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Chandler’s Model of Integrated Managerial Enterprise Essay


Introduction

In the 18th century, most of the US companies operated as small enterprises that were directly operated by the owners. However, this trend changed after increased industrialization led to introduction of new technologies for production and transportation (Rodriguez 2009, pp. 284-298).

Additionally, the demand for goods and services increased as businesses discovered new overseas markets. As a result, large multinational companies emerged whose operations were mainly controlled by managers (Jeffs 2008, p. 89). Neoclassical economists attribute the rise and organization of large firms to the ability of entrepreneurs to respond effectively to the dictates of the invisible hand of the competitive market.

By contrast, Chandler and his school of thought attribute the rise and organization of large firms to the managerial revolution, which replaced the invisible hand of the market (Fruin 2009, pp. 261-271). This paper will shed light on the extent to which Chandler’s model of integrated managerial enterprise explain the organization of large companies in major economies. It will also analyze the model’s ability to explain the competitiveness of nations.

Integrated Managerial Enterprise Model

Managerial enterprise refers to “large industrial/ business concerns in which operating and investment decisions are made by a hierarchy of salaried managers who report to a board of directors” (Rodriguez, Eisenhardt & McKenna 2002, pp. 20-26). The organizational structure of the modern business enterprise has various operating units with their own offices, managers, and systems of accountability.

According to Chandler, modern businesses adopt a centralized managerial hierarchy because the decentralized market system is not effective as companies expand (Rodriguez, Eisenhardt & McKenna 2002, pp. 20-26). Large companies believe that the centralized managerial hierarchy will improve their competitiveness by facilitating economies of scale and scope, as well as, generation of new knowledge.

The gains outlined in the foregoing paragraph could only be realized after technological advancements led to development of railroads and telegraphs, as well as, utilization of coal (Fruin 2009, pp. 261-271). These technologies led to increased production. Thus, management hierarchies (visible hand) had to be established to supervise and to coordinate production processes (Rodriguez, Eisenhardt & McKenna 2002, pp. 20-26).

Extent to Which the Model Explain the Organization of Large Companies

The Managerial Hierarchies

Virtually all large companies in advanced economies have adopted an organizational structure with different levels of management and business units. The functional organizational structure can be identified in nearly every company.

All large companies in advanced economies have departments, which are responsible for specific functions such as marketing, production, and human resource management (Ingham 2009, pp. 1-12). The heads of these departments often report to a higher level of management. For instance, they can report to the chief operations officer (COO) or the chief executive officer (CEO).

Given the increase in competition, large companies that produce several products that are often unrelated have opted to adopt a multidivisional organizational structure. In this case, the company is organized into divisions that are responsible for serving specific markets (Caves 1980, pp. 64-92).

Each division has several departments whose heads report to a single coordinating officer. The coordinator is responsible for appraising the performance of the division and developing long-term growth plans for the division (Fruin 2009, pp. 261-271). The head of each division reports to the CEO of the company.

The multidivisional structure enables large companies to improve the brand equity of each of their products and to achieve economies of scale (Ingham 2009, pp. 1-12). Companies that have adopted the multidivisional organizational structure include Disney, AIG, and General Motors.

The holding company organizational structure is also common among large multinational companies. This organizational structure is used by companies to invest in unrelated businesses in various parts of the world.

For instance, the AP Moller Group has four companies that are engaged in different businesses such as shipping, mining, oil distribution, and managing port facilities. The holding company organizational structure enables large companies to diversify their revenue streams by investing in different industries (Freeman 2010, p. 134).

Although the hierarchical management system has been adopted by all large companies, its application varies from region to region. The managerial form of a business enterprise envisioned by Chandler has not emerged in many Asian economies such as Japan, India, New Zealand, and China.

In China, most large companies are still owned and controlled by the founding families (Mesure 2007, pp. 219-220). Most Chinese large companies are controlled by the head of the founding family who uses his networks and relations to manage the business.

Thus, the governance structure of Chinese firms, especially, at the top is unstructured. In some cases, the activities of large companies are supervised by loose and flexible groups who advise the owner (Mesure 2007, pp. 219-220). This organizational system suggests that large Chinese companies are still using the traditional structure.

Personal Capitalism

The success of Chinese companies suggests that Chandler’s analysis of British firms is biased. He argues that British companies were reluctant to establish effective management systems to undertake functions such as mass production and mass marketing (Fruin 2009, pp. 261-271).

Consequently, British companies lost their competitiveness to the German and the US companies that had clear separation of management and ownership. However, the failure of British companies in the 20th century was not necessarily because of personal capitalism.

The companies might have failed due to technological challenges and market dynamics rather than the inability of their owners to invest in managerial capabilities (Fridenson 2004, pp. 564-569). Chandler did to consider the role of national characteristics in determining the success of businesses. For instance, the large size of the US economy and availability of effective financial systems led to the emergence of large firms. By contrast, the small size of the British economy inhibited the growth of its companies.

In Japan, multinationals such as Toyota are still owned and managed by members of the founding families. Similarly, major US and UK companies such as Microsoft, Virgin Atlantic, and Apple have always been managed by members of the founding families who still own a substantial amount of equity.

Chandler’s claim that the managerial business enterprise arises primarily to coordinate production and distribution does not fully explain the organization of modern large companies. In most countries, public companies are forced by regulators of capital markets to separate ownership and management before listing their equities (Hill & Jones 2012, p. 192). Thus, compliance with regulation is sometimes the main factor that forces business owners to hire an independent management.

Structure and Strategy

According to Chandler, companies accumulate simple strategies that increase the complexity of their structures. For instance, as a company’s strategy changes from volume expansion to geographic dispersion, its structure evolves from an administrative office to a departmental headquarters. Ultimately, the strategy shift to vertical integration and diversification. As a result, the company’s structure changes from divisional central office to multidivisional general office (Fruin 2009, pp. 261-271).

Generally, the organizational structure of large companies is determined by the strategies that they adopt (Ansoff 2007, p. 235). For instance, vertical integration was an important element of large companies in the US before the 1980s.

Large manufacturers such as Ford Motor Company controlled their supply chains by investing in the companies that produced their inputs and distributed their products (Kleinand & Lien 2009, pp. 289-312). Generally, vertical integration improves the competitiveness of large companies by reducing the bargaining power of their suppliers, as well as, ensuring steady supply of high quality inputs (Ansoff 2007, p. 236).

However, advancements in transportation and communication technologies in the 20th century coupled with intense competition have reduced the attractiveness of vertical integration. The creation of virtual offices and improvements in shipping technologies has led to a shift from vertical integration to modularity, outsourcing, and networking (Fruin 2009, pp. 261-271). Coordination of the supply chain has shifted to independent firms such as shipping companies and contract manufacturers who require little supervision.

Contrary to Chandler’s view, modern large companies have been able to achieve differentiation without adopting a multidivisional organizational structure. The importance of this strategy is that it enables large companies to reduce their operating costs by eliminating multiple levels of management (Helper & Sako 2010, pp.399-429). This increases the profits of large companies that operate in markets where profit margins are constantly shrinking due to high competition (Helper & Sako 2010, pp.399-429).

Internal Management and Market Factors

Chandler argues that modern businesses “allocate their resources by managing rather than using the market” (Rodriguez 2009, pp. 284-298). Specifically, the managers at various levels in the organizational structure have taken over all the allocative functions of the invisible hand of the market. According to Chandler, managing involves employing managers to coordinate various supply chain functions such as producing inputs (Rodriguez 2009, pp. 284-298).

By contrast, using the market involves depending on external and independent entities to supply key inputs (Rodriguez 2009, pp. 284-298). This distinction does not explain the organization of large companies. Undoubtedly, there is no large company that supersedes the market by adopting a managerial hierarchy to coordinate its allocative functions. For instance, the large companies that produce their inputs (managing) must use the labor market to hire the best talent to supervise the production (using the market).

Contrary to Chandler’s view, managers must rely on the market to allocate the resources of the company. In particular, managers’ decisions concerning resource allocation must be determined by market needs for the company to succeed.

In a competitive market, it is the customers who decide the type of goods to be produced, where they are sold, and the quality standards to be maintained (Mathews 2004, p. 217). Large companies adopt managerial hierarchies to understand and to implement these decisions rather than to make them. Thus, managing and using the market are inseparable elements of large companies.

Chandler also assumes that the governance structure of modern companies, especially, public companies gives authority to managers to make all key decisions on behalf of the owners of the company. This perspective ignores the role of the boards of directors and shareholders in controlling their companies. Undoubtedly, the capital market rewards good management and punishes poor management (Freeman 2010, p. 216).

Specifically, companies whose managers report poor financial performance can hardly attract external capital and vice versa. In this regard, the board of directors and shareholders control large companies by setting financial goals, which the CEOs and managers must achieve in order to attract their capital.

The Extent to which the Model Explains the Competitiveness of Nations

Transport and Communication Technologies

Countries with advanced transport and communication technologies find it easy to attract foreign direct investments. Empirical studies have shown that rapid growth of large businesses in Europe, Asia, and the US is partly attributed to the availability of adequate and efficient transport and communication infrastructure (Freeman 2010, p. 221).

By contrast, African countries are less attractive to multinational companies due to the absence of transport infrastructure such as railroads. Transport infrastructure is important because it helps in reducing operating costs and enables companies to access external markets.

Research and Development

According to Chandler, managerial hierarchies enable companies to generate the knowledge that they need to succeed in various markets (Kleinand & Lien 2009, pp. 289-312). Through vertical integration, large companies establish their own research and development centers to create new knowledge (Kleinand & Lien 2009, pp. 289-312).

The knowledge and discoveries made by the large companies are often available to the entire country through patent and copyright agreements. For instance, the research done by GE Aviation has helped the US military to acquire the equipment that they need to maintain security. As a result, the US is one of the most attractive countries to multinational companies due to its high national security standards.

Governance Structure of Publicly Traded Companies

The concept of separating management and ownership in publicly traded companies borrows heavily from Chandler’s model of integrated managerial enterprise (Fridenson 2004, pp. 564-569). Countries that are able to attract foreign financial capital have clear rules on corporate governance.

In particular, public companies are required to employ an independent management to oversee their activities (Fridenson 2004, pp. 564-569). This enhances transparency in financial reporting and facilitates the use of incentives to encourage high performance among managers. This attracts foreign companies to invest in local companies by purchasing equities through the equity securities markets.

Limitations of the Model

Chandler’s model overemphasizes the importance of technology in determining the success of modern firms and nations. The model ignores the importance of the labor market in determining the attractiveness of nations (Ansoff 2007, p. 258). For instance, India and China have mainly succeeded due to their low labor cost advantage.

Majority of the US and European manufacturers have relocated to China and India to take advantage of low labor costs. Thus, China and India have developed rapidly at the expense of the US and Europe where labor costs are very high.

Chandler’s model also ignores the importance of national cultures and values in determining the success of companies and attractiveness of nations. In the US business culture, companies require specific skills, promote employees based on merit, and reward employees based on current performance (Jeffs 2008, 278).

In Japan, companies require general skills, provide permanent jobs, and some times consider seniority when promoting or rewarding employees. In China, the Confucian culture enhances the success of businesses through hard work, frugality, and discipline among employees. Thus, multinational companies will always invest in nations whose business cultures present little challenges to success.

Chandler’s model fails to account for government intervention in enhancing the success of businesses (Helper & Sako 2010, pp.399-429). For instance, transport and communication technologies, which are at the heart of Chandler’s model, are often developed by the government.

Thus, government policy concerning transport and communication infrastructure should be considered when analyzing the success of businesses and long-term attractiveness of nations. For instance, Japanese companies succeeded in the 19th and the 20th centuries due to the government’s ability to align its policies to the needs of the business community (Jeffs 2008, 287).

Conclusion

The central argument of Chandler’s model is that as companies become large, they adopt managerial hierarchies that supervise their operations. Generally, nearly all large companies in major economies have managerial hierarchies because they are too large to be controlled by an individual.

However, Chandler’s claim that modern companies will ultimately be controlled by people with little or no relationship with the owners is not applicable in most developed countries. Several multinational companies are still managed by at least one member of the founder’s family.

Chandler’s model explains the competitiveness of nations in terms of the role of transport and communication infrastructure in opening up external markets. However, it ignores the importance of national labor markets, cultures, and government policy in enhancing the attractiveness of nations.

References

Ansoff, H 2007, Strategic Management, Sage, London.

Caves, R 1980, Industrial Organization, Corporate Strategy, and Structure, Journal of Economic Literature, vol. 18 no. 1, pp. 64-92.

Freeman, R 2010, Strategic Management: A Stakeholder Approach, McGraw-Hill, New York.

Fridenson, P 2004, Business Failure and the Agenda of Business History, Enterprise and Society, vol. 15 no. 4, pp. 564-569.

Fruin, W 2009, Globalization and Alfred Chandler’s Modern American Firm, Journal of Management History, vol. 15 no. 3, pp. 261-271.

Helper, S & Sako, M 2010, Management Innovation in Supply Chain: Appreciating Chandler in the Twenty-first Century, Industrial and Corporate Change, vol. 19 no. 2, pp. 399-429.

Hill, C & Jones, G 2012, Strategic Management: An Integrated Approach, Sage, London.

Ingham, H 2009, Organizational Structure and Firm Performance: An International Perspective, Journal of Economic Studies, vol. 19 no. 5, pp. 1-12.

Jeffs, C 2008, Strategic Management, John Wiley and Sons, New York.

Kleinand, G & Lien, B 2009, Diversification, Industry Structure, and Firm Strategy: An Organizational Economics Perspective, Advances in Strategic Management, vol. 26 no. 1, pp. 289-312.

Mathews, D 2004, The Visible Hand? The Economics of Alfred Chandler, Coastal Georgia Community Collage Press, Atlanta.

Mesure, H 2007, Multinational Corporations and the New Global History, Society and Business Review, vol. 2 no. 2, pp. 219-220.

Rodriguez, R 2009, From a Family-owned to a Family-controlled Business: Applying Chandler’s Insights to Explain Family Business Transitional Stages, Journal of Management History, vol. 15 no. 3, pp. 284-298.

Rodriguez, N, Eisenhardt, M & McKenna, C 2002, Strategy and Structure Redux: review of Alfred Chandler’s Work, Business Strategy Review, vol. 13 no. 3, pp. 20-26.

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