Economics of StrategyBesanko, Dranove, Shanley and Schaefer, 3rd Edition

Slide show prepared by

Richard PonArulCalifornia State University, Chico

John Wiley Sons, Inc.

Chapter 1

The Evolution of the Modern Firm

1840, 1910 and Today

The years 1840, 1910 and 2003 represent widely disparate business conditions

A historical analysis of business conditions illustrates the durability of fundamental economic principles behind business strategy

Infrastructure in 1840

Infrastructure in transportation, communication and finance were poorly developed in 1840

Poor infrastructure was behind the dominance of small family firms in that period

Transportation in 1840

Though railroads had begun to replace horse and wagon for transportation of goods, national railway network had not arrived

Waterways used for long distance transportation was still in initial stages of development

With poor transportation, producers were limited to local markets

Communication in 1840

Postal service which was the dominant mode of long distance communication still relied on the horse

Telegraph was still in an early stage and was very expensive to use

Finance in 1840

Most businesses were partnerships and they found it difficult to obtain long term debt

Shares of stock were not easily traded and cost of capital was high

No institutional mechanism existed for handling business risk

Futures trading was still to come about

Production Technology in 1840

Most factories used century old methods of production

Use of standardized parts (prevalent in clocks and guns then) was just beginning

Factories operated on the basis of internal contracts with supervisors leasing space, hiring workers and producing the goods

Government in 1840

Government was involved in large infrastructure investments such as canals and railroads

Government also resolved commercial disputes and set the rules of the game for the businesses

Business in 1840

Technology limited production to traditional levels

Without transportation infrastructure and access to large markets, mass production technologies would not have been useful

Business in 1840

Without communication infrastructure, information on prices, sellers and buyers were not readily available

Given the tremendous risk, banks were unwilling to finance business expansion

Under these conditions, businesses were small and informally organized

Business Conditions in 1910

Mass production technologies made possible high volume low cost manufacture of goods

Railroads dominated transportation and allowed mass distributors to reach widely scattered customers

Telegraph and telephones greatly improved long distance communications

Finance in 1910

Securities markets traded shares of large industrial firms

Credit bureaus made credit information easily accessible

Public disclosure of accounting information was in vogue

Government in 1910

Government regulation extended to such areas as corporate law, antitrust and worker safety

Increased regulation forced managers to collect a lot of data on internal operations

Mandatory secondary schooling provided the labor force needed by large bureaucratic organizations

Business in 1910

Expanded infrastructure allowed firms to expand their markets, product lines and production scale

New technologies allowed high volume standardized production

Growth of financial infrastructure made large scale firms viable

Transportation Infrastructure Today

Air, rail and ground transportation have become better coordinated

Cities like Atlanta have grown relying on air transport in spite of poor rail and water connections

Communications

Telecommunication technology made instantaneous transmission of data possible and created global markets for some products and services

Coordination of activities has become easier with modern computer and communication technologies

Finance

Capital markets and financial institutions have become more active in evaluating firm performance

Globalization of financial markets made many mergers and acquisitions (such as Daimler-Chrysler) possible

Financial accounting developed to cope with the complexities of multi-divisional firms

Production Technologies

Modern technologies such as CAD/CAM have made low cost tailor-made production feasible

Use of new technologies often means reorganizing the firm around these technologies

Government

In some areas traditional regulation has been relaxed (deregulation of airlines, trucking, financial services)

Regulation has increased in other areas (health care, workplace safety, discrimination, environmental protection)

Government

Government support for basic research and commercialization of R & D projects

Intergovernmental treaties and agreements create regional free trade zones

Business Today

Strategies that were effective when competition was essentially domestic do not work well in globally competitive times

Internal structure of firms have been changing, with firms focussing on their core businesses and leaving the rest to specialists

Traditional hierarchies within organizations have been weakening

Business Today

Advantage of large scale production diminished in some areas

Advances in computing and communication long with industry standards have enabled complex coordination over long distances

The role of the general manager has changed as the structure of the business organizations has changed

Infrastructure in Emerging Markets

The variation seen among 1840, 1910 and 2003 can be seen to exist today when we look at cross section of countries

Unlike the advanced nations, many developing nations still lack transportation and finance infrastructures

Businesses are reluctant to invest in countries where corruption, cronyism and conflicts are rampant

Business Conditions and Strategy

Vertical integration was not needed in 1840 since scale of production was small

Vertical integration trend is being reversed today since computer and communication technologies make complex coordination of tasks possible

In some instances “virtual corporation” begins to make sense

Business Conditions and Strategy

Business conditions change over time and so do the optimal strategies

Principles needed to arrive at successful strategies do not change

Recipes change from period to period but principles behind the recipes do not