[I watched American capitalism going through one more of its transformations as I sat in Stanford; this is how it looked then. This column was published in Business Standard of 31 July 2000.]
It is conventional wisdom in the United States that economic change has accelerated throughout the 20th century. Igor Ansoff’s books best reflect this. A hundred years ago, consumer demand was for basic commodities. Consumers were price-sensitive. Price mattered, and businesses succeeded by bringing down costs. Labour was still important, and the way to bring costs down was by making people work hard and keeping wages down. Change was slow, so annual balance sheets and profit-and-loss accounts were good enough to base business planning on. Work methods changed little, so they could be written up in systems manuals. The typical management structure was a hierarchical one, in which a higher administration concentrated decision-making and information and controlled the productive organization.
Then, after World War I, the markets for basic goods became saturated. Instead came cars, refrigerators and cooking ranges. With consumer durables came product differentiation and branding. Marketing gained in importance. With the rise in differentiated competition, future became more uncertain. It was not enough to look at accounts of the past; the past had to be extrapolated. That was how strategic planning emerged. Management structures became more functional; it became customary to distinguish production, procurement, marketing, accounting, personnel R&D and other functions. Basically, the higher reaches of management became more specialized and differentiated. This was the time when big companies emerged, supported by the emergence of the New York and Chicago capital markets.
World War II not only accelerated the growth of the economy, but generated so many innovations that were exploited in the next 25 years. New materials emerged, the relative costs of different materials changed. It was not enough to look ahead; it became necessary to control the future by innovating. Markets began to become multinational. US firms went first to Europe, then to Latin America, and then to East Asia. Production in many locations became the norm. Strategic planning encompassed new functions like location planning and innovation planning. With a rise in the number of locations within the same company, the trend was towards decentralized management. The businesses came to be divided into profit centers. Companies developed internal capital markets, drawing capital from less profitable and older parts and investing it in newer and more profitable businesses. The managements of the big companies became portfolio managers for the shareholders, so to speak.
After the oil crisis, there was a radical change in the financial markets. Starting with the oil producers, big investors arose who were not industrialists; mediating their savings, big banks and financial houses became important. The newly available debt capital led to leveraged buyouts of many companies; board-managed companies with broad shareholdings were taken over by financial entrepreneurs, who sold or closed down less profitable businesses. They made companies issue junk bonds and buy their own equity with the money raised in order to throw out outside shareholders. That was the era of restructuring and reengineering.
In the 1990s, there has been a financial revolution of quite another kind. On the one hand, the supply of risk capital has increased manifold, and to handle it, a new type of intermediary, the venture capitalist, has emerged. The venture capitalist does not finance a business. He finances an idea, an innovation. He spreads his risks by investing in a large number of ideas. He sets short-term profit targets for each; he takes a sufficient share of the equity to replace the entrepreneur if the latter does not deliver on profit targets. The majority of start-up entrepreneurs are routinely replaced. Once an idea is successful, the venture capitalist pours more money into it.
The big difference is that earlier, it was the companies that took the initiative, and the investors had to take their pick. Now the venture capitalist – with his financiers – does the picking. And he is not a long-term investor; he pays by the job, so to speak. This form of financing does not suit big companies at all. And the venture capitalists’ bets were so successful – thanks largely to the rapid rise of information technology – that they sucked away finance.
Hitherto there has been little interaction between this new capital and the old industrial capital. New capital is located in the west – venture capitalists living on Sand Hill Road, where I live, control 70 per cent of the venture capital in the US – while old capital is on the east coast. New capital invests in start-ups; old capital continues to manage old businesses. New capital goes about in slacks and T-shirts, old capital in grey suits.
Not that the old companies have not tried. They have tried to quicken their responses. That meant revamping their accounting and information systems; that is why Indian software companies have been so heavily involved in working for Fortune 500 companies. Most companies have set up web portals. Some have started selling on the web as well. But however hard they tried, they could not make themselves attractive to venture capitalists.
That will start to change soon. The first portent is the crash of the technology stocks in March. It has drastically brought down investors’ growth expectations about the start-ups, and reduced the capital flowing to the latter. Venture capitalists have become far more cautiou
At the same time, old companies are asking themselves how they can participate in the gold rush of information technology. For there is no doubt that web-based marketing is capable of cutting down distribution costs enormously – making big stores and warehouses unnecessary, improving consumer choice, cutting down the time spent by consumers in shopping. That is a threat to distributors, but not to producers. The old-style producers can make the same profits as the new start-ups, if only they can duplicate the processes of the latter which are very different from the traditional ones. Some companies are beginning to see their way to doing this.