Business Structures in Britain in the Inter-War Period - Research Paper Example

 Introduction By the 1870s, Britain unlike other industrializing nations, had almost completely changed from an agrarian commercial economy to an urban industrial one, a transformation which had begun at the end of the previous century. The “rapid internal migration from country to city and from agriculture to industry” [Chandler & Hikino (1990), p.251] resulted in the earliest and one of the largest consumer markets developed till that time. Being the first urban industrial nation, Britain became the world’s first consumer society. Industrialization at a great pace and the high quality of the pre-railroad transportation system resulted in business enterprises in both commerce and industry becoming more specialized in Britain than in the United States, during the pre-railroad era. With new transportation and communication networks British entrepreneurs responded in full measure towards opportunities for mass production and distribution.. The different types of business structures in Britain between World War I (1914-1918) and World War II (1939-1945) included family firms, personal capitalism, cartelization, formation of mergers, diversification and growth of modern industrial empires. The purpose of this paper is to outline the main types of business structures during the inter-war years, indicating their strengths and weaknesses. Discussion During the early period of the interwar years, many British product markets were characterized by fragmentation, as companies attempted to differentiate their product separately from others’ products. Managerial and supervisory systems were weak, managers were poorly educated and trained, and the levels of managerial hierarchy were inadequately demarcated resulting in poor coordination and efficiency [Gospel (1992), p.178]. According to Westall [1994, p.207], late nineteenth century businessmen had the usual three strategy options: competition, collusion or integration. Each option had further choices for example, competition could be by non-price means such as a differentiation of products to make them more appealing to consumers. Collusion referred to cooperation between businesses to raise prices and profitability. Integration was the process by which companies joined together to accommodate larger shares of economic activity internally rather than rely on market mediation. Family Firms and Personal Capitalism in Britain The term family firm refers to various types of owner-managed firms. This ranges from personal enterprises which has the distinctive feature of owner control being predominant and in which the owner is also the chief executive, to entrepreneurial organizations. The latter are owner-controlled firms in which managers are employed by the owners to run the organization. Three core characteristic features of the family firm are: “family generations, family ownership, and family management” [Church (1986), p.165]. In the case of the motor industry whose economics required sizeable production units, business and managerial development, businesses depended heavily on inheritance, which was consequently a significant factor. Personally managed firms frequently controlled by family interests were pre British holding companies, and were of two types: Imperial Tobacco is an example of one, a combination of a large number of comparatively small, single-function family enterprises. These could be sixty to eighty firms in number in a horizontal combination, and occured more frequently in textiles. The second type is exemplified by the Cadbury-Fry alliance, in a combination of two or three leading family firms in an industry. This occurred more frequently in metal fabrication, brewing and food processing [Chandler & Hikino (1990), p.288]. According to Rose [1994, p.61], the rapid creation of new family firms undoubtedly “contributed a vital dynamism during the early phases of industrialization”. However, the detrimental effect of such firms in the later stages of development has been acknowledged by scholars such as Chandler (1990).. The criteria for classifying corporate ownership and control has been a point of dispute especially among economists and sociologists. Although holding a majority of the company’s shares bestows ownership, the minimum percentage of total votes that an individual or a clearly defined group needs to hold in order to secure minority control has not been clearly denoted “although this might fall short of actual effective control” [Church (1986), p.166]. Only by reviewing each case could be revealed a perpetuation of control by an individual, group or family, which did not possess share ownership to a substantial extent. The period of the development of modern capitalism which started in the 1850s continued until the 1920s, characterized by the evolution of large-scale business enterprise, big business and its managers. “The visible hand of management” according to Chandler [1977, p.1] replaced the invisible hand of market forces. The direct influence of the quality of entrepreneurship, the availability of capital or public policy were exceeded by the more critical impact of the fundamental shift toward managers running large enterprises. The continuation of the personally managed firm, known as personal capitalism, may be the root cause of Britain’s entrepreneurial failure and long term industrial decline [Chandler (1990), p.262]. This is attributed to the fact that the majority of British firms did not incorporate managerial hierarchies, retaining personal control over the company’s functioning. This was a wrong strategy which had long term impacts, causing impediments and disability to British industries and the British economy for several decades. Personally managed firms which were generally controlled by family interests were extensively prevalent, encompassing a wide range of British industries in the late nineteenth century, and continued well into the twentieth century. This emerged from the First Industrial Revolution (1750-1850). According to Hannah [1981, p.55] and Payne [1984, p.197], the term “family firm” cannot be used as generic nomenclature to encompass the strategy and structures of all companies that are operated by families. The difference in performance found between firms of contrasting structure might not support the hypothesis that British personally managed business was causing a decline in the economy. The Cadbury brothers’ enterprise producing high-grade chocolate began in 1861. It operated along the lines of a family concern in all areas: production, marketing, sales as well as the functioning of the whole enterprise. The operation and administration, the structure of governance of the company during the inter-war years was almost entirely towards the coordination and monitoring of the production and selling facilities. In 1919, Cadbury’s joined with J.S. Fry & Sons, Britain’s third largest chocolate producer, to form the British Cocoa and Chocolate Company. That company held the voting shares or the ordinary shares of the two companies, and is an example of a strategy widely used in Britain to facilitate close cooperation between the leaders of an industry. The activities of the two companies remained separate, and they retained their legal and administrative autonomy even after 1935 when the shares and debentures of each were consolidated and retired [Chandler & Hikino (1990), p.246]. The family firm and personal capitalism were replaced by the managerial firm to ensure improvement in company operations by trained and skilled personnel. The Rise of Big Business in Britain Following the first World War, a big wave of mergers took place in the British banking industry. In 1918, five mergers involving the ten largest banks in the country resulted in the formation of five large banks. This extensive amalgamation led to the British banks becoming larger than their German and French rivals in capital, deposits as well as in total assets [Cassis (1997), p.36]. British big business was already diversified to a large extent by 1914, and in this dimension, was more advanced than its German or French counterparts. This continued during the interwar years. However, the balance between the various sectors changed, especially between the old and new industries. British banks made long term commitments for industrial finance. The amalgamation movement, with bank mergers taking place affected banking industrial policy. General managers in London banks attempted to harmonize practices within their bank by terminating over commitments. However, commercial banks complied with industrial clients’ specific requests for loans and withdrawals [Cottrell (1980), p.200-203]. Mass Distribution By the end of World War I, new mass retailers in Britain increased their commercial activities from department stores, multiple or chain stores and the consumer cooperatives, to include the market for perishable foods, apparel and furnishings. They depended on a high volume stock turn to reduce prices low enough for the working class customer to pay cash rather than rely on credit. The mass retailers had buyers for each product line, who determined price, output and specifications, and who scheduled the high-volume flow from the factories to the retail outlets. This type of administrative coordination quickly lowered unit costs leading to lower prices for the consumer and higher profits to the merchandiser. Since the urban working class was the main market for the British consumer cooperatives, multiples and even department stores, the number of lines handled were smaller, and “they relied more on economies of scale rather than of scope” [Chandler & Hikino (1990), p.261] to reduce costs. Because they focused on marketing a comparatively low number of standardized products, they required much less of a managerial hierarchy. Therefore, management of mass distribution remained personal and non-hierarchical. Formation of Cartels Composed of Independent Business Organizations Britain’s law supported the emergence of a corporate economy characterized by greater cartelization or combining of independent business organizations. The cartels were formed to control and coordinate production, pricing and marketing of goods by the members [Freyer (1992), p.198]. The change in company law resolved the problem of enforceability by strengthening the financial and organizational incentives to form a holding company with control over management and operations, and facilitating the merger wave. The courts not only permitted cartel practices, but concurrently allowed the enforcement of looser trade restraints. Thus legal rules stimulated both corporate concentration and cartelization, until monopoly and restrictive practices prevailed increasingly. Though the law promoted the formation of a corporate economy, it also gave formal sanction to the types of self-regulation and the get-along ethos among the companies, which permitted a lack of high standards. By 1928, the tendency to spread out, to not form a monopoly of a single product, to bring a group of related industries under the management of a single group of men, were acknowledged as contributing to a better business structure. However, in Britain the adoption of the diversified business structure was limited. Imperial Chemical Industries (ICI) was one of the few most effective, giant British corporations, that achieved a decentralized and divisionalized corporate structure. The ICI was the result of a merger between Brunner, Mond, Nobel Industries, British Dyestuffs, and United Alkali in 1926. Along with DuPont and I.G. Farben, ICI formed an international cartel dominating the global chemical industry [Freyer (1992), p.199]. Large-scale corporations that were supported by Chandler (1990), is challenged in recent times by supporters of a new economic system based on enterprise and networks. Big business is considered to be an anachronism, displaced in time and no longer relevant [Whittington & Mayer (2002), p.47]. The weaknesses in the operations of conglomerates include the non-availability or minimum availability of opportunity to combine or transfer resources between unrelated businesses in a financially beneficial way. Another downside is that conglomerates burden otherwise autonomous and free-standing businesses “with the expense and constraints of a corporate head office” [Whittington & Mayer (2002), p.58]. Viewed from the perspective of resources required, conglomerates are unsuitable, are eliminated soon during constricting conditions such as during recession. The authors state that conglomerates are essentially a freak of nature, and cannot survive as they are highly unprofitable to operate. On the other hand, some advantages or strengths of conglomerates are that: they have access to reliable internal reporting and accounting information; hence the corporate headquarters have complete information about its portfolio of businesses than any external investors could possibly hope to have. Therefore, even across unrelated businesses, headquarters can allocate and monitor investments better than external markets; that is, the conglomerate serves as a well-informed internal capital market. In this way, the conglomerate has some potential advantages over external capital markets with inadequate information, but has no advantages over related diversified firms which have even greater informational advantages over the conglomerate. This is because of its superior capabilities in accessing and processing information on a relatively limited range of products and markets. When the related diversification strategy is an accessible and well-advertised alternative, it is difficult to find the reasons for the continued survival of conglomerates [Whittington & Mayer (2002), p.58]. The Formation of Mergers In the 1920s it was comparatively rare to find mergers as a union of many firms into a consolidation with a very high market share [Hannah (1979), p. 307]. The enforcement of antitrust law being rather irregular, market leaders were discouraged from merger, for monopoly to remain predominant. However, mergers among lower ranking firms took place, thus creating an oligopolistic industry structure. This meant that a small number of participants dominated the market, and were collectively able to exert control over supply and market prices. Further, the actions of any one of the participants would potentially affect prices, and have a significant impact on competitors. An early type of merger in the British economy was one which brought together a large number of small family firms which were owned and controlled by families, into an industry-wide holding company. An example of this is Imperial Tobacco which in terms of its market value and shares was the fifth largest in 1919, the second largest in 1930, and the largest industrial enterprise in 1948 [Chandler (1990), p.247]. The merger between the two companies Cadbury and Fry who had remained only allies until the 1930s, was typical of mergers carried out in the inter-war years betwen two or more of an industry’s largest companies. Even after the merger in 1935, both firms continued to “produce, advertise, ship their own brands; to develop new ones and to allocate resources for future growth” [Chandler & Hikino (1990), p.246]. The impact of the law determined the status of the holding company. In companies such as Cadbury’s or Fry’s or Imperial Tobacco, the holding company enabled the formation of separate smaller firms to retain autonomy as much as possible. More than for the purpose of attaining organizational efficiency as such, such consolidations were formed in order to take advantage of tax exemptions. For the purpose of limiting competition, through a loophole in the Clayton Act, the purchase of stock by holding companies was prohibited. However, more unitary structures were encouraged indirectly by supporting the acquiring of one corporation’s assets by another corporation. Thus, a significant outcome of Britain’s moves towards catching up with the market in the United States, was the comparative underdevelopment of managerial organization [Freyer (1992), p.198]. Through the interwar years occurred significant changes in the structure of the economy; marked by growth in industries such as motor vehicles, electrical products, chemicals and food processing. After the merger wave of the 1920s, the importance of large companies became more widely recognized. This also gave rise to the demarcation of managerial hierarchies. However, most large companies continued to be managed by family members, had weak managerial structures and were loosely coordinated. Competitive pressures on firms were weakened by developments such as the introduction of general protection in 1932 in the product market, and the growth in restrictive agreements [Gospel (1992), p.173]. Diversification According to Whittington & Mayer [2002, p.56], diversification is essentially about market power; and “diversified firms can use the profits drawn from one product market to subsidize a price war in another market”. When confronted with particular competitors in multiple markets they can take action to ensure mutual agreement and decide not to compete too hard. Further, they can exploit reciprocal buying arrangements using inter-relationships with other large diversified firms to squeeze smaller competitors out of markets. In all the above ways, diversified companies have a greater advantage over undiversified companies, and will gradually replace the latter, by driving them out. Individual strategies for diversification are generally based on the exploitation of market power. Another view of diversification is rooted in the optimal use of under-utilized resources especially managerial time and skills. This means that the existence of surplus resources fuels diversification, and it is the nature of these existing resources that determine the progress and direction of diversification. In some cases, the initiative may be because of the goal of dominating external markets or towards the more beneficial motive of the efficient use of internal resources [Whittington & Mayer (2002), p.56]. Chandler & Hikino [1990, p.361] asserted that “centralization and consolidation followed by rationalization must precede decentralization and divisionalization”. The divisionalized organizational structure was pioneered by Alfred Sloan during the 1920s. The two basic priciples followed by such a business structure were firstly that each organization would be a complete unit in itself, headed by its chief executive, self-sufficient in carrying out every necessary function, and facilitated to exercise its full initiative and progressive development. Secondly, certain central organization functions are vital to the logical development and proper regulation of the corporation’s activities. Sloan’s system was useful in promoting greater diversification especially in the marketing function. The policy of diversification ensured continuity in earnings. The process of diversification occurs through acquisition to a large extent; and diversification can be carried out through product range or through expansion in terms of geography. An acquisitive conglomerate refers to a large business enterprise that undertakes a strategy of growth through aggressive acquisition of companies “rather than by concentrating on managing the firms it has acquired” [Channon (1973), p.188]. Most firms that diversify do so by the process of acquisition; by purchasing businesses in areas which appear to be related to the core competencies of the firm. Lack of attention for achieving the expected synergy as reflected in the board structure, a failure to identify relatedness to the original firm are reasons due to which this strategy is often flawed. Strategic policies on diversification and growth can make a far greater contribution to financial performance than does the degree to which structural forms have shifted according to such strategies. Before the Second World War, even large corporations were frequently small and specialized in function, as compared to the larger and diversified companies that developed after the world wars. With the emergence of managerial control in the pre-war years, diversification received two kinds of support: a self-interested version in which diversification served managers to grow in terms of prestige, power, the satisfaction of professional achievements, salary and security; but on the other hand, did not serve shareholders. In the other type of managerial control, the managers deluded themselves with an exaggerated idea of their own capacity to manage new businesses, and were not driven by self-interest but rather an overestimation of their own capabilities [Whittington & Mayer (2002), pp.64, 65]. Managerial self-centredness has been controlled with changes in corporate governance and managerial incentives provided. Wrong diversification initiatives as well as imperialistic ones can now be prevented by stronger surveillance mechanisms and the alignment of managerial incentives with those of shareholders. Conclusion This paper has highlighted the main types of business structures that existed in Britain between the World Wars, indicating their strengths and weaknesses. The essential nature of an economy is defined by the types of firms that constitute it, their size, their method of establishment, development and doing business, as well as the relationship between the companies [Penrose (1959), p.9]. Thus, examining the main types of business structures which existed during the inter-war years, has helped in understanding the British economy of that time. Before World War I, the British economy was characterized by a large number of small, family-owned and managed enterprises which served highly differentiated markets both in Britain and abroad. Within most companies, managerial hierarchies were weak, and various forms of sub-contracting and employment of independent foremen were used by owners for maintaining workplace control. In response to increased foreign competition especially from Germany and the United States, there was the occurrence of the merger wave in British businesses at the turn of the century. However, this move resulted in the formation of loose, defensive combinations of businesses which were held together as holding companies; and sophisticated managerial hierarchies were not successfully developed. In many industries market collusion through trade associations was also resorted to in response to competitive pressures. During the interwar years, there were sharp fluctuations in demand. Important changes in the structure of the economy led to significant growth of industries [Gospel (1992), pp.171, 173]. Corporate relatedness in conglomerates may come in the form of similarities between otherwise different businesses in terms of risk, time-span and scale of investments, life-cycle positions and other criteria. These corporate similarities give rise to a common logic in decision making, in terms of the types of information required, the decision making and the implementation. Thus, conglomerates find a rationale for their functioning, by being good at managing similar types of businesses, without taking into consideration market or technological linkages [Whittington & Mayer (2002), p.59]. It was found that in all the types of business structures that existed during the interwar years: family firms, personal capitalism, cartelization, formation of mergers, and diversification, there were weaknesses, as well as strengths to support the organization’s continued use. For example, just a couple of decades ago, most British firms were family owned enterprises. 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