[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.]
Accelerating change
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.
