Firms and Industries

Firms and Industries Industrial organisation and the size/ scope/ and development of firms: what’s it all about?

References • For the stats on the descriptive background for firms and industries see • L&W chap 4 on concentration, chap 9 on vertical integration, and chap 10 on diversification. • P&S discuss firm scope issues in chap 11, and multinationals in chap 16. F&I introduction

Industry from the air • Consider an aerial photo of British industry, showing the physical side, the separate production units or plants like oil refineries, car assembly plants, and silicon factories. • From this we could count the number of oil refineries, car factories, chip factories, electricity generators, brewers, publishers, steel makers, soap makers, ……. • We could then say how many plants were in each industry and talk about their size distribution and location, maybe say something about the different stages of production, but that’s about it. The physical reality of industry in fact tells us little about how it is organised in the economic sense because it misses a key reality: THE FIRM F&I introduction

The firm or business enterprise • This is the key reality in ind org because the firm is a legal entity (IBM inc, BP plc) that is able to own and control several plants in the same industry or operations at different stages of production or businesses in different industries and even plants in different countries. • And it is this fact that makes the firm, its size, its scope, its development, the key to understanding how industry is organised in the economic sense. F&I introduction

IO in the economic sense • When economist talk/ write of ind org they refer to the following dimensions: • Horizontal org refers to the number and size distribution of firms in the same industry: say brewing or oil refining. • Vertical org refers to the relationship between the various layers of the value chain. Say steel making and car production. Or electricity generation and distribution. • Diversification refers to the possibility that a firm can transcend industries and o/c operations in quite distinct sectors: say brewing and hotels. Or indeed in different countries. F&I introduction

More on the vertical • Most products we know like cars, houses, PCs, newspapers, petrol, …. • Are the outcome of a chain of value adding starting with the raw material, transport and processing, manufacturing, assembly, distribution and retailing. In principle we could take a car apart and trace all the bits and pieces back up the vertical value chain to the raw material. There may be hundreds of different firms operating along this chain. • V organisation refers to how the v chain is organised, in particular the degree to which it is done through market transactions as opposed to within integrated businesses. F&I introduction

The firm again • And this is why firms (their size and scope) are the key to understanding ind org. • Firms can own one or 21 plants in the same industry. • Firms can own plants at several different stages of the production process, or value chain. Like oil refineries, transportation operations, and petrol stations. • Firms can own plants in different sectors (or even in diff countries) such as some making medical equipment and others making aero engines. F&I introduction

Liberalia • IF we assume that by Government decree all firms/ enterprises must be single plant/ single business, (but not necessarily national). That no H/ V integration is permitted. • Call it Liberalia. • Then explaining Ind Org would be easy because all you have to do here is explain the size of the production units which will depend largely on technology. There are no complex multi plant firms to worry about. F&I introduction

Bureaucratia • Or we assume, again by decree, that all plants in the same industry must be owned and controlled by a single national firm/ enterprise. There must be total H/V integration and thus giant multi plant complex combines (eg the NHS). • Call it Bureacratia. • Then again, explaining Ind Org is easy. No theory of IO is needed. IO is determined by gov decree. F&I introduction

Simple SP/SP fragmented exchange by markets competitive technology and politics Complex MP/MP integrated H/V organisational exchange monopoly technology and politics Liberalia v bureaucratia F&I introduction

Reality?? • Neither extreme applies. Under normal circumstances Ind Org evolves as technology, markets, cost factors, government policies, and the firm’s search for profits pushes firms and industries into a variety of shapes horizontally and vertically. • Autos, pharmaceuticals, software, banking all differ. • We get a variety of firms, many very simple, some quite complex, and a few very complex indeed. • Think of Glaxo-SKB in the UK or GE in the USA. Huge complex multi product, multi plant, multi market, multi business, multi nationals. F&I introduction

British industry in the 1990’s • 83,000 single plant enterprises (22% of output). • 2,200 multi plant (av 3 each) (23% of output). • 300 largest businesses, multi plant multi product (av 23 plants) accounted for 55% of output! • This dominance of the few had increased greatly since the 1950’s F&I introduction

Reality • Many simple and some very complex firms. • Industry in aggregate dom by relatively small number of complex businesses. • Some industries dominated by a few big firms (highly concentrated) some not. • Some firms vertically integrated some not. • Some firms operating in several distinct industries. • Some firms operating in several countries. • Some firms/ industries state owned (NHS), most now private, quite a few foreign owned, some regulated by state, others not. • WHY? Accident or economic logic? F&I introduction

Objective • What we seek to understand in this course is the logic involved, the factors influencing the size & scope of enterprises and thus what drives the organisation of industry (H/V). • Is this a random process or is there an underlying economic logic we can point to? Why do such complex organisations develop when simplicity seems so much easier? And what are the consequences of this logic for society as a whole? Is this process necessarily benign? F&I introduction

The changing org of industry • Industrial change in general and trends in: • Aggregate concentration (big business) • Industrial concentration (horizontal structure). • Vertical integration (vertical structure). • Diversification (multi bus corporations). • Internationalisation (multinationals). • Ownership and control. • Private/ public ownership • Mergers and acquisitions. F&I introduction

Change in general • British industry has changed dramatically since 1950. At the aggregate level the key changes have been the decline of manufacturing and the rise of services • Whilst within manufacturing (best documented sector) we see the decline of shipbuilding, textiles, and metal bashing and the rise of electronics and pharmaceuticals. F&I introduction

Manufacturing • Nowadays accounts for only around one fifth of GDP. Like other advanced economies Britain is predominantly a service economy. (Health, education, etc.) • Manufacturing was 36% of output in 1950’s, and its decline is called ‘de-industrialisation’. (Earlier we had de-agriculturalisation). • Note however manufacturing still accounts for almost 70% of British exports. F&I introduction

Aggregate concentration in manf. • The largest 100 enterprises as a proportion of total manufacturing output. • In 1950 accounted for 22% of output, but by 1980 this peaked at 41%. It declined slightly thereafter and was around 39% in the early1990. It seems fairly stable around 40% although public policy has had an impact on this. F&I introduction

Industry level concentration • Measures the H organisation of industry or the degree to which a particular industry is dominated by a small number of firms. • Complete dom would be a monopoly of course, and complete lack of dom would be p comp. Most inds are oligopolies. Some are dominated by 2/3 producers (tobacco), others by more (oil, banking, advertising, …) . F&I introduction

Industry level (horizontal) concentration: on level and trends see George or L&W (4) texts. Level of detail provided is crucial. • UK Census of Production uses the Standard Industrial Classification system (SIC) to allocate production units or plants to specific sectors or industries. There are 3 levels: • 2 digit level (not much detail) eg class 35 motor vehicles • 3 digit level (more detailed) eg 35 (2) mv, caravan and trailer bodies • 4 digit level (much more detail) eg 352 (2) trailers. F&I introduction

EC definitions • Since 1992 Europe has used a common SIC similar to the UK system of classification. • Division (2 digit) such as food inds • group (3) such a meat processing • sub class (4) such as bacon and ham • see L&W ch 4 F&I introduction

Terminology • Industry is a useful term for describing things at the 2 dig level, such as the chemical ind or engineering ind. • As we move towards 4 digit levels we are getting towards what are better described as markets. The chemicals ind produces dozens of different chemical products which in fact are not close substitutes and sell in distinct markets • There is thus two types of comp at least. General competition between chemical businesses (Du Pont v ICI) or engineering businesses and competition in specific well defined markets such as the market for paint or explosives or dyes or fragrances or food additives which are all served by chemical companies. F&I introduction

Note on semantics • Industry is an unsatisfactory term. • It is ok for some purposes to talk of the hotel industry, the publishing industry, the auto industry. But it is imprecise. • Competition is about specific markets not industries. Think of industries such as hotel, publishing, auto, education, finance, pharmaceuticals? • In hotels we have luxury hotels, mid range hotels, cheap and cheerful, backpackers. (US/EC/SEA etc) In drugs, there is no single market, but dozens of distinctive markets relating to particular problems. • Point? Competition is about reasonably well defined distinctive markets for particular customer segments in particular places. • In autos it is true in general that Ford ‘competes’ with VW. But even here the important action is in well defined market segments (small cars) in particular areas (UK). F&I introduction

Concentration measured? • Concentration is measured as follows: • Sales or production (or sometimes employment) of largest 5 producers/ total sales or production in this industry or market. It thus varies from 100% down…… F&I introduction

Trends • Consider: what has happened to industry level concentration levels over time? • Is it always increasing as existing firms get bigger? Or does it always decrease as new competitors come along? • What do the figures suggest about competition in British industry? F&I introduction

Qualifications • Trade. Statistics concern production in Britain and so do not take account of the fact that a lot of what is consumed here comes from abroad. So auto production has become more concentrated but the market has become more competitive. • The figures are based on production process not on markets. So glass bottles, plastic, and tetra pak are in separate industries but compete in the same market. This limits usefulness of the figures. • Check the weighting system in use. F&I introduction

For example • All 3 digit industries, weighted by sales, • Average five-firm concentration was tending to decline slightly in the early 1990’s and was just below 50%. Some inds are thus highly conc but others are not. • The most concentrated industries were large scale homogeneous product industries like glass, cement and steel and large scale differentiated product industries such as autos and tobacco. • Source: OECD F&I introduction

Vertical integration (or scope) • Harder to identify level and trend over time. Less easy to measure than concentration/ div. And no easy data base to look up. • A recent study based on UK input-output tables covering 300 + large UK enterprises concluded: • 50% firms with no significant VI at all. • 50% had integrated at least on stage (f/b). • 10% of enterprises were ‘highly’ v integrated. • Figures suggest increasing trend to mid 1980’s and subsequently some decline. F&I introduction

Input-output tables? • These are large matrices (see next) which show the links between all the industry sectors in the economy. The columns show the output value of say of autos or books, and the rows show which sectors (steel, paper, glass, …) provided the input value required for producing autos or books. The columns thus give insight into the industry value chain or vertical relationships. F&I introduction

F&I introduction

Diversification (scope) • Largest corporations in the UK, 1950 on. • 50 80 93 • Single business 35 9 5 • Dominant bus. 41 26 13 • Related div. 20 47 57 • Conglomerate* 4 18 25 • * ie unrelated diversifiers F&I introduction

Utton’s study • Based on detailed SIC data at the 3 digit level for top 200 manufacturing firms. • Found that average large firm had 43% of its employees outside the ‘primary’ industry it was identified with. • Average large firm operated in 4 out of a possible 120 industries. • What does this suggest? F&I introduction

Business scope • Business scope goes beyond just product range/variety to distinctive (in principle separable) businesses. Thus it is hard to see Ford Fiesta and Ford Focus as separable businesses, but easier with Ford autos/ Ford finance/ Ford marque (upmarket cars)/Ford trucks/ and quik fit centres. • Multi business corporations come in different forms depending on the relationship amongst the businesses in the group and the policy choices/ motives involved. • Vertically related businesses (BP, Exxon) • Related diversified businesses (GE, Sony, HP-Compaq) • Unrelated diversifiers (conglomerates like Unilever/ Reckitt/ Vivendi) • If the businesses are in different countries we can add ‘international’ business scope to the list. F&I introduction

Differences still relate to economies of scope however. • Compare the nature/ sources of business scope economies in GE, Citigroup, BP, Sony, Tyco, L’Oreal, Tesco, IBM, Unilever….. • What would you conclude if in some cases it was difficult to identify any significant business scope economies? F&I introduction

Internationalisation • UK CAPITAL STAKES OUT/ IN (£M) • 62 5000 2200 • 77 20,000 14,100 • 90 91,000 53,000 • British capital goes to US and EC. • It comes in from US,EC, and increasingly J. F&I introduction

Current flows in and out • In 2000 the flow coming in (NB not stock) was 150 billion pounds • and going out was 75 billion • so the internationalisation or globalisation of the UK economy, which has always been relatively high, is still increasing. • Source: ONS (on line) F&I introduction

One third of Britain’s major businesses are foreign owned. • Foreign ownership dominates in autos and auto parts, office machinery and electronics. • It is lowest in traditional sectors like timber and furnishings. • Foreign ownership of manufacturing rose dramatically in the 80’s: it was 20% of total value added by the early 90’s. • Business Monitor reports, various. F&I introduction

Ownership and control • Private sector case: the increasing degree of separation of ownership from control, between the ‘owners’ (shareholders) and controllers (professional managers). • UK 1990’s shares held by value: individuals (21%), overseas (12%). institutions (pension funds, insurance companies etc. 67%). Such as Prudential, Mercury Asset Managers, Schroder, Scottish Widows, …… • Question is does ownership matter? Who governs the business and how? Come to this issue soon. F&I introduction

Public and private ownership • Nationalisation (40’s, 50’s, 60’s) and privatisation (80’s, 90’s) changes balance between p/p ownership. Electricity etc. Nationalisation (H/V integration) prevented the natural evolution of structures in such inds. No competition, no entry, no diversification, no internationalisation. • By 1979 10% of UK GDP was from nationalised* sector. • *NB this doesn’t include the NHS which was never designated as a nationalised industry and is still in the state sector. It is one of the largest most complex hor and vert integrated business organisations in the world. How it would be organised the in absence of gov fiat we don’t know. F&I introduction

Privatisation • Mrs Thatcher reversed all of this in the 80’s. • Industries were made private again and in many case divided horizontally & vertically. Question was: • What was the best way of organising these industries H/V? Evolution was stopped, so the ‘natural’ organisation was unknown. Still trying to find the answer. BR for example was broken up H and V and it is argued that it hasn’t worked. Question is how to restructure it. Time will tell. F&I introduction

Mergers and acquisitions • A key determinant of the changing organisation and ownership of industry. • UK is very merger/ acquisition intensive. • Three major periods which transformed British industry through m&as were 68/72, 85/90, 95/00. • Important to understand these booms and their effects, which we will examine later. • UK/US have systems of contested take-overs and these are vital to corporate governance as we will soon see. F&I introduction

Sum up • The organisation and ownership of B industry has changed dramatically over time. Horizontally, vertically and through the development of giant multi business/multinationals such as GSKB & BP & Diageo and so on. • We seek to first to understand the economic logic behind this process, in particular why should such complex organisations come about, and later the consequences for society as a whole. F&I introduction

Firms and Industries