The Network Law Review is pleased to present you with a Dynamic Competition Initiative (“DCI”) symposium. Co-sponsored by UC Berkeley, EUI, and Vrije Universiteit Amsterdam’s ALTI, the DCI seeks to develop and advance innovation-based dynamic competition theories, tools, and policy processes adapted to the nature and pace of innovation in the 21st century. The symposium features guest speakers and panelists from DCI’s first annual conference held in April 2023. This contribution is signed by Richard N. Langlois, Professor of Economics at the University of Connecticut.
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This session is about ecosystems and managers. One can interpret that in many ways. I want to interpret it in a way that is not perhaps what the organizers had in mind: I want to argue that ecosystems and managers are substitutes for one another. All too often, we tend to think of dynamic competition solely in terms of technological innovation. But as Schumpeter emphasized, the invention of organizational forms, and the substitution of one organizational form for another, are also importantly part of the innovation process. This has significant implications for antitrust policy. Institutional innovation takes place in response not only to changes in relative scarcities and transaction costs but also in response to public policy. Antitrust can be a spur to institutional innovation when it impels entrepreneurs to “invent around” legal impediments to effective transacting. The result can be – and, I argue, has long been – unintended consequences and the distortion of organizational choices.
The corporate form is itself ultimately a system of economic institutions, an alternative in many ways to similar institutions in the larger sphere of market activity. When external events, including the actions of government, hamper or destroy market exchange along the supply chain, internal organization offers a substitute – though perhaps a second-best substitute. It is this process of institutional substitution, far more than the inherent superiority of internal organization as a system of large-scale planning, that explains much of the rise to prominence of the large multi-unit American corporation in the middle of the twentieth century (Langlois 2023). Yet antitrust policy has failed to take into account the institutional character of the competitive economy, and as a result has failed – and arguably continues to fail – to understand the institutional response of enterprise to government policy.
We have understood at least since Coase (1937) that the choice between markets and firms depends on which organizational form tends to minimize the sum of production costs and transaction costs (Williamson 1985). Both exogenous events and government policy can affect that calculus. The middle years of the twentieth century – years of devastating depression and total war – were destructive of markets and market-supporting institutions. The Great Depression obliterated financial networks and eliminated many other nodes of market transaction. World War II elevated non-market modes of resources allocation over market modes. In this catastrophic environment, the corporation became a safe haven, with its own internal stores of cash and an ability to act as an internal capital market.
To be sure, external forces and government policy are by no means the only drivers of vertical integration and disintegration. When products and processes are changing radically, especially in a systemic way, firms tend to pull activities in-house so that they can better understand, adjust, and create the production process (Langlois 1992). Like all auto manufacturers in the early twentieth century, for example, Ford Motor Company began as an assembler of parts made by others. But as the company began developing the process of mass production in earnest, it famously integrated vertically into the manufacture of virtually all the parts of the Model-T, first at its Highland Park Plant and then at a giant complex on the River Rouge. With the production process in flux – and with much of it still to be invented – Ford found it costly to work with outside suppliers, both because of the difficulty of specifying what was needed and because Ford had itself developed capabilities superior to what existed among outside suppliers.
Yet Ford was something of an outlier in the early American auto industry for its level of vertical integration. As mass-production techniques diffused to other manufacturers, there emerged geographically coherent ecosystems in which the large assemblers worked with a network of suppliers. As many authors have argued, it was the fluid and decentralized character of these ecosystems that drove considerable technological innovation (Helper, MacDuffie and Sabel 2000; Schwartz 2000). A close look at the ecosystems in automobiles and other industries reveals that the institutional landscape encompasses far more than the alternatives of markets and firms narrowly understood. As George Richardson argued, much of economic activity is in fact coordinated “by means of agreements, of one kind or another, between independent firms” (Richardson 1960, p. 84). Although Coase originally analyzed the market-firm boundary, many later economists inspired by Coase have analyzed the complex (and often superficially puzzling) contracts we observe between the extremes of market and firm, contracts that in essence constitute the ecosystem.
But contracting, especially complex contracting, depends on the existence of legal institutions. Courts can facilitate or discourage effective transacting by the way they enforce contracts. Other government policies can also facilitate – or impede – complex contracting. It is a great irony, for example, that despite its general hostility to the large corporation during most of the twentieth century, antitrust policy often, and perhaps mostly, worked unintentionally to favor internal corporate modes of governance over more decentralized market modes of governance.
The Sherman Antitrust Act of 1891 made it illegal for small independent firms to collude. At the same time, the relatively unrestricted corporate charter emerged as a kind of modular institutional container in which transactions could take place unobserved. As the twentieth century dawned, small firms in many industries merged at astonishing speed to form large holding companies, which seemed to offer a legally safe alternative to cartels. But holding companies engendered widespread suspicion and even fear, especially because holding companies were permitted to own the stock of other companies, sometimes creating multilevel pyramids of control. The courts began ruling that whenever corporate entities were made up of holding companies that could conceivably have competed with one another, those entities were guilty of restraint of trade. On this basis enterprises like Standard Oil, American Tobacco, and Du Pont were broken up. American business learned that the modular form of the holding company had morphed from a safe haven to a source of danger. The solution was to create unified, centrally administered – effectively non-modular – organizations that would not be so easy to break up. The large multi-unit enterprise of the twentieth century was born.
But central planning of a complex production process works no better within an organization than it does within an economy. American firms needed to establish a new way to modularize themselves in emulation of the market. They did this by setting up largely independent product-oriented divisions, creating what came to be called the multidivisional or M-form structure. For example, during some periods General Motors’s car brands – Chevrolet, Buick, Pontiac, Oldsmobile, Cadillac – were each produced within their own separate divisions. In the face of the intense antitrust regime that emerged after the war, however, GM and other large companies began to fear that modularity would once again provide the antitrust authorities with clean break points for dismemberment. Like other firms, GM scrambled its M-form in response, creating the General Motors Assembly Division, which would come to preside over all the company’s increasingly dysfunctional manufacturing plants. The incentive to scramble corporate structure was reinforced by the strong industry-wide unionism that had emerged from the Depression, as firms deskilled their once-innovative suppliers and pulled activities in-house to better control labor relations. It is arguable that these corporate responses contributed materially to the failings of the industry at the end of the century in the face of Japanese competition. As many authors have also argued, Japanese firms succeeded in the late twentieth century in major part precisely because they emulated the ecosystem structure that American firms had pioneered earlier in the century but then abandoned.
The crucial lesson is that business is transacted not merely in “the firm” and “the market” but by means of a skein of complex contracts and organizational structures that are often imperfect substitutes for one another. Contrary to its portrayal in formal theory, “the market” itself is not merely about price-mediated spot transactions between anonymous buyers and sellers but is most often a system of complex and often puzzling contractual arrangements. Economists have come to see many if not most of these contractual arrangements as designed to solve vexing problems of uncertainty, incentives, and transaction costs. In the popular mind, and all-too-often in the halls of the antitrust authorities, the same arrangements are often dismissed as “unfair” or “anticompetitive” practices. What is frequently forgotten is that forbidding such practices will often induce firms to relocate the targeted transactions behind the corporate veil, thus evacuating the institutional space between the corporation and the anonymous market. Since the beginning of the twentieth century, policies aimed at fostering decentralized competition have frequently had the unintended consequence of bolstering the large multi-unit enterprise.
Richard N. Langlois
References:
- Coase, Ronald H. 1937. “The Nature of the Firm,” Economica (N.S.) 4: 386-405.
- Helper, Susan, John Paul MacDuffie and Charles Sabel. 2000. “Pragmatic Collaborations: Advancing Knowledge While Controlling Opportunism,” Industrial and Corporate Change 9(3): 443-488.
- Langlois, Richard N. 1992. “Transaction Cost Economics in Real Time,” Industrial and Corporate Change 1(1): 99-127.
- Langlois, Richard N. 2023. The Corporation and the Twentieth Century: The History of American Business Enterprise. Princeton: Princeton University Press.
- Richardson, G. B. 1960. Information and Investment: A Study in the Working of the Competitive Economy. Oxford: Oxford University Press.
- Schwartz, Michael. 2000. “Markets, Networks, and the Rise of Chrysler in Old Detroit, 1920-1940,” Enterprise & Society 1(1): 63-99.
- Williamson, Oliver E. 1985. The Economic Institutions of Capitalism. New York: The Free Press.
| Citation: Richard N. Langlois, “Ecosystems and Managers”, Network Law Review, Summer 2023. |
