Even when a firm exploits to the fullest possible extent the opportunities for monopolistic gain available to it, the protection afforded, though often extensive, can neither be complete nor absolutely certain. For many, if not most firms, the more effective long-run protection both against direct competition as well as against the indirect competition of new products will lie in the firm’s ability to anticipate, or at least to match, threatening innovations in processes, products, and marketing techniques. In a society characterized by a widespread ‘spirit of enterprise’ and a highly developed technology, the threat of competition from new products, new techniques, new channels of distribution, new ways of influencing consumer demand, is in many ways a more important influence on the conduct of existing producers than any other kind of competition.116 Its primary effect is to force a firm wanting to maintain itself in the market for any given product to learn all it can about the product, its market and, in particular, the relevant technology, and to endeavour to anticipate the innovations of other firms.117
Industrial innovations come, for the most part, from industrial firms, and those firms that introduce them first are likely to have a competitive advantage because they can obtain patent protection or otherwise prevent imitation, or merely because they are first. Of this, firms are very much aware, and if one wants to examine the influence of ‘environmental’ factors on the growth of firms, here is one of the most important to note. We have already indicated that the environment exerts its influence primarily through its effects on entrepreneurial judgments; if a firm believes that the advantages which create its own ‘business opportunity’ are likely to be temporary because new things will inevitably be introduced by other firms, it will respond by an active ‘innovation policy’ of its own.118 Even if the primary purpose is to develop ways of reducing the costs and improving the quality of existing products, the exploration and research involved will certainly speed up the production of new knowledge and the creation of new productive services within the firm.119
There is no reason to assume that the new knowledge and services will be useful only in the production of a firm’s existing products; on the contrary, they may well be useless for that purpose but still provide a foundation which will give the firm an advantage in some entirely new area. A firm’s opportunities are necessarily widened when it develops a specialized knowledge of a technology which is not in itself very specific to any particular kind of product, for example, knowledge of different types of engineering or industrial chemistry.120
Thus whether research be originally undertaken merely because the firm is convinced that profitable new opportunities will come out of it, or because it is considered necessary for survival in a competitive world, it enables at least the large firms to turn aside the process of ‘creative destruction’ and to thrive on the novelty which might otherwise have destroyed them. The spectacular results of industrial research were bound, of course, to stimulate that imitative response which follows any important innovation, and firms of all descriptions have become convinced that a research laboratory is the panacea for their difficulties.
The vision of unlimited opportunity thus invoked is a mere mirage for many.121 New knowledge may be gained, but at great expense, and for the small firm the use of its resources for ‘research’ in general is as likely to be wasteful as it is to be profitable unless the firm has specific and reasonably original ideas upon which it is working. The appraisal of the results of research is extremely difficult and methods of appraisal are still in a primitive state.122 The amount of funds to be devoted to research is often determined on some arbitrary basis (for example, some per cent of sales), for there is as yet no reasonably accurate way of determining in advance how much investment in any particular type of research will turn out to have been justified. Research is essentially speculative activity, frequently adopted under necessity or as a matter of faith.123
The Significance of Selling Efforts
Opportunities for the production of new products arise not only from the productive activities of a firm, including its technological research, but also from its selling activities. This second source of opportunity is important for all kinds of firms, but it is perhaps of greatest importance for firms whose productive processes are either highly specialized with respect to the kind of product for which they are suitable, or are simple and easily imitated and of a kind where research yields little that provides particular firms with any competitive advantage—for example, some types of food processing such as milk production or flour milling, tobacco processing, and some types of textile production.
Whenever a firm adopts policies under which the sale of its products is associated with the advertisement in one way or another of the firm itself, the demand, not only for existing products, but also for other products of the firm is likely to be affected; the productive opportunity of the firm is changed by the demand-creating process itself. It makes a great difference for the prospects of diversification whether competition in a given market forces the cutting of prices (or absorption of transport costs) or requires the exertion of selling efforts. The former is an impersonal market response leaving the identity of the seller of no significance to the buyers. The latter will almost of necessity be connected not only with the product but also with the name or trademarks of the seller, and the identity of the firm emerges as a significant competitive factor. The firm having to create new markets for its products, for example, is virtually always in this position, for it is rarely possible to advertise or otherwise push sales of a product without at the same time advertising the source of supply, if not to the final consumer, certainly to the wholesaler or retailer.124
When a significant part of the market-creating process consists of the personal sales efforts of a firm’s staff, several important changes take place. A relationship is established between the firm and its customers which, other things being equal, places the firm in a preferred position compared to complete newcomers. Frequently this relationship goes much further than a friendly and personal confidence of one man in another and extends to ‘technical’ matters. For example, the selling firm makes special efforts to adjust the quality and characteristics of its products to the customers’ requirements, and the buying firm makes special efforts to inform the seller of its peculiar requirements in order to get the seller’s help in meeting them and in solving its own problems. This tends to give a firm that has succeeded in establishing such relationships an ‘inside track’ with the buyer should it become interested in supplying other products quite different from those it is selling at the time. Consequently after a firm has established such relationships with customer firms it is faced with a different set of productive opportunities. These opportunities may continue to grow as the firm learns more, not only about its markets, but also about the technical potentialities of its own resources.
The other general method of establishing a market is through various forms of advertising in the several popular and technical media of public communication. Just what type of advertising is deemed most effective depends on the product, the type of competition, and the customs of the trade. But again it is often the firm itself that is advertised as well as, and sometimes more than, the product. For non-durable consumer goods where quality is either of little importance or is reasonably evident from untutored inspection, the reputation of the firm makes little real difference, although even here the customer can often be led to choose the products, otherwise equal, of the better-known firm or of the firm producing the better-known products. For goods whose quality is difficult to judge or where service, dependability, and continuity of supply are really part of the ‘utility’ the customer purchases when he buys the product, the reputation of the firm is of great importance whether the customer is a manufacturer, a dealer, or simply the household consumer.
The Importance of a Technological Base
Although the possibilities of successful diversification based on strength in the market are often given
pride of place, it is a mistake to stress them to the neglect of the concomitant development of the technological base of the firm. As will be shown in the section concerned with the significance of competition for diversification, a strong market position without technological competence is as precarious as is strong technological competence but weak selling ability. Furthermore, when a firm’s strength is not closely related to its technological strength, but rests primarily on a dominant position in important markets, it is more difficult for the firm to move into entirely new basic areas of specialization. Not only is such a firm unlikely to develop abilities that would give it a substantial technological advantage in an entirely new field, but it is also handicapped in the acquisition of other firms in fields where technology is substantially different.
In the first place, in the absence of strong legal protection, the mere fact that a firm with no technical superiority can establish a dominant market position is prima facie evidence that the technique of the industry in which it operates is either fairly standardized or fairly simple, and consequently that innovations can be easily matched by other firms. If this were not so, we should expect a technical superiority to have been established by some other firm in the industry which would undermine the market position of the dominant firm. When the technology of a firm is standardized and fairly simple the productive services available within the firm are unlikely to generate many opportunities for expansion into areas where superior or unusual technical capacity is required. In other words, the existing resources of such a firm are not favourable for the development of a specialized technological superiority in the use of raw materials, special skills, or processes in substantially different areas of operation. Similarly, the firm will be less able to acquire other firms with a substantially different technology partly because the management of the firm is unlikely to feel great confidence in its ability to operate in fields entirely alien to its own experience, and partly because it will in general be more difficult for a firm with no special advantage in a new field to acquire firms with the special technical qualifications at a profitable price.125
Many firms in the United States have expanded rapidly, largely through acquisition, in fields where they have had no apparent technological superiority—for example, firms in the dairy industry—and have succeeded in establishing strong market positions on a national scale. Such positions facilitated diversification into complementary markets, which was often effected through the acquisition of other firms with prominent brand names or other selling advantages. As long as the expanding firms remain in their original market areas, their dominant market position may protect them for a considerable period. But the ‘carry-over’ of this position into other areas becomes weaker as they go farther afield, and the necessity of developing a technological as well as a marketing advantage becomes increasingly pressing. Hence one finds firms such as National Dairy, whose chief method of growth was originally the acquisition of local dairy concerns, placing great emphasis on research as they moved into other food products where technological innovation was an important competitive requirement.
Diversification and expansion based primarily on a high degree of competence and technical knowledge in specialized areas of manufacture are characteristic of many of the largest firms in the economy. This type of competence together with the market position it ensures is the strongest and most enduring position a firm can develop. It incidentally, of course, gives considerable scope for the exploitation of opportunities for the monopolistic control of markets and for the use of restrictive monopolistic practices, but extensive and indefinite expansion is by no means dependent on the direct exercise of monopolistic power in any restrictive sense. Diversification through both internal and external expansion is likely to be extensive because of the wide variety of productive services generated within such firms and because the especially powerful competitive advantages they possess are conducive to acquisition. Opportunities for expansion both within existing bases and through the establishment of new bases are likely to be so prevalent that the firm has carefully to choose between many different possibilities of action.
Some Examples
One of the more prominent of the corporations in the United States today is the General Motors Corporation, in 1956 the second largest industrial corporation in the country. It is primarily known as an automobile producer but it also produces a wide variety of other products—durable consumer goods of many kinds, locomotives, and airplane engines, to name a few of the more important types. The history of the company is well known: the original product was automobiles; the basic area of specialization, engineering for mass production. The broad lines of diversification are easily traced and are logically related to the original areas, growing out of them but also growing up and away from them as new production bases were established.
To avoid being tedious, I shall mention here only those diversifying activities of General Motors which are not within the general area of automobile production. One of the earliest of its acquisitions outside the automobile field was the Guardian Frigerator Corporation acquired in 1919. In a sense, the acquisition of this concern by the company was an accident: it had been bought in 1918 with his own funds by W. C. Durant, the founder of General Motors, when it was a moribund and virtually bankrupt firm, and he suggested General Motors take it over. A programme of research and development was launched and the name ‘Frigidaire’ adopted. By 1925 the company said of the product:
This apparatus lends itself both from the standpoint of type of manufacture as well as market possibilities to quantity production. The Corporation believes that through its broad experience in quantity manufacture, its research activities and through its purchasing ability on account of the large volume of its operations, it can more than maintain the dominating position that Frigidaire now enjoys. It is believed further that market possibilities largely parallel those of the motor car. (Annual Report, 1925).
In other words, the company believed that the general type of productive services already existing within the firm provided a basis for the development and extension of the production of refrigerators. In the next few years Frigidaire production was set up in a separate operating division in line with General Motors’ ‘belief, based upon the former experience of the Corporation, that the decentralization of these activities into separate and distinct responsible managements will mean increased effectiveness from every standpoint.’ (Annual Report, 1928). The broad base which led the company to develop the product was competence in engineering for quantity production, but further diversification arose as the new subsidiary went ahead to develop its own products. By 1933 the Frigidaire division was well on the way to further diversification:
As part of its engineering program, Frigidaire has developed a line of air conditioning units covering virtually every field of application; the home, the office, the hotel, the hospital, the railroad car and other industrial fields. (Annual Report, 1934).
During 1936 General Motors further
broadened its position… by adding a line of electric ranges and other household accessories and equipment. The objective was not primarily that of expansion but rather that of protecting, from the commercial standpoint, the already existing lines by the development of a complete General Motors line of electric household utility devices. (Annual Report, 1937).
As early as 1927 diversification had gone so far that the company reported
.. .that the total earnings of the Corporation must not be taken as a measure of its earnings from motor car divisions. Notwithstanding the fact that the Corporation’s motor car operations are equally if not more completely, self-contained than those of competitors, yet the motor car operations contribute only about one-half of the Corporation’s total profits. (Annual Report, 1928).
The next major diversification steps are reported in 1928 when General Motors acquired a 40 per cent interest in the Fokker Aircraft Corporation of America.
General Motors, in forming
this association, felt that, in view of the more or less close relationship in an engineering way between the airplane and the motor car, its operating organization, technical and otherwise, should be placed in a position where it would have an opportunity to contact with the specific problems involved in transportation by air. What the future of the airplane may be no one can positively state at this time. Through this association General Motors will be able to evaluate the development of the industry and determine its future policies with a more definite knowledge of the facts. (Annual Report, 1929).
In 1929 the Allison Aircraft Company was acquired and by 1938 the Allison Division, which manufactured airplane engines, had
attained a position of importance in the development and manufacture of high-powered aviation engines. In view of the substantial increase in orders, the manufacturing facilities of this activity are being materially enlarged by the addition of an entirely new plant. (Annual Report 1939).
The war, of course, hastened the exploitation of this base of operations, and airplane engines and hundreds of minor products related thereto are now a substantial part of the company’s activities.
In the same year that General Motors went into the airplane industry, it entered the radio industry.
General Motors Corporation became interested in the radio industry through a study made in connection with the application of the radio to its motor cars. As a result of this study and recognizing that General Motors already had technical ability, manufacturing capacity and opportunities for distribution, it was deemed advisable to capitalize these advantages and diversify still further the Corporation’s operations by entering this particular field in which a constructive opportunity existed. (Annual Report, 1929).
Theory of the Growth of the Firm Page 20