Basic Economics Page 12
What is important is not the success or failure of particular individuals or companies, but the success of particular knowledge and insights in prevailing despite the blindness or resistance of particular business owners and managers. Given the scarcity of mental resources, an economy in which knowledge and insights have such decisive advantages in the competition of the marketplace is an economy which itself has great advantages in creating a higher standard of living for the population at large. A society in which only members of a hereditary aristocracy, a military junta, or a ruling political party can make major decisions is a society which has thrown away much of the knowledge, insights, and talents of most of its own people. A society in which such decisions can only be made by males has thrown away half of its knowledge, talents, and insights.
Contrast societies with such restricted sources of decision-making ability with a society in which a farm boy who walked eight miles to Detroit to look for a job could end up creating the Ford Motor Company and changing the face of America with mass-produced automobiles—or a society in which a couple of young bicycle mechanics could invent the airplane and change the whole world. Neither a lack of pedigree, nor a lack of academic degrees, nor even a lack of money could stop ideas that worked, for investment money is always looking for a winner to back and cash in on. A society which can tap all kinds of talents from all segments of its population has obvious advantages over societies in which only the talents of a preselected few are allowed to determine its destiny.
No economic system can depend on the continuing wisdom of its current leaders. A price-coordinated economy with competition in the marketplace does not have to, because those leaders can be forced to change course—or be replaced—whether because of red ink, irate stockholders, outside investors ready to move in and take over, or because of bankruptcy. Given such economic pressures, it is hardly surprising that economies under the thumbs of kings or commissars have seldom matched the track record of economies based on competition and prices.
Technological Changes
For decades during the twentieth century, television sets were built around a cathode ray tube, in which an image was projected from the small back end of the tube to the larger front screen, where the picture was viewed. But a new century saw this technology replaced by new technologies that produced a thinner and flatter screen, with sharper images. By 2006, only 21 percent of the television sets sold in the United States had picture tube technology, while 49 percent of all television sets sold had liquid crystal display (LCD) screens and another 10 percent had plasma screens.{142}
For more than a century, Eastman Kodak company was the largest photographic company in the world. In 1976, Kodak sold 90 percent of all the film sold in the United States and 85 percent of all the cameras.{143} But new technology created new competitors. At the end of the twentieth century and the beginning of the twenty-first century, digital cameras began to be produced not only by such traditional manufacturers of cameras for film as Nikon, Canon, and Minolta, but also by producers of other computerized products such as Sony and Samsung. Moreover, “smart phones” could now take pictures, providing easy substitutes for the kinds of small, simple and inexpensive cameras that Kodak manufactured.
Film sales began falling for the first time after 2000, and digital camera sales surpassed the sales of film cameras for the first time three years later. This sudden change left Kodak scrambling to convert from film photography to digital photography, while companies specializing in digital photography took away Kodak’s customers. The ultimate irony in all this was that the digital camera was invented by Kodak.{144} But apparently other companies saw its potential earlier and developed the technology better.
By the third quarter of 2011, Eastman Kodak reported a $222 million loss, its ninth quarterly loss in three years. Both the price of its stock and the number of its employees fell to less than one-tenth of what they had once been.{145} In January 2012, Eastman Kodak filed for bankruptcy.{146} Meanwhile, its biggest competitor in the business, the Japanese firm Fuji, which produced both film and cameras, diversified into other fields, including cosmetics and flat-screen television.{147}
Similar technological revolutions have occurred in other industries and in other times. Clocks and watches for centuries depended on springs and gears to keep time and move the hour and minute hands. The Swiss became renowned for the high quality of the internal watch mechanisms they produced, and the leading American watch company in the mid-twentieth century—Bulova—used mechanisms made in Switzerland for its best-selling watches. However, the appearance of quartz time-keeping technology in the early 1970s, which was more accurate and had lower costs, led to a dramatic fall in the sales of Bulova watches, and vanishing profits for the company that made them. As the Wall Street Journal reported:
For 1975, the firm reported a $21 million loss on $55 million in sales. That year, the company was reported to have 8% of domestic U.S. watch sales, one-tenth of what it claimed at its zenith in the early 1960s.{148}
Changes in Business Leadership
Perhaps the most overlooked fact about industry and commerce is that they are run by people who differ greatly from one another in insight, foresight, leadership, organizational ability, and dedication—just as people do in every other walk of life. Therefore the companies they lead likewise differ in the efficiency with which they perform their work. Moreover, these differences change over time.
The automobile industry is just one example. According to Forbes business magazine in 2003, “other automakers can’t come close to Toyota on how much it costs to build cars” and this shows up on the bottom line. “Toyota earned $1,800 for every vehicle sold, GM made $300 and Ford lost $240,” Forbes reported.{149} Toyota “makes a net profit far bigger than the combined total for Detroit’s Big three,” according to The Economist magazine in 2005.{150} But, by 2010 Detroit’s big three automakers were earning more profits per vehicle than the average of Toyota and Honda.{151} By 2012, the Ford Motor Company’s annual profit was $5.7 billion, while General Motors earned $4.9 billion and Toyota earned $3.45 billion.{152}
Toyota’s lead in the quality of its cars was likewise not permanent. BusinessWeek in 2003 reported that, although Toyota spent fewer hours manufacturing each automobile, its cars had fewer defects than those of any of the American big three automakers.{153} High rankings for quality by Consumer Reports magazine during the 1970s and 1980s have been credited with helping Toyota’s automobiles gain widespread acceptance in the American market and, though Honda and Subaru overtook Toyota in the Consumer Reports rankings in 2007, Toyota continued to outrank any American automobile manufacturer in quality at that time.{154} Over the years, however, competition from Japanese automakers brought marked improvements in American-made cars, “closing the quality gap with Asian auto makers,” according to the Wall Street Journal.{155} However, in 2012, Consumer Reports reported that “a perfect storm of reliability problems” dropped the Ford Motor Company out of the top ten, while Toyota “swept the top spots.”{156}
Although Toyota surpassed General Motors as the world’s largest automobile manufacturer, in 2010 it had to stop production and recall more than 8 million cars because of problems with their acceleration.{157} Neither quality leadership, nor any other kind of leadership, is permanent in a market economy.
What matters far more than the fate of any given business is how much its efficiency can benefit consumers. As BusinessWeek said of the Wal-Mart retail chain:
At Wal-Mart, “everyday low prices” is more than a slogan; it is the fundamental tenet of a cult masquerading as a company. . . New England Consulting estimates that Wal-Mart saved its U.S. customers $20 billion last year alone.{158}
Business leadership is a factor, not only in the relative success of various enterprises but more fundamentally in the advance of the economy as a whole through the spread of the impact of new and better business methods to competing companies and other industries. While the motives for these improvem
ents are the bottom lines of the companies involved, the bottom line for the economy as a whole is the standard of living of the people who buy the products and services that these companies produce.
Although we measure the amount of petroleum in barrels, which is how it was once shipped in the nineteenth century, today it is actually shipped in railroad tank cars or tanker trucks on land or in gigantic oil tankers at sea. The most famous fortune in American history, that of John D. Rockefeller, was made by revolutionizing the way oil was refined and distributed, drastically lowering the cost of delivering its various finished products to the consumer. When Rockefeller entered the oil business in the 1860s, there were no automobiles, so the principal use of petroleum was to produce kerosene for lamps, since there were no electric lights then either. When petroleum was refined to produce kerosene, the gasoline that was a by-product was so little valued that some oil companies simply poured it into a river to get rid of it.{159}
In an industry where many investors and businesses went bankrupt, Rockefeller made the world’s largest fortune by revolutionizing the industry. Shipping his oil in railroad tank cars, rather than in barrels like his competitors, was just one of the cost-saving innovations that made Rockefeller’s Standard Oil Company the biggest and most profitable enterprise in the petroleum industry. He also hired scientists to create numerous new products from petroleum, ranging from paints to paraffin to anesthetics to vaseline—and they used gasoline for fuel in the production process, instead of letting it go to waste. Kerosene was still the principal product of petroleum but, because Standard Oil did not have to recover all its production costs from the sale of kerosene, it was able to sell the kerosene more cheaply. The net result, from a business standpoint, was that Standard Oil ended up selling about 90 percent of the kerosene in the country.{160}
From the standpoint of the consumers, the results were even more striking. Kerosene was literally the difference between light and darkness for most people at night. As the price of kerosene fell from 58 cents a gallon in 1865 to 26 cents a gallon in 1870, and then to 8 cents a gallon during the 1870s, {161}far more people were able to have light after sundown. As a distinguished historian put it:
Before 1870, only the rich could afford whale oil and candles. The rest had to go to bed early to save money. By the 1870s, with the drop in the price of kerosene, middle and working class people all over the nation could afford the one cent an hour that it cost to light their homes at night. Working and reading became after-dark activities new to most Americans in the 1870s.{162}
The later rise of the automobile created a vast new market for gasoline, just as Standard Oil’s more efficient production of petroleum products facilitated the growth of the automobile industry.
It is not always one individual who is the key to the success of a given business, as Rockefeller was to the success of Standard Oil. What is really key is the role of knowledge and insights in the economy, whether they are concentrated in one individual or more widely dispersed. Some business leaders are very good at some aspects of management and very weak in other aspects. The success of the business then depends on which aspects happen to be crucial at a particular time. Sometimes two executives with very different skills and weaknesses combine to produce a very successful management team, whereas either one of them might have failed completely if operating alone.
Ray Kroc, founder of the McDonald’s chain, was a genius at operating details and may well have known more about hamburgers, milk shakes, and French fries than any other human being—and there is a lot to know—but he was out of his depth in complex financial operations. These matters were handled by Harry Sonneborn, who was a financial genius whose improvisations rescued the company from the brink of bankruptcy more than once during its rocky early years. But Sonneborn didn’t even eat hamburgers, much less have any interest in how they were made or marketed. However, as a team, Kroc and Sonneborn made McDonald’s one of the leading corporations in the world.
When an industry or a sector of the economy is undergoing rapid change through new ways of doing business, sometimes the leaders of the past find it hardest to break the mold of their previous experience. For example, when the fast food revolution burst forth in the 1950s, existing leaders in restaurant franchises such as Howard Johnson were very unsuccessful in trying to compete with upstarts like McDonald’s in the fast food segment of the market. Even when Howard Johnson set up imitations of the new fast food restaurants under the name “Howard Johnson Jr.,” these imitations were unable to compete successfully, because they carried over into the fast food business approaches and practices that were successful in conventional restaurants, but which slowed down operations too much to be successful in the new fast food sector, where rapid turnover with inexpensive food was the key to profits.
Selecting managers can be as chancy as any other aspect of a business. Only by trial and error did the new McDonald’s franchise chain discover back in the 1950s what kinds of people were most successful at running their restaurants. The first few franchisees were people with business experience, who nevertheless did very poorly. The first two really successful McDonald’s franchisees—who were very successful—were a working class married couple who drained their life’s savings in order to go into business for themselves. They were so financially strained at the beginning that they even had trouble coming up with the $100 needed to put into the cash register on their opening day, so as to be able to make change.{163} But they ended up millionaires.
Other working class people who put everything they owned on the line to open a McDonald’s restaurant also succeeded on a grand scale, even when they had no experience in running a restaurant or managing a business. When McDonald’s set up its own company-owned restaurants, these restaurants did not succeed nearly as well as restaurants owned by people whose life’s savings were at stake. But there was no way to know that in advance.
The importance of the personal factor in the performance of corporate management was suggested in another way by a study of chief executive officers in Denmark. A death in the family of a Danish CEO led, on average, to a 9 percent decline in the profitability of the corporation. If it was the death of a spouse, the decline was 15 percent and, if it was a child who died, 21 percent.{164} According to the Wall Street Journal, “The drop was sharper when the child was under 18, and greater still if it was the death of an only child.”{165} Although corporations are often spoken of as impersonal institutions operating in an impersonal market, both the market and the corporations reflect the personal priorities and performances of people.
Market economies must rely not only on price competition between various producers to allow the most successful to continue and expand, they must also find some way to weed out those business owners or managers who do not get the most from the nation’s resources. Losses accomplish that. Bankruptcy shuts down the entire enterprise that is consistently failing to come up to the standards of its competitors or is producing a product that has been superseded by some other product.
Before reaching that point, however, losses can force a firm to make internal reassessments of its policies and personnel. These include the chief executive, who can be replaced by irate stockholders who are not receiving the dividends they expected.
A poorly managed company is more valuable to outside investors than to its existing owners, when these outside investors are convinced that they can improve its performance. Outside investors can therefore offer existing stockholders more for their stock than it is currently worth, and still make a profit, if that stock’s value later rises to the level expected when existing management is replaced by more efficient managers. For example, if the stock is selling in the market for $50 a share under inefficient management, outside investors can start buying it up at $60 a share until they own a controlling interest in the corporation.
After using that control to fire existing managers and replace them with a more efficient management team, the value of the stock may then
rise to $100 a share. While this profit is what motivates the investors, from the standpoint of the economy as a whole what matters is that such a rise in stock prices usually means that either the business is now serving more customers, or offering them better quality or lower prices, or is operating at lower cost—or some combination of these things.
Like so many other things, running a business looks easy from the outside. On the eve of the Bolshevik revolution the leader of the Communist movement, V.I. Lenin, declared that “accounting and control” were the key factors in running an enterprise, and that capitalism had already “reduced” the administration of businesses to “extraordinarily simple operations” that “any literate person can perform”—that is, “supervising and recording, knowledge of the four rules of arithmetic, and issuing appropriate receipts.”{166} Such “exceedingly simple operations of registration, filing and checking” could, according to Lenin, “easily be performed” by people receiving ordinary workmen’s wages.{167}
After just a few years in power as ruler of the Soviet Union, however, Lenin confronted a very different—and very bitter—reality. He himself wrote of a “fuel crisis” which “threatens to disrupt all Soviet work,”{168} of economic “ruin, starvation and devastation”{169} in the country and even admitted that peasant uprisings had become “a common occurrence”{170} under Communist rule. In short, the economic functions which had seemed so easy and simple before having to perform them now seemed almost overwhelmingly difficult.