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The Evolution of the Modern Firm
Example 1.1: The Emergence of Chicago
Example 1.2: Responding to the Business Environment: The Case of American Whaling
Example 1.3: Evolution of the Steel Industry
Example 1.4: Economic Gyrations and Traffic Gridlock in Thailand
Example 1.5: Infrastructure and Emerging Markets: The Russian Privatization Program
Example 1.6: Building National Infrastructure: The Transcontinental Railroad
This chapter analyses the business environment in three different time periods: 1840, 1910 and the present. It looks at the business infrastructure, market conditions, the size and scope of a firm’s activities and a firm’s response to changes. This historical perspective shows that all successful businesses have used similar principles to adapt to widely varying business conditions in order to succeed.
Businesses in the period before 1840 were small and operated in localized markets. The size of a business was restricted by the lack of production technology, professional managers, capital and large-scale distribution networks. The limited transportation and communication infrastructures made it risky for businesses to expand and restricted them to small local markets. Owners ran their own businesses and depended on market specialists to match the products with the needs of the buyers. There were forces in place, however, that would enable businesses to expand their economic activity over a larger geographic area.
The infrastructure for conducting business expanded tremendously by 1910. New technologies permitted the higher volume of standardized production. The expansion of the rail system permitted the reliable distribution of manufactured goods to a wider geographic area. The telegraph enabled businesses to monitor and control suppliers, distributors and factories. Finally, the growth of financial institutions allowed businesses to raise capital and transact on a global scale. Businesses expanded in size and market-reach by making investments to capture the benefits of these innovations.
Businesses which invested in these new technologies needed a sufficient flow of throughput to keep productions level high. That is, even the largest and best-managed firms of that time were still constrained by the problem of control—how to gain sufficient information on a timely enough basis to adapt to change. As a result, manufacturing firms vertically integrated into raw materials acquisition, distribution, and retailing—eliminating the need to rely on independent factors, suppliers and agents. The growth in the size and enhancement of functional responsibilities, or horizontal integration, was critical to manage these large organizations. Price wars drove weaker rivals out of the market as the firms tried to build volume and spread the fixed costs. Businesses established managerial hierarchies to administrate and coordinate the various functions being performed within the organization. These hierarchies gave rise to a class of professional managers who became experts in certain functions performed by the firm and they became a source of competitive advantage. But the goals of these managers had to be aligned with that of the firm. Large hierarchical firms would dominate the first half of the 20th century.
The entire business infrastructure has undergone massive changes over the last 30 years. Improvements in transportation, communication and financial infrastructures have facilitated the globalization of markets increasing competition and have placed a premium on quickness and flexibility. Innovations in technology have minimized the advantages of large-scale production facilities and have made it possible for firms to coordinate extremely complex tasks over large distances without being vertically integrated. Smaller and flatter organizations are the preferred way of structuring firms to take advantages of these changes.
These changes have created opportunities as well as constraints. They have made the modern marketplace a global one but they have also increased the number of competitors at the same time. Technological innovations have given firms more control and decreased the geographic distances but they have also allowed smaller nimble firms to compete with big firms in meeting the rapid changes in consumer needs. Well-developed financial markets have lowered the cost of capital but these same markets have made large firms targets for potential hostile takeover.
The three periods, with widely different business practices and infrastructure, illustrate that a consistent set of principles have to be applied to changing business conditions in order to implement a successful business strategy. The business tactics used by firms varied from one period to another to meet the different business circumstances but the economic principles and the behavioral relationships used to form the tactics are general. These principles and relationships haven't changed and can be applied to wide variety of business circumstances. By judiciously applying these principles, managers can successfully adapt their firm’s business strategy to their competitive environment.
Approaches to Teaching this Chapter
This chapter encourages students to be cognizant of the most “bird’s eye” view one can adapt of the context in which firms compete – what are the opportunities and constraints that result from current state of the world’s development? This chapter is intended to shed light on some key strategic concepts developed later in this book including: the fluidity of firm boundaries, the importance of scale and scope, the importance of throughput, and how technology and infrastructure affect strategic choices.
Infrastructure: assets that assist in the production or distribution of goods and services that an individual firm can not provide, such as transportation (roads, bridges, etc.), telecommunications, financing.
Throughput: the movement of inputs and outputs through a production process
Vertical integration: the act by which firms choose to produce raw materials and/or distribute finished goods themselves, rather than rely on independent suppliers, etc.
Horizontal integration: growth in size and enhancement of functional responsibilities in a business area.
Path Dependence: the dependence of an actor's position on its starting conditions, initial decisions, and history.
You might want to discuss that the key business issues in 1840 (riskiness, large number of owner-operators, inefficiency, etc.) and their causes (poor communications, lack of technology etc.) can be seen today in many emerging markets (for example Tanzania, Ivory Coast, and Poland). You could also raise issues of the mistakes that Western firms could make in "emerging markets" if they misunderstand basic business conditions.
The Chicago example is a terrific illustration of how technological changes can change the environment under which firms operate. It would be interesting to ask students why Chicago emerged as the center of distribution if grain elevator technology was available throughout the Midwest at the time. It will come out that Chicago's location, with access to the Great Lakes and Mississippi River, created the advantage. It was essentially a "hub" as in the airline industry today. Furthermore, improvements in communications favored Chicago as a location for distribution activity. Distributors in Chicago had begun the practice of grading grain and were willing to buy and sell grain at guaranteed prices in Chicago before the price was actually set in NY. This was the beginning of a futures market, now called the Chicago Board of Trade (CBOT). Superior information transfer allowed grain traders to bear the risk and still profit. Conclusion: the confluence of technology development allowed Chicago to outperform those who vied for its position at the time.
Today there are still distinct infrastructure changes and new organizational forms emerging. You might discuss the media's current attention on mergers in the telecommunications, financial services, entertainment, and health care industries and the opposing fact that most industries are experiencing quite a different trend, i.e., the virtual corporation. Mention the largest manufacturers of athletic footwear in the world (Nike, Boss, Benetton, and Trek) which are "network" firms. Explain the concept of "network" firms. You could also mention how "global" firms are facing simultaneous pressures to both coordinate on a worldwide scale and pass more decisions down to local managers.
In addition to these examples, it may be helpful to encourage your students to draw on their own life/work experiences and think of the following:
Suggested Harvard Case Studies1
Prochnik: Privatization of a Polish Clothing Manufacturer, HBS 9-394-038 Rev. 1/5/94. This case brings to life the concept that key business issues in 1840 (riskiness, large number of owner-operators, inefficiency, etc.) and their causes (poor communications, lack of technology etc.) exist today in many emerging markets, such as Poland. While this case can be an interesting first introduction to case analysis, it is also a particularly good example of value creation and a strategic turnaround based on a differentiation strategy, which will be discussed in Chapter 11.
House of Tata, HBS 9-792-065. This case traces the evolution of the largest business group in India. Its primary focus is on the organizational structure of the group and how it changed in response to internal and external forces. The instructor can link the absence of infrastructure as well as governmental policies to firm activities and overall performance. This chapter is useful for illustrating some of the concepts in the following chapters: 1, 2, 5, 14, 15 and 16.
Business history is an academic field in its own right, with a large volume of sources to choose from for additional reading. Instructors wishing to provide additional reading or supplemental lectures should consult the following sources:
Atack, J. and P. Passell. A New Economic View of American History, 2nd Ed., Norton, 1994.
Chandler, A.D., Amatori, F. and T. Hikino (eds), Big Business and the Wealth of Nations. Cambridge, U.K.: Cambridge University Press, 1997.
Chandler, A.D. and H Daems (eds.). Managerial Hierarchies: Comparative Perspectives on the Rise of the Modem Industrial Enterprise. Cambridge: MA: Harvard University Press, 1980.
Chandler, A.D. and R.S. Tedlow. The Coming of Managerial Capitalism. Homewood, IL: Irwin, 1985.
Chandler, A.D. The Visible Hand. Cambridge, MA: Belknap, 1977
Chandler, A.D. Scale and Scope: The Dynamics of Industrial Capitalism. Cambridge, MA: Belknap,
Cochran, T.C. and W. Miller. The Age of Enterprise: A Social History of Industrial America. New York; Harper and Row, 1961.
Galenson, D. W. (ed.). Markets in History: Economic Studies of the Past. Cambridge, U.K.: Cambridge University Press, 1989.
Krugman, P. Geography and Trade. Cambridge, MA: MIT Press, 1991.
Lamoreaux, N. R. and D. Raff (eds). Coordination and Information: Historical Perspectives on the Organization of Enterprise. NBER Chicago: University of Chicago Press, 1995.
Lamoreaux, N. R. and Raff, D. and P. Temin (eds), Learning by Doing in Markets, Firms and Countries, NBER Chicago, University of Chicago Press, 1999
Pollard, S. "Industrialization and the European Economy," Economic History Review, 26, November 1973: 636-648.
Temin, P. (ed), Inside the Business Enterprise: Historical Perspective on the Use of Information, NBER Chicago, University of Chicago Press, 1991.
Answers to End of Chapter Questions
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