The Managerial Revolution in American Business: General Patterns of Institutional Growth

The significance of the coming of this new function and class for an understanding of American economic history can be pinpointed by briefly summarizing the general patterns of growth. Such a summary demon- strates how historical experience substantiates the general propositions outlined in the introduction to this study. It suggests areas of research for economists concerned with industrial organization and the theory of the firm and for historians concerned with the new class and its growing power in the American economy. Although this summary deals only with the institution in the United States, it can provide a set of ideas for analyzing and explaining its history in other economies as well.

The multiunit business enterprise, it must always be kept in mind, is a modern phenomenon. It did not exist in the United States in 1840. At that time the volume of economic activity was not yet large enough to make administrative coordination more productive and, therefore, more profit- able than market coordination. Neither the needs nor the opportunities existed to build a multiunit enterprise. The few prototypes of the modern firm—textile mills and the Springfield Armory—remained single-unit enterprises. The earliest multiunit enterprise, the Bank of the United States, became extremely powerful and, partly because of its power, was short- lived. Until coal provided a cheap and flexible source of energy and until the railroad made possible fast, regular all-weather transportation, the processes of production and distribution continued to be managed in much the same way as they had been for half a millennium. All these processes, including transportation and finance, were carried out by small personally owned and managed firms.

The first modern enterprises were those created to administer the operation of the new railroad and telegraph companies. Adminstrative coordination of the movement of trains and the flow of traffic was essential for the safety of the passengers and the efficient movement of a wide variety of freight across the nation’s rails. Such coordination was also necessary to transmit thousands of messages across its telegraph wires. In other forms of transportation and communication, where the volume of traffic was less varied or moved at slower speeds, coordination was less necessary. There the large enterprise was slower in coming. When steamship and urban traction lines did increase in size, they had little difficulty in adapting procedures perfected by the railroads. And when the development of long-distance technology permitted the creation of a national telephone system, the enterprise that managed it became organized along the lines of Western Union.

The new speed and volume of distribution brought a revolution in marketing. Multiunit enterprises began to coordinate the greatly expanded flows of goods from producers to consumers. The commodity dealers, the large full-line wholesalers, and the new mass retailers (department stores, mail-order houses, and chains) pushed aside the existing commission merchants. The administrative coordination they provided permitted them to lower prices and still make profits higher than those of the mer chants they replaced. As time passed, the mass retailers supplanted the wholesalers because they internalized one more set of transactions and so coordinated flows more directly and efficiently.

In production, the first modern managers came in those industries and enterprises where technology permitted several processes of production to be carried on within a single factory or works (that is, internalized). In those industries, output soared as energy was used more intensively and as machinery, plant design, and administrative procedures were improved. As the number of workers required for a given unit of output declined, the number of managers needed to supervise these flows increased. Mass production factories became manager-intensive. Nevertheless, as long as the output of these factories was distributed efficiently by the new mass marketers, the manufacturing enterprise remained small. Only a score of managers were needed to manage even the largest of the new factories.

On the other hand, where the mass marketers were unable to provide the services needed to distribute the goods in the volume in which they could be produced, the enterprise became large. The modern industrial enterprise began when manufacturers built their own sales and distribution networks, and then their own extensive purchasing organizations. By integrating mass production with mass distribution, they came to coor- dinate administratively the flow of a high volume of goods from the suppliers of the raw materials through the processes of production and distribution to the retailer or ultimate consumer.

In all these new enterprises—the railroads, the telegraph, the mass mar- keters, and the mass producers—a managerial hierarchy had to be created to supervise several operating units and to coordinate and monitor their activities. The railroads, in managing their huge regional systems, and Western Union, in administering its national one, had to recruit large managerial staffs that included several levels of middle managers. On the other hand, in the marketing and the nonintegrated mass producing enter- prises and in all but the largest steamship, traction, and utilities companies, the managerial hierarchy remained relatively small. But when an enterprise integrated mass production with mass distribution, its management became even larger than those in transportation and communication.

Once such a hierarchy had successfully taken over the function of coordinating flows, the desire of the managers to assure the success of their enterprise as a profit-making institution created strong pressures for its continuing growth. Such growth normally resulted from two quite different strategies of expansion. One was defensive or negative and stemmed from a desire for security. Its purpose was to prevent sources of supplies or outlets for goods and services from being cut off or to limit entry of new competitors into the trade. The other strategy was more positive. Its aim was to add new units, permitting by means of administrative coordination a more intensive use of existing facilities and personnel. Such positive growth might be considered as productive expansion and negative or defensive growth as nonproductive expansion. One increased productivity by lowering unit costs, the other rarely did.

In the growth of railroad and telegraph enterprises, both positive and negative motives were significant. Expanding the system by building or buying lines into another major commercial center helped to assure fuller use of existing facilities and personnel. This was particularly true if connecting lines were not adequate to handle the full flow of current traffic. Such expansion was also used to prevent a basic source or outlet of traffic from being taken over by a rival road or to prevent a rival from obtaining access to sources of traffic. Once the nation’s basic transportation network had been completed, defensive rather than productive growth became the norm. Where lines already existed with capacity to carry current traffic, the building or buying of additional roads resulted almost wholly from defensive measures. The costs of such expansion were far greater than any savings that might be achieved from more efficient coordination of flows. For this reason, the building of the giant systems during the 1880s and 1890s resulted in nonproductive rather than productive expansion of railroad enterprises.

Defensive motives were less significant to the modern marketing enterprises. Because the marketers normally had a number of suppliers, they were rarely threatened by the possibility of having their stocks cut off. Nor was there much opportunity to keep stocks out of competitors’ hands. The marketers went into manufacturing only on those relatively rare occasions when processors were unable to provide the goods at the price, quality, and quantity desired. The cost of obtaining expensive manufacturing plants normally outweighed any gains to be achieved by more effective coordination. Nor were there defensive reasons to integrate forward. The wholesalers had little to gain by purchasing their customers, and the retailers were, of course, at the end of the distribution line.

The basic strategy of growth for the mass marketers was, then, one of productive expansion. They expanded by adding new outlets and new lines that permitted them to make more complete use of their centralized buying, goods handling, and administrative facilities. A comparable strategy of productive expansion was carried on in the twentieth century by banks and other financial and service enterprises. They became large, managerial firms by adding new branches or outlets that permitted them to make more intensive use of their centralized services and facilities.

For those manufacturers who moved into mass distribution when they found existing marketers inadequate for their distribution needs, the motives for expansion were both defensive and productive. The initial reasons for building their marketing and then their purchasing organizations were positive; in the beginning the creation of a buying and selling network was essential to insure the administrative coordination needed to keep their production facilities fully employed. Necessary for the mass production and mass distribution of their products, the administrative coordination made possible by obtaining such selling, buying, and transportation facilities provided these enterprises with a powerful barrier to competition.

Integration backwards into the control of materials, on the other hand, tended to be more defensive than productive. It was productive where, as in the case of food and tobacco companies, suppliers were numerous and scattered. Then the creation of an extensive buying network made possible the maintenance of a high-volume flow of perishable or semiperishable products into processing plants. But where supplies were limited or could be easily controlled by a small number of enterprises, expansion was de- fensive. Mass producers wanted to have assured control over at least some of the sources of raw or semifinished materials. They also found it ad- vantageous to bar others from access to these supplies. The savings from improved scheduling hardly covered the heavy cost of such investments.

Positive motives appeared and played a larger role than did defensive ones in the continuing growth of the large integrated industrial enterprise. Like the marketers, the industrialists continued to set up new branch sales offices at home and abroad. Increases in sales, in turn, brought expansion in manufacturing facilities and enlarged purchasing organizations. These industrial firms also added new lines to make more intensive use of their buying, selling, and processing facilities. Such additions, in turn, required the creation of new facilities. The sale of by-products in markets different from those of the primary line called for the creation of new marketing departments. Lines taken on to make fuller use of a distributing network often required the development of new manufacturing and purchasing units. In time such enterprises found it profitable to produce and market products that made use of only their technological capacities and mana- gerial experience. Such moves into new product lines for new markets were not done to protect their own sources or outlets, or to take preventive action against others. They were to permit the continuing use of existing resources as well as to develop new ones.

Because large integrated industrial enterprises carried on a wider variety of functions over a wider geographical area than did marketing, trans- portation, and communications enterprises, they had greater potential for continuing growth. The facilities and administrative skills of the railroad and telegraph companies could not be easily transferred to other economic activities. The marketers, with their small investment in and little pressure to buy into manufacturing, remained marketers. Their expansion was limited to the number of outlets that could make effective use of their centralized purchasing and other facilities. Much the same was true of financial firms and a variety of such enterprises.

On the other hand, the large integrated industrial enterprises, with their extensive marketing, manufacturing, purchasing, raw-materials producing, transportation, and research facilities, had a wider variety of resources that could be transferred to the production and distribution of other products for other markets. The executives in these large managerial hierarchies were trained in different types of economic activity and so were better equipped to take on the manufacture and sale of new products in new markets than were those in enterprises that carried out only one basic function—finance, marketing, transportation, or communication. Moreover, because the large integrated industrial had more and different types of operating units than other kinds of business enterprises, the likelihood that units might be underutilized was greater. It was rare for all units in such an enterprise to be operating at the same speed and capacity. Such disequilibrium provided constant pressure for the growth of the firm.1 Whether the enterprise was pushed by the need to use existing physical and human resources or pulled by the coming of new markets that might use its facilities, it tended to move into areas where existing demand and technology created the needs and opportunities for administrative coordination. Such productive expansion was inherently more profitable than defensive expansion, and so set the direction in which the enterprise grew. And the distance the enterprise moved in this direction was closely related to the nature of its resources, the skills of its managers, and the transferability of these resources and skills to new products, services, and markets.

In those industries where administrative coordination of mass production and

mass distribution was profitable, a few large vertically integrated firms quickly dominated. Concentration and oligopoly appeared as a consequence of the need for and the profitability of administrative coordination. Where markets and technology did not give the manufacturing or processing enterprises a competitive advantage, large mass retailers came increasingly to coordinate flows. Because of the number and complexity, of these flows, many small suppliers and distributors, including brokers and freight forwarders, continued to fill-in and even-out the flows. Their functions, however, supplemented, and were integrated into, the larger economy by the coordinating activities of the mass producers and mass marketers.

Although administrative coordination has been a basic function in the modernization of the American economy, economists have given it little attention. Many have remained satisfied with Adam Smith’s dictum that the division of labor reflects the extent of the market. Like George Stigler, they see the natural response to improved technology and markets as one of increasing specialization in the activities of the enterprise and vertical disintegration in the industries in which these enterprises operate.2 Such an analysis has historical validity for the years before 1850 but has little relevance to much of the economy after the completion of the trans- portation and communication infrastructure. Besides ignoring the his- torical experience, such a view fails to consider the fact that increasing specialization must, almost by definition, call for more carefully planned coordination if volume output demanded by mass markets is to be achieved.

Economists have also often failed to relate administrative coordination to the theory of the firm. For example, far more economies result from the careful coordination of flow through the processes of production and dis- tribution than from increasing the size of producing or distributing units in terms of capital facilities or number of workers. Any theory of the firm that defines the enterprise merely as a factory or even a number of factories, and therefore fails to take into account the role of administrative coordination, is far removed from reality.

In addition, administrative coordination helps to account for a signifi- cant segment of what economists have defined as a residual, that is, the proportion of output that cannot be explained by the growth of input. Certainly the speed and regularity with which goods flow through the processes of production and distribution and the way these flows are or- ganized affect the volume and unit cost. Until economists analyze the function of administrative coordination, the theory of the firm will remain essentially a theory of production. The institution through which the factors of production are combined, which coordinates current flows, and which allocates resources for future economic activities in major sectors of the economy deserves more attention than it has yet received from economists.

Source: Chandler Alfred D. Jr. (1977), The Visible Hand: The Managerial Revolution in American Business, Harvard University Press.

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