Three Faces of Capitalism

Scale and Scope: The Dynamics of Industrial Capitalism is the culmination of Alfred Chandler’s long and distinguished career as a business historian.¹ Chandler has never been interested in capitalism as an abstract economic order. He is interested in it as a social terrain in which business corporations, the central institutions of capitalism, carry on the internecine warfare we call competition. I use military terms because Chandler has always attributed corporate success primarily to superior arms and generalship, not to luck, monopoly, or the abuse of labor.

In Scale and Scope he traces the strategies and tactics of the two hundred leading industrial companies in the United States, Great Britain, and Germany at three historically significant moments—1917, 1930, and 1948—and in so doing he has compiled the first broadly comparative account of business success and failure.² If a historian compared the abilities of three countries to fight wars by making a battle-by-battle analysis over many fronts during three significantly different periods, he would produce a book analogous to Chandler’s. In casting fresh light on capitalism’s success and failure, his analysis also casts a long shadow over the American future if things continue along their present course.

The weapons that Chandler’s battling corporations use are provided by technology. In the industrial era that he is interested in, new capital-intensive techniques of production, in which a small number of machines could do the work formerly done by hundreds or thousands of men, gave rise to a means of profit-seeking previously present only in embryo. This means was the huge reduction in costs, called economies of scale, that resulted when plants equipped with the new technology ran at or near full capacity. For example, by the late 1890s a dozen men on the floor of a Pittsburgh rolling mill were able to turn out three thousand tons of steel each day, as much as a steel mill employing several hundred men produced during an entire year in the 1850s. As a consequence, the price of steel in Pittsburgh fell from $67.50 per ton in 1880 to $29.95 nine years later; and by the next decade the cost in Andrew Carnegie’s plants had dropped to $11.25. This technology had an aggressive side in the huge advantage it gave to the industrial pioneers who were willing to install it, and who then cut prices so dramatically that less well-equipped competitors were forced out of business.

Closely related to these economies of scale were economies of scope—the capacity to use capital-heavy industrial processes to diversify output, thereby making it possible for one firm to produce a variety of products for different markets. The three biggest German dye producers—Bayer, Hoechst, and BASF—expanded by using both methods. Huge investments in research and new products and manufacturing methods enabled them at first to win tremendous economies of scale: between 1873 and 1881, for example, the price of alizarin dye fell from 120 marks to 17.5 marks. Thereafter, all three companies achieved economies of scope. By 1900 each of the firms was producing several hundred dyes; by 1913 Bayer alone produced 2,000, a range unmatched elsewhere in the world.

Industrial technology provided the means of economic warfare, but successful campaigns required the planning and audacity of the kind successful generals use in war. Indeed, Chandler’s central theme is that in business, too, the quality of command provided the crucial difference between successful firms and unsuccessful ones, as well as between successful national economies and unsuccessful ones. Here the famous contrast between Ford and General Motors is particularly instructive. In 1921, the Ford Motor Company produced just over half the cars in the United States; and General Motors, Ford’s major competitor, only 12.3 percent of them. By 1940 the positions were almost reversed. GM was then making 47.5 percent of all American cars, Ford 18.9 percent. The reversal was not the consequence of any significant difference in the technology used by the two companies but was entirely the outcome of two different styles of management.

Henry Ford’s company rose to early prominence on the strength of its founder’s remarkable personal qualities, while General Motors stumbled along under the strong but erratic leadership of William C. Durant. After General Motors’ third financial disaster, Durant was replaced by Alfred P. Sloan, Jr., a protégé of the Du Pont stockholding interests that controlled the company. Sloan began an immediate reorganization of GM’s hodgepodge of operations, creating a multidivisional structure with five separate units for production and distribution. In the new regime, the work of the different units was coordinated by adjusting purchases of new materials and parts to annual forecasts and adjusting daily outputs to monthly reports of new car registrations. Relationships with dealers were carefully cultivated and strengthened, and provision was made for cars to be bought on credit. For the first time, the “style” of automobiles became a primary consideration.

By contrast, Ford used these years to destroy his company’s emerging managerial structure. He fired the talented executives in charge of production and sales, both of whom joined GM. During the 1921 recession he forced dealers to accept cars despite a collapse in demand. Surrounded by yes-men, and deeply distrusting anything that smacked of professional organization, Ford effectively prevented the development of a managerial civil service within his company. Later he would repeat the same approach abroad, with equally disastrous results.

The importance of organization becomes even more evident when we compare the managerial styles of the United States, Britain, and Germany. Just as different domestic conditions and historical experiences lead to different styles of military strategy, so differences in the extent of markets, in commercial law, and in national culture led to distinct approaches to the management of industrial production. Chandler calls the American style “Competitive Managerial Capitalism.” Discussing the “managerial” element, he traces how the hierarchies of supervision that are displayed on management organization charts became a common aspect of business life.

We now take for granted the diagrams showing corporate chains of command with their lines of authority running from stockholders to directors to corporate officers to department managers and submanagers. We forget that such diagrams showing staff officers and line officers, and their relations to such noncommissioned officers as shop foremen, had to be devised and put into place at a time when large companies were still largely the personal fiefdoms of the commanding figures who had given rise to them. As for competition, the combination of vast national markets, antitrust laws, and a tradition of swashbuckling rivalry prevented American capitalism, despite its many efforts to create restrictive trusts and mergers, from succumbing to the temptations to create cartels and other devices to monopolize markets.³

In Britain, by contrast, a commitment to what Chandler calls “Personal Capitalism” became the prevalent style. He cites an extract from the minutes of the board of directors of the Pilkington Brothers, a large plate-glass manufacturer, in which the point at issue was whether Alastair Pilkington, who despite his name was not a member of the immediate family, could be brought into management:

The Directors considered a report furnished by Col. Phelps of an interview which he and Mr. W.H. Pilkington had had with Col. Lionel G. Pilkington on the subject of the possibility of his second son, Alastair, joining the P.B. Organization…. The matter had arisen from an almost casual introduction by Mr. Richard Pilkington. The Directors felt it should be pointed out to Mr. Richard Pilkington that the method of introduction was very irregular. Mr. L.G. Pilkington’s branch of the Family broke away at least 15 generations ago…. It was agreed, however, that a member of the Pilkington Family, however remote, could be accepted only as a potential Family Director.

It should be added that the Pilkington firm, far from being a stick-in-the-mud, was one of Britain’s most successful industrial enterprises, and that the anxious concern with family management occurred in 1945, long after the Pilkington board had been “modernized” in 1931 by admitting two (raised in 1939 to three) non-family members to the board. The widespread practice of personal capitalism led British capitalism in a very different direction than American. “In American managerial firms,” observes Chandler, “the basic goals appear to have been long-term profit and growth…. In Britain the goal for family firms appears to have been to provide a steady flow of cash to owners—owners who were also managers.”

The cost of the British commitment to personal management, with its associated failure to take full advantage of economies of scale and scope, was part of the ailment we have come to call the British Disease. Its consequence was Britain’s loss of its place in world competition. As Chandler puts it:

British entrepreneurs had the patents. They had access to advertising agencies. They had created enforceable cartels in the form of holding companies. They had much closer ties with and access to British financial institutions, government bureaux, and Parliament than did American and German competitors producing and selling in British markets. In a number of basic industries they enjoyed every source of market power against these competitors, except the capability to compete. Thus British entrepreneurs lost out in many of the most dynamic new industries of the Second Industrial Revolution.

What Chandler calls the Cooperative Managerial style of German capitalism has long been misunderstood in the US. German entrepreneurs fully perceived the logic of the need for heavy investment to capture the potential of industrial technology. Before World War I, for example, Siemens, a leading “first mover” in electrical equipment, had created the largest industrial complex in the world, Siemensstadt, in the municipality of Nonnendamm. Chandler describes the complex as the equivalent of placing all of General Electric’s manufacturing facilities at Schenectady, New York, Lynn and Pittsfield, Massachusetts, Harrison, New Jersey, and Erie, Pennsylvania, together with its Western Electric plant in Chicago, at a single site near 125th Street in New York City. Moreover, the Germans were quick to recognize the necessity of a business bureaucracy. By 1913—before any British firm had drawn up so much as a sketch of a systematic table of managerial organization—at least one large German firm had published for internal use a minutely detailed organizational chart, accompanied by a manual of over one hundred pages detailing the functions and relationships of its offices.

The German model was different from the others in making much more extensive use of “cooperation” to allocate shares of the market. Agreements to do so, never entirely reliable, eventually took the form of IGs—Interessengemeinschafte (“communities of interest”)—or Konzerne, integrated company groups controlled by a few tycoons. We would call them cartels. The most famous was the IG Farben company which, by 1937; produced 98 percent of the dyestuffs produced in Germany, 50 percent of its pharmaceuticals, between 60 and 70 percent of its photographic film, 70 percent of its nitrogen, and 100 percent of its magnesium. The elaborate systems devised by the Germans to divide up markets, while investing and selling as if they were still under heavy pressure from competition, seem for the most part to have worked very well—probably as well as the American, despite our recurring declarations about the deleterious effects of cartelization. Chandler does not evaluate the German style as a whole, but his judgment with respect to the post World War I performance of the major companies in the all-important electrical industry can be plausibly applied to national economies as well:

The most obvious difference between the Germans and the Americans was the complex and varied arrangements that the German firms had with each other…. Did the antitrust laws, then, make a significant difference? Did they make American industry more effective and German industry less so? The initial success of the two German leaders (Siemens and its sister firm AEG, Allgemeine Elektricitäts Gesellschaft), their industry’s quick recovery after the [First World] war, and the relatively parallel development in the growth and the structures of the first movers in each of the two countries suggests they did not.

It would be too much to expect the chief executive officers of the Fortune list of the 500 largest manufacturing corporations, or the members of the House and Senate committees on finance and taxation to read Chandler’s monumental book. They would find most of it unexciting. It is an uninflected account, full of names but empty of personalities; crammed with detailed history but almost devoid of drama or anecdote. Nevertheless, without this systematic historical survey, Chandler could not have written the thirty-five-page conclusion that ought to be required reading for all CEOs and congressmen.

Here Chandler leaves behind his painstaking account of management methods for an “impressionistic analysis” of more recent events, in which he raises two very large questions. The first concerns the changes that have affected the strategies of major industrial firms in all nations. He begins by discussing changes that are by now familiar—the explosion of technology and a shrinkage of distance. The computer and the jet plane have made it possible to conceive, finance, and run enterprises on a global scale. European capitalism has arisen from the ashes and Japanese capitalism from its improbable past. The result has been a ferocious intensification of competition that has driven managements everywhere to search for new ways to expand.

Chandler then takes up less familiar trends: the ways managements have sought expansion by diversifying into related industries. By 1969, for instance, only 7 percent of the Fortune 500 list derived 95 percent or more of their sales from a single product, compared with 28 percent twenty years earlier. The same trend is to be found in England and Germany, as well as in Europe generally and in Japan.

Diversification is taking place in all capitalist economies, not only because all face the same intensifying of pressures, but also because all now respond in similar ways to these pressures. Chandler reminds us that in The American Challenge, published in 1968, J.J. Servan-Schreiber described the threat posed by the rise of American investment in European companies not as a “technological gap,” but as “something quite new and considerably more serious—the extension to Europe of an organization that is still a mystery to us.” It is a mystery no longer. The prospective success of increasingly integrated European economies will depend at least as much on organizational know-how of the kind exemplified by Sloan’s reforms as on technological advantages. Even in Great Britain things have changed. Already by 1970, more than half its leading industrial firms had used the services of McKinsey & Company, one of the best known US management consultants—with what success Chandler does not say. Meanwhile, the organizational talents of Japanese business firms, working in close association with the Japanese government, have become legendary.

In his last eight pages, Chandler pushes the analysis still further, concentrating on the specific ways in which the strategy of corporate management has changed in the United States. He identifies six such changes, all generally familiar to the reader, but suddenly charged with a new and disquieting significance. One of them has been an extension of economies of scope—without, however, the technological rationale that underpinned the earlier development of such economies. Here Chandler describes corporate growth through the creation of conglomerates whose different divisions have no links, either for production or distribution, to the parent firm. “For the first time in history,” Chandler writes of the Sixties and Seventies, “American managers began to invest extensively and systematically in facilities and enterprises in which they had little or no experience.”

A second problem derives from the first. The separation of top from middle level management, Chandler writes, has produced “a breakdown of communications.” In the new firms created by conglomeration, the new managers often lacked direct knowledge of the technology or the markets of the subsidiaries for which they were responsible. An example is readily seen in the difficulties encountered by International Telephone and Telegraph (ITT), which attained giant size by absorbing a hotel chain, a car rental company, a baker, a builder, and literally dozens more companies, thereby becoming by 1975 the fourth largest employer in the world—only to suffer from severe indigestion that has since led to almost as dramatic a course of deconglomerization. Moreover, as diversification has increased, so has the load of management’s responsibilities. Before World War II, corporate main offices rarely handled more than ten divisions; by the late 1960s, they were typically handling well over forty.

The third and fourth changes follow logically. Relatively unprofitable branches, rather than being revived or reorganized, were increasingly severed from the organization and sold off. Before the late 1960s, such divestitures were rare; by the mid-1970s there was one for every two mergers or acquisitions. As a result, by the late 1970s, we find yet another change, as divestiture itself was enlarged into a new business of mergers and acquisitions, the hottest business in town.

In turn, this brought another turn of the screw: “[The] brand-new business of buying and selling corporations,” Chandler writes,

was further stimulated by an unprecedented change in the nature of the “ownership” of American industrial companies, that is, of the holders, buyers, and sellers of their shares.

Financial managers commanding huge blocks of capital now became buyers and sellers of controlling interests in corporations, able to determine their success or failure. They traded for immediate gain and lost no sleep over “their” companies, once they were no longer part of their portfolios of stocks and bonds. As Chandler says, “[they] had neither the time, the information, nor the need to be concerned about the long-term health and growth of the individual firms whose securities they daily bought and sold.” Finally, supporting the whole system has been the extraordinary expansion of the financial markets in which corporations were offered for purchase and sale. The volume of shares on the New York Stock Exchange has risen from roughly a half billion shares annually in the early 1950s to almost thirty billion in the mid-1980s. More than one writer has suggested that the institution that best symbolizes capitalism today is the gambling casino, not the factory.

The last two pages of Chandler’s book are the most disturbing. He points out that the erosion of managerial capitalism has not afflicted all countries alike. Not content with struggling against the British disease, English management caught casino fever during the 1970s. Up to that time Germany and Japan had been largely spared its ravages. In those countries the energies of management were still addressed to guiding corporations toward long-term growth. Chandler’s survey only extends through the 1970s, but it is premonitory of what was to happen in the next ten years. There has been a paroxysm of corporate dismemberment in the United States. England has not been far behind. But in Germany and Japan, our two great competitors, the system is still largely following the patterns combining managerial cooperation and competition that have proved powerfully effective in the past. If the trends described in Chandler’s monumental study continue, America may well become the Britain of the twenty-first century.