Entrepreneurs and Business

1. Entrepreneurs and Business

2. Standard Oil, Nail, Copper, Sugar, Iron, Steel Beam, Tin, Coal, & Paper Bag Trusts Keppler “The Bosses of the Senate,” Puck 1889

3. Bigness and Business • I want to talk about three factors that influence the ability of businesses to: • Form and Compete • How they Compete • Why business became so large at the end of the 19th century

4. Entry • One of the most important elements in creating and maintaining competitive markets is the ability of new competitors to enter. • Since most business organizations are large (larger than families), and may require formal organizations (like corporations), a fundamental determinant of entry is the ease of forming an formal business entity.

5. General Incorporation • Beginning in the 1840s, state constitutions began requiring that state legislatures pass ‘general incorporation acts.’ A general incorporation act allowed any one to form a corporation as long as they met minimum requirements. • In banking this was known as ‘free banking,’ where the free referred to entry.

7. The table is from Wallis, “Constitutions, Corporations, and Corruption.” Journal of Economic History, 2005.

8. General and Liberal General Incorporation • Of the 12 states to write new constitutions in the 1840s, 8 mandated general incorporation laws, and all 4 of the new states mandated general incorporation laws. • By the 1870s most states had general incorporation and some form of free banking (general incorporation for banks). • In the 1880s and 1890s, states beginning with New Jersey, began liberalizing their incorporation laws, making it easier for corporations to regulate their own internal structures. • What followed was the Great Merger Wave.

9. What’s Bigger: The GMM or that of the 1980s? 20 % GNP increased by about 15 times from 1900 to 1990 3 % 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990

10. Some Resulting Firms

11. Schumpeter and Creative Destruction • The economic model of perfect competition calls for many small firms competing with each other, and many small consumers competing with each other. • By the early 20th century, economists were beginning to recognize that the American (and European) economies, didn’t look very ‘competitive’ in traditional terms. Yet the economies continued to grow, innovate, and by all appearances, remained very competitive. • Why?

12. Capitalism, Socialism, and Democracy • In his famous book, Joseph Schumpeter analyzed the phenomenon of growing size of business in combination with continued competition. • He suggested two things: • First, that many business firms competed more on the basis of new products and higher quality products, that on the basis of lower prices. • When the automobile was invented, the market for horse drawn carriages and wagons was just reduced, it was destroyed. • Schumpeter called this process: Creative Destruction.

13. Second, Schumpeter argued that in order to compete in markets characterized by creative destruction, firms had to be technologically innovative. To do so, firms had to make large investments in ideas and technologies before they could possibly know whether the ideas would work out. • In order for firms to make those investments rationally, the firms had to believe that a new technology would enjoy a period where competitors were behind the curve. During that period the firm would enjoy substantial economic rents (returns above opportunity costs). • Size, in Schumpeter’s view, is a prerequisite for technological dynamism.

14. Chandler, Visible Hand Managerial Revolution Some firms in the 1860s, 1870s, and particularly the 1880s, began to grow larger and (in cases of this type) their industries became highly concentrated. Their products were often new and they required either control of inventories because the product would spoil or close connection with the consumer. These technologies were often characterized by one or more types of ‘economies of scale.’

15. Price, Cost ATC, t > 0 • ATC, t = 0 • Transport costs Q/t

16. High Fixed Costs $/Q AC Fixed Costs MC AFC Q

17. High Fixed Costs $/Q AC Fixed Costs MC Pac AFC Qac Q

18. $/Q Pure Economy of Scale MC AC Q

19. $/Q Pure Economy of Scale MC AC Pac Qac Q

20. Long Run and Short Run Factorsin the Rise of Big Business Long-run Factors: inevitability Transportation cost reductions Technological changes (e.g., flour, steel, oats, sugar, paper, film) Widened scope of firms, vertical integration (e.g., finance, transport, raw materials)

21. Chandler, Visible Hand Their products were often new and they required either control of inventories because the product would spoil or close connection with the consumer Production methods were usually continuous process methods (cigarettes, soap, etc.) with significant economies of scale. In order to capture the economies, however, the firms needed to ensure that they could move their product to consumers

22. $/Q MC AC MC AC Qmin Q

23. Investment in plant and equipment would only be profitable if the volume of production per unit of time, the throughput, could be kept at a high enough level. So firms in these industries began integrating forward to ensure themselves of markets and integrating backwards to ensure themselves continual supplies.

24. Bonsack’s Original Continuous Process Cigarette Machine Also: Bessemer process of making steel; Pillsbury and flour milling; paper making; oats and Quaker; film and Kodak; various types of machinery and new consumer durables; detergents and P&G; shipping advances for beef and Armour, Swift, and Cudahy.

25. High Fixed Costs The high fixed costs on Duke’s firm were in the marketing and purchasing organizations he built. Because of the high fixed costs, both he and his competitors had incentives in the short run to lower price below average costs to maintain market share. In 1890, the large tobacco firms merged to form the American Tobacco Company. RJR-Nabisco, a familiar modern day tobacco villain, is really a very large marketing organization sitting on top of a set of high volume production machines.

26. Matches (Diamond), Oatmeal (Quaker Oats) (less in flour), Canned food (Heinz and Campbell’s Soup), soap (Procter and Gamble), cameras and film (Kodak) are still around today. These were firms whose advantage lay in some economies scale in production, but largely economies of scale in distribution. Their advantages lay in vertical integration.

27. Vertical Integration and Branding:The Refrigerated Railroad Car Ratio of “dressed” to live beef shipments increased by > 10 timesin the 5 years from 1880 to 1885 (0.07 in 1880, 0.82 in 1885)..

28. Perishables Large national and international firms arose in meat packing and brewing, because of the perishable nature of the commodity, and the need to build large refrigerated distribution networks.

29. Machinery The production and sale of complex machines also required a large distribution network with a highly trained sales and repair force. Consumer machines: sewing machines and typewriters Farm machinery: reapers, threshers, binders, combines

30. Entrepreneurs and Business • After the Civil War, changes in production technology as well as changes in the organization of business led to large firms emerging in industries with high fixed costs and economies of scale and in industries where distribution networks played an important role in selling the product. • There were many attempts to create bigger firms that would enjoy market power. In general, mergers in industries where costs did not fall with firm size did not last.

31. Entrepreneurs • As Schumpeter argued, successful innovation often involved not just a new production technology, it also involved creating an organization that could take advantage of the physical technology. • Whether large firms grew large because of market power is, often, an open question. But in general, institutions put in place in the 1840s allowed individuals and organizations (in the form of corporations) to enter almost any line of business they wanted. So while market power existed, and was an important part of driving creative destruction, productivity generally increased over time.