Theory of the Growth of the Firm
Page 33
I shall not here be concerned with the traditional problems of competition and monopoly as they relate to the price and output decisions of firms; rather I want to examine some aspects of the significance for the economy as a whole of the development of opportunities for the growth of small firms, and of the competitive relationships among large firms. In the light of this examination, I shall analyse the relation between the growth of firms of different sizes and the process of industrial concentration. We shall begin with the restrictions on the ability of small firms to fill the ‘interstices’—to take advantage of the opportunities for profitable investment left open by the larger firms.
Barriers to Entry
Existing firms, though themselves unwilling or unable at particular times to take advantage of opportunities that would yield a respectable return over cost at current prices and interest rates, are often in a position to prevent others from doing so. They may desire to keep others out, either to protect some existing position of their own, or merely to reserve the opportunities for themselves at some later time when it may become more profitable to take advantage of them. The power to keep others out may rest on legal (or illegal) control over the relevant technology, raw materials, or even essential producers’ goods, on the ability to threaten ‘price wars’, or on various types of relationships with distributors. This kind of restriction on entry I shall term ‘artificial’, to contrast it with the difficulties of entry arising from large-scale capital requirements, from the usual cost and market disadvantages of small firms, from the fact that consumers have developed a strong attachment for certain brands, from the superior performance of existing occupants, and similar conditions. The reason for the distinction will become clear when we consider the effects of such restrictions on the interstices in a growing economy.
General Effect on Investment in the Economy as a Whole
If some firms, unable to take advantage of specific opportunities for expansion, succeed in preventing others from doing so, the obvious and immediate effect is either to reduce the effective opportunities for investment in the economy as a whole or to reduce the productivity of investment actually made. The restricting firms may be expanding as much as they can, but the restricted firms are either expanding less than they might, or expanding in less profitable directions. If the power to restrict entry is largely in the hands of the larger firms, the smaller firms are the ones most severely affected. If such power is great and widespread, it may seriously retard the growth of the economy.225
Consider the extreme case. In any given state of technology, the rate of growth of all firms taken together, and therefore of the economy as a whole is, in the last analysis, limited by the availability of resources for expansion. But if the opportunities for profitable investment are artificially restricted, it is conceivable that the amount of investment actually attempted will fall short of using the resources available.
Let us maintain our assumption that the large firms in the economy are not restricted in their investment opportunities by the availability or cost of capital but only by the nature of their internal resources, including the quality and amount of the managerial services available to them. To simplify matters, let us further assume that the availability in the economy as a whole of real resources for investment is reflected in the total supply of funds for investment. It follows that the funds available at current interest rates will exceed the amount the large firms will absorb. If at the same time, the large firms are in a position to restrict severely the opportunities for investment of all other groups of firms, even a sharp fall in the rate of interest will not do much to stimulate investment, and the rate of growth of the economy will not only be lower than it would otherwise have been, but unemployment and even prolonged stagnation could be expected. I do not suggest that this is either an explanation of ‘secular stagnation’ or an important cause of depressions; I put it forward to bring out the type of underlying general effect that severe restrictions on entry may have. To produce such serious effects, restrictions on entry would have to be extraordinarily widespread. Although monopolistic restrictions on new competition do play some role in some of the theories of the business cycle, they are rarely given pride of place, other factors usually being considered more important in the explanation of the periods of depressed activity in an economy.
Nevertheless, even if artificial restrictions on entry are not extensive enough to produce really flagrant results or to prevent the full utilization of the resources available for investment, they tend, if thoroughly effective, to reduce the productivity of investment in the economy as a whole, and the rate at which output in the economy grows may be less than it might have been. If individual firms take the trouble to enforce measures designed to restrict the entry of new competitors into a specific field of activity, it can be presumed not only that entry would be profitable but also that further expansion in the field would be an efficient use of resources from the point of view of the economy as a whole. Barred access means, then, that resources which could have been more profitably employed must be diverted to the next best alternatives, which presumably represent less desirable ways of using the economy’s resources. In other words, the productivity of investment is lower than it would have been, even if capital formation does not fall below that required to use fully the resources available for investment.
If the restrictions on entry are primarily enforced by large firms against small firms, then of course the ‘interstices’ in the economy which provide the opportunities for the expansion of small firms are significantly reduced, and the industrial domination of existing large firms will not in time be diluted from below. If the restrictions are enforced by each large firm not only against small firms but also against all other large firms, then output in each of the protected areas may be lower than otherwise, but this may have a relatively insignificant effect on the economy when the competitive struggle between the large firms takes the form of innovations designed to get round the restrictions. Restrictions against the entry of small firms may effectively keep them out of extensive areas of production; those against large firms are more likely only to prevent the production of identical products or the use of identical technology, for both of which substitutes may quickly be developed. Thus they will not be completely effective.
The Importance of ‘Big Business’ Competition
Great and widespread admiration, which is indeed justified, for the technological achievements of ‘big business’ appears to be responsible for a distinct tendency in many quarters not only to play down the notion that restrictions on newcomers’ competition are deleterious to the economy, but even to insist that they are, within limits, desirable as a means of permitting the large firms to attain the kind of market position necessary to induce them to engage in extensive and expensive research, larger-scale capital investment, and longrange programmes of industrial development.226 ‘Big Business’ competition, though different from the classical competition among small firms, is held to be even more beneficial to the economy and more effective in meeting consumers’ wants. The competition between the large firms involves large amounts of investment and undoubtedly results in an increasing quantity and variety of goods and services which become cheaper and cheaper under the pressure of competition.
Those who see in this kind of competition the chief sources of the enormous progress in real income in the more advanced capitalist countries urge, and quite correctly, that the large firms could not afford the competitive innovating race if small firms were immediately able to take the fruits of their research, copy their innovation, and put products on the market at prices which did not reflect the costs of developing them. It follows that the control of output, the control of markets, and the control of price must remain in the hands of those who bear between them the ‘development cost’ required for constantly increasing output and continually improving products. How then are we to evaluate the restrictions against the competition of small firms, restrictions
which, at best, may be an important factor maintaining the profit margins of the large firms that make possible the results achieved, and, at worst, have nothing but a thoroughly insignificant effect on the performance of the economy?
It should be noted that the results so widely deemed beneficial flow from competition, from competition among the few to be sure, but competition so effective and intense that no large firm can afford to act the role of a contented monopolist greedily exploiting the economy.227 Should the numbers of large firms become so reduced that competition between them were significantly impaired, a new ‘case’ for big business would have to be made.228 How many firms are sufficient for the purpose is perhaps a question to be settled in the light of experience, but it seems clear that if there is only one firm (or perhaps even two or three when they arrange to stay out of each other’s way) effectively dominating each major line of activity, the process of competition in innovation will be substantially diluted. Thus in an economy whose market is not large enough to sustain extensive and vigorous oligopolistic competition, the effect of barriers against the rise of smaller firms may be serious indeed, and the lack of interstices for the smaller firms may greatly retard the economy’s growth.
With the possible exception of patent protection of limited scope for a reasonably short period, the economist can fairly safely insist that economic advance is impaired by artificial barriers against the rise of new competitors wherever such barriers are enforced on behalf of a few firms that are not in competition with each other; here the incentive to innovate and the pressure of competition, which are the chief sources of the advantages alleged to flow from the power of the large firms to protect and stabilize their markets, are absent. The problem becomes more complicated when we turn to an evaluation of the effect of barriers to entry against new competitors when competition among the large firms is very active. It remains true that the opportunities for smaller firms are restricted and the prospects of the dilution of the dominant positions of the large firms reduced. But what is the importance of this result?
There are two approaches to this question. One is essentially political and revolves round the desirable nature of a vigorous and free society, the political significance of a concentrated structure of economic power, and the social significance of the absence of widespread economic opportunities for the ‘independent’ man. I do not intend to discuss this aspect of the matter here. The other approach, perhaps more relevant for economic analysis, relates to the effect on output in the economy, and here enters the significance of the difference between the kinds of barrier I have called ‘artificial’ and other barriers to the entry of small firms into those areas of production only partly occupied by large firms. Of these latter barriers, two are widely considered to be of primary significance—the capital requirements for large-scale operations, and the difficulty of breaking through an extensive attachment of consumers to well known brands.229 Both of these are more effective barriers against smaller and little-known firms than against other large and well-known firms.
Capital Requirements and Consumer Loyalty
In some types of activity there are important economies in production or distribution to be obtained from producing on a large scale, and new firms, to produce efficiently, must be able to undertake extensive initial capital investment. This will bar many firms from taking up that type of production so long as the existing large producers put their products on the market at prices which prevent smaller-scale high-cost producers from making profits and which do not encourage other large firms with adequate capital to enter. As demand grows, existing firms must be able to expand output sufficiently to keep prices below these levels, or new firms will come in. The position of existing producers is thus protected only to a limited extent, and they must be willing and able to maintain both quality and output at a level sufficient to leave no profit openings for newcomers. Profits will, of course, be higher than they could have been if the outlays required of newcomers were lower, but as the market grows, the economies of large-scale operation will not alone be sufficient to relieve the firm of extensive pressure to maintain its position against competitors.
The fact that existing large firms are often able to establish relationships with distributors or to capture the preferences of consumers for their own brands will also limit entry of new firms, since any attack on such positions may be very expensive indeed and it may take a very long time to break down long-established preferences. Nevertheless, even this kind of entrenched position is protected only so long as the protected firm’s performance is acceptable to the public. The willingness of consumers to pay a premium for ‘favourite’ brands, or even more, to put up with poor quality or poor service, sets limits to the protection given to the competitive position of firms who have succeeded in establishing market positions of this kind. Such protection against potential competitors may well permit somewhat higher profits in spite of the extensive expenditures required to establish and maintain the protection, and such profits, together with the resultant ‘stability’ of the firm’s market position, may be necessary for the encouragement of large-scale innovation and research, but again, any decline in the performance of the large firms from the point of view of the consumer will weaken their position.
The essential point is the difference between barriers to entry that are weakened by a firm’s inability to maintain an ‘adequate’ level of performance and those that can be maintained regardless of performance. So long as the protected firms are in active competition, and so long as their profits are used to improve old products and introduce new products and technology, one cannot assert categorically that either type of barrier against new competition necessarily reduces total output. Nor can one assert categorically that output is necessarily greater because of ‘big business’ competition than it would be with a different type of competitive organization. This is the crux of the argument between those who insist on the advantages of ‘creative’ big-business and those who emphasize the restrictiveness of strong monopoly power. The composition of output is undoubtedly different from what it would have been; the output of some products is lower and prices higher than they might have been, but other products are produced that might not have even been ‘created’ under different circumstances. There is no easy way of resolving this issue on economic grounds alone, especially if we take account of the ‘irrational’ satisfactions of consumers. An unweighted list of sins and virtues, with the attackers listing innumerable examples of exploitation and clear-cut abuse of power, and the defenders listing innumerable examples of creativeness and public spirit, helps but little; a weighted list might be relevant, but we do not know what weights to use.
Artificial Barriers and the Interstices
Nevertheless, if we accept the ‘case’ for big-business competition as put forth by its proponents, we must note that it rests entirely on the assumption that competitive pressures are intense. Therefore, any barriers to competition that protect a firm regardless of its competitive performance are presumably to be condemned by both sides.
It will be recalled that the significance of barriers to entry derives in part from the fact that there is a limit on the rate of growth of the large firms as a result of which they are unable to take advantage of all opportunities for investment in the economy and thus leave openings for the small firms. The opportunities left open are determined by the rate of growth that the large firms can maintain in relation to the rate of growth of the economy as a whole. If the growth of large firms must eventually level off, as we have argued, the opportunities for the smaller firms may increase, but only if there are few artificial barriers to their entry, that is to say, barriers which do not depend on the performance of the large firms.
The decline that we have analyzed in the rate of growth of the large firm occurs precisely because a continued expansion of operations at the same rate becomes inconsistent with the maintenance of standards of performance imposed on the firm by competitive conditions. Whe
n the larger firms in an economy reach the size where this restriction on their rate of expansion becomes significant, it then becomes important for the growth of the economy that these firms are not in a position to prevent smaller firms from taking up those investment opportunities that they themselves cannot take up. Even patent protection may be undesirable if the large firms as a group have developed, and in fact control, a significant proportion of the patentable technology of the economy.230 It is highly probable that patents are less effective against other large firms, who often can develop alternative technology, than against small firms who in general cannot; and if an attack is made on artificial barriers to the entry of smaller firms, patents must receive their share of attention, for if small firms are not permitted to take advantage of the leftover opportunities, the rate of growth of the economy will suffer.231 From the point of view of the growth of firms, the most significant attribute of monopoly power is the power to restrict the entry of new competitors, and especially smaller ones, into promising areas of production.
Merger in a Growing Economy
There can be little question that historically merger and acquisition have been one of the most powerful forces offsetting the tendency of an expanding economy to produce widening opportunities for smaller firms.232 The maximum rate of growth of firms is, as we have seen, immeasurably increased when acquisition is a possible method of expansion, and firms have not been slow to take advantage of this method. It is generally agreed that much of the dominant position of the large firms in the United States economy today can still be traced to the ‘waves’ of merger at the end of the last century;233 the very early rise to dominance of one or two firms in so many industries in Australia, still relatively young as an industrial economy, can undoubtedly be traced to merger;234 and in Canada merger has been important ‘in many of the industries in which concentration is high’.235