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of economies is found. It is often difficult to distinguish the economies of combination from those of large scale production. It is difficult to define the boundary between productive economies and acquisitive economies. Nevertheless, these distinctions in the broad are clear and significant. They must be borne in mind in the following discussion of specific economies of big business.
(1) Control of Raw Materials. In lines of production where the cost of raw materials is a crucial factor in determining profit or loss, it is an advantage for large units to control sources of raw material. This advantage is best obtained through vertical combination, or business integration. The International Harvester Company has plants not only for the manufacture of farm implements but also for the mining of its own coal and its own iron ore. The United States Steel Corporation owns mines, mills, railroads, and ships. Sugar companies have sometimes bought up sugar plantations. The integrated industry frees itself somewhat from price fluctuations in raw materials, eliminates many of the costs of selling, and saves at least part of the profit which would otherwise be paid to related lines of business.
(2) Use of Automatic Machinery. By organizing for quantity output, a concern may be able to substitute automatic machinery for expensive labor. Standardization of processes, routine methods, mass output, lend themselves to large scale operation.
(3) Substituting Capital for Labor. Trades which require a heavy labor cost in proportion to capital are difficult to operate on a large scale. In order to expand the size of business units, it is necessary to minimize the labor factor in industry. Great aggregates of labor cannot be given the personal attention requisite to efficiency. Where capital can be made the main factor in production, large scale enterprise is likely to be effective.
(4) Continuous Use of Expensive Machinery. Expensive machinery may pay only when it can be operated continuously. A small enterprise is often unable to avail itself of the economies of such machinery, because of the large scale upon which the correlative processes of production would have to be organized. The large plant does not operate under this limitation. Big business thus permits the more profitable use of expensive machinery.
(5) Business Control of Labor. Since labor is organized in large units, business may find it necessary to organize on a like scale in order to maintain a balance of power. The warfare on unionism has at times been a strong incentive to business combination. The power of the large business to cope with labor unions is often a most attractive advantage.
(6) Exploitation of By-products. Meat packing, gas manufacture, petroleum industries, may be cited as illustrations of the ability of large business combinations to profit from the utilization of by-products. Large scale production permits the full time use of the equipment necessary for the manufacture of by-products. Waste is prevented, and economical output of the by-product is achieved.
(7) Purchasing. Big business can often obtain discounts on the
. materials bought by making contracts for huge quantities. Quantity buying is often cheap buying. Moreover, in some lines, the expert purchasing agent is able to survey the whole range of the market, locality by locality, and to make important savings by buying where prices are lowest. This advantage is commonly cited as being one of the main sources of profit to chain stores, department stores, and mail order houses.
(8) Selling. When a number of concerns in the same line of business compete with each other, each maintains a sales department and keeps salesmen on the road. The time and effort of each sales unit is directed toward keeping trade away from its rivals. A combination of units in the same line of business is called horizontal combination. Horizontal expansion eliminates the duplication of salesmen and sales effort.
(9) Advertising. Competing units spend much money in advertising in order to attract trade away from their rivals. After horizontal combination, competitive advertising is superseded by centralized advertising to boost the total sales of the whole business.
(10) Financing. Big business can often take better advantage of trade discounts for cash payment than can small business. Big business can secure capital more cheaply by virtue of the fact that it has a wider market for its security issues. Banks will underwrite their security issues and give them financial backing. The public will pay a higher price for the securities of a big nationally known concern than for those of a small, obscure one. Often, the directors of industrial corporations interlock with those of banks. Such alliances establish firm financial backing for big business.
(11) Freights. In an earlier period, trusts counted as one of their greatest advantages the rebates which they could secure from railroads. That discrimination has been eliminated. A combination can save crossfreights by filling each order at the plant nearest to the buyer. It can occasionally save by taking advantage of lowered rates on carload lot shipments. But an offset to these mild gains is found in the fact that the more an industry concentrates in a given area, the greater the distances from factory to consumer, and the greater the amount of transportation necessary for the conduct of business.
(12) Insurance. A concern having a large number of plants well scattered may take advantage of the law of averages by setting aside a moderate reserve to provide for self-insurance on its properties. The larger chain store systems and steel manufacturers exemplify the possibilities of this principle.
(13) Experts. Although the large concern cannot utilize the type of personal attention and interest that the proprietor of the small concern gives to his business, nevertheless it substitutes therefor the services of specialists and highly trained experts. The corps of expert engineers, accountants, lawyers, sales managers, purchasing agents, and other specialists insure the highest types of ability in the management of the business.
(14) Diversified Markets. Combination may be necessary to enable an industry to survey the international market and to take account of the sectional differences in buying power at home. The broader the market, the more diversified the purchasing power upon which the business relies, and the more steady its volume of sales.
(15) General Use of Patents. When numerous independent plants consolidate, the patents and secret processes of each become the common property of all. This enables all concerns in the consolidation to use the most efficient processes of the whole group thus made available.
(16) Laboratory Research. The large corporations commonly employ high paid scientists in expensive laboratories to carry on research. The overhead of laboratory expense is too great for the small concern. Progress in many lines of industrial research has been traceable to the support given by large corporations.
(17) Control of Customers. Large concerns can often force customers to accept more favorable terms of sale. Customers can be forced to pay cash without the concession of drastic cash discounts. Moreover, pressure can be brought to bear more fearlessly to make creditors pay up. The large corporation can often place middlemen in a subservient position, and require exclusive contracts, and other specially favorable treatment.
(18) Price Control. The desire to control prices by controlling supply doubtless has been a dominant motive in a great many business consolidations. If business combinations had always been forced to rely solely upon the economies of production as a source of gain, many of them would never have survived. Their ability to succeed and endure has with surprising frequency not been their superior efficiency, but their superior ability to sustain prices above the point that would have prevailed under free competition.19 The element of monopoly which inheres in much of business combination leads to arbitrary price increases. This is not necessarily the general practice, but there is strong indication that it is not by any means infrequent.
The Part Played by Promoters.—The expected advantages of combination would probably never have made the strong appeal to the minds of business men which was necessary to launch the great combination movement had it not been for the fact that certain interested parties, promoters, took it upon themselves to “sell” the combination idea to the bankers, the investing public, the boards of directors, the owners, and all parties concerned. It has been repeatedly stated by economic students that business combinations owe their existence in every case to the constructive imagination and irresistible initiative of some one man, or some very small group of men. Business combinations
19 An interesting attempt to substantiate this observation is contained in Eliot Jones, The Trust Problem in the United States, Chapters 19-20.
do not come into being without creative effort on the part of somebody, and in the business world there are certain individuals who specialize in the promotion of corporate combinations. Often they are professional promoters whose special life work is conceiving and executing first one business venture and then another. The promoter may be a man of successful manufacturing experience, or an engineer, or a railroad executive. He may be actively engaged in a part of the business which he hopes to make a part of the prospective combination, or he may be a total outsider. Whatever his origin, he performs certain vital and indispensable functions. His mind originates and grasps the idea of the possibilities of the new business organization. The promoter is an inventor of a new business plan, of a new corporation project. The promoter has the love of creative, original achievement. He has unbounded originality, a power of vision, a prophetic judgment of the future, and a delight in setting out upon new and momentous adventures. Were it not for this type of personality, many of the most significant combinations would never be born.
But this is only the first stage of the promoter's task. He must collate a mass of statistical data, of financial evidence, of technical facts about production and marketing, and must fully acquaint himself with the basic policies of the branch of industry in which the combination is projected. From these facts, the promoter is able to explain convincingly the economies and advantages that will accrue from the new combination. It is necessary, also, to interest bankers in the project, and to evolve a financial plan for the capitalization of the company, and for the sale of security issues. The bankers undertake the execution of the financial part of the venture, usually through the formation of a syndicate of bankers to underwrite the stock issues of the new corporation. The syndicate of bankers thus accepts the responsibility of marketing the securities of the undertaking. The promoter has to persuade the owners and controlling powers in the separate companies to sell their properties, and this step is attempted through the securing of options giving the promoting interests the right to buy the properties at stated prices within stated periods of time. The promoter must have available satisfactory estimates of the probable earnings of the new company, and must be able to point out how and why these will almost surely exceed the combined earnings of the separate independent companies. To the owners of companies which have been suffering already from cut-throat competition, the opportunity to sell and to save their fortunes is most welcome. In other cases, intensive urging and much persuasive power has been necessary, and even coercion must at times be resorted to.
In order to carry through these difficult achievements, the promoter must be a person who commands the confidence of the people whom he is trying to combine. The promoter's task is “one that requires the very highest intelligence, and, as a rule, neutral parties—parties not interested, men of the intelligence and reputations to inspire unlimited confidence on the part of manufacturers, are needed to bring manufacturers together." 20 The promoter performs a specialized function of the utmost importance, because any number of the most effective business combinations could not come about merely as a result of the natural forces of economic life, or of the menace of sharp competition. Some one has to take the initiative in overcoming the jealousies of men who have been desperate rivals for years; some one has to allay the skepticism which springs up at the suggestion of a new adventure, and to lift men out of the inertia and lethargy which exists everywhere. For this service to the economic community, the promoter exacts a profit, commonly in the form of a bonus of the common stock. His work is extremely precarious, and he is as likely to fail as to succeed. In the successful promotions, the promoter usually charges all that the traffic will bear, and secures an appropriation of common stock which is generous to say the least.21
Successes and Failures in Combination. It is difficult to measure with exactness the extent to which the combinations formed under these conditions have realized the economies and advantages which were claimed for them. In so far as they aimed at the suppression of competition, they of course put an end to competition between the companies which came into the consolidations. However, they often found themselves face to face with a new competition in which the competing units were bigger. Even at the time of formation, it appears that the majority of the combinations controlled less than 50 per cent of the production in their respective lines of industry. It was comparatively rare for a combination to control more than 75 per cent of the product. The hopes of optimistic promoters and the dreams of corporation executives for a domination of the market and a control of a given branch of industry were scarcely ever fully realized. Many of the combinations which started out with the largest measure of control have experienced a marked shrinkage thereof in recent years. For instance, during its first years, the output of the American Sugar Refining Company was from 80 to 90 per cent of the sugar refined in the United States, but by 1921 its percentage of the total output had fallen to about 24 per cent. And the United States Steel Corporation, from making 50.1 per cent of the nation's iron and steel products in 1901, declined to 45.7 per cent in 1911. And yet, although competition was not suppressed by the large combinations, the more dangerous and destructive phases of competition were brought under restraint in large measure; and in the new era, large combinations were decidedly better able to protect themselves from the worst features of cut-throat competition. The inefficiencies of many oversized consolidations, the anti-trust decisions of state and federal courts, and the governmental prohibitions of unfair competitive methods have been causes behind the failure of so many combinations to realize in full their original hopes for the suppression of competition.
20 Meade, Corporation Finance, Testimony of Mr. Flint, p. 39.
21 Ibid., pp. 21, 38, 39. See, also, Dewing's Corporate Promotions and Reorganizations, Chapter XX.