SCALE AND SCOPE The Dynamics of Industrial Capitalism

1. SCALE AND SCOPEThe Dynamics of Industrial Capitalism Alfred D. Chandler, JR 劉耀仁 世新大學平傳系

2. Introduction : Scale and Scope Before the railroad & telegraph system Process of production, Distribution, Transportation, and Communication in capitalistic economies had been carried on by enterprises personally managed by their owners Operating the railroad & telegraph system Create new type of Business enterprise Team of salaried managers who had little or no equity in the firm New forms of the transportation & communication system Modern mass marketing & Modern mass production Operating decisions became concentrated in the hand of the managers.

3. Introduction : Scale and Scope With Salaried Manager coming A new type of capitalism Decision about current operations, employment, output, and the allocation of resources for the future operations were made by salaried managers. New institution and new type of economic provided a central dynamic of continuing economic growth and transformation Examine the beginnings and growth of managerial capitalism globally and focusing on the history of its basic institution in the world’s three leading industrial nations.

4. Chapter 1 : The Modern Industrial Enterprise Simon Kuznets : National economies  3 sectors Agriculture, Industry and Services Simon Kuznets : Industry  6 sectors Mining Manufacturing Construction Utilities Transportation Communication

5. Chapter 1 : The Modern Industrial Enterprise US, Great Britain and Germany accounted for 2/3 of the world’s industrial output in 1870 In all 3 countries the largest economic growth came in the industrial sector, while agriculture drastically declined in the long run

9. Chapter 1 : The Modern Industrial Enterprise Fundamental dynamicfor change in capitalist economies The manufacturing enterprises whose collective histories are presented in this study have provided a fundamental dynamic or force for change in capitalist economies since the 1880s. New and improved processes of production developed Substantial economies of scale and scope Cost advantages Three-pronged investment in Production, Distributionand Management Powerful Competitive Advantage Their industries quickly became oligopolistic; no longer competed on the basis of price Instead they competed for market share and profit through functional and strategic effectiveness

10. Chapter 2:Scale, Scope, and Organizational Capabilities The New Institution Modern industrial enterprise - Contains a number of distinct operating units - Managed by a hierarchy of full-time salaried executives - More than a production function (commercial, and research functions) - Each unit has its own office, managers and staffs, and acts as an independent enterprise. Modern multiunit enterprise - Owners  top-level executive  middle-level executive  lower-level executive - Boards of directors include both top managers (inside director) and part-time representatives of the owners (outside directors). - Hierarchy (composed of middle and top managers) makes the activities and operations of the whole enterprise more than the sum of its operation units.

11. Chapter 2:Scale, Scope, and Organizational Capabilities How and why the institution grew why adding new units? • The manufacturing enterprises became multifunctional, multi-regional and multi-product - Maintain a long-term rate of return on investment(by reducing overall costs of production and distribution) - By providing products that satisfied existing demands - By transferring facilities and skills to more profit markets - To assure access to market, and prevent competitors from obtaining such access - Merely to reinvest retained earnings - Financial reasons(tax, price of securities, extend portfolio investment) - Managerial reasons(greater control over the work force)

12. Chapter 2:Scale, Scope, and Organizational Capabilities The initial motivation for its investment in new operating units • Maintain its position of dominance - Actually permitted its managerial hierarchy to reduce cost - Improve functional efficiency in marketing and purchasing as well as production - Improve existing products and process and to develop a new ones - Allocate resources to meet the challenges and opportunities of ever-changing technologies and markets

13. Chapter 2:Scale, Scope, and Organizational Capabilities Historical Attributes • Modern industrial enterprise’s three most significant attributes : - Clustered from the start in industries having similar characteristics - Appeared quite suddenly in the last quarter of nineteen century - Born and then continued to grow in much the same manner • Table 5 - 72% of the 401 companies were clustered in food, chemicals, petroleum, primary metals ,and the three machinery groups. - The predominance of American firms among the world’s largest industrial corporations - Only in chemicals, primary metals, and electrical machinery did the non- American firms outnumber the American firms

15. Chapter 2:Scale, Scope, and Organizational Capabilities The large industrial corporations in U.S. ,Britain and Germany • The large industrial corporations in U.S. had clustered in the same industry (Earlier in the twentieth ; 1973) • The pattern is much the same for Britain and Germany • American firms were bigger and more numerous • American – consumer goods, industrial goods Britain – consumer goods (food & tobacco industries) Germany– producer’s goods (chemicals & heavy machinery)

16. Chapter 2:Scale, Scope, and Organizational Capabilities Economies of Scale and Scale in Production • Major innovations in the process of production during the last quarter of the 19th century (exploiting the cost advantage of the economies of scale and scope) • Newer industry -- drastic change in capital-labor ratio, expanded output by improving and rearranging inputs - Greatly improved equipment - Reorienting the process of production - Placing the several intermediary process within a single works - Increasing the application of energy

17. Chapter 2:Scale, Scope, and Organizational Capabilities • Labor-intensive industries (apparel, textiles, lumber, furniture, printing and publishing ) - Large modern firm remained relatively rare - A sharp reduction of unit cost did not accompany an increase in the volume of materials processed by the plant • Capital-intensive industries - Production units achieved much greater economies of scale - “Minimum efficient scale”-- had an impressive cost advantage over small plants - Economies of joint production – a significant cost reduction - Fixed costs and sunk costs much higher than in the more labor-intensive industries

18. Chapter 2:Scale, Scope, and Organizational Capabilities • In 1880s~1890s Second Industrial Revolution - New mass-production - A sharp reduction in costs as plants reached minimum efficient scale - Only a small number of them could meet the existing national and even global demand – became oligopolistic - The first to build a plant of minimum efficient scale and recruit the essential management team remained the leader in its industry for decades. - The revolution in transportation and communication created opportunities that led to a revolution in both production and distribution.

19. Chapter 2:Scale, Scope, and Organizational Capabilities The essential step in exploiting the new technologies of production • Construct a plant of the optimal size • The investment in production facilities large enough to exploit the full potential of the economies of scale • Both technologies and markets were dynamic • Size and costs of production plants differed widely from industry to industry

20. Chapter 2:Scale, Scope, and Organizational Capabilities Economics of Scale and Scope in Distribution • By integrating forward into distribution and backward intopurchasing. • Explaining such vertical integration requires a more precise understanding of the • processes of volume distribution. • The intermediary • The intermediaries’ cost advantage had resulted from exploiting the economies of • both scale and scope. • The wholesalers’ advantages of both scope and scale had their limits. • - A manufacturer of a single product rarely achieved such a volume in retailing • - When limits were reached, it become more advantageous for manufacturers.

21. Chapter 2:Scale, Scope, and Organizational Capabilities Specialized facilities & Skills in marketing and distribution • The manufacturer had more accurate understanding of special facilities and skills than the wholesaler. • The more the products required such skills and facilities, the less were the opportunities for the intermediary to achieve economies of scope. Intermediary’sincreasing investment in product-specificity • Reduced the intermediary’s cost advantage • Discouraged intermediary making the necessary investment

22. Chapter 2:Scale, Scope, and Organizational Capabilities Another incentive for the manufacturer to invest in a sale force of his own was competition • New production technologies with their unprecedented output created a new type of competition. • These few large plants could meet existing demand and quickly began to compete for international market. • Cost advantages of scale reflected the market share. In the new capital-intensive, oligopolistic industries • No longer afford to depend on intermediary. • Need a sale force of their own which holding a market share large enough to assure the cost advantage of scale.

23. Chapter 2:Scale, Scope, and Organizational Capabilities The motive for integrating backward by building a purchasing Organization • Take the place of commercial intermediaries. • Integrating forward to into wholesaling. The establishment of a central purchasing office • Provide the enterprise with skilled, product-specialized buyers. • To schedule flows between production and traffic departments Product-specific services and facilities were essential in coordinating flows and reducing cost In these ways integrating backward into purchasing, like integrating forward into distribution, replace the existing commercial intermediaries.

24. Chapter 2:Scale, Scope, and Organizational Capabilities Building the Integrative Hierarchy In the creation of modern industrial enterprise • The firststep in the creation of modern industrial enterprise was the investment in production facilities large enough to achieve the cost advantage s of scale and scope. • The second step was the investment in product-specific marketing , distributing , and purchasing networks. • The third and final step was the recruiting and organizing of the managers needed to supervise functional activities. Organizing • The resulting managerial hierarchies were established along functional lines.Each function was administered by a department. • Normally, the functional departments were organized along the line-and-staff principle , with line officer having executive authority and staff officers having an advisory role.

25. Chapter 2:Scale, Scope, and Organizational Capabilities Top management • Theheadsof the major functional departments, thepresident, and sometimes a full-time chairman. • The full-time salaries top managers, the “inside directors”and their staff, monitoredthe activities and performance of the middle managers. • In making broad strategic decisions they worked closely with the “outsidedirectors”, the part-time representatives of families, banks, and other shareholders.

26. Chapter 2:Scale, Scope, and Organizational Capabilities First-Mover Advantages and Oligopolistic Competition Inventors, Pioneers, First-movers • First in the development of a new set of improved products or processes came theinventors. • Then came the pioneers, the entrepreneurs who made the investment in facilities needed to commercialize a product or process. • The first moverswere pioneers or other entrepreneurs who made the three of investments in production, distribution, and management required to achieve the competitive advantages of scale, scope or both.

27. Chapter 2:Scale, Scope, and Organizational Capabilities First-mover advantages • The entrepreneurs who invested in plants big enough to exploit the economies of scale or scope brought into being the modern industrial enterprise . - The first to do so acquired powerful competitive or “First-mover” advantages. • The first movers managers had already worked out the bugs in the production processes .They had already becomepracticedin assuring prompt delivery. • They knew how to meet customers’ special needs and to provide consumer credit ,installation ,and after-sales repair and maintenance. • Tocompete with the first movers ,rival had to build plants of comparable size and to make necessary investment.

28. Chapter 2:Scale, Scope, and Organizational Capabilities Oligopolistic Competition • In those industries where scale or scope provided cost advantage,the number of players remained small,and there was little turnover among the leaders. • The largest firm in the industries may become the price leader,basing prices on estimates of demand in relation to its own plant capacities and those of its competitor. • Priceremained a significant competitive weapon,but these firms competed more forcefully for market share and increased profits by means offunctionaland strategic efficiency. Continuing Growth of the Modern Enterprise • Once the investment in production and distribution was large enough to exploit fully the economies of scale and scope ,and once the necessary managerial hierarchy was in place, the industrial enterprisegrew -it added new unit-in four ways. 1.Horizontal integration. 2.Vertical integration. 3.Geographical expansion. 4.Product diversification.

29. Chapter 2:Scale, Scope, and Organizational Capabilities Horizontal and vertical combination Horizontal combination • In a large number of cases the incentive for acquisition or merger of enterprises producing competitive products was to gain more effectivecontrolofoutput , price, and markets. • Such horizontal combination increased organizational capabilities and productivity only if a single, centralizedadministrative controlwas quickly established. Vertical combination • The reasons for vertical integration were more complex. • Increased productivities rarely resulted from vertical integration unless the additional processes were directly connected to the firm’s existing ones by its own rails, conveyors, or pipe.

30. Chapter 2:Scale, Scope, and Organizational Capabilities The reason for vertical integration: • Vertical integration was to assure a steady supply of material into the enterprise’s production process. • It reduced the costof high inventory storage and other caring costs. It lowered the risk that suppliers wouldfailto carry out contractualagreements. • If the investment was not made to reduce thecostof transaction risk, it might be made merely as a profitable portfolio investment. Geographical Expansion And Product Diversification • Geographical expansion into distant markets was based primarily on organizational capabilities that had been developed by exploiting economies of scale. • Product diversification was based on organizational capabilities that had been developed by economies of scope.

31. Chapter 2:Scale, Scope, and Organizational Capabilities Structural change • When diversification moved beyond producing a full line, new marketing personnel and facilities had to be acquired . • Diversification into related industries brought far more thoroughgoing administrative restructuring. This structural change came when the senior managers realized that they had neither the time nor the necessary information to coordinate and monitor day-to-day operations. • The solution was to establish a structure consisting of divisional offices to administer each of the major product line.

32. Competitive Managerial CapitalismThe United States PARTⅡ • Competitive Managerial Capitalism • From the 1890s on, the United States was the world’s leading industrial nation. • What Crucial differences in the nature of markets and in the speed of adopting new technologies led American industrialists to make a greater investment in new units of distribution, purchasing, production, and research and development than did industrialists in other economies? • Why did the modern, integrated, multiunit enterprise appear in greater numbers and attain a greater size in a shorter period of time in the United States than it did in Europe? • Why, by World War I, were managerial hierarchies becoming more extensive and the resulting separation of ownership and management becoming more clear-cut in the United States than in other economies?

33. Competitive Managerial CapitalismThe United States

34. Chapter3: The Foundations of Managerial Capitalism in American Industry The Domestic Market • What most strikingly differentiated the United States from Great Britain and Germany in the late 19 century were the geographical size and very rapid growth of its domestic market. • In addition to its size, from the 1870s until the Great Depression of the 1930s the American domestic market grew faster than that of any other nation. • Until the depression the United States outdistanced other leading industrial economies in the growth of both population and per-capita income—the two basic ingredients that determined overall consumer demand. • American manufacturers were much less dependent on foreign trade than were those of Britain and Germany.

35. Chapter3: The Foundations of Managerial Capitalism in American Industry The Impact of the Railroads and Telegraph • In the United States the geographical extent of the country(even before the West was won)as well as the distances between urban centers meant that far greater mileage had to be constructed than in other industrial countries. • The railroad provided the technology, not only to move an unprecedented volume of goods at unprecedented speed, but to do so on a precise schedule, that is, a schedule stated not in terms of weeks or months but of days and even hours. • These managers subdivided their operations into smaller operating groups and then appointed middle managers to supervise, monitor, and coordinate the different functional activities on each division.

36. Chapter3: The Foundations of Managerial Capitalism in American Industry • To prevent what railroad managers had come to consider ruinous competition and to assure the continuing flow of traffic needed for economic survival, the railroads formed regional federations. • Besides being the first businesses to be administered through extensive hierarchies and the first to compete in a modern oligopolistic manner, the railroads were the first enterprises to be funded by modern financial institutions. • The cost of constructing and equipping railroads was so much higher than that of all previous business ventures, railroad transportation became the first modern high-fixed-cost business, and so the first in which continuous capacity utilization became a major concern.

37. Chapter3: The Foundations of Managerial Capitalism in American Industry • The Revolution in Production • Branded, Packaged product • Mass-Produced Light Machinery • Electrical Equipment • Industry Chemical • Metals • The new form of transportation and communication • Brought about an organization revolution in distribution. • Created an even greater revolution in production. • Stimulating impressive technological and organization change. • The laying down of railway and telegraph precipitated a wave of the Second Industrial Revolution at the end of nineteenth century.

38. Chapter3: The Foundations of Managerial Capitalism in American Industry • The new technologies • Transformed the processing of many foods • Revolutionized the refining of many metals and materials. • Created brand new chemical industries • Brought into being a wide range of machinery • In the last decade of nineteenth century had a most profound impact by Thomas Edison, Werner Siemens, and other inventor that led to mass production and distribution of electric power. • Transformed mechanical processes of production . • Created a new form of urban transportation. • Revolutionized the making of many metals and chemicals.

39. Chapter3: The Foundations of Managerial Capitalism in American Industry • Technological innovations become available worldwide, entrepreneurs had to make the three-pronged investment. (It was the investment,not the innovation ) • To realize the cost advantages of scale and scope in production. • To create a product-specific marketing network . • To recruit and train a team of salaries managers who would assure the continuing flow of goods through the processes of production and distribution. • The major investments of the critical decades (1880s~1890s). • Transformed the American industry. • Had a powerful impact on the legal,financial and education environment until the twentieth century.

40. Chapter3: The Foundations of Managerial Capitalism in American Industry • Branded, Packaged product • Occur in : • Tobacco industry • Grain industry • Consumer chemicals industry • Fresh meat and other perishable products • The large enterprise had a competitive advantage over smaller firms. • The cost advantage of both were enough to transform industries • and to create powerful new enterprises.

41. Chapter3: The Foundations of Managerial Capitalism in American Industry • For example : • Packaging and brand became part of the production process. • The manufacturer placed its brand name on the packaged product • and began to advertised it. • Fresh meat and other perishable products--develop and build a • network of refrigerated cars, ships, and depots.

42. Singer Sewing machine company 1.market share 2.the rest McCormick Harvesting machine company 75% Chapter3: The Foundations of Managerial Capitalism in American Industry Mass-Produced Light Machinery • Originally developed to produce small arms—”American system • of manufacturing “ in the 1880s. • Adopted the first modern mass-production methods of fabricating • and assembling fully interchangeable and standardized parts. • Including: - Small arms - Sewing machine - Agricultural machine

43. Chapter3: The Foundations of Managerial Capitalism in American Industry ELECTRICAL EQUIPMENT The enterprises created in the 1880sto commercialize the invention of Thomas Edison, Elihu Thomson,and George Westing-house. Thomson-Houston---created the most effective sales organization both at home and abroad American General Electrical had become the leaders of a global oligopoly that would remain little changed until well after World War Ⅱ Westinghouse Siemens & Halske European (AEG)

44. Chapter3: The Foundations of Managerial Capitalism in American Industry • INDUSTRIAL CHEMICALS • In the late l880s and early l890s American entrepreneurs made the investments and created the managerial teams necessary to exploit new electrolytic technologies in chemistry and also metallurgy. • Skill engineers and with the knowledge of chemistry as well as physics • knowledge →replace commercial intermediaries • Invented and produce dynamite (Alfred Nobel’s patent) • Based on coal and coke • Beginning to make impressive investments in research and development by • World WarⅠand much larger than those of British firms.(greatly enhanced • organizational capabilities)

45. Chapter3: The Foundations of Managerial Capitalism in American Industry Leadership --- German entrepreneurs • Exploiting the new processes for producing man-made dyes, pharmaceuticals, • and aim on the basis of coal-tar chemistry • Had responded even more rapidly and efficiently to the new opportunities and • had achieved a strong competitive advantage in the all-important European • markets

46. Chapter 3: The foundations of Managerial Capitalism in American Industry Pioneering Enterprise Only pioneering enterprises made interrelated investments in production, distribution, and management, these enterprises quickly dominated the market. Overcapacity and Declining throughput At established industries pioneers were plagued by overcapacity, and declining throughput. Increasing output and overcapacityintensified completion and drove down prices. The resulting decline of pricein manufactured goods.

47. Chapter 3: The foundations of Managerial Capitalism in American Industry Formal agreement The respond to intensified competition and resulting price decline  Reach formal agreements (enforced by trade associations) - Reduce output - Set prices - Allocate regional markers New capital and energy-intensive industries specially intensified to form such associations. Unstable Situation Such cartels remained unstable because the difficulty for providing mechanism from secretly cutting prices by granting rebates or falsifying their books. In US& UK, such opportunistic behavior was particularly rampant because contractual arrangement between manufacturers.

48. Chapter 3: The foundations of Managerial Capitalism in American Industry Sherman Antitrust Act Enforcement became even more difficult in US after 1890, when congress passed the Sherman Antitrust Act. Reinforced the common lawby declaring such combinationsillegal. Close inter-firm cooperation was defined as illegalcollusion • Circumstance of Sherman Antitrust Act • With little debate and even less opposition, Act made clear the strong • antimonopoly bias of the American public • Act also reflected the most important non-economic cultural difference • between the US & UK, Germany

49. Chapter 3: The foundations of Managerial Capitalism in American Industry Impact of Sherman Antitrust Act Sherman Antitrust Act was to have a profound impact on the evolution of modern industrial enterprises in US. Technology and markets determined when enterprises appeared and in what industries they were located. Sherman Act defined the continuing interrelationships between the new enterprises within a single industry.

50. Chapter 3: The foundations of Managerial Capitalism in American Industry State of New Jersey (1889) Authorizingthe formation of holding companies that might operate on national scale. Permitted the formation of a company that couldhold the stockof existing corporationscharteredin any state. Impact Members of trade associations, as well as other corporations, were able toexchange their stock for shares in a new holding company. The legal form - Permitted rationalization of facilities and personnel - The consolidationor creation of nation-wide sales forces - The recruitmentof amanagerial hierarchy to operated andplan for the enterprise as a whole.