11Infrastructure and Evolution Infrastructure and Evolution of the Modern Firmof the Modern Firm

Clearly, strategy is partly about long-term Clearly, strategy is partly about long-term planning and also partly about studying planning and also partly about studying and adapting to a changing environment. and adapting to a changing environment.

In this section, we will look at the relatively In this section, we will look at the relatively recent history of U.S. business firms. recent history of U.S. business firms. Emphasis is on the evolving environment Emphasis is on the evolving environment and how it affects the nature of the firm.and how it affects the nature of the firm.

We view three snapshots in time: c1840, We view three snapshots in time: c1840, c1910, and c2000.c1910, and c2000.

22Some DefinitionsSome Definitions

Throughput: The rate of movement of inputs and Throughput: The rate of movement of inputs and outputs through a production process.outputs through a production process.

Infrastructure: An indicator of the availability of Infrastructure: An indicator of the availability of resources the firm can draw upon to assist in the resources the firm can draw upon to assist in the production/distribution of a firm’s output of goods/ production/distribution of a firm’s output of goods/ services.services.

Infrastructure may be privately or publicly provided.Infrastructure may be privately or publicly provided. It includes ports, roads, bridges, power plants, It includes ports, roads, bridges, power plants,

internet, banking services, capital markets, tele-internet, banking services, capital markets, tele-communications, education infrastructure, etc.communications, education infrastructure, etc.

33Public GoodsPublic Goods Public provision of a good is often motivated by the Public provision of a good is often motivated by the

existence of a public goods externality.existence of a public goods externality.

A good is nonexcludable in consumption if a user A good is nonexcludable in consumption if a user cannot be excluded. Street lighting, police, army. cannot be excluded. Street lighting, police, army. Nonexcludability as a technology or ethics constraint.Nonexcludability as a technology or ethics constraint.

Excludability allows for private incentives to provide Excludability allows for private incentives to provide the good, i.e., infrastructure.the good, i.e., infrastructure.

A good is nonrival in consumption if consumption by A good is nonrival in consumption if consumption by one party does not detract from consumption by one party does not detract from consumption by other parties. Cable TV is nonrival and excludable.other parties. Cable TV is nonrival and excludable.

44Public Goods, Cont’dPublic Goods, Cont’d

A public good is a nonrival, A public good is a nonrival, nonexcludable good. Roads.nonexcludable good. Roads.

Decisionmakers tend to free ride on Decisionmakers tend to free ride on public goods, and so private provision public goods, and so private provision tends to be suboptimal.tends to be suboptimal.

The government steps in to redress the The government steps in to redress the externality.externality.

55Definitions on Firm Definitions on Firm OrganizationOrganization

Vertical integration: Act by which firms choose to Vertical integration: Act by which firms choose to produce raw materials and/or distribute finished produce raw materials and/or distribute finished goods themselves rather than rely on marketplace goods themselves rather than rely on marketplace relationships with independent firms.relationships with independent firms.

Horizontal integration: Growth by acquisition of Horizontal integration: Growth by acquisition of assets by a firm which intends to increase the assets by a firm which intends to increase the levels of output of products that the firm already levels of output of products that the firm already produces.produces.

Path dependence: Idea that initial conditions may Path dependence: Idea that initial conditions may determine the course of history (the local and the determine the course of history (the local and the lost traveler, sunk costs issue, career choice).lost traveler, sunk costs issue, career choice).

66Circa 1840Circa 1840

BDS relates the story of John Burrows, a merchant who BDS relates the story of John Burrows, a merchant who bought potatoes in Iowa, bagged them and took them bought potatoes in Iowa, bagged them and took them down the Mississippi. The belief was that there would down the Mississippi. The belief was that there would be better prices down south.be better prices down south.

It took 3-4 weeks to get there (poor infrastructure). It took 3-4 weeks to get there (poor infrastructure). Information sources were slow and unreliable. So the Information sources were slow and unreliable. So the business environment was very risky. What if there was business environment was very risky. What if there was a glut by the time he got down south?a glut by the time he got down south?

Burrows was self-employed, traded with small Burrows was self-employed, traded with small businesses and did many of the tasks in the business. businesses and did many of the tasks in the business. He was somewhat unusual; his business was not locally He was somewhat unusual; his business was not locally oriented.oriented.

77Circa 1840, Shaping Nature Circa 1840, Shaping Nature of Firmsof Firms

In the main, the available infrastructure shaped the In the main, the available infrastructure shaped the firm.firm.

Transportation was bad, but improving. The horse Transportation was bad, but improving. The horse ruled. Railroads on horizon. As yet it was difficult to ruled. Railroads on horizon. As yet it was difficult to avail of scale economies (brief explanation) to expand avail of scale economies (brief explanation) to expand the firm. Local input sources and local markets may the firm. Local input sources and local markets may have been too small.have been too small.

Communications were poor. Coordination difficult for Communications were poor. Coordination difficult for firms with scattered business activities. Management firms with scattered business activities. Management decisions had to be devolved to local managers who decisions had to be devolved to local managers who had to be trustworthy. Multinational firms mainly had to be trustworthy. Multinational firms mainly traded high value-added products.traded high value-added products.

88Circa 1840, Shaping Firms Circa 1840, Shaping Firms Cont’dCont’d

Finance was poorly structured and localized. Lenders Finance was poorly structured and localized. Lenders liked to be nearby to monitor the borrower. Personal liked to be nearby to monitor the borrower. Personal relations were very important. This is inefficient from relations were very important. This is inefficient from a systemic risk perspective (e.g., local drought hurts a systemic risk perspective (e.g., local drought hurts all the loans of a bank). Major projects were usually all the loans of a bank). Major projects were usually government backed, e.g. Erie canal.government backed, e.g. Erie canal.

Industrialization was spreading to more products. Industrialization was spreading to more products. Massive scale economies were being realized in Massive scale economies were being realized in textiles. But a lack of standardization of parts. Local textiles. But a lack of standardization of parts. Local blacksmiths were important. Education was not blacksmiths were important. Education was not critical.critical.

99Circa 1840, ChicagoCirca 1840, Chicago

Why did Chicago become the largest midwestern Why did Chicago become the largest midwestern city? Others were just as big 160 years ago.city? Others were just as big 160 years ago.

A suggestion is infrastructure, (access to the Great A suggestion is infrastructure, (access to the Great Lakes). But St Louis had the Mississippi.Lakes). But St Louis had the Mississippi.

Entrepreneurial government.Entrepreneurial government.

Economies of scale and scope (brief explanation) Economies of scale and scope (brief explanation) arising from high throughput. Other regional corn arising from high throughput. Other regional corn and beef centers found it hard to compete when and beef centers found it hard to compete when Chicago’s size economies brought railways, Chicago’s size economies brought railways, specialized storage, futures markets, etc.specialized storage, futures markets, etc.

1010ReCap on circa 1840ReCap on circa 1840

Infrastructure problems tended to localize markets, Infrastructure problems tended to localize markets, and so preclude exploiting economies associated and so preclude exploiting economies associated with high throughput. There was not much with high throughput. There was not much specialization.specialization.

Low quality information caused high risk (story of Low quality information caused high risk (story of Rothschilds in 1815), localized lending, and the need Rothschilds in 1815), localized lending, and the need for trust. Capital markets did not operate well.for trust. Capital markets did not operate well.

Most workers produced things rather than services.Most workers produced things rather than services.

There was rapid change going on nonetheless.There was rapid change going on nonetheless.

Compare with some developing countries today.Compare with some developing countries today.

1111Circa 1910, PhenomenaCirca 1910, Phenomena

By now firms tended to be larger in size, and By now firms tended to be larger in size, and were often run by professional managers.were often run by professional managers.

Management became more specialized: Management became more specialized: engineering, finance, personnel etc.engineering, finance, personnel etc.

Many firms were diversified into many Many firms were diversified into many products to exploit economies of scope.products to exploit economies of scope.

A more prosperous and urban U.S. and global A more prosperous and urban U.S. and global population.population.

1212Circa 1910, Firm Circa 1910, Firm OrganizationOrganization

Many firms had vertically integrated. In part, Many firms had vertically integrated. In part, they wanted to work more closely with up- and they wanted to work more closely with up- and down-stream firms to avoid coordination down-stream firms to avoid coordination problems. Sometimes this gave a firm problems. Sometimes this gave a firm enormous power in a market (trustbusting). enormous power in a market (trustbusting).

Management was quite hierarchical. Management was quite hierarchical. This may have been because while the This may have been because while the firm had to be big to be efficient, the firm had to be big to be efficient, the efficiencies were not in administration.efficiencies were not in administration.

1313Circa 1910, Financial Circa 1910, Financial MarketsMarkets

Financial markets had deepened Financial markets had deepened considerably. The notion of feedbackconsiderably. The notion of feedback. . (Feedback concept with suppliers, quality in (Feedback concept with suppliers, quality in the supply chain)the supply chain)

Large Corporations

Good Financial Markets

1414Circa 1910, TechnologyCirca 1910, Technology

Many technology-driven firms, e.g., car Many technology-driven firms, e.g., car companies, Ma Bell, NCR, Standard Oil. Many had companies, Ma Bell, NCR, Standard Oil. Many had R&D programs. Universities increasingly saw R&D programs. Universities increasingly saw their role as the providers of technology for their role as the providers of technology for industry.industry.

Transportation innovations gave access to larger Transportation innovations gave access to larger markets and hinterlands for resource/input acquisition. markets and hinterlands for resource/input acquisition. State of communications enabled the distribution of State of communications enabled the distribution of large volumes produced centrally, but perhaps not the large volumes produced centrally, but perhaps not the task of decentralized production (vs. task of decentralized production (vs. software/newspapers now). Pres. Hayes and the software/newspapers now). Pres. Hayes and the phone.phone.

1515Circa 1910, GovernmentCirca 1910, Government

Many governments were more involved Many governments were more involved in providing infrastructure, e.g., in providing infrastructure, e.g., mandatory primary education because mandatory primary education because of public good externalities. They set of public good externalities. They set safety and information standards (e.g., safety and information standards (e.g., account disclosures by public firms). account disclosures by public firms). Public utilities.Public utilities.

1616Circa 2000, PhenomenaCirca 2000, Phenomena

Technological innovation seems to be Technological innovation seems to be accelerating. (Billy Joel, “We didn’t start accelerating. (Billy Joel, “We didn’t start the fire.”)the fire.”)

80% of U.S. economy is service related, 80% of U.S. economy is service related, but the difference between manufacturing but the difference between manufacturing and services can be moot.and services can be moot.

Continual re-education becomes the norm Continual re-education becomes the norm in developed economies.in developed economies.

1717Circa 2000, Phenomena Circa 2000, Phenomena Cont’dCont’d

Deregulation in U.S., and then elsewhere Deregulation in U.S., and then elsewhere (railroads, trucking, airlines, (railroads, trucking, airlines, telecommunications.) Privatizations.telecommunications.) Privatizations.

Transportation costs fall. Communication costs Transportation costs fall. Communication costs collapse. Competition and new means of selling collapse. Competition and new means of selling and distributing reshape many sectors.and distributing reshape many sectors.

Firm structure has flattened (paper shuffling Firm structure has flattened (paper shuffling and information management has been and information management has been facilitated by cheap computing power?).facilitated by cheap computing power?).

Many firms outsource most of the components Many firms outsource most of the components of what they produce.of what they produce.

1818Circa 2000, Cont’dCirca 2000, Cont’d

Overview of state of infrastructure:Overview of state of infrastructure:– Transportation: air travel etc.Transportation: air travel etc.– Communications: international Communications: international

telemarketing.telemarketing.– Finance: global trading; banking online Finance: global trading; banking online

and horizontal integration; Junk bonds and and horizontal integration; Junk bonds and venture capital financing of startups (CNN, venture capital financing of startups (CNN, McCaw, Viacom, Silicon Valley firms); McCaw, Viacom, Silicon Valley firms); Efficiency and transparency of capital Efficiency and transparency of capital markets emphasized.markets emphasized.

1919Circa 2000, TechnologyCirca 2000, Technology

Overview of Production TechnologyOverview of Production Technology R&D the lifeblood, even the purpose, of many R&D the lifeblood, even the purpose, of many

firms. Employee retraining necessary.firms. Employee retraining necessary. High workplace specialization: do managers High workplace specialization: do managers

understand what some employees do?understand what some employees do? Universities and firms collaborate more closelyUniversities and firms collaborate more closely The biotech (life sciences) revolutionThe biotech (life sciences) revolution Increasing emphasis on environmental issuesIncreasing emphasis on environmental issues

2020Some Lessons from HistorySome Lessons from History

Environments are in continual flux.Environments are in continual flux.

Infrastructure is very important in shaping Infrastructure is very important in shaping the purpose, size and organization of firms.the purpose, size and organization of firms.

Firms must adapt to thrive or even survive.Firms must adapt to thrive or even survive.

Good strategies should be flexible to Good strategies should be flexible to environmental changes. Keynes quote on environmental changes. Keynes quote on facts.facts.