The company’s entry into the diesel engine field also stemmed from its automobile manufacturing activities:
General Motors Research Laboratories started development work on the two-cycle, light-weight Diesel as early as 1928, two years before either Winton or Electro-Motive was acquired. Our primary objective was to develop a practical Diesel truck engine that would result in important operating economies.126
In 1930 the engine manufacturing activities of the corporation were extended when it acquired a firm that manufactured power plants with engines employing both the Otto and Diesel cycles:
In view of the developments taking place in the general direction of the Diesel type of construction it was thought desirable for the Corporation to deal in a practical way with the problem. Furthermore, it was felt that the Corporation’s engineering and research staffs could contribute to progress in that direction. (Annual Report, 1929).
In 1933 improvements of Diesel engines were made:
For the purpose of aggressively exploiting the possibilities of this new development, the Corporation has recently authorized the building of a Diesel electric locomotive plant, which will make possible complete Diesel electric locomotives engineered and assembled within the Corporation’s activities. (Annual Report, 1934).
The general diversification policy of the General Motors Corporation was summed up in the Annual Report of 1937:
The policy of the Corporation is to maintain as broad a coverage as is practicable in the various fields in which it is engaged, giving consideration, of course, to the market possibilities for such products. The scope of its activities has broadened continually over the years, not so much as the result of a definite policy, but rather from the fact that through the evolution of its primary products in an engineering way there frequently arise opportunities to engage in the manufacture of additional components. This results in expanding the possibilities of profits and at the same time provides a more reliable, more efficient and more aggressive source of supply than is usually available in the outside market. Equally important is the fact that out of the Corporation’s research and engineering activities there frequently arise opportunities for profitable expansion in the manufacture of new technical developments, more or less independent of the Corporation’s scheme of things, but generally allied thereto in technical characteristics. Further, ways and means are frequently evolved whereby the exploitation of already existing products may be accelerated and markets expanded through the application of advanced engineering and research.
The strength of the type of ‘basic position’ developed by General Motors was strikingly demonstrated by the rapidity with which extensive adaptation could be made to the exigencies of war production.
One of the most important long-range policies of General Motors has been concerned with the promotion of technical progress throughout its research, engineering and production activities, which has resulted in steady, evolutionary advancements in the Corporation’s products. Today, the experience thus gained, the adaptability to change and the technique of applying mass production principles have become of inestimable value in dealing with the technical problems presented by the production of intricate machines of war. (Annual Report, 1941).
The principle applies equally to the ‘technical problems presented’ by the adaptations required to maintain and extend a firm’s activities in peacetime.
A very different type of company, much smaller than General Motors, but also illustrating some of the principles of diversification, is General Mills Incorporated. General Mills was founded in 1928 as a consolidation of five milling companies; some other companies were added in 1929 and a research laboratory established. The original products were flour, commercial feeds, and allied grain products. In 1937 these were still the only products mentioned in the company’s annual report. But research activities were stressed from the beginning, both in the chemistry of the basic food products and in the mechanical problems of handling them. And by 1938 the company’s subsequent extensive diversification was foreshadowed in its report to stockholders, which, though not mentioning the restricted possibilities for expansion in flour production, made clear in the language appropriate for public relations that the company believed its future lay in diversification:
Increasingly it is apparent that progress, both for society as a whole and for the individual productive units within it, depends above all on the opening of new frontiers for useful and profitable effort through the development of new products and services. Such development can be accomplished only through ably directed and adequately financed research, in close association with the realities of manufacturing, merchandising and consumer needs. . .
General Mills, Inc., has definitely committed itself to a policy of expanding research activities.. . . Of equal significance is the Mechanical Development department.... The problems of converting the cereal grains into acceptable food products are primarily physical, and the Mechanical Development department has already developed notable and profitable improvements in machinery and methods used by the Company. Here, as in the Research Laboratory, the progress already made is doubly significant because of the promise it holds out for the future.... The Co-mapny is engaged in the experimental development and testing of additional products, in the firm belief that its future progress depends not only on doing the same things better, but on doing new things which will widen the scope of public acceptance of the Company’s products. (11th Annual Report, 1939).
Subsequent reports trace a progressive extension of the company’s product line—numerous nutritional items, vitamin products and vitamin enrichment of old products, dietary food supplements, and non-food uses of agricultural products; in addition, an extensive mechanical department producing food processing machinery was developed. New raw materials became important, such as soya beans, and led to the production of oil and polyamide resins. Once research into food chemistry became significant, the company had prospective opportunities for new products continually ‘under review’, but its major activity remained the processing of cereal grains into flour, package foods, and animal feeds.
Another field of production in which General Mills became engaged is of particular interest because it illustrates the effect of war on the productive services available to firms and also the effect of competition on attempts at diversification. Anything that significantly alters the selling relationships of the individual firm or the character of its productive activities will substantially alter its opportunities for producing new products. The mobilization of industry for war production brought innumerable firms into the production of products for which they had little, and sometimes, no, skill. When the same firms began once more devoting their attention to peacetime production, they found that they had developed extensive productive services suitable for products far removed from their pre-war products, services which would clearly remain unused in the absence of diversification. These included not only knowledge and skills of management, but also plant and equipment and the skilled services of workers, to say nothing of an abnormally large amount of liquid assets. Clearly an increased interest in the possibilities of using such services for appropriate peacetime products was to be expected, and some of the eager postwar search for new products can be thus explained.
The mechanical development department of General Mills was made into a division in 1940 and the division turned over to the production of war materials. The tools and equipment that had been used for engineering research and for the development of packaging and milling machinery were converted to the production of gunnery fire control equipment and instruments and other precision instruments. The company noted that the food production aspects of its wartime production
were natural outgrowths of our customary business, but our present large operation in the manufacture of precision instruments for the United States Navy has taken us far afield. Our interesting but complicated experience with close tolerance production points the way to future opportu
nities in the field of mechanical products. (Annual Report, 1943).
In 1946 with the termination of the war contracts, an electric iron, the first of a new line of home appliances, was put in production by the Mechanical Division. It was later followed by pressure cookers, toasters, food mixers, coffee makers, and other items. Eight years later the new line was abandoned, the home appliance business sold, and the mechanical division returned to its older specialities—the production of various lines of industrial equipment and precision equipment for the Armed Forces.127 The fate of this attempt illustrates one of the restrictions that competition puts on efforts of firms to diversify; competition forces a certain measure of specialization, as we shall see a little later, because it forces firms to continue extensive investment in any new field they enter if they are to remain in it successfully.
The diversification of General Mills is extensive and continuing. At first sight it also seems to encompass a variety of unrelated products ‘ranging from fine foods to electronic machines’.128 Yet if the process of diversification is examined in detail the progressive movement into different products has clearly been based in the firm’s existing areas of specialization, whether they be food or cellulose chemistry, the household markets for cereal products, or mechanical equipment.
Not only did mobilization of industry for war production significantly change the character of the production base of many firms, it also changed selling opportunities through the impetus it gave to the practice of sub-contracting. Connections were made which persisted in other forms after the war production programme was over, and postwar discussions of the possibilities of diversification, especially for small and ‘ailing’ firms, stressed the opportunities that could be found in contracting to produce part of the requirements of larger firms.129
So much for our general discussion of the origin of opportunities for diversification. We have not included two considerations which are often put forward as incentives to, or ‘causes’ of, diversification—the possession by a firm of extensive cash reserves and the existence of favourable opportunities to acquire other going concerns. The first is not specifically an incentive to diversify; it may provide an incentive, or even pressure, to expand but in itself does not affect whether expansion takes place in existing or new products. The second is more complicated and a separate discussion is required. There can be no question that much diversification which would not otherwise have occurred takes place through acquisition; on the other hand, diversification in any given direction will not ‘normally’ occur through acquisition unless the firm has reasons for diversifying in that direction other than the mere possibility of acquiring another firm on favorable terms.
The Role of Acquisition
Acquisition plays such an important part in the diversification activities of firms that many writers purporting to discuss diversification in fact discuss only acquisition.130 Our analysis of the effect of the continual creation of new productive services and knowledge on the productive opportunity of a firm was developed with reference to internal expansion—expansion through acquisition was put off for another chapter. Some of that discussion must be anticipated here, however, for this method of expansion has peculiar advantages as a means of taking up the production of new products.
It is evident that the out-of-pocket costs and the managerial and technical difficulties of entering a new field can be substantially reduced if a firm can acquire another going concern. Plant can often be acquired at considerably less than its reproduction cost, a valuable market position can be obtained which might otherwise have taken years to build up, and immediate pressure from competition may be substantially reduced. Of especial importance is the fact that a firm can also acquire an experienced management ‘team’ and an experienced technical and labour force. Hence acquisition can be used as a means of obtaining the productive services and knowledge that are necessary for a firm to establish itself in a new field, and the addition of new managerial and technical services to the firm’s internal supply of productive services is often far more important than the elimination of competition and the reduction of the costs of entry. For this reason acquisition is often a peculiarly suitable means of becoming acquainted with the techniques and problems of a new field when a firm wants to decide whether expansion in that field is an appropriate use of its own resources. Furthermore, acquisition frequently requires no cash outlay, and for firms whose financial position is not strong and whose managerial and technical services are highly specific to existing products, acquisition may be virtually the only way of diversifying activities.
Nevertheless, in spite of all these advantages, acquisition is by no means a universally available panacea for the ailing firm, nor does it permit indiscriminate and unlimited diversification for the prosperous one; a firm attempting to diversify and grow through acquisition does not entirely escape the limitations either on the rate or on the direction of expansion imposed on it by its existing resources. Even external growth presupposes the existence of certain types of entrepreneurial qualities in the firm, and the successful integration of the acquiring and acquired firms into a single firm in the sense used in this study requires the managerial services of the acquiring firm.
In consequence, there is a limit to the rate of expansion of a firm even if acquisition is the principal method of expansion, for the managerial problems of regulating the relation between the parent firm and its new acquisition cannot be avoided. Consistent general policies must be worked out, financial and accounting procedures co-ordinated, personnel policies and the numerous other problems handled by the ‘staff service’ departments must be integrated.131 When the acquisition takes the firm into new and relatively unfamiliar fields, the problems of integration are less in some directions but are greater in others: more autonomy in its own area may be permitted the new acquisition without risking a conflict with the parent company’s policies and activities; on the other hand, the difficulties of working out an appropriate relationship between the two companies may be intensified.132
This limit on the rate of expansion implies that no firm can acquire every likely firm in sight in any given period of time; it must choose, and since mistakes may be costly and not always reparable, it will choose those enterprises which seem most likely to complement or supplement its existing activities, partly because of the predilections and experience of its management, and partly because such enterprises will tend to seem the more profitable. The expected profitability of a contemplated acquisition depends on the price paid for the new concern compared with its expected contribution to the earnings of the parent. Since acquisition is a purchase in which the price must be agreeable to the seller as well as to the buyer, the acquired firm must be more valuable to the acquiring firm (or combined with it) than it is to itself (or by itself); for only under these conditions will the one be willing to sell and the other be willing to buy at the same price.133 There may be special reasons in individual cases (tax motives, desire of owners to retire, etc.) giving rise to the required difference in valuation, but by far the most overwhelming general reason is that the acquired firm in some way so complements the position of the acquiring firm that a bargain expected to be profitable to both parties can be reached. As we shall see in the next chapter, expansion by acquisition does not necessarily, or perhaps even usually, mean that a firm is entering a field for which it would otherwise have had no qualifications. Acquisition is often a profitable process precisely because the firm has peculiar qualifications in the new field.134
Thus the existing resources of a firm will not only limit the extent to which successful expansion can be effected through acquisition, but will also influence the direction of external expansion. It is not surprising, therefore, that investigations of merger and diversification show only a minority of firms moving into completely unrelated fields; and even then there is often more connection between the various activities of the merging firms than is immediately evident.135 Where diversification involves n
ot only entry into new markets but also the establishment of a new production base, the competitive advantage in the new field can often be traced to the fact that the firm has developed productive services in its existing productive activities which are especially valuable in the new activity. These services may arise from the high development of a particular type of engineering skill, or a particular kind of chemical process, or from an extensive knowledge of some material or waste product that the firm has discovered can be profitably used. Of hundreds of examples of diversification examined in the course of this study only a handful could be found where there appeared to be no technological link whatsoever between the new production base and the old, and this held true even though a large proportion of diversification was effected through the acquisition of other firms.136
The fact that firms are by and large specialized in a relatively few broad areas of activity, even when opportunities to diversify more extensively through acquisition have been open to them, is not entirely explained by the tendency of firms to restrict their attempts to diversify to areas in which they already have some qualifications. After all, there are examples of truly ‘conglomerate’ acquisitions and of firms which have clearly made no effort to establish themselves in any particular field, who have moved from product to product in a rather heterogeneous, free-swinging, and essentially uncoordinated manner. For considerable periods the productive activities of some firms have been scattered and unconnected, there being no discernible ‘sense’ in their selection of products. We have previously noted, but left for later discussion, the fact that extensive and rapid acquisition can create ‘firms’ which in certain stages of their growth have such an anomalous and amorphous organizational structure that it is hard to see in what sense they can be called industrial firms. The process also often results in a similar dispersion of the productive activities of a firm and can create an extremely messy ‘product structure’.
Theory of the Growth of the Firm Page 21