Week 1

Markets, Management, and Strategy

Learning Objectives:

1. How price regulates competitive markets and how the market selects "winners" and "losers".
2. Describe the firm in the market model
3. Describe the evolution of modern managers and the modern firm
4. Explain how the modern corporation differs from the firm in the market model
5. Explain how through vertical and horizontal integration the modern firm usurps market functions

Adam Smith and the Industrial Revolution:

The Industrial Revolution transformed society and commerce. In the period 1770 to 1860, technologies arise that permit mass production of cheaply produced goods that are transported across national markets. Rural, family based enterprise is displaced by the factory system. In the industrial society there is a major population shift from the country side to the city. A new labor social class is created . Demands for capital to finance industrial development advance the emergence of modern banking. Colonization is firmly rooted in Western development needs for raw materials. The notions of economy, markets, and business begin with the Industrial Revolution.

Many historians date the beginning of this Revolution with the first factory in 1769. The Scotsman Richard Arkwright built a textile plant that used the new technology of the spinning jenny for weaving fabric. Unlike home based manufacturing, the factory concentrated production factors - labor and equipment - in one location to produce in great numbers the cloth that historically was produced on a small scale. The technology of the revolution was a "large scale" in production to yield lower costs and prices. Mass manufacturing of finished goods would not become a reality until 1780, when Eli Whitney introduced the technology of using inter-changeable, standardized parts. Changes in power technology would not be realized until 1785 when steam power supplanted human and water power in textile manufacturing.

In the period 1770 to 1860, an ever expanding array of manufactured goods displaced traditional crafts and cottage based industry to transform markets. Based on the combination of technologies in the manufacturing of iron and the use of steam for power, the Industrial Revolution made possible new products at low costs for wider markets accessed by the emerging technologies of rail and steam ship transportation. At the dawn of this revolution and coincident with the birth of the United States in 1776, Adam Smith publishes The Wealth of Nations. Adam Smith provided a framework by which the emergent modern economy is understood. His explanation is rooted in a basic understanding of man's behavior, found in his rational, persistent pursuit of self-interest:

"It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest."

From this assumption Adam Smith constructed the basis for modern economic theory: Individuals pursue individual self interest. People have a natural tendency to create, transport, and barter goods. In the creation of goods, a producer will use available resources in ways that yield the highest return or profit. Once produced, goods are sold to the highest bidder. The quantities of goods produced are governed by their costs and selling prices and the demand at each price. Each producer and each buyer acts independently; and, each acts in his own interest. But, all producers and all buyers by virtue of the need to exchange are interdependent, giving rise to the market. To Adam Smith, the market created by economic interdependence is the "invisible hand" that maintains the social fabric of community.

What make this view engaging is that what links people together is economy - producing and buying. An earlier English philosopher Thomas Hobbes had argued that the social glue was the absolute power of the sovereign. Locke and Rousseau imaged that the social glue that held people together in community was the "social contract" whereby individuals, from whom legitimate authority rested, collectively consented to unity through government. In Adam Smith's formulation, though, we have a social contract theory by which the economy binds society through every man acting in his own self interest, acting out of a natural "propensity to truck, barter, and exchange", and finding harmony in the interaction of supplying and demanding,

The Wealth of Nations is an "inquiry" into the nature and causes of national economic development. Smith places at the center of his treatise that greater productivity is derived from manufacturing. In his visit to a pin factory he observed that the traditional craftsman might manufacture one pin a day. The pin factory, however, using ten men created 48,000 pins a day. This leap of productivity, Smith attributed to organization and technology: the division of labor in which one man draws out the wire, another straightens it, a third cuts it, a forth points it, a fifth grinds the head, and so on through about 18 different operations; and, to the ability to utilize time saving machinery by which one laborer can do the work of many.

Smith's pin factory, however, is not the modern business firm. Absent in The Wealth of Nations and, indeed, in most of the literature on industry prior to the beginning of the 20th century is a concept of management as a distinct and noteworthy business activity. The notion of a business firm was a factory, shop, retailer, bank, or other economic agent owned by a single person, or by a few owners, operating at a single location, producing a single product or service, under the supervision of a proprietor-manager. In these types of ventures, ownership is indistinguishable from management. This will remain the dominant form of enterprise until near the twentieth century.