corporate Governance Institute (ECGI) ( email )

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Todd T. Milbourn

Washington University in Saint Louis - Olin Business School ( email )

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St. Louis, MO 63130-4899
United States
314-935-6392 (Phone)
314-935-6359 (Fax)

HOME PAGE: http://www.olin.wustl.edu/faculty/milbourn/

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