The Competitiveness of Nations in a Global Knowledge-Based Economy

Alfred D. Chandler, Jr.

Decision Making and Modern Institutional Change

Journal of Economic History, 33 (1)

The Tasks of Economic History, Mar., 1973, 1-15.

Content

I – Introduction

II – The American Story

III – Conclusions

HHC: titles added to numbered sections

I - Introduction

WHEN I began to prepare this talk, I recalled that the first such address I ever listened to helped persuade me to become an economic historian. It was Herbert Heaton’s delightful “The Making of an Economic Historian,” which began with a bit of elegant doggerel. If a discipline could produce such an address, I decided that this association was certainly worth joining. But alas, I was optimistic. I was to hear more erudite presidential addresses but few so witty and informative. Nearly all these rituals, in this association or others, have followed the traditional recipe so well summarized by Shepard Clough. In a systematic review of our past meetings Shep found that “most of our presidential addresses have been devoted to making suggestions for research (mostly to be undertaken by others), to delineating the broad ‘tasks’ of economic history, to defending the kind of work in which the speaker has been engaged, and to advocating some particular methodology in our discipline.” Mine is no exception.

This is a talk about decisions; and let me begin with a personal one. Mine to become an economic historian was real enough. There was a genuine alternative. Shortly after Herbert Heaton had attracted me toward economic history, I was asked to assist in editing the letters of Theodore Roosevelt. Immersing myself in the selection and annotation of the correspondence of one of the most active and articulate American presidents provided me with an inside view of the decision-making processes in the nation’s most powerful office. The significance of this type of data for understanding major political, military and diplomatic developments has been reinforced

during the past eight years in editing the vast correspondence of Dwight D. Eisenhower.

Such work pulled me away from economic history. Roosevelt and Eisenhower were involved in myriad issues, only a very few of which were of special interest to the practitioners of our field. But my earlier interest in economic history was strengthened when I had a chance to review the papers of two men who were near the heart of the twentieth century economy, Alfred P. Sloan, Jr. and Pierre S. du Pont. In the case of Sloan of General Motors fame, I had the opportunity, as I have had with Eisenhower, to talk at length with a key actor about the decisions he had made and the actions he had taken.

Such close study of these men, all of whom had a powerful impact on the organizations in which they worked and on the economies and polities in which they operated, left three clear impressions. First, this experience emphasized the value of the documentary record. The documents of these men were more than mere records. They were the instruments of action of real men whose choices directly affected the lives of thousands, indeed hundreds of thousands, of people. The documents indicated the motives as well as methods of the decision makers far more accurately than views of outside observers, current or contemporary. Interpretations of why these men spoke and acted as they did will of course change; but to be convincing, any interpretations must be based on the documentary record.

A second impression was that the decision makers were normally faced with extremely complex alternatives. Their choices were limited but choices had to be made. Moreover, making these decisions normally involved conflict. It is hard to recall any important decision in which these four men were involved where there was not genuine disagreement at the top. Even when motives were similar, different men often chose different alternatives. An awareness of the alternatives perceived by the key actors (as well as those they did not see); an awareness of the information on which choices were based; and an awareness of the process by which the final choice was determined is essential to an understanding of the larger issues and events in which these men were involved.

My third point is that, although Roosevelt and Eisenhower, and du Pont and Sloan, concerned themselves with very different types of problems, the processes by which decisions were reached and actions implemented had many similarities. And these similarities

differentiated their activities and careers from those of earlier presidents, generals and businessmen. Theirs were usually group decisions, based on a vast flow of information, and synthesized by offices within the enterprise. The information that went up the line as well as the directives that went down, passed through an extensive bureaucracy which could turn and shape them, and which required a never-ending process of checks and review. For this reason Sloan’s day to day activities were closer to Eisenhower’s than they were, say, to those of John Jacob Astor or even Cornelius Vanderbilt; Eisenhower’s were much closer to Sloan’s than to those of Andrew Jackson or even Ulysses S. Grant.

A primary task of historians has always been to record and analyze the motives of, the alternatives open to, and the actions taken by men whose decisions have directly affected many people and indirectly helped to shape the institutions in which the bulk of the population carried on their daily work. An additional task awaiting historians who use the documentary record is to look at the process of decision making itself; to analyze the institutional arrangements within which the decisions were made; to investigate how and why these processes and institutions have changed over time; and finally, to consider how such changes have themselves affected the alternatives and actions open to the decision makers. For economic history such analysis provides the central challenge to business and entrepreneurial historians.

II – The American Story

The value of such historical analysis is emphasized when we consider how drastically the institutions in which economic decisions are made have been re-shaped during the past century and a half. These changes have not only altered the process of deciding about prices, investment, output, inventory, employment and technological and organizational innovation. They have also created new types of business enterprise and helped to reform the structure of many industries and indeed the organization of whole economies. In viewing these developments I will consider only the American scene, for here my information is the fullest. Yet a brief look at the experience of Western Europe and Japan - indeed of all technologically advanced economies - shows that the American story is hardly unique.

Until the 1850’s, most economic decisions were made in the United States by entrepreneurs working alone or with one or two partners. The merchants, who were the dominant businessmen, operated much as they had in the Western world for the previous 500 years. Manufacturing, mining, and agriculture were carried out almost entirely by small, single-unit enterprises operated by their owners.

Only a very few businesses were large enough to be divided into sub-sections. These few - textile mills, ironworks, and cotton, rice and tobacco plantations - had only a single manager to supervise the work of a handful of foremen. Decisions concerning the enterprise were rarely made by more than a couple of men. These units had little systematic internal organization. Their accounts were merely records of financial transactions. Their clerical staffs were even smaller than those of the merchants. Economic enterprise was still wholly a personal affair. The individuals and partners who operated these small personal enterprises had little control over their supplies, markets and prices. Their actions were based on external (not internally generated) information and such information was rarely fresh or full. The model of the economy, defined long ago by classical economists, made some sense in early nineteenth-century America.

After 1850 a new and very different type of decision-making unit appeared. It was a large, multi-unit enterprise operated by managers rather than owners. It appeared suddenly and almost full blown in the 1850’s to operate the major railroad and telegraph lines. Then, similar large enterprises began to appear in industries and trades, where the use of new technologies permitted high-volume production and where the new transportation and communication systems encouraged high volume distribution. The origins and growth of this new style enterprise involved two processes. One was the internal subdivision of railroads, factories, and marketing enterprises into smaller sub-units. More important, however, was the consolidation of already specialized, subdivided units into larger enterprises.

The centralized coordination, evaluation, and planning for the activities of a large number of sub-units which often carried out several different functions of production, distribution, and transportation within a single, purely private enterprise was something new in economic history. Such needs brought the managerial enter-

prise into being. The new enterprises could not run efficiently without a formal internal organization. They required the generation of internal operating, financial and cost data. Only through a flow of internal impersonal statistics could control of these large enterprises be maintained. Finally they needed the services of a large number of specially, often technically trained managers. The operating requirements of the new multi-unit enterprises thus gave rise to a new type of decision-making unit and to a new class of decision makers.

The appearance of these great administrative networks altered the external relations between decision-making units and between these units and the larger environment. In many industries as many transactions came to be carried on within the enterprise as were carried on between the company and other enterprises. Prices came to be based more on cost estimates than on the impersonal forces of supply and demand. The structure of numerous industries and in fact the structure of entire economies was changed. The concentrated economic power of the new enterprises stimulated the growth of countervailing institutions in the form of labor unions and a new role for government in the form of regulatory commissions.

The sudden appearance and swift spread of large managerial enterprise was closely related to the increased speed of transportation, communication, distribution, and production. Increased speed in turn was made possible by new technologies, particularly those that permitted the exploitation of energy stored in the fossil fuels. The application of steam and electricity to transportation and communication permitted a continuous and steady flow of goods across the land at a speed hitherto impossible to attain. And the new speed demanded organization.

Canals and turnpikes had required almost no management at all. In 1840 the managerial force on the Erie Canal included the Comptroller of New York (usually the state’s leading politician) and four clerks. On the great state canal systems of Pennsylvania and Ohio, as well as New York, the entire working force - lock tenders, toll collectors and maintenance men as well as the Comptroller and his clerks - turned over as one political party succeeded another into office. In contrast, by the 1880’s many a railroad enterprise had built a permanent working force of tens of thousands of workers administered by hundreds of salaried managers, operating systems of thousands of miles in length, and involving hundreds

of millions of capital investment. And as early as 1867 Western Union had created a nation-wide administrative network to coordinate the activities of 2,500 offices.

The potential of the new means of transportation and communication could only be fully realized through new methods of organization. The operation of the railroad and telegraph systems required the creation of a complex managerial structure to assure steady and continuing flows of information and orders essential to guide the movement of trains, traffic, and messages. Because of greater speed and fewer transshipments, a railroad car could make in two days the round trip that had required a stage coach or canal boat a week. By careful coordination of flow within and between the large railroad enterprises, the time involved decreased still more. As the rate of traffic flow increased, so did output per worker and per unit of capital and equipment used in the movement of goods.

The expanded speed of transportation and communications quickly brought the large scale enterprise into the distribution of goods. In the marketing of agricultural commodities and manufactured products the factor and the commission merchant were replaced very quickly by brand new marketing institutions. Large commodity buyers of grain and cotton began to purchase directly from the producer at the rail head and sell to the flour miller or the textile factory in this country and abroad, using futures and “hedging” and handling their transactions through specialized commodity and produce exchanges that first made their appearance in the 1850’s and 1860’s. In the same years full line wholesale jobbers created international buying and regional and often national selling organizations. The first great mass retailers - the department stores - appeared in the 1860’s and 1870’s to sell to the concentrated urban markets. Shortly thereafter Montgomery Ward and Sears Roebuck began to retail to the rural market by mail. Then came the first of the chains in groceries, drugs, and notions that were to become so predominant in the twentieth century. All mass marketers of finished goods - the wholesale jobber, the department store, the mail order house and the chains - created similar organizations. They had buyers for each major line who set the prices, specifications, and volume of goods handled, while their operating organization became responsible for the physical movement of the goods from the supplier to the consumer. Where the railroad and telegraph

made possible direct, through-flow of goods without transshipment from one commercial center to another, the new mass marketers coordinated flows directly from the individual producer to the individual consumer.

For the mass marketers velocity or rate of flow was a basic criterion of performance. They called it stock turn. High stock turn permitted high volume of sales with the same plant and personnel, cut unit costs, and permitted a higher profit at lower margins. And the volume thus attained was impressive. In 1840 annual sales of $500,000 were still exceptional for a merchant specializing in the marketing of manufactured products. In 1873, seven years after Marshall Field established his wholesale house in Chicago, his annual sales reached over $14 million. A decade later, with much the same plant and personnel, they had risen to $23 million. Ten years after it began to compete directly with Montgomery Ward, Sears Roebuck was filling 100,000 orders a day. This was more than most merchants handled in pre-railroad days in a decade or even a life time.

In mass marketing, increased velocity within the firm came from organization alone. In large scale production it resulted from the employment of better machines and an increasing application of energy as well as improved organization. In most mechanical industries, such as those involved in the production of cloth and lumber, and in the fabrication and assembling of clothing and of wood and leather products, increases in velocity were limited by the energies and abilities of men handling the machines. The limits of increased speed of cutting and shaping wood, cloth, and leather by machinery were quickly reached and energy could be used only to power these machines.

On the other hand, in the heat using and metal working industries far greater opportunities existed for increasing velocity of through-put by improving machinery and by applying energy more intensively. Again, as in transportation and distribution, the realization of the potential for increased efficiency required the creation of an organization to coordinate and control the faster operations being undertaken. In the refining industries - petroleum, chemicals, sugar and some other foods - the intensified use of heat by “cracking” and super-heated steam processes as well as the improved design of stills and refineries to permit continuous operation, multistage distillation, greatly enlarged the daily through-put. In the

furnace industries - iron, steel and other metals, glass and rubber - improved furnaces, converters, rolling and finishing equipment and carefully designed plants vastly increased the amount of energy consumed by these mills and greatly expanded the volume of output per man and per unit of capital per day. In both the refining and furnace industries increased velocity demanded the creation of managerial organizations to assure a full and steady use of men and equipment.

In metal working, improved management became even more essential than in the refining and furnace industries to obtaining and maintaining a high velocity of through-put. Here the basic material required more time to cut and shape than did cloth, leather, and wood. Finer tolerances were demanded in the fabrication and assembling of machinery and other metal products than in the making of clothes or furniture. Thus, the period from the 1850’s to the 1870’s witnessed the major innovations in American machine tools and these innovations came primarily in machines produced for the metal working industries. Then, in the 1880’s and 1890’s the major innovations in factory management came in these same industries. It was here that systematic or scientific management was developed by Frederick W. Taylor, Henry R. Towne, and Alexander H. Church in order to get the maximum use from men and machines. Improved management, in turn, encouraged the more intensive application of energy. Taylor, for example, developed alloyed metals that permitted machines to carry out their specialized cutting and shaping operations at much greater speed. And Henry Ford found a way to use power to move materials from one operation to the next. Systematic management, high speed steel, and the moving assembly line made it possible for metal working enterprises to obtain and maintain a rate of through-put similar to that earlier achieved in refining and furnace companies.

These became the mass production industries in the modern sense. In all - in oil, sugar and other refined products; in iron, steel and other metals, glass, rubber, chemicals; in complex machinery, particularly electrical, and then the automobile - plant and equipment replaced men. These industries became capital intensive. The need to keep this capital employed by maintaining a continuing high rate of through-put caused such enterprises to move backward to obtain a more certain supply of raw and semi-finished materials and to move forward to assure direct and regular deliv-

eries to customers. By the beginning of the twentieth century all these industries had become or were becoming dominated by a few large integrated enterprises. These firms coordinated the flow of materials from the suppliers of raw material through the processes of production to the ultimate consumer. And they competed with one another in the modern oligopolistic manner.

In textiles, lumber, leather, clothing, shoes, furniture, printing and publishing, and many foods, the opportunities for increasing the velocity of through-put by an intensified application of energy and by improved systems of management remained limited. In those industries therefore, enterprises stayed small, non-integrated and labor intensive. In them, large firms had few cost and productivity advantages over small ones. Those industries remained competitive, although the enterprises in them relied increasingly on the mass marketers to sell their products.

This briefest of historical sketches of the rise of large scale managerial enterprise in American transportation, communications, distribution, and production, emphasizes that the economies of scale within the firm resulted far more from speed than from size. It was not the size of an enterprise but the velocity of through-put that permitted economies that lowered costs and increased output per worker and per machine and so provided the classic, competitive advantage. The savings from using the same power, light, maintenance and other facilities were small compared to those made by greatly increasing the daily use of equipment and personnel. Speed brought size; but size in no sense insured speed.

For example, improvements in the design of petroleum refineries and stills permitted a 6,500 barrel daily through-put by the mid-1880’s as compared to a 1,000 barrel one a few years before. The new, large refineries brought the cost down from 50 to 1/20 a barrel. Quickly, close to two-fifths of the petroleum processed in the United States was concentrated in three refineries. It would have been senseless to try to put two-fifths of the country’s production of shoes, apparel or furniture in three factories. Diseconomies of size would have been overwhelming.

Economies of speed came, then, in production when manufacturing processes permitted an increased application of energy just as they came in transportation, communications, and distribution with the application of steam and electricity. In all cases, however, organization provided by the large managerial enterprise became neces-

sary to develop fully and to maintain economies of speed. And unless such organization was achieved, large corporations had difficulty in remaining viable business units over an extended period of time.

Once such economies were attained, the large managerial, multi-unit enterprise rarely disappeared. At least it continued on until its product or function became technologically obsolete. It might be merged into another enterprise or its resources might be transferred into another line of business, but the men, money and materials once accumulated were rarely dissipated. Unlike the entrepreneur and his partners, the new managerial enterprise did not retire, die, or even fade away. It came to have a life of its own.

The need to keep accumulated resources fully employed created stronger internal pressures to achieve steady growth than existed in the small personal enterprise. The new marketing enterprises grew by adding lines, enlarging purchasing organizations, and expanding operating units through the building of branches and chains. Mass production enterprises at first continued to grow by integration. The search for markets quickly took them abroad to the advanced economies of Europe and the need for supplies and raw materials turned them to underdeveloped areas where oil, rubber, iron, copper and other basic raw materials could be found. Later these industrial enterprises grew by developing new processes and products. Where specialized skills of the managers and workers were involved in the exploitation of a particular technology or market know-how, diversification into new areas came relatively easily. Where the resources were concentrated instead on the mass production of a single line of goods in which the technology was fairly simple and yet required much capital, diversification proved to be more difficult.

Small personal enterprise, it must be stressed, did not disappear. It still peoples agriculture and other industries in the biologically oriented primary sector of the economy as well as most of the construction industries, and some of the industries in the service or tertiary sector. It is often found in the forefront of technological innovation. Yet even in these sectors the managerial enterprise has gained rapidly since World War II. The small retailer, for example, has been replaced by the mass marketer in many trades, and chains have moved into many services such as hotels, road-side eating and car rentals.

In the secondary sector the size and numbers of managerial

enterprises expanded impressively all through the twentieth century. The tremendous increase in the use of electricity, petroleum, and natural gas greatly expanded the exploitation of the energy provided by fossil fuels. The replacement of biologically produced materials like cloth, wood, and leather by chemically produced synthetics made possible further increases in the velocity of production. So too did the application of electronics, especially through automation and the computer. Increased velocity in turn intensified the need for complex managerial organization. The resulting economies of speed must surely help to explain why what economists term “the residual” has become large by the mid-twentieth century.

The replacement of small personal enterprises by large managerial ones in many industries radically altered the nature of the decision-making unit, the process of decision making and the types of decisions made within the unit. This transition also altered the recruitment, training, and even the goals of the decision makers themselves. Buying and selling, carried out on a far greater scale than had been done by any earlier business enterprise, was now handled by specialists for whom price was usually only one of several specifications. Other specialized managers concentrated on scheduling and coordinating the flow of goods through their departments or through the enterprise as a whole. A number of others spent their full time on the development of new products and processes, while still others came to concentrate on relations with the working force, stockholders, governmental offices, and the public.

The senior executives at the top attempted to focus their energies on the critical decisions concerning present and future allocation of resources. Such investment decisions involved amounts far exceeding those made by the earlier personal enterprises and included the allocation of skilled and specially trained personnel as well as funds. Such long-term investment decisions came to be made by groups. At first, when the enterprise was new, representatives of investors or the founders and their families conferred with the managers. Within a generation, however, the full-time executives had taken over the major investment and policy formulating decisions. Only they had the necessary information and knowledge. The Board of Directors could no longer direct - it had become little more than a ratifying body.

The experience and outlook of the new managerial decision makers was very different from that of the older entrepreneurs and

partners. They had little financial interest in the enterprises they operated, and if the managers did not own, neither did the owners manage. These managers usually attended college, acquiring specialized training in engineering and then in business management. Indeed, the rise of American engineering and business schools was a direct response to the demands of the new, large enterprises for managers. The latter quickly formed professional societies where they met regularly to discuss mutual problems and activities. They looked on their work within the enterprises as a lifetime career to be spent climbing up the executive ladder with the expectation of retirement at 65 on a pension. Until the age of 50 these managers remained specialists, concentrating in internal tasks, almost none of which had existed before the coming of the railroads.

It is difficult to conceive of a greater difference between the roles, training, experience, and activities of the decision makers who manage the high velocity of through-put in the mid-twentieth century economy and those of the men who carried on the smaller and much slower economic activities of early nineteenth-century America. One way to indicate the magnitude of this change is to point to our present surroundings - the general office complex of the du Pont Company - and to remind you that buildings such as these did not and could not have existed before the middle of the nineteenth century. In fact a large part of the managerial class of the America of 1840 could have been housed in this one general office complex. The 1500 to 1800 plantation overseers who managed a working force of 50 or more field hands and the 500 or so salaried managers of textile mills, iron works, and other industrial establishments with working forces of the same size could find ample office space in the du Pont and in the Nemours Buildings. (Then as now a force of less than 50 workers rarely required the full time attention of a salaried factory manager above the level of foreman or first line supervisor.) There would still be room in these two buildings to house the presidents and cashiers of the 1000 commercial and savings banks operating in the country and the agents of a smaller number of fire and marine insurance companies; while the salaried captains of ships of 1000 tons or over (which carried crews of 20 to 30 men) could have easily fitted into the Brandywine Building.

The importance of this illustration is not only that the managerial class in 1840 was tiny, but also that these men were usually the only managers in their enterprises. Except for a miniscule number of

plantation stewards, almost none of these managers managed other managers. There was no middle or top management in 1840. In that day managers worked closely with the owners. Their enterprises remained personal ones.

On the other hand, there are today approximately 10,000 managers in the du Pont Company above the level of first line supervisor. These are all linked together in a single administrative network. Literally hundreds of managers at du Pont manage other managers, carrying out tasks that did not exist in 1840. But they rarely confer with the owners or their representatives. Theirs is purely a managerial enterprise.

And du Pont is only one of many hundreds of comparable enterprises. One has only to look out on Park Avenue from the offices of the Social Science Research Council headquarters in New York and gaze on the forest of skyscrapers that house similar general office complexes to feel the presence of the modern managerial class. It is properly symbolic that while church steeples dominated the sky-lines of American cities in the eighteenth century, and smokestacks in the nineteenth century, central office skyscrapers have come to do so in the twentieth century.

The managers in these general offices are surely the most important set of economic decision makers in the United States today. Their vast administrative networks cover the nation and often the globe. They manage more funds, supervise more workers, make larger investments than did the governments of nation-states in the eighteenth and even the twentieth century. In 1965 General Motors’ revenues of $20 billion were just under those of Great Britain and France. Only the United States and Russia handled substantially larger sums. And by 1971 General Motors’ income was over $28 billion. This economic class has more to say than farmers, small businessmen, labor leaders and government officials about pricing, investment, employment, output and technological innovation. Since the great depression of the 1930’s, the role of government has shifted more from that of regulation to that of providing a favorable environment for these decision makers. It has done so by assuring full employment and adequate aggregate demand, by offering a market and by subsidizing research and development. But while government officials can affect the larger business environment, they still have little direct say in the day to day operating decisions in the economy.

The same is true in other industrial and technologically advanced economies. Despite a stronger commitment to government supervision - to a belief in a mixed economy - the decisions in nearly all the high technology and growth industries in Western Europe and Japan are made by professional managers operating large multi-unit enterprises. Even in Russia and the more industrialized Communist nations the managers of multi-unit enterprises are critical to the successful execution of state economic plans.

III - Conclusions

That fundamental changes have occurred since 1850 in the process of economic decision making, in the institutions which make decisions, and in the type of men who make them, seems obvious. Few would seriously argue that major economic decisions in industrialized, technologically advanced countries - those that have achieved sustained economic growth - are still made by individuals and partners rather than by career managers operating within large enterprises. Nor would anyone claim that the institutions through which modern economies are managed have remained unchanged. Yet some historians and economists still deal with the economic developments of the past 150 years as if the decision-making process and the resulting management of production, distribution, transportation, communications, and finance have remained much the same since 1850. Since this is the case; since the transformation has been relatively recent; and since the awareness of the new style of making decisions and of the institutions through which they are made and carried out is so essential to an understanding of the operation and control of modern economies; since all this is so, historical analysis of the transition from the personal to the managerial enterprise and the resulting impact on the economic order is surely a vital field of study.

Let me, then, conclude this traditional presentation of a time-honored ritual by urging economic historians to look further into the rise, spread, and impact of managerial enterprise, not only in this country, but abroad. It is a field that should have a special appeal to historians who find satisfaction in working with the documentary record. Admittedly the focus is narrow. It deals only with a period of a couple of hundred years and it addresses itself only to one aspect or thread of economic history. Yet its very narrowness

opens the way for careful comparative analysis and interdisciplinary work that would be far more difficult in carrying out a broader, less well defined problem. Analyses of the rise of a new and most powerful economic class, of a new and most formidable economic institution is still a large order. The dominance of our society by this and other large-scale organizations is one characteristic of the twentieth century that distinguishes it from all others. The enormously increased speed and volume of economic activity is another. An analysis of the creation and growth of managerial enterprise and of the new managerial class can tell us much about the why and the how of recent economic change. It can provide us, I think, with new insights into the distinctive nature of the modem world.

ALFRED D. CHANDLER, JR., Harvard University