The Evolution of Holding Companies and Business Structures

Richard Langlois, author of the book The Corporation and the 20th Century: The History of American Business Enterprise, and Will Bachman discuss the transition from entrepreneur-led businesses to modern multi-unit businesses. Richard talks about the drivers behind this transformation, including antitrust, which led to unintended consequences such as making coordination between firms illegal, and the shift from vertically integrated businesses to modular corporations.  His book highlights the impact of the depression, which eliminated many financial institutions, making it possible for internal capital markets to function and fund innovation. His book also explores the issue of  price controls and government interference with markets also interfered with market mechanisms, making it difficult for smaller businesses to coordinate resources.

From Entrepreneur-led Businesses to Multi-unit Businesses

Richard explains that the rise of large companies and far-flung enterprises in the mid-20th century required conscious management and professional managers who weren't also owners, and that transactions in a market require market supporting institutions, such as financial markets and legal systems, which can be provided in a decentralized way or within the firm. He argues that the success of large, vertically integrated corporations is partly due to the lack of success of alternatives to these structures. Antitrust also plays a role in this transition, as it made it difficult for firms to engage in complex contracts and do things internally. He talks about how the transition from entrepreneur-led businesses to multi-unit businesses was driven by factors such as antitrust, the Great Depression, World War 2, and the New Deal. Richard offers a few examples of antitrust in action with the concept of block booking, where movie studios pre-sell entire blocks of movies to cinemas without allowing them to preview them first to ensure the studios could recoup costs of production.

Another interesting aspect he cites is the leverage theory. Taking us back to the 1930s, he talks about IBM who used control over proprietary punch cards to sell their mechanical computing equipment to maintain quality control and price discrimination, which is charging high prices to those who want the product and low prices to those who don't. He goes on to explain how this became the "one lump of monopoly theory," and what this means.

 The History of Leasing Machines and Government Opposition

Richard defines the concept and history of leasing machines, which began in the early industrial revolution. In Britain, the textile industry was highly vertically disintegrated. Entrepreneurs could rent equipment to get into manufacturing products. This allowed entrepreneurs to lower upfront fixed costs and easily enter the business. However, the federal government's antitrust policy made it difficult for companies to lease their machines and wanted them to sell them. This led to lawsuits against them from the entrepreneurs who, once they knew how to use the manufacturing equipment, decided they wanted to break the lease to rent cheaper equipment from a competitor. 

However, manufacturers enforced long leases and prevented customers from buying cheaper equipment elsewhere, and breaking their original lease. This practice was seen as anti-competitive, as retailers couldn't compete on price, but manufacturers wanted retailers to compete on quality, service, repairs, and service rather than price.

Resale Price Maintenance 

In the early 20th century, companies would charge high prices for complex products like vacuum cleaners and washing machines, which required hard salesmanship and servicing. This discouraged customers from visiting full-service showrooms and purchasing cheap products online. Resale price maintenance is a strategy to prevent resellers from freeriding on services, but the antitrust authorities argued it was anti-competitive because it wasn’t allowing resellers to compete on price.  This was partly intellectual and partly thinking that businesses tend to be anti-competitive, and partly in the interest of consumers. He talks about management consulting and the role of scientific management and how it is all about learning through trial and error, and coming up with new theories.

 Regulating the Corporation and Controversial Opinions

One view on antitrust is that it is driven by what profit opportunities there are in the world and what relative prices are. He believes that part of the reason the large corporation got torn apart into much more specialized corporations was in part that market supporting institutions had come back to life, capital markets were working again, and external capital markets were more effective than internal capital markets and firms. Regulations were impending innovation, and so there were profit opportunities for entrepreneurs who could pressure Congress and the executive branch to try to undo some of the regulations that made it hard for them to innovate.

He states that it is important to be aware of the potential unintended consequences of antitrust. He argues that if antitrust goes against complex contracts as anti-competitive, it could lead to people hiding those contracts within the boundaries of the firm. This idea is controversial, as it suggests that the history of corporations was a story about institutional choice and some institutions being preferred over others.

 Deregulation, Holding Companies, and Pyramidal Business Groups

Richard talks about the common belief that the rise of neoliberalism in the late 1900s led to deregulation, but he argues that most of the deregulation occurred before this, as the market economy transitioned from the Depression and World War Two. He goes on to talk about the concept of holding companies, which were once common in the early 20th century, and how  most industrial organizations today are organized around business groups, with a family or foundation at the top owning controlling shares and subsidiaries, but The US is an outlier in this, due to public policy concerns about allowing one company to own the stock of another.  Richard talks about  private equity in the modern corporate world, wholly owned subsidiaries, and majority and minority stockholders.

 The Modular Corporation

The corporate form of corporations evolved over time and became more akin to the incorporation of modules. These modules are created like personal computers, allowing them to interact and buy shares from other modules without necessarily being integrated with their operations. This modularity was a key factor in the creation of the corporation and it differs from the vertically integrated business model where everything is connected to everything, but this doesn’t scale well. So, as corporations grew, they began to recognize the need for modularity, breaking up operations into smaller pieces that didn't constantly transmit information to each other.  These modules were wholly-owned subsidiaries, for example, Chevrolet was a module of General Motors. During the conglomerate era, people could buy these divisions from one another. This allowed them to operate through the interface of the market and the corporate hierarchy.

 The US Monetary System and the Gold Standard

Richard explores the history of the US monetary system, which was initially tied to gold. This was a conscious decision by business interests, particularly those involved in international trade, to ensure the currency was taken seriously by other countries like Britain. However, the US imposed tariffs to protect manufacturing interests, which were essentially attacks on exporters. Exporters, who were primarily farmers, wanted a weak dollar, while importers and financiers wanted a strong dollar. Keeping the currency low was a common strategy in developing countries. Anchoring to the gold standard kept the currency stable.  The 19th century saw the demand of a mixed standard with silver. This was driven by inflation, as tying money to other items led to more money and a decrease in the value of the dollar. The West, who were exporters, supported free silver, and the East, who were financiers dealing with the British and importers, wanted a strong dollar. The monetary macro was simpler in the days of a fixed metallic standard, which stopped happening after World War One. After World War One, the US was technically on the gold standard, but it was a managed gold standard where people hoarded gold. Most economic historians believe that these manipulations led to the Great Depression, as the Federal Reserve had just been created without knowledge of its actions and allowed the country to fall into a depression.

 Timestamps:

01:22 What drove the transformation into the corporate world

05:17 Transactions in a market require institutions

07:36 Antitrust and anti-trust

05:39 Why did we see the end of the large managerial firm?

09:44 Leverage theory and hedging

15:09 The one lump of monopoly theory

20:37 How to stop free riding

27:12 How important are ideas in anti-trust policy?

32:03 Why did holding companies become illegal?

37:12 Why vertically integrated companies were precluded by deregulation

44:33 Recommended biographies

Links:

http://langlois.uconn.edu/

 The book: https://www.amazon.com/Corporation-Twentieth-Century-American-Enterprise-ebook/dp/B0BRBWG6LX/

Unleashed is produced by Umbrex, which has a mission of connecting independent management consultants with one another, creating opportunities for members to meet, build relationships, and share lessons learned. Learn more at www.umbrex.com.