SCALE AND SCOPE- The Modern Industrial Enterprise
CHAPTER 1
In an earlier study, The Visible Hand, I investigated the coming of managerial capitalism by examining the
evolution of several types of modem business enterprises in a single country, the United States. Here I
examine the beginnings and growth of managerial capitalism globally, focusing on the history of its basic
institution, the modem industrial enterprise, in the world’s three leading industrial nation. Of all the new
forms of managerial enterprise, the modem industrial enterprise played the most fundamental role in the
transformation of Western economies. They had been rural, agrarian, and commercial; they became
industrial and urban. That transformation, in tum, brought the most rapid economic growth in the history
of mankind. The industrial sector grew significantly in the United States and Germany; in Great Britain the
development was slower, but sustained. And again, growth in manufacturing was more notable in the
United States and Germany than in Great Britain. By the twentieth century manufacturing accounted for
the largest share of the gross domestic product in the industrial sector in all three economies. Again,
whereas Great Britain experienced only a moderate change of employment structure after the 1880s, the
United States, and Germany to a lesser degree, showed a dramatic transformation from an agrarian to a
modem economy in which almost half of the employment centred in industry. Finally, within the
manufacturing subdivision the branches that showed the greatest growth in the United States from 1880 to
1948 were those capital intensive
industries in which large manufacturing firms predominated. As a result of the regularity, increased volume,
and greater speed of the flows of goods and materials made possible by the new transportation and
communication systems, new and improved processes of production developed that for the first time in
history enjoyed substantial economies of scale and scope. Large manufacturing works applying the new
technologies could produce at lower unit costs than could the smaller works. In order to benefit from the
cost advantages of these new, high-volume technologies of production, entrepreneurs had to make three
sets of interrelated investments. The first was an investment in production facilities large enough to exploit
a technology’s potential economies of scale or scope. The second was an investment in a national and
international marketing and distributing network, so that the volume of sales might keep pace with the
new volume of production. Finally, to benefit fully from these two kinds of investment the entrepreneurs
also had to invest in management: they had to recruit and train managers not only to administer the
enlarged facilities and increased personnel in both production and distribution, but also to monitor and
coordinate those two basic functional activities and to plan and allocate resources for future production
and distribution. It was this three-pronged investment in production, distribution, and management that
brought the modern industrial enterprise into being. The first entrepreneurs to create such enterprises
acquired powerful. Competitive advantages. Their industries quickly became oligopolistic, that is,
dominated by a small number of first movers. Functionally. They did so by improving their product, their
processes of production, their marketing, their strategically purchasing, and their labor relations, and by
moving into growing markets more rapidly, and out of declining ones more quickly and effectively, than did
their competitors. Salaried managers, not owners, came to make the decisions about cur rent
operating activities and long-term growth and investment. Their decisions determined the ability of their
enterprises, and of the industries in which they operated, to compete and grow. If a firm became a major
player, the decisions of its senior managers shaped the ways in which it continued to respond to changing
technological innovation, to market demand, to the availability of sup plies, and to the more encompassing
depressions and global wars. Because in each of the new industries there were only a small number of
major players, the responses of their managers often determined the ways in which entire industries and
even national economies responded to the changing market, technological, economic, and political
environment.
CHAPTER 2
The New Institution
the modem business enterprise (of which the modern industrial enterprise is a subspecies) as having two
basic characteristics: it contains a number of distinct operating units, and it is managed by a hierarchy of
full-time salaried executives. The modern industrial enterprise is the particular subspecies that carries out
modem production processes. It has more than a production function, however. It is also a “governance
structure. In such an enterprise each unit-a factory, a sales or purchasing office, or a research laboratory-
has its own administrative office, its own managers and staff, its own set of books, as well as its own
resources (physical facilities and personnel) to carry out a specific function involved in the production
or distribution of a specific product in a specific geographical area. Each unit-each factory, sales office,
purchasing office, research laboratory-could theoretically act as an independent business enterprise. In the
modern multiunit enterprise, the activities of the managers of these units (lower-level managers) are
monitored and coordinated by middle-level managers. The latter, in turn, are monitored
and coordinated by a full-time top-level executive, or a team of such executives, who plan and allocate
resources for the operating units and the enterprise as a whole. The decisions of these top managers
normally have to be ratified by a board of directors, legally defined as representatives of the owners. Such
boards of directors nearly always include both top managers (the inside directors) and part-time
representatives of the owners (the outside directors). Thus the institution under consideration, the modern
industrial firm, can be defined as a collection of operating units, each with its own specific facilities and
personnel, whose combined resources and activities are coordinated, monitored,
and allocated by a hierarchy of middle and top managers. As the definition of the institution suggests, its
size, its managerial team or hierarchy, and the nature of the resources it controls are directly related to the
number of its operating units; in fact, it is the number of these units, rather than total assets or the size of
the work force, that determines the number of middle and top managers, the nature of their tasks, and the
complexity of the institution they manage. It then becomes critical to explain how and why the institution
grew by adding new units-units that carried out different economic functions, operated in different
geographical regions, and handled different lines of products. An initial explanation is that manufacturing
enterprises became multifunctional, multiregional, and multiproduct because the addition of new units
pennitted them to maintain a long-term rate of return on investment by reducing overall costs of
production and distribution, by providing products that satisfied existing demands, and by transferring
facilities and skills to more profitable markets when returns were reduced by competition, changing
technology, or altered market demand. There were, of course, other reasons: to ensure access to markets
and supplies. prevent competitors from obtaining such access, to obtain control over competitors, to
eliminate competition in other ways, or merely to reinvest retained earnings. In more recent years’
financial reasons have played a role: to improve the firm’s overall tax position, to alter the price of its
securities, to carry out other financial manipulations, or merely to extend its portfolio of investments.
Furthermore, managers have added units in order to acquire greater control over the work force, or simply
to gain personal status and power. Whatever the initial motivation for its investment in new operating
units, the modern industrial enterprise has rarely continued to grow or maintain its com over an extended
period of time petitive position unless the addition of new units (and to a lesser extent the elimination of
old ones) has actually permitted its managerial hierarchy to reduce costs, to improve functional efficiency
in marketing and purchasing as well as production, to improve existing products and processes and to
develop new ones, and to allocate resources to meet the challenges and opportunities of ever-changing
technologies and markets. It was the development of new technologies and the opening of new markets,
which resulted in economies of scale and of scope and in reduced transaction costs, that made the large
multiunit industrial enterprise come when it did, where it did, and in the way it did. These technological
and market changes explain why the institution appeared and continued to cluster in certain industries
and not in others, why it came into being by integrating units of volume production with those of volume
distribution, and finally, why this multifunctional enterprise continued to grow (though not in all cases) by
becoming multinational and multiproduct.
Historical Attributes
The ability of the modern industrial enterprise to exploit fully the economies of scale, scope, and
transaction costs was the dynamic that produced its three most significant historical attributes. First, such
enterprises clustered from the start in industries having similar characteristics. Second, they appeared quite
suddenly in the last quarter of the nineteenth century. Finally, all were born and then continued to grow in
much the same manner. In 1973, 289 (72.0%) of the 401 companies were clustered in food, chemicals,
petroleum, primary metals, and the three machinery groups-nonelectrical and electrical machinery and
transportation equipment. Cigarettes in tobacco; tires in rubber; newsprint in paper; plate and flat glass in
stone, clay, and glass; cans and razor blades in fabricated metals; and mass-produced cameras in
instruments. Only 21 companies (5.2%) were in the remaining two digit categories-textiles, apparel,
lumber, furniture, leather, printing and publishing, and miscellaneous. For example, in the United States
throughout the twentieth century the great enterprises produced both consumer and industrial goods.
Britain had proportionately larger firms in consumer goods than did the United States, while the biggest
industrials in Germany concentrated much more on producer’s goods. Even as late as 1973, close to one-
third-sixteen of the fifty-firms in Great Britain employing more than 20,000 persons were engaged in the
production and distribution of food and tobacco products, whereas Germany, and also France and Japan,
each had only one firm in the same two categories. On the other hand, before World War II Germany had
had many more firms than Britain in chemicals and heavy machinery.
Economies of Scale and Scope in Production
The major innovations made in the processes of production during the last quarter of the nineteenth
century created many new industries and transformed many old industries. These processes differed from
earlier ones in their potential for exploiting the unprecedented cost advantages of the economies of scale
and scope. In the older, labour-intensive industries, increases in the output of a manufacturing
establishment came primarily by adding more machines and more workers to operate them. In newer
industries, expanded output came by a drastic change in capital-labor ratios. It came by improving and
rearranging inputs; by using new or greatly improved machinery, furnaces. The first set of industries
remained labour-intensive. In industries such as apparel, textiles made from natural fibers, lumber,
furniture, printing and publishing- in which the large modern firm remained relatively rare-improvements in
equipment and plant design did bring economies of scale, but they were not extensive. A sharp reduction
of unit costs did not accompany an increase in the volume of materials processed by the plant. In these
industries the large mills, factories, or works often had observable, but not striking, cost advantages over
the smaller ones. In the second set, the more capital-intensive industries, new processes of production
were invented or existing ones vastly improved in the late nineteenth
century-processes for the refining and distilling of sugar, petroleum, animal and vegetable oil, whiskey and
other liquids; for the refining and smelting of iron, steel, copper, and aluminium; for the mechanical
processing and packaging of grain, tobacco, and other agricultural products; for the manufacturing of
complex light, standardized machinery through the fabrication and assembly of interchangeable parts; and
for the production of technologically advanced industrial machinery and chemicals by a series of
interrelated mechanical and chemical processes. In these capital-intensive industries, investment in new
facilities greatly increased the ratio of capital to labor involved in producing a unit of output. Production
units achieved much greater economies of scale that is, the cost per unit dropped more quickly as the
volume of materials being processed increased. had an impressive cost advantage over smaller plants that
did not reach that scale. The economies of joint production, or scope, also brought significant cost
reduction. Here the cost advantage came from making a number of products in the same production unit
from much the same raw and semi-finished materials and by the same intermediate processes. The
increase in the number of products made simultaneously in the same factory reduced the unit costs of each
individual product. These potential cost advantages, however, could not be fully realized unless a constant
flow of materials through the plant or factory was maintained to assure effective capacity utilization. In the
capital-intensive industries the throughput needed to maintain minimum efficient scale requires careful
coordination not only of the flow through the processes of production but also of the flow of inputs from
suppliers and the flow of outputs to intermediaries and final users. Such coordination did not, and indeed
could not, happen automatically. It demanded the constant attention of a managerial team or hierarchy.
The potential economies of scale and scope, as measured by rated capacity, are the physical characteristics
of the production facilities. The actual economies of scale or of scope, as determined by throughput, are
organizational. Such economies depend on knowledge, skill, experience, and teamwork-on the organized
human capabilities essential to exploit the potential of technological processes.
John D. Rockefeller’s Standard Oil Company already had a monopoly Standard Oil Trust was formed to
provide a legal instrument to rationalize the industry and exploit economies of scale more fully. The trust
provided the essential legal means to create a central or corporate office that could do two things. First, it
could reorganize the processes of production by shutting down some refineries, reshaping others, and
building new ones. Second, it could coordinate the flow of materials, not only through the several
refineries, but from the oil fields to the refineries and from the refineries to the consumers. Even as
Standard Oil was investing in its large refineries to exploit the economies of scale, the German dye makers
were making still larger investments to permit them to exploit fully the economies of scope. The enlarged
plants produced literally hundreds of dyes, as well as many pharmaceuticals, from the same raw materials
and the same set of intermediate chemical. A new dye or pharmaceutical added little to the production
cost of these items, and the additions permitted a reduction in the unit cost of the others. On the other
hand, the development of new dyes and pharmaceuticals was not only costly, but each new product
