Corporate Analysis The Evolution of the Modern Firm

1. Corporate AnalysisThe Evolution of the Modern Firm Lecture Slides Rui Baptista

2. There are three main stages in the evolution of the modern firm: • Before the XIX Century Revolution in Transports: firms are constrained to operate in small localised markets; • Before the Revolution in Information Technology: growth and geographical spread of corporate giants; • Information Age: decay of corporate giants; small firm networking and high rates of innovation and corporate change.

3. Business Before 1840 • Business concerns are mostly “single factor” (family operated). • Transport costs and delays increase risk and facilitate local monopoly. • Lack of knowledge about prices, buyers and sellers - dependence on brokers. • Uncertainty and small market size prevent firms from investing and growing.

4. Infrastructure before 1840 (I) • Transport: steam power and early development of railways; most transport flows through waterways, and is expensive and risky. • Communications: highly reliant on postal services (slow); telegraph develops alongside the rail. • Finance: uncertainty and underdeveloped capital markets prevent firms from obtaining long term credit; lack of mechanisms to reduce the risk of price fluctuations (first futures market created in 1840).

5. Infrastructure before 1840 (II) • Technology: the pace of development is very slow when compared to what it would become in the next century. Standardisation and the use of new power sources (coal, steam, fuel) would remain relatively uncommon until the 1850’s. • Government: sets the basic rules under which business operates and undertakes major infrastructure investments (railroads, waterways, roads), financed through taxes and public debt; there is no relevant regulatory involvement.

6. Business after the Revolution in Transports (I) • Business is dominated by large scale corporations, involved in various stages of the productive cycle. • Corporations are managed by professionals and are hierarchical in structure. • Mass production technologies yield lower costs with increased scale of production. • Infrastructure development increases the geographical scope of markets and reduce uncertainty (greater access to investment capital).

7. Business after the Revolution in Transports (II) • Product line and volume expansion lead to horizontal and vertical integration, and to the the creation of multi-product conglomerates. • The growth of firm size increased the market power of single firms, leading to mergers and collusion practices.

8. Infrastructure after the Revolution in Transports (I) • Technology: growth of mass production - high-volume, low-cost manufacturing; hierarchical organisation forms dependent on professional managers. • Transportation: continued growth of railroads; improved transport conditions for fragile and perishable goods; better access to raw materials and final goods markets. • Communications: improvement in postal services; widespread use of telegraph and telephone; (cont.)

9. Infrastructure after the Revolution in Transports (II) • Communications (Cont.’d): telephone and rail spawn the growth of other industries (steel, oil) and enable large firms to monitor geographically separated businesses. • Finance: development of investment banking and of new accounting methods promoted the financing of large investment projects. • Government: increasing role in regulation - anti-trust and financial markets; mandatory education established as a basis for productivity growth.

10. Business in the Information Age (I) • Competition is global: the same geographic market is shared by competitors located everywhere. • Consumers grew more sophisticated as product differentiation increased - scale and costs became less important - competition has increased. • The pace of diversification increased (anti-trust regulations, generalised technologies and distribution channels. • Strategic planning and consulting have entered the firms’ structure; hierarchy has become “flatter”.

11. Business in the Information Age (II) • “Downsizing” and “outsourcing” reduce vertical integration - firms sub-contract in order to improve flexibility and lower costs. • Strategic partnerships and joint-ventures cut across organisational charts, allowing large firms to profit from innovations developed by small businesses. • Start-up companies are set off by technological opportunities that originate from R&D conducted outside the corporate environment.

12. Infrastructure in the Information Age (I) • Transportation: enormous increase in the weight of automobile and air travel; speed and reliability of both passenger and freight transport has increased dramatically; geographical proximity to markets and raw materials has lost relevance. • Communications: extensive development of telecommunications technologies (fax, modem) has made possible the nearly instantaneous transmission of information world-wide, increasing co-ordination.

13. Infrastructure in the Information Age (II) • Technology: innovation has become a strategic tool - R&D is now a major capital investment; end of “trade-off” between price and quality. • Finance: deregulation has lead to an upsurge of new financial instruments (“junk-bonds”, venture capital); take-over activity has made finance the central focus of large firm management. • Government regulation has increased significantly, taking up new roles (environment, safety) and became highly developed in specific sectors

14. High Tech Capitalism • “High value” has replaced “high volume”. • Increasing complexity. • Large hierarchical structures are too rigid to keep up with the pace of technological innovation. • Incremental innovation adds “layers” of new uses for existing products (upgrades). • Products are made of different and increasingly complex components - vertical separation is the only way to achieve scale effects in R&D.

15. The Evolution of the American Steel Industry (I) • Typical case of a “high volume” industry facing radical changes. • Bessemer method for making steel revolutionised the industry in the 1870’s; the growth of the railway provided high demand. • A. Carnegie built the largest steel plant in the world in Pittsburgh; as output soared, cost per unit fell. • Partnership with J. P. Morgan formed the U.S. Steel conglomerate - the biggest company in the world, holding 75% of the U.S. steel market.

16. The Evolution of the American Steel Industry (II) • From the 1950’s, changes in technology and in the nature of demand began to transform the industry. • Strips and sheets of metal used to produce cars and home appliances became relatively more important than heavy plates; this became clear from the 1970’s. • Technological advances such as the basic oxygen furnace, the continuous casting process and the electric furnace reduced the prominence of scale. • Incumbents were “chained” to the old technologies by irrecoverable investment costs.

17. The Evolution of the American Steel Industry (III) • New firms developed “minimills” - small non-vertically integrated producers who convert scrap metal into steel products, adapted to the particular needs of customers (Chapparral, Nucor), supplying at low cost and locating closer. • Competition from “minimills” and foreign producers with new technologies drove the existing firms (in particular U.S. Steel, now USX) to reduce capacity by more than 40% and, although more efficient than ever, are now barely profitable; Pittsburgh entered urban decline.