chandler, 1992

Corporate Strategy, Structure and ControlMethods in the United States During the

20th Century*

ALFRED D. CHANDLER, JR(Graduate School of Business Administration, Harvard University, Soliders Field,

Boston, MA 02163, USA)

The title of this session is 'National Patterns—an historical analysis in termsof organizational forms, strategies, and control methods, e t c ' My assign-ment is to review the United States' experience. Such organizational forms,strategies and control methods were responses to specific business challenges.As the papers that follow emphasize, responses to these challenges differedfrom nation to nation reflecting different national business, economic, politicaland cultural environments.

Nevertheless, all these national patterns are historically modern ones.They begin with the coming of the modern business enterprises—those thatemployed a number of full-time salaried managers—that first appeared inthe mid-19th century. Before the building of modern transportation andcommunication systems the movement of goods, information and people wasso slow and uncertain that there was no need to create enterprises directed by

g teams of salaried managers.For centuries business organizational forms, structure and control methods

jj in the Western World remained little changed. The partnership that came1 and went with the lives and changing activities of a small number of

individual partners was still the standard organizational form. Double-entry| bookkeeping and handwritten correspondence were the methods of control.J As a study of Baltimore merchants, the Olivers, at the beginning of the 19th

century noted, their 'form of organization, and their method of managingmen, records and investment would have been almost immediately under-

| stood by the 15th century merchant of Venice.'1 Even the great trading

" 'Presented u the conference on Organization and Strategy in the Evolution of che Enterprise, Milan,^ October 3 - 5 , 1991-1 ' Quoted in Alfred D. dandier, Jr. TbtVisiUt HtaJ: Tbt MMnMprUl RatUtwi h Ammtam Buhms1 (Cambridge, MA: BeUcmp Press/Harvard University Press, 19T7), p. 16.

2 © Oxford Unrveniry Press 1992

263

at Cukurova U

niversity on March 23, 2012

http://icc.oxfordjournals.org/D

ownloaded from

http://icc.oxfordjournals.org/

Corporate Strategy, Structure and Control Methods

companies of the 17th and 18th centuries rarely employed more salariedmanagers than a small local business enterprise of today.

1. The Coming of the Modern Business Enterprise

In the United States the railroad and its handmaiden, the telegraph,pioneered in the modern forms of organization, control and strategy. Theirmanagers did so because they had to. Railroad construction and operationsraised completely new sets of challenges. The capital required to build amajor railroad was greater than that of any earlier business enterprise (andfrom the 1840s on not one but many such enterprises were demanding suchunprecedented amounts of capital at the same time) and their operation wasfar more complex than any previous business enterprise. Not only were thesunk costs unprecedented, so too were the fixed costs—those that did notvary with the flow of traffic and, therefore, income. Moreover, unless themovement of trains and the flow of goods were carefully monitored andcoordinated, accidents occurred, lives were lost and goods moved slowly andwith uncertainty. Hierarchies of salaried managers had to be recruited andtrained if railroad and telegraph enterprises were to achieve their promise ofproviding a high volume, fast, scheduled flow of goods, services and infor-mation.

In meeting these challenges American railroad managers brought intobeing many of the institutions and practices of the modern corporate world.In the United Staes their financing created its modern capital markets—Wall Street and the financial instruments traded on that national exchange.Their size and high fixed costs led to the coming of modern oligopolisticcompetition and with it the American brand of government regulation ofindividual business enterprises. Their size also led to the coming of modernlabor relations with collective bargaining between national trade unions andthe managers of the new enterprises. Most important of all, for the subject inhand, these executives pioneered in creating the first large multi-levelmanagerial hierarchies and developing brand new techniques of controllingoperations and of determining costs and profits. Finally, during the period ofconstruction and consolidation, when managers were building the giantinter-regional systems, they concentrated on outmaneuvering their rivalsthrough carefully considered strategic moves to protect their large invest-ment and to maintain and increase their revenues.2

2 Alfred D. Chandler, Jr. Tbt RailmJs: Tbt Nttin'i F'mi Big Buna (New York: Hircoun, Bnce &World, Inc., 1963), especially Puts II. Ill, tod V. Thomsj C. Cochran, fUilntul LtaJm: Tbt BunasMiuJ in Actwt (Cambridge, MA: Harrsrd University Press, 1953), especially Ch. 6 The Foundations ofManagement,' and Ch. 9 The Strategy of Railroad Expansion.'

264

at Cukurova U



ownloaded from



The railroad, and to a lesser extent the telegraph, not only pioneered inthe new ways of corporate organization, control methods, strategy, financeand labor and government relations. They also provided the essential base orinfrastructure on which modern large-scale production and distributionrested.

In distribution the unprecedented speed, volume and regularity of flowsbrought into being the modern wholesaler who took title to goods and madeprofit on mark-up rather than by selling on commission. Quickly too camethe mass retailer—the department stores, mail-order houses and chainstores—whose profits were based on low price and high 'stock-turn'. That is,the number of times stock 'inventory' was sold and replaced within a speci-fied time period. The higher the stock-turn with the same working force andequipment, the lower the unit costs, the higher the output per worker andthe greater the profit.3

In production the new speed, volume and certainty of flows of materialsand information stimulated a wave of technological innovations that sweptthrough western Europe and the United States. Old industries such as foodprocessing and metal making were transformed. New ones were created,including oil, rubber, heavy machinery, light machinery (such as sewing,agriculture, construction and business equipment), chemicals (such as man-made dyes, medicines, fertilizers and materials), and electrical equipment forlight, industrial power and urban transportation. In these industries 'through-put' (that is the amount of materials processed within a production facilityduring a specified period of time) determined profit much as stock-turn didfor the new mass retailing. Up to its rated capacity a production establish-ment's unit costs fell as the speed of throughput increased and rose as itdecreased. Thus, the cost advantages of the economies of scale reflected bothcapacity of a facility and the intensity in which it was used. Another source ofunit cost reduction came from the economies of scope. That is, by producingmore products in a single establishment that used similar raw and semi-finished materials and much the same processing equipment, the cost of eachindividual product was lowered.4

In nearly all these cases, these new or transformed industries with capital-intensive, technologically complex processes of production were quicklydominated by a small number of 'first movers'. These were those pioneeringenterprises which invested in production facilities large enough to exploitfully the potential cost advantages of scale and scope of the new technologies,which built product-specific national and then international marketing and

1 Chandler, Tbt Visiilt H**J, p. 223.4 Alfred D. Chandler, Jr, Suit tmd Soft: Tin Dymtmia tf Industrie! C*pii*lism (Cambridge, MA:

Belknap Prai/Harrud University Pren, 1990), p. 24.

265

at Cukurova U



ownloaded from



distribution networks and which recruited and trained teams of managersessential to monitor and coordinate the flow of goods through the enterprise.Such first movers began to compete oligopolistically—that is they competedfor market share and profit less on price and more by functional effectiveness(improved manufacturing, research and development, marketing and dis-tribution, and labor relations) and by strategically moving more quickly intonew markets and out of old ones.5 These large managerial integrated enter-prises continued to dominate the industries of the 1880s and 1890s thattransformed the economies of their day. They played a similar role in thelater transforming industries such as motor vehicles in the 1920s and 30s andcomputers after World War II.

These long-lived dominant firms in these industries led the way duringthe twentieth century in shaping strategies of growth and competition, indeveloping the most complex of organizational forms and control of systems.Therefore, I concentrate this historical analysis on these industrial enter-prises. But let me stress, where the technologies of production did not fostercost advantages of scale and scope—in industries such as textiles, apparel,lumber, furniture, printing and publishing, shipbuilding and mining—companies had less needs for such relatively complex organizational formsand methods.

2. Strategy, Structure and Control Methods in the Yearsof Enterprise Growth

The development of corporate strategies, structures and control systems inthe US firms in modern capital-intensive industries rested on three sources—those developed in the management of railroads, those that came from themanagement of units of production (the factory or works) and finally thosecreated by the corporate managers themselves. Because the railroad sodominated the US industrial scene in the late 19th century and becauseAmerican industrialists had fewer business or governmental models uponwhich to draw, the railroad had a greater impact on organizational andcontrol forms and possibly on strategic planning in the large industrialenterprise than was the case in Britain or on the continent.

From the railroad came a three-level organizational structure. On therailroads the lower level managers included division superintendents (respon-sible for roughly 100 miles of track) who reported to middle managers, thegeneral superintendents (responsible for roughly 500—1000 miles of track).Each had the same set of staff executives for traffic (freight and passengers),

' ibid, pp. 34-36.

266

at Cukurova U



ownloaded from


• Corporate Strategy, Structure and Control Methods •

maintenance of locomotives and rolling stock, maintenance of way andtelegraph and those for purchasing and accounting. At the top were 'the VicePresident and General Manager' responsible for transportation and the vicepresidents in charge of traffic and finance. In the new industrial structuresthe lower level managers become responsible for an operating unit (a factory,sales office, purchasing unit or laboratory) and reported to middle managerswho were responsible for coordinating and monitoring multi-unit functionaldepartments (those for production, sales, purchasing, and research and develop-ment and also for financial control). At both the railroads and the new industrialsthe vice presidents for functional activities with the president were responsible,not only for overall monitoring and coordinating current departmentalactivities but also planning and allocating resources for future operations.6

From the railroads, too, came the line and staff definition of the duties ofthe managers on each level. On the railroads the line of authority ran fromthe Vice President and General Manager to the general superintendents andthen to the division superintendents. The staff executives were responsiblefor maintenance and repair, for establishing systems for the movement ofgoods and passengers, analyzing methods, checking quality and maintainingaccounts. At the new industrials the line of authority ran from the functionalvice presidents to the managers of factories or sales offices or laboratories. Thestaff executives provided supporting activities. Thus Harrington Emerson,an early factory management consultant with long railroad experience, urgedthe appointment of factory staff executives for personnel, plant and machinery,materials (purchasing), accounting and operational methods.7

The new industrials also took over from the railroads the structure of thetop policy-making office—the corporation's Board of Directors. On bothfull-time executives—the president and heads of the major functionaldepartments—made up the Executive Committee of the Board. They weresoon known as the 'inside directors'. Part-time representatives of large share-holders—outside directors—made up the Finance Committee.8 Because theinside directors set the agenda for the Board's monthly meetings, providedthe information discussed and were responsible for implementing decisionstaken and because the part-time outside directors were almost always in-volved in their own full-time business or professional activities, the insidedirectors—the Executive Committee—dominated top level decision making.

6 ,s Chandler, Tit VuiUt Htad, pp. 94—109 describes the development of railroad organizational forms;Chandler, Satlt «W Snpt, pp. 31—34 the development of the U-Form in industry.

7 Chandler, Til VisiUt Had, p. 277.1 By the 1970s the New York Central and the Pennsylvania Railroad had their Executive and Finance

Committees; by the 1880s these committees of the boards of directors had become standard on major USrailroads. Industrial first-movers quickly adopted the form—including such firms as Standard Oil,General Electric, Du Pont and US Rubber.

267

at Cukurova U



ownloaded from



In their control methods the new industrial corporation modified onlyslightly railroad accounting practices to meet their own somewhat differentneeds. As did the railroad managers, the industrial managers made a carefuldistinction between capital and operating costs and between fixed andvariable costs. In accounting for depreciation, they, as did their counterpartson the railroads, relied on 'renewal accounting'. That is they considereddepreciation as an operating cost and charged all maintenance and repairs tooperating accounts. In addition the industrial managers set up monthly ratesfor depreciation so as to account for technical obsolescence and unexpectedfire or accidents. In determining profit and loss they used comparable balancesheets and looked on the 'operating ratio', which the railroads had used sincethe 1850s, as the criterion for financial performance. For the railroadsquickly learned that the dollar value of earnings was not enough. Earningshad to be related to the volume of business. So the ratio between earningsand operating costs or, as the railroads defined it, earnings from operationsrequired to meet operating expenses became the critical measure of financialperformance. The executives of the new industrials first used earnings(revenues from sales minus costs) as a percentage of costs and then, moreoften as a percentage of sales.9

The factory—particularly those establishments in processing metals ormetal making machinery—was a source for modern control methods, butnot for strategy or organizational forms. First came a more precise definitionof a factory's direct costs based on determining standard costs and standardvolume through 'scientific' methods. Here Frederick W. Taylor was apioneer. Then came the determination of indirect costs or 'factory burden',particularly those that fluctuated with the volume of output. Here suchconsultants as Alexander Hamilton Church and Henry Gantt were theinnovators. They realized that the critical item in determining indirect costswas throughput. When throughput was lower than standard volume, say,80% of rated capacity, the increased unit costs were termed 'unabsorbedburden' and when it was over, decreased unit costs were termed 'over-absorbed burden'.10 Over and unabsorbed burdens soon became major itemson factory cost sheets. By 1910 the internal cost control methods for a singlefactory or works in the United States had been effectively defined.

But Taylor and other management experts of the first years of the 19thcentury rarely went beyond factory accounting. They paid little attention tothe overall costs of running a multi-function enterprise that integrated

9 Chandler, TU VisihU HSMJ, pp. 110-112, 445; William Z. Ripley, fUilntds: VbuanmdOrpmh*-lam (New York, NY: Longmans, Green, 1915), pp. 612-615; Thomas Johmon and Robert S. Kaplan,RtUvcxa Lest: Tbt Rist ad Fail tf M*nsgmaa Acntmthf (Boston, MA: Harvard Business School Press,1987), pp. 8, 37, 90.

10 Chandler, Tbt VisibU HMMJ, pp. 278-279.

268

at Cukurova U



ownloaded from



production and distribution. Nor did they consider the financial accountingneeded for capital budgeting for the enterprise as a whole. Here innovationscame from the corporate executives themselves.

Especially innovative were the managers of the E.I. du Pont de NemoursPowder Company formed by three du Pont cousins in 1903 to consolidatethe American explosives industry. Du Pont managers realized that in de-fining overall corporate financial performance the modified railroad operatingratio was not enough. As one Du Pont executive argued: The true test ofwhether the profit is too great or too small is the rate of return on the moneyinvested in the business and not the percent of profit on the cost. A com-modity requiring an inexpensive plant might, when sold only 10% above itscost, show a higher rate of return on the investment than a commodity soldat double its cost, but manufactured in an expensive plant.'11 To obtain anaccurate figure of investment Pierre du Pont, the youngest of the threecousins and the new company's treasurer, made the distinction between'permanent investment' and working capital used in operations. To deter-mine the former he reviewed the valuations of the properties that werebrought into the 1903 merger. Then he set up a 'permanent investment'account to which all new construction (and dismantle assets) were charged.

By 1910 one of Pierre du Pont's subordinates, Donaldson Brown, hadrefined this approach. Brown stressed that if prices remained the same, therate of return on invested capital increased as volume rose and decreased as itfell. The higher the throughput and stock-turn, the greater the rate ofreturn. Brown termed this rate of flow 'turnover'. He then multiplied turn-over by the accepted older definition of profit—earnings as a percent of sales.Figure 1 provides an oversimplified, but still valid, description of how theDu Pont Company determined their ROI. (In this formula over and underabsorbed burden were listed as part of working capital.) As two present dayaccounting experts point out, 'the formula . . . shows how return on invest-ment is affected by a change in any element of either the income statement(via the operating ratio) or the balance sheet (via the turnover ratio).'12

Besides its use in evaluating, coordinating and planning divisional opera-tions, the ROI formula became central to the capital budgeting process.Even before World War I, capital appropriation procedures in the industrialenterprises were being systematized. At Du Pont, for example, as early as1908 proposals for capital expenditures had to include detailed blueprints,cost data, market studies and, most important of all, a breakdown ofexpected rate of return. In addition, plant sites had to be approved by thesales, purchasing and traffic departments to assure that the costs involved had

11 Ibid, pp. 446-447.12 Johmon and Kipltn, Rdtotwa Lit, p. 84.

269

at Cukurova U



ownloaded from


Return oninvestment

Turnover

Sales

Total investment

Working capltala

K)©

Permanentinvestment

Earnings aspercent of sales

Earnings

Sates

\

Cost of sales

'Also includes small amounts of deferred chargeswhich are not charted.

Sales

Inventories

Accountsreceivable

Cash

Mill costof sales

Selling expense

Freight anddelivery

Administrative

fto

t

FIGURE 1. The Du Pont Company: relationship of factors affecting return on investment. Source: T. C. Davies (1950), 'How the du PontOrganization Appraises Its Performance,' in American Management Association, Financial Mjaugtmtmt Stria, No. 94:7.

at Cukurova U



ownloaded from



been factored in. Once a project was underway, a member of the ExecutiveCommittee was responsible for reviewing and acting on the regularly scheduledflow of reports as to its progress.1} These control methods in which Du Pontpioneered were adopted by other industrial enterprises in the 1920s. Theywere valuable in assisting American firms to carry out strategies of growthafter World War I.

In the United States modern industrial enterprises grew in four ways.They merged with competitors in the same market (horizontal combination)or they obtained suppliers or distributors (vertical integration). But thesemoves were usually in response to specific, more immediate business situa-tions. The continuing long-term strategy of the still relatively new largeenterprises in the capital-intensive industries was to grow by moving intodistant markets (geographical expansion) or into related markets (productdiversification). They did so by moving into markets—markets in whichtheir organizational learning based on the initial product- and process-specific investments in production and distribution gave them a competitiveadvantage. Those companies whose organizational capabilities were honed byexploiting the economies of scale tended to move into new more distantgeographical markets and became increasingly multi-national. Those whosecapabilities were based on the economies of scope tended to enter relatedproduct markets and became multi-industrial.

This strategic growth brought into being a new basic organizational formor structure. In the interwar years, US firms rationalized the management oftheir multi-market businesses by adopting some version of the multidivisionalstructure (the M-Form) which had a corporate headquarters and a number ofproduct or geographical operating divisions.

The M-Form was a response by senior managers operating through existingcentralized, functionally departmentalized U-Form structures to the demandsof implementing their strategy of growth. They quickly realized that they hadneither the time nor the necessary information to coordinate and monitor day-to-day operations, or to devise and implement long-term plans for the severalproduct or geographical divisions. The administrative overload had becomesimply too great. Du Pont in 1921 (here again Du Pont was an innovator),and then other new multibusiness enterprises, turned over the responsibility formonitoring and coordinating production and distribution (and often productdevelopment) to the division managers. The major role of the new corporateheadquarters became, and remained, that of maintaining the long-term health(usually defined as continued profitability) and growth of their firms.14

11 Chandler, Tbt VaiUt Html, pp. 460-461.14 Alfred D. Chandler, Jr, Strsttgj **d Stnctm: Chtptm in tbt History e{ tbt imiutrUJ Euurprist

(Cambridge, MA: M.I.T. Pren, 1962), Ch. 2.

271

at Cukurova U



ownloaded from



To implement this role the executives at the new headquarters carried outtwo closely related functions. One was entrepreneurial or value-creating, thatis to determine strategies to maintain and then to utilize for the long-termthe firm's organizational skills, facilities and capital and to allocateresources—capital and product-specific technical and managerial skills—topursue these strategies. The second was more administrative or loss-preventive. It was to monitor the performance of the operating divisions; tocheck on the use of the resources allocated; and, when necessary, redefine theproduct or geographical lines of the divisions so as to continue to use moreeffectively the firm's organizational capabilities.

The administrative tasks of monitoring were, of course, intimately relatedto the entrepreneurial task of strategic planning and resource allocation. Formonitoring provided the essential information about changing technologyand markets, and the nature and pace of competition in the differentbusinesses. And it permitted a continuing evaluation of the performance ofdivisional operating managers.

The control- systems developed before World War I were even moreessential to the management of the new M-Form than they had been to theU-Form. At Du Pont until well after World War II the Executive Committeemet every Monday in the 'Chart Room' with a division manager and his staffto review divisional operations. From the Chart Room's ceiling 'hung large,metal-framed charts displaying the overall return on investment and each ofthe constituent parts of the ROI formula for each of the divisions. A systemof tracks and switches allowed any one of the 350 charts to be moved to thecenter position. There the committee, seated in a semi-circle, could view anddiscuss trends for a given division or for two or more divisions.'15 At thesemeetings the Committee reviewed seriatim the operating performance of thecompany's several divisions (in the interwar years Du Pont operated through8—10 divisions), checked on the implementation of approved capital projectsand considered future capital expenditures.

The cost management and budgetary procedures adopted at Du Pont andat other large industrial enterprises were not seen as pictures of reality butrather as guidelines to understanding reality. The continuing close inter-action between the top and operating managers was a learning process forboth. It enhanced product- and process-specific management and technicalskills of the company as a whole and created organizational capabilities thatwere not only specific to the enterprise but to the industries in which itoperated.

Facilitated by the adoption of the M-Form and refinement of earlier

" JoAnne Yares, Casni Tbnufb CananucMt'um: Tbt Riu tf Spurn it Amman Mjmgpmtm (Baltimore:Johm Hopkins Uniyeniry Press, 1989), pp. 266-267.

272

at Cukurova U



ownloaded from


- Corporate Strategy, Structure and Control Methods •

control methods, the size and number of US multimarket firms—bothmultinational and multiproduct—grew before World War II and expandedmore rapidly after that war. So too did the number of the markets theyentered, and therefore the number of the divisions in which they operated.Moreover many dominant firms in the capital-intensive industries in Europefollowed much the same strategy of growth, although they rarely adopted theM-Form structure until after World War II. I document the extent of thisexpansion into new geographical and product markets in the United States,Great Britain and Germany between the 1880s and 1940s in Scale and Scope.Bruce Scott, in 1973, summarized the several studies of continuing diversi-fication into new markets between 1950 and 1970 in France and Italy as wellas United States, Britain and Germany.16 By the 1960s the multibusinessenterprise had become the norm in most modern capital-intensive, techno-logically complex industries.

Such strategies of growth into new markets obviously intensified interfirmcompetition. Until the 1960s, however, world events—the two global warsand the massive global depression of the 1930s—held back the full impact ofinternational and inter-industry competition. The two wars weakened thecompetitive strength of the US firms' most powerful foreign rivals, particu-larly the Germans. And the Great Depression reduced markets and broughteconomic autocracy. It was not, therefore, until the 1960s after the economichealth of the European nations had been fully restored, and after Japan,following a massive transfer of technology, began to industrialize rapidly,that the international competition which had been developing before 1914became a full-fledged reality. In these same years US enterprises which hadbegun to enter closely related product markets during the interwar years,began to expand in this manner more aggressively. For example, by the.1960s, agricultural, mining, industrial, and construction machinery as wellas truck and automobile companies had moved into each other's industrialmarkets and glass, rubber, and food firms had expanded their activities inchemicals. Rapidly growing R&D expenditures intensified such interindustrycompetition.

3. The Impact of Continuing Growth and Intensified Competition

In the 1960s continued growth and intensified competition began to affectthe organizational structure, the strategy of growth, and the control methodsof large US industrial firms. Continued growth by the adding of new productlines and to a lesser extent moving into distant geographical markets forced

14 Bruce R. Scon, The Industrial Scate: Old Myths and New Realities,' HcrutrJ Btuimtu Raw,March-April 1973, 133-145.

273 -^

at Cukurova U



ownloaded from



structural change in much the same manner as had the initial productdiversification and overseas expansion. The decision-making overload soaredat both the corporate and divisional headquarters. So senior executives at DuPont reviewing the company's organizational structure 'saw striking parallelsbetween the company's problems in the 1920s and those of the late 1960s.'17

The solution at Du Pont and many other companies was to form functionallyintegrated business units (often termed profit centers) within their enlargeddivisions to coordinate and control a single product or very closely relatedproduct lines. In others it was to place a number of divisions under thecontrol of a larger 'group' office.

But whatever the name used, by the 1970s most large multibusinessenterprises had at least three (not just two) levels of autonomous planningand administrative offices—the business unit, the division and the corporateheadquarters. The first normally operated through functional U-Form struc-tures, while the divisions, like the corporate office, operated through aversion of the M-Form structure with its senior line executives supported byan extensive staff responsible for profit, market share, and other measure-ments of performance.

The corporate office continued to define growth paths and goals for thecorporation as a whole and to monitor the performance of the subordinateoperating units. In these same years the headquarters' role as mediator withgovernment agencies and other public bodies increased sharply with newregulatory legislation.

In the same years that brought structural modifications many US industrialenterprises began to alter their strategies. Intensified competition resultingfrom new players from abroad and from related industries gave US companiesthe greatest competitive challenge they had had to face since their founding,often decades earlier. The long-established strategies of growth were difficultto maintain. New markets where an enterprise's organizational capabilitiesgave it a competitive advantage were harder to find. Even new ventures suchas those carried out at Du Pont, Hercules, General Electric and Westing-house, based explicitly on perceived organizational capabilities too oftenproved unprofitable.18

The strong revival of powerful firms abroad made direct overseas invest-

17 David A. Houmbell and John K. Smith, Sdaa MMJ Corponu Strsttgy: DM Put R&D, 1902-1980(New York: Cambridge Univenity Press, 1988), p. 586.

18 H. D. Fan, Tbt Rist and Fail of New Ctrpontt Vatnrt Dmsmo (Ann Arbor, MI: MI Research Press,1977). Hounsheli and Smith, Saner and Corporau Strattgy, Ch. 22. Davis Djrer and David R. SJcilU,Labors of a Modtrn Htmdts: Evolution of a CbtmicaJ Company (Boston, MA: Harvard Business School Press,1990), pp. 363-372 . At G.E. the CEO, Reginald Jones, referred in 1975 to the "venture mas', and 'theventure problems', quoted in Alfred D. Chandler, Jr, and Richard S. Tedlow, Tbt Ctmmg ofManagtriaJCmfitaJum: A Cmtxieei on tbt History of Amtrium Economic Initiation! (Homewood, IL: Richard Irwin,1985). p. 785.

274

at Cukurova U



ownloaded from



ment more risky for US firms; while expansion from firms in related indus-tries began to crowd their markets at home. Excess capacity increased. Pricesfell, costs rose, ROI dropped. Many managers responded, as their predecessorshad done particularly in the depression years, to investing revenue intoimproving product and the performance of their functional activities. Butothers looked for investment opportunities in industries that appeared toshow greater profit potential even though their operations called for a verydifferent set of organizational capabilities—of different facilities and skills.

For the first time in American industrial history firms now began to growby entering businesses in which their enterprises had little distinctive com-petitive advantage. Because of their lack of knowledge of the operations ofthe target industries, they rarely moved, as they had earlier into relatedindustries, through direct investment, that is, by building their own factoriesand hiring or transferring their own workers and managers. Instead theyobtained facilities and personnel by acquisitions or, less often, by merger.

There were, of course, other reasons besides intensifying competition forthe new strategy of growth through mergers and acquisitions into distantlyrelated or unrelated markets and industries. With the passage of the Cellar-Kefauver Act in 1950 the federal government's antitrust forces began totighten restrictions on enterprise growth through horizontal and verticalmergers.19 Even moves into closely related industries became suspect. Fur-thermore, accounting practices under existing tax laws often made mergersand acquisitions profitable. Railroads, pipe lines, and utility companiescould not enlarge their existing markets and had few resources that might betransferred to other businesses. To grow they had to acquire firms in distantlyor unrelated businesses. This was also the case for manufacturing firms insuch industries as textiles, shipbuilding and railroad equipment whosecapabilities were also difficult to transfer to other product markets.

Nevertheless, the primary motive for the acquisition and mergers in the1960s was the desire of managers to assure continuing growth of theirenterprises by entering industries that promised higher ROIs and lessercompetition than did their own. Because of the wartime expansion and earlypost-war success, many of that generation of managers overrated the poten-tial of the product-specific organizational capabilities of their enterprises.The growing flood of business school graduates had been trained to believethat what they had learned for one set of industries could be easily transferredto another. The computer created new flows of information and new tech-niques to analyze these data as to both current and future operations. The

" Neil Fligtrein, The Trmufirwutiow tfCarfortu Cutrol (Cambridge, MA: Hirriid Univenicy Pros,1990), cb. 6 provides in excellent review of the impact of intitnut policies on corporate itruegy afterWorid Wtr II.

275 :

at Cukurova U



ownloaded from



information revolution reinforced the beliefs of the new 'scientific' approachto corporate management. As one careful observer noted in 1969, 'the newscience of management is the primary force behind conglomeration.'20

In that year, 1969, the drive to growth through merger and acquisition inrelated industries had become almost a mania. In 1965 the number ofmergers and acquisitions was just over 2000. Managerial hubris and to amuch lesser extent, antitrust laws, tax advantages and in some industriesobvious limits to enterprise growth raised the number to 4500 in 1968 andthen to over 6000 in 1969. Then the mania waned. By 1974 the number ofmergers had dropped to 2861. During the period 1963—1972 close to three-fourths of the assets acquired were for product diversification. One-half ofthese were in unrelated product lines. In the years 1973—1977 one-half of allassets acquired through merger and acquisition came from those in unrelatedindustries.21

This new strategy of acquisitions of or mergers with firms in distantly orunrelated businesses often weakened the effectiveness of the enlarged M-Form organization and of the existing control systems. Increasingly topmanagers at the corporate office—the executives responsible for coordinat-ing, monitoring, and planning and allocating resources for the enterprise as awhole—lost touch with the middle managers responsible for maintainingthe competitive capabilities of the operating divisions in the battle formarket share and profits. This disconnection of corporate from operatingmanagement affected the competitive strength of American companies andindustries far more than the separation of ownership control and manage-ment ever had. For it undermined top managers' ability to carry two of theirbasic functions—the monitoring and coordinating of current operations andthe allocation o£ resources for future ones.

Diversification by acquisition led to such separation for two reasons. First,the top managers often had little specific knowledge of, and experience with,technological processes and markets in many of the businesses they hadacquired. The second was simply that the large number of diflferent businessesacquired created a still greater overload in decision-making at the corporateoffice. Whereas before World War II the corporate office of large diversifiedinternational enterprises rarely managed more than ten divisions and only thelargest as many as 25, by 1969 numerous companies were operating from 40to 70 divisions and a few even more.

2 0 Neil H. Jacoby, The Corponce Conglomerate Corporation,' Tbt Ctmtn Mjignitt, Spring 1969,reprinted in Chandler and Tedlow, Tbt Ceming ofMtmpruU Cspitslism, p. 739. The next few paragraphsfollow closely pages in my 'Competitive Performance ofU. S. Industrial Enterprise: A Historical Perspective,'in Michael E. Porter, ed., Tnm Horhns i* Atmiaa ImUstry (a tentative tide) to be published in 1992.

1 1 David J. Ravenscroft and F. M. Scherer, Mtrpn, Sdl-effi, tnd EnmcxicEfficincy (Washington, DC:Brooking! Institution, 1989), ch. 6.

276

at Cukurova U



ownloaded from



Because few senior executives had either the training or experience necess-ary to evaluate the proposals and monitor the performance of so manydivisions in so many different activities, they had to rely more and more onimpersonal statistics to maintain their link with operating management.But, as Thomas Johnson and Robert Kaplan point out in their Relevance Lost:The Rise and Fall of Managerial Accounting, 1987, such data were becomingincreasingly less pertinent to realistically controlling costs and understandingthe complexities of competitive battles. Too often management cost accountingas taught in colleges and graduate schools and as practiced by accountantsbecame divorced from the complex operating needs of the decentralized,multidivisional organization. 'Cost accounting textbooks and academic re-search continued to concentrate on highly simplified, frequently abstractrepresentations of cost systems.' Such representations were 'in stark contrast' toactual practice in firms. Historical cost procedures in "generally acceptedaccounting principles (G. A. A. P.),' permitted plenty of leeway for managers toadjust accounts to meet budget and cost targets. 'As a result,' the authorsconclude, 'cost accounting and management systems found in most U.S. com-panies in the 1980s are of little use for determining product cost, for enhancingcost control, or for encouraging the creation of long-term economic wealth.'22

Even so problems lay less in the quality of the data and more in their use.Many divisions had themselves become multiprodua and multiregional andthe number of business units (profit centers) increased impressively. In the1960s, for example, GE had 190 and ITT over 200 such units. At GE the190 business units were managed by 46 divisions which in turn came underthe supervision of 10 groups whose heads look to the corporate office forsupervision.23 This meant that the statistical ROI data were no longer thebasis for discussion between corporate and operating management as to per-formance, profit and long-term plans. Instead ROI became a reality initself—a target sent down from the corporate office for division managers tomeet. Divisional offices, in turn, sent comparable targets to the businessunits or profit centers. Since managers' compensation and promotion pros-pects depended on their ability to meet targets, these middle managers had astrong incentive to adjust their data accordingly.24 As dangerous to competi-tive success, they rarely had the chance to review with top management theimplications of the numbers.

22 Johnson and Kaplan, RdawnaLul, pp. 169, 197, 221. They comment on the impact ofthe growthof the enterprise and other institutional changes in recent years on the use of ROI in evaluating divisionalperformance, pp. 203 -204 .

23 Francis J. Aguilar and Richard Hamermesh, 'General Electric, Strategic Position-1981,' in Chandlerand Tedlow, Tit Cmh% tf MsiugrrUl Ctfuulhm, p. 777.

24 I analyze these changes and systematizing and bureaucrat izing of the strategic planning process in myTrteFurjcaaruoftiKHQUoitintrieMidti1>usinessFinn?'.?/rw^ 1992.

277

at Cukurova U



ownloaded from



In the post-war years capital budgeting, like the monitoring of perform-ance, became more statistically based. In the late 1950s a capital budgetingmodel began to be used in determining long-term ROI of proposed capitalprojects. The new concept was a more precise determination of the earningrate required to make a project profitable. The model was used to determinecost of time, and then took into account the risk involved; the longer thetime, the greater the risk, the larger the rate.25 Such seemingly preciseestimates of anticipated project costs, if taken literally, could shorten man-ager's investment time horizons. Although experienced executives under-stood that this calculation of the required earning rate was only the place tobegin discussions, its use may account for the fact that US managers appearto require a higher threshold or 'hurdle' rate of return for financially justi-fiable projects than do Japanese or Continental European managers.26

Finally, increase in the size and the number of operating divisions forcedthe systematizing and indeed the bureaucratizing of strategic planning pro-cedures. The senior corporate officers now had to allocate resources on thebasis of strategic plans and capital budgets developed by scores of businessunits. Those strategic planning reports were initially reviewed and culled bythe division headquarters in which the units operated. Those offices, in turn,sent divisional plans to corporate headquarters, sometimes via group head-quarters. Thus the top executives at the corporate office not only lost personalcontact with the operating managers of divisions and business units; but alsothey set budgets and targets and allocated resources on the basis of writtenoften statistical data distilled by at least two levels (and sometimes three) ofplanning staffs.

Moreover, these capital budgeting and strategic review processes, like thestatistical evaluations of ROI, too often failed^ to incorporate complex non-quantifiable data as to the nature of specific product markets, changingproduction technology, competitor's activities and internal organizationalproblems—data that corporate and operating managers had in the pastdiscussed in their long person-to-person evaluation of past and current per-formance and allocation of resources.27 Top management decisions werebecoming based on numbers, not knowledge. In too many cases the existingcontrol methods no longer guided discussions between corporate and operat-ing managers. Instead they became devices for setting targets—ROI and

35 Johnson and Kaplan, Rtbuama List, pp. 163—16). Robert N . Anthony, 'Reminiscences AboutManagement Accounting,' Jtmnul of Msm^mtmt Acamuing Retcrtb, 1:7-9 (Fill, 1989).

26 James M. Poterba and Lawrence H. Summers, Time Horizons of American Firms: New Evidencefrom a Survey of CEOs,' Porter, Tmt Homom. They found the average hurdle rate for U.S. firms to be1 1 . 6 * for manufacturing firms and 12.2% (brail firms in their sample. Japanese reported hurdle rates ofbelow 10%.

27 Carliss Baldwin and Kim Clark, 'Strategic Capital Budgeting: The Case of New Product Introduc-tions,' in Porter, Turn* Horixau.

278

at Cukurova U



ownloaded from



budget targets decided by the corporate managers who had little or no directcontact with operating realities.

The strategy of unrelated or distantly related mergers and acquisitions andthe resulting weakening of organizational structure and control systems canaccount in part for the unprecedented numbers of divestitures that occurred inthe years that followed the mergers of the late 1960s. Before that merger move-ment, divestitures were rare. By the early 1970s they had become common-place. In 1965 there was only one divestiture for every 11 mergers; in 1969, atthe height of the merger wave, the ratio was 1 to 8; by 1970, 1 to 2.4; and thenfor four years 1974 to 1977 the ratio was close to or even under 1 to 2 . 2 8

The unprecedented number of mergers and acquisitions followed so shortlyby an unprecedented number of divestitures helped to bring into beinganother new phenomenon—the buying and selling of corporations as anestablished business, and a most lucrative one at that. Although industrial-ists pioneered in this business, the financial community prospered from it.

The new business of buying and selling companies and, with it, theresulting change in the basic role of US investment banks from underwritinglong-term corporate investments to profiting from the greatly increasedmerger and acquisition activity was further stimulated by the rise of a newset of financial intermediaries—the mutual and pension funds administeredby professional managers. With their rise came an unprecedented change inthe nature of the 'ownership' of American industrial companies. After WorldWar II, increasingly larger amounts of the voting shares of Americanindustrial enterprises came to be held in the portfolios of pension and mutualfunds. These funds, which had their beginnings in the 1920s and sufferedseverely during the depression years of the 1930s, began to come into theirown in the 1960s. The success of the managers of these funds was measuredby their ability to have the value (dividends and appreciation) of their port-folios outperform the Standard & Poor's index of the value of 500 companies.To meet their portfolio objectives, they had constantly to buy and sellsecurities—transactions made far more on the basis of short-term perform-ance than on long-term potential. As time passed, these portfolio managers—the new owners of American industry—increasingly traded securities in largeblocks of 10 000 shares or more. Block trading accounted for only 3 .1% oftotal sales on the New York Stock Exchange in 1965. By 1985 it accountedfor 5 1 % of sales. In those years, too, the volume of total transactions roseon the Exchange from close to one-half a billion shares annually in the early1950s to three billion at the end of the decade and to 27.5 billion by 1985. w

28 W. T. Grimm & Company, Mtrpnlst Rantw, 1988 (Chiogo, IL Grimm * Company, 1988),pp. 103-104.

» Ntw Ymk Sttck Exdxngt Ptcl Btoi, 1987 (New York, NY: New York Stock Exduuige 1988), p. 71.

279

at Cukurova U



ownloaded from



The great increase in the total volume of transactions, the rise in theturnover rate, and the growth of block sales made possible still another newphenomenon—the coming of an institutionalized market for corporate con-trol. For the first time individuals, groups, and companies could obtaincontrol of well-established enterprises in industries in which the buyers hadno previous connection simply by purchasing their shares on the stockexchange. Large blocks of stock were being traded regularly; and such buyershad difficulty in raising funds for these purchases from financial institutionsand financiers.

Thus, the diversification of the 1960s, the divestitures of the 1970s, thebusiness of buying and selling corporations stimulated by the shift inownership, and finally the coming of the market for corporate control greatlyfacilitated the ease with which the modern managerial enterprise could berestructured. Such firms could now be bought, sold, split up, and recom-bined in ways that would have been exceedingly difficult before the acquisi-tion wave of the 1960s.

During the 1970s a new financial environment and the continuing inten-sifying battle for markets brought a basic change in the strategies of manylarge multimarket US industrial firms. Their managers appreciated that anera of competition demanded different responses than did one of growth.They were learning that competitive advantages in highly contested marketsrequired close attention to the competitive potential of their companies'distinctive capabilities—of their specialized organizational facilities andskills. So the senior executives of these multimarket enterprises began torestructure and size down the portfolio of the businesses in which theycompeted. This restructuring was facilitated by the new institutionalizedmarket for corporate control. In these same years these managers werelearning that competitive success also depended on the ability of theircorporate offices to carry out the basic functions of monitoring the perform-ance of the operating units and planning and allocating resources for futureproduction and distribution. As they redefine their strategies, they alsoreshape their organizational structures and attempted to revitalize theircontrol methods.

In carrying out their restructuring strategies corporate and operatingexecutives continued to learn more about the specific nature of the enter-prises' organizational capabilities and how their product, process, andmanagerial labor and technical skills might best be used. This process ofrestructuring was usually one of trial and error. As a result the spinning off ofexisting operating units was often accompanied by the acquisition of otherproduct or service lines.

During the mid- and late 1970s such corporate restructuring was carried

280

at Cukurova U



ownloaded from



out almost wholly by senior executives at corporate headquarters. Investmentbankers and other financial intermediaries happily profited from their newrole of financially facilitating the transactions involved in the spinning off ofexisting operations and acquiring the new ones. In these transactions thecorporate managers preferred friendly takeovers; but if they determined theacquisition was valuable in their long-term strategic plans, they were willingenough to acquire it without the target company's support. Hostile take-overs, until then rare in American business, became common place as thedecade came to a close.

During the 1980s financial intermediaries and entrepreneurs became moreaggressively involved in corporate restructuring. They began to instigatemergers and acquisitions in order to profit from the transactions themselves,rather than from long-term strategic gains. These were the years of thehighly profitable transaction-oriented mergers and acquisitions carried outby raiders, greenmailers, and the instigators of 'bust-up' transactions (i.e.the purchasing of companies for the purpose of selling off their parts).30 Evenso, as one study points out, companies, divisions or subsidiaries involved inthese transaction-oriented mergers and acquisitions usually ended up in thehand of firms with similar or closely related products and processes. In thesetransaction-oriented deals the financiers acted as brokers, making profits (andoften extravagant ones at that) in carrying out the brokerage function.31

But even in the mid-1980s when such transaction-oriented mergers andacquisitions peaked, they were still outnumbered by those carried out bymanagers of industrial enterprises involved in the long-term strategic reshapingof the portfolios of the businesses they managed. In the 1980s these corporaterestructurings involved more than just acquisitions and divestitures. In thatdecade corporate managers carried out more joint ventures and other allianceswith foreign companies in global markets and domestic firms in related onesthan had ever occurred in earlier years.

In some industries such corporate restructuring was successful. In others itwas less so. These variations reflect the nature and the intensity of com-petition.32 In industries where new product development has been criticalfor continuing success, restructuring has been the most effective. In suchindustries as chemicals, pharmaceuticals, aerospace, computers and someelectrical equipment—industries in which R&D expenditures have been the

w I review the negative imptcc of ludi transactions-oriented mergers and acquisitions in my 'Competi-tive Performance of U.S. Industrial Enterprise!' in Porter, Time Horizons.

J1 Sanjai Bhagat, Andrei Schleifcr, Robert W. Vishney, 'Hostile Takeovers in the 1980s: The Returnto Corporate Specialization,' Bnokhtp Paptn m Ecomm Activity: Micmamunia (Washington, DC: TheBrookingi Institution 1990), p. 55.

52 The difference* in the basic nature of competition in these three categories (high, low and stable techindustries) and the relative success and failure in restructuring in each of these categories is spelled out inmy 'Competitive Performance of U.S. Industrial Enterprise*,' in Porter, Timt Htrizaa.

281

at Cukurova U



ownloaded from



largest—companies have succeeded in maintaining and expanding theirpositions in some markets as they have moved out of others, using the fundsthey received from selling off to enter new product lines. Thus, chemicalfirms have moved away from petrochemicals and other commodities (turningthese over to oil companies) into a wide variety of specialty chemicals.Makers of over-the-counter drugs and toiletries have transformed themselvesinto modern capital-intensive, research-intensive, pharmaceutical com-panies. Aerospace companies have been moving from defense to commercialproducts.

In the low-tech industries where research and development expendituresare low and where competition has been based much more on marketing anddistribution than on production and R&D, leading companies have success-fully completed their cycle of expansion and contraction. One reason why thecompanies in food and drink, tobacco, lumber, furniture, publishing andprinting were successful in making these strategic moves was that foreignand interindustry competition was much less intensive than it was in thestable and high tech industries. By the end of the 1980s these firms hadpulled back to producing and distributing products on which their corecapabilities had long rested.

It was in the stable tech industries—stable because their final productsremain much the same—that restructuring has been the most difficult. Inthese industries R&D and capital expenditures which, concentrated mostlyin cost-cutting procedures, were still essential to competitive success andhere both international and interindustry competition was the most inten-sive. In such industries as motor vehicles (especially trucks, parts andaccessories); light machinery (agricultural, industrial, mining and construc-tion equipment) tires, glass, steel and nonferrous metals a number of leadingUS firms failed to meet the challenges and disappeared. These includeInternational Harvester, Allis-Chalmers, Singer Sewing Machine, UnitedShoe Machinery, US Rubber, Libbey-Owens Glass, American Can andContinental Can. On the other hand, others like John Deere, Caterpillar,Dresser Industries, Ingersoll-Rand, Cooper Industries, FMC, PittsburghPlate Glass, 3M, Alcoa, Gillette, and the leading oil companies havereadjusted their product lines and remain effective competitors in globalmarkets.

During these yean of strategic restructuring organizational forms andcontrol methods were modified. Nearly all of the leading firms have gonethrough a major reorientation of their organizational forms. For multimarketfirms the M-Form is still standard, but the number of levels have beenreduced. The divisions and business units remain, while group offices havebeen dropped as have been many of the smaller business units within the

282

at Cukurova U



ownloaded from



divisions. As these operating offices were being reshaped, the relationshipsbetween them (particularly between those on different levels of management)were being redefined so as to permit the enterprise to respond more swiftlyand effectively to worldwide competition and rapid technological change. Asthe information revolution continues to transform the speed, accuracy andthe flow of data, the size of the staffs in the operating units and corporateoffices has been reduced.33

Control methods are also being redefined to take advantage of new,computer-based technologies and to meet the cost-cutting demands createdby continuing powerful international and interindustry competition. The de-velopment of flexible, computer-aided manufacturing systems have sharplyreduced labor, variable and other direct costs and proportionally increasedindirect, fixed and sunk costs require a thorough rethinking of cost account-ing. Similar challenges are reorienting the data that make up ROI and othermeasures of operating and financial performance. Budgeting and other con-trol measures are being rethought.

I can say little more about the reshaping of structures and the revising ofcontrol methods that are the response to the strategic restructuring of UScorporate businesses in recent years. The reshaping process is still going on.Information about these changes is not yet fully compiled and has only begunto be analyzed. The task of examining and understanding current develop-ment is, as the format of this conference indicates, one for economists andstudents of management rather than for historians. I would hope, however,that students of recent developments would place their finding in the differ-ent national historical frameworks outlined in this, the third, session of theconference.

The development of organizational forms, strategies and control methodshave differed from nation to nation. This was because the national environ-ments differed in many ways when over a century ago modern businessenterprise first appeared and also because each nation was differently affectedby continuing economic growth and transformation and by the great andsmaller wars and the depressions and recessions of the past century. We stillhave much to learn about the historical evolution of corporate organizationalforms, strategies and control methods. We know something about thesechanges during the period of rapid enterprise growth that began in the late

3 3 The recent reorganizations at Du Pone and GE are described in my The Functions of the HQ Unit inthe Multibuiinen Firm.' Foe adjusting control methods to meet new needs and structures see Johnson andKaplan, Rtltvtna Ust, chs. 9 - 1 1 ; Robert S. Kaplan, 'One Got System Isn't Enough,' Hjtnmrd BusinasRattv (January—February 1988); and Robin Cooper and Robert S. Kaplan, 'Activity Based UsageModels,' Harvard Business School working paper, July 25, 1991- The new information-based maniiftr-turing technologta indude Computer-Aid-Design and Engineering (CAD/CAE), Computer IntegratedManufacturing (C1M), and Flexible Manufacturing Systems (FMS). For changes in capital budgeting, seeBaldwin and dark, 'Strategic Capital Budgeting,' Porter, Tim Htriiau.

283

at Cukurova U



ownloaded from



19th century and came to a close in the 1960s. We know much less about theways in which firms adjusted their structures, strategies and accountingtechniques in the new era of intensified international and interindustry com-petition. By learning more about present practices we can better appreciatetheir roots in the past and better understand continuing different nationalpatterns of corporate change.

284

at Cukurova U



ownloaded from


chandler, 1992

Documents

world war

strategic

19th century

world war

du pont

strategic

organizational

operating