The variety of business enterprise

The firm investigated in Chapter 6 was beginning to take on some of the characteristics of hierarchical organisations and to reflect a few of the structural features associated with modern business enterprise, but our dis­cussion of internal structure is hardly complete. We have presented various attempts at rationalising employment hierarchies, yet many other charac­teristics of the firm remain to be considered. In this chapter we consider explicitly the question of the determinants of the size and scope of firms. Firms, as was noted at the very beginning of Chapter 1, vary greatly in size from organisations of tens of thousands of employees which generate income for those involved equivalent to the national income of some inde­pendent nation states, to small local business enterprises, one-person busi­nesses and partnerships. Why do we observe this variety? If hierarchies have the incentive properties noted in Chapter 6, why not organise the whole economy as one gigantic hierarchy? What forces determine the limits of the firm and at what point do alternative contractual arrangements begin to reassert themselves?

Pure size is not the only matter of interest. Size is related to, and perhaps even the outcome of, decisions concerning the scope of the firm. Some firms are highly specialised while others undertake an apparently diverse set of activities. This diversity of activity is usually reflected in three dimen­sions – vertical, lateral and geographical.

1. Vertical Integration

Production of final output usually requires materials to be transformed through many intermediate stages. In some instances, a single firm will attempt to integrate these stages, even where quite different technical problems may be encountered at each stage. Historically well-known exam­ples of ‘spectacular’ backward vertical integration are the acquisition by Lever in the early twentieth century of raw material investments in West Africa in order to supply his requirements for vegetable oils used in soap and margarine manufacture. Dunlop also integrated backwards into rubber plantations, Guest Keen and Nettlefolds and Tube Investments (the engineering companies) into steel production in the 1950s, and General Motors (in the USA) into the production of motor-car bodies and other components (1929). The last case was mirrored later in the UK with the acquisition by Ford of Briggs Motor Bodies Ltd, and of Fisher and Ludlow Ltd by the British Motor Corporation in 1952, and it has been the focus of some theoretical interest in recent years (section 5.4). Examples of forward vertical integration include the ownership by brewers of public houses (‘tied houses’) or of petrol stations by oil refiners, and also special links between motor manufacturers and dealers.

Examples can be found, however, of companies that have not integrated backwards or forwards in this way, or at least have remained specialised at a particular stage for a substantial period of time. From the late eighteenth century to the 1950s, for example, Guinness specialised in what used to be called porter and is now known to most people only as ‘Guinness’. In 1951, a director of Guinness could write¹ ‘Nothing in the nature of either verti­cal or horizontal trustification was attempted.’ Guinness produced only a little malt – ‘just enough to give them a clear insight into all the problems of barley and malt’. They owned no retail outlets. ‘They have done just one thing and done it better than anyone else. That policy has been fixed at the top and has run right through at all levels.’ Until the last quarter of the twentieth century, therefore, a deliberate business strategy of specialisation was adopted at Guinness. At the retail level, a similar strategy appears to be pursued by most chain stores. Again, in the mid-1950s Dr A.J. Sainsbury wrote that² ‘It has never been our policy to manufacture a considerable pro­portion of the goods we sell’, while other famous stores in the UK such as Marks and Spencer also purchase their wares on the open market. The rise of ‘own brands’ by which Sainsbury’s, Tesco and other chain stores vouch for the quality of some item but arrange for its manufacture by an ‘inde­pendent’ firm is, however, an interesting form of ‘integration’ which high­lights the difficulty of distinguishing where in the spectrum of contractual arrangements the boundary between market and firm is to be found.

2. Conglomerate Diversification

Some firms, vertically integrated or otherwise, still operate within a limited sphere. This may be defined technologically in terms of a specific limited type of output, or by concentration on products all derived from a partic­ular input or particular industrial process. Thus, Edwards and Townsend (1967) write of the history of Pilkington Brothers up until the mid-1950s as follows: ‘Pilkington Brothers have grown by stretching backwards into earlier stages of production, forwards into processing and distribution of glass, and sideways into the manufacture of additional glass products; their growth has taken them all over the world but it has always been concerned with glass’ (p.60). Other firms seem capable of undertaking operations in apparently ‘distant’ areas. Products may be quite different both in terms of the market served (with very low cross-price elasticities of demand) and of the technology and inputs required. The growth of these ‘conglomerate’ organisations was a notable feature of the four decades up to the mid-1980s and the links between the component parts of such enterprises are not always very obvious. The history of Guinness is an interesting example of the changing patterns of recent business enterprise. From the textbook example of a specialised firm, strategy changed radically, and in the mid- 1980s, Guinness became involved in a notorious takeover battle for Distillers, and extended its interests into other areas. The goal became the development of ‘an international brand-orientated consumer products business’.³

The great variety of activities undertaken in a conglomerate does not imply that there is no underlying logic to its development, and the history of each enterprise usually reveals the sometimes surprising links between apparently quite different industrial processes. Technological developments and marketing skills clearly play an important role in moulding the modern conglomerate. Guinness, to pursue this example further, has always been celebrated for its advertising and its skill in marketing a ‘branded’ product. It may be that this expertise which can be applied in other areas, rather than detailed knowledge of the properties of stout or porter, is the more valu­able under modern conditions and is to form the foundation for future developments. Knowledge not of a particular product but of how to develop and sell new ones must feature prominently in any attempt to make sense of the widely diversified corporation. An important objective of this chapter will be to discuss why firms rather than markets may be an appro­priate institutional response to the problem of coordinating resources in a world of continual technical change.

3. International Integration

Another form of integration which has developed rapidly in recent years is geographical integration; the combining in a single firm of operations in many different locations and often in different countries. Standard theory is hard pressed to explain this phenomenon. It may, of course, be a simple consequence of vertical integration, if raw material supplies are derived from different countries. The structure of many multinational enterprises, however, cannot be explained in this way, and once again it is to the problem of information that modern analysis has turned, in an attempt to find the forces which encourage the development of this geographically dis­persed type of corporation.

Source: Ricketts Martin (2002), The Economics of Business Enterprise: An Introduction to Economic Organisation and the Theory of the Firm, Edward Elgar Pub; 3rd edition.