The Visible Hand: The Managerial Revolution in American Business was written by Alfred Chandler and released in 1977. It’s a great history and study on business and why it exists the way it does today. For some books I read, I transcribe and summarize my highlights/notes in order to better learn the material and for future reference. Below you’ll find my (very long) summary of The Visible Hand. Some passages are direct quotes and others are my own paraphrasing/summaries. So if you’re interested in this sort of topic, send this baby to Instapaper, plop down on the couch, and enjoy.
The Visible Hand
Modern business enterprise is easily defined, having two specific characteristics: (1) it contains many distinct operating units and (2) it is managed by a hierarchy of salaried executives. Each unit has its own administrative office, set of books and accounts. Each could theoretically operate as an independent business enterprise. Such enterprises did not exist in the U.S. in 1840. By World War I this type of firm had become the dominant business institution. It was the institutional response to the rapid pace of technological innovation and increasing consumer demand.
This study is a history, moving chronologically. Before entering the historical experience, here is a list of general propositions to make more precise the primary concerns of the study:
The initial appearance of modern business enterprise:
- Modern multiunit business enterprise replaced small traditional enterprise when administrative coordination permitted greater productivity, lower costs, and higher profits than coordination by marker mechanisms. [This was due to both corporate efficiency and economies of scale.]
- The advantages of internalizing the activities of many business units within a single enterprise could not be realized until a managerial hierarchy had been created. An enterprise without such managers remains little more than a federation of autonomous offices.
- Modern business enterprise appeared for the first time in history when the volume of economic activities reached a level that made administrative coordination more efficient and more profitable than market coordination. It came with new technology and expanding markets.
Growth of the modern business enterprise:
- The hierarchy itself became a source of permanence, power, and continued growth.
- The careers of the salaried managers who directed these hierarchies became increasingly technical and professional. Training became longer and more formalized.
- The management of the enterprise became separated from its ownership. Stockholders didn’t have the influence, knowledge, experience, or commitment to take part in the high command.
- Career managers preferred policies that favored the long-term stability and growth of their enterprises to those that maximized current profits. For salaried managers the continuing existence of their enterprises was essential to their lifetime careers.
- As the large enterprises grew and dominated major sectors of the economy, they altered the basic structure of these sectors and of the economy as a whole.
Traditional Processes of Production and Distribution
In 1790 general merchants still ruled the economy. The family and the family farm remained the basic units. Artisans in small shops carried out some manufacturing. The activities of these units were coordinated through merchants in port and river towns. Merchants were an all-purpose businessman who dominated the economy. Before 1790 specialization was already appearing in the distribution of goods in large cities. The distinction between merchants and shopkeepers was becoming clear. Merchants continued to sell at retail and wholesale, but shopkeepers sold only at retail, buying from the merchants rather than directly from abroad.
Expansion of trade in the early 1800s also caused specialization in finance and transportation. This led to an important institutional development: the growth of incorporated joint-stock companies. Merchants continued in partnership form only until they found it advantageous to pool large sums to improve financial and transportation services by setting up banks, turnpikes, and canals—then they turned to the corporation. Merchants regarded these services primarily as vehicles for furthering their commercial activities (and the flow of goods through the economy). Finance and transportation made it easier for the merchants to specialize in handling one set of products and to carry out tasks from efficiently.
Specialization brought an end to the personal business world of the general merchant of the colonial era and replaced it with the increasingly impersonal world of the commission merchant. It lowered information and transactional costs as well as the costs of financing and transporting the flow of goods through the economy. Modern multiunit business enterprise did not make its appearance before 1840 for technological reasons.
In production, the relative scarcity of labor in the U.S. was a more significant constraint on the size of the enterprise than it was in distribution, simply because more men were usually needed to produce goods than distribute them.
Until the 1840s, the armories and textile mills remained the exception. In all other manufacturing enterprises the volume of production was not enough to bring the subdivision of labor nor the integration of several production processes within a single establishment. The almost simultaneous availability of an abundant new form of energy and revolutionary new means of transportation and communication led to the rise of modern business enterprise in American commerce and industry.
Revolution in Transportation and Communication
Railroads: the first modern business enterprise
The railroads were the first modern business enterprises. They were the first to require a large number of salaried managers, the first to have a central office, the first to build large internal organizational structure with carefully defined lines of responsibility, and they were the first to develop financial and statistical flows to control and evaluate the work of many managers. In all this they were the first because they had to be.
Innovation in tech and organization: The first railroad boom began in the late 1840s and 1850s. Railroads provided more direct communication than did the river, lake, or coastal routes. It was also cheaper to build in rugged terrain and had cheaper maintenance per ton-mile than canals. “Railroads could provide at least three times as much freight service as canals for an equivalent resource cost—and probably more nearly five times as much.” But the size of the organization required equivalently sized administration. The early history of the business enterprises created to operate the telegraph and then the telephone was quite similar to that of the railroads.
The nation’s first railroad boom provided a basic impetus to the rise of the large-scale construction firm and the modern investment banking house. No other business or nonbusiness institution had ever required the coordination and control of so many different types of units carrying out so great a variety of tasks that demanded such close scheduling.
Railroad cooperation and competition
The integration of many different railroad enterprises into a single national transportation system required the managers to cooperate on three different sets of concerns: (1) arranging the physical connection of the many roads; (2) devising uniform operating, accounting, and other organizational procedures; and (3) agreeing on the use of a standardized technology.
Never before had a small number of very large companies competed for the same business. And never before had competitors been saddled with such high fixed costs. In the 1880s fixed costs averaged two-thirds of total cost. This quickly convinced railroad managers that uncontrolled competition for through traffic would be ruinous. From the start, they looked on inter-firm cooperation to control competition. They followed what had been termed a “territorial strategy.” After the depression started in 1873 nearly all managers and investors agreed that informal cooperation was no longer enough.
The answer was better, more formal cooperation. Formal federations were created, and they soon had their own legislative, executive, and judicial bodies. This method appeared to get control of competition, with the exception of disruption by weaker roads and speculators.
No man had a greater impact on the strategy of American railroads than Jay Gould, the most formidable and best known of the late nineteenth-century speculators. Short-lived as his empire was, it had a lasting impact on American railroad history. His rapid purchases, moves into territorial domains of other lines, delight in breaking rate or freight allocation agreements, all forced the major roads to embark on a strategy of system-building.
System-building proved costly to individual roads and to some extend the entire economy as well. The growth of the individual enterprises led to a redundancy of facilities, and in the 1890s more mileage was in bankruptcy than in any decade before or since. Many redundancies were only temporary.
The large roads that were to operate the network throughout the 20th century took their modern form in the 1880s. Salaried career executives played a critical role. The managers, far more than the speculators and investors, defined strategic plans and directed tactical maneuvers. Successful managers used the speculators to obtain the support of reluctant investors to spend the funds needed for system-building. Thus, it was the managers and financiers who built the systems and collaborated in devising the structures to manage them.
It was in the years immediately after 1892 that the investment bankers came to play their most influential role in American railroading. To tighten control, bankers and managers of the leading systems developed what they described as “community of interests” between roads in the same areas (one system would buy stock in neighboring ones and vice versa—win win!).
J. P. Morgan, trained in the Vanderbilt school, carefully picked experienced, tested career managers as presidents of the roads he reorganized. He gave them almost complete autonomy in operating matters, while having the board retain a close oversight of financial affairs including capital allocation strategy. On the financial side they lowered fixed charges by converting bonds into preferred stock. No other enterprise required such large sums of outside capital.
Completing the infrastructure
Every businessman who produced or distributed goods in volume had to work closely with railroad managers. In carrying out their own businesses they daily observed the operations of the railroads. No enterprises were more intimately related to railroads than other transporters and communication companies.
Steamship lines had the least impact on the development of modern business. Mass transit in American cities was another form of transportation where managerial enterprise dominated. The first substitute to the horse-drawn streetcar was the cable car, initially put into operating in San Francisco in 1873. But cable cars were expensive to install and run. The electric streetcar system was cheaper than and almost as flexible to operate as the horse-drawn version. By 1890, 15% of urban transit lines in the U.S. were already using electric-powered streetcars and by 1902 94% were.
A communication revolution accompanied the revolution in transportation, with the telegraph marching alongside railroads in unison. At its inception the invention had strong government sponsorship. In 1845 the Post Office took over telegraph operation, but because of the difficulties of public financing and management, they turned it over to private development. By 1852, 23,000 miles were in operation. Telephone communication also was soon dominated by a single national enterprise in the American Bell Company.
Revolution in Distribution and Production
Modern mass production and distribution depend on the speed, volume, and regularity in movement of goods and messages made possible by transportation and communication. In distribution the railroad and telegraph were primarily responsible for the coming of the modern mass marketer.
The buying/selling organizations of mass marketers coordinated the flow of crops and finished goods from a great number of individual producers to an even larger number of individual consumers. This transformation reduced the number of transactions involved in the flow of goods, increased speed and regularity, and so lowered costs and improved productivity of the overall distribution system.
The transformation began with the marketing of farm crops. Commodity dealers soon replaced the traditional merchant in the American crop trade. The new firms bought directly from the farmer, took title to shipments, and arranged for their transportation and delivery to the processors.
Wholesalers were the first to use modern multiunit enterprise to mass market goods. Tech change affected the wholesaler in three ways: (1) the merchant handling consumer goods became a jobber. He no longer sold on commission, taking title to the goods. By the 1870s nearly all wholesalers had become jobbers. (2) The jobbers moved west, breaking the monopoly of east coast middle-men. And (3) jobbers created large buying networks and marketing organizations to sell to general stores in rural areas. No longer did storekeepers need to make regular treks—the jobbers came to them.
Wholesaler dominance peaked in the early 1880s. Total numbers continued to grow, but they lost market share to mass retailers. Department stores were the first of the mass retailers in the ‘60s and ‘70s catering to the growing urban market. Mail-order houses appeared in the late ‘70s to serve the rural markers but didn’t reach full flower until the end of the century. They were the clearest case of taking advantage of new technology to communicate with and distribute goods to their customers. Chains that moved into smaller cities, towns and suburbs began to expand only after 1900. They first appeared in sectors that existing mass retailers were not yet strongly established (grocery, drug, furniture). Velocity of inventory turnover permitted mass retailers to take lower margins and to sell at lower prices and still make higher profits than small specialized urban retailers and wholesalers.
In manufacturing the railroad and the telegraph gave rise to mass production by encouraging the concentration within a single establishment of all or nearly all the processes involved in making of a product. But the revolution in production came slower than in distribution. The realization of this potential required the invention of new machinery and processes. So the basic difference lies in technology.
Mass production industries can be defined as those in which technological and organizational innovation created a high rate of throughput and therefore permitted a small working force to produce a massive output. As in modern distribution and transportation, economies resulted more from speed than from size. Mass production differed from existing factory production in that machinery and equipment did more merely replace manual operation. They made possible a much greater output at each stage in the overall process of production.
Innovations in mechanical manufacturing were of two types: (1) the adoption of continuous-process machines that turned out products automatically; or (2) the building of factories or plants in which materials flowed continuously from and through one stage to the next (“comparable” machines). Both involved a number of different inventions.
Modern factory management was first fully worked out in the metal industries. In metal-making, it came in response to the need to integrate within a single works several major processes of production previously carried on in different locations. Andrew Carnegie’s steel operations were some of the first to pioneer efficient steel making processes.
When the prolonged economic depression of the 1870s brought a continuing drop in demand, manufacturers began to turn their attention from technology to organization. This included managerial problems, production methods, and cost accounting methods. In 1895 Frederick Taylor delivered his first paper on what he soon termed “scientific management.” Taylor would apply both the stick and the carrot. He soon became the nation’s best known expert on factory management. It was the production of the automobile in the 20th century that the new organizational changes and processes were most fully applied.
Integration of Mass Production with Mass Distribution
The modern industrial enterprise resulted from the integration of the processes of mass production and mass distribution within a single firm. These businesses united the types of distributing organization created by the mass marketers with the types of factory organization developed to manage the new processes of mass production.
The coming of the modern industrial corporation
Integration offered an opportunity for manufacturers to lower costs and increase productivity through more effective administration and coordination. The most dramatic examples came in those industries adopting continuous-process machinery during the decade of the 1880s. Such machinery was invested almost simultaneously for making cigarettes, matches, flour, breakfast cereals, soup, and other canned products. Firms utilizing this method (ex. Heinz, Campbell Soup, Quaker Oats, Proctor & Gamble soap, Kodak film) were eventually producing huge volumes and found the need to market their products themselves.
Their processes of production were so capital-intensive (the ratio of workers to the quantity of units produced was so small) that production became concentrated in just a few plants. The national network of sales offices took over from the wholesaler the functions of branding and advertising. Although capital-intensive, new machinery was not expensive, nor were patents a problem. The makers of continuous-process machinery were eager to sell their products to all takers. Nor was branding or advertising a barrier to entry. The most imposing barrier in these industries was the organization the pioneers built to market and distribute their newly mass-produced products. [Production and marketing economies of scale, plus consumer habit.]
The other manufacturers to bypass the wholesalers were the makers of recently invented machines that were produced in volume by assembling interchangeable parts. Sewing machines, agriculture equipment, office machinery, elevators, printing presses were sold primarily to produce goods and not for the end customer. They were complex, large, standardized machines that required specialized installation as well as sales, repair and long-term credit. Again, they required their own distribution and marketing to accomplish this.
The companies that integrated in the late 19th century were among the world’s first multinationals. Other companies quickly caught on, again mostly centered in the food and machinery industries: Wrigley, Coca-Cola, National Cash Register, Ingersoll Rand. For other companies, M&A was the name of the game.
Integration by way of merger
While some integrated vertically, others did so by merging through horizontal combination, which aimed at maintaining profits by controlling the price and output rather than cost efficiencies. In the U.S., this rarely proved to be a viable long-term strategy. These enterprises all grew by a similar path: (1) started as trade associations that managed cartels; (2) consolidated legally into a single enterprise in the form of a trust (tuning stock over to a board of trustees, receiving trust certificates of equivalent value) or holding company; (3) following legal consolidation with administrative consolidation; and finally (4) integrating forward into marketing and backward into control of raw materials. Some charted this course with deliberation. A greater number move from step to step in response to immediate business problems. Until the passage of the Sherman Act in 1890, horizontal combination did not violate federal law.
Successful pre-1890 examples include the Standard Oil Trust, the American Cotton Oil Trust, and the National Lead Trust. Trusts (and later holding companies) in whiskey, sugar, wallpaper, starch and cattle proved less successful [moats didn’t materialize, or were more labor intensive]. After 1890, mergers came in two waves. The first, driven by the legal attack on combinations, was from 1890 to the start of the depression in 1893. The second and much larger surge began when the depression ended in 1898 until the end of 1902.
This surge reflected both good economic conditions and the Supreme Court’s interpretation of the Sherman Act. In a suit the government brought against the American Sugar Refining Co. in 1895, the court’s decision appeared to sanction the legality of the holding company. After 1899 lawyers were advising their clients to abandon all agreements or alliances carried out through cartels or trusts and to consolidate into single, legally defined enterprises.
By the second decade of the 20th century, the shakedown period following the merger movement was over. The successful mergers were established and the unsuccessful ones had failed. Which company or industry succeeded reveals important generalizations about growth. One is that the nature of the market was more important than the methods of production in determining the size and defining the activities of the modern industrial corporation. A second is that, although integration led to more concentration, it rarely resulted in monopoly.
Markets and technology were the primary determinants of size and concentration in industries—as opposed to the quality of entrepreneurship, availability of capital, or public policy. The most brilliant industrialists or ruthless robber barons were unable to create giant multinational corporations in the furniture, apparel, leather, or textile industries. Yet in other industries, the first to try often succeeded. Once these men had completed their integrated organizations, opportunities for empire building became limited. New enterprises were rarely built. Such an opportunity came again only with changes in technology and major shifts in markets.
Management and Growth of Modern Industrial Enterprise
Many of the above functions were first worked out in entrepreneurial organizations where one person or family controlled everything. But as these companies grew, neither the entrepreneurs nor their close associates could carry on the multitude of activities involved in producing, marketing, and purchasing goods for global markers. And because they owned and personally managed the empire, they felt little need to recruit top management. Because of this dichotomy, these enterprises ended up pioneering the functions of middle management.
The operations of integrated companies required the hiring of dozens and in time hundreds of lower and middle managers. These managers had to pioneer in the ways of modern administrative coordination. They did more than devise ways to coordinate the high-volume flow from suppliers of raw materials to consumers. They invented and perfected ways to expand markets and to speed up the processes of production and distribution. They created new and faster channels of distribution, and devised new types of accounting and statistical controls.
But coordination of the flow of materials through the enterprise was not optimal. Evaluation and review of departmental performance was rarely systematic. One reason for this weakness was that owners still managed. The entrepreneurs continued to look on their enterprises as small-business owners previously had.
The contribution to top management grew out of the early industry-wide mergers. In the new consolidations a family or single group of associates rarely held all the voting stock. It was scattered among the owners of the constituent companies and the financiers and promoters who had assisted in the merger. The process of merger brought more people, with more varied backgrounds, into top management.
The owners no longer administered the enterprise. The experienced manufacturers, who helped carry the merger and who rationalized the facilities of a new consolidation, became the core of its top management. Although they were still large stockholders, they rarely controlled the company as did the owners of entrepreneurial firms. In carrying out the reorganization, these top managers began to define their specific tasks, instituting uniform procedures and controls.
The methods developed and perfected by these early mergers were widely adopted because they permitted their managers to perform effectively the two basic functions of modern business enterprise: (1) the coordination and monitoring of production and distribution; and (2) the allocation of resources for future production and distribution. Nevertheless, in 1917 modern industrial enterprise still had structural weaknesses, and the managerial class was only beginning to become professionalized.
The maturing of modern business enterprise
In the years after World War I the managers of these large industrials devised and perfected a new form of overall organizational structure to remedy these weaknesses. A businessman of today (1977) would find himself at home in the business world of 1910, but the business world of 1840 would be a strange and arcane place. So, too, the businessman of 1840 would find the environment in 15th century Italy more familiar than that of his own country 70 years later. The history of post-World War I business becomes an extension of the story already told here.
The techniques of industrial management were best perfected by top management at General Electric, Du Pont, and General Motors. These techniques spread rapidly between the two wars. During the 1920s, new accounting, budgeting, and forecasting methods were becoming normal operating procedures. Central to the professionalization of management in the new multiunit business enterprises were modern business schools. Their appearance marked an educational development that at the time was unique to the U.S. More evidence of professionalism was the appearance of the management consultant. Before WWI, there were engineering consultants like Taylor, but later purely managerial consultants began to dominate.
The instruments of professionalism—societies, journals, university training, and specialized consultants—hardly existed in the U.S. in 1900. By the 1920s they were all flourishing. Even then, they were uniquely American and didn’t start appearing in any strength abroad until after World War II. The fundamental changes in the organization of American business enterprise and of the economy came before World War I; and they came as a response to profound market and technological changes that began in the middle of the 19th century.
Why did the institution appear so quickly and in such profusion in the United States? An obvious reason was the size and nature of its domestic market. In the second part of the 19th century the American domestic market was the largest and fastest growing market in the world. It was also more homogeneous. Income distribution appears to have been less skewed than in other nations. Markets were less defined by class lines than they were in Europe. The newness of the American market also meant that business enterprises were new and arrangements had not had the time to become routinized and rigid. Legally, the Sherman Act and its interpretation by the courts provided a powerful pressure that did not exist elsewhere to force family firms to consolidate their operations into a single, centrally operated enterprise administered by salaried managers.