Development is delegated to divisional managers under the

Development overview

Chandler was
responsible for the rise of big business as better than other scholars have
done over the years. He emphasized very clear that prosperity and economic
growth depend on educated and well-trained managers. He was most probably the
first to drive home the importance to prosperity and productivity of
innovations in internal procedures and corporate structure.

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Chandler made
it very clear that the contributions of managers and management in the
corporate setting was to be taken seriously. He helped explain, how and why
large industrial enterprises emerged and expanded, both domestically and
internationally. He further noted the differences in managerial structure and styles
between the United States, Japan and Europe. He endeavored, with somewhat less
success, to explain the origins of new business ecosystems like Silicon Valley.

Alfred
Chandler left a considerable legacy across the social sciences. Among myriad
other benefits, he provided helpful foundations and support for a
“capabilities” theory of economic organization. Developing more robust and
testable capability theories is a task he left for others.

Williamson
(1975, 1991, 2009) likewise sees multidivisional (M-form) corporate
organization as an organizational innovation providing a means of better
allocating corporate cash relative to the unitary, functionally divided
(U-form) organization. The M-form allows top managers to redirect cash flow to
the highest-return opportunities among the operating divisions. Chandler (1962)
explains how the M-form structure helped facilitate diversification as well as
efficiency. In the M-form organization, control over capital is delegated to
divisional managers under the auspices of a strategically-focused headquarters
function. Divisional managers then compete in what Williamson (1975) called a
“miniature capital market,” with potential gains in efficiency over external
markets deriving from the superior depth of management’s knowledge of the
firm’s opportunities compared to the knowledge of investors and bankers.
Chandler’s and Williamson’s assessments of the adoption of the M-form on
organizational performance have been corroborated empirically by Armour and
Teece, 1978; Steer and Cable, 1978; Teece, 1980, 1981.

Chandler’s
insights into the relationship of strategy, structure, and performance were
broadened by the international comparisons in Scale and Scope (1990a). One of
these was his analysis of the origins of market leadership. For Chandler,
competitive advantage in the early 20th century flowed from execution of a
three-pronged strategy: investment in large-scale production to lower unit
cost; investment in marketing, distribution, and purchasing networks; and
recruitment and organization of professional managers. Entrepreneurs able to
perform these actions in young or changing industries gained advantages not
only from low unit costs, but also from product-specific learning across all
functional areas.

The language
of organization-specific “capabilities” can be traced back at least to Selznick
(1957). Cyert and March (1963) developed an influential model of organizational
learning in which standard operating procedures are seen as the memory of the
organization, thereby undergirding capability.

The concepts
of capabilities and organizational learning were joined and gained further
prominence and stronger micro foundations with their use and elaboration by
Nelson and Winter (1982), who extended the idea of organizational routines as
the firm-specific repository of know-how. These ideas have now been employed in
numerous other studies, e.g. Cohen and Levinthal (1990), Henderson and Clark
(1990) and Teece (1982).

As Mowery in
this issue notes, Chandler’s analysis rarely penetrated much more deeply than a
repeated emphasis on the elements of the three-pronged investment (Mowery,
2010). However, he can perhaps be said to anticipate what has come to be known
as “dynamic capabilities” (Teece et al., 1990, 1997; Teece, 2009). Dynamic
capabilities are the firm’s ability to integrate, build, and reconfigure internal
and external resources/competences to address and shape rapidly changing
business environments. They determine the speed and degree to which the firm’s
resources/ competences can be aligned and realigned to match the opportunities
and requirements of the business environment.

Chandler
engaged with the capabilities literature in a 1992 Journal of Economic Perspectives
article that relies in part on Nelson (1991), which in turn drew in part on one
of the first articles about the theory of “dynamic capabilities” (Teece et al.,
1990). In it, Chandler introduced the idea of strategic (as opposed to functional)
efficiency, which included, e.g. “moving more quickly into expanding markets
and out
of declining ones”. He also noted that capabilities are a potentially sound
basis for competitive advantage because they’re “company-specific” and
“difficult to transfer” yet they must be “enhanced by constant learning”.

 Embracing Nelson’s concept of routines as the
building blocks of capabilities, he writes that Even more important are those
routines acquired to coordinate these several functional activities. Essential,
too, are those learned in the strategic activities of responding to moves by
competitors, of carrying on the long, costly, and risky process of moving into
new markets and of adjusting to the constantly changing economic, social and
political environment. The resulting organizational capabilities permit the
enterprise to be more than the sum of its parts.

Critiquing Chandler’s work

Chandler made
enormous contributions and provided brilliant insights, but it is not clear
that he fully appreciated the substantive shift in the relationship between leading
firms and their suppliers that was well underway by the late 1980s. By the same
token, he may have overestimated the extent to which Chandlerian (large,
integrated) firms would dominate capital-intensive industries in the future.
Nor is it clear that he appreciated the transformations brought about by the
expansion of venture capital, which greatly facilitated the formation of new
enterprises aimed at bringing new products to market. The following sections
examine each of these issues.

Underestimating supplier capabilities

While
Chandler had a relatively sophisticated understanding of the evolution of the
supply base over time, he underestimated the potential for overseas suppliers
to develop capabilities which would allow them to evolve into global competitors.

Although he
highlighted the virtues of vertical integration in most of his work, by the
1990s he had come to understand how vertical integration interacts with the capabilities
of the supply base.

As their
industries grew and especially as the demand for replacement parts and
accessories expanded, so too did the number of suppliers who had acquired the
necessary capabilities. Once such goods were available from a sizeable number
of suppliers, the need for vertical integration through direct ownership
lessened.

Chandler’s
capabilities theory of vertical integration appears to be quite different from
mainstream (pre-transaction cost economics) interpretations such as the life
cycle of integration that Stigler (1951) identified. Stigler stated that firms
in young industries needed to internalize supply until markets had matured to a
size that would justify entry by specialist suppliers. Stigler’s theory of
vertical integration is a scale theory, not a capabilities theory.

Sturgeon
(2002) points out that Chandler’s (1977) model of integration and growth, which
relied on “economies of speed” (high throughput and utilization) and a growing
market for output, was undermined, at least in the US electronics industry, by
global competition in the 1970s and 1980s. To escape from under the high-fixed
costs of their in-house manufacturing, the US firms embraced what Sturgeon calls a “modular production network,” in which the
value chain is divided between firms at points where the specifications of the
transaction can be codified using standardized protocols.

Modularized
production is most common for manufacturing technologies (e.g. the placement of
components on a circuit board or the fabrication of digital logic microchips)
that are generic, i.e. not specific to individual products. In many cases the
processes involved are highly automated and can be readily reprogrammed to
serve a different customer. These specialist (but not co-specialized) suppliers
can realize the economies of speed for their customers that in Chandler’s
heyday were only realizable within a highly coordinated corporate environment.

Ironically,
some of these new generic suppliers have themselves begun to invest in vertical
integration, although more in pursuit of cost control or opportunities for
differentiation than for purposes of ensuring throughput. Typical examples
include product assemblers that invest in the manufacture of inputs such as
plastic enclosures, or a microchip “foundry” that invests in the downstream
process of chip assembly.

When Chandler
surveyed the industrial landscape of the electronics industry at the end of the
20th century, he reduced the whole outsourcing phenomenon to a word, “nexus”
(2001: 5), by which he meant the industry’s pool of suppliers. This was his way
of minimizing a global phenomenon even as it was exhibiting expansion beyond
the electronics sector where it began. He perhaps failed to recognize that the
boundaries of the firm could no longer be sharply delineated given the growing
importance of alliances and networks, and the case of accessing components and
raw materials from unaffiliated suppliers.22

Among other
things, Chandler’s vertical integration may have reduced his ability to
recognize that suppliers, over time, could build the competences needed to
supply entire systems from design to distribution and emerge as viable “core
firms” as Chandler put it. This has occurred in the cases of Taiwan’s Acer and
Korea’s Samsung. Although their more visible successes came after the
publication of his book, they were already actively developing capabilities in
marketing and distribution that might have alerted Chandler to their purposes
and potential.

These facts
also raise important issues about the dynamic consequences of extensive
outsourcing for the competitiveness of firms, who may find that more than just
the supply source has moved outside the boundaries of the firm. Vertical structures
have informational advantages that the theory of the firm has not yet fully appreciated (Teece, 2007). Integration can also ensure the
availability of complements or bottleneck assets necessary to assure the
appropriation of the profits from a firm’s own innovations (Teece, 1986, 2006).23

The
informational advantages of integration have been noted in the context of some
applied studies. For example, in the case of natural gas pipelines and the
“merchant” function (buying and selling gas), integration permits
“informational efficiencies” from such facts as the accessing of data about
supply interruptions, demand shifts, and transportation bottlenecks that might
be too transitory and/or too business-sensitive to be worth sharing between a
stand-alone pipeline and multiple merchant partners (Teece, 1990). Incidents
like the gradual consolidation of the elements of the post-break-up AT&T
into a small number of firms and the poorly formulated deregulation of
California’s electricity market following the forced de-integration of
generation and transmission suggest that the potential benefits of vertical
integration are still not well understood by industry regulators, many of whom
have been hostile to vertical structures.

In the
computer industry, IBM under CEO Louis Gerstner in the 1990s was able to
demonstrate the benefits of bucking the trend toward disintegration by building
on the firm’s well-established capabilities to provide complete hardware and
service solutions, even if this meant supporting competitors’ hardware in some
cases (Davies et al., 2007). Other hardware firms are unable to match IBM’s
internal competences, but they have followed its example of forward integration
into services (Davies, 2004). One of the most valuable capabilities is now
system integration (Prencipe et al., 2003), with varying degrees of vertical
integration underpinning it depending on each firm’s capabilities, including
the transformational capability of its managers. A more nuanced understanding
of the benefits of vertical integration (particularly in the innovation
context) may be starting to emerge (Teece, 2000).

Over-emphasizing
large enterprises?

Chandler
remained convinced of the continued dominance of large, long-lived,
multidivisional enterprises with a significant degree of vertical integration:

‘I am willing
to predict not only that the modern industrial firm, will be as powerful an
economic institution at the beginning of the twenty-first century as it is in
the twentieth, but that a number (though certainly not all) of the U.S. global
leaders today will remain as dominant in their global industries in the future
as they have been in the past. Moreover, their rivals will continue to be, as
has been true in the past half-century, not entrepreneurial start-ups but
comparable enterprises from overseas or from related industries (1990c: 758)’.

His
confidence extended to the point of believing that venture capital-fueled
start-ups would remain relatively unimportant, established firms in recent
years have played a greater role in the creation of new industries than
entrepreneurial start-ups because the time and cost of commercializing
technologically complex new products and processes is not in invention or
research. It is in development in the long and complex course required to
produce goods in large enough quantity and with high enough quality to be
purchased by a substantial number of customers in national and global markets.
The commercializing of a new product or process, in itself a continuing
learning experience, rests on cumulative organizational learning in the
development, production and marketing of earlier products. Moreover, large
industrial multi-market firms be they American, European or Japanese have throughout
this century used retained earnings (the profits from products earlier
commercialized) to fund the high cost of developing new ones” (1992: 97).

However, as
early as Scale and Scope (1990), Chandler recognized that supply conditions had
changed significantly from those that led to industrial gigantism, in
established industries, the need for assured supplies and outlets lessened. As
economies expanded and markets were internationalized, alternative stable
sources of supply became available. Therefore, companies had less need to
reduce transaction costs by owning their suppliers and outlets. Indeed, many
companies performed vertical disintegration.

Chandler
nevertheless believed there were private and social benefits that flowed from
vertically integrated firms. In his later book about the information technology
and consumer electronics industries, published in 2001 just as the first
Internet boom was finishing a period of amazing growth, Chandler compares the
prospects of the United States, with its wealth of start-ups, against those of
the large, vertically integrated Japanese producers.

This
historian’s verdict is that the Japanese challengers have strong advantages in
shaping the infrastructure of the Electronic Century. First, the
multi-sectored, multi-industry enterprises have more of the organizational
capabilities and income required to commercialize products of new technologies
and to enhance products of existing technologies than do the single-sector
enterprises. Second, Japan’s economies of proximity and its far-wider range of
electronic products and specialized organizational capabilities give the
Japanese industry an edge on the development of new and improved hardware
systems. If evolution continues as it has in the past,
through the commercializing of new Information Technology hardware and the
enhancing of existing onessic, then the U.S. industry is handicapped. If, on
the other hand, the central innovative thrust in the new Electronic Century is
based on exploitation of the revolutionary new ways of communication, broadly
defined, then the U.S. enterprises have the advantage” (2001: 236–237).

His
fundamental insights are in many ways still very sound. Integration (whether
vertical, lateral, or horizontal) still plays a very large role in economic
organization. Witness the “reintegration” of many telephony companies since the
AT divestiture, the recent acquisition of Sun Microsystems by Oracle, and
Boeing’s recent “reintegration” backwards into components and subsystems
following delays with its “Dreamliner” project.

Chandler
failed to see much role at all for outsourcing and “open innovation”
models of business organization. He also underestimated the importance of
start-ups in the United States and overseas. This can perhaps be attributed to
his vantage point, that of successful industrial firms during a century
(roughly 1850–1950) in which American industrial might rose to an unrivaled
stature and markets were more domestically oriented than during the current
period, in which world trade has been liberalized and China has joined the
global system.

Ironically,
Chandler was probably also handicapped by his embrace of the concept of
organizational capabilities (and the advantages of learning generally) without
a deeper understanding of the sources of competitive advantage. Where Chandler
saw strength in the multidivisional structure of the Japanese electronics
giants, there was actually some weakness. When Howard Stringer, a non-engineer
as well as a non-Japanese, was brought in as CEO, one of his first priorities
was to induce Sony’s divisions to cooperate amongst themselves in significant
efforts such as software development (Borland, 2006). Moreover, the companies’
learned routines of relying on the Japanese market for the development of
successful products that could later be rolled out worldwide became a handicap
as markets began to move at Internet speed and/or became fragmented among
competing standards.

Neglect of “financialization?”

Chandler did
pay some attention to mergers and acquisitions, but less to merger and
acquisition financing. Granted, his focus was on the industrial enterprise, not
the banks, venture capital firms, and private equity firms that expanded
greatly on the back of financial innovations from the 1980s onward. However,
the expansion of financial markets and the introduction of new financial
instruments undoubtedly affected the evolution of firms and industries.
Chandler’s neglect of these complex phenomena left a significant lacuna for
others to fill. Because of the latest crisis in financial markets, there is now
urgency to this task.