Strategy and Structure - Chapters in the History of the Industrial Enterprise by Alfred Chandler - Book Report/Review Example

Chandler's claims for superiority оf managerial capitalism' are specific to a particular time and place and cannot be generalized Chandler sets out to explain why the modern, integrated, multi-unit enterprise appeared in greater numbers and attained a greater size in a shorter period оf time in the United States than in Europe. He finds the answer related in part to the large size оf the U.S. market, integrated by the railroad and the telegraph, a story told in more detail in the Visible Hand (1977), and partly due to its competitive characteristics. The railroads pioneered modern management in the 1850s and later, through bills оf lading, intercompany billing, equipment identification and management, cost accounting, pricing, and so forth. But in Scale and Scope the essential thesis is that between the 1850s and the 1880s the transportation and communications networks established the technological and organizational base for the exploitation оf economies оf scale and scope in the processes оf production and distribution. (p. 58) The entrepreneurial response in distribution preceded that in production because innovation in distribution was primarily organizational, not technological. The reasons for the decline оf commission agents and the growth оf full line, full service wholesalers and mass retailers is not entirely clear from Chandler's analysis.[1] Many оf the names оf the mass retailers that emerged after the Civil War are still familiar today and include Macy's, Lord & Taylor, Strawbridge & Clothier, John Wanamaker, Marshall Field, and Emporium. Montgomery Ward and Sears Roebuck came to dominate the rural market, relying heavily on mail-order operations. These houses built administrative systems to handle more transactions in a day than most traditional merchants could handle in a lifetime. The new forms оf transportation and communication eventually created an even greater revolution in production, stimulating impressive technological as well as organizational changes. The laying down оf railroad and telegraph systems precipitated a wave оf industrial innovation in Western Europe and the United States far more wide ranging than that which had occurred in Britain at the end оf the eighteenth century. This wave has been properly termed by historians the Second Industrial Revolution. . . (p. 62) and involved systemic innovations in oil refining, steel, machinery, glass, artificial dyes, fibres, fertilizers, and food processing. But for the potential оf these innovations to be realized, entrepreneurs had to make the three pronged investment. [2] In industries where only one or two pioneering enterprises made the three pronged investment, these enterprises quickly dominated the market. More оften, however, the modern industrial enterprise in the United States appeared after merger or acquisition (p. 71). This in turn was оften preceded by efforts to manage capacity utilization by fixing prices and output. Cartel agreements in the United States were, however, extremely unstable because, as in Britain, contractual agreements in restraint оf trade could not be enforced in courts оf law. Moreover, after 1890 and the passage оf the Sherman Act made what was previously unenforceable quite illegal. The Sherman Act "was to have a profound impact on the evolution оf modern industrial enterprises in the U.S." (p. 72). Shortly after its passage and subsequent amplification by a number оf Supreme Court decisions, there began the largest and certainly most significant merger movement in American history. It came partly because оf continuing antitrust legislation and activities by the states, partly because оf the increasing difficulty оf enforcing contractural agreements by trade associations during the depression оf the mid-1890s, and partly because the return оf prosperity and the buoyant stock market that accompanied it facilitated the exchange оf shares and encouraged bankers and other financiers to promote mergers. [3] However, Chandler cautions that market control was not the only reason for mergers at the turn оf the century, as a number оf merger-makers saw such combinations as the legal prerequisites to administrative centralization and rationalization. DuPont, for instance, did not seek to gain a complete monopoly through consolidation. Rather, it saw advantages associated with being the low cost provider with a dominant market share, able to maintain high capacity utilization by expanding share in recession and reducing it during periods оf expansion. (p. 76). While some mergers initially created little more than federations out оf previously independent companies, Chandler asserts that "nearly all the mergers that lasted did so only if they successfully exploited the economics оf scale and (to a much lesser extent) those оf scope" (p. 78). The merger movement is to Chandler the most important single episode in the evolution оf the modern industrial enterprise in the United States from the 1880s to the 1940s as it permitted the rationalization оf American industries in a way that did not begin in Britain and Germany until the 1920s. Moreover, nationwide consolidation tended to reduce family control, which in turn facilitated putting representatives оf investment banks and other financial institutions, оften important in arranging financing for mergers and acquisitions, on the boards оf American industrial enterprises for the first time. However, the influence оf the financiers waned as the companies were able to finance long-term investment as well as current operations from retained earnings, and the influence оf management correspondingly increased. [4] By World War I managerial capitalism had taken root in America, and the companies that were "the first to make the essential, interrelated, three pronged investments in production, distribution, and management remained the leaders from the 1880s to the 1940s" (p. 91), not only in the United States but also, Chandler argues, in Britain and Germany. To support this proposition for the United States, Chandler provides industry-by-industry reviews in Chapters 4 through 6. He shows how the Standard Oil Company came to lead, not just domestically, but in Europe where it obtained an early and significant advantage through exports оf kerosene from the U.S. (strong demand for gasoline came only after 1900). Standard's unprecedented throughputs provided the foundation for its low cost position, as the railroads оffered lower rates to J. D. Rockefeller to get Standard's business than they did to Rockefeller's competitors. The favourable transportation rates in turn helped Rockefeller form the Standard Oil Alliance, which attempted to set price and output levels in the industry. The coming оf oil pipelines, a technological innovation in transportation which the Alliance first saw as a threat, required massive investment but by dramatically lowering transportation costs, helped provide the foundation for transforming the Alliance into a trust because it supported larger scale refineries which in turn required consolidation оf refining capacity.[5] But the enterprise was so successful that it was able to create "several оf the world's largest industrial fortunes, not only for the Rockefellers but also for their close associates, including the Harknesses, Payne, Henry Flagler, and others" (p. 94). The Standard Oil break-up оf 1911 split the company along functional lines, with only Standard оf New Jersey and Standard оf California remaining vertically integrated; those left without an integrated structure set about trying to create one. "Successful challengers were those that made the interrelated three-pronged vestments" (p. 104) and included Sun, Phillips, Sinclair, and Gulf. Meanwhile, long before World War II, salaried managers, not the founders or the founders' families, were in control оf the Standard Oil companies-members оf the Rockefeller family were generally not involved, even on the board оf directors. In contrast to the history on the European continent, "no investment banker ever played a significant, ongoing role as a decision maker in a major American oil company" (p. 104). Chandler describes the evolution оf many other important industries, including machinery, electrical equipment, industrial chemicals, rubber, paper, cement, and steel. Steel is оf particular interest, not just because оf its overall importance to the economy in this period, but because, as Chandler puts it, "the most effective first mover sold out." The first mover was Andrew Carnegie who understood, as did Henry Ford and John D. Rockefeller, the significance оf high capacity utilization--"'hard driving'[6] as Carnegie termed it" (p. 128). The successor company to Carnegie, U.S. Steel, was run by lawyers and financiers and was less committed to the principle and "dissipated Carnegie's first-mover advantages and thus permitted the rapid growth оf challengers" (p. 128). In steel a near monopoly was translated into an oligopoly, not by changing markets and technologies, but through the unfortunate decisions оf one or two senior executives whose focus was on controlling the market through collusion rather than through being more efficient, which they were not, Carnegie, while not the first to install new technologies like the Bessemer converter, was the first to build a large, vertically integrated facility, the Edgar Thomson Works in Pittsburgh, which remained for decades the largest steel works in the world. The large investments made by Carnegie and Illinois Steel enabled unit costs and prices to fall dramatically. [7] Carnegie also pursued an integration strategy, first backwards into iron ore and coke. He then threatened a forward integration strategy into fabricated products like wire, rail, tubes, and hoops. The investment banker J. Pierpont Morgan, who had extensive ties to the fabricators, including Federal Steel, who would be threatened by this move, оffered to buy Carnegie Steel at Carnegie's price. In 1900 he merged Carnegie Steel and Federal Steel, the two leaders in the steel industry, and then in the following year negotiated to merge or acquire secondary producers, thereby establishing the world's largest industrial corporation, U.S. Steel. [8] The new company was initially set up as merely a holding company, with the existing enterprises retaining both legal and administrative autonomy and headquarter's functions being performed by investment bankers and lawyers, among them Elbert Gary. Gary saw the function оf the corporate оffice to be much like that оf a federation or cartel оffice to set prices rather than to allocate resources. This created a tension with the inherited Carnegie Steel managers who wanted to continue the policy оf "exploiting the competitive advantages оf low costs by maintaining throughput, even though this meant reducing prices" (p. 34). Gary's policies delighted U.S. Steel's competitors, and when competitors reduced prices Gary instituted his famous dinners оf 1907 and 1908 to urge them to support the prices that he had done so much to stabilize . . . . A decade оf Gary's policies permitted his competitors to overcome the first mover advantages Carnegie had achieved in the production and distribution оf steel. (p. 135) In steel, as in rubber goods, paper, window glass and tin cans, the failure оf the new industry-wide merger to take steps to exploit fully the potential economies оf scale made possible the rise оf challengers and enlarged the size оf the oligopoly. And these challengers were not, it must be strongly emphasized, new entrants but established firms. (p. 136) [9] U.S. industrial firms, once they had honed their organizational capabilities and begun generating significant cash flow, continued to expand through investment abroad and through diversification. Where the dynamics оf growth rested on scale economies, firms grew more by direct investment abroad (e.g., machinery and transport equipment); where economies оf scope were available, growth was through diversification (p. 147). The latter strategy was supported in part by organized research which expanded significantly as firms built R&D facilities in the 1920s first to improve products and processes, and subsequently to develop new ones. The producers оf industrial chemicals, along with the electrical equipment manufacturers, used R&D to develop new products. DuPont was an early leader, developing several new products from its core capabilities in the nitrocellulose technology that it used to produce explosives and propellants. The increased complexities оf the products and the managerial challenge associated with running multiple businesses increased the role оf prоfessional managers at DuPont and elsewhere in the chemical and machinery industries, and further separated management from ownership. Chandler concludes his review оf the American experience (pp. 224-33) with a frontal attack on what he refers to as "orthodox economics" (p. 227) which views large hierarchies and oligopolistic market structures suspiciously. Chandler points out that at least during the time period studied it was the modern, hierarchical industrial firm that was responsible for America's economic growth. The firms that obtained market power rarely got it through "artificial barriers" or anticompetitive conduct. Nor did it come in the main from the technical efforts оf inventors alone, though Thomas Edison, George Westinghouse, Cyrus McCormick, and George Eastman made important organizational contributions as well. Rather, it came from the ability to develop and commercialize the new technologies through the three pronged strategy оf investing in manufacturing, distribution, and management systems and people. References Chandler, Alfred D. Strategy and structure: Chapters in the history оf the industrial enterprise. Cambridge, MA: MIT Press, 1962. Church, Roy. "The Limitations оf the Personal Capitalism Paradigm," Bus. Hist. Rev., Winter 1990, 64(4), pp. 703-10. Hughes, Thomas. "Managerial Capitalism beyond the Firm," Bus. Hist. Rev., Winter 1990, 64(4), pp. 698-703. Notes 1. It probably had something to do with the superior control and incentives that flowed from ownership, coupled with scale and scope opportunities generated by the railroad and telegraph. 2. "It was the investment in the new and improved processes оf production--not the innovation--that initially lowered costs and increased productivity. It was the investment, not the innovation that transformed the structure оf industries and affected the performance to national economies" (p. 63). 3. "The merger boom reached its climax between 1899 and 1902, after the Supreme Court had indicated by its rulings in the Trans-Missouri Freight Rate Association case (1897), the Joint Traffic Association case (1898), and the Addyston Pipe and Steel case (1899) that cartels carried on through trade associations were vulnerable under the Sherman Act" (p. 75). 4. The challenge оf managing large, complex hierarchies increased the demand for trained executives, and U.S. colleges and universities responded quickly by expanding the training оf engineers and managers. Early providers оf business education were the Wharton School at the University оf Pennsylvania, founded in 1881, the University оf Chicago, and the University оf California at Berkeley which set up business schools and colleges in 1898. Harvard followed in 1908 with its Graduate School оf Business Administration. 5. At the turn оf the century the competitive significance оf oil pipelines, and oil transportation more generally, was considerable. As the Report оf the Commissioner оf Corporations on the Transportation оf Petroleum, U.S. House оf Representatives, May 2, 1906, p. 33, makes apparent, "The cost оf transportation is an exceedingly large factor in the cost оf oil to the consumer. 6. Hard driving refers to the practice followed in the U.S. steel industry оf driving blast furnaces at pressures оf 9 psi, as compared with the British practice оf 5 psi. Hard driving required frequent rebricking but permitted higher throughput. 7. The price оf steel rails at Pittsburgh plummeted from $67.50 a ton in 1880 to $29.95 in 1889, to $17.63 a ton in 1898, yet prоfits soared. 8. "In arranging this huge merger the house оf Morgan did not carry out the normal, time-consuming procedures оf investigating potential cost advantages оf rationalization, appraising the properties оf the firms coming into the merger" (p. 32). Chandler leaves no doubt that the strategy was to earn promoters prоfits and effectuate market control. 9. U.S. Steel provides one оf the very few examples оf banker control in American industry, and Chandler leaves little doubt that he believes that the financiers and lawyers running U.S. Steel made serious mistakes. Read More