The Limitations of the Personal Capitalism Paradigm - Case Study Example

Running Head: Chandler's claims Chandler's claims for superiority f managerial capitalism' are specific to a particular time and place andcannot be generalized [Name f the writer appears here] [Name f the institution appears here] Chandler's claims for superiority f 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 f time in the United States than in Europe. He finds the answer related in part to the large size f 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 f 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 f economies f scale and scope in the processes f 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 f commission agents and the growth f full line, full service wholesalers and mass retailers is not entirely clear from Chandler's analysis.[1] Many f the names f 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 f transportation and communication eventually created an even greater revolution in production, stimulating impressive technological as well as organizational changes. The laying down f railroad and telegraph systems precipitated a wave f industrial innovation in Western Europe and the United States far more wide ranging than that which had occurred in Britain at the end f 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 f 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 ften, however, the modern industrial enterprise in the United States appeared after merger or acquisition (p. 71). This in turn was ften 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 f trade could not be enforced in courts f law. Moreover, after 1890 and the passage f the Sherman Act made what was previously unenforceable quite illegal. The Sherman Act "was to have a profound impact on the evolution f modern industrial enterprises in the U.S." (p. 72). Shortly after its passage and subsequent amplification by a number f Supreme Court decisions, there began the largest and certainly most significant merger movement in American history. It came partly because f continuing antitrust legislation and activities by the states, partly because f the increasing difficulty f enforcing contractural agreements by trade associations during the depression f the mid-1890s, and partly because the return f prosperity and the buoyant stock market that accompanied it facilitated the exchange f 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 f the century, as a number f 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 f expansion. (p. 76). While some mergers initially created little more than federations out f previously independent companies, Chandler asserts that "nearly all the mergers that lasted did so only if they successfully exploited the economics f scale and (to a much lesser extent) those f scope" (p. 78). The merger movement is to Chandler the most important single episode in the evolution f the modern industrial enterprise in the United States from the 1880s to the 1940s as it permitted the rationalization f 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 f investment banks and other financial institutions, ften important in arranging financing for mergers and acquisitions, on the boards f American industrial enterprises for the first time. However, the influence f the financiers waned as the companies were able to finance long-term investment as well as current operations from retained earnings, and the influence f 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 f 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 ffered 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 f 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 f refining capacity.[5] But the enterprise was so successful that it was able to create "several f 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 f 1911 split the company along functional lines, with only Standard f New Jersey and Standard f 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 f the Standard Oil companies-members f the Rockefeller family were generally not involved, even on the board f 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 f many other important industries, including machinery, electrical equipment, industrial chemicals, rubber, paper, cement, and steel. Steel is f particular interest, not just because f 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 f 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 f challengers" (p. 128). In steel a near monopoly was translated into an oligopoly, not by changing markets and technologies, but through the unfortunate decisions f 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, ffered 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 f the corporate ffice to be much like that f a federation or cartel ffice to set prices rather than to allocate resources. This created a tension with the inherited Carnegie Steel managers who wanted to continue the policy f "exploiting the competitive advantages f 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 f 1907 and 1908 to urge them to support the prices that he had done so much to stabilize . . . . A decade f Gary's policies permitted his competitors to overcome the first mover advantages Carnegie had achieved in the production and distribution f steel. (p. 135) In steel, as in rubber goods, paper, window glass and tin cans, the failure f the new industry-wide merger to take steps to exploit fully the potential economies f scale made possible the rise f challengers and enlarged the size f 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 f growth rested on scale economies, firms grew more by direct investment abroad (e.g., machinery and transport equipment); where economies f 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 f 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 f the products and the managerial challenge associated with running multiple businesses increased the role f prfessional managers at DuPont and elsewhere in the chemical and machinery industries, and further separated management from ownership. Chandler concludes his review f 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 f 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 f investing in manufacturing, distribution, and management systems and people. References Chandler, Alfred D. Strategy and structure: Chapters in the history f the industrial enterprise. Cambridge, MA: MIT Press, 1962. Church, Roy. "The Limitations f 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 f production--not the innovation--that initially lowered costs and increased productivity. It was the investment, not the innovation that transformed the structure f 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 f managing large, complex hierarchies increased the demand for trained executives, and U.S. colleges and universities responded quickly by expanding the training f engineers and managers. Early providers f business education were the Wharton School at the University f Pennsylvania, founded in 1881, the University f Chicago, and the University f California at Berkeley which set up business schools and colleges in 1898. Harvard followed in 1908 with its Graduate School f Business Administration. 5. At the turn f the century the competitive significance f oil pipelines, and oil transportation more generally, was considerable. As the Report f the Commissioner f Corporations on the Transportation f Petroleum, U.S. House f Representatives, May 2, 1906, p. 33, makes apparent, "The cost f transportation is an exceedingly large factor in the cost f oil to the consumer. 6. Hard driving refers to the practice followed in the U.S. steel industry f driving blast furnaces at pressures f 9 psi, as compared with the British practice f 5 psi. Hard driving required frequent rebricking but permitted higher throughput. 7. The price f 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 prfits soared. 8. "In arranging this huge merger the house f Morgan did not carry out the normal, time-consuming procedures f investigating potential cost advantages f rationalization, appraising the properties f the firms coming into the merger" (p. 32). Chandler leaves no doubt that the strategy was to earn promoters prfits and effectuate market control. 9. U.S. Steel provides one f the very few examples f 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