Capacity constraints as a trigger for high growth

Plain English Summary Operating above maximum capacity is like a "fork in the road": while some firms shrink back to stay within existing capacity constraints, others respond by launching into broad-based growth. We develop a theory of firm growth, according to which some firms are better positioned for subsequent growth, depending upon their state of capacity utilisation. Firms with plenty of slack capacity can easily grow within the bounds of existing capacity constraints. Firms that are already operating above maximum capacity cannot grow by drawing on slack resources, but instead, their growth requires a broad-based investment in many interconnected areas. Our statistical analysis shows that operating above maximum capacity is relatively rare and unlikely to persist and seems due to rising demand. Some firms respond to being above maximum capacity by slowing down and adapting to existing capacity constraints, while others treat overcapacity as a "trigger point" that launches them into subsequent growth. Our results are of interest to those seeking to understand and predict firm growth: investors, entrepreneurs, academics and policymakers. High-growth enterprises (HGEs) have a large economic impact but are notoriously hard to predict. Previous research has linked high-growth episodes to the configuration of lumpy indivisible resources inside firms, such that high capacity utilisation levels might stimulate future growth. We theorize that firms reaching critically high capacity utilisation levels reach a "trigger point" involving either broad-based investment in further growth or shrinking back to previous levels. We analyze EIBIS survey data (matched to ORBIS) which features a question on time-varying capacity utilisation. Overcapacity is a transitory state. Firms enter into overcapacity after a period of the rapid growth of sales and profits, and the years surrounding overcapacity have higher employment growth rates. Firms operating at overcapacity make incremental investments (e.g. capacity expansion, process improvements and modern machinery) rather than investing in R&D and new product development. We find support for the "fork in the road" hypothesis: for some firms, overcapacity is associated with launching into massive investments and subsequent sales growth, while for other firms, overcapacity is negatively related to both investments and sales growth.