Territories of Profit: Communications, Capitalist Development, and the Innovative Enterprises of G. F. Swift and Dell Computer (Innovation and Technology in the World Economy)

Territories of Profit: Communications, Capitalist Development, and the Innovative Enterprises of G. F. Swift and Dell Computer

Gary Fields

STANFORD BUSINESS BOOKS

Advance praise for Territories of Profit “Territories of Profit brings together rigorous scholarly research and an acute awareness of the new technological and social environment in which firms operate nowadays. It is essential reading for both students and practitioners in business and policy making.” —Manuel Castells, Wallis Annenberg Professor of Communication Technology and Society,Annenberg School for Communication, University of Southern California “Gary Fields’s amazingly original book shows us why we need an ‘actorcentered approach’ to regional development. Reinstating the corporation and its behavior as central to the innovative process, he deftly slays several sacred cows of the new economy: that wealth is now, unlike before, generated from information rather than production; that free markets necessarily facilitate innovation; that egalitarian networks among companies have displaced oligopolists and unbalanced market power. Probing two historical pace-setters, Swift Meatpacking and Dell Computer, he documents parallels between two periods of communications revolutions and how each firm used administrative control, market power, and reconfigured industrial districts to achieve super-profits. Anyone who thinks that the digital revolution will bring apocalyptic societal and geographical change or a kinder, gentler networked world should read this book cover to cover.” —Ann Markusen, Professor of Political Economy, Regional Planning and Geography, Humphrey Institute of Public Affairs, University of Minnesota “Many books have recently been written about the ‘Communication Revolution’ and the ‘Information Revolution.’ This fascinating and highly original comparative study of G. F. Swift and Dell makes compulsive reading and serves admirably to illustrate the outstanding features of both revolutions, of economic theory, and of innovation studies.” —Christopher Freeman, Emeritus Professor and Professorial Fellow, SPRU, University of Sussex

“This book makes an important contribution to our understanding of the evolution of the global economy by inserting business organization into the discussion. The comparison of Swift and Dell is compelling, linking transformations by US industrial corporations that have taken place a century apart through the concept of ‘administrative control.’ It provides an antidote to the popular view that the ‘managerial revolution’ is a thing of the past and that the ‘market coordination’ of the economy has reemerged as the organizing principle.” —William Lazonick, Research Professor, INSEAD, and Professor, University of Massachusetts, Lowell “This manuscript is timely. The stock market let-down has forced a reexamination of the ‘new economy,’ which scholars arguably found hard to come to terms with during its heyday. There is nothing like a nineteenthcentury viewpoint to help put the twentieth into perspective.” —Richard Langlois, Professor of Economics, University of Connecticut Gary Fields’s Territories of Profit tells a fascinating story about two firms that distill the essence of successful profit-making—G. F. Swift, the meat packing and distributing giant of the nineteenth century, and Dell Computer. Fields leads the reader through a penetrating analysis of how firms develop the capacity to respond in particularly effective ways to the opportunities presented to them by technological change. He demonstrates that ours is not the only era in which revolutionary changes in information and communications technologies gave firms new strategic options. He also shows how important it is not to separate information from its uses in the production and distribution of goods. Not coincidentally, Fields expands our geographic imagination, demonstrating how space for production and new markets enters into firms’ strategies. By doing so he brings us to a new understanding of the real processes shaping the global economy. —Susan Christopherson, Professor of City and Regional Planning, Cornell University

Territories of Profit

Innovation and Technology in the World Economy

editors Martin Kenney, University of California, Davis/Berkeley Round Table on the International Economy Bruce Kogut, Wharton School, University of Pennsylvania

Urs von Borg, The Triumph of Ethernet:Technological Communities and the Battle for the LAN Standard Gary Fields, Territories of Profit: Communications, Capitalist Development, and the Innovative Enterprises of G. F. Swift and Dell Computer

Territories of Profit Communications, Capitalist Development, and the Innovative Enterprises of G. F. Swift and Dell Computer

Gary Fields

stanford business books An imprint of Stanford University Press Stanford, California

2004

Stanford University Press Stanford, California www.sup.edu © 2004 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. Library of Congress Cataloging-in-Publication Data Fields, Gary, 1954– Territories of profit : communications, capitalist development, and innovation at G. F. Swift and Dell Computer / Gary Fields. p. cm. — (Innovations and technology in the world economy) Includes bibliographical references. ISBN 0-8047-4721-0 (alk. paper) — ISBN 0-8047-4722-9 (pbk : alk. paper) 1. Technological innovations. 2. Computer industry—Technological innovations—Case studies. 3. Meat industry and trade—Technological innovations—Case studies. I. Title. II. Series. HC79.T4 F54 2003 338'.064—dc22 2003019107 Printed in the United States of America on acid-free, archival-quality paper Original Printing 2004 The last figure below indicates the year of this printing: 13 12 11 10 09 08 07 06 05 04 Designed and typeset at Stanford University Press in 10.5/12 Bembo.

For Amy

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Contents

List of Tables and Illustrations Preface and Acknowledgments 1. Introduction: Communications and Innovation, Business Organization and Territory

xi xv

1

Part 1. Theory 2. From Communications and Innovation to Business Organization and Territory: A Synthesis

27

Part 2. Rails, Telegraphy, and the Business Enterprise of G. F. Swift & Company 3. The Railroad and Telegraph as Commerce System and Market Space

63

4. Continental Divide: The Business Enterprise of of G. F. Swift & Company

91

Part 3. The Internet and the Business Organization of Dell Computer 5. The Internet as Commerce System and Market Space

139

6. Global Reach: The Business Organization of Dell Computer

165

7. Conclusion: The Rhyme of History

220

Notes References Index

233 247 267

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Tables and Illustrations

Tables 3.1 3.2

Expansion of Rail and Telegraph Systems, 1848–1902 Percentage of Western Exports Shipped via New Orleans, 1839–1860 3.3 Shipments of Grain and Flour from Chicago, 1840–1861 3.4 Rail Receipts at Chicago for Various Commodities, 1852–1856 3.5 Rail and Water Shipments of Flour and Grain Received at New York, 1860–1890 3.6 Live Cattle Shipments from Chicago, 1852–1861 3.7 Relative Wholesale Price Indexes in Different Cities, 1866–1868 and 1889–1891 3.8 Urbanization, Railroadization, and Industrialization of the United States, 1850–1900 3.9 Size Rank of Largest Cities, 1820–1850 and 1850–1890 3.10 Growth of Manufacturing Employment in U.S. Cities, 1860–1890 4.1 Size of Beef- and Pork-Packing Industries, 1870 4.2 Comparative Expansion of Beef and Pork Packing, 1870–1890 4.3 Chicago Meatpacking Firms Ranked by Size, 1878 and 1884 4.4 Number of Branch Houses of Swift and Major Firms, 1878–1899 4.5 Number of Cattle Shipped from Chicago, Live and as Dressed Beef, 1878–1887 4.6 Manufacturing Industries Ranked by Dollar Value of Output, 1870 and 1900

65 74 75 76 77 81 83 85 86 87 98 103 109 111 112 114

xii List of Tables and Illustrations 4.7

Capital Value and Sales of G. F. Swift & Company, 1885–1904 4.8 Rank of Individual Firms Constituting the Beef Trust, 1903 4.9 Largest Slaughtering States by Dollar Value of Animals Slaughtered, 1860 and 1900 4.10 Output of Meat Products and Manufactured Ice, 1869–1904 5.1 Number of Host Computers Connected to the Internet, 1982–1990 5.2 Estimated Number of Individual Internet Users Worldwide, 1993–2001 5.3 Internet Domain Name Registrations, 1992–2001 5.4 Growth in Percentage of .com Web Sites, 1993–1996 5.5 Estimated Levels of Internet Commerce, 1996–2001 6.1 The Early PC Market in the United States, 1976–1983 6.2 Computer Hardware Production in East Asia, 1980–1990 6.3 Early Sales and Profit of Dell Computer, 1985–1990 6.4 PC Firms Ranked by PC Revenues, 1990 6.5 Computer Firms Ranked by World Market Share, 1994 6.6 Daily Internet Sales of Dell Computer, 1996–2001 6.7 Days’ Supply of Inventory at Dell and Compaq, 1994–2001 6.8 Computer Firms Ranked by World Market Share, 1997 6.9 Year-by-Year Percentage Increases in PC Shipments, 1996–2000 6.10 Computer Firms Ranked by U.S. Market Share, 2001

115 116 121 130 149 150 151 152 159 171 172 181 183 185 188 190 191 213 214

Maps 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 6.1 6.2 6.3

Travel Time (from New York) as Market Space, 1830 Travel Time (from New York) as Market Space, 1857 The Dressed Beef Enterprise of G. F. Swift, 1878 The Dressed Beef Enterprise of G. F. Swift, 1880 Expansion of G. F. Swift Production Facilities Top Five Slaughtering States, 1860 Top Five Slaughtering States, 1900 The Dressed Beef Enterprise of G. F. Swift, 1903 Centralization and Decentralization in the Dressed Beef Enterprise of G. F. Swift, 1903 The Dell Business Enterprise, 1990 The Expansion of Dell Assembly Sites, 1991–1999 The Dell Business Enterprise, 2001

78 79 106 110 118 122 123 124 128 182 204 212

List of Tables and Illustrations xiii

Figures 1.1

From Communications Revolution to Territorial Transformation 2.1 Schematic Outline of Communications Revolution 4.1 Schematic Outline of Beef Channels 4.2 Slaughtering and Meatpacking Output for Eight Cities, 1900 5.1 Number of Venture-Backed Initial Public Offerings and Amount Raised, 1978–2000 6.1. Schematic Outline of PC Channels 6.2 Dell’s Growth Before and During the Internet Period 6.3 Growth of Dell Sales and Employment, 1994–2001 6.4 Inventory of Dell and Inventory/Shipments Ratio of PC Industry, 1994–2000 6.5 Declines in Computer Prices, 1987–1999 6.6 Productivity Index for Dell, Compaq, and Gateway, 1994–2001

12 58 108 119 158 180 186 187 216 217 218

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Preface and Acknowledgments

this study began as an effort to uncover historical analogies to Internet commerce. In the course of its development, it established two parallel worlds, one occurring in the late nineteenth century, marked by the railroad and telegraph revolution, the other occurring during the final years of the twentieth century, marked by the ascendancy of the Internet. Two business firms, G. F. Swift and Dell Computer, eventually emerged as the protagonists of these dual universes and became the focus of the research for this study. One of the primary aims in setting up this comparison and examining the impacts of a previous communication revolution was to temper some of the exaggerated claims, rampant when research for this book was undertaken, about the uniqueness of the Internet and the so-called information age. There is no denying this uniqueness, but in the absence of a serious look back in time, such claims are historically static with little insight into what is actually new. Perhaps more importantly, however, this study set out to challenge a far more dubious set of principles being formulated in academic, policy, and business circles on the convergence of Internet communication, perfect markets, nonhierarchical organizations, and innovation. By supposedly equalizing access to information, Internet technology, we were told, was not only converging with more perfectly efficient markets. The Internet was promoting a more innovative economy, less hierarchical business organizations contracting as equals through the price system, and a recession-resistant pattern of capitalist development different from the past. Challenges to these conceits form the threads of this study. The lessons to be learned from Territories of Profit are threefold: first, while the Internet is unique, its impacts on innovation and profit making of business users are intelligible only as part of a much broader historical revolution in communications; second, innovation driving capitalist development is not something that occurs through established markets and the price system but is instead the outcome of firms creating organizations and using mechanisms of power strategically in pursuit of profit; and third, in pursuing this mission of

xvi Preface and Acknowledgments

crafting more innovative routes to accumulation, firms use power and organization to reconfigure territory such that the continental economic empire building of the vertically integrated firm and the global market development of the network firm share similar histories. Numerous people played critical roles in this project as it evolved along this trajectory, and they were instrumental in helping me along the route. First and foremost, I extend my gratitude to the people at the Berkeley Roundtable on the International Economy (BRIE). Without the unwavering support of BRIE and the intellectually vibrant environment that it cultivates, I would never have been able to conceive, much less undertake, this project. I hope that my work has in some way provided a source of enrichment to BRIE and the community associated with it. I also want to thank colleagues in the Department of Communication at the University of California, San Diego. They contributed numerous insights as the book was being completed. Several individuals made unique contributions to this study. Martin Kenney played a pivotal role. He first suggested to me that I might profit by examining the personal computer industry and perhaps even Dell Computer. He was also a tireless critic of my work at every step of the way, as well as a formidable source of information on a broad array of topics. I especially enjoyed our intellectual sparring sessions and was enormously gratified by his dedication and commitment to my work. In an early draft of the project proposal, AnnaLee Saxenian observed that what was interesting about the issue of business organization was the way firms organized economic activity across geographical space. Consequently, the territorial component of this project owes much to her input. Her frank and candid assessments of the work as it progressed always provoked me to refine my thinking and sharpen my arguments. Manuel Castells was an ongoing inspiration, providing me with an opportunity to launch my idea for comparing Swift and Dell in a presentation to his class on the Internet three years ago. His input on this presentation, at the time little more than a concept, convinced me that the idea was feasible. Brad DeLong was a constant source of encouragement for my comparison. He challenged me to draw out what I had learned from juxtaposing the two periods, the two infrastructures, and the two firms. Other individuals, though not directly involved in this study, contributed in other ways to its success. Michael Watts provided me with exposure to a broad and critical literature on development. Jan de Vries introduced me to a level of historical studies and an historical literature previously unknown to me. Mary Yeager was kind enough to respond to my early queries about the meatpacking industry and raised obvious issues about comparing beef and computers. Susan Christopherson made invaluable suggestions on an early presentation of the concepts in this book at a conference of the Asso-

Preface and Acknowledgments

xvii

ciated Schools of Planning. Finally, I am grateful to Michael Teitz for his ongoing support over many years of mentorship and friendship. Mike was responsible for challenging me to extend my theoretical inclinations into an empirical direction and had many insights on the project itself. Numerous individuals helped me with critical feedback as ideas in this book began to take shape. Todd Goldman, Asha Weinstein, Isabelle Fauconnier, Matt Zook, Larry Barone, Larissa Muller, and Claudia Leal read my early material and were at times my harshest critics. They were also among my most encouraging backers. Several people responded directly to the manuscript with comments and criticisms that, because of their efforts, are now part of the book. William Lazonick encouraged me to elevate business organization to a more prominent position in the analysis. Richard Langlois’s comments on an early draft and his paper “The Vanishing Hand” were critical in helping me frame my own ideas. Richard John read draft after draft of material on the nineteenth century and tirelessly kept commenting on ways to improve the book. Paul Duguid reviewed and critiqued what I considered some of the more controversial elements in the analysis, adding a level of erudition in his comments that I found exciting as well as insightful. Francois Bar made invaluable suggestions on the Internet as a communications and commerce infrastructure. Jan Birger Vagn Lauridsen was especially helpful in critiquing my formulations of transaction cost economics. Finally, my good friend Peter V. Hall, who witnessed this book as it emerged from its primitive roots, provided an excellent critique of Chapter 2 as well as other ideas in the study. Specialized technical support was also an important part of this study. Jeremy Shaw provided crucial assistance with cartography and showed great sense in linking my arguments to actual map design. Tony Hicks did a wonderful job in the layout of the book especially with regard to the tables and figures. Claudia DaMetz lent critical ideas to the design of the cover created so masterfully by Rob Ehle. On a more personal but somber note, I am truly saddened that my good friend Marvin Rosen could not witness the completion of this study. Marvin was the first to teach me the value of history and historical materialism. I believe he would have been both critical and pleased with this project, but ultimately gratified that he played a decisive role in the pathway leading to it. One of the most difficult hurdles I confronted in this study was interacting with representatives of Dell Computer. Laura Tyson was kind enough to write me a letter of introduction explaining the value of my study. Nigel Johnson, formerly of the Eclipse Group, was indispensable in orienting me to the world of Dell, and he played the critical role in helping me obtain my first interviews inside Dell. My lifelong friend Charles Piller of the Los An-

xviii Preface and Acknowledgments

geles Times helped me contact key Dell personnel as well as computer industry analysts. Several individuals at Dell took an active interest in my book, including Stephen Cook, Daryl Robertson, Simon Wong, and Lance St. Clair, all of whom were enormously helpful in enabling me to understand aspects of the Dell business system. I am also exceedingly grateful to Patricia Katayama at Stanford University Press. Pat took an interest in the project at an early date and made certain that the process was efficient. Her interest at every step was making certain that the final product was the best it could be. It is difficult to sustain momentum on a book without ongoing feedback. My wife and partner, Amy Rakley, tirelessly endured my theoretical incantations and made critical suggestions on issues such as the perishability of beef and personal computers. In addition, she heroically reviewed the manuscript when I could no longer do it. At key points, she prevented my writing from straying into the often arcane and indecipherable world of the academy and made me see connections in my own work that I did not realize were there. Her observations and input were indispensable. Finally, my most heartfelt thanks go to Stephen S. Cohen. His unflagging support and supreme confidence in my work, even in moments when I was not at all clear how I could complete this study, were a constant source of inspiration to me. A couple of years ago Steve suggested that I use my interest in history to write a book on the Internet age. I followed this advice and am truly grateful for the support he has given me. I hope that this offering will fulfill his wishes. San Diego, September 2003

Territories of Profit

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chapte r

1

Introduction Communications and Innovation, Business Organization and Territory

economies and technologies are historical creations. The way human beings organize their economic activity and the technologies available to them for producing, buying, and selling emerge from historically constructed settings and evolve in conjunction with the historical process. This study tells a comparative story of economic development and technological change that takes place during two historical periods. One period encompasses the early years of the mass-production economy in the late nineteenth century. The other focuses on the formative years of the Internet economy at the end of the twentieth century. Two business firms, G. F. Swift and Dell Computer—one from each period—are the central protagonists in this comparison. These two firms reveal parallel stories of innovation and economic transformation with a set of common themes. The narrative for these two stories begins by tracing how business users of transport and communications systems learn to reorient their competitive strategies and operational routines as the technology of these systems changes. It goes on to describe how, as businesses alter their strategies and routines and assume new capabilities, they transform the organizations through which they compete and seek profit. What this study compares are the business organizations that get created as firms use new transport and communications technology to innovate their competitive activity. At the center of this comparison is a story of how transformations in business organization are part of a general process of innovation within the firm and how the emergence of innovative enterprises reshapes the geographical territory of profit making.1

2 Introduction

The Comparison This comparison of innovative business organizations is organized around a central research problem: How does technological change in systems of communications and transport enable business users of such systems to recast their profit-making activities and innovate the organizations through which they produce, buy, and sell, and how do such enterprises reshape the development of territory for economic activity? This problem, in turn, seeks to explain the relationship between four phenomena: (1) transport and communications technology; (2) innovation within the firm; (3) the organizational structure of the firm; and (4) the geographical territory where the firm operates. While in formal terms these elements are related as “independent” and “dependent” phenomena, they provide a far more compelling set of analytical threads for comparison when ordered as a sequence of questions: (1) How does technological change in systems of transport and communications transform opportunities for profit making by firms? (2) How do changes in profit-making opportunities stemming from new transport and communications systems enable business users to innovate their strategies and routines for producing, buying, and selling? (3) How do these innovations result in the transformation of business organizations through which firms compete and make profit? and (4) How do these organizations assume territorial characteristics in the way they coordinate business activity within and across geographical space? To address the central research problem and the analytical relationships upon which this problem is built, this study examines two highly innovative business users of transport and communications systems as case studies. The first case is historical and focuses on G. F. Swift, a user of the rail and telegraph system for producing, buying, and selling during the late nineteenth century. The second case is contemporary and examines Dell Computer, a user of the Internet as an infrastructure for procurement, production, and distribution. Swift is the pioneering founder of the mass-produced fresh beef industry during the late nineteenth century. Dell is the contemporary developer of custom-built personal computers (PCs). These firms rank among the most innovative organizations of their respective time periods, ascending to this shared status by responding to different communications revolutions in a similar way. Both companies used technologies of communications revolutions to create enormously innovative production-and-distribution organizations that redefined competitive practices for business activity in their own time. In changing how products were built and distributed, the organizations created by these two companies redirected the routes by which goods trav-

Introduction 3

eled within and between firms to final customers. In the process, the innovative enterprises of Swift and Dell reconfigured territories for accumulation and profit. The focus on these two firms, however, is far from a worshipful paean to individual entrepreneurial heroism. This study seeks to tell a more fundamental story about innovation and capitalist development. Within this broad frame, Swift and Dell reveal how business organizations are inherently geographical in the way they occupy territory as they coordinate their competitive activities and how capitalist development, fueled by innovation and organizational change, is a territorial phenomenon linked to the activity of firms (Walker 1988; Markusen 1994). In effect, the experiences of these two companies raise one of the most compelling issues in the study of economic development: How is geographical space for profit making (re)configured from the innovative activity of business firms? The stories of Swift and Dell uncover answers to this puzzle. In addition to the comparative focus on innovation and capitalist development, this study raises issues of contemporary economic relevance by engaging with the economies of both present and past. First, at a time when economic policy makers throughout the world elevate models of the market as the source of innovation and economic growth, the experiences of Swift and Dell reveal innovative activity to occur largely outside the parameters of established markets and the price system in both contemporary and historical settings. As the business models of Swift and Dell make clear, innovative business organizations use administrative planning and corporate power—not the market—as the mechanism for generating profit and increasing returns. Consequently, the cases of Swift and Dell suggest that policies seeking to enhance innovativeness through the creation of more open markets may very well be wrongly targeted and even misguided. Second, this study establishes a more precise picture of global economic development by removing the historical isolation in which processes of contemporary globalization are often shrouded. While the phenomenon of globalization has its historically unique elements, the current processes of global market making represented by Dell reveal striking symmetry with the continental economic empire building of the late nineteenth century represented by Swift. In seeking innovative outlets for accumulation and profit, both firms reconfigure territory in a similar pattern of building organizations that spread and reconcentrate economic activity in new ways. Consequently, the comparison of Swift and Dell has special significance in providing a vantage for understanding the broader meaning of contemporary globalization and outlining historical pathways along which the contemporary global economy is being shaped by firms.

4 Introduction Admittedly, the comparison in this study draws upon a compelling model. Twelve years ago, Paul David, in a provocative and beguiling essay (1991), suggested that a comparison between modern-day computers and nineteenth-century electric motors provided a methodological pathway for explaining the so-called productivity paradox of the 1980s and early 1990s. In his piece, David accounts for the anomaly in the productivity statistics beginning in the 1980s, when computers entered the workplace, by referring to a similar lag in productivity growth following the introduction of electric dynamos in factories of the late nineteenth century. By way of the earlier example, he reasons that a period of adjustment was necessary following the introduction of new technology before productivity gains were possible. In the process, he succeeds in linking historically unique technological artifacts and the experiences they embody, across time. David’s theory of the productivity paradox derives from a specific type of comparative history described as parallel comparison (Skocpol and Somers 1980). As one of three comparative historical logics, parallel comparative history asserts a fundamental similarity among selected cases based on their conformity to underlying theoretical propositions. In their role as research subjects, Swift and Dell function as intensive (as opposed to extensive) case studies in a parallel comparison of business firms, with the business enterprise serving as the unit of analysis. Whereas extensive case study research seeks to discover common characteristics in a population of subjects based upon a large number of observations, intensive research reveals how a causal process uncovered from an engagement with theory manifests in a particular case and how the particular case, in reflecting this causal process, is representative of a broad-based and generalizable trend (Sayer 1992, 242–43). In this book, Swift and Dell are comparatively similar intensive cases representing a general causal process—the route from communications revolutions to innovation, organizational change, and territorial transformation—that connects different historical periods. In employing this logic of similarity between cases, David’s comparison emerges as a potent example of the use of history to explain recent economic outcomes. By casting technology and the economy of the late twentieth century into what he described as a “not-too-distant mirror,” David finds answers to questions about present technology that would not have been discernible from current observations alone. In the process, he provides insights about the perils of subordinating historical memory to the technological present. David notes the human tendency to lose sight of the past when confronted by the achievements of current innovation, an affliction he vividly describes as “technological presbyopia” (David 1991, 317). To sufferers of this malady, the technological future appears closer at hand than the historical path leading to it, and the afflicted, in their neglect of the past, ex-

Introduction 5

aggerate the sense in which the present is “unprecedented” and unique. David’s analysis suggests that such fixation on the future, and neglect of the historical route to present-day innovation, leads to a truncated and ultimately superficial engagement with technology itself. In the present study, the comparison of Swift and Dell—the rail and telegraph system and the Internet, and fresh beef and custom-built PCs—overcomes such afflictions. It uses history to provide insight into the economy around us.

Findings at a Glance When applied to the cases of Swift and Dell, this historically oriented comparative approach to innovation and economic development reveals several critical findings. First, the two cases reveal communications revolutions to be the catalyst for innovations in distribution and marketing. Such breakthroughs in the socalled sphere of circulation enabled Swift and Dell to elevate the role of logistics as the source of value creation and competitive advantage. These logistics-oriented process innovations led to the creation of organizations designed to coordinate the movement of materials, semifinished goods, and finished goods from suppliers to producers and customers in new ways. While both firms did succeed in using new infrastructure systems to create new commodities—dressed beef shipped long-distance and PCs configured through Internet communication—the logistics-oriented process innovations of Swift and Dell proved as formidable as new products in transforming the economies of their respective eras. With this emphasis on distribution and logistics, Swift and Dell reveal striking symmetry in attributes and aims. Dell uses the Internet to link customer orders with procurement, production, and delivery of PCs in creating an extremely innovative “directpull,” “just-in-time” production-and-distribution network. Swift, however, created a similar organization from rail and telegraph technology, using telegraphy to link orders from retail butchers with procurement of cattle supplies, disassembly, and final marketing. Admittedly the pioneering system of Swift operated in a more extended time horizon than the continuous orderand-fulfillment flow of Dell. Nevertheless, by linking customer orders to sources of supply and eliminating intermediaries between producer and customer, Swift’s network anticipates the basic idea of Dell’s “closed-loop” organization by a century. Second, this study on the logistics-driven organizations created by Swift and Dell challenges the belief that the mass-production age created wealth from goods whereas the Internet age creates wealth from information. Such partial truths ignore the ways in which Swift and Dell developed organizations that relied on both the processing of enormous amounts of real-time

6 Introduction information and the manipulation of high-volume flows of goods. Swift built its network not only from its rail-transported fresh beef. It created an organization on the basis of telegraphic information coordinating the movement of this product from its raw material form as cattle at stockyards to its finished form as edible beef at retail butcher shops. Real-time information exchange between the primary nodes in Swift’s network—stockyards, slaughtering facilities, and branch distribution houses—shaped a process of procurement, production, and sale that was modulated daily in order to balance conditions of supply and demand in the context of a highly perishable product (U.S. Bureau of Corporations 1905, 21). Information secured through telegraph technology was as critical to Swift in capturing value from its production and distribution as transformation and manipulation of the physical product. The production and distribution of the product, in effect, and Swift’s capacity to capture value from this activity of producing and selling were completely dependent on the capacity of the firm to manage information directing these flows. Dell, in turn, not only captures value from its logistics-oriented activity by the Internet-based information it maintains to link the primary nodes in its organization. It also makes profit and distinguishes itself from competitors by the way it links Web-generated information to the physical movement of supplies, semifinished and finished commodities from supplier factories, to supply logistics centers where components are staged for assembly, to its own assembly sites. While information is essential in coordinating these logistics, executing the movement of physical materials through these organizational nodes is as critical to Dell’s success as the Internet-generated information system that underlies how the hardware in this network is assembled and delivered. Third, the organizations of Swift and Dell reveal a similar geographical tendency to spread and concentrate in a pattern characteristic of industrial districts. From the rail and telegraph system, Swift built a production-anddistribution organization extending throughout the entire United States that obliterated the formerly localized markets of beef production and consumption. As it widened routes of distribution across the entire continent, the company decentralized slaughtering away from its original hub in Chicago and reconcentrated it in other locations in the Midwest. The result was a new system of meatpacking ensembles located in the center of the country, serving a vastly extended set of marketing routes. This new structure of production and distribution succeeded in articulating a national market space. Dell is building an organization on the basis of Internet technology with a similar geographical configuration. It has spread and decentralized computer assembly activity from its original hub in Austin, Texas, to locations around the world. At the same time, it has created concentrations of assembly activity in selected localities to build and sell products for the

Introduction 7

regions where assembly sites are located. In this way, Dell is playing a critical role in the development of high-technology industrial districts. In these place-based concentrations of manufacturing, both firms rely on critical relationships of territorial proximity between key nodes in their networks— stockyards, disassembly facilities, and branch distribution houses in the case of Swift and supplier factories, supply logistics centers, and assembly facilities in the case of Dell.2 The two companies actively shape these relationships of proximity in order to manage and control the movement of materials between these nodes and to execute their direct-pull high-velocity systems of production and distribution. In the process, both firms have emerged as agents in reshaping territory for profit making. Nevertheless, the pattern of elongation and concentration created by the two firms reveals a clear and obvious geographical difference. In the case of Swift, the elongation of distribution routes and the decentralization of cattle disassembly created a nationally based set of regionally concentrated production complexes. In the case of Dell, the spread and decentralization of PC assembly has created a globally based set of regional production ensembles.Yet, at the same time, the pattern of spread and concentration, while configured differently across time, appears to be the fundamental territorial manifestation of innovation, expansion, and the capitalist process. Finally, this comparison of Swift and Dell clears new ground in understanding firms as business organizations and networks that deploy mechanisms of power, coordination, and control as the basis for innovation. First, this study reexamines and clarifies the idea that economic activity and organizations in the current period are distinguished by the phenomenon of networking. Seemingly incontrovertible, the notion that firms and economic activity have only recently evolved into networks is an historically static formulation and consequently problematic. What, for example, is the appropriate designation of the myriad intermediate forms of subcontracting and networklike trade relationships in existence before the current period, observed by theorists from Ronald Coase (1937) to G. B. Richardson (1972)? Indeed, if there is one basic insight revealed in the history of economic life, it is that the activities of producing, buying, and selling have always occurred in networks (Braudel 1977, 1979). Far more critical in assessing whether the current period is one of networking is the task of identifying how the network linkages used by firms and individual economic actors to organize production and trade have evolved in different historical periods and uncovering the attributes of these connections—localized, regional or global, interfirm or intrafirm—inherent in economic activity. Business organizations, by their very nature, are networks with distinct characteristics that change over time. The integrated intrafirm organization of Swift is no less a net-

8 Introduction work than the dis-integrated interfirm organization currently being created by Dell. Furthermore, networks are not egalitarian substitutes for the hierarchical power relations of vertically integrated organizations (Barley and Kunda 2001). They reorganize relations of power. As networks evolve, they recast adjacent operations in the creation of products and services and redistribute where, among these activities, firms are most able to capture profit. Different steps performed within networks thus become contested with economic rents accruing to those firms capable of performing the most profitable activities and defending such rent-generating positions. Networking, in effect, retains the basic characteristics of linkage and connection common to economic life. At the same time, contemporary networking reproduces relationships of competition and cooperation between firms along with contests for power at the core of capitalist development. The proliferation of interfirm relationships within regions and across continents that seems to be driving the idea of the current period as one of networking is not entirely new. It is more accurately networking in a new form. Second, this comparison decisively reveals that while Dell and Swift reflect undeniable differences in structure, the integrated organization of Swift and the interfirm organization of Dell share the same need for mechanisms of power and control to mitigate risk in coordinating adjacent steps of procurement, production, and distribution and in innovating the logistics of these operations. Such mechanisms of power and control are fundamental to the innovative enterprise. In the case of Swift, these mechanisms, achieved through rail and telegraph technology, are exercised within the boundaries of the firm through the ownership of assets, that is, through vertical integration. In the case of Dell, these mechanisms, achieved through Internet communication, are exercised over other firms that lie outside the organizational boundaries of Dell but within the network of the PC maker. Dell is compelled to use such control in achieving what it calls virtual integration with its suppliers and logistic partners in order to coordinate the high-speed information and material flows needed in managing the logistics of its justin-time procurement, production, and distribution system. Dell interacts with other firms in its network not through markets and the price system but through an enforced structure of relationships—using the Internet as a tool to help facilitate this control. Consequently, this study takes issue with prevailing views of interfirm production networks as the organizational embodiment of ascendant market forces and presents an alternative view of interfirm networks as innovative organizations equally dependent on mechanisms of power, control, and administration used by vertically integrated firms such as Swift. Far from affirming the current period to be a revolution in production based on market

Introduction 9

coordination within interfirm networks, the comparison of Swift and Dell reveals that corporate power and administrative coordination lie at the foundation of the innovative enterprise and are deployed in different organizational settings. This underlying characteristic of the innovative firm, in turn, and the ongoing role of innovation in modern capitalist development, establish bridges between the late nineteenth and the late twentieth centuries.

Theoretical Framework Three distinct but often overlapping sets of literature provide the theoretical context for the comparison in this study. innovation as history The first set of literature, traceable to the influence of Karl Marx, employs a fundamentally historical approach in examining the phenomena of technological transformation and innovation within the firm.3 Developed systematically in the work of Joseph Schumpeter (1942, 1947) and elaborated more recently by theorists influenced by his notion of evolutionary economic change, this literature seeks to uncover the sources of innovation and its impacts on economic development within and across historical periods. In this framework, innovation is conceived more broadly than the accumulation of discrete inventions and new technologies. Innovation is the deployment and transformation of inventions into commercially viable products and profit-making activities and the diffusion of these new products and processes throughout the economy. It involves what Schumpeter described as the “creative response” of entrepreneurial firms and the adaptive response of other firms that, in trying to compete with innovators, imitate the original innovation. In seeking to explain how this process of invention, innovation, and diffusion occurs, theorists in this tradition focus on the process of learning within the firm. This process of learning to compete differently and choosing how to implement a new vision of profit making is what leads to the creation of new strategies, products, routines, and business organizations. These activities of learning about new profit opportunities and selecting alternatives for capturing profit in new ways transform patterns of competition and enable firms to create different trajectories of growth and development. This body of theory is used to position Swift and Dell as innovative firms. the firm as business organization and network The second set of literature examines how firms, as business organizations, coordinate their activity in both internal and external networks. The-

10 Introduction orists within this literature focus on two primary attributes of business organization. One group of theorists examines business enterprise as organizational linkages within and between firms. Such linkages result from the choices of firms on how to undertake and divide up the various activities in producing and selling a good or service and stem from a search by firms for “competitive advantage.”4 In this way, organizational linkages within and between firms reflect operational decisions on competing. Such linkages establish boundaries between firms and lie at the core of theories on business organization in terms of the degree to which firms internalize various economic activities and are integrated or the degree to which firms transact with other firms across markets for these activities and are dis-integrated. Business organization, and the networks through which organization becomes operational, whether intrafirm reflecting integration, or interfirm reflecting dis-integration, are thus the outcome of how firms choose to compete in economic space. A second group within this tradition extends the idea of business organization into the realm of territory. Using insights from the first group, these theorists reveal business organization to be inseparable from geographical organization and seek to identify how business organizations reflect geographical linkages in the coordination of economic activity, thereby embedding the firm in territory (Walker 1988, 385). This process occurs in the way firms organize the locations of their assets and coordinate the flows of activity, material, and information within and between these assets and between these assets and those of other firms in their production-and-distribution networks. The pivotal concern of these theorists is how the territory through which business organizations operate is constructed and reconfigured. While the starting point of this literature is the structure of the firm as a competitive unit in economic space, theorists in this tradition also emphasize how forms of business organization occupy a second analytical realm—geographical space. This body of theory is used to position Swift and Dell as creators of business organizations with attributes that occupy an economic realm of competition and a spatial realm of territory. communications as revolution The final set of literature focuses on the role of new communications systems in promoting discontinuities in the historical process. This phenomenon of communications as a revolutionary force, however, is not some inexorable driver of history and economic development. Innovative users of communications systems employ agency to discover attributes of communications revolutions. Through a process of learning, firms as historical actors put these attributes to use in recasting routines, organizations, and territory. Pioneered as an historical concept by Robert Albion, the communications revolu-

Introduction 11

tion represented a new era of “speed” in moving information, goods, and people across space (Albion 1932; John 1994). Although Albion acknowledged this phenomenon to be the prelude to the “Machine Age” and “Big Business,” his work elevated the communication revolution’s independent emergence. Nevertheless, his insight into the role of new transport and communications systems as prologue to transformations in economy and society established an enduring legacy. Theorists from Alfred Chandler (1977) to Manuel Castells (1996) have acknowledged the centrality of communications and transport in the process of historical change. Moreover, Albion’s depiction of the communications revolution as an ongoing phenomenon finds support in the more recent representation of communications as a “carrier wave,” a fundamentally unified historical pathway of communications breakthroughs beginning with the telegraph, demarcating different periods of innovation (Hall and Preston 1988). This notion of the communications revolution as “catalyst” and “carrier wave” is the foundation for the connections in this study between the competitive economic environment, the process of innovation and organizational change in the firm, and territorial transformation. It is what ultimately links the experiences of Swift and Dell.

The Argument From a synthesis of these literatures, this study illustrates how firms, in confronting revolutions in transport and communications technology, reshape the development of territory for profit making. Four key concepts provide the threads for this connection: (1) the communications revolution; (2) innovation within the firm referring to the creation of new products, the reorganization of routines to make new products, and the exploitation of new markets for selling new products and carrying out new routines; (3) the business organization of the firm consisting of the organizational and geographical linkages created by the firm to coordinate innovative activity; and (4) territory, referring to the geographical pattern of the informational and material flows coordinated by the business organization to carry out innovative activity. In this argument, the communications revolution is connected to territorial transformation through the process of innovation within the firm and the changes in business organizations made by firms as they undertake innovative activity (represented schematically in Figure 1.1). Revolutions in communications provide a pathway to innovation by enabling firms to recast the routes by which products circulate from their origins as raw materials, through the process of fabrication, to their final destination. As firms change their organizational structure to implement processes for redirecting these routes traveled by products from production to consumption, they reshape the territory in which they operate. It is in this role as catalysts for in-

12 Introduction

Territorial Transformation Communications Revolution

Business Organization Innovation

figure 1.1 From Communications Revolution to Territorial Transformation

novation in logistics and business organization that communications revolutions have a defining impact in reconfiguring territories for profit making. theoretical contours From these outlines, the argument in this study begins from the concept of the firm framed roughly forty years ago by Edith Penrose (1959). For Penrose, the firm is a profit-seeking repository of human and material resources bound within an administrative framework. The mission of the firm is to grow by transforming its resources into profit-making activities. Such activities include creating new products and production processes and exploiting the market environment in new ways to accumulate wealth. Competition and the profit system compel firms to grow and accumulate profit in order to survive. Growth occurs when firms compete differently after acquiring new knowledge about profit making and adding what they have learned to their base of resources. When firms learn to compete differently, they acquire new capabilities derived from three types of knowledge—technical, functional, and managerial (Chandler 2001, 2–3). Technical capabilities are learned from applying broad-based scientific and engineering knowledge to products and processes while functional capabilities refer to knowledge specific to a particular product. Managerial capabilities refer to knowledge essential to coordinate the operations of the enterprise. Enhancement of capabilities is what enables firms to provide the market with new goods and services created from new processes and to exploit new territories in which to undertake this activity.

Introduction 13

Acquisition of new capabilities, however, compels firms to modify their organizational structure. Capabilities and organization evolve interactively in creating new routines. Consequently, the augmentation of capabilities is an organizational phenomenon. This enhancement of capabilities and the creation of new business organizations are the sources of growth in the firm. They represent an expansion in the firm’s resource base, not simply an increase in resources from a mobilization of more production factors. In this way, innovation, based on learning, and organizational change are integral to the growth process at the foundation of capitalist development. Firms are historically conditioned entities. They learn to make profit within environments in which the basic parameters for capital accumulation—technical, organizational, legal, political, and social—are essentially given. In these environments, established business practices, along with available technologies for profit making, and institutional frameworks condition the strategic, operational, organizational, and territorial choices of firms for accumulating. From these choices emerge products, routines, business organizations, and market structures. Although these environments condition competitive choices, they are at the same time constantly evolving and creating new opportunities for organizational learning. Consequently, firms’ strategic, operational, organizational, and territorial choices for accumulating profit are always open-ended and contingent. Learning in such environments is thus a function of both structure and agency. Similar to individual historical actors, firms “make their own history,” not exactly as they please but from “circumstances given and transmitted from the past” that condition both the range of choices for competing and the opportunities for competing differently.5 Among the most disruptive historical forces affecting the environment of profit making and competitive choice is the phenomenon of technological change in systems of communications and transport and the eventual buildout of such new systems. The railroad/telegraph system and the Internet represent different historical manifestations of this phenomenon. Two distinct though often overlapping groups of firms participate in the creation of communications revolutions. Spearheading this phenomenon are builders of transport and communications systems. This group encompasses an array of actors including inventor entrepreneurs, investors, government, and firms that undertake the build-out of infrastructure systems. Such infrastructure, when put into use, creates new systems of access across and within space, enabling people, merchandise, and information to circulate over distance and within distances of close proximity in new ways. These new systems of circulation and access alter conditions for accumulation and profit making. In the process, new infrastructure systems beckon to a second, more numerous group in the economy.

14 Introduction This second group consists of business users of transport and communications systems. In experimenting with the new technologies, these firms actually play an integral role in shaping the deployment of the new infrastructure itself. As these users learn to deploy new infrastructure in their business models and exploit the new systems of access and circulation created by such technologies, they innovate how they compete. This activity of innovation through learning is marked most decisively by a process of transformation in the strategy and structure of the business enterprise (Chandler 1962). Swift and Dell represent two such users. They exploit the profit-making opportunities of communications revolutions and create new standards for competing on the basis of changes in strategic outlook and innovations in business organization. Communications revolutions change the profit-making environment for transport and communications users by transforming a fundamental element in the economic system—the geographical structure of markets. Systems of transport and communications influence the territorial configuration of markets in two ways. First, technologies of transport and communications act to delimit market boundaries (Irwin and Kasarda 1994; Christaller 1933). They do so by influencing the costs to economic actors of producing and trading across distance. Market boundaries emerge at those locations where “costs of transfer”—the costs to economic actors of moving goods or securing information across territorial barriers—drive the prices of goods and services beyond their original value (Ohlin 1933, 100). The size of markets is thus dependent on the costs to and capacity of market actors to produce and exchange goods and services over distance and to communicate information needed to organize these activities (Du Boff 1980, 478). In this way, market boundaries correspond to territorial systems of access for producing and trading. Such systems of access are shaped and reshaped by the build-out and deployment of transport and communications systems and the ways that business users of this infrastructure actually deploy it in economic use. Second, in addition to delimiting boundaries between different market areas, technologies of transport and communications reshape systems of access within the boundaries of markets. It is users, however, in experimenting with the infrastructure, that act as the agents in this transformation. As routes and means of access within markets become reconstituted from breakthroughs in transport and communications, such new access systems alter the costs of economic activity and enable users to transform business routines in close proximity. In this way, technologies of communications and transport shape and reshape systems of market access across and within geographical space, thereby changing the environment of profit making for users of these technologies.6

Introduction 15

Embedded most fundamentally in the geography of markets and systems of market access are relationships between business firms and economic activities structured around time and space. In all periods of capitalist development, control over time and space is a centrally important strategic, operational, and organizational problem for the firm (Schoenberger 1997, 12; Harvey 1996, 240–41). Businesses are constantly engaged in reshaping their strategies, routines, and organizations in an effort to overcome the temporal and territorial barriers to accumulating profit. Communications revolutions create possibilities for firms to control time and space in economic activity differently so that what is inefficient or even impossible as a business model at one point in time may be viable as a profit-making venture in another historical moment. When firms grasp the opportunities for crafting new routines from breakthroughs in communications, and as firms create new forms of organization to implement such routines, their efforts lead to changes in the timing cycles and territorial arrangements of business operations. In this way, changes in business routines and changes in the economies of time and space are mutually reinforcing. A change in routine shifts the timing and territorial spacing of business operations. Changes in routines, in turn, present the firm with new challenges of control over these recalibrated and reconfigured time and space relationships. As the firm learns to use new systems of communication in creating innovative routines, and as the firm deploys such systems in assuming control over the time and space relationships recast by these routines, the innovative organization created in this process reconfigures the territory for economic activity and profit making. Communications revolutions, in effect, are control revolutions.7 They change the environment of profit opportunities by providing firms with different and more intensified types of control over space and time in economic activity. Such control in turn enables firms to create new routes to efficiency in the form of more innovative routines. As firms discover these routes to more efficient routines, they are compelled to assume new and different capabilities in order to capture the profit—the rents—from doing things differently. In recasting business practices and assuming new capabilities, the innovative firm reorganizes the structure of its enterprise and in the process reshapes the territory in which it assumes control over newly crafted routines. Not all firms are equally successful in learning about profit opportunities in economic environments modified by new transport and communications systems. As communications revolutions reshape markets and enhance systems of control over space and time in business activity, very few firms are able to grasp how to profit differently from the new economic environment. Such variation stems from the fact that the choices of strategies, routines, and business organizations made by firms do not derive from so-called per-

16 Introduction fect information of the most profit-optimizing pathway available in the market as assumed in rational choice models of human action. Variations and heterogeneity characterize strategic, operational, and organizational choices, even among firms confronting identical information and notions of profit opportunities (Dosi 1997, 1531; Metcalfe 1998, 35; Lamoreaux, Raff, and Temin 1999, 6–8). While most businesses adapt to the innovations of others, a few firms succeed in making choices that result in what Schumpeter described as creative responses in economic history. Swift and Dell are two such firms. empirical outlines Communications revolutions provided Swift and Dell with the technological tools to develop process innovations as the basis for profit making. While they used new transport and communications systems in conceiving new products, the innovative advance of both firms was the creation of organizations not only for producing but more importantly for distributing these products. Swift and Dell learned to deploy the technologies of communications revolutions in essentially becoming innovative logistics firms. In both cases, transformation into logistics-oriented enterprises was driven by a strategic vision of profit-making opportunities existing in a more direct relationship to the final customer. Such a shift in outlook derived from an understanding, however vague initially, of the potential for new communications systems to help forge this more direct route to the customer and bypass intermediaries entrenched in the two industries. The direct systems of marketing created by Swift and Dell served as their primary source of profit. Operationally, this direct route posed enormous challenges for the two firms. To solve the problems of making and marketing mass-produced fresh beef and Internet-customized mass-produced PCs and reaching the final customer in a more direct way, Swift and Dell had to reinvent logistics systems for the entire circuit of procurement, production, and distribution. This process of discovery occurred in both cases through experimentation and use—learning by “using.” In this learning process, resolution of one problem invariably uncovered other logistical difficulties that both firms had to overcome in moving toward a final and workable operational and organizational design.8 The outcome of this learning process was an enhancement of organizational capabilities and creation of enormously innovative logistics systems for mass-producing and mass-distributing products directly to buyers. These process-oriented innovations not only succeeded in establishing new standards of competition and new pathways of profit making in the meatpacking and PC industries. The innovations of both companies also diffused

Introduction 17

across different economic sectors, resulting in new patterns of growth and development throughout the economy. In both cases, communications revolutions—the rail and telegraph and the Internet—played pivotal roles in securing this innovative pathway of distribution to the customer. Organizationally, this direct path to the customer assumed two outcomes. As they created high-volume direct organizations, Swift and Dell faced critical choices with respect to systems of coordination and control over adjacent steps in procurement, production, and selling. These choices centered on the degree to which firms absorb sequential operations in procurement, production, and selling and the degree to which they contract with other businesses in allocating these tasks. In the case of Swift, the route to a more direct relationship with the customer occurred through vertical integration. In the case of Dell, this route occurred through an interfirm structure of organization, but one with a level of functional and operational integration sufficient for Dell itself to refer to its own organization as virtual integration. In spite of these structural differences, the enterprises of the two firms share a fundamental attribute of coordination and governance. In both organizations, the market is not the mechanism of coordination for organizing adjacent steps of procurement, production, and selling. Instead, both Swift and Dell used forms of corporate power and administrative planning to coordinate and control the activities within their networks, both inside and outside the formal boundaries of the firm. Consequently, although their formal structures differ, nonmarket mechanisms of coordination and control are fundamental to both firms. These nonmarket mechanisms proved critical to Swift and Dell in forging their direct path to the customer and securing an innovative route to profit making. Territorially, the organizations of the two firms that emerged from a more direct engagement with the customer reveal a similar tendency to extend and concentrate circuits of procurement, production, and marketing in new ways. This geographical pattern of spread and concentration contributes to the formation of industrial districts—the creation of new industrial spaces—and is fundamental to the process of innovation and capitalist development. As firms seek innovative modes of accumulation and acquire the organizational capabilities to implement these innovations, they reshape the territorial theaters in which the accumulation process takes place. In this context, firms, through planning and power, reconfigure landscapes of economic geography. They create differently ordered relationships of proximity between various economic assets under their control, both inside and outside their own boundaries, and recast flows of economic activity connecting these assets. Such reconfiguring is critical in implementing new and innovative economic routines and mastering the novel demands of time and space embedded in these innovations. This pattern of spread and concentration,

18 Introduction accomplished through the power of agency within the firm, links the experiences of Swift and Dell across time. Nevertheless, the two organizations and the territories they exploit reveal a paramount difference. The vertically integrated organization of Swift spreads and concentrates its innovative logistics activity over a fundamentally continental market space. The interfirm organization of Dell extends and concentrates its innovative logistics activity over a global market space. Whereas Swift played a central role in helping to articulate a unified national market, Dell is creating production complexes helping to articulate an emerging system of globalized markets. The organization of Swift consisted of three primary nodes: (1) stockyard facilities, where cattle supplies were stored and where Swift secured its cattle raw materials; (2) disassembly facilities, located immediately adjacent to the stockyard sources of supply; and (3) branch distribution houses, located throughout the country, where the firm shipped its product in order to supply retail butchers with fresh beef. In learning to coordinate the activity between these nodes and reach the customer directly, Swift created an early type of direct-pull just-in-time system of production and distribution. Orders taken at branch houses from retail butchers were telegraphed daily to Swift headquarters and provided the source of demand for procurement of cattle supplies. Stockyards served as warehouses for inventories of cattle supplies that Swift would purchase and “pull” into slaughtering plants for disassembly in accordance with orders received. In this way, Swift created an early, if rudimentary, form of product customization and differentiation on the basis of standardized cattle grades and cuts. Cattle pulled into slaughtering factories on the basis of order demand were butchered and sent to branch houses, where the various cuts and grades requested by retail butchers were distributed. One of the most critical core capabilities of this direct-pull system mastered by Swift was the balancing of supply and demand in close to real time, made possible as a result of the railroad and telegraph. Spatial proximity to raw material inventories was critical to the directpull system of production and distribution pioneered by Swift. Slaughtering facilities were located by the company adjacent to stockyards in a configuration linking sources of cattle supply and cattle disassembly. These slaughtering facilities, opened by Swift at other stockyard sites in the Midwest, represented new points of concentration in beef production and distribution. Branch houses, on the other hand, dispersed the product over a wide territory. In this way, territorial spread and concentration coexisted as part of Swift’s profit-making enterprise while Swift acted as the agent in configuring these relationships. As it built this national network of slaughterhouses and branch houses, Swift integrated into its own organization virtually all of the steps from pro-

Introduction 19

duction to final marketing of fresh beef and coordinated these steps through internal systems of administrative planning. In assuming ownership of these various functions, Swift eliminated—disintermediated—a large layer of the traditional wholesalers in the beef trade, enabling the firm to forge its more direct path to the buyers of beef. This organizational innovation of disintermediation is what provided the direct path to the customer. It was also the foundation of the company’s direct-pull system and its source of competitive advantage. The railroad and telegraph provided the infrastructure for coordinating this direct-pull production-and-distribution system built on disintermediation, territorial spread, and concentration. Dell’s production-and-distribution organization also consists of three primary nodes: (1) assembly plants, where Dell configures finished systems; (2) supplier factories, where components are manufactured; and (3) supply logistics centers (SLCs), located next to assembly plants, where components are stored as inventory. In learning to coordinate the activity between these three nodes and reach the customer directly, Dell, much like Swift, has successfully eliminated layers of traditional intermediaries and has created what is arguably the most innovative direct-pull just-in-time system existing in the world today. Customer orders processed through the Web initiate a process of pulling only those components from supply logistics centers into Dell assembly sites needed for configuration into finished products to fulfill orders received. Supply-and-demand balancing and the direct closed-loop relationship to the customer are the foundations of this just-in-time pull system and the source of the company’s competitive advantage over other PC firms. The Internet provides the infrastructure to forge this direct path to the customer and undertake the challenge of balancing supply and demand in real time. Like Swift, Dell is compelled to organize critical relationships of territorial proximity between its assembly operations and its sources of component supply in order to manage the logistics of its just-in-time direct-pull system. As a consequence, Dell has established supply logistics centers, where components are stored as inventory within twenty minutes’ driving time of assembly facilities at each of its six different computer assembly locations. Suppliers, through third parties, operate these warehouses and assume the inventory and carrying costs. In these warehouses, components originating from supplier factories located throughout the world are stored and “pulled” into Dell’s assembly plants as they are needed on a just-in-time basis. Internet messaging between Dell, supplier factories, and SLCs is the foundation of this direct-pull system. The virtually integrated organization of Dell, built upon relationships of cooperation and power, is the agent for implementing these relationships of proximity. Although formally separated from the suppliers in its network and

20 Introduction dependent on the external capabilities of other firms to help produce and deliver its products (Langlois 1990, 1992b), Dell is nevertheless compelled to enforce certain types of control over these other companies to ensure that its just-in-time system operates efficiently. As a consequence, Dell establishes these relationships of proximity organizationally, through mechanisms of administrative control, with its suppliers and network partners. Territorial relationships of proximity, created organizationally through virtual integration, are among the most critical value-creating assets in the Dell organization. Dell has extended and decentralized this direct-pull just-in-time production-and-distribution system across four continents. At the same time, the PC maker has chosen six regional locales in which to concentrate these operations. Global spread, regional concentration, and localized relationships of territorial proximity form a patterned geography of just-in-time production-and-distribution complexes fused together through Internet communication and virtual integration. Parallels in operational routines, organizational control, and territorial reconfiguration created by Swift and Dell are neither imaginary nor accidental. In very different historical contexts, Swift and Dell confronted similar underlying problems related to issues of control and coordination in the search for competitive advantage. The disruptive capacity of communications revolutions enabled both firms to discover profit-making opportunities in recasting the logistics of production and distribution and controlling these logistical routines in new and innovative ways. This study seizes upon patterns in this route from communications revolutions to innovation in routines and systems of organizational control to territorial reconfiguration in an effort to uncover underlying rhythms in capitalist development.

Why Swift and Dell? Despite the years that separate them and the different products that define them, both Swift and Dell reveal stories with striking symmetries that link communications revolutions and business innovation across time. First, Swift and Dell are comparable as two of the most innovative firms in their respective time periods. Both began as upstarts in industries with much larger, well-established companies. Both succeeded in outcompeting their older, larger rivals and transforming existing business practices in their respective industries. Both used breakthroughs in transport and communications to create process innovations linking procurement and manufacturing to distribution systems for reaching the final customer directly. These innovations redefined standards of competition in the meatpacking and personal computer industries as well as other industries in the economy of their respective periods. The organizations pioneered by Swift and Dell are, in ef-

Introduction 21

fect, paragons of innovation deriving from communications revolutions, one born with the rail and telegraph economy, the other the progeny of the Internet economy. Other similarities also link the innovations of these two companies. While dressed beef and personal computers may appear oddly matched, the two commodities actually share common attributes. Although they had already emerged as new products when Swift and Dell began to do business, both firms succeeded in transforming these products through new systems of distribution. As a result of the innovations in production-and-distribution networks, both products became accessible, affordable, and mass-consumed. Perhaps most important, however, dressed beef and custom-created personal computers share a fundamental attribute as “perishable” goods. They have a limited shelf life, after which they start to devalue and essentially spoil. This shared quality of perishability played a decisive role in motivating both Swift and Dell to transform the channels of distribution in the beef and PC industry and develop their innovative organizations for making and selling these products. The Swift case covers the initial years of the company from 1875 to roughly 1903. These dates encompass two significant developments in the American economy. First, this period witnessed the completion of a nationally integrated and standardized rail and telegraph infrastructure in the United States. Second, this period marked the appearance of the mass-production economy and the large-scale integrated industrial corporation connected to new production-and-distribution systems pioneered by firms such as Swift. Infrastructure, firm structure, and market structure evolved together during this period. The year 1903 as an end point is also not arbitrary. As the culmination of the first great merger wave in American history, this date, in most accounts of the period, brings the initial heroic period of the massproduction economy to a close. Whether by chance or fate, it also marks the date when Swift surpasses all of its competitors and becomes the largest meatpacking firm in the country and even the world. The Dell case covers the firm from its founding in 1984 and carries the story forward to late 2001. These dates also frame two critical developments. First, this period witnesses the creation of a mass market for the personal computer. Perhaps more significantly, the latter years of this period mark the development of the Internet as a communications and commerce system. Similar to the advent and expansion of the rail and telegraph, the emergence of the Internet as a commerce system has enabled firms to use the new infrastructure for producing and selling goods and services and coordinating business operations in entirely new ways. Dell has managed to reorganize its business model for producing and selling PCs in responding to the opportunities presented by the Internet. Much like Swift, Dell has used the new

22 Introduction technology to assume a position of first rank in its industry. The end point in this story of Dell is also not arbitrary. It was in 2001 that Dell ascended to the position of the largest PC firm in the world. Finally, the choice of Swift and Dell as case studies is the result of unique research opportunities presented by the two firms. Surprisingly, while there are a number of studies on meatpacking in the late nineteenth century, notably the work of Mary Yeager (1981), Margaret Walsh (1982), and Louise Carroll Wade (1987), and numerous references to the innovations of Swift in both general and specialized economic histories of the period (Chandler 1977; Cronon 1991), there is only one scholarly work on the firm of Swift itself, a dissertation written fifty years ago (Unfer 1951).9 The present study revisits these works along with primary material on Swift in an effort to uncover how the company created its pioneering dressed beef network from the rail and telegraph and the economic development impacts of this innovation. Dell, on the other hand, presents a different type of opportunity. With its modest beginnings and meteoric rise within the PC ranks, Dell has generated a type of modern business folklore. As a consequence, the company has garnered a large following in the business and trade press during the past five years. CEO Michael Dell added to his firm’s reputation with his own book about Dell and the business model he created (Dell and Fredman 1999). A plethora of how-to books on “business the Dell way,” mostly repeating insights from Dell’s own book, have followed (Saunders 2000). There is, in effect, an abundance of available information on the firm. Nevertheless, there are few scholarly studies of Dell (i.e., Curry and Kenney 1999; Kenney and Curry 2000a; Kraemer, Dedrick, and Yamashiro 1999; Albers 2000; Kraemer and Dedrick 2001). With the exception of the study by Toni Lynn Albers, who worked as an intern at Dell, these works reveal limited access to sources inside the company. As a consequence, much remains unknown about the specific mechanisms of Dell’s logistics-oriented organization. The present study overcomes this gap. Through interviews with Dell managers in supply chain operations, along with interviews with several key suppliers of Dell, this study provides an inside view of logistics at a firm shaping some of the most defining characteristics of economic globalization. Both familiar and new facts serve to position the two firms within an historically comparative framework. The comparison that follows reveals new insights about the two firms, the transport and communications systems they used, the innovations they created, and the past and present economies they helped to transform.

Introduction 23

Plan for the Book This study consists of three parts that follow this introductory chapter. Part 1, consisting of Chapter 2, establishes the theoretical framework for the study. This chapter critiques literature on innovation, business organization, and communications revolutions and from this critique sets out a taxonomy of the route from communications revolutions, to innovation within the firm, to organizational change, to territorial transformation. This taxonomy informs the comparison of Swift and Dell. Part 2, encompassing Chapters 3 and 4, focuses on the railroad and telegraph and the case of the G. F. Swift Company. Chapter 3 examines how rails and telegraphy created preconditions for Swift’s innovative enterprise in terms of the geography of markets and the pattern of urbanization during the mid to late nineteenth century. It outlines how the rail and telegraph system opened markets for more long-distance interregional trade and created a system of cities in which manufacturing and the consumption of manufactured goods became concentrated in large urban areas. Swift, in effect, not only relied on the rail and telegraph for the operation of its innovative organization but also built its organization from the interregional markets and entrepôts of consumption concentrated in cities that the rail and telegraph system helped to establish. Chapter 4 examines how Swift used the rail and telegraph infrastructure to create a mass-production and mass-distribution organization for fresh beef that revolutionized the meat industry. It analyzes how this innovation established new patterns of territorial development in the economy of the late nineteenth century that spread business activity nationally while at the same time concentrating development in new places, notably Chicago and other cities in the American Midwest. This chapter also examines how Swift was forced to confront the politics of interstate commerce in order to protect the far-flung market for beef it had engineered. Part 3, comprising Chapters 5 and 6, focuses on the Internet and the case of Dell Computer Corporation. Chapter 5 parallels Chapter 3, outlining how the Internet evolved from a communications system to an infrastructure for commerce and how the phenomenon of Internet commerce established the foundations for Dell’s innovative advance. Chapter 6, paralleling Chapter 4, examines how Dell is using the Internet to organize what is arguably the most innovative production-and-distribution organization of any current manufacturing firm. The research for this chapter focuses on the operational and organizational mechanisms Dell used to create its direct-pull procurement, production, and distribution organization and the role of Internet communication in providing the foundation for the innovative advances in this system. This chapter also describes the territorial outcomes of

24 Introduction Dell’s organization and how it has emerged as a paradigm of economic globalization. Chapter 7 subjects the two cases to comparative scrutiny, examining the innovations of Swift and Dell as uniquely tied to the two periods in question. At the same time, this chapter searches for common meaning in the innovations and enterprises the two firms created. This chapter adds to several current cross-disciplinary debates on the significance of the so-called information society, the nature of the firm and its relationship to innovation and economic development, the role of the business organization in the modern economy, and the role of logistics or, more broadly, the so-called sphere of circulation in production innovation and economic growth. In intervening in these debates and framing conclusions about the two cases of Swift and Dell, Chapter 7 also uncovers the meaning of the communications revolution from past and present. At the core of this revolution is a story of what occurs when the journey traveled by commodities from production to consumption assumes a different character and takes a different route. How fresh beef becomes mass-produced, travels across a continent in breaking the boundaries of localized markets, and in the end takes a more direct path in arriving at the butcher, and how the personal computer is custom-assembled in large volumes and travels across the globe in arriving on the desktop, and the economic development consequences of these routes, are the themes of the story that follows.

part 1

Theory

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chapte r

2

From Communications and Innovation to Business Organization and Territory A Synthesis

Such phrases as the Romantic Movement, the Mercantile System, and the Second Hundred Years’ War have been of real value in helping students visualize and coordinate historical movements and influences. If there were a board of historians empowered to pass upon such labeling, one might propose to them another phrase—the “Communication Revolution.” Robert Albion, 1932 Whenever the economy or an industry or some firms do something that is outside the range of existing practice, we may speak of creative response. . . . Creative response changes social and economic situations for good [and] is an essential element in the historical process. Joseph Schumpeter, 1947 Firms are not islands but are linked together in patterns of cooperation and affiliation. . . . Co-operation may come close to direction when one of the parties is clearly predominant. G. B. Richardson, 1972

From Communications to Territory Technologies of transport and communications play a central role in economic life. Alongside financial systems and energy systems, transport and communications systems provide the basic infrastructure upon which economic activity takes place (Horwitz 1989, 7). Transport and communications technologies shape the parameters of efficiency by recalibrating the costs of basic elements in producing, buying, and selling. These elements include securing information from the market on opportunities for, and risks of, engaging in economic activity; shipping products across distance as well as

28 A Synthesis within distances of close proximity; and communicating with other agents in and across markets on opportunities for, and terms of, business activity. Historically, new technologies of transport and communications have promoted more efficient types of economic activity by creating new and less costly systems of access for firms both across and within markets. Such different forms of access have reconfigured the territorial limits of markets, blurring the boundaries of once-separated market areas while reshaping the spatial relationships between economic actors and activities within markets. In these environments where the geography of markets gets reshaped by breakthroughs in transport and communications and possibilities for economic activity are redefined, firms are presented with opportunities to change the way they seek profit. Such are the basic outlines of the stories at Swift and Dell. During the last half of the nineteenth century and the final years of the twentieth century, rail and telegraph technology and Internet technology created communications revolutions that assumed the role of what Schumpeter described as “leading sectors” in the economy (Schumpeter 1939). More than simply high-growth industries, these lead sectors ignited more widespread patterns of innovation among firms in both periods. This pattern included more than new products and new production processes. Businesses used breakthroughs in transport and communications to reorganize the structure of the firm itself. They developed pioneering forms of industrial governance that resulted in entrepreneurial types of business organization. These enterprises, in turn, used the power of administrative coordination rather than markets in creating distinct geographies of profit making. This chapter develops a taxonomy of this route from communications revolutions to innovation, organizational change, and territorial transformation across different historical periods. This taxonomy reveals how the innovations of Swift and Dell are not random acts of individual initiative but instead are catalytic elements in a broader process of economic development understood in the context of three often-distinct literatures on innovation, business organization, and communications revolutions. What follows is a critical examination of these three lineages in which communications and innovation, business organization, and territory are synthesized and recast to create a framework for understanding the role of the innovative firm in the development of the capitalist economy.

Innovation and Technological Change It is indeed an irony how the notion of innovation and the idea of markets have somehow become inextricably linked. So strong is this association that

A Synthesis 29

according to orthodox economic policy prescriptions, creation of the latter begets the former. While it seems incontrovertible that capitalist development occurs through a market process punctuated by instances of innovation, it is also true that these two concepts, innovation and markets, in many ways share at best an uneasy mutual affiliation. That the capitalist economy is driven fundamentally by the process of innovation rather than an equilibrated allocation process of market clearing is perhaps the greatest legacy left to economic theory by Joseph Schumpeter. In contrast to neoclassical economists, Schumpeter insisted that the capitalist process was not one of equilibrium in which markets adjusted according to the price system and laws of supply and demand. Capitalism instead was essentially a disequilibrium system in a state of continuous turbulence, driven by the innovative activities of firms and individuals in creating new products and processes, new business organizations and markets. Schumpeter crafted his celebrated metaphor of “creative destruction” to describe this process of innovation and the disruptive impacts of these activities underlying this phenomenon. This view of the market and the development process placed Schumpeter outside the economics mainstream. Economists, he contended, erroneously visualized the fundamental problem in economics to be one of “how capitalism administers existing structures,” whereas, according to Schumpeter (1942), “the relevant problem is how it creates and destroys them” (p. 84). This destructive and creative process of innovation was unevenly spread over time, tending to occur in periodized clusters or waves. Such unevenness gave an historical dimension to both innovation and capitalist development. In his work on business cycles (1939), Schumpeter argued that the process of innovation, with its cycle of creativity by entrepreneurs and diffusion to other firms, accounted for the uneven historical swings of recession and expansion in the capitalist economy. Schumpeter’s preoccupation with the historical dimension of innovation and the economy was an ongoing theme throughout his later work (Lazonick 1990, 1994). In summing up his approach to the study of the economy, Schumpeter wrote how “the subject of economics is essentially a unique process in historic time.” Nobody can hope to understand economic phenomena, he argues, without “an adequate command of historical facts and an adequate amount of historical sense or of what may be described as historical experience” (Schumpeter 1954, 12). It was this integration of history that distinguished Schumpeter’s approach to innovation and economic development. Schumpeter, however, was not the first to embrace history as the foundation for understanding the economy.

30 A Synthesis schumpeter and the legacy of marx While Schumpeter’s work on innovation is highly original, it derives much of its influence from Karl Marx. Four themes stand out in Schumpeter’s theory of innovation and economic growth that reveal this influence: (1) the decisive role of technology in capitalist development, (2) the disruptive and revolutionizing tendencies of technological change, (3) the crisisprone character of capitalism, and (4) the historical character of technology and the economy. Schumpeter himself critically acknowledged this legacy of “Marx the economist” in framing his own fundamentally historical theory of innovation (Schumpeter 1942, 21–44).1 Aspects of Marx’s work are therefore a logical starting point for profiling Schumpeter’s views on innovation and development. Marx, in Schumpeter’s view, was the first of the classical economists to recognize the role of technological dynamism in the development of capitalism and the first to understand the role of history in influencing both technological change and economic development. Much as Schumpeter drew upon the neoclassical work of L´eon Walras to reveal how equilibrium models of commodity flows did not represent the historical process of economic development, Marx drew upon the classical economists, primarily Adam Smith and David Ricardo, in critiquing the absence of history in the economic orthodoxy of his own day. “Economists explain to us the process of production under given conditions,” Marx wrote. “What they do not explain is how these conditions themselves are produced, that is, the historical movement that brings them into being” (Marx 1847, 199). According to Marx, capitalism leads to an immense expansion in productivity because the system of private property rights, together with market competition, creates historically unique institutions that generate powerful incentives for firms to innovate and accelerate the process of technological change (Marx 1848; Rosenberg 1982a, 8). These institutions of private property, along with competitive markets and the incentives they establish, make the capitalist class the first ruling class in history whose interests are linked not to maintaining the status quo but instead to overturning it by developing new technologies as a source of profit and accumulation. Anticipating the now celebrated passage of Schumpeter on creative destruction, and providing insights about the current period, Marx observed that “the bourgeoisie cannot exist without constantly revolutionizing the instruments of production. . . . Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones. All fixed, fast-frozen relations . . . are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into air” (Marx 1848, 111). This view of

A Synthesis 31

the capitalist process as one of incessant innovation and disruption stemming from new technology had an unmistakable influence on Schumpeter. Marx employed a fundamentally historical method in accounting for new technologies. He ascribed the catalyst for technological change to growing markets beginning in the sixteenth century. Such widened markets provided the environment in which firms could exploit new technologies as a source of profit and accumulation. In this way, Marx was decidedly not a technological determinist (Rosenberg 1982a, 36–38). Far from assigning technology an autonomous and independent role in transforming the economy, Marx attributed changes in technology to the enlarged horizon of possibilities for profit created by ever-growing markets as the economy evolved from early manufacture to modern industry (Marx 1848). Once established as historical outcomes, however, new technologies emerge in Marx as a central element in capitalist development. The conflicts between technology as a productive force and the social relations of production in terms of ownership and control over technology and the surpluses generated from it are, for Marx, what drive the economy. Technology plays a critical role in this rhythm of development, but it is not some ineluctable force. Capitalists make choices to innovate in order to compete more effectively and accumulate profit. Nevertheless, Marx acknowledged that as technology changed in conjunction with market expansion so too did business enterprise. He had a theory of firm concentration in which competition, innovation, the cheapening of commodities, and the scale economies of large enterprise developed in an evolutionary way. What Marx understood as the tendency of technology to develop alongside the enlargement of the capitalist firm, however, Schumpeter took one step further in equating the phenomenon of innovation with oligopoly. In Marx, capitalist development, technological change, and transformations in the size and organizational structure of business establishments were all part of the same historically driven process. A similar story would be told by Schumpeter—but with important differences. innovation and entrepreneurialism While in broad outline Schumpeter accepted these key elements from Marx in creating his theory of economic development, he added a critical idea about the process of innovation that separated him from Marx—the idea of entrepreneurialism.2 Schumpeter also distinguished different phases of the innovation process itself. According to Schumpeter, innovation consists of three distinct moments—initial invention of new products, processes, organizations, and markets; commercialization of these elements; and finally diffusion of these elements to other firms. In conceiving of innovation as a series of historically conditioned moments, Schumpeter was interested first in differentiating the behavior of firms at each of the three phases. Second, he

32 A Synthesis was particularly intent on tracing how the responses of entrepreneurial firms to the profit-making environment resulted in new business routines that challenged existing business practice, diffused to other firms, and transformed the entire economic system.3 For Schumpeter, innovation was both artifact and impact. Central to Schumpeter’s theory of economic development is the creative act of entrepreneurs in commercializing new technology and, in the process, launching innovation (Schumpeter 1947). It was only an act of entrepreneurship that enabled technical inventions to emerge from obscurity and assume the role of commercial artifacts (Freeman 1991, 304). Schumpeter, however, defined this process of innovation broadly. He conceived of innovation as “the carrying out of new combinations” corresponding to the new products, new methods of production and distribution, new forms of business enterprise, and new markets associated by Schumpeter with technological change (Schumpeter 1911, 1942). Entrepreneurialism acts as a disruptive force in the economy, challenging the competitive strategies and behavior of existing firms. The relatively short bursts of technological creativity by entrepreneurs, however, engender longer periods of assimilation and adaptation marked by imitation and complementary types of innovation. This process of diffusion has profound consequences for the economy as a whole. It completes the pathway of creative destruction along which are the new products, new operational routines, new forms of business enterprise, and new markets where firms seek profit. Schumpeter observed how new technological combinations marking the process of creative destruction were distributed unevenly throughout the history of capitalism. Such combinations tended to cluster in “swarms” that marked the beginning of the growth cycle (Schumpeter 1911, 223). As the economy moves outward along a new production frontier owing to the expansionary effects of new technology, the economic rents accruing to innovators that ignite the growth process are eventually competed away as other firms adapt to and imitate new innovation. This leveling of profit rates then paves the way for downturn and depression. Far from repeating, however, these business cycles redefine the context for the next round of innovation, expansion, and contraction. From this notion of business cycles and technological clusters, Schumpeter arrived at a long-term view of capitalist development punctuated by distinct industrial revolutions separated in time.4 He dates the first industrial revolution from the 1780s to 1842. The second occurs from 1842 to 1897, while the third begins in 1898 and corresponds to Schumpeter’s own time. Although time-specific, these revolutions share common features of transformation that act as drivers of the capitalist process. Schumpeter actually referenced a key aspect of the nineteenth-century communications revolu-

A Synthesis 33

tion in coining the term “railroadization” to describe the pattern of economic change associated with these features (Schumpeter 1939, 304, 325–51, 72–192; Andersen 1994, 26–62). In focusing on the railroads to illustrate his theory of economic change, Schumpeter built a model starting with an equilibrated system of competitive strategies, routines, business organizations, and markets that is “disturbed” by the innovation of railway-based transport networks.5 This innovation in the transport and communications sector of the economy provokes responses by business users of this infrastructure. Entrepreneurial firms among these users develop strategies, routines, and forms of enterprise that challenge the products, processes, organizations, and markets of other firms. These innovators create a new cost and pricing structure for economic activity and, more important, new activity itself. These changes in costs, prices, and types of economic activity are the basis of what Schumpeter described as new production functions in the economy. In order to compete, other firms adapt to the innovative activity of entrepreneurs and the production functions they establish. The result of these innovative and adaptive activities is a broader process of economic transformation. Schumpeter, however, was far from a technological determinist. He conceded that entrepreneurialism in the railway sector, which ignited such broad-based changes in the late-nineteenth-century economy, had a political edge. The leadership within particular groups of rail builders and the relationship of these groups to local, state, and national political figures played essential roles in promoting the viability of the railroad as a profit-making venture. These alliances between rail entrepreneurs and their political backers are what secured for rail builders the land and the rights of way necessary for rail building to occur in the first place. According to Schumpeter, such relationships not only were critical in promoting railroad development. Railroad entrepreneurialism tied to politics is what enabled the railroad to act as a catalyst for economic development. As railroads expanded, they triggered a range of innovations in other sectors of the economy because of opportunities to get involved in business activities supported either directly or indirectly by government. In this way, industries tied to rail building such as steel making emerged, while others, such as mail coaches, became extinct. Furthermore, according to Schumpeter, railroads supported by government homesteading promoted economic development in regions of road building ahead of population (Schumpeter 1939, 327–30). In effect, the visualization by individuals and firms of financial gain from railroad technology was an insufficient condition for launching the new infrastructure. For Schumpeter, the process of railroadization was an entrepreneurial as well as a political phenomenon. Initially, Schumpeter interpreted innovation to be an entrepreneurial

34 A Synthesis function of individuals (Schumpeter 1911; Freeman 1994). Later Schumpeter conceded that the entrepreneurial function had become increasingly socialized within the large capitalist enterprise. From the vantage of the mid-twentieth century, it was these firms that created the new products, processes, organizations, and markets of capitalist development. His “creative destruction” was a process occurring within these enterprises. The question still largely unanswered by Schumpeter, however, focused on what was actually occurring inside these enterprises to promote the innovation process. innovation as learning What Schumpeter conceded to be a still dimly perceived problem inside the firm emerged somewhat more illuminated several years later with the revelation that the innovation process is essentially a learning process (O’Sullivan 2000, 407). In many ways, the source for this now commonly accepted connection between innovation and learning derives from the work of Edith Penrose. In this link, Penrose uncovered the source of growth within the firm and throughout the economy. For Penrose, growth revealed an evolutionary process, at the core of which was the cumulative expansion of knowledge within the business enterprise (Penrose 1959, xii). As a pool of human and material resources bound within an administrative framework, the firm promotes growth by learning to transform its resources into new profit-making activities, that is, different products, more efficient processes, and even new ways of manipulating the market environment to serve its interests (Penrose 1959, xiii). Growth occurs when knowledge is added to this base of resources, and the firm subsequently provides the market with new goods and services in fundamentally new ways. In accounting for the socalled residual in the growth process, that is, the increment of expansion not attributable to increases in production factors, Penrose uncovered in the learning process one of growth’s critical missing links. As with Schumpeter’s growth concept, growth is generated within the enterprise. Innovation resulting from new knowledge is the catalytic agent for this expansionary transformation. These insights have spawned a more recent literature on innovation focusing on how firms learn, how firms act when they acquire new knowledge, and how the economy develops as a result of this process of learning and acting differently.6 One of the most compelling theoretical and empirical problems explored in this literature is how firms, in learning to generate profit differently in a given market environment, transform such knowledge into new capabilities. How, in effect, does the firm assume a role as an innovative enterprise? This route to innovative enterprise is distinguished by three primary elements (Dosi 1997, 1532). It begins from an economic environment with op-

A Synthesis 35

portunities for firms to learn about new alternatives for making profit and sufficient incentives for firms to exploit these opportunities. Second, this route to innovative enterprise is marked by the effort of firms to act on new knowledge by seeking to master capabilities lying outside their established business practices. Finally, this route approaches completion as firms create appropriate organizational arrangements to implement innovative advances. The environments where this learning process occurs are historical creations. Often referred to as technological “regimes” (Nelson and Winter 1982) or technological “paradigms” (Dosi 1982, 1984; Perez 1983), these historically conditioned environments share similarities with Schumpeter’s technologically based industrial revolutions.7 They demarcate periods of capitalist development based upon aligned sets of technologies, markets, business organizations, and institutions. As conceived by Carlota Perez (1983), periods of capitalist expansion reflect “complementarity” between dominant technologies and the organizational and institutional framework, while periods of contraction create crisis that promotes so-called creative destruction (pp. 358–61). This rhythm of the business cycle and innovation is the foundation for paradigm or regime change. These historically created environments also circumscribe what firms are capable of learning during a specific period. Based on the attributes of technologies, markets, and institutions in existence at a given moment in time, regimes or paradigms condition the types of economic problems firms confront, and therefore what firms in a given period can create. Nevertheless, historically conditioned regimes or paradigms leave open various forms of technological novelty and learning from one moment to the next (Dosi 1997, 1531). When one form of technological novelty gains momentum and becomes generalized among a broad population of firms, the nature of the regime or paradigm shifts. The result is transition from one historically periodized industrial revolution to another. What launches this learning process leading to the enhancement of capabilities and organizational transformation is the search and selection by firms for more profitable economic routines (Nelson and Winter 1982). Conceived broadly, routines refer to the “technology” of the firm, or what is often described as “getting things done.” Modifying the technology of the firm through learning—changing routines—involves a shift in the capabilities of the business organization and a shift in the organizational structure of the firm itself. This creation of capabilities and organization is the essence of the innovative process. When the process of search and selection is carried out by innumerable firms in imitating an initially successful innovation and the initial innovation becomes generalized, the overall economy evolves and there is transition from one historically periodized industrial revolution to another. Consequently, the route from learning within individual firms to

36 A Synthesis the development of innovative capabilities throughout a generalized population of firms occurs as part of an historical transformation. Organizational learning involves an investment by the firm in reorganizing its resources (O’Sullivan 2000, 407). Such investment, however, exposes the firm to risk and uncertainty.8 Firms that commit to learning and enhancing capabilities confront the risk of having to forgo a measure of both the use and exchange value of these resources as they are redeployed as part of learning process. At the same time, they confront uncertainty of two varieties: productive uncertainty and competitive uncertainty (O’Sullivan 2000, 407). Productive uncertainty exists because firms committed to learning have to figure out how to develop the capabilities in which they are investing before these resources can generate more profitable returns. Competitive uncertainty exists because even if a business develops a new product or better process it may not be superior to that of a competitor pursuing an alternative approach. Consequently, a critical element of the learning process involves the assessment by the firm of potential outcomes stemming from investments to acquire new capabilities. Firms learn to assess such outcomes in a variety of ways (Pavitt 1992, 220–21; Dosi 1997, 1532). They learn from direct experimentation with new products, processes, and entries into new markets in a process encompassing trial and error; they learn from competitors and other businesses, such as their own suppliers; they learn from other organizations and institutions, such as universities and government; and finally they learn from unsuccessful efforts at solving problems and even by failing at such attempts. Seldom do firms understand fully the exact trajectory of where the learning process will take them. As Schumpeter himself acknowledged, innovation is often the outcome of action taken without a complete understanding of future results (see O’Sullivan 2000, 407–9). In solving one problem to enhance capabilities, firms normally encounter additional problems unforeseen at the beginning of the learning process. For this reason, firms in the course of learning are often compelled to solve contingent problems that arise only after certain other difficulties have been overcome. What differentiates firms is the degree to which they are able to develop the capabilities to achieve a set of outcomes foreseen from an innovative advance. This process of organizational coherence, or “integration,” is central to the creation of innovative enterprises (Lazonick and Mass 1995, xv). Through their own agency to learn and make choices about technologies for getting things done, firms create their own levels of coherence that establish this differentiation. These choices, however, do not derive from some omniscient understanding of the most profit-optimizing pathway available in the market as assumed in rational choice models of human action. Firms seek solutions to problems and select alternatives for competing on the basis

A Synthesis 37

of imperfect knowledge about profit opportunities and an incomplete picture of the technological solutions available for pursuing these opportunities (Dosi 1997, 1531–32; Lamoreaux, Raff, and Temin, 1999, 6–8).9 This imperfect knowledge gives rise to variation in the choices firms are likely to make regarding strategy, routines, and organization. While business firms exist in the same world, they see the world differently, and they learn different things from the same world. As a result, they make choices that are not programmable but instead are highly contingent (Metcalfe 1998, 35). Some firms achieve much higher levels of learning and coherence than others. At the same time, the selection of competitive strategies, operational routines, and forms of business organization is not random. Because firms compete in historically conditioned environments, they make choices from a range of options that derive from such environments. Thus, while the parameters for the choices of firms are historically created, firms exercise agency in making their selections (Yates 1997).10 These choices drive the economic development process (Nelson 1998, 322). They not only provide the basis for innovation in the economy but also are the mechanism by which the innovation process diffuses, spreads, and transforms patterns of economic development. innovation as inducement While the literature on innovation as learning provides an analytical route from the microactivity in the firm to the increasing returns generated from new capabilities, it is less precise in specifying what in the market environment is providing the catalyst for acquisition of new knowledge. Here, as Giovanni Dosi (1997) insists, a valuable link may be made with the growth literature on inducements to innovation. From this perspective, innovation results from the responses of firms to specific transformations in the market environment. Changes in market demand, factor prices, even new technologies act as inducements on firms to compete in new ways. As a consequence, firms, in seeking the profit opportunities from different circumstances, learn new things and alter the supply of knowledge in the economy. The outcome of such collective organizational learning is innovation and growth.11 Inducements to growth and innovation, however, are not limited to changes in demand, prices, or technology. Inducements—as well as constraints—to innovation also exist outside the formal boundaries of the market within the realm of politics and institutional settings (Christopherson 1993; Zysman 1994; John 1998). Accordingly, innovation is more than a process of knowledge acquisition to alter routines for accumulating profit. Innovation involves the interaction of the firm with systems of economic rule making established through politics and structures of power related to

38 A Synthesis conflict and consent among groups and classes. Innovation, in effect, has two components (Mokyr 1990, 11): (1) an epistemological component involving the acquisition of knowledge and its transformation into new capabilities; and (2) a social and political component involving the influence on firms of institutions and the power struggles within society and within the firm itself. Such influences shape firm behavior and thus affect technological outcomes. This second dimension of innovation, according to its adherents, has been subordinated to the perspective on innovation as learning (Hughes 1983, x). For this group the learning environment is a product of politics, institutions, and struggle. Two closely related approaches to technological change, namely “contextualism” (Hughes 1983) and “social construction” (Bijker, Hughes, and Pinch 1989), seek to remedy this omission of politics and power relations.12 The model of innovative advance found in contextualism and social constructionism borrows certain features from Schumpeter, namely the ideas of invention and diffusion (called “transfer” in the social construction literature). To these two concepts, however, Thomas Hughes (1983) and Wiebe Bijker et al. (1989) add the notions of “reverse salients” and “momentum.” According to Hughes, reverse salients refer to critical technical problems where the line of innovative advance encounters bottlenecks in the form of knowledge gaps that if left unresolved preclude innovation (Hughes 1983, 14–17). For social constructionists, reverse salients also refer to constraints on innovation emerging within the social and political environment ranging from opponents of technological change including labor, to rule-making environments that create legal barriers to change. Critical to this group of theorists is the actor network, the medium through which individuals, groups, and classes interact and struggle with each other and through institutions to shape innovative outcomes according to their interests. Momentum refers to the phase in the innovation process when the problems of reverse salients are confronted and resolved, enabling innovation to strengthen. Central to this phase is the resolution of power struggles within actor networks, the outcome of which enables certain actors and groups with particular technological interests to prevail. Winners can choose to promote, thwart, or redirect the trajectory of innovation. Actors that prevail in these contests for power use the rule-making authority of politics and institutions to legitimize the chosen technological pathway corresponding to their interests. The critical aspect of this approach is that innovation is a contingent process shaped by choices, politics, struggles, and power.13 With similar concerns, but placing a greater emphasis on history, is a group of scholars who critique the idea of innovation as an outcome of the search for efficiency (Berk 1994; Roy 1997; John 1997; Sabel and Zeitlin 1985). Far more central than “the logic of efficiency” in understanding innovative outcomes is the role of politics, institutions, and relations of power. Equating

A Synthesis 39

innovation with efficiency, they argue, is akin to an ex post vision of the innovative process that suffers from what they insist is technological determinism. Moreover, they contend such arguments about innovation cast in the logic of efficiency are essentially restatements of neoclassical economic models. Innovation in these models is the result of efficient allocative outcomes. This overly determined, neoclassical vision of economic activity, they insist, has been overlaid upon the historical process and, much like neoclassical models, omits any substantial role for institutions, politics, and power struggles in the economy.14 Similar to the contextual and social constructionist approaches, these scholars seek to tell a story in which innovation, when it occurs, is induced and constrained by the social and political environment. Inducement is also the underlying theme in depictions of innovation as the outcome of the contentious relations and unequal power between workers and management. From this perspective, innovation is the result of class conflict and the ongoing efforts by management to gain greater levels of control over workers and work (Marglin 1974; Noble 1984). In pursuit of this aim, management searches for new technologies that empower managers with enhanced capabilities to reorganize work more efficiently with less resistance from workers. For their part, however, workers are endlessly seeking ways to resist these encroachments of management (Burawoy 1979). In this way, this interplay of managerial power and worker resistance induces continuous innovative advance. Finally, if conditions in the environment are what induce firms to learn and expand capabilities, then some of the most critical inducements to learning are the external economies and networklike interactive relationships of firms in so-called milieux of innovation or learning regions. Inspired by the insights of Alfred Marshall, this view of the innovation process derives from the observation that innovation tends to concentrate geographically in certain regional economies. In these place-based concentrations of economic activity emerge the interactive network relationships within and between firms that provide firms with the external scale economies—Marshall’s “mysteries in the air”—from which firms learn and innovate and from which regions become differentiated (Saxenian 1994).15 In this way, changes in the economic environment and conditions of concentration in the environment induce the process of learning within firms. The innovative enterprises that by definition are the agents of this growth process are also, it turns out, transformed by it and assume identities as new business organizations. The idea of innovation as inducement complements the idea of innovation as learning by emphasizing that the learning environment itself is circumscribed by the influence of politics, institutions, and power on the actors involved in economic activity. What firms learn and what they are able to implement is not the outcome of a mechanical functionalist process. Learning

40 A Synthesis by firms and the creation of new capabilities is a contingent process in which an innovative advance emerges under the influence of economic rules, institutional legacies, and the contested interests of different political, organizational, and class actors.

The Firm as Business Organization Business firms create forms of organization in the course of seeking profit. As firms learn about new ways to accumulate, they not only transform their routines for producing, buying, and selling. Firms reorganize to implement these new routines. In this way, organizational transformation is an integral part of the innovative process. This relationship between innovation and organizational change has its origins in Marx and Marshall. It also has a more recent lineage. In the late 1920s, economist Allyn Young (1928) observed that the marketplace consists essentially of “productive activities tied together by trade” (p. 533). He used this characterization as a starting point to determine how the relationship between the market, the division of labor, and innovative methods of production produces increasing returns and economic growth. His aim in revealing the outcome of this relationship was twofold. First, he wanted to demonstrate why forces counter to economic equilibrium “are more pervasive and more deeply rooted in the economic system” than is commonly realized (Young 1928, 533). Second,Young wanted to show how external economies, deriving from the extent of the market and the division of labor, provided the source for what he metaphorically termed “roundabout,” or innovative methods of production. In this effort, he not only drew upon the seminal insight of Adam Smith linking growth to the interplay of the market and the division of labor.Young also seized upon the observation made by Marshall of the business firm as a unit of organizational change and used this characterization to argue that innovation and economic progress derived from the capacity of firms to evolve in conjunction with changes in the market environment. Emerging from Young’s synthesis of Smith and Marshall is a marketplace of business firms evolving in organizational structure as they seek roundabout methods for producing and trading in an effort to generate increasing returns. While Young’s article provided a dynamic, even evolutionary view of economic development, his approach focused more on the aggregate economy than the business activity of individual firms (Lazonick 1991a, 294–95). It was Ronald Coase (1937), who, in a highly original article written roughly ten years later, asked a fundamental question about the nature of the firm that provided a critical theoretical insight on firms as forms of business organization. The issue that interested Coase was why and under what cir-

A Synthesis 41

cumstances a firm would choose either to produce on its own or purchase a given input in creating a product or service. “To make or to buy” was the essence of this choice. As a practical matter, in exercising this choice firms decide on the extent to which they internalize adjacent steps of producing, buying, and selling and the extent to which they contract with other firms in undertaking these activities. Such decisions situate firms along a continuum of discrete alternatives framed at each end by two basic types of business organization: intrafirm organization, in which the firm is highly integrated, and interfirm organization, marked by interactions among separate firms on the basis of price signals coordinated in markets. What Coase sought to uncover was the condition under which firms make the choice to internalize certain activities through planning and administrative coordination or contract with other firms through the price system, and the impacts of these choices on forms of governance and the boundaries of firms. integrated firms, intrafirm organization As a starting point in addressing this puzzle of organization, Coase imagined an economy “under no central control,” but unlike Young he focused his analysis on the individual firm in seeking to identify how the functions performed by firms are divided up among and between them. This issue led Coase to pose three basic questions: (1) When do firms produce for themselves internally, and when do firms purchase from other firms? (2) What types of economic organization derive from these decisions to make or buy? (3) What determines which activities a firm chooses to do for itself and which it procures from others? Coase, in effect, sought answers to why firms exist, what determines their internal organization, and what determines their boundaries. These questions, in turn, led Coase to address the puzzle of why, when there is a price mechanism for securing all goods and services in a specialized exchange economy, there should be any economic organization— that is, firms—at all (Coase 1937, 388). To solve this problem, Coase observed that the economy, although absent a central control, is only partially coordinated by the price mechanism. Firms employ a different organizing principle in which “conscious power” or planning is used to allocate resources. “If a workman moves from department Y to department X,” argued Coase, “he does not go because of a change in relative prices, but because he is ordered to do so” (Coase 1937, 387). Coase equated this power of planning to “entrepreneurs” and distinguished their activity of coordinating the operations of the firm internally from the activities of firms transacting through the price system. In the economy, he observed, “price movements direct production which is coordinated through a series of exchange transactions on the market.” In the firm, by contrast, “these market transactions are eliminated and in place of the complicated

42 A Synthesis market structure . . . is substituted the entrepreneur co-ordinator, who directs production” (Coase 1937, 388). For Coase, internalizing these transactions within the firm, and transacting in the market with other firms through the price system for the same goods and services are the two alternative methods for coordinating economic activity (Coase 1937, 387–89). For the answer to his central question of why there are firms, Coase proposed that there are costs to firms—transaction costs—of using the market and the price system to exchange goods and services. When the costs of coordinating transactions internally are less than the costs of using the market and the price system to transact for these items, the firm absorbs the activities represented by these transactions into its own organizational structure. As a consequence, the firm becomes more integrated and less reliant on the marketplace to secure the items needed to create a product or service. For Coase, a firm has a role to play in the economy if “transactions [can] be organized within the firm at less cost than if the same transactions were carried out through the market.” Firm boundaries are also established through this same mechanism of choice deriving from the costs of transactions. The limit to the size of the firm is reached “when the costs of organizing additional transactions within the firm exceed the costs of carrying out the same transactions through the market” (Coase 1991, 48). Managers of firms, he claimed, are preoccupied with the single overriding concern of transaction costs in calculating the trade-offs of using the market or absorbing business activities internally (Coase 1937, 404).16 This singular focus with transaction costs, however, compelled Coase to ignore other critically important aspects of business organization. Coase rejected a role for technology in the organization of the firm (Williamson and Winter 1991, 4). Coase also did not view politics, or contingencies in the historical process itself, as influential on the organization of the firm. His model is abstract and ultimately ahistorical (Lazonick 1991a, 195). Despite these omissions, in his 1937 article, Coase produced a seminal work with an enduring legacy. In posing basic questions about the structure of enterprise, he provided a theoretical starting point to account for the organizational variation in firms. He found in transaction costs a compelling, if one-sided, explanation for why firms were vertically integrated or why they interacted with other firms across markets. Coase’s pathbreaking approach to the nature of the firm, though surprisingly neglected for many years, has nevertheless provided the motivation for more recent theory on firms as forms of organization, most notably in the work of Oliver Williamson (1975). Starting from Coase’s dichotomy of the way firms either internalize transactions or transact through the market, Williamson used transaction costs to account for firms as representative of markets and hierarchies. Market-oriented firms were those that used the mar-

A Synthesis 43

ketplace to transact with other firms for inputs to make goods or provide services. These firms would also transact with other firms to distribute and sell their products and services. Hierarchies, by contrast, were those firms that assumed ownership over the input activities, the productive activities, and the marketing activities in creating and selling a product or service. Hierarchies, in effect, assume ownership and control over large portions of procurement, production, and distribution and are the equivalent of Coase’s directing “entrepreneur.” What Williamson did that differed significantly from Coase, however, was twofold. First, unlike Coase, Williamson proposed that transactions and transaction costs not only exist in market exchange but are also part of the operations internal to the firm. Consequently, transactions for Williamson exist both within firms and between firms contracting across markets. Costs of transactions result from uncertainty in exchange, which arises from three primary sources: (1) the self-interested opportunism of other parties to the transaction, that is, the potential of a party to a transaction to lie or cheat; (2) incomplete information or bounded rationality regarding the parameters of the transaction; and (3) asset specificity, that is, whether an asset necessary for a certain type of activity can be secured and controlled and whether such an asset can be redeployed for other use. The choices of firms to transact through the market or internalize transaction activities derive from their efforts to minimize the costs of these uncertainties. For Williamson, minimization of the uncertainties related to opportunism and bounded rationality suggests organization of transactions through markets. By contrast, minimization of the uncertainty related to being without assets necessary for a certain type of transaction or possession of assets without alternative uses compels firms to remedy such problems through integrated and hierarchical organization. Although Williamson accounts for three basic conditions that affect transactions costs, it is asset specificity upon which his predictive theory of organization hinges (Lazonick 2002, 11). Specifically, Williamson hypothesizes that “market contracting gives way to bilateral contracting which in turn is supplanted by unified contracting [hierarchical organization] as asset specificity progressively deepens” (Williamson 1985, 78; see also Lazonick 2002, 11). Second, unlike Coase, Williamson tested his approach to transactions costs and organization in actual historical situations. He was especially interested in the formation of corporate hierarchies and the process of vertical integration in the United States during the late nineteenth century. In this sense, Williamson’s interest in history aligned his work with Alfred Chandler’s approach. Nevertheless there is at least one important difference between the transactions-cost approach to firm structure elaborated by Williamson and the strategy-and-structure approach to the organization of the firm pioneered by Chandler. This difference focuses on the issue of the

44 A Synthesis relationship between innovation and organization. As Williamson concedes, the introduction of innovation complicates the assignment of transactions to markets and hierarchies (Williamson 1985, 143; see also Lazonick 2002, 13). It was Chandler who would more systematically make this connection between innovation and technology on the one hand and business organization on the other. For Chandler, the strategy of the firm, deriving from an “awareness of needs and opportunities created by a changing economic environment,” fundamentally influenced the structure of the firm, defined as the “design of organization through which the enterprise is administered” (Chandler 1962, 14).17 Beginning in the second half of the nineteenth century, the appearance of the vertically integrated enterprise reflected new strategies developed by management to produce and market goods in high volume. Through such strategic and organizational adaptations, management created what Chandler describes as “economies of speed” in an effort to achieve high-volume throughput. It was the ongoing efforts of firms to master economies of speed and high-volume production and marketing that account for the tendency of vertical integration to assume a dominant role in the organizational structure of late-nineteenth-century business enterprise (Chandler 1977). According to Chandler, there were good reasons for the link between the size of the firm, the volume of throughput, and the speed at which goods were produced and sold. Faster, high-volume throughput hinged on uninterrupted sources of supply and unimpeded sales of finished goods. Such requirements implied that functions once mediated by different firms using the market mechanism began to accumulate within the boundaries of a single firm using the “visible hand” of management (Chandler 1977). This form of administrative planning provided better forms of coordination between inputs and output in the environment of high volume and economies of speed. In addition, the need for management to secure more predictable sales outlets for the higher volumes of throughput, coupled with antiquated distributions systems, pushed numerous firms into marketing activities and forward integration. In this way, the strategy of the firm became linked to organizational structure through innovation that transformed production and distribution.18 In Chandler’s view, communications and transport technologies figured prominently in the emergence and development of this new business institution (see “Communications as Catalyst and Carrier Wave” below). The rail and telegraph system helped integrate formerly isolated localized markets into a geographically extended national market while at the same time concentrating market demand in cities. This market structure, in turn, created a new set of strategic opportunities for the firm. In the wake of more

A Synthesis 45

extended markets and mass markets in cities, producers had incentives to expand volumes in order to service this more extended and concentrated national market space. Rails and telegraphy furnished producers with the reliability and speed necessary to coordinate flows of supplies and finished goods long distances, as well as to and from urban factories in sufficiently high volumes to service this new market structure. As a consequence, firms became larger to take advantage of scale economies and assumed new capabilities in coordinating larger flows of inputs and outputs. Business firms also integrated backward into raw material suppliers and forward into marketing to sell their finished products. In Chandler’s model, changes in technology and markets created a new strategic orientation for producers based on high-volume throughput. Drawing upon Max Weber and Schumpeter, strategy became structure in the form of the vertically integrated, administratively coordinated intrafirm business organization. Chandler argued forcefully that the large corporation, coordinating its activity through internal administration rather than market transactions, was a more efficient form of business organization than the small-scale proprietary firm coordinating its activity through markets. Contrary to the claims of his critics, however, Chandler did not insist that the integrated corporation reflected an innately superior form of organization in economic life. His work seeks to explain the ascendancy of the vertically integrated firm in the American economy in a particular setting—the period of 1870 to 1920. For Chandler, this form of enterprise emerged around an historically conditioned set of efficiency objectives—economies of speed and economies of scale—that became realized through management control and vertical integration. It prevailed during the period for this historically specific economic reason.19 interfirm organization Ironically, when Chandler’s Visible Hand appeared in 1977, the large-scale, vertically integrated corporation appeared to be suffering the first serious challenge to its hegemony as a profit-generating institution since its initial creation in the late nineteenth century. Beginning in the early 1970s, large corporations in the industrial countries, especially in the United States, exhibited a precipitous decline in profitability that continued into the 1980s (Harrison 1994, 125–27). At the same time, a range of new firms, mostly from Japan but also from other countries in East Asia, along with smaller, more entrepreneurial firms, emerged as serious competitors to these previously formidable corporate organizations. Associated with a phenomenon described as the new competition, these firms were distinguished by their market-shaping, as opposed to market-reacting, behavior (Best 1990, 11). Interestingly, the economic challenge to corporate America represented by

46 A Synthesis Japan came from firms that were seemingly even more highly integrated than American companies. These Asian firms actually helped provoke this profit crisis by exposing the complacency and uncompetitive character of their once dominant American counterparts. The Japanese keiretsu and the Korean chaebol were business organizations integrated both vertically and across sectors, including finance (Gerlach 1989; Amsden 1989). Eschewing forms of market exchange, the keiretsu and the chaebol organized their business operations through tightly coordinated and highly administered relationships. In many ways, these organizations were the quintessential embodiment of the “visible hand.” Nevertheless, a very different story of this challenge—and one that has had a more enduring impact owing to the eventual slowdown and sustained malaise of the Japanese economy—has emerged with a focus on a far different organizational phenomenon. In this interpretation, the role of the large firm in economic development was being undermined by examples of place-based innovation deriving from clusters of medium-sized and even small firms, notably in Italy, Germany, and the United States. Such examples suggested the possibility of alternative models of economic growth and development to those driven by large-scale integrated enterprises. Together, this decline of large firms and the allure of alternative growth models based on clusters of smaller companies created what appeared to be a new environment for competing. By the mid-1980s, this change was apparently so pervasive that Michael Piore and Charles Sabel, in an influential book (1984), argued that the capitalist economy had arrived at what they termed a second industrial divide. Piore and Sabel compared this historical conjuncture to a similar moment during the previous century when mass production emerged from craft production. In the divide of the 1980s, however, the strategy that they advocated for relaunching growth was based upon a vision of transition to smaller— and more importantly—more flexible forms of business enterprise (Piore and Sabel 1984, 6). Not only did they find inspiration for this vision in certain industrial communities of craft production in the nineteenth century that, in their view, represented historical alternatives to mass production.20 Piore and Sabel were also able to reference the existence of smaller and medium-sized firms clustered in numerous place-based industrial districts as the living seeds of the new industrial order. What distinguished these communities, both past and present, were networks of firms based on relationships of cooperation and competition. Regardless of whether their vision was viable, Piore and Sabel had uncovered in these networks of firms an emerging trend in economic and organizational development. Following in the wake of Piore and Sabel’s book was an enormous amount of new theorizing about interfirm networks as a new form of business enterprise.21

A Synthesis 47

Much of this theorizing about regionally concentrated networks of firms derived from two overlapping convictions. First was the affirmation that the integrated firm was in a deep and perhaps irreversible malaise, its crisis the result of internal bureaucratic rigidities stemming from integration as an organizational form that precluded possibilities for innovation (Best 1990). These organizational characteristics, which at one time may have enabled the vertically integrated enterprise to compete effectively, now tended to act as blocks on innovative learning and the development of capabilities to enhance competitiveness. Implicit in this critique was the notion that as an organization the integrated firm possessed little capacity for adapting to a more competitive market environment. At the same time, part of this critique was the embrace of interfirm networking as a solution to the problems of the large-scale integrated firm. These network organizations, it was argued, promoted pathways of learning and adaptability that enabled them to innovate and compete. As institutions, integrated firms, from this perspective, were becoming competitively inferior if not obsolete, while enterprises organized from networks of firms were hallmarks of the future. Second, and perhaps more profound, was the conviction that existing theories of the firm provided little insight about interfirm networks as a specific organizational phenomenon. The dichotomy between contracting relationships undertaken through markets and contracting relationships organized administratively within firms, first developed by Coase and later refined by Williamson and Chandler, was from the perspective of these theorists insufficient as a framework for explaining the emergence and proliferation of interfirm contracting relationships in the aftermath of the profit crisis of the 1970s and 1980s. Signals for such a perspective, however, had already emerged independent of, and prior to, the competitive crisis of large firms. In a compelling article on industry and organization, G. B. Richardson (1972) argued that “by looking at industrial reality in terms of a sharp dichotomy between firm and market we obtain a distorted view of how the system works” (p. 884). His observations on forms of networking and contracting relationships between firms suggested first that business organization was highly open-ended and second that the choices made by firms on forms of organization represented a continuum, passing from pure market-type transactions through intermediate forms of cooperation to cooperation fully and formally developed within the same organization (p. 887). For this reason, Richardson was highly critical of the dichotomy between firm and market. Such a dichotomy, he claimed, “leaves out of account . . . the dense network of cooperation and affiliation by which firms are inter-related” (p. 883). Richardson’s insights into networks as unique forms of organization

48 A Synthesis resonated strongly in the more recent theorizing of network enterprises. “Neither Market nor Hierarchy” expressed this rejection of the lineage established by Coase (Powell 1990). In emphasizing the unique attributes of interfirm networks, Powell would write, “I do not share the belief that the bulk of economic exchange fits comfortably at either of the poles of the market-hierarchy continuum. . . . My aim is to identify a coherent set of factors that make it meaningful to talk about networks as a distinctive form of coordinating economic activity” (Powell 1990, 293, 300–301). From this framework, several contributions have attempted to explain the nature of interfirm networks as forms of business organization and issues of governance and coordination that supposedly make them uniquely innovative. Manuel Castells is perhaps the most emphatic in affirming the uniqueness of interfirm networks as an organizational form of business enterprise. Castells, however, has a far different point to make than simply distinguishing networks from either markets or hierarchies. He equates this organizational phenomenon—“linkages between economic agents”—with what he insists is a broader, historically unique networking phenomenon in the economy linked to “the information technology revolution” (Castells 2000, 5, 77). These linkages are essentially horizontal relationships in which the operating unit of the business is not really a firm but instead more a project enacted between nodes in networks (pp. 177, 214). For Castells, such ephemeral forms of organization correspond to the flexible nature of economic activity in the new millennium and the need of business enterprise for adaptability to compete in the restructured environment of capitalism dominated by the Internet. Project-oriented linkages can easily be transformed and reconstituted as business needs change and as conditions for profitability are redefined. Nevertheless, if, as Castells argues, these networks are unique to the information technology revolution, is it technology that is creating these forms of organization? And if networks are linked to the information technology revolution, what is one to make of interfirm networking before this revolution? Furthermore, apart from references to the power of information technology, it remains unclear what the mechanisms of coordination and governance are within this new organizational form that enable them not only to function but to function more innovatively than other forms of organization. In contrast to Castells is the literature describing the networking phenomenon as commodity chains. This phenomenon is defined as a network of production and labor processes the result of which is the creation and sale of a finished commodity. It differs from Castells in acknowledging the existence of commodity chains as forms of capitalist business organization dating from the early period of capitalism in the sixteenth century. In effect, the

A Synthesis 49

literature on commodity chains takes a more long-term view of interfirm networking and its role in the development of capitalism. At the same time, however, it acknowledges that commodity chains in each period possess unique attributes. This historically based perspective derives from a synthesis of two unlikely intellectual partners. On the one hand, theoretical inspiration for this literature derives from the “world systems” approach to capitalist development, in which different commodity chains spanning great distances across the globe fuel capitalist expansion beginning in the sixteenth century (Hopkins and Wallerstein 1994). On the other hand, this approach draws upon Michael Porter’s notion of the value chain defined as “an interdependent system or network of activities connected by linkages” that represent the various adjacent stages in the production and distribution of goods and services (Porter 1990, 41). In borrowing from both world systems theory and value chain theory, the commodity chain approach focuses on goods as a complete process of production, labor, and marketing. It seeks to reveal where the different parts of this process occur geographically and who controls the process (Gereffi and Korzeniewicz 1994, 2; Hopkins and Wallerstein 1994, 50). Commodity chains have three basic characteristics (Gereffi and Korzeniewicz 1994, 7). First, they have an input-output structure corresponding to a sequence of value-adding activities at different nodes. Second, they have a “territoriality” corresponding to the location of the various activities in the commodity chain and the way these activities occupy space. Third, commodity chains have a governance structure in the form of authority and power relationships within the network. These attributes, however, give commodity chains an historically specific character. During the late nineteenth and early twentieth centuries, certain types of commodity chains were internalized within the boundaries of vertically integrated corporations, where they coordinated mass production activities over national territories. What is distinct about the late twentieth century is the transformation of commodity chains into networks of independent firms organizing adjacent operations of procuring, producing, and selling around the globe (Gereffi and Korzeniewicz 1994, 7). Within these interfirm networks, profitability shifts from one node to another as an outcome of work organization and the distribution of power between the different nodes. Power, in effect, plays a key role in the governance of these organizations. Related to this approach but offering an analysis of more recent and specific forms of interfirm organization is the work of Tim Sturgeon (1997a, 1997b), who uncovers what he considers a new model of network organization: the turnkey production network. Functionally, this new entity is characterized by the separation of innovative capacity and production capacity marked by a distinctly new form of production outsourcing. Organization-

50 A Synthesis ally, this separation is represented by the emergence of a distinctly new entity: the contract manufacturer. Sturgeon observes that since the mid-1980s and particularly in the 1990s, large American name-brand electronics companies such as Apple, IBM, Hewlett-Packard, and indeed Dell Computer have been abandoning their internal manufacturing operations and turning to contract manufacturers such as SCI, Solectron, and Flextronics to build all or part of their products. These contract manufacturers fabricate and assemble the products of their clients through what is known as a turnkey contract (Sturgeon 1997a, 11). The contractor assumes responsibility for production, while design and marketing are retained inside the boundaries of the name-brand firm. The contractors themselves undertake this production activity through myriad subcontracting arrangements, dispersing and concentrating production in complex networks throughout the world. Costs, the diffusion of capabilities and skills to firms throughout the world, and the retreat of namebrand firms into “core competencies” are what drive the development of this new networking organization. Contract manufacturing and interfirm networking are thus part of the same organizational phenomenon. In this phenomenon, however, innovative capabilities in production migrate to the contractors while innovative capabilities in design remain within the name brand firm. By contrast, in the work of AnnaLee Saxenian (1994), networks of firms emerging from specific industrial systems are the sources of innovation and competitive advantage that differentiate firms within one region from firms in another and the regional economies where firms operate. Silicon Valley, according to Saxenian, is a network-based industrial system (p. 9). It is an innovative region because the industrial system upon which the region is built promotes horizontal and decentralized interfirm network relationships. These interactions, in turn, emerge from, and at the same time reinforce relationships built from mutual reciprocity and trust. Network-like ties between specialized firms enable multiple and spontaneous interactions to occur that create ongoing recombinations of knowledge and information sharing. Such network relationships are the basis for a process of collective technological learning (p. 9). While on the one hand reference is made to the increasing specialization and division of labor in Silicon Valley, there is, on the other hand, strong suggestion in Saxenian’s work that the interactions and relationships so central to innovativeness are not conducted at all through markets. Instead, cooperation between partners in the decentralized networks of Silicon Valley seems to more closely resemble nonmarket-coordinated interactions based on “embedded” relationships and the concept of trust within “business groups.”22 Consequently, Saxenian raises an interesting puzzle about the structure of organizations that are neither market nor hierarchy. While a highly specialized division of labor suggestive of markets

A Synthesis 51

drives the existence of interfirm networks, the constituent firms within these organizations appear to contract through relationships lying outside the market and the price system. In this way innovation, instead of being driven by markets, derives from relationships with a strongly nonmarket character. This issue of whether markets or administered relationships prevail within interfirm networks is central in understanding contemporary hightechnology value chains. In a highly original approach to this issue, Richard Langlois argues that increasing modularity in product design is creating the basis for the reemergence and proliferation of markets as the preferred mechanism of coordinating activity between firms. Langlois develops his case by acknowledging that the world of the late nineteenth century described by Alfred Chandler represented an industrial revolution, marked organizationally by vertical integration and governed by the visible hand of management. He insists that the current period is characterized by a revolution “at least as important as the one Chandler described . . . as profound as the one of the late nineteenth century.” In contrast to the enabling technologies of the rail and telegraph, this revolution has as its technological infrastructure the computer and the Internet. In place of mass-production processes, the current revolution is one based on product customization oriented around modular component parts. Perhaps most important, while the earlier revolution replaced Adam Smith’s invisible hand with the visible hand of managerial coordination, the modular revolution is marked increasingly by “coordination through arm’s-length trading on thick markets. . . . In this epoch, Smithian forces may be outpacing Chandlerian ones” (Langlois 2001, 2). Langlois calls this new form of governance the “Vanishing Hand.” His aim is to explain why the mechanism for coordinating mass production— Chandler’s visible hand—“is fading into ghostly translucence” and why markets are outpacing administered forms of coordination for economic activity. While the logic of this argument is compelling, there may be good reasons why, in an environment where competition has shifted away from the product and toward the efficiency of supply chain systems, the invisible hand of Smith may be too risky for coordinating complex processes of just-intime procurement and assembly among different firms (see Chapter 6). Instead, it is the visible hand of Chandler—conscious command and control— that appears more suitable as a coordination mechanism for high-risk just-in-time supply chain systems despite the fact that the different activities in these value chains are being undertaken within networks of separate companies.23 In this sense, the observation made thirty years ago by Richardson on the possibilities of firms exercising power beyond their own firm boundaries is prescient. “Planned co-ordination does not stop at the frontiers of the indi-

52 A Synthesis vidual firm,” he writes, “but can be effected through co-operation between firms. . . . Anti-trust legislation has checked vertical integration, but the same co-ordination is achieved through close co-operation between individual firms at each stage. . . . Co-operation may come close to direction when one of the parties is clearly predominant” (Richardson 1972, 895–96). For Richardson, interfirm networking may in some instances resemble the integrated firm. Forms of power and control are common to both types of organization. What is critical in assessing interfirm networks is not the organizational form per se by which coordination is achieved, but rather the way in which power and control are exercised through different forms of organization in achieving certain economic outcomes.

Communications as Catalyst and Carrier Wave There are few inducements to innovation and organizational transformation that equal the effects of a fundamental change in the means by which society communicates. As William McNeill (2000) writes, “major landmarks in human history” along with “the impulse to innovate” depended principally on improvements in communications that allowed messages to travel farther and more accurately across time and distance (p. 9). It was historian Robert Albion, however, who was the first to write extensively about the impacts of what he described as the “communications revolution” on economy and society (Albion 1932; John 1994). Albion originated this concept to describe the creation of an unprecedented “veritable age of speed” beginning in the late eighteenth century with which new transport and communications networks moved merchandise, information, and the public itself (Albion 1932; John 1994, 101).24 This preoccupation with speed led him to highlight the role of the communications revolution in the United States, where speed was critical in bridging the enormity of the nation’s continental-sized distances. Despite his insistence that the communications revolution emerged independently of industrialization—“it had performed wonders while our industries were still legitimate ‘infants’”—he acknowledged the impacts of new transport and communications systems on the growth of machine production and largescale business enterprise (Albion 1932: 718–19). Nevertheless, Albion did little to develop these links systematically (John 1994). It was left to a student of Albion, Alfred Chandler, to provide what has become a defining set of connections between new technologies of transport and communications, production innovation, and transformations in business organization. Similarly to Albion, Chandler emphasized the role of speed in the compression of geographical space as the defining impact of the communications revolution. Chandler, however, placed more importance on the tech-

A Synthesis 53

nological breakthroughs of the steam railroad and the electric telegraph in defining the communications revolution. Such an approach led Chandler to insist upon the mid-nineteenth century as the turning point in the communications revolution. More important, Chandler would make explicit the causal links between the revolution of rails and telegraphy, the emergence of the integrated corporation of the late nineteenth century, and the system of high-volume production and distribution built upon economies of speed. In building his model of organizational transformation on the rail and telegraph revolution, Chandler, in fact, was largely responsible for introducing transport and communications infrastructure into the vocabulary of historical analysis as a catalyst of economic and organizational change (John 1994, 102). What Chandler represents in terms of the revolution of rails and telegraphy has its counterpart in the work of Castells (1996) on information technology. Like Chandler, Castells seeks to demarcate an historically unique economic and social phenomenon. In contrast to Chandler, Castells finds this break in the late twentieth century, which he describes alternately as the “information age” and the “network society.” His point of departure in accounting for this phenomenon is the “information technology revolution, which emerged in the 1970s and is represented in its most recent manifestation by the Internet (Castells 1996, 5).25 For Castells, this revolution consists of the converging set of technologies in microelectronics, computing, telecommunications, and biotechnology (p. 29). These technologies and the revolution they have engendered have shaped the restructuring of capitalism since the 1980s (p. 13). For Castells, the source of the “new economy” created from this restructuring process is unmistakable. “This new economy emerged in the last quarter of the twentieth century,” he writes, “because the information technology revolution provided the indispensable, material basis for its creation” (Castells 2000, 77). Castells is convinced that the information technology revolution represented most decisively by the Internet and the informational economy spawned from it reveal decisive breaks with industrial society preceding it. While conceding that past forms of economy relied on the processing of information, Castells distinguishes these previous information societies from the informational society that has emerged only in the last twenty-five to thirty years. In the informational economy, productivity and competitiveness derive from the capacity of economic agents to generate and process knowledge-based information, whereas in the industrial economy the source of productivity derived from manipulation of materials and access to sources of energy (Castells 1996, 17, 66). The information technology revolution is thus an historical discontinuity on the same level as the industrial revolution of the eighteenth and nineteenth century (Castells 1996, 30). In Castells’s work

54 A Synthesis (1997, 244–45) is a call to historians of technology to compare and contrast the recent period of transformation marked by the Internet with analogous transformations in the past. Castells is certain that history will judge the current period of the Internet revolution to be one of epoch-making discontinuity. A compelling counterclaim to this perspective insists upon a largely unified “dominant line of development,” beginning with the telegraph and culminating in the extended electronic and computer networking technologies of the late twentieth century (Hall and Preston 1988, 37). This “carrier wave” of communication technologies provides links between the midnineteenth and late twentieth centuries. Comparison of the innovative enterprises created by Swift and Dell may very well provide an ideal test case for assessing these contrasting claims.

Toward Synthesis The starting point for comparison of Swift and Dell is Schumpeter’s observation that capitalist development is punctuated by waves of technological innovation beginning in the late eighteenth century. These waves demarcate distinct periods of industrial revolution in the development of modern capitalism. Each period is distinguished by a system of dominant technologies, around which cluster specific types of economic routines, business organizations, geographies of economic activity, and institutions providing legal frameworks of economic rule making. Competition and the search for profit compel firms in these periodized environments to seek more innovative ways of accumulating. This process of search is a learning process. In this learning process firms confront limits posed by existing economic routines, business organizations, market geographies, politics, and labor relations that condition pathways of accumulation. The learning process is an effort to overcome such limits by conceiving how to act differently about producing, buying and selling, and accumulating profit. Although each of these periods is unique, features common to this innovation process create comparable economic environments across time. Among the most disruptive historical forces transforming the economic environment is the phenomenon of communications revolutions. Two groups of firms create this phenomenon and act as agents for the process of innovation, in which the disruptive impacts of new transport and communications technology emerge, spread, and transform the rest of the economy. Igniting this phenomenon is the actor network of new transport and communications infrastructure builders that mobilizes the resources for construction of new systems. Extending this phenomenon are business users of the new transport and communications systems. These users complete a more

A Synthesis 55

sweeping set of changes in the economy by deploying new infrastructure to transform existing business models for profit making. The interaction of these two groups shapes the build-out of the new infrastructure and the pathway of transformation throughout the rest of the economy resulting from the choices of users in deploying the new systems to compete (Cohen, DeLong, and Zysman 2000). The roles of builders and users in creating the communications revolution and spreading its impacts reveal a certain identifiable pattern. This pattern starts with a breakthrough invention in transport and communications technology that is exploited and commercialized by inventor-entrepreneurs within the ranks of communications revolution builders. Although patent rights frequently protect the new invention, the patent process reveals limitations in stemming the entry of companies anxious to capitalize on the commercial potential of the new technology. Accordingly, the ranks of firms interested in transforming the new technology into built systems and constructing new infrastructure for such systems—rail, telegraph, and Internet firms—though initially small in number soon explode after this first stage of commercial success. Competing companies, sometimes numbering in the hundreds, invariably get involved in this early period of infrastructure creation and development. In the initial stages of new infrastructure development, multiple variants of the new transport and communications technology emerge among the different firms, unleashing intense competition for control over what is defined as the most technically superior system design. As these myriad firms compete to build out the new systems, the competitive process gradually gives way to a process of consolidation in which a small number of builder firms survive. During this process of contraction in the number of builder firms, the multiple variants of the new technology created at the outset of commercialization also diminish. The surviving firms compete ferociously to establish a dominant design or standard defining the path along which subsequent infrastructure development takes place. At stake in these standards wars is control over future profit making. On the one hand, individual firms seek to use their mastery over a particular technological design to set the terms for subsequent development of the infrastructure. On the other hand, firms that successfully develop a dominant standard are in a position to control terms of infrastructure access and use. The telegraph, the railroads, and the Internet all went through this process of standard setting—with clear winners and losers. The build-out of new transport and communications infrastructure has a transforming impact on system users in two ways. First, the build-out of the new transport and communications systems alters the strategic outlook of business users for competing and accumulating profit. Second, break-

56 A Synthesis throughs in transport and communications provide users with a set of tools for changing business routines and transforming organizational capabilities to accommodate such strategic shifts. Communications revolutions alter the strategic horizons of business users by reconfiguring the geography of economic activity. Such reconfiguration has two components. In the first place, the deployment of the new transport and communications systems provides users with new and different levels of access across and within markets for buying, selling, and producing. Second, these new levels of access create a different structure of costs in coordinating the movement of goods and securing information across distant markets and between areas of proximity within markets. As communications revolutions reshape the geography of economic activity, and as user firms confront opportunities for engaging in economic activity with a different structure of costs and a different map of access routes to profit, the strategic environment for firms assumes a different meaning. What changes for business users as access and costs get reconstituted are fundamental relationships in economic activity oriented around space and time. Shifts in the strategic orientation of firms deriving from transformations in the geography of economic activity ultimately involve a change in the way firms organize the territorial and temporal relationships in their operational routines. Throughout capitalist development, accelerating time in the circuit of capital from procurement of materials to final sale and exploiting new territories as sales outlets as well as places for procurement and production has driven the competitive activity of firms (Schoenberger 1997, 12; Harvey 1996, 240–41). If businesses are to exploit new geographies of economic activity and take advantage of reconfigured structures of access and costs, they must develop different, even intensified systems of control over territory and the cycle times of procurement, production, and selling taking place there. Technologies of communications provide firms with possibilities for such control. In this way communications revolutions are control revolutions. Consequently, in addition to providing the catalyst for transformations in strategic outlook, communications revolutions provide firms with technological pathways for developing the capabilities—operational and organizational—to exercise control over space and time in new and different ways. The economic environments of communications revolutions, where opportunities emerge for learning to control time and space in new ways, are without predictable outcomes. Certain firms learn about the profit-making opportunities associated with the communications revolution more decisively than do others and integrate the new infrastructure into their business models in accordance with their understanding of such opportunities. Nevertheless, the business models of such innovative firms rarely emerge fully

A Synthesis 57

formed. They evolve as incremental experiments in a process of learning by doing and learning by using. Gradually, through trial and error, firms create new systems of codified and tacit knowledge. This knowledge is the basis of new capabilities for producing, buying, and selling. It is also the foundation from which firms, in developing new capabilities, evolve into innovative enterprises. Business organizations are inherently territorial. They assume this territorial character in the way they choose to organize economic activities in geographical space. They organize their activities geographically in the way they locate their own physical assets, or nodes, and in the way they organize the flows of activity between these nodes and the nodes of other firms with whom they interact in producing, buying, and selling. While to some extent, the location of nodes and the configuration of flows reflect the capabilities of available transport and communications technology, nodes and flows also emerge as a function of the way firms choose to organize internally. Such choices involve the extent to which firms are integrated and absorb sequential steps in procurement, production, and marketing and the degree to which they are dis-integrated and contract with other firms in allocating these tasks. These choices of firm structure influence the locations of key assets and the routes by which flows of economic activity between these assets circulate. In this way, innovations in business organization deriving from the influence of the communications revolution and the process of organizational learning reshape territories of profit making. The outline of this route from communications to territory, which is depicted in Figure 2.1, can thus be summarized schematically as follows. From a given profit-making environment, new transport and communications technologies emerge, establishing the initial impulses of the communications revolution. These new technologies become commercialized by entrepreneurial infrastructure builders, who deploy and build out new transport and communications systems. When reaching a certain threshold, this build-out creates fundamental changes in the geography of economic activity marked most decisively by reconfigured systems of access across and within market boundaries and recalibrated systems of costs. Such changes in economic geography create opportunities for firms to accumulate profit differently. At the same time, the new infrastructure provides firms with tools to develop capabilities for implementing routines conceived from a new strategic vision of profit making. In this environment of initial infrastructure build-out, certain businesses successfully learn about and exploit the new infrastructure and the new structures of access and costs, space and time, created by these systems in developing business models to compete differently. Emerging from this learning process are initial experiments with innovative routines for profit mak-

Communications Revolution'

Territorial Transformation ∆ Market Rules

Profit-making Environment'

Transport Communications Infrastructure Build-out

Communications Revolution ∆ Flows of Product/ Information

∆ Technology

Profit-making Environment

∆ Economic Geography

∆ Business Organization ∆ Business Strategies and Routines figure 2.1 Schematic Outline of Communications Revolution

Experimentation Innovation (Users)

A Synthesis 59

ing. Gradually, as firms develop and implement new knowledge, they create new capabilities including work systems and forms of labor control, at times openly contentious, to undertake these innovative routines. As they enhance their capabilities, firms transform the organizational structures through which they carry out their operations and compete. Innovative business organizations, in turn, recast geographical landscapes for profit making by shifting the locations of productive assets and by rerouting flows of activities between these assets and the assets of other entities with which they interact in the course of procuring, producing, and selling. In certain instances, profit making in these reconfigured territories requires new systems of rule making to accommodate the innovations in routines and the business organizations developed for the new activities. Collectively, these changes—transport and communications technology, economic geography, business routines, and labor systems, organizational structure, territorial transformation, and market rules—produce a new profit-making environment (profit-making environment prime in Figure 2.1). This environment then paves the way for the next communications revolution—communications revolution prime—and the process continues.26

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part 2

Rails,Telegraphy, and the Business Enterprise of G. F. Swift & Company

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chapte r

3

The Railroad and Telegraph as Commerce System and Market Space

No doubt, the most significant object in the office was the ticker. . . . The offices of the ranches were thus connected by wire with San Francisco, and through that city with Minneapolis, Duluth, Chicago, New York. . . . During a flurry in the Chicago wheat pits, Harran and Magnus had sat up nearly half of one night watching the strip of white tape jerking unsteadily from the reel. At such moments they no longer felt their individuality. The ranch became merely the part of an enormous whole, a unit in the vast agglomeration of wheat land the world round. Frank Norris, The Octopus, 1901 As the organized type of society develops, the fusion of the various elements entails the fusion of the markets into one single market. . . . The result is that each industry produces for consumers who are dispersed over the length and breadth of the country, or even the whole world. Emile Durkheim, The Division of Labor in Society, 1893

Communications and Commerce When Swift began sending shipments of beef from Chicago to New England in the late 1870s, the communications revolution of rails and telegraphy—the precondition for the company’s long-distance system of production and distribution—was already in an intermediate stage of build-out. Two critical attributes of the infrastructure enabled Swift to reconceptualize the existing practice of beef slaughter and sale and create an enormously innovative network for producing and distributing beef in large volumes on a national scale. First, the rail and telegraph system had essentially become a commerce system. It had evolved into an infrastructure for moving freight and facilitating

64 The Railroad and Telegraph the exchange of information and messages needed to coordinate such movement of commodities. Such a development as a commerce system was not necessarily preordained. Nevertheless, soon after the initial deployment of the rail and telegraph systems, business uses—shipping goods and sending messages for buying and selling these commodities—assumed the dominant form of use on these new infrastructures. Second, Swift took advantage of the rail and telegraph not only as a freight-moving and transaction-facilitating system but also as an infrastructure with an increasingly national reach. This process of national integration, however, was not geographically uniform in its effects. At the outset of system expansion, linkages between the Northeast and the Midwest emerged far stronger than North-South connections. What resulted was a more vibrant set of trade relationships between the eastern seaboard and the agricultural heartland of the Midwest (Fishlow 1965, 262). Only after the 1870s did North and South become more integrated on the basis of rail and telegraph connections, though never to the extent of East-West connections. The evolution of the organization created by Swift reflected this spatial pattern. The firm relied upon the more established East-West links forged by the rail and telegraph system in launching its system of fresh beef shipments from Chicago to the Northeast in 1878–80. Gradually the firm expanded the geographical reach of these shipments so that the network extended into virtually every corner of the country. This chapter describes how the rail and telegraph revolution became a nationally oriented commercial revolution that provided the Swift Company with the foundations for its procurement, production, and distribution network. It examines how this communications revolution established an environment of opportunity for innovation. The rail and telegraph revolution created this environment by providing business users with a vision of how the geography of markets could be expanded and reconfigured. Rails and telegraphy enabled users to exploit an expanded and reconfigured structure of markets by redefining what was economically viable and efficient for firms across regions and within localities. This chapter also reveals how the politics and rule-making environment for these enlarged markets evolved as Swift and other large-scale firms sought to protect the national networks they had created. Finally, this chapter reveals how the rail and telegraph revolution rearranged trade linkages in the U.S. urban system and created mass consumer markets in cities that Swift used in building its national beef empire. infrastructure interconnection The commerce-oriented transport and communications system that provided Swift with the preconditions for its network began to take shape over the territory of the United States in the decades after 1850 (Fishlow 1965,

The Railroad and Telegraph 65 table 3.1 Expansion of Rail and Telegraph Systems, 1848–1902 1848

1852

1860

1870

1880

1890

1902

Rail track (thousands 5.9 of miles) Freight (millions of tons) 10.6 Telegraph wire (thou3.4 sands of miles) Messages sent (millions 0.5 per year)

12.9

30.6

52.9

115.6

208.2

252.5

17.6 23.3

46.5 56.0

147.6 133.6

338.9 291.2

691.4 1,200.7 848.8 1,307.0

1.4

5.0

11.5

31.7

58.4

89.7

sources: Alfred D. Chandler Jr., The Railroads:The Nation’s First Big Business (New York: Harcourt, Brace & World, 1965), Tables 1 and 2; Richard D. DuBoff, “The Telegraph and the Structure of Markets and Firms,” Research in Economic History 8 (1983): Table 1, p. 256; Edwin Frickey, Production in the United States, 1860–1914 (Cambridge: Harvard University Press, 1947), Table 13, p. 100.

262; Thompson 1947; Du Boff 1983; Table 3.1). Evolving from myriad locally based rail and telegraph operations, the national character of this infrastructure emerged most dramatically when the breach separating the Atlantic and Pacific coasts was finally enjoined by telegraph wires in 1861 and by rails in 1869. Although these two events captured the imagination of the country and inspired subsequent historical accounts of the rail and telegraph system, the story of how this infrastructure became a national system occurred in the nation’s interior. Alongside the bicoastal reach of rails and telegraph wires, expansion in the total mileage within the agricultural heartland of the country and the connections such interior growth represented were decisive in the creation of a nationally integrated rail and telegraph transport and communications system. Yet while expansion in rail and wire mileage provided the basis of a nationally oriented transport and communications system, it was the symbiotic development of rails and telegraphy that enabled this expansion to occur. Despite very different technological origins and initially separate development trajectories, the rail and telegraph infrastructure assumed its national orientation after 1850 as an essentially single transport and communications system. Telegraph wires expanded along railroad rights of way, and telegraphic communication became indispensable by the mid-1850s in enabling the railroads to operate safely. In 1849 the New York and Erie Railroad pioneered the use of the telegraph on its lines to control operations. Five years later, the telegraph was standard equipment for the scheduling of all rail operations. Railroads furnished transportation and materials for the construction of telegraph wires and operated telegraph offices from their depots. By 1870, U.S. railroads had funded and were managing two-thirds of Western

66 The Railroad and Telegraph Union’s twelve thousand telegraph offices (Chandler and Cortada 2000, 12). Although the capital and labor requirements to build and operate the two infrastructures were vastly different, rails and telegraphy became fused as the “twins” of nineteenth-century commerce (Field 1992).1 Prior to the Civil War, however, the rail and telegraph system suffered from numerous obstacles to interoperability. These problems were due in no small part to the large number of firms in each industry. In 1850, roughly five years after commercialization of the telegraph, there were already hundreds of telegraph companies (Jones 1852; Thompson 1947). During this same period, there were at least an equal number of rail firms, a number that eventually reached over two thousand (Chandler 1965). As a result of such unbridled competition, railroad track gauges, locomotives, and railcars varied throughout different regions of the country. Seven different track gauges were still in use in 1860 (Friedlander 1995). Similarly, telegraphy operated on competing Morse, Bain, and House technologies. Points of transshipment between competing lines, whether rail or telegraph wires, were sources of bottlenecks, where freight and messages had to be modified in order to accommodate the standards on the next leg of the route. These transshipment points added both time and costs to the movement of freight and messages over the rail and telegraph infrastructure. Without standards for interconnection, the rail and telegraph system was not able to fully exploit its technological capabilities for efficient long-distance transfer of goods and information.2 As the builders of these systems consolidated after 1850, they gradually addressed many of the most urgent problems of long-distance interconnectedness. Rail and telegraph builders began to establish uniform standards for track gauge and telegraph wires that eventually integrated rail and telegraph lines into a more unbroken network for freight and message traffic. They improved the technology of locomotives and freight cars that enabled the system to increase the size and speed of freight shipments. At the same time, builders agreed on construction standards for both track and wires. Steel replaced iron rails, and iron became the standard over less durable copper telegraph wires. Finally, railroads managed to overcome the problem of multiple local time standards in the United States, where in 1870 there were still roughly two hundred local times and eighty different railroad times in use. In 1883, railroads imposed a uniform time that enabled them to end confusion and operate more profitably (Kern 1983, 12). These ameliorations— technological, structural, and even social—resulted in more efficient overland movement of merchandise and facilitated the message transmissions for both rail companies carrying freight and business users of the infrastructure shipping and receiving merchandise.

The Railroad and Telegraph 67

interregional trade and mass markets The outcome of these improvements was a shift after the 1850s from water transport as the primary means of conveyance for interregional commerce to a rail- and telegraph-dominated system of overland long-distance trade. In 1850, despite gains by the railroads during the previous decade in hauling freight, boats and barges still dominated interregional transportation of bulk agricultural goods (Fogel 1964, 22). Of the estimated $1.46 billion in internal commerce in 1852, almost two-thirds traveled over water courses (Schmidt 1939, 818). Ten years later, however, the situation was reversed. By 1862, rails accounted for roughly two-thirds of the long-distance freight traveling from West to East. As rail use expanded, river routes declined. By the time of the approaching Civil War, the Mississippi had ceased to be an economically viable transport route used by grain merchants (U.S. Bureau of the Census 1864, clv). The decline in canals stemming from rail competition occurred more slowly, but the final outcome was little different from the fate of river routes. Although still widely in use during the 1870s and 1880s, canals were attracting very little business by 1890. Rails and telegraphy had subordinated rivers, canals, and lakes to a position of largely secondary importance in the nation’s internal trade. This rail and telegraph revolution was most fundamentally a marketing revolution in the movement of commodities and information. This marketing revolution made possible more rapid, larger, more geographically extended shipments of goods for delivery at definite times in specific places (Du Boff 1983, 255). Long-distance overland freight shipments by rail and long-distance real-time information exchange by telegraph thus became inextricably linked. As goods and information circulated over a rail and telegraph infrastructure increasingly national in scope, changes in the nation’s structure of markets and system of cities resulting from this circulation redefined the parameters for the profit-making activities of firms. The communications revolution of rails and telegraphy opened the boundaries between localized markets prevailing before the 1850s and created a wider, more spatially extended market system (Du Boff 1983; Yates 1986). This infrastructure enabled economic actors to expand their business operations to more distant locations by diminishing geographical barriers on freight and information movements between market areas and by reducing the time needed for commodities and information to circulate from one area to another. The resulting enlargement of market boundaries led to the establishment of a more geographically extended system of overland interregional trade. Alongside this change in the market geography of the country was an

68 The Railroad and Telegraph equally profound shift in the nation’s urban system, where market activity was concentrated. By the late nineteenth century, the United States had become a much more highly urban society. During the decade of 1860–70, the increase in the urban population exceeded the increase in the rural population for the first time in U.S. history (Pred 1966, 18). Existing cities expanded, and an enormous number of new urban settlements emerged from 1850 to 1890. Perhaps more important, cities after 1850, especially those in the top ranks of the U.S. urban system, assumed a more multifunctional role complementing their traditional commercial activities. Cities became centers of factory industrialization (Pred 1977, 85). With their burgeoning populations of businesses and consumers, cities were enormous concentrations of supply and demand. In these environments, raw materials entered, intermediate goods circulated, and finished products exited. It was in cities where these items were also consumed in unprecedented quantities by both firms and the urban public. In emerging as concentrations of supply and demand within production economies, cities evolved into entrepôts of mass markets. Ignited by rail transport and telegraphic communications, these changes in markets and cities served as platforms upon which Swift launched its fresh beef network. The firm linked procurement of cattle raw materials and production in the West with final marketing of the finished dressed beef output in the East through a distribution network built upon the foundations of wider markets and the system of rail-and-telegraph-based overland interregional trade. At the same time, cities were the points of concentration in Swift’s procurement, production, and marketing activity. On the buying side, Swift found mass markets for its cattle raw materials first in Chicago and then in other cities on the frontier of the cattle range in the Midwest. The firm established its production facilities and marshaled its factory labor force in these same urban centers. In selling its products, Swift used the expanding populations of cities, first in the East and later in the rest of the country, as centers of consumer demand and mass consumer markets. The firm in essence appropriated the impacts of the communications revolution on markets and cities. It crafted its own business model of using refrigerated rail transport and telegraphic communications from the market-shaping and city-building impacts of this revolution in creating an innovative enterprise linking the mass production and mass distribution of fresh beef. In forging the long-distance connections for its high-volume production and distribution system and focusing its activities in urban centers, Swift reinforced the very transformations in markets and urbanization that made its enterprise possible. In the process, Swift played a critical role in establishing the linkages between production and distribution activities that helped define a national market space.

The Railroad and Telegraph 69

Markets as Territory Markets, as territories where economic actors produce, buy, and sell, have boundaries that define them as places. The geographical size of markets is dependent on the costs to and capacity of market actors to exchange goods and services over distance and to communicate information needed to negotiate exchanges (Du Boff 1980, 478). Distance and the time needed by economic actors to bridge distance in transporting merchandise and communicating terms of an exchange act as limits on the size of markets. Market boundaries become fixed at those points where goods and information cannot circulate beyond barriers of geography in a timely manner. They also become fixed where the costs of moving goods or securing information beyond such geographical barriers drive the prices of merchandise to unmarketable levels, that is, when the cost of transporting merchandise or communicating the terms of exchange exceeds the value of the merchandise at its origin. These “costs of transfer,” that is, the costs of transferring goods and information over distance, limit the size of markets (Ohlin 1933, 100). In addition to this calculus of time, distance, and costs of transfer, two additional factors—technology and politics—shape the boundaries of markets. Historically, transport and communications technologies have conditioned the size boundaries of markets by controlling how merchandise and information circulates and by influencing the costs of such circulation (Du Boff 1980, 479). Politics also shapes the reach of market areas owing to the role of political authorities in establishing rules for market behavior (Polanyi 1944; Braudel 1979, 1977; Christopherson 1993; Zysman 1994). Political rule making influences the extent to which market actors can engage in commercial activity over politically divided territories. Perhaps more important, market rules influence the rewards and penalties economic actors can expect from such activity in terms of private gain or loss, thereby influencing the choices of whether market activity is worth pursuing in the first place. In effect, time and distance, technology and politics converge in creating a cost structure for market activity that establishes market boundaries. Time and distance, measured by the costs of using transport technology to convey goods and services from one location to another, and the costs to economic actors of using communications technology to secure information integral to an exchange act in concert with politics in shaping the boundaries of market areas. Such a view of markets borrows elements from a long-standing geographical tradition. In the 1930s, German geographer Walter Christaller (1933) synthesized ideas about transport, distance, and costs in developing a theory of what he called “central places,” where goods, firms, and populations concentrate. At the core of his theory was the “principle of markets.”

70 The Railroad and Telegraph For Christaller, the market was a territorial unit. It represented a range corresponding to an upper limit in terms of the distance beyond which essential commodities or “central goods” could no longer be exchanged in a cost-efficient manner. The central places that formed around markets, however, could be reshaped by two other secondary principles (Christaller 1933, 76–80). The first was the principle of transportation. Conveyance of goods through improved transport broadened the range in which such goods could circulate, therefore expanding the market area. The second principle was politics. Christaller conceded that markets and central places frequently emerged and grew in conjunction with administrative decisions of government. For Christaller, the three principles interact in defining the boundaries of markets where trade can occur (Christaller 1933, 76–80). Christaller’s theory has an undeniable elegance in its explanatory power. In focusing on distance, transport costs, and politics, Christaller succeeded in uncovering basic principles of market configuration. For Christaller, markets configured from these three elements exist as hexagonally shaped territories delineating central places of varying importance in a hierarchical system of equilibrium. This elegance and simplicity, however, also reveals certain weaknesses. The model suffers from an overreliance on mathematical abstraction. Paradoxically, not only is real geography absent from Christaller’s featureless landscape. Missing are meaningful references to the history of how these market areas emerge and how they change over time.

Markets Before the Railroad and Telegraph Prior to rail transport and telegraphic communication, markets for most products and economic activities in the United States were predominantly local in scope (Schmidt 1939, 820;Yates 1986, 151). These markets, especially in the less populated western areas of the country, were characterized by high levels of self-sufficiency and low levels of trade and exchange (Schmidt 1939, 818). In these areas of self-sufficiency there was an underdeveloped division of labor. Products originated, circulated, and were consumed within close proximity. Relatively few transactions occurred across market boundaries (Yates 1986, 151). Typical of this local market structure was the early meat industry itself (Walsh 1982). Virtually every town had its own abattoir where cattle and hogs were processed or where farm-slaughtered animals were further butchered (Clemen 1923). Although the slaughter and consumption of fresh meat possessed unique attributes that in the absence of efficient transport and refrigeration technology made it an overwhelmingly local activity, markets for other products, especially consumer perishables but also durable

The Railroad and Telegraph 71

manufactured goods, possessed similar localized patterns of production and consumption (Chandler 1977). Highly variegated conditions of supply and demand for goods and services existed between local markets. Perhaps even more profound were differences in the prices of commodities from one local market area to the next (Carey 1988, 216). Such variation in markets had profound impacts on intermarket trade. In the absence of well-developed transport and communications links, variations between markets constrained intermarket economic activity in two principal ways: (1) by limiting exchanges of information between economic actors separated by distance about prices, quantities, and types of goods available in different markets; and (2) by imposing formidable obstacles on the overland movement of goods between market areas. Trade under such circumstances conferred high levels of risk and uncertainty on merchants contemplating intermarket expansion. The sources of such risk and uncertainty derived from the capabilities of existing systems of communications and transport and the role of such systems in the activity of trade itself. Trade has to be preceded by the exchange of information between two types of economic actors. Economic actors on the demand side (purchasing retailer, wholesaler, or industrial enterprise) need information on supply sources and prices, while agents on the supply side (farmer, wholesaler, manufacturer) need to know outlets of final marketing and what buyers are willing to pay (Pred 1977, 38–39). Shared information, in effect, is a precondition to trade. If information cannot be exchanged over distance in a timely and cost-efficient manner, the consequences for markets are increased risk, reluctance by economic actors to engage in trade between distant points, and preservation of market boundaries. Similarly, if goods cannot move between buyers and sellers across geographical barriers owing to underdeveloped transport links, the consequences are the same—low levels of trade over distance and market boundaries that remain narrow. In the period before the introduction of the rail and telegraph system, intermarket trade imposed formidable costs on most merchants that exceeded the potential gains of such trade (Pred 1966, 163). In the absence of rail transport and telegraphic communication, these costs stemmed from shipping difficulties and information deficiencies related to the barriers of distance between markets. The costs of overcoming distance and the time needed to bridge distance in sending and receiving shipments and securing information to consummate transactions for such shipments placed obstacles on intermarket exchange. These cost constraints kept markets localized and hampered intermarket growth well into the 1840s (Du Boff 1983, 257). Despite the dominance of localized markets and the limitations on intermarket commerce, there was in place during the early nineteenth century a

72 The Railroad and Telegraph system of long-distance trade. This trade, however, did not go overland. Commodities could not move overland for any appreciable distance without raising their prices to unmarketable levels. In 1816, the freight costs for shipping corn by wagon 136 miles amounted to its selling price (Pred 1977, 66). Wheat, although less costly to ship by cart, still exceeded its selling price at a distance of 330 miles (Riley 1911, 94). Clearly, such costs for the overland movement of commodities represented a formidable constraint on intermarket trade. More significant than the costs associated with long-distance shipments was the time associated with shipping freight interregionally. In 1817, it took fifty-two days to ship a load of freight from Cincinnati to New York using available wagon and river routes (Slaughter 1995, 6–7). By contrast, in 1852 the same freight shipment from Cincinnati to New York took only six days on the Erie Railroad and its feeder lines (Slaughter 1995, 6–7). Owing to these circumstances, interregional trade during this period circulated overwhelmingly via coastal shipping between coastal port cities (Pred 1977, 66). In the first two decades of the nineteenth century, long-distance commerce between regions occurred along two principal routes: (1) between U.S. coastal ports and European (mostly British) ports; and (2) between northeastern and southern coastal ports oriented primarily on the cotton trade (Pred 1977, 66–70). In many respects, these two routes overlapped. Much of the cotton trade originating from southern coastal cities was shipped first to northern ports and then transshipped to British textile mills. This routing formed both a domestic coastal trade and a foreign export trade. Similarly, a portion of European manufactures entering U.S. eastern ports was sent to southern port cities. Inland from this very narrow corridor of long-distance coastal trade, however, localized markets prevailed. Interregional commerce was an export-oriented, coastal-dominated activity controlled largely by eastern merchants favorably situated between the southern market and Europe. During this period, the western interior of the United States as a marketplace was of marginal interest to eastern merchants or southern cotton shippers (Pred 1966, 18–19). This interior area known at that time as “The West” engaged in comparatively little interregional commerce. Isolated geographically from the other two regions of the country, less settled, and without direct access to the Atlantic and Gulf coasts where the nation’s interregional trade took place, the West had an even more localized and selfsufficient system of markets than did the other two regions (Schmidt 1939, 800). The region was overwhelmingly agricultural, although some manufacturing, oriented mostly for the farm, was part of the settlement pattern in the West from the very beginning (Page and Walker 1991, 282).

The Railroad and Telegraph 73

Trade in the West was overwhelmingly intraregional. Exchanges of agricultural commodities and locally produced manufacturers occurred primarily among the region’s river ports as the territory developed its own internal trade system (Pred 1977, 69). This intraregional system of trade reinforced the region’s localized markets structure in which producing, buying, and selling occurred in largely self-contained geographical areas. Farmers in the West were caught in a cycle of inertia. Lacking easy access to long-distance markets, western farmers had little incentive to produce surpluses in sufficient quantity for export outside the region (Schmidt 1939, 800–806). Without surpluses, western producers had little reason to seek long-distance interregional markets.

The Beginning of Interregional Trade After 1820, however, as population and economic activity continued to expand west of the Appalachian Mountains and as cities, notably Cincinnati and Saint Louis, became trading centers, this pattern of self-sufficiency was disrupted, and the West emerged as the source for a very different pattern of long-distance interregional trade. Sparked by the growth of Western agriculture, this new pattern of interregional trade diverted long-distance freight shipments away from the coastal routes and oriented it along an East-West axis. More important, as the West became the nation’s agricultural breadbasket, this East-West commerce shifted from water routes to the rails. Thus, in the broad sense, the route to the rail-and-telegraph-based system of longdistance interregional trade emanated from what was perhaps the most compelling feature of American historical geography during the early nineteenth century, the expansion of population settlements and economic activity in the region west of the Appalachian Mountains (North, Anderson, and Hill 1983, 111).3 While western agricultural development provided the stimulus for the rail-and-telegraph-based interregional trade system, long-distance freight shipments to and from the West began on water. Steamboats and canals provided western farmers with their first opportunity to sell in distant markets. These early forays by the West into long-distance trade occurred initially in the markets of the South (Schmidt 1939, 801, 806). By the 1830s, the South had become dependent on the West for grains and foodstuffs (Schmidt 1939, 803).4 In responding to this demand, however, western farmers also exploited opportunities to sell in the eastern market by shipping agricultural commodities on steamboats and barges downriver to New Orleans. There, western farm exports were either distributed to southern market centers for consumption on the plantations or transshipped to the East. In both cases, access

74 The Railroad and Telegraph table 3.2 Percentage of Western Exports Shipped via New Orleans, 1839–1860

Flour Meat Corn All foodstuffs

1839

1844

1849

1853

1857

1860

53 51 98 49

30 63 90 44

31 50 39 40

27 38 37 31

34 28 32 27

22 24 19 17

source: Albert Fishlow, American Railroads and the Transformation of the Ante-Bellum Economy (Cambridge: Harvard University Press, 1965), Table 39, p. 284.

to long-distance markets through the river trade enabled western agriculture to change from a largely self-sufficient activity to a surplus-producing industry that by the 1840s rivaled the great grain producers of Europe. This transformation of western agriculture into an export-oriented activity played the central role in shifting the mode of conveyance for longdistance freight shipments from water courses to the railroads. At the same time, the surplus-producing agriculture of the West, coupled with the population growth of the Northeast, diverted the primary direction of interregional trade along an East-West axis. The sequence of events that triggered this transformation in both the directional axis and the mode of conveyance for long-distance trade begins with the completion of the Illinois and Michigan Canal in 1848. Built in response to the expansion of grain production in the Illinois River valley, the Illinois and Michigan Canal enabled wheat and corn from Illinois to be routed to New York and the Atlantic through the Great Lakes, the Erie Canal, and the Hudson River. This Canal-Lake course also sent western grain through the Saint Lawrence to Montreal. The impact of this route was to divert Illinois and western grain intended for eastern markets away from the river route, bypassing Saint Louis and, with more far-reaching consequences, New Orleans (Table 3.2). Perhaps more significantly, it created a strategic point in this East-West trade at the southern tip of Lake Michigan, where a small but growing urban settlement and grain market existed. This settlement was the city of Chicago. During the first season of the canal’s operation in 1848, corn shipments from Chicago, situated at the key crossroads of the canal-lake route, increased eightfold from 67,000 bushels to 550,000 as farmers discovered the advantages of shipments away from the Mississippi and New Orleans (Table 3.3). Perhaps more significantly, the canal and lake route, in establishing a direct link between East and West, shifted the direction of long-distance in-

The Railroad and Telegraph 75 table 3.3 Shipments of Grain and Flour from Chicago, 1840–1861 (Thousands of bushels)

Flour and wheat Corn Total grain and flour

1840

1842

1845

1847

1848

1851

1855

1861

10

587

1,025

2,137

2,386

799

7,1150

23,886

— 10

— 587

— 1,025

67 2,243

550 3,002

3,221 4,647

7,518 16,634

24,379 50,512

source: U.S. Bureau of the Census, Agriculture of the United States in 1860, Eighth Census (Washington, D.C.: Government Printing Office, 1864), Table H, p. cxlix.

terregional trade along an East-West axis. This axis of trade, in turn, reinforced a convergence of interests evolving between the West and the East. With an expanding agricultural surplus and a resulting growth in incomes, the West became increasingly attractive to the East, both as a source of foodstuffs and as a market for manufactures. The East, in turn, represented a far more lucrative market outlet for western grain farmers than the South. An entirely new system of extended markets and long-distance trade was thus emerging on the basis of a new relationship between the regions of East and West in which the interior of the country occupied the primary interests of the nation’s business class (Pred 1966, 16–18; 1977, 66–70).

From Water to Rail- and Telegraph-Based Trade In bridging the two regions, the lake route actually served as a catalyst for development of the rail and telegraph trade system by creating a privileged position at the base of Lake Michigan for Chicago as a concentration point and primary market for the East-West grain trade. It was this position as a primary grain market, in turn, that made the city attractive as a railhead. The Galena and Chicago Union Railroad completed in 1849 marked the first step in this evolution. Illinois grain farmers now had access to the Chicago market via a rail route. During the 1850s, Chicago became a terminus for twenty-one different railroad lines. The four eastern trunk lines converged on Chicago as the rail system began to develop its long-distance East-West linkages. The remaining seventeen lines extended into the city’s tributary agricultural area as small agricultural towns competed fiercely for rail stations (Riley 1911, 88–89). The construction of these roads from Chicago into the West, however, did not occur as a massive building project ahead of demand. Nor did the

76 The Railroad and Telegraph table 3.4 Rail Receipts at Chicago for Various Commodities, 1852–1856

Flour (barrels) Wheat (bushels) Corn (bushels) All grain (bushels) Lumber (feet) Coal (tons) Hogs

1852

1854

1856

124,316 937,496 2,991,011 4,195,192 147,816,000 46,233 65,158

234,575 3,038,935 7,490,753 5,726,968 238,337,000 56,774 138,515

410,989 8,767,760 11,888,398 25,817,248 441,962,000 93,020 220,702

source: Elmer A. Riley, “The Development of Chicago and Vicinity as a Manufacturing Center Prior to 1880” (Ph.D. diss., Department of History, University of Chicago, 1911), 94.

railroads create settlement and economic development in open territory as some exogenous force. Instead, railroads followed grain cultivation. Rail infrastructure was routed to western areas that were already surplus grain producers (Fishlow 1965, 165–235).5 This geographical bias is reflected in the relationship between the rail routes and the grain-growing areas. By the end of 1853, more than 60 percent of new railroad construction in Illinois occurred in the eleven leading wheat- and corn-growing counties of the state, areas which represented only 25 percent of total statewide land area (Fishlow 1965, 173). From its location at the base of Lake Michigan, where it had become a primary grain market, Chicago established a hegemonic position as a rail center for a broad range of commodities (Table 3.4). In the process, it emerged as the crossroads for a new system of long-distance trade between West and East. It was the railroad and telegraph and the focus of this infrastructure system on Chicago that differentiated the new system of long-distance commerce from the earlier water-based system of interregional trade. A small trading post of 4,853 inhabitants in 1840, Chicago grew to 29,963 by 1850, when the first large shipments of grain began to arrive in the city. By 1860, as railroads linked it with the East and traversed its agricultural hinterland, Chicago exploded, its population reaching 110,000 people. It was the center of the nation’s grain trade, a commercial enterprise described at that time as a “revolution” and “one of the chief marvels of modern commercial history” (U.S. Bureau of the Census 1863, cxxxv, clvii; Fishlow 1965, 289). Central to this revolution is the story of how the rail and telegraph trade system succeeded in replacing water routes for moving grain from the western grain belt to the East (Table 3.5). This revolution, however, is also

The Railroad and Telegraph 77 table 3.5 Rail and Water Shipments of Flour and Grain Received at New York, 1860–1890 (Millions of bushels)

Water Rail

1860

1870

1880

1890

41.1 16.0

36.3 34.2

71.1 98.0

30.2 90.2

source: Louis Bernard Schmidt, “The Internal Grain Trade of the United States, 1860–1890,” Iowa Journal of History and Politics 20 (1922): 105.

the story of how Chicago emerged as the privileged location for this railand-telegraph-based activity. By 1862, as Chicago asserted its centrality in the rail system, freight carried from Chicago on the Pennsylvania, Erie, New York Central, and Baltimore and Ohio Railroads reached 6 million tons, or roughly two-thirds of the total internal trade of just over 9 million tons. “In one word,” notes the 1860 census, “railroads did what could not have been done without them” (U.S. Bureau of the Census 1864, clxvi). Chicago, in turn, was the epicenter of this historical transformation.

Advantages of the Rail and Telegraph System As a means of conveyance for freight, the rail and telegraph system had a number of advantages over water routes. The most obvious advantage was speed. The velocity of shipments by rail shrank distances much more dramatically than did any previous form of transport (Cronon 1991, 74). Not only did freight arrive faster. The railroads’ liberation from geographical and seasonal constraints gave it other advantages over competing river and lake routes in terms of reliability. The river route south was extremely risky for grain shipments. River navigation in the southern states during summer months, especially in drought seasons, was often impossible. At the same time, owing to weather, the risk of damage to grain and flour from overheating as well as moisture were of particular concern to grain shippers. Such risks imposed costs in the form of high damage insurance rates and warehousing costs where shipments were interrupted and rerouted due to nonnavigable waterways. Similarly, lake and river routes in the north during winter months were plagued by the uncertainty of freezing. Speed and reliability, in turn, had considerable impacts on costs. Although freight rates on rivers and canals were considerably lower than rail rates, the

78 The Railroad and Telegraph

6 weeks 5 weeks 4 weeks 1 day 3 weeks 2 days

3 weeks

3 days 4 days 5 days 6 days 1 week

© Jeremy Shaw

2 weeks

map 3.1 Travel Time (from New York) as Market Space, 1830 source: Adapted from William Cronon, Nature’s Metropolis (New York: Norton, 1991), 77.

greater levels of certainty and the faster speeds of rail shipments narrowed such differences (Maps 3.1 and 3.2). The extent to which shippers discounted differences on paper between freight rates on water and rates on the rails is perhaps best reflected by the ever larger volume of commodities that began to move over the rail and telegraph system. In addition to its operational advantages of certainty, speed, and low costs, the rail and telegraph marketing system was able to expand owing to the

The Railroad and Telegraph 79

1 day 4 days

2 days 6 days

1 week

5 days

3 days

© Jeremy Shaw

6 days

4 days

map 3.2 Travel Time (from New York) as Market Space, 1857 source: Adapted from William Cronon, Nature’s Metropolis (New York: Norton, 1991), 77.

benefits conferred by government on rail and telegraph companies. Both rail and telegraph builders profited enormously from privileged access to the system of entitlements—especially development rights and land grants— provided by government as incentives to expand their systems (Berk 1994). Politics thus worked in tandem with technology in giving decided advantages to rail and telegraph builders in opening markets and creating a railand-telegraph-dominated system of long-distance interregional commerce.

80 The Railroad and Telegraph

Rails,Telegraphy, and the Livestock Trade While the grain trade was decisive in creating the conditions for a rail-andtelegraph-dominated system of interregional trade, it was the shipment of livestock from the western range areas to eastern markets that revealed most clearly the capacity of the rail and telegraph infrastructure to extend market boundaries and concentrate trade in cities.6 Unlike grain and other bulk commodities, the livestock trade in live animal shipments did not have a competitive means of conveyance over watercourses. For the most part, livestock had never been transported any appreciable distance on boats or barges. Hogs were far too difficult to manage on such trips, while cattle were too large and unwieldy. In the absence of a viable means of live animal conveyance prior to the railroads, markets for the slaughter of live hogs and cattle were overwhelmingly local in scope. The large-scale, high-speed overland movement of livestock and the establishment of an elaborate system of long-distance trade in live animals were entirely creations of the rail and telegraph era (Fishlow 1965, 68). Before the completion of railroad trunk lines, however, there was some overland movement of livestock. Hogs raised on western farms in the Ohio and Illinois River valleys were driven overland relatively short distances to Cincinnati and numerous other, smaller packing centers in southern Illinois. There the animals were slaughtered, butchered, and packed during winter months. Seasonality in the trade was essential because the curing process needed the refrigeration of winter so that the meat would not spoil as it cured (Walsh 1982). In contrast to hogs, cattle were driven great distances overland from the western cattle ranges to eastern markets, especially during the 1840s. These celebrated cattle drives, however, often covering over a thousand miles, imposed significant costs on the cattle raiser and cattle shipper. Cattle lost weight on such drives—anywhere from 150 to 250 pounds—and had to be fed and watered along the route. Along with the labor costs of droving, the losses accruing to cattle shippers amounted to roughly twelve to twenty dollars per head, depending on the length of the drive and the quality of the stock (Fishlow 1965, 68–69). At an eastern price of eight cents per pound for a thousand-pound beeve, or roughly eighty dollars per head of cattle, such charges for long-distance cattle shipments amounted to as much as a quarter of the animal’s value at market. Beginning in the 1850s, the railroads began to offer competitive rates to ship live cattle from the western range areas to Chicago, and then from Chicago to eastern slaughterhouses. As a consequence, the business of live cattle shipping grew spectacularly during the 1850s (Table 3.6). The same forces that made Chicago the largest interior grain market in the country el-

The Railroad and Telegraph 81 table 3.6 Live Cattle Shipments from Chicago, 1852–1861

Cattle shipped

1852

1854

1856

1858

1860

1861

77

11,221

22,502

42,638

97,474

124,146

source: Louis Bernard Schmidt, “The Internal Grain Trade of the United States, 1860– 1890,” Iowa Journal of History and Politics 20(1922): 105.

evated the city to the greatest collecting point for livestock (Chicago Board of Trade 1864, 46). This development had actually encouraged the cattlegrazing business to migrate further west to cheaper grazing areas, where an increasing percentage of the nation’s cattle was being raised. As a consequence, live cattle shipments emerged during the 1850s as one of the most lucrative businesses of the railroads (Chandler 1988, 230). By 1860, livestock shipments accounted for roughly 33 percent of total eastbound tonnage and about 50 percent of eastbound freight charges (Fishlow 1965, 79). On the eve of the Civil War, as the railroads assumed more and more control of the long-distance cattle traffic, the cattle-driving business had actually become obsolete (U.S. Bureau of the Census 1864, cxxxi). With the railroad and telegraph, the market in live animals reached from the western plains to the Atlantic coast. Consequently, this rail- and telegraph-based system of long-distance trade not only redefined the livestock business but fundamentally reshaped the geographical structure of markets in which this business operated.

The Institutionalization of Interregional Trade The system of enlarged markets and East-West interregional trade became strengthened and institutionalized through the creation of formalized commodity exchanges. The establishment of boards of trade in Buffalo (1845), Chicago (1848), Toledo (1849), New York (1850), and Saint Louis, Philadelphia, and Milwaukee (1854) and the emergence of the Chicago Board of Trade as the country’s central commodity exchange marked the stages in this process of institution-building and market integration. Rails and telegraphy played a defining role in the way these institutions formalized a system of long-distance intermarket trade that was interurban as well as between urban and agricultural areas. The rail and telegraph system provided unique advantages to buyers and sellers of commodities in terms of shipping and communications that were essential in reducing the risks necessary for promoting intermarket activity. By accelerating the speed of shipments, providing new levels of certainty in

82 The Railroad and Telegraph transporting goods over geographical barriers, and conveying information to traders about supplies and delivery schedules, rails and telegraphy enabled both shippers and buyers to negotiate the transfer and arrival of commodities across different market locales. Pivotal to this more extended intermarket system of buying and selling were two critical innovations pioneered by the newly institutionalized commodities markets—the forward, “to arrive” futures contract and the system of standardized grades for commodities. Both were dependent on the rail and telegraph. Prior to these innovations, long-distance trade between bulk commodity shippers and buyers occurred on the basis of the consignment system. The high levels of risk to both parties in this system undermined intermarket commerce. In the consignment system, sellers of bulk commodities delivered by rail a small representative sample from their larger lots of bulk goods to eastern buyers, who would examine the sample and bid over the telegraph for the remainder. By the time the shipment reached the buyer, however, prices might have already changed. In combination with the system of standard commodity grades, the futures contract enabled buyers and sellers to complete a transaction by telegraph without need for a specially shipped consignment. The buyer would know what was being purchased because commodities of a particular grade would be fundamentally identical, while both parties could lock in a price through the futures contract on delivery of the grade specified. Furthermore, futures contracts provided buyers and sellers with other types of riskreducing flexibility. In contrast with the consignment system, futures contracts permitted commodities to be transported and delivered at chosen future dates when processors of agricultural goods—millers, wholesale butchers—were ready to refine them or when retail grocers were ready to sell (Du Boff 1983, 259). The impact of this system was to spread more uniform and less risky exchange practices over a wider territory while involving a more geographically dispersed pool of buyers and sellers in long-distance trade. As a result, commodities moved farther and faster while market areas, widened by the expansion of the rail and telegraph trade system and the institutionalization of commodities exchanges, became more integrated and uniform (Du Boff 1980, 479). Price uniformity across geographical areas generally reflects an absence of barriers to trade resulting from distance. When geographical barriers to trade diminish owing to such phenomena as new transport and communications systems, the result is greater levels of intermarket activity. As intermarket trade expands, prices tend to equalize across geography (Ohlin 1933). In the absence of specific data on intermarket trade, the movement toward price uniformity or dispersion across geography is actually a proxy for levels of intermarket activity in the economy. Thus commodity prices in different ge-

The Railroad and Telegraph 83 table 3.7 Relative Wholesale Price Indexes in Different Cities, 1866–1868 and 1889–1891 (New York = 1) Average

Baltimore Chicago New Orleans New York St. Louis San Francisco

Standard Deviation

1866–1868

1889–1891

1866–1868

1889–1891

1.099 1.055 1.068 1.000 1.102 1.133

0.976 0.969 0.919 1.000 0.944 0.980

0.212 0.219 0.166 0.000 0.250 0.318

0.083 0.073 0.117 0.000 0.087 0.170

sources: Jaime Jue, “Price Convergence and Interregional Arbitrage Opportunities in the Postbellum United States: Evidence from the U.S. Department of War” (Unpublished paper, University of California, Berkeley, Department of Economics, 1998), Table 1; U.S. Senate Committee on Finance, Wholesale Prices,Wages, and Transportation: Report by Mr. Aldrich [known as Aldrich Report], 52nd Cong., 2nd sess. Senate Report 1493, 4 vols. (Washington, D.C.: Government Printing Office, 1893), vol. 4, Table 18. note: These indexes comprise eight commodities for which comparative data are available (beans, candles, coffee, flour, rice, soap, sugar, tea).

ographical locales are a measure of the degree to which the U.S. economy was moving toward a more unified national market tied together by interregional trade. The effect of the rail and telegraph was clear. These infrastructure systems evened out markets in space (Carey 1988, 217).7 Commodity price data suggest that the prices of commodities in different regions, which had started to equalize during the antebellum period owing to intermarket economic activity from canals and steamboats, continued to converge at an even faster pace after the Civil War (Slaughter 1995; Jue 1998; Table 3.7). Variations in regional markets did not disappear entirely. There remained critical issues of interconnection on the rail system not fully resolved until the 1880s with the use of one single standard track gauge. In addition, the South, largely excluded from the system of East-West trade that had evolved in the decade prior to sectional conflict, was still not fully integrated into the interregional compact that continued to evolve between East and West after Reconstruction. Nevertheless, as the railroad and telegraph became more interconnected and interoperable in the post–Civil War period, and as these systems enhanced the overland transfer of goods and enabled information to become more widespread and evenly distributed, this infrastructure created an environment of greater certainty in the long-distance shipment of merchandise. The result was an enormous expansion in

84 The Railroad and Telegraph the movement of freight and information over rails and telegraph wires, and as a consequence, a greater equalization of prices across geographical space. As shipments of goods expanded, and as commodity prices equalized, a more nationally oriented interregional trade system emerged by the last quarter of the nineteenth century. It was this market structure and system of trade that served as a platform for the business organization of Swift.

Urban Impacts of Interregional Trade As the rail and telegraph system was reconfiguring market boundaries, it was also engineering the equally profound shifts in the nation’s urban system that served as a second platform for the network of Swift. These changes in the U.S. system of cities were marked most decisively by an increase in both the urban population and the overall number of urban places. As market boundaries enlarged, and as market activity assumed a more geographically extended character, trade and production actually became more highly concentrated in cities. The territorial spread of markets and the concentration of this spatially extended economic activity in cities were thus part of the same process of urbanization and economic growth. This pattern of urbanization and growth was the basis for one of the most far-reaching changes in the late-nineteenth-century economy, the advent of mass markets. The creation of urban mass markets, in turn, both business and consumer markets, reflected two important consequences of urbanization: (1) a shift in the internal size ranking among the nation’s cities, and (2) a change in the pattern of geographical linkages between cities. Mass markets also reflected an even more profound transformation occurring within cities themselves—the emergence of cities as manufacturing centers (Pred 1966, 1977). In this role, cities served as the focus of production economies, where production factors, supplies of materials, and demand for intermediate goods used in manufacturing became concentrated. As mass markets, cities became the centers of powerful transformative feedbacks in the economy. The growth of urban populations, the shifting rank of cities, the changing directional patterns of interurban trade, and factory industrialization emerged as mutually reinforcing catalysts for economic growth. At the same time, alongside this activity was the continuing expansion, standardization, and integration of the rail and telegraph system. Transport and communications, manufacturing and urbanization, and mass markets in cities thus evolved as interactive elements in a pattern of evolutionary economic change (Table 3.8).

The Railroad and Telegraph 85 table 3.8 Urbanization, Railroadization, and Industrialization of the United States, 1850–1900

Total population (millions) Urban population Cities with population over 10,000 Railroad mileage (thousands) Telegraph mileage (thousands) Index of manufacturing

1850

1860

1870

1880

1890

1900

23.1

31.5

39.9

50.3

76.1

92.4

11.3% 62

19.7% 93

24.8% 168

28.1% 223

35.1% 363

39.6% 440

9.0

30.6

52.9

93.3

166.7

206.6

12.0

56.0

133.6

291.2

848.8

1307.0*

—

16

25

42

71

100

sources: Allan R. Pred, The Spatial Dynamics of U.S. Urban-Industrial Growth, 1800–1914: Interpretive and Theoretical Essays (Cambridge: M.I.T. Press, 1966), 17; U.S. Bureau of the Census, Historical Statistics of the United States: Colonial Times to 1970 (Washington, D.C.: U.S. Department of Commerce, 1975); Edwin Frickey, Production in the United States, 1860–1914 (Cambridge: Harvard University Press, 1947), 10–11. *Mileage for 1902.

urbanization and city rankings The urban population of the United States, which reached 5 percent of the total population only in 1830, began to expand dramatically after 1850, when rail and telegraph firms began to standardize their infrastructure and create a more uniform and nationally oriented transport and communications system.8 By the eve of the Civil War in 1860, roughly 20 percent of the population was living in cities. In 1890, the country’s 22.1 million urban inhabitants represented 35 percent of the total U.S. population. By the end of the century, roughly 40 percent of the nation was urbanized. Equally dramatic in this period was the increase in the number of urban places. In 1850 there were 236 cities, that is, places with a population of at least twenty-five hundred. By 1890, there were 1,348 such places. Even more profound was the increase in larger cities. Four cities in 1850 had populations in the range of fifty thousand to one hundred thousand. By 1890 there were thirty of these larger midsize cities. As early as 1820, the four largest cities of the Northeast—New York, Philadelphia, Baltimore, and Boston—had developed a system of large-city interdependence in terms of both imports and exports (Pred 1977, 67). These cities also dominated the trade with the South, where, unlike the Northeast, there was very little intraregional economic activity in the period before the rail and telegraph system. This southern trade with the cities

86 The Railroad and Telegraph table 3.9 Size Rank of Largest Cities, 1820–1850 and 1850–1890 1820 Rank 1850 Rank New York Philadelphia Baltimore Boston New Orleans

1 2 3 4 5

1 2 3 4 5

New York Chicago Philadelphia St. Louis Boston

1850 Rank

1890 Rank

1 19 2 7 4

1 2 3 4 5

source: U.S. Department of the Interior, Census Office, Report on the Population of the United States at the Eleventh Census: 1890 (Washington, D.C.: Government Printing Office, 1895), 370–72.

of the Northeast was controlled by Charleston and New Orleans. Such control established clearly defined patterns of interurban commodity movements between the southern and Northeast regions. Furthermore, New Orleans was also in a position to control commodity movements from the Ohio and Mississippi River valleys to both the Northeast and the South. These goods went by canal and river routes through the Ohio and Mississippi River systems to New Orleans, where they were then transshipped to other southern port cities or to the port cities of the Northeast. These interurban connections defined the geographical pattern of the interregional trade system before the rail and telegraph system came into use (Pred 1966, 1977). As the urban population increased after 1850, the ranking of first-tier cities within the nation’s urban system shifted in a dramatic way (Table 3.9). One city in particular, Chicago, grew unlike any other. Its emergence as the nation’s second-largest city by 1890 was vastly different from the pattern of rank size city growth from 1820 to 1850, which was marked by relative stability in the size rank of the nation’s very largest cities.9 The emergence of Chicago transformed the economic interdependencies and the geographical linkages between cities and the regions where they were located. In the process, Chicago helped reshape the pattern of both interurban and interregional commercial relationships that had been established in the mercantile era. As Chicago expanded by taking advantage of its position of primacy within the rail and telegraph system, and as it evolved into the nation’s premier commodities market, it became the focal point of the nation’s EastWest interregional trade system. Chicago successfully siphoned off flows of grain from its primary competitor, Saint Louis. It drove New Orleans and the river economy to a secondary role in the nation’s internal commerce system. It relegated the once dominant pork-packing city of Cincinnati to a

The Railroad and Telegraph 87 table 3.10 Growth of Manufacturing Employment in U.S. Cities, 1860–1890 Manufacturing Employment (Thousands)

New York Philadelphia Chicago St. Louis Boston Baltimore Pittsburgh Cleveland Detroit

Population in Manufacturing (%)

1860

1890

1860

1890

106.2 99.0 5.4 9.4 19.3 17.1 8.8 3.5 2.3

477.2 260.2 210.4 94.1 91.0 83.7 56.4 50.7 38.2

9.0 17.5 4.8 5.8 10.8 8.0 18.0 8.0 5.2

19.0 24.9 19.1 20.8 20.2 19.3 23.7 19.4 18.5

source: Allan R. Pred, The Spatial Dynamics of U.S. Urban-Industrial Growth, 1800–1914: Interpretive and Theoretical Essays (Cambridge: M.I.T. Press, 1966), 20.

secondary position, both as a livestock market and a meatpacking center. Its control of the nation’s internal trade and its emergence slightly later as an industrial center became sources of wonder even to the actors at the Chicago Board of Trade who made this happen.10 mass markets and manufacturing From 1860 to 1890, the top-ranking cities in the United States became characterized more by industrial and multifunctional activities and less by mercantile and trading functions (Table 3.10). This manufacturing activity also became increasingly concentrated in fewer, larger cities. In 1860 the ten largest cities accounted for 24 percent of all U.S. manufacturing value added. In 1890 the figure for the top ten cities was 38 percent (Pred 1977, 85). This change toward manufacturing was one of the most significant attributes of the urbanization process that enabled cities to emerge as mass markets. Owing to this transformation, the channels of interdependence among larger cities within the U.S. urban system increasingly involved commodity flows tied to both manufacturing activities and consumption. Such flows of incoming inputs and outgoing manufactures, both finished goods for final demand and intermediate goods for other factories, were not limited to durable products. These flows also included an exploding interurban trade in foods fabricated in factories to feed an increasingly urban manufacturing population (Pred 1977, 94). Such foodstuffs linked agriculture to industry

88 The Railroad and Telegraph and production to consumption in a reconfigured interregional and interurban trade and manufacturing system. Continued expansion and standardization of the nation’s rail and telegraph system, and the dramatic reductions in freight charges and communication costs that accompanied this build-out, enhanced the phenomenon of urban mass-production activity. From 1865 to 1890, costs for moving commodities on a per-ton-mile basis decreased by roughly 75 percent (Pred 1977, 94). These cost reductions, in turn, provided opportunities and incentives for firms to produce in high volumes. As cities evolved into concentrated sources of supply and demand for manufacturing activities within a system of enlarged markets, and as improvements in the transport and communications infrastructure enhanced the capacity of firms to produce in higher volumes, factory production became firmly anchored to cities. In this way, transport economies, information economies, mass-production economies, and urbanization economies were connected to a pattern of economic growth focused on urban mass markets and interregional trade. This sequence of transport economies, information economies, internal scale economies, and urbanization economies thus became mutually reinforcing, enabling the rail and telegraph revolution, mass production, interregional trade, and the urban system to evolve along the same trajectory.

The Politics of Market Space If this enlarged structure of markets and system of long-distance interregional and interurban trade begins with technology, it assumes its more complete form in the realm of politics. By the 1870s, when patterns of national market integration had become widespread, numerous state governments, responding to local business interests, succeeded in creating a web of regulatory barriers to internal commerce. These barriers were designed to protect local business firms in certain states from the competitive encroachments of firms from outside the area. As market areas enlarged and as the boundaries between markets blurred, business firms became more vulnerable to competitors residing outside the former market boundaries. Although efforts by local governments to protect local business interests by restricting commerce between states conflicted with the spirit of the commerce clause in the Constitution, states nevertheless took advantage of their own broadly defined authority known as states’ rights to circumscribe interregional trade within narrow limits. Such protectionist rule making on the part of state legislatures contributed to a specific type of market inefficiency. Protections extended to local business firms often enabled local merchants to assume what was effectively monopoly power in those markets where they operated. As late as 1875, the fed-

The Railroad and Telegraph 89

eral courts said nothing to disturb this impulse of states to intervene and protect local businesses, despite the efforts of the constitutional framers to create a single national market (McCurdy 1978, 635). States used the doctrine of states’ rights to implement protectionist legislation in two ways. First, certain states required nonresident salespersons to pay higher licensing fees than local merchants. For example, in the case of the Singer Sewing Machine Company, these fees aimed at restricting the company from setting up its network of retail outlets to compete with the firms of Wheeler and Wilson, and Wilcox and Gibbs. In a Supreme Court case in 1880, Webber v. Virginia, the Court, in acceding to the demands of Singer, struck down the rights of states to impose such fees. This decision revealed the extent to which the idea of a unified national market had become an integral part of the nation’s legal doctrine (McCurdy 1978, 642). The other mechanism implemented by states was the use of local inspection laws for food, most notably in the meatpacking industry itself. As the market power of Swift and other large interstate packers expanded during the 1880s, local butchers persuaded lawmakers in Minnesota, Indiana, Colorado, and Massachusetts to enact preslaughter inspections laws where beef and pork were sold. Although lawmakers claimed that their intent was to protect the public interest, these laws aimed at eliminating the ability of large packers to sell products transported across state lines. In this case, the remedy upholding the national market space was legislative. In 1891 the federal government authorized the Federal Meat Inspection service to conduct federal inspections of beef and pork produced for interstate sales. While these cases reflected the shift toward greater levels of long-distance trade, they also revealed the role of corporate political power in establishing policy in the marketplace. At the same time, the changing legal framework for interregional economic activity reflected new thinking among policyoriented academics about the market itself (Parrini and Sklar 1983). In this new outlook, not only was the country supposedly better served by longdistance commerce and a unified national market. Large oligopolistic firms emerged in this new view of markets as the most efficient organizers of economic activity within a unified national economic space.

The Platform for Innovation at Swift Innovation at the G. F. Swift Company would be neither wholly fortuitous nor the result of individual genius. It emerged on the basis of widespread trends in the economic geography of the nation ignited by the communications revolution of rails and telegraphy and its build-out. First, Swift would establish its organization for producing and distributing beef on the foundations of the rail and telegraph infrastructure and the

90 The Railroad and Telegraph system of interregional markets created by the build-out of this infrastructure. Such markets differed from the highly variegated and localized markets prevailing at midcentury. Consequently, by 1875, when G. F. Swift first conceived of ways to reorganize beef production and sale, he had at his disposal for this learning process a transport and communications infrastructure sufficiently developed and a market structure capable of supporting his idea for a new type of production and distribution organization. Infrastructure, market structure, and the interregional system of commerce created by the two thus provided Swift with a critical platform for innovation. Second, Swift built its innovative production and distribution network on the basis of profound changes in the nation’s urban system. These transformations, which were linked to the rail and telegraph revolution, elevated cities as manufacturing centers, as concentration points for interregional commerce, and as mass markets. In establishing its business, the G. F. Swift Company took advantage of these urban characteristics and exploited what was arguably the most defining event in the urban history of the nation during the latter nineteenth century, the emergence of Chicago as the nation’s second city. As the nation’s rail center and main commodities market, Chicago forged powerful economic linkages with other cities throughout the country. Equally important, Chicago also established critical linkages with a vast agricultural hinterland, including the cattle-raising areas of the western range. These interurban and urban-agricultural connections were fundamental for Swift. Furthermore, the firm profited from the development of Chicago and cities in the Midwest as mass markets for the purchase of cattle raw materials and as sites for factory operations. Perhaps even more important, Swift exploited cities as burgeoning centers of consumer demand for foodstuffs. The firm developed its beef network on the foundations of these cities, relying on the enormous expansion in the number of urban places as mass consumer markets for dressed beef.11 Eventually, the location of the branches in the firm’s dressed beef network resembled the map of U.S. cities with populations of twenty-five thousand inhabitants. Innovation at the firm was thus intimately connected to the nation’s urban history. It was upon these structures—technological, interregional, and urban— that Swift would emerge as an agent for change.

chapte r

4

Continental Divide The Business Enterprise of G. F. Swift & Company

I was determined to eradicate the waste of buying cattle which had passed through the hands of too many middle men and against which too many charges had accumulated. Gustavus Swift, 1890 We followed a few years after Mr. Swift. We had to learn the methods of dressed beef and experiment. The methods have been gradually growing. We have perfected them year by year, learning something every year as to how to do the business better. P. D. Armour, 1889 All along this east side of the yards ran the railroad tracks, into which the cars were run, loaded with cattle. “And what will become of these creatures?” cried Teta Elzbieta. “By tonight,” Jokubas answered, “they will all be killed and cut up; and over there on the other side of the packinghouses are more railroad tracks where the cars come to take them away.” Upton Sinclair, The Jungle, 1906

Gateway to Innovation In 1879, architects Daniel Burnham and John Root, pioneers of the Chicago architectural avant-garde of the late nineteenth century, completed a commission for the Union Stockyard Company to build a monumental entry to the company’s sprawling facility on Chicago’s southwest side. When it was built, the Gate of Burnham and Root celebrated the ascendancy of a particular industry—meatpacking—and a particular place—Chicago, which had evolved into “the great bovine city of the world” (Wade 1987, 56–57). The gateway, however, proved to be more than a celebration of previous ac-

92 G. F. Swift & Company complishment. It was both homage to industrial creativity in the recent past and prophecy of creativity to come.1 During the previous two years, Gustavus Swift had initiated a series of experiments in shipping slaughtered beef from Chicago to New England in his own refrigerated railcars. While not the first to try this technique—the Chicago Board of Trade had already conceded in 1876 how such shipments represented “important traffic” (Taylor 1917, 684–85)—Swift was the first firm aiming to build a business around such a system. By 1878, Swift, undaunted by the skepticism of other meatpacking firms that dressed beef shipments would fail as a business model, began forging an extremely innovative though still experimental system for slaughtering beef in one location and selling the dressed beef in markets located great distances from the point of slaughter. This innovation would have decisive consequences. It transformed the entire meatpacking industry within the next decade and recast the organizational and territorial pathways for the accumulation of profit in the U.S. economy of the late nineteenth century. communications and creative destruction Central to Swift’s innovation was a new type of business organization for mastering the control needed to produce and distribute the highly perishable dressed beef product. Such control, in turn, hinged on the development of the rail and telegraph system (Chandler 1992, 264; 1977, 392, 402). Although surprisingly neglected by Schumpeter, the dressed beef enterprise of Swift is among the most innovative business breakthroughs of the late nineteenth century. As an upstart among more established firms such as Armour, Swift assumed this entrepreneurial role and built this organization by developing a new product—beef slaughtered and butchered in one location and sold in another—and more fundamentally, a new process for making and selling this new product.2 In engineering these changes, the company occupies a position of centrality in what Schumpeter insisted was the essence of capitalist development—“creative destruction”—rooted in the phenomenon of innovation and technological change. What Swift succeeded in destroying was the market structure and system of beef production, consumption, and sale prevailing before 1875. In this system, butchers slaughtered cattle and sold beef to consumers living nearby, creating a highly localized structure of markets for cattle slaughter and beef consumption. Long-distance shipments of live cattle by rail from West to East, which coexisted with this pattern and provided supplies for eastern butchers, did little to undermine the fundamentally localized relationship of cattle slaughter and beef consumption. In these conditions of market localization, myriad intermediaries—wholesalers, jobbers, and merchants—were the dominant actors, creating numerous—and according to Swift—ineffi-

G. F. Swift & Company 93

cient steps in the process of beef production, slaughter, and final sale to retail butchers and consumers. By exploiting the rail and telegraph system to undersell existing butchers in local markets and make this new product affordable, Swift created the demand in eastern markets for his new product (Destler 1946, 42).3 As part of this effort to create a market, the company built a brand name, Swift “Premium,” and connected its brand to the newly discovered power of advertising in a concerted campaign to strengthen consumer preferences for Midwest-slaughtered beef among an initially skeptical public (Neyhart 1952, 154; Cockburn 1996). With an ever-increasing share of the consumer market for beef, Swift disrupted the relationships of supply and demand between buyers and sellers of beef that gave the beef trade and beef markets their local character. In the process, the company essentially destroyed the intricate system of intermediaries formerly prevailing in the beef trade. In place of these actors emerged a new type of business organization for coordinating the system of cattle slaughter and beef sale. the organization of swift The organization built by Swift for producing and marketing freshly slaughtered beef in high volumes over a national territory represented a revolution in logistics. This revolution elevated the role of process innovation as the route to profit making in the industry and transformed the business of meatpacking into a distribution business (Aduddell and Cain 1973, 97). This process-oriented innovation pioneered by Swift consisted of four fundamental elements. The core of the company’s innovative advance was the creation of a dispersed network of branch distribution houses for selling dressed beef to the firm’s final customers, retail butchers. This branch house network played a pivotal role in securing the demand necessary for the company’s dressed beef business to operate on the basis of high volumes. Through direct interaction with retail butchers, these branch houses provided the bridge between volume production, with its economies of scale, and mass consumer demand, which Swift had actually helped to create. It was the system of branch houses that enabled Swift to bypass the traditional intermediaries in the cattle and beef trade and create a more direct route to the customer. The direct system of moving beef from producer to retailer through the branch houses removed distribution bottlenecks created by the wholesale network that had constrained volumes and opened the channel for increased levels of throughput necessary for Swift’s system to operate profitably. Perhaps most important, this elimination of intermediaries enabled Swift to outcompete the two prevailing business models of the beef trade based on slaughter of cattle raised locally or alternatively on localized slaughter of cattle shipped

94 G. F. Swift & Company long-distance. Swift’s direct distribution system was, in effect, a nineteenthcentury form of disintermediation. It emerged as a pioneering example of institutional change within a wider reorganization in the nation’s wholesale networks as the mass production economy expanded and as vertically integrated manufacturers assumed a more dominant role in marketing their own products (Porter and Livesay 1971). Second, the high-volume system of cattle procurement, slaughter, and disassembly on the front end of the organization represented a pull system. Customer orders for cuts and grades of beef placed at branch houses by retail butchers and telegraphed daily to Swift headquarters were the basis for procurement orders of cattle supplies at the various stockyards to satisfy customer demand. Such a system “pulled” cattle supplies through the organization as orders were received instead of pushing finished product out of disassembly factories for sale to customers on the basis of demand forecasts. From its headquarters in Chicago, Swift & Company relied on telegraphic communication with its purchasing agents at the major livestock markets of Saint Louis, Kansas City, Saint Joseph, Saint Paul, and Fort Worth, where the company had slaughtering facilities, to convey orders to its buyers and receive messages on available cattle supplies. Swift, in effect, used the telegraph to balance cattle demand and supply in real time in this pull system while the railroad acted as the fulfillment mechanism for transporting supplies and finished product. Third, this organization incorporated a new structure of ownership and control over the adjacent steps in the production and distribution of fresh beef. A formerly disaggregated, locally oriented, and small-scale activity had given way to an industry controlled by vertically integrated, large-scale enterprises. As the first vertically integrated meatpacking firm, Swift was the forerunner of large-scale, nationally oriented business organizations. Along with five other packing firms, Swift was part of an oligopoly dominating the meat industry, a pattern that would characterize numerous other industries of the period (Chandler 1977). Finally, this organization created a new geography of economic activity incorporating tendencies of territorial spread and localized concentration. For the first time in history, shipments of fresh beef were transported great distances in refrigerated railcars. Such shipments helped to establish the foundations of a more uniform and integrated national marketplace, “annihilating space” in the process (Cronon 1991, 207–59). At the same time, as Swift was extending its network through the proliferation of branches throughout the continent, the company was concentrating economic activity in new locations. Chicago and then other cities in the Midwest where Swift expanded disassembly operations became place-based concentrations of slaughtering. Assuming the status of late-nineteenth-century industrial

G. F. Swift & Company 95

districts first observed by Alfred Marshall, these concentrations of slaughtering emerged as command centers of continentally organized industrial empires, gateways to a new territory of profit making.

Early Meatpacking In order to grasp the innovative and transformative impacts of Swift’s production and distribution network on the rest of the industry, it is imperative to understand the nature of the industry in which Swift initially operated. Until the last quarter of the nineteenth century, cattle slaughtering and fresh beef distribution were under the control of local butchers (Clemen 1923, 225). By 1890, however, local butchers in most places had become little more than retail conduits for a trade dominated by nationally organized firms. The business organization pioneered by Swift played the decisive role in this transformation by challenging the two most fundamental attributes of early meatpacking: (1) the decentralized markets of the industry, and (2) the dominance of pork over beef. In challenging these attributes, the organization of Swift recast the relationships between actors in the meat industry while creating a new type of firm, a more far-flung market geography, and a pattern of economic growth based upon high-volume, long-distance throughput. How the meat industry evolved from a locally oriented activity focused overwhelmingly on pork to a national activity in which beef rivaled and even surpassed pork in importance and how, as the beef industry expanded, the practice of shipping beef in carcass form great distances assumed ascendancy over live cattle shipments are the central themes in the Swift story of innovation and economic change.4 markets and meat Prior to the railroads and the refrigerated railcar, slaughtering and meatpacking was the domain of innumerable small farmers and firms that supplied local markets (Clemen 1923, 173;Yeager 1981; Walsh 1978, 1982). The geography and market structure of the industry was a mirror image of the localized markets that dominated the U.S. economy in the early nineteenth century (Pred 1966, 163–67). Virtually every town had its own slaughtering facility, usually located on the outskirts where urban and rural boundaries met, that provided for local consumption (Clemen 1928, 440). Large cities had multiple facilities. New York had more than two hundred abattoirs servicing various neighborhoods. Slaughtering and the consumption of beef were thus reflections of local markets that, in the absence of well-developed interregional transport and communications links, were largely self-contained.

96 G. F. Swift & Company Under these conditions, the overwhelming influence on slaughtering and meatpacking was seasonality. Grazing and feeding of cattle and hogs began in spring and lasted through the autumn. Slaughtering occurred at the end of the grazing and feeding season, while animals not yet mature were held and fed on corn during the winter. Because fresh meat was perishable, it had to be either consumed quickly after it was killed or preserved by salting, smoking, or curing. Meat preservation occurred in the winter, since the meat had to remain cool to prevent spoilage while the cure mixture penetrated the flesh, a process that lasted several weeks. Cured meat was eventually shipped on riverboats during the spring thaw (Yeager 1981, 5). This seasonal activity, undertaken by numerous small producers, supplied local markets under the guidance of the so-called invisible hand (Yeager 1981, 1). During the first half of the nineteenth century, consumption of pork far exceeded that of beef. The reason was that pork was more easily preserved and more readily eaten in preserved form than was beef. In addition, hogs were less expensive to raise than cattle (Yeager 1981, 4). Fresh beef was available, but conditions for the consumption of beef had severe restrictions. In the absence of rapid overland transportation, beef had to be butchered and sold close to where it was raised and slaughtered or it would spoil. This constraint limited the distance that slaughtered beef could be transported. Rarely did slaughtered beef, whether killed on farms or in abattoirs on the outskirts of towns, travel more than fifteen miles to market. Although river steamboats widened the meat trade after the 1820s, the growth occurred in the trade for cured rather than fresh meats. Because cured meats consisted overwhelmingly of pork, the expansion in meatpacking stemming from steamboats occurred in pork packing. Hauling of live cattle on steamboats for slaughter and sale in locales distant from where animals were raised was simply not technically or economically feasible (Yeager 1981, 4–5). The alternative to hauling live cattle was to ship freshly slaughtered beef by steamboat. Even this new form of transport, however, did not represent a sufficient technological advance to alter the local character of the beef industry. In the absence of refrigeration technologies, river steamboats did not provide enough speed to widen the market for freshly slaughtered beef. As a consequence, fresh beef remained a local product that could not be traded over long distances. Pork packing undertaken by numerous small and medium-sized firms and the transport of cured pork by river steamboats dominated the packing business in the early part of the nineteenth century.5 There was little in the way of an organized fresh beef industry in the United States. Cattle slaughtering for fresh beef was more an agricultural activity in which cattle merchants and local butchers acted as intermediaries for delivering beef from farms to consumers.

G. F. Swift & Company 97

the early beef trade Given the constraints imposed by distance and available transport, urban consumers in the population centers of New England and the Middle Atlantic states could avail themselves of fresh beef from two basic sources. One source was cattle raised on eastern farms. Networks of eastern cattle farmers, cattle merchants, and urban wholesale and retail butchers organized the beef trade that brought beef to eastern cities from nearby cattle farms. Sometimes the farmer would slaughter the cattle and sell the carcasses to a wholesaler, who delivered them to wholesale or retail butchers for further butchering and sale. At other times, the farmer would sell live animals to a wholesale agent, who would drive the live animals to a local abattoir for slaughtering or deliver them to a local wholesale butcher for slaughter and sale to retailers. Still another possibility was for the farmer himself to drive his stock to the local abattoir or to wholesale butchers for slaughter and sale. These networks of farmers, cattle merchants, and butchers became relatively well entrenched within localities. The other source for fresh beef was cattle made available in the East as a result of the much-celebrated long-distance cattle drives. The importance of cattle driving as a source of eastern beef consumption stemmed from the steady westward migration of cattle raising during the nineteenth century. Because it was extremely land-intensive, the raising of cattle gradually moved from the population centers of the East toward the frontier in search of open pasture. This migration increasingly separated the location of the country’s cattle from the human population and provided the fundamental stimulus for cattle driving. At their peak in the 1840s, cattle drives transported animals from Texas, the Great Plains, and the grain belt states to the eastern population centers on time-consuming and arduous journeys often exceeding a thousand miles (Clemen 1923, 174–79). Drives were seasonal, beginning anywhere from late February until June and terminating at eastern stockyards between April and August. Six principal actors played essential roles in cattle driving (Clemen 1923, 63–65). First was the cattle “grazer,” who raised the stock. Cattle “feeders” then purchased the stock in the fall and fattened the animals on corn during the winter months in corn belt states such as Illinois for marketing in the East during the following driving season. “Drovers” would drive the live animals to the East. At the end of the driving process, cattle were consigned by drovers to eastern cattle merchants. Slaughtering took place sometimes under the control of these wholesalers at eastern stockyards employing wholesale butchers, other times by large wholesale butchers in their own shops. Finally, wholesale butchers distributed dressed sides to retail butchers, who in turn would process the dressed carcasses for final sale to retail customers. The boundaries between these actors, however, often overlapped.

98 G. F. Swift & Company table 4.1 Size of Beef- and Pork-Packing Industries, 1870 Establishments Beef packing Pork packing Miscellaneous meat

36 206 17

Employees 435 5,551 499

Output ($ millions) 1.95 56.43 3.76

source: U.S. Bureau of the Census, The Statistics of the Wealth and Industry of the United States, Ninth Census, vol. 3. (Washington, D.C.: Government Printing Office, 1872), Table 8(c), p. 458.

Despite the high visibility of cattle drives and the creation of institutions along the trails for these drives such as livestock pens for animals and hotels and taverns for drovers, beef still remained a subordinate product to pork (Table 4.1). Pork packing tied to river conveyance was the overwhelmingly dominant trend in the packing business (Walsh 1978, 9). As late as 1870, cattle slaughtering and beef packing, as an industrial activity, was still extremely small compared to pork packing. Overall, the industry, with an output of $62 million in 1870, ranked as the eleventh-largest in the nation.

Rails and Cattle During the 1850s and after the Civil War, as railroads began to replace water as the primary means of conveyance for commodities, a profound transformation occurred in the beef trade. Railroads made possible the large-scale long-distance shipment of live cattle. This development, in turn, reinforced an already evolving geographical separation between cattle-grazing areas of the West and the population areas of the East. With railroads as transport and with the telegraph providing information on cattle prices and supply and demand conditions, the East became more viable as a market for long-distance cattle shipping from the western range. the stockyards In eastern cities, demand for fresh beef had outstripped the supply available from local cattle farms or through drovers.6 Rail transport enabled cattle from the West to be shipped “on the hoof ” to these burgeoning urban markets. Consequently, the 1850s and the period immediately following the Civil War witnessed the advent of a new business activity in the form of eastbound rail shipments of live cattle. This period also brought a powerful actor into the cattle and beef business—the railroads. In elevating Chicago to a position of primacy within the nation’s transport system beginning in the 1850s, the railroads created a new geography of

G. F. Swift & Company 99

concentration for the cattle trade. At this location emerged a huge cattle market and point of transshipment for the movement of cattle from the West to eastern slaughtering markets. Decisive in this process was the establishment in 1865 of the Chicago Union Stockyard Company. Capitalized at $1 million, the stockyard was spearheaded by the railroads and supported by Chicago meat-slaughtering firms with nine railroads subscribing $925,000, eight Chicago meatpackers contributing $50,000, and the public purchasing shares worth $25,000 (Wade 1987, 48–49). The aim of this project, located five miles southwest of downtown Chicago, was to create one large-scale centralized stockyard accessible to all the railroads as well as livestock dealers and meatpackers. Such a consolidated stockyard facility was entirely without precedent (Wade 1987, 50). Upon opening in 1865, the Chicago Union Stockyard was enormously successful both as a market for the local cattle trade and as a conduit for eastbound cattle traffic. By 1867, cattle were being driven from the ranges to so-called cowtowns of the West, such as Abilene, Kansas. These were essentially railheads where the animals were consigned to cattle merchants and then shipped by rail to Chicago. What emerged in the process was a differently configured territorial nexus between Chicago and the western grazing ranges, and Chicago and the East, with the Union Stockyards playing a vital role in the creation of this new geography. Central to this new system of cattle shipment was an entirely new institutional actor, the cattle commission house, which acted as a critical intermediary in the trade.7 Cattle commission firms were consignees operating in the Chicago stockyards. They helped make the market at the Union Stockyards by absolving cattle farmers and drovers of the need to travel with their stock to Chicago to secure their sale. Instead, cattle commission houses, working through local cattle merchants or their own agents in Abilene and other western shipping points, paid cash for delivery of stock prior to actual sale in the Chicago market and made a commission on the sale as a market maker. This system created new incentives for cattle farmers and drovers to make cattle available for sale to the Chicago market. In conjunction with the opening of the Union Stockyards, cattle commission houses provided critical institutional supports for Chicago’s cattle market and enabled it by 1870 to become “the great bovine city of the world” (Wade 1987, 57). one step forward . . . Despite advances in shipping cattle made possible by the railroads and the Union Stockyard facilities in Chicago, the new business of cattle shipping was not without problems. At the Chicago market, three issues confronted cattle shippers aiming to transport cattle by rail from sources of supply in the West to places of demand in the East. The first problem facing cattle buyers and shippers stemmed from the

100 G. F. Swift & Company system of intermediation in the cattle trade that had emerged following the creation of the Union Stockyards and the cattle commission houses. After 1865, localized cattle merchant networks that had formerly dominated the trade gave way to a more geographically dispersed and more numerous set of wholesale actors who entered the trade as adjuncts of the consignment system being perfected by cattle commission houses. As a consequence, myriad new jobbers, merchant wholesalers, consignees, and commission agents became part of the cattle-shipping business facilitating the movement of cattle from collection points such as Abilene to delivery points at eastern slaughterhouses. While this network made cattle distribution more efficient overall, the numerous exchange points in the network, between sources of cattle supply and shipper-buyers of cattle at the Chicago stockyards and between cattle shippers and retail butchers in the East, drove down margins for the business as whole. Shippers of live cattle purchased at Chicago for shipment East were therefore positioned within a selling chain with numerous steps that provided them with meager returns. Second, the cattle shipper confronted technical problems in successfully shipping live cattle on existing cattle trains. Cattle had to be fed and watered along the route. In addition, animals invariably lost weight during these trips, bringing in less money for cattle shippers at the point of sale. These difficulties, however, were far from the most onerous. A report by the Massachusetts Railroad Commissioners in 1870 describes in detail the ultimate risk facing cattle shippers in transporting cattle long distances by train: Cattle trains yield the road to most others and pass hours on the sidings; the animals are without food or water and often with insufficient ventilation in summer or shelter in winter; they are jolted off their legs and goaded till they struggle up, for they can not be permitted to lie down. They thus arrive at their destination trampled upon, torn by each other’s horns, bruised, bleeding, having in fact suffered all that animals can and still live. Under the most favorable circumstances they leave the train panting, fevered and unfit to kill; under the least favorable, a regular percentage of dead animals is hauled out of the car. (quoted in Clemen 1923, 195)

Finally, adding to the logistical challenges of shipping live cattle was perhaps an even more formidable obstacle—the fact that roughly 55 percent of the animal was inedible. This unusable part of the cow placed a freight cost burden on cattle shippers without the possibility of a return. As a result, the business of shipping live cattle was far more lucrative for the railroads. By the late 1850s, cattle shipments had emerged as the rail industry’s most profitable eastbound trade (Chandler 1988, 230). Upon completion of the Chicago stockyards, this trade expanded even more rapidly. Consequently, this was a business that the railroad companies aimed to protect. In order to maintain the cattle trade at profitable rates, the major live-

G. F. Swift & Company 101

stock-carrying railroads entered into pooling arrangements during the 1870s. The most notable of these agreements was the “Evener System,” in which the railroads and the largest cattle shippers worked in concert.8 Although the largest cattle shippers benefited from such cartel agreements, the fundamental problem of shipping live cattle—the freight charges levied on the inedible portion of the animal—remained unresolved even for the large cattle firms. Furthermore, despite cooperation between the largest cattle shippers and the railroads, these two groups did not meet in the marketplace as equals. The size of the railroads and their control over such a vital transportation service provided them with the power to maintain freight rates over cattle shippers.9 The need to overcome the cost problems posed by rail shipments of livestock compelled Swift to conceive of the production and sale of beef in a completely different way. In this reconceptualization, the idea of slaughtering and butchering meat in the West and shipping the dressed beef to the East over the rail system without spoilage was the basic problem that Swift would try to resolve. The key obstacles facing Swift in trying to overcome this problem were thus time and distance: the window of time before the meat spoiled and the distance between the disparate locations of slaughter in the West and sale in the East. The solution was both technological and organizational. Through trial and error, Swift came to understand that the solution to overcoming the barriers in shipping dressed beef was an integrated production and distribution strategy. On the technical side, the route to this integrated strategy was to link breakthroughs in refrigeration to the transport and communications infrastructure of rails and telegraphy. Organizationally, G. F. Swift confronted two issues. On the one hand, he had to confront the power of the railroads to set freight rates. Second, Swift somehow had to bypass the expanding channel of intermediaries in the rail-based cattle and beef trade. Dressed beef shipments on a large scale were incompatible with the organizational channels of distribution that had emerged in the cattle and beef trade (Porter and Livesay 1971, 168–73). Many of these distributors in the East were incapable of handling dressed beef, while others were openly hostile to the product, fearing the competition that dressed beef represented to their businesses with live cattle. Ultimately, the key to resolving these problems resided in the creation of a new type of business enterprise. Such an enterprise had to possess the capability of coordinating the various activities of procuring and slaughtering cattle, shipping dressed beef long-distance, and distributing the dressed beef in these geographically dispersed market areas. Only with such an organization could Swift integrate production and distribution and achieve the volumes necessary to make the

102 G. F. Swift & Company dressed beef project feasible. While the integrated organization pioneered by Swift represented the solution to this challenge, the initial steps leading to the creation of this organization actually began as experiments with the technology of refrigerated transportation. In these experiments, Swift was able to take advantage of earlier precedents in the technology of refrigeration.

Early Refrigeration By the close of the 1860s, the idea of adapting principles of refrigeration to transport systems for shipping perishable items was particularly compelling to early meat industry visionaries who influenced Swift. Initial efforts to ship refrigerated beef, however, were small-scale and still dependent on cold weather. In 1868 Henry Peyton Howard made an experimental shipment in his own steam freighter but soon discovered that weather conditions in the gulf area where he was operating were too unpredictable to sustain the business. Another pioneer, Thomas Rankin, shipped refrigerated beef from Denison, Texas, to New York City in refrigerated railcars but was forced to close his company after failing to achieve the volumes needed to make such a business profitable. The most viable precedent for Swift in terms of refrigeration strategies came from the meatpacking firm of George H. Hammond. In 1869 Hammond used a refrigerated railcar to ship eight tons of freshly slaughtered dressed beef from Detroit to Boston on the New York Central and Boston & Albany Railroads. Building upon this success, Hammond expanded his business after 1870, distributing his meat through existing networks of wholesalers and commission merchants. His railcar, however, had serious shortcomings, forcing him to confine his shipments to the winter months and thereby keeping his operation relatively small-scale. Because his business remained far too modest to compete with the live cattle shipment business, Hammond did not encounter resistance from the railroads. Nor did he meet with opposition from local eastern wholesale butchers since he did not undercut them on price. His western dressed beef cost the same or slightly more than locally slaughtered meat (Yeager 1981, 54). Nevertheless, Hammond’s business generated sufficient interest to lure other competitors into trying to perfect the system of grafting the technology of refrigeration onto transportation networks for shipping dressed beef from the West to the East. Firms run by Nelson Morris and T. C. Eastman experimented with refrigeration systems of their own. Others in the cattle and butchering business soon followed. By 1877, the ChicagoTribune wrote how the dressed beef business was now a significant activity (Taylor 1917, 549). Perhaps more important, the beef business in general was in the beginning stages of a large-scale

G. F. Swift & Company 103 table 4.2 Comparative Expansion of Beef and Pork Packing, 1870–1890

Establishments Employees Total output Pork, % of total Beef, % of total

1870

1880

1890

259 6,485 $62.1m 90.8% 3.2%

872 27,297 $303.6m 61.8% 27.8%

1,367 44,812 $564.7m 42.1% 34.4%

sources: U.S. Bureau of the Census, The Statistics of the Wealth and Industry of the United States, Ninth Census, vol. 3 (Washington, D.C.: Government Printing Office, 1872), Table 8(c); U.S. Bureau of the Census, The Statistics of Manufactures, Tenth Census, vol. 2 (Washington, D.C.: Government Printing Office, 1883), Table 7, pp. 464–65; U.S. Bureau of the Census, Report on Manufacturing Industries, Eleventh Census, part 1 (Washington, D.C.: Government Printing Office, 1895), Table 8, pp. 730–35. note: Pork and beef do not sum to 100 percent because of “miscellaneous” meatpacking products.

expansion (Table 4.2). It was in this environment that Swift would launch its own experiments in refrigerated dressed beef shipments over the railroads.

Entrepreneurial Opportunity G. F. Swift came to Chicago in 1875 to set up a cattle-buying office for his Boston-based wholesale meat business. At that time, refrigerated dressed beef shipments from the Midwest to the East, pioneered by Hammond and Morris, were expanding among other Chicago packers, although refrigeration techniques were still rudimentary. More important, there was no established business model capable of making the overland trade in dressed beef secure and reasonably profitable. The meat business was still dominated by live cattle shipments from the West through the entrenched channel of cattle merchants, brokers, and wholesalers. This experience from 1875 to 1877 of buying cattle in Chicago and shipping the animals East for his butchering business in Massachusetts brought Swift into direct contact with the economics and logistics of the live cattle-shipping business. It was the experiments in dressed beef, notably by his competitors Morris and Hammond, that especially drew his attention (Russell 1904, 23; Swift 1927). Not only was Swift looking for ways to avoid freight charges on the 55 percent inedible portion of the animals and eliminate the weight losses and bruising of the meat during shipment. Equally important to Swift was his determined effort to eradicate “the waste of buying cattle which had passed through the hands of too many middle men and against which too many

104 G. F. Swift & Company charges had accumulated” (quoted in Yeager 1981, 59). Because Swift understood the problem of supplying eastern markets with beef to be one of distribution—the damage to cattle from rail transport, the exorbitant freight rates on cattle, and the numerous intermediaries in the trade—he established as his objective the creation of a system for distributing his product differently. This objective, in turn, is what pushed Swift into experimenting with the idea of shipping dressed beef slaughtered in Chicago rather than shipping live animals. G. F. Swift seemed to possess the drive, skills, and temperament for this creative task. According to Charles Edward Russell, a radical critic of the Beef Trust, the “chief founder” of what was to become the dressed beef industry was big-boned, big-brained, resolute, indomitable, obsessed with that strange consuming passion for money-making that seems to be an exclusively American trait, a tireless worker, a devout Methodist, and of habits austerely and almost painfully correct. . . . He drifted westward to find some road to wealth. At the time Nelson Morris was experimenting with frozen meat in box cars, Swift was clinging desperately to the very skirts of the Chicago cattle market, a small speculator without capital or credit. . . . He was poor but was slowly forging ahead. The frozen-meat experiment came under his notice and he gave to it the searching scrutiny of an alert and powerful mind. . . . Mr. Swift studied this scheme and gradually unfolded in his mind a plan, having the prospect of enormous profits. (Russell 1904, 23)

In response to this challenge of seeking profit in a new way, Swift developed a business model linking four elements—refrigeration, transportation, communications, and organization—that succeeded in overcoming the fundamental obstacles to the long-distance trade in dressed beef. This business model, however, unlike that used earlier by Hammond, did not accommodate existing wholesalers in the industry. It obliterated them and created a cost structure based upon a branch system of distribution and high-volume throughput that exerted an irrepressible force on others aiming to compete in the industry.

Learning a New Business Swift launched his system in a series of experiments linking transportation and refrigeration. From the proceeds of his cattle-buying activity, he acquired sufficient capital for the purchase of his own slaughtering plant, which he used for initial trials of refrigerated dressed beef shipments (Yeager 1981, 58–63). For these early shipments, however, Swift used ordinary railcars, shipping the dressed product during winter months. He next rented refrigerated railcars from freight companies that were experimenting with

G. F. Swift & Company 105

the fresh fruit trade, but he was unable to lease enough of these cars to make the trade practical. By 1877, Swift decided to try to perfect his own refrigerator car as a first step in creating a dressed beef business. His partner at the time, however, James Hathaway, regarded the scheme as unsound, and the two dissolved the partnership. With thirty thousand dollars from the sale of his stake in the partnership, Swift formed a new enterprise with his brother, Edwin Swift. The aim of the Swift Brothers was to launch a business for procuring, slaughtering, shipping, and selling dressed beef. In 1878, Swift hired engineer Andrew Chase to help him perfect plans for an insulated and ventilated refrigerator car for the railroad. The design was highly innovative, with unique features that resolved some of the technical problems, such as moisture and ventilation, that had plagued cars built earlier for Hammond by William Davis. The central element of Chase’s design for Swift was a unique cold blast system that provided automatic circulation of dry air through the cooling compartment. Ice bunkers positioned in the upper corners of the car cooled the air, forcing warmer, lighter air to escape through ventilators. An advantage of these ice bunkers was that they could be filled from the exterior, making them easier and more efficient to operate. swift and the railroads When Swift approached the railroads of the Eastern Trunk Line Association to ask for assistance in building the cars, however, they rejected his request, fearing both the short- and long-term consequences such cars might pose to them as livestock shippers.10 Swift eventually found a builder in the Michigan Car Company, mortgaging his business as collateral for construction of ten cars. He then approached the Grand Trunk Railroad to enlist it as the carrier for his dressed beef. Unlike the railroads of the Eastern Trunk, the Grand Trunk Railroad had limited investments in the livestock trade and was therefore not threatened by Swift’s undertaking. Although its route east went through Ontario and Quebec, the Grand Trunk shipped into New England, where Swift intended to launch his initial dressed beef shipments. Furthermore, by giving the Grand Trunk his business, Swift offered the railroad a product capable of competing with the lucrative livestock-hauling trade of the other trunk-line rail carriers. There was another good reason, however, for Swift to give his business to the Grand Trunk. A competing railroad to Boston, the New York Central–Boston & Albany Railroad, carried the much smaller dressed beef shipments of his competitor, George Hammond. Swift’s refrigerated dressed beef shipments and the Grand Trunk Railroad were thus a natural combination. With a more technologically advanced refrigerator car and rail carrier in place, Swift began trial shipments of dressed beef from Chicago to New England in the winter of 1878. He established his first branch houses in Fall

d

nk Railro a Tru d ran

G

Clinton Fall River

Slaughtering facility Stockyard / cattle supplier Branch house

map 4.1 The Dressed Beef Enterprise of G. F. Swift, 1878

© Jerem S h a w y

Chicago

G. F. Swift & Company 107

River, Massachusetts, in a partnership with D. M. Anthony, who owned a wholesale butchering business there, and in Clinton, Massachusetts, where his brother Edwin managed the family slaughtering operation (Wade 1987, 106). These two locations formed the early foundations of the Swift beef network (Map 4.1). By 1878–79, Swift was sending shipments of refrigerated dressed beef on the Grand Trunk Railroad from a small slaughtering facility leased from Hammond to these two New England branches for distribution and sale. swift and the butchers Although Swift relied initially on the two branch houses in Clinton and Fall River for marketing dressed beef, his idea for expansion was to enlist existing wholesale butchers in New England as agents in a new system of distribution (Clemen 1923, 235). His strategy was to secure the cooperation of these actors as a means of gaining entry into local markets. His tactic was to buy stakes in these butchering firms. In this way, local butchers would be able to remain independent while becoming distribution agents for G. F. Swift, handling Swift’s dressed beef on a commission or consignment basis (Yeager 1981, 61). Swift used this strategy of alliances to build branches and secure larger sales volumes. Consequently, the early expansion of branch houses in the Swift network came from these consignment arrangements with existing wholesale butchers. More than mere conduits for sales, these relationships built by Swift represented a concerted effort to stem potential opposition to his expansion plans from New England butchers. Such opposition, however, was not long in coming. The hostility of eastern wholesale butchers to Swift stemmed from fear of being outcompeted by the new product and ultimately displaced. By slaughtering in Chicago and avoiding freight charges of shipping live cattle, Swift was able to sell dressed beef from seventy-five cents to one dollar cheaper per hundred pounds in New York or Boston than butchers who slaughtered rail-shipped animals (Yeager 1981, 62; Clemen 1923, 235). This differential provided Swift with a cost advantage over most eastern slaughterers of 3–5 percent for beef of equal quality. “You can ship about two cars and a half of live stock in one car as dressed product,” explained Albert McCurdy, a livestock commission merchant at the Chicago stockyards, “so that the cost of transportation is greater on the live stock than it is on the dressed product in proportion” (U.S. Senate 1890, 239). Although Swift’s dressed beef business was not profitable at the outset of establishing his branch system—he had high fixed costs initially for railcars and warehouses with cooling facilities—Swift was determined to maintain a pricing advantage over its competitors and endure possible losses in much the same way that modern firms use pricing to gain market share. Such price

108 G. F. Swift & Company Indirect Channel of the Older Beef Industry Cattle Grazers and Stockers

Cattle Commission Houses

Cattle Shippers

Wholesale Butchers

Retail Butchers

Swift's Direct Channel Cattle Grazers and Stockers

Swift

Retail Butchers

figure 4.1 Schematic Outline of Beef Channels

cutting, however, not only was aimed at securing customers but was also intended to convince butchers of the “wisdom” in joining Swift in the dressed beef trade. While some of these butchers joined Swift, on occasion the tactics used, in the face of resistance, were combative and ruthless.11 Yet even wholesale butchers with a more open approach to doing business with Swift were reluctant to handle the product because they were unwilling to make necessary investments in refrigerated warehouses for storing the dressed beef. Such butchering firms, while not actively opposed to the new product, rebuffed Swift’s overtures because they refused to pay what Swift regarded as a fair price for dressed beef, fearing that the product, in the absence of refrigeration, would spoil before they could sell it. Their reluctance and incapacity to handle dressed beef and the concerns that they harbored about being undersold by the new product and outcompeted turned most wholesale butchers into active opponents of Swift. It was thus the incapacity of and opposition from this eastern wholesale network that eventually compelled Swift to bypass existing outlets of meat distribution and begin setting up his own independent branch houses. This network of branch distribution, in turn, enabled Swift to outcompete and eventually subdue opposition from local eastern wholesale butchers by creating a more direct route to the final customer (Figure 4.1). As the competitive superiority of Swift’s system became apparent, other beef processors took notice. As a result, Swift’s branch house business model began to grow and diffuse to other firms.

Enterprise Expansion and Diffusion By 1880, Swift was operating twelve branches in New England. Two years later, Swift opened its first independent branch house in New York City, an event announced in an approving editorial in Harper’s Weekly. Editors at

G. F. Swift & Company 109 table 4.3 Chicago Meatpacking Firms Ranked by Size, 1878 and 1884 1878 Rank 1 2 3 4 5 6 7 8 9 10

Firm Chicago Packing Armour Fowler Bros. S. A. Ricker G. H. Hammond Tobey & Booth Davies, Atkinson & Co. Allerton Botsford & Co. Chapin & Cudahy

1884 Rank 1 2 3 4 5 6 7 8 9 10

Firm Armour G. F. Swift G. H. Hammond Anglo-American Libby, McNeil & Libby Fairbank Canning Chicago Packing B. F. Murphy Packing Hately Bros. Tobey & Booth

sources: Chicago Board of Trade, Twenty-first Annual Report of the Trade and Commerce for the Year Ending December 31, 1879 (Chicago: Knight & Leonard, 1879); Chicago Board of Trade, Twenty-sixth Annual Report of the Trade and Commerce for the Year Ending December 31, 1884 (Chicago: Knight & Leonard, 1885); Mary Yeager, Competition and Regulation:The Development of Oligopoly in the Meat Packing Industry (Greenwich, Conn.: JAI Press, 1981), 64. note: Rankings based on number of animals slaughtered and revenue generated from slaughtered animals.

Harper’s noted how other cities had benefited from the dressed beef trade and went on to describe the good fortunes of New York in gaining access to the lower prices of the dressed beef operators. The article concluded by marveling at how a side of beef leaving Swift’s plant in Chicago was hung on a railway hook, transferred to a refrigerated railcar, and pushed into the freezer of the branch house when it arrived in New York “without being removed from the hook on which it was hung when killed” (Harper’s Weekly 1882). During the 1880s, as Swift’s system of long-distance dressed beef shipments emerged as a competitively viable business model, two outcomes from that model began to change the structure of the industry. One outcome focused on Swift’s growth in relation to other meatpacking firms. As a result of its branch house system, Swift broke into the top ranks of the industry (Table 4.3). By 1884, after only six years in operation, Swift had become the second-largest meatpacking firm in the United States. Only Armour was larger. Second, and perhaps more significant, with the ascent of Swift among the top ranks of meatpacking firms, other packers began to imitate key elements of Swift’s production and distribution network. The most decisive element in this process of imitation was Swift’s branch house system. P. D. Ar-

d

k Railro run a dT n a Gr

Slaughtering facility Stockyard / cattle supplier Branch house

map 4.2 The Dressed Beef Enterprise of G. F. Swift, 1880

© Jeremy S h a w

Chicago

G. F. Swift & Company 111 table 4.4 Number of Branch Houses of Swift and Major Firms, 1878–1899

Swift Armour Morris S&S Cudahy All Firms

1878

1880

1884

1888

1895

1899

2 — — — — 2

12 — — — — 12

43 2 — — — 45

67* 10 9 2 1 89

138 125 61 31 28 383

189 152 87 42 47 517

source: G.F. Swift & Company, Branch House Dividends 1895, Swift & Company Records, Box 4, Chicago Historical Society; Mary Yeager, Competition and Regulation:The Development of Oligopoly in the Meat Packing Industry (Greenwich, Conn.: JAI Press, 1981), 63; U.S. Bureau of Corporations, Report of the Commissioner of Corporations on the Beef Industry (Washington, D.C.: U.S. Government Printing Office, 1905), 32. *Estimate (precise figure for Swift missing that year).

mour himself, in testimony before the Senate committee of 1890, conceded that his firm, along with others, had essentially learned the dressed beef business from Swift (U.S. Senate 1890, 432). In effect, Swift’s branch house innovation was undergoing a process of diffusion to competitors (Table 4.4).12 At the same time, this innovation was defining a new set of standards for entry and competition within the meatpacking industry. Nevertheless, despite this diffusion process, Swift retained certain advantages as the “first mover” of this process. Armour, Swift’s most powerful rival, did not open its first branch house until 1884. By that time, Swift was operating forty-three branches in a continuing effort to build a national distribution system (see Map 4.2) (Yeager 1981, 63). Perhaps the most decisive measure of change in the industry stemming from this process of innovation and diffusion is the relative shift that occurred in shipments of live cattle and dressed beef during the crucial transition years of 1878–87. During this period, dressed beef assumed a dominant role in the beef trade, completely overwhelming shipments of live cattle (see Table 4.5). With the exception of New York City, which maintained a thriving kosher industry, demand for beef in the East was being supplied not by live cattle but instead by beef slaughtered in Chicago. The impact of the new dressed beef product and Swift’s business model for distributing this product through branch houses was transforming how beef was being produced and sold. In an environment where the cattle and beef business was expanding and where beef consumption was on the rise, it was beef slaughtered in Chicago and shipped long-distance that was beginning to dominate the character of the trade.

112 G. F. Swift & Company table 4.5 Number of Cattle Shipped from Chicago, Live and as Dressed Beef, 1878–1887

1878 1879 1880 1881 1882 1883 1884 1885 1886 1887

Received

Shipped Live

Shipped Dressed

Shipped Dressed (%)

1,083,068 1,215,732 1,382,477 1,547,498 1,607,495 1,909,167 1,870,050 1,964,018 2,015,190 2,447,867

669,490 692,061 833,835 880,853 820,586 841,136 661,127 619,818 570,705 605,812

413,578 523,671 548,642 666,645 786,909 1,068,031 1,208,923 1,354,200 1,444,485 1,832,055

38 43 40 43 49 56 64 69 72 75

source: U.S Senate, U.S. Congressional Hearings, vol. 3, no. 829, Select Committee on the Transportation and Sale of Meat Products [known as the Vest Committee Report], 51st Cong., 1st. sess., 1890, p. 3.

Equally profound was the way these transformations reshaped the craft of butchering and the lives of individuals dependent on it. Gradually, during the course of the 1880s, as Swift’s business system spread and other packers established their own branch house networks, local slaughtering of cattle by wholesale butchers became an historical relic. In testimony before the Senate committee of 1890 on the meatpacking industry, Levi Samuels, a wholesale butcher from New York, provided a graphic description of this historical evolution (U.S. Senate 1890, 118–19). Q. [Senator Vest] What has been the effect of the dressed beef business upon the local butchers? A. [Samuels] In every section of the country, in nearly every small town, it has had the effect of completely stopping the slaughter of cattle by butchers. . . . Q. How do they [local butchers] operate now? A. Now the butchers, as a class, purchase Western dressed beef. Q. Suppose they do not choose to purchase the dressed beef, what is the result then? A. There is nothing else for them to purchase. Q. When you speak of Western people of course you do not mean all of us, but you refer to the Chicago people?

G. F. Swift & Company 113

A. I mean to say the dressed beef men. They sold their beef at a very much lower rate than the butcher could buy the cattle and produce the beef. . . . Q. In other words, they crushed out the business of the local butchers and then put their own dressed beef on the market? A. They crushed it out with their dressed beef. Q. Do you know of any specific instances where that has been done? A. Where it has not been done is the exception. In only a decade, the innovation of dressed beef had made local butchers such as Levi Samuels historical casualties. Many lost their livelihood as butchers. “Very few hold on [to the trade]” explained Mr. L. Leonard to the Senate committee (U.S. Senate 1890, 97). Although some former butchers were drawn in to the new slaughtering plants as part of a highly skilled “butcher aristocracy,” their presence was dwarfed by the number of semiskilled and unskilled workers in the cattle-killing gangs (Commons 1904, 3). From this process of stratification on the one hand and deskilling on the other emerged a new type of “butcher workman,” transformed into an industrial laborer (Brody 1964; Horowitz 1997). Where at one time a skilled butcher killed and dressed an entire animal, a newly created division of labor in the slaughtering plants turned a cow or steer into a detailed “map,” apportioning to each worker a tiny part of the total cutting operation (Commons 1904, 4; Brody 1964, 4). “Skill has become specialized to fit the anatomy,” observed economist John Commons in 1904 (p. 4). There were, for example, seventy-eight different occupations in the beef-killing gangs at the Chicago plants by 1904 (U.S. Bureau of Corporations 1905, 17–18). During this period in meatpacking, the number of wage earners in slaughtering plants increased from roughly eight thousand in 1870 to seventy thousand by the turn of the century (Horowitz 1997, 17). In effect, butchers assumed a new identity as part of a growing industrial working class. As Swift and the other large packers responsible for these changes became increasingly dominant, the meatpacking industry itself assumed a different role in the industrial structure of the U.S. economy. Little more than a decent-sized industry in 1870, meatpacking grew to a position of premier rank among other industries in the United States by 1900 (Table 4.6). Only the iron and steel industry was larger. Swift and the firms involved in this transformation operated national organizations. These enterprises redefined patterns of development in the economy of the late nineteenth century, creating a new geography of profit making. At the core of this geography was a very different fusion of spread and concentration.

114 G. F. Swift & Company table 4.6 Manufacturing Industries Ranked by Dollar Value of Output, 1870 and 1900 1870 Rank 1 2 3 4 5 6 7 8 9 10 11

Industry Flour milling Textiles Lumber Iron and steel Clothing Leather goods Machinery Sugar refining Tobacco products Furniture Meatpacking Pork Beef Miscellaneous

1900 Output ($ millions)

Rank

Industry

Output ($ millions)

445.0 380.9 252.3 199.5 116.5 157.2 138.5 119.6 71.8 69.1 62.1 56.4 1.9 3.8

1 2

Iron and steel Meatpacking Pork Beef Miscellaneous Machine shop products Textiles Clothing Lumber Flour milling Industrial machinery Boots and shoes Publishing Tobacco products

803.9 790.3 321.3 230.0 239.0 644.9

3 4 5 6 7 8 9 10 11

640.4 622.9 566.6 560.7 385.0 359.9 347.1 264.0

sources: U.S. Bureau of the Census, The Statistics of the Wealth and Industry of the United States, Ninth Census, vol. 3. (Washington, D.C.: Government Printing Office, 1872), Table 8c, p. 458; U.S. Bureau of the Census, Abstract of the Twelfth Census of the United States, 1900 (Washington, D.C.: Government Printing Office, 1904), Table 154, pp. 302–21; William Howard Shaw, Value of Commodity Output Since 1869 (New York: National Bureau of Economic Research, 1947), Table I-1, p. 52.

The Geography of Operational and Organizational Innovation With its network approaching seventy branch houses by the late 1880s, Swift was forced to seek additional slaughtering capacity in order to keep these marketing outlets supplied. After initially leasing slaughtering facilities and then purchasing its own plant at the Chicago stockyards in 1880, Swift opened its first expansion site for slaughtering at the Kansas City stockyards in 1888 (Unfer 1951, 57–59). Other disassembly sites soon followed. Swift opened plants in Omaha (1890), East Saint Louis (1892), Saint Joseph (1896), Saint Paul (1898), and Fort Worth (1902) as the number of its branch houses climbed above one hundred by the mid-1890s and close to two hundred by the turn of the century (U.S. Bureau of Corporations 1905, 32).13

G. F. Swift & Company 115 table 4.7 Capital Value and Sales of G. F. Swift & Company, 1885–1904 ($ millions)

Capital Value Sales

1885

1886

1890

1899

1902

1904

0.3 1.7

3.0 17.1

7.5 44.8

20.0 103.6

25.0 152.2

35.0 200.0

sources: U.S. Bureau of Corporations, Report of the Commissioner of Corporations on the Beef Industry (Washington, D.C.: U.S. Government Printing Office, 1905), 286; Federal Trade Commission, Report of the Federal Trade Commission on the Meat-Packing Industry, 6 parts (Washington, D.C.: Government Printing Office, 1919), pt. 4, pp. 25–27. note: Except for 1904, sales figures are estimates based on backward projections from the $200 million sales figure supplied by Swift for 1904 and relationship between capital value and sales.

A mutually reinforcing relationship between branch house proliferation and slaughtering capacity drove this growth. Nevertheless, in accounting for the catalyst in this expansion process, production and distribution were not equal. The mass-production economies in slaughtering, made famous in The Jungle by Upton Sinclair (1906), derived fundamentally from the innovation in distribution pioneered by Swift. This marketing revolution, which created a more direct route from producer to customer, made slaughtering a relatively small part of the beef business in comparison with distribution (Walker 1906, 493). “Essentially the packer is not engaged in production, but in distribution,” read a contemporary account of the meatpacking business. “The plant operations may therefore be looked on simply as processes preparatory to the distribution of meat and by-products in a more economical way than that afforded by the earlier method of sending the live animals to the consuming centers” (quoted in Aduddell and Cain 1973, 97). As Swift’s branch house and slaughtering network expanded during the 1880s and 1890s, the capital value of the company escalated dramatically. Incorporated in 1885 with a capital value of three hundred thousand dollars, Swift by 1904 had grown over one hundredfold, amassing a capital value of $35 million and generating revenues of $200 million (Table 4.7). At that time, it was one of the fifteen largest industrial corporations in the United States. Perhaps more significantly, in that year Swift emerged as the largest meatpacking concern in the United States, surpassing Armour in terms of revenues, slaughtering and distribution capacity, and market capitalization (Table 4.8). Indeed, by 1903, when the first great wave of merger mania in the United States had come to a close, G. F. Swift & Company was the largest meatpacking firm in the world.

116 G. F. Swift & Company table 4.8 Rank of Individual Firms Constituting the Beef Trust, 1903 Rank

Company

Cattle Slaughtered

Hogs Slaughtered

Market Capitalization ($ millions)

1 2 3 4 5 6

G. F. Swift Armour National Packing Morris/Fairbank Cudahy Packing Schwarzchild & Sulzberger (S & S)

1,578,215 1,255,366 848,884 761,179 469,228 559,200

4,079,756 3,451,892 3,101,425 1,247,393 1,347,675 623,598

35.0 27.5 15.0 6.0 7.5 4.4

source: U.S. Bureau of Corporations, Report of the Commissioner of Corporations on the Beef Industry (Washington, D.C.: U.S. Government Printing Office, 1905), xix–xx.

expansion and control This expansion in the Swift production and distribution organization, however, did not occur in arbitrary locations. The pattern of Swift’s expansion in slaughtering facilities paralleled the opening of new stockyard companies west of the Mississippi. In this process, Swift, as well as other large packers, was both follower and shaper of a new slaughtering geography. To some extent, these western stockyards where Swift migrated began to compete with Chicago as cattle markets, although Chicago maintained an overwhelming dominance as a cattle center well past the turn of the century. Nevertheless, Swift and the packers constituting the Dressed Beef Trust expanded into these growing cattle markets to gain control over access to sources of cattle supply for their growing national production and distribution networks. At their disposal in accomplishing this aim was their power as dominant firms. As large cattle purchasers, Swift and the Beef Trust came to control the practice of cattle buying and selling at the stockyards. One of the most critical tasks facing Swift and the other large packers was securing access to cattle supplies. By purchasing in volume, Swift and the other large packers essentially subverted the once independent role of the cattle commission business and transformed these merchant houses into unofficial purchasing agents for the Dressed Beef Trust. Given the opportunity to dispose of large consignments with Swift and the Beef Trust, these commission houses, which historically had facilitated the transfer of cattle from producers to buyers at the stockyards, now directed cattle purchases toward Swift

G. F. Swift & Company 117

and the largest packers. Cattle raisers suffered in this system from the low prices Swift was able to command. Perhaps more importantly, however, smaller independent cattle buyers and shippers were largely excluded from access to the best cattle supplies. In this regard, the remarks of Brewster Cameron, a cattle grazer and shipper, at the Senate committee of 1890 are particularly revealing. When asked by Senator Vest, the committee chair, how the cattle business was conducted in Chicago, Cameron replied that “the cattle are disposed of chiefly to what is known as the Dressed Beef Trust” (U.S. Senate 1890, 81). “The butchers of the country, the feeders, and all other buyers,” Cameron continued, “do not have a free opportunity to buy in competition with the Big Four.” Samuel Cady, a cattle commission merchant at the Chicago stockyards, echoed this theme when asked if there had been any change in the business of buying and selling cattle the last few years. “We do not have near as many buyers as we used to,” explained Cady (U.S. Senate 1890, 212). The reason? “I should express it something like the old expression that ‘the big fish are eating up the little ones.’” In addition to these informal mechanisms of control based on size, Swift and the other large firms benefited from more overt sources of power in the form of ownership interests in the stockyard companies themselves. Packers secured such ownership stakes in the stockyards in two related ways. The primary mechanism was for stockyard companies to offer stockholding as incentives to the packing firms to set up a plant at a particular stockyard site. Omaha, Saint Louis, Saint Paul, and Fort Worth extended such inducements to Swift. Similarly, Kansas City asked Swift to make an investment in the Kansas City Stockyard Company in exchange for subsidies such as free land for the Swift slaughtering facility. In both cases, ownership in the stockyard companies, through either subsidy or investment, provided Swift and the large firms with opportunities to gain greater control of the cattle markets at stockyard locations. While the ownership stakes themselves were relatively small (U.S. Bureau of Corporations 1905, 288), they nevertheless provided Swift with access to the governance authority at the stockyards that established systems of rule making for buying and selling livestock (Aduddell and Cain 1973, 106–7). In this way, Swift and the large packing firms transformed the stockyards from competitive cattle markets to highly controlled supply points for their national production and distribution systems. By expanding into these new stockyard locations, Swift influenced the development of a new geographical trend in slaughtering activity while changing the relationships by which cattle supplies were transferred from producers to the new slaughtering establishments. By the turn of the century, as a result of these expansion decisions by Swift and others, slaughtering had completed an ongoing migration to the

St. Paul (1898) Omaha (1890) St. Joseph (1896)

Chicago (1880) E. St. Louis (1892)

Kansas City (1888)

Slaughtering facility (Year opened) Stockyard / cattle supplier

map 4.3 Expansion of G. F. Swift Production Facilities

© Jeremy S h a w

Ft. Worth (1902)

G. F. Swift & Company 119 Chicago 248.8

73.2

Kansas City

67.7

Omaha St. Joseph

19.0

Indianapolis

18.3 12.3

St. Louis Buffalo

9.6

Cincinnati

9.5 0

50

100

150

200

250

Value of output ($ millions) figure 4.2 Slaughtering and Meatpacking Output for Eight Cities, 1900. source: U.S. Bureau of the Census, Manufactures, Twelfth Census, part 1, vol. 7 (Washington, D.C.: Government Printing Office, 1902),Table CXXXIV, p. ccvii.

nation’s Midwest in a pattern of regional concentration. In addition, slaughtering itself became highly localized. Chicago was the most dominant center, followed by Kansas City, Omaha, and Saint Joseph, cities where Swift expanded (see Figure 4.2). These concentrations of slaughtering represented the formation of what Alfred Marshall (1890) described as industrial districts (see Map 4.3). In these places, Swift and other firms profited not only from internal economies of scale based on high-volume slaughtering but also from what Marshall termed external economies deriving from place-based proximity to sources of supply, concentrations of labor and skill, and access to technical knowledge specific to the trade. Industrial districts of slaughtering and dispersed nodes of distribution thus coexisted in this new pattern of profit making. anatomy of the new geography This pattern of concentration for the slaughtering component of the meatpacking business replaced an older, far less concentrated geography for slaughtering. Although this older pattern included tendencies of both geographical concentration and decentralized spread, it was the latter that prevailed in the balance between the two. This older geographical pattern of weak concentration and strong decentralization was based upon two earlier attributes of the meatpacking business. One attribute, marked by the overwhelming primacy of pork in the meatpacking business, did, in fact, create places of concentration where pork was slaughtered (Walsh 1978, 1982).Yet, despite the concentration of slaugh-

120 G. F. Swift & Company tering in places such as Cincinnati—dubbed “Porkopolis” in 1850—pork slaughtering and packing also occurred in numerous river towns, especially in the Ohio River valley and central Illinois, as well as numerous towns in the East. In effect, while there were points of concentration in pork slaughtering, a highly decentralized structure of pork-packing towns, along with the slaughtering and curing of pork on numerous farms, acted as an offset to this tendency. The second characteristic that had strengthened the tendencies of geographical spread prior to the advent of dressed beef stemmed from the slaughtering of cattle in virtually all locales in the country. Because cattle slaughter and beef consumption had to occur in close proximity, the slaughtering of cattle was highly localized and geographically dispersed. This second attribute acted to decentralize slaughtering even more profoundly than pork packing and slaughtering, spreading it more uniformly throughout the country. Together these two elements created a geography of slaughtering marked more by decentralization than concentration. In effect, while there was concentration in slaughtering during the early period of meatpacking, the widespread slaughtering of animals throughout numerous towns and farms acted as a powerful countervailing force. Consequently, the pattern of concentration and spread for slaughtering that prevailed prior to the ascendancy of dressed beef was different from the geography of concentration and spread exhibited by the industry beginning in the 1880s, when dressed beef emerged as a dominant new product and business model. From 1860 to 1900, as slaughtering migrated into the nation’s midsection, the map of slaughtering activity changed dramatically (Table 4.9; Maps 4.4 and 4.5). This transformation is marked by the shift of slaughtering from its former base in Cincinnati and other river towns that had produced pork and from numerous local farms and local abattoirs spread throughout the country that had slaughtered cattle for beef consumption. This industrial structure had made New York, with the largest population, the largest slaughtering state. At the same time, the largest five slaughtering states accounted for 33 percent of total slaughtering activity. By 1900, slaughtering industrial districts in Chicago, Kansas City, Omaha, and Saint Joseph replaced this older, dispersed geography. One state, Illinois, and one city, Chicago, were overwhelmingly dominant, while the top five states in 1900 were doing close to three-quarters of all the slaughtering in the country. What had occurred during this period to change the geography of meatpacking activity so profoundly was the ascendancy of distribution as the source of territorial spread in the industry and the decisive element of the meatpacking business. Deriving from the rail and telegraph revolution and

G. F. Swift & Company 121 table 4.9 Largest Slaughtering States by Dollar Value of Animals Slaughtered, 1860 and 1900 1860 Rank

State

1 2 3 4 5

New York Illinois Ohio Pennsylvania Tennessee Top 5

1900

Value % of Total ($ millions) Slaughtering 15.8 15.0 14.7 13.4 12.4

Rank

7.4 7.0 6.9 6.3 5.8 33.4

1 2 3 4 5

State

Illinois Kansas Nebraska Indiana Missouri Top 5

Value % of Total ($ millions) Slaughtering 279.8 76.8 71.0 42.9 42.2

40.1 11.0 10.1 6.2 6.0 73.4

sources: U.S. Bureau of the Census, Agriculture of the United States in 1860, Eighth Census (Washington, D.C.: Government Printing Office, 1864), 186–87; U.S. Bureau of the Census, Manufactures, Twelfth Census, part 1, vol. 7 (Washington, D.C.: Government Printing Office, 1902), Table CXXXIII, p. ccvii.

the innovation of Swift, branch house distribution networks, and the logistics of sending dressed beef to branch houses located long distances from the places of slaughter are what elongated and spread the activity of meatpacking. As Swift expanded its network of branch houses during the 1880s and 1890s, and as it established additional slaughtering facilities outside Chicago to supply these branches, the company began to shape the foundations for a new geography of profit making in meatpacking (Map 4.6). Alongside the concentrated pattern of slaughter in industrial districts, the elongated activity of distribution through branch houses created the linkages for a new geography of concentration and spread. At the foundation of this concentrated and elongated geography, however, were innovations in business organization and operational routines deriving from a very different relationship—a more direct relationship—between Swift as a manufacturer and its customers. the direct system of operations The network of branch houses and slaughtering facilities built by Swift represented a direct system of producing and marketing (Rhoades 1929, 262). Fresh beef produced in high volume was sold directly by Swift to retail butchers without the involvement of wholesale intermediaries, who had formerly assumed an integral role in the process. This phenomenon of disintermediation gave the direct system of Swift its innovative character. In bridging the territorial separation of slaughtering facilities and consumption outlets, the system of direct marketing eliminated an historically entrenched

New York 7.4% Pennsylvania 6.3% Illinois 7.0%

Ohio 6.9%

Percentage of total slaughtering map 4.4 Top Five Slaughtering States, 1860.

© Jere m y S h a

w

Tennessee 5.8%

Nebraska 10.1%

Indiana 6.2%

Missouri 6.0%

Percentage of total slaughtering

map 4.5 Top Five Slaughtering States, 1900.

© Jere m y S h a

w

Kansas 11.0%

Illinois 40.1%

1 Branch house

map 4.6 The Dressed Beef Enterprise of G. F. Swift, 1903

Slaughtering facility Stockyard / cattle supplier

© Jeremy S h a w

5 Branch houses 2–4 Branch houses

G. F. Swift & Company 125

group of wholesalers in the beef business (Porter and Livesay 1971, 168–73). Swift had essentially learned how to bypass these actors and capture that portion of the value that had formerly accrued to them in their role of facilitating the transfer of beef from cattle producers to consumers. In addition to disintermediation, Swift’s system of direct marketing had four other key operational attributes. First, Swift’s system was a pull system of procurement, production, and selling. In contrast to supply-driven systems, in which goods are produced and then pushed into various market channels for final sale, Swift’s system relied on actual demand in the form of orders from retail butchers to ignite the circuit of procurement, production, and sale. These orders for certain cuts, grades, and quantities from retail butchers served as the basis for pulling cattle supplies through procurement at stockyards, disassembly at factories, and sale as dressed beef at branch houses. In this sense, Swift’s pull system operated as an early type of just-in-time system. Second, Swift’s system operated on the basis of high-volume throughput. Dependent upon such volumes for balancing mass distribution and mass production, Swift’s system generated economies of scale by compressing time in the circuit of procurement, production, and final sale. Here the most formidable obstacle to time compression was in the slaughtering process. By the late 1880s, however, as a result of rationalizing and mechanizing the slaughtering process, ninety seconds is what it took to fell, slaughter, decapitate, and run to bleed a head of cattle (U.S. Department of Agriculture 1889, 365). With multiple killing lines running simultaneously, the most productive plants by the turn of the century were slaughtering as many as three thousand cattle per day (Commons 1904, 3). Third, because actual orders served to draw raw materials, semifinished sides, and finished cuts through the network, the pull system incorporated elements of an early if primitive form of customization. While it is important not to overstate this element, it is also critical to recognize how the different grades and cuts of beef ordered by retail butchers became part of a high-volume procurement and production system driven by the specific needs of retail customers. “In the marketing of beef there is the widest difference with regard to the character of the pieces sold,” noted the Bureau of Corporations (1905, 21). “A large proportion of the carcasses are sold as sides, but many retail dealers desire special parts . . . cut in a variety of ways.” Almost paradoxically, the highly standardized nature of the product—its capacity to be broken down into standard grades, cuts, and sizes—created parameters for both high volumes and customization. Finally, this direct-pull system relied upon an intricate process of supply and demand balancing in order to function. Demand and supply flows of product between the different branch houses, stockyard sites, and disassem-

126 G. F. Swift & Company bly factories constantly had to be modulated and adjusted as conditions changed. In fact, supply and demand balancing in close to real time provided the foundation for the direct-pull high-volume system oriented around customer orders. Much of what drove these operational process-oriented attributes was the time-sensitive nature of Swift’s product. Dressed beef was a perishable commodity. With a limited shelf life, dressed beef posed its most formidable set of production and distribution challenges with respect to time. Owing to the geographical separation of slaughter and sale, however, the issue of time was inseparable from the issue of distance. Compressing time and bridging distance were therefore the two most significant operational obstacles facing Swift. Confronted by this interrelated issue of time and distance, the direct-pull system of Swift was dependent upon the rapid transfer of information through telegraphic communications for balancing supply and demand and rapid transportation for moving product over distance through the network. Orders from customers had to be coordinated with the securing of cattle supplies, the slaughtering of cattle at disassembly sites, and shipments of dressed beef to branch houses for final sale. This process of supply and demand balancing in highly compressed time frames emerged as one of the most critical core competencies of the company. The telegraph provided the communications and information infrastructure for Swift in establishing this core capability. In describing the critical operational elements common to Swift and the largest packing firms, the Bureau of Corporations (1905) made specific reference to the challenge of supplying a customized and perishable product in high volume and balancing inventories of this product through telegraphic communication. “Differences in quality of animals and of their products are so great,” explained the Bureau, “that the closest supervision of the central office is necessary” in order to ensure the balancing of appropriate inventory in the network. “The central office is in constant telegraphic correspondence with the distributing houses, with a view to adjusting the supply of meat and the prices as nearly as possible to the demand” (p. 21). Operationally, the circuit of procurement, production, and sale in Swift’s direct-pull system began with the order-intake process and concluded with final sale at branch houses. These branch houses telegraphed orders for quantities on a daily basis to the company’s central office in Chicago. Depending upon the location of the branch, these orders were then conveyed by the central office to Swift’s seven slaughtering locations. Each branch house was normally assigned to a particular slaughtering plant upon which to draw product based on proximity to stockyard and slaughtering sites. Generally, the communication from branch houses was routed through the

G. F. Swift & Company 127

central office in Chicago (Chandler 1988, 53). At times, however, branches communicated their needs directly to the slaughtering plant to which they were assigned. In addition to refrigerated storage space for receiving dressed sides, each branch house included a sales office and a sales staff that procured orders from and sold the dressed beef to retail butchers, grocers, and other retail food outlets (Chandler 1977, 300). This sales staff contacted local butchers, conferred with them regarding their needs, and telegraphed orders to headquarters or assigned slaughtering plants either at the end or at the very beginning of the day. After receiving orders from its branch houses, Swift’s central office telegraphed instructions to its cattle buyers at stockyards as to the needs of the company in terms of breeds, grades, and quantities on any given day (U.S. Bureau of Corporations 1905, 21). Cattle generally arrived by train from transshipment points at night and would be held in stockyard pens. Procurement took place in the early morning with the aim of transferring cattle by rail spur from pens where they would be purchased to the killing floors of the plants no later than 11 a.m.14 From the slaughtering facilities, sides of dressed beef were shipped by rail to designated branch houses, where they were transferred to the chilled storage area. There, the dressed sides were matched with orders and further butchered by Swift employees in accordance with the orders received. Retailers would then call at the branch house and pick up their goods. As cattle moved from stockyards to the disassembly line in the various slaughtering facilities, the final branch house destination of the various sides and parts was already known (Chandler 1988, 237). Such a system was information-intensive and inconceivable without instantaneous communications provided by the telegraph. By the 1890s, Swift was spending two hundred thousand dollars per year on telegraphic communications to keep inventories in its network balanced in close to real time between cattle purchases at stockyards, production at slaughtering facilities, and orders from branch houses (U.S. Bureau of Corporations 1905, 207). Critical relationships of spatial proximity involving branch houses, stockyard sites, and slaughtering facilities were also integral to the direct-pull production and distribution network developed by Swift. First, branch houses required convenient railroad facilities for receiving finished goods. Consequently, branch houses were located where switching capability from railroad trunk lines could be expedited (Rhoades 1929, 270). Far more important, however, were the relationships between stockyard supply locations and slaughtering facilities. With its attributes of just-in-time procurement, driven by demand pull in real time, the dressed beef business avoided the buildup of cattle raw material inventories. Stockyards essentially assumed the responsibility—and costs—of holding inventories of supplies for the dressed

map 4.7 Centralization and Decentralization in the Dressed Beef Enterprise of G. F. Swift, 1903

Information flow Stockyard / slaughtering facility

© Jeremy S h a w

5 Branch houses 2–4 Branch houses 1 Branch house

G. F. Swift & Company 129

beef industry. A well-developed system, built over time, ensured that inventories of cattle supplies would be available in these locations to Swift and the other dressed beef firms for disassembly. In this way, inventories of cattle raw materials, which Swift essentially controlled without having to bear the carrying costs, and disassembly of these raw materials occurred in spatially adjacent locations. This direct-pull system, with its attributes of just-in-time procurement, product customization in high volume, and supply and demand balancing, redefined conditions for entry and competition in the business of meatpacking. Firms aiming to compete in the industry on a national level were compelled to imitate these elements. Implementation of these operational innovations, in turn, meant deploying the technologies of the railroad and the telegraph in fundamentally new ways. It also entailed the creation of a far different type of business organization. the vertically integrated organization The scope of the Swift operation in terms of branch houses and slaughtering facilities, coupled with the system of direct distribution to retail butchers, created unprecedented challenges of management and control. Confronting Swift was the complexity—and risk—of coordinating the long-distance flows of product and information between stockyards, slaughtering units, and branch houses and between branch houses and final customers. One of the most significant outcomes of this challenge involved a profound transformation in the organizational structure of the firm. The innovation of Swift in slaughtering and selling in disparate locations was as much an organizational phenomenon as it was an operational and processoriented set of changes. The solution pioneered by Swift to address this challenge of operational control and management of risk was vertical integration. Swift gradually absorbed the diverse and dispersed activities involved in the slaughter and sale of fresh beef within the boundaries of the company. The vertically integrated enterprise developed by Swift, though decentralized geographically, was highly centralized organizationally and operationally (Map 4.7). Major departments—procurement, disassembly, distribution, and accounting— functioned on the basis of instructions devised and communicated from headquarters in Chicago (Chandler 1988, 53). The reason for such central control stemmed from the logistical challenges of managing the various steps in producing and distributing a highly perishable product. In this process of organizational transformation, Swift not only assumed control over the operations most directly connected to cattle and beef processing but also incorporated a variety of ancillary but necessary steps into its own organization. This process of vertical integration represented an en-

130 G. F. Swift & Company table 4.10 Output of Meat Products and Manufactured Ice, 1869–1904 ($ millions)

Meat Ice

1869

1879

1889

1899

1904

Increase, 1869–1904

75.2 0.3

249.9 0.5

477.8 4.8

634.2 13.4

704.4 24.4

937% 974%

source: William Howard Shaw, Value of Commodity Output Since 1869 (New York: National Bureau of Economic Research, 1947), Tables II-1 and II-2. note: Meat products include fresh and cured beef and pork.

tirely new development in the history of American business enterprise (Chandler 1977). For the first time, a single company, in integrating production and distribution, began to systematically absorb a widening range of different activities within its organizational boundaries. Among the most notable of these ancillary operations was the Swift Refrigerator Transportation Company, which built refrigerated railcars for the firm’s dressed beef business (U.S. Bureau of Corporations 1905, 287). Instead of assuming the risk of having to purchase refrigerated freight services from the railroads, Swift instead produced and operated its own refrigerated railcar fleet (Raff and Temin 1991, 24–25). Similarly, rather than relying on the market to secure ice for cooling the refrigerator cars and branch houses, Swift became an ice manufacturer and distributor (Table 4.10). It purchased ice-harvesting rights on lakes all over Illinois and Wisconsin, sending iceharvesting gangs as far north as Green Bay during mild winters to ensure adequate supply (Unfer 1951, 36). It built immense ice storage houses near harvesting facilities and constructed icing stations along railroad routes to resupply railcars. Although ice was not a costly asset, the risk to Swift of being without it, as the largest single ice user in the country, was sufficient reason for the company to assume control over this seemingly minor detail in the production and distribution of dressed beef (Swift 1927, 191). Ice, in effect was an asset critically specific to Swift’s business. Much like other assets specific to the operation, it became a source of organizational integration within the boundaries of the firm (Raff and Temin 1991, 24–25). As the dressed beef business expanded and assumed a more complex character, the company became involved in business ventures that did not have a connection to the industry at the outset of Swift’s branch house innovation. An example of such a business was the Swift Fertilizer Works, established to make profits from the inedible by-products of cattle. This business in meat by-products compelled Swift to develop an industrial research

G. F. Swift & Company 131

business in the 1890s as the by-products portion of the industry, derived largely from cattle and classified as “miscellaneous meat products,” expanded to roughly the same size as the beef industry itself (Table 4.6). Animal-rendered margarine was one of the breakthrough products resulting from such activities in research and development.15 At the same time it was moving into new activities, Swift intensified its dominance over aspects of the distribution process that had initially escaped its control. Swift created “peddler car routes” outside its primary branch house distribution outlets in large cities; in the less urbanized areas of these peddler car routes, the company sold dressed beef butchered into retail cuts directly to the public, bypassing local retail butchers (U.S. Bureau of Corporations 1905, 30–32). Finally, the relationship of Swift and the stockyards, mediated through stockholdings in the stockyard companies and other subsidies (see above), reveals how Swift was able to extend control over the critical element of cattle procurement without assuming the costs of owning an asset outright. This “functional integration” with aspects of the stockyard operations, and the assumption of control over cattle buying that resulted from such integration, enabled Swift to minimize one of the greatest risks to its high-volume direct-pull system, that is, the ability to secure cattle raw materials. As a result of this relationship, sources of cattle supply at stockyards, while not formally integrated into Swift’s operation, became, in a practical sense, a part of the Swift enterprise.16 The company, in effect, sought control of the beef trade primarily through ownership of assets and creation of new businesses in a process of vertical integration. It also sought control over the beef business through mechanisms of market power and domination over terms of trade. Finally, Swift used investment and mechanisms of rule making and governance when such mechanisms were economically viable and politically desirable as in the case of the stockyards. This control, both formal and informal, extended the geographical reach of Swift into every region of the country. For Swift, there were several advantages to owning or controlling the adjacent steps in this high-volume production and distribution system (Aduddell and Cain 1973, 98–99). First was the fact that the creation and capture of surplus value in this network was dependent upon high volumes and internal scale economies. Such internal economies of scale, in turn, were generated from a division of labor difficult to find in any other industry of the period—a division of labor that was fundamental in creating the capacity to slaughter two to three thousand cattle per day in the most productive plants (Commons 1904, 3). Owning and controlling much of the channel, from sources of supply to slaughtering and distribution, possessed obvious advantages of certainty for organizing the steps needed to generate such levels of throughput. In this way, vertical integration and internal economies of scale

132 G. F. Swift & Company were mutually reinforcing. Second, the branch system of marketing eliminated the profit of the traditional wholesalers and consignees in the beef industry. Such value, historically captured by intermediaries, now flowed instead to Swift. Third, distribution and marketing was more efficient. As an integrated firm with its own centrally controlled procurement, production, and distribution network, Swift could match demand and supply of beef over a wider area and regulate product flows in accordance with shifting demand, supply, and price conditions. Derived from telegraph technology, this power of information reinforced its power of control through ownership of assets. Finally, as the turnover of product accelerated, owing to the highly organized integration of the branch, slaughtering, and procurement systems, and as demand and supply became more highly balanced, costs per unit of output were further reduced, thereby reinforcing the scale economies of high volumes. In the system pioneered by Swift, innovation was the foundation of a reinforcing set of relationships between economies of scale, the division of labor, and the extent of the market. As it turned out, however, the extent of the market was not a function of innovation and technology alone. The national markets created by the innovation of dressed beef also had a decidedly political dimension.

The Politics of the National Beef Market By the mid-1880s, vertical integration had become the standard for entry and competition in the meatpacking industry. In 1887, five of these firms— Swift, Armour, Hammond, Cudahy, and Morris—controlled 85 percent of the dressed beef trade, that is, the shipments of beef slaughtered at the major cattle markets of the Midwest and shipped long distance. Three years later, with the addition of Schwarzschild & Sulzberger, these firms controlled 90 percent of all dressed beef shipments. Although by 1903 these companies controlled only about one-half of the beef supply in the entire country (owing to the survival of farm-slaughtered beef and the role of local butchers in small towns and agrarian areas), their share in large eastern cities often exceeded 75 percent (U.S. Bureau of Corporations 1905, xxi). The system of centralized slaughter in Chicago and the national branch house distribution networks of the firms in this Beef Trust oligopoly established the operational and organizational standards for firms intent on competing for national markets. Nevertheless, even the smaller butchering firms that sold outside their immediate locality, but not on a national scale, and had managed to survive the competitive pressures of the dressed beef oligopoly began to adopt the organization and methods of the branch house system of production and marketing (Rhoades 1929, 265). Yet this transformation of

G. F. Swift & Company 133

the beef industry, in which the oligopoly of large-scale firms dominated, did not go unchallenged. First, resistance to the dressed beef trust emerged from the labor force in the large packing plants. In May 1886, thousands of workers in the Chicago slaughtering plants, despite being unorganized, answered the call issued by the Federation of Organized Trades and Labor Unions for a general strike to secure an eight-hour workday (Brody 1964, 13). Among packing firms, Gustavus Swift was recognized as a leader in breaking this strike of packinghouse workers (Swift 1927, 181). When the action of May failed and the packers, at the behest of Swift along with Armour, restored the ten-hour day in the packing plants, two more strikes involving nine thousand workers in Chicago occurred in October 1886. Again Swift was among the most aggressive in hiring strikebreakers to cross picket lines during these actions. A second round of strike activity occurred in the summer of 1894, after packing companies, in the aftermath of the 1893 depression, reduced workers’ wages. Unlike the earlier actions, however, this strike was accompanied by the use of troops from Fort Sheridan near Chicago, authorized by President Grover Cleveland, to keep trainloads of dressed beef moving from the packing plants to branch houses. Owing to this use of force, this action by packinghouse workers also suffered defeat. Other strikes followed throughout the remainder of the 1890s. Though sporadic and generally unsuccessful, these uprisings exposed the conflict existing in the stockyards between workers and owners of the packing firms that continued throughout this initial cycle of packinghouse unionization (Brody 1964, 13–33). While the trade union impulse represented a powerful source of resistance to Swift and the dressed beef firms, a second source of resistance emerged among smaller wholesale butchers. In 1886, wholesale butchers in several states formed a trade association, the National Butchers’ Protective Association. Its aim was to protect the livelihood of local butchers from the competitive encroachment of the large dressed beef firms. Taking advantage of still-existing sentiment against nonlocally slaughtered beef, this organization campaigned vigorously to defend the markets of local butchers by seeking passage of state laws requiring local inspection of cattle prior to slaughter. So successful were their efforts that they were able to persuade lawmakers in Minnesota, Indiana, Colorado, and Massachusetts to enact such state-level, preslaughter inspection laws. Under the provisions of these laws, animals would have to be inspected by state officials twenty-four hours prior to being butchered. Clearly protectionist in aim, the laws of these states were designed to block the interstate operations of Swift and other large packers and insulate local butchers from the competition of dressed beef slaughtered in Chicago and shipped long-distance. The large dressed beef firms chose to ignore the laws, instructing their

134 G. F. Swift & Company local agents to invite arrest and conviction (McCurdy 1978, 632). State authorities accordingly indicted the local sales agents of Swift and others. By 1890, the leading case, Minnesota v. Barber, was under review by the U.S. Supreme Court. In its judgment, the Court concurred with the argument of Armour, the defendant in this case speaking for the large dressed beef firms, that the preinspection law was established as a form of protection to the detriment of internal free trade. Furthermore, the Court held that such legislation represented a potential breach of the Commerce Clause of the Constitution. In the view of the Court, the Commerce Clause was intended by the constitutional framers to create a unified national market. Finally, the Court concluded that if government had a responsibility to protect consumers against the dangers of tainted meat, as counsel for Minnesota had contended, a remedy other than state-sponsored inspection would have to be created. The solution was federal inspection that preserved the idea of government regulation of the industry while at the same time maintaining the integrity of interstate trade and the idea of a national market (McCurdy 1978, 643–48). The outcome was the passage by Congress in 1891 of the Federal Meat Inspection Act. This legislation placed a new regulatory burden upon the industry. At the same time, however, this legislation legitimized the long-distance interstate traffic in dressed beef dominated by the large vertically integrated dressed beef firms. The new legal and regulatory environment enabled Swift and the large packers to secure the national markets they had created from innovation deriving from the rail and telegraph revolution. Yet, in legalizing the national markets of Swift and others and upholding the sanctity of interstate commerce, the Supreme Court in the Barber case and national lawmakers through the Federal Meat Inspection legislation gave new legitimacy to the importance of large-scale manufacturers (McCurdy 1978, 648–49). In the process, Swift and the dressed beef firms, as vertically integrated manufacturers, became the source of a new problem for the government. The issue was antitrust. Swift and the dressed beef firms faced ongoing confrontation from government in its role as a regulator of monopolies and trusts following passage of the Sherman Act in 1890. At least some of the political momentum for passage of the act itself came from the Senate Committee Hearings on the Meat Industry (U.S. Senate 1890). Its conclusions set the tone for much of the government’s antitrust activity involving Swift and the Beef Trust over the course of the next thirty years. According to the committee, “the principal cause of the depression in the prices paid the cattle raiser, and of the remarkable fact that the cost of beef to the consumer is not decreased in proportion, comes from the artificial and abnormal centralization of markets, and the absolute control by a few operations thereby made possible.”

G. F. Swift & Company 135

Other causes are also contributing factors, noted the committee, “but so long as the combine at Chicago can dominate the entire cattle interest of the country there will be the same result” (U.S. Senate 1890, 33). Throughout the 1890s and the first years of the new century, Swift and its erstwhile competitors entered into a variety of pooling arrangements and price-fixing schemes that became well publicized through journalistic exposés undertaken by the New York Herald and the Chicago Tribune (Gordon 1984). These accounts compelled a newly formed government agency, the Bureau of Corporations, to pursue an antitrust investigation of the beef industry in 1904. Relying upon data supplied by the Beef Trust itself, the report, issued the following year, concurred with the statements of the packers that no illegal monopolizing of the beef trade existed. This was only one in a long series of government investigations of the beef industry under the auspices of the Sherman Act. The most famous decision in the government’s lengthy battle against the beef industry—and one that emphasizes why these firms successfully evaded prosecution when the evidence against them appeared so overwhelming— involved the firm of G. F. Swift. The case in question was the 1905 decision in Swift & Co. v. United States (Gordon 1984). In this Supreme Court case, the Court affirmed that a party’s intent would subsequently be a material consideration in determining whether a combination constituted a restraint of interstate commerce (Gordon 1984, 245). In practice, this ruling had a profound impact on the enforcement of antitrust legislation. It placed a burden upon the complaining party to prove that firms, in this case Swift, intended to control terms of trade through illegal combination with other firms. Even under such rigid standards, however, Swift in this case received a judgment against it. Nevertheless, the injunction issued against Swift by Justice Oliver Wendell Holmes was so carefully qualified that the victory of the government was indeed “a pyrrhic one” (Yeager 1981, 184). The decision allowed Swift and the dressed beef industry sufficient room to conduct their operations as vertically integrated and oligopolistic firms. Furthermore, Swift and the other firms in the Dressed Beef Trust were permitted to combine for the purpose of limiting shipments and avoiding gluts in the various consuming centers of the nation (Yeager 1981, 184). Although forced to confront government regulators and the courts since the late 1880s, Swift had once again managed to prevail. For the first time, the Supreme Court in the 1905 Swift case recognized the implications of late nineteenth-century industrialization for adjudication of economic affairs (Gordon 1984, 279). Innovation pioneered by Swift had converged with politics and the courts in affirming the legitimacy of the large-scale business enterprise and the national territory where this new entity could make profit.

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part 3

The Internet and the Business Organization of Dell Computer

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chapte r

5

The Internet as Commerce System and Market Space

Of all the applications emerging on the Internet infrastructure, Internet commerce will have the most profound impact. Peter Drucker, 1999

From Communications to Commerce When Dell began selling PCs over the Internet and reorganizing its procurement and assembly activity through Web-based interactions with its suppliers and logistics partners, the PC maker was able to craft these innovations on the basis of an historical transformation similar to the breakthrough that had enabled Swift to recast the system of production and marketing in the beef industry a century earlier. Like Swift, Dell has seized upon a revolution in communications as a platform for reorganizing its competitive activity. Just as Swift deployed the railroad and telegraph at the center of its extended and concentrated production and distribution organization, Dell has succeeded in transforming its organizational structure and territorial reach for profit making as a result of the revolution represented by the Internet. In both cases, new communications technology resulted in the development of commerce systems for producing, buying, and selling in fundamentally new ways.1 This chapter examines how this transformation of the Internet from communications system to commerce system occurred and how this process of commercialization created the foundations enabling firms such as Dell to compete differently. the contours of commercialization When Dell began experimenting with the Internet in 1996, the so-called network of networks had just passed through an initial period of takeoff as

140 The Internet an infrastructure for commerce supplementing its original role as a communications system (Reid 1997). This progression from an essentially noncommercial defense-oriented communications system to a commerce-oriented infrastructure is one of the most compelling features of Internet development (Kenney and Curry 2001, 45). Nevertheless, this pattern of commercialization is not unique to the Internet. The history of the Internet has certain features of creation and commercialization that are broadly similar to the pattern of earlier infrastructure systems.2 This pattern is represented in its initial creation phase by a technical breakthrough associated with the phenomenon of “invention.” Railroads, telegraphy, telephony, and the Internet all utilized breakthrough inventions for moving people, materials, and messages. Commercialization of breakthrough technologies, however, occurs primarily through the efforts of two types of firms. First, commercialization begins when such technologies become sources of profit for firms involved in construction and build-out of infrastructure systems. Second, commercialization advances when these technologies become sources of profit for firms that put the newly built infrastructure to uses in ways often unanticipated at the outset of creation and construction. With the exception of the telegraph, in which profit-making activity for telegraph firms and business users of telegraph systems followed only five years after initial demonstration of the new technology, a period of gestation separates the initial technological breakthrough from the commercial period. With the Internet, this period of gestation actually lasted almost twenty-five years, from initial demonstration in 1969 of the system’s core packet-switching technology, to a commercially oriented system marked by profit making in the build-out of the infrastructure and profit opportunities in Internet use by the early 1990s. Thus, while the Internet has its own unique history in evolving from a communications system to a commerce system, it shares three essential features of creation and commercialization with other infrastructure systems: (1) invention of the core infrastructure technology; (2) transformation of the technology into a built system providing profit to infrastructure builders; and (3) exploitation of the built system as a source of profit to a broader group of business users largely unconnected to the creation and construction of the infrastructure. These attributes, in turn, are marked by several key historical themes: infrastructure expansion and interoperability, creation of infrastructure standards, and the establishment of a legal and political rule-making environment for infrastructure deployment and use. It is in the role of infrastructure users that Swift and Dell emerge as key actors in this process.

The Internet 141

users as innovators Although not directly involved in creation and construction of infrastructure, business users are decisive in providing momentum for the buildout of infrastructure systems and in transforming invention into the broader process of innovation and economic change. As the economic viability of invention becomes clear, and as early investors along with technical experts promote initial infrastructure expansion, certain business users experiment in an effort to incorporate the new infrastructure into their business models and change the way they operate. It is this process of experimentation that results in commercial uses not anticipated by infrastructure builders at the outset. The rail and telegraph system was no more envisioned as the agent for the long-distance movement of commodities when it first emerged in the early part of the nineteenth century than was the Internet envisioned as a platform for buying and selling goods and services when it debuted as ARPANET in the 1960s. Such business use of transport and communications infrastructure originates at what has been termed the “consumption junction” of new infrastructure technology systems (Fischer 1992, 17). At this historical intersection, users of transport and communications systems come in contact with the initial variants of new transport and communications technology. As these actors begin to experiment and deploy the newly created infrastructure for profit-making ventures in ways unforeseen by the inventors and early builders of the new infrastructure systems, they become the functional source of innovation during communications revolutions. Alongside the initial creators of the actual technology, users provide the agency through which invention spreads and assumes the transforming attributes of innovation (Von Hippel 1988; Lundvall 1988). In this role as carriers of the innovation process, business users actually help to shape the development of new infrastructure, defining the goals and aims of newly deployed communications systems while influencing the trajectory of subsequent infrastructure deployment (Cohen, DeLong, and Zysman 2000). Business users in effect provide momentum for build-out of new communications systems as commercial enterprises. In concert with the inventors and developers of new infrastructure, business users of communications systems enable the impacts of communications revolutions to spread and act as catalysts for innovation in the economy. expandability and interoperability In ascending to its commercial status in the early 1990s, the Internet had to pass through two critical historical developments. First, the infrastructure had to expand. Second, the disparate pieces of the infrastructure had to in-

142 The Internet terconnect and become interoperable. Expansion and interoperability were thus interrelated.3 Similar to the development of the rail and telegraph, geographical expansion was integral in the evolution of the Internet from communications system to commerce system. Like the railroad and telegraph, the Internet after its initial creation developed as disparate communications networks which had to fit together and function as a system. Just as the disparate and often incompatible track gauges of the separate railroads and the different chemical and electrical technologies of various telegraph firms were made to interconnect in creating a unified transport and communications system, so too has the Internet assumed its role as a commercial infrastructure in stages marked by the efforts of Internet builders and users to enhance the interoperability of the new infrastructure. This process of expansion and interoperability, in turn, is dependent upon two additional elements: standards for infrastructure compatibility and rules for infrastructure deployment and use. Standards enable different elements of an infrastructure to function as a system while providing specifications around which new pieces can be added so the system can expand. Legal and political rules create the environment needed by businesses to participate in commercial ventures either in building or in using the new infrastructure. Standards and rules, in effect, provide momentum for new communications infrastructures to become more built out and interoperable.4 Several metrics are commonly used to provide indications of Internet expansion and interoperability. These indicators include the number of Internet users, host computers, Internet domain name registrations, and even the amount of venture capital expended on start-up firms. Modest growth in these measures began during the mid to late 1980s.5 The period of commercial takeoff in the early to mid-1990s, however, reveals several dramatic departures from previous trends, especially with respect to the number of users, the percentage of .com Web sites, and venture capital outlays. It was during this time, as expansion proceeded apace, that the Internet conformed to what has been termed Metcalfe’s law, named after the founder of 3Com Corporation, Robert Metcalfe. The basic idea of this principle is one of scale. According to Metcalfe, the value and functionality of a network will increase exponentially with each additional user. Consequently, at a certain threshold of nodes, a network’s value will exceed its costs so that the larger a network becomes in terms of the number of users, the more potential value it has to those users. Just as this principle drove expansion of earlier infrastructure systems such as the telegraph and telephone, so too is it also driving the expansion of the Internet (Moschella 1997, 106–7).

The Internet 143

the contingencies of internet commercialization Despite historical precedent and similarities between the commercial development of the Internet and infrastructure systems of the past, the passage of the Internet from communications system to commerce system was not preordained. Contingent events, occurring as the Internet evolved, were critical in pushing the Internet away from its military roots and creating the basis for an interoperable and commercially viable communications infrastructure. Four crucial developments proved decisive in this transformation. First was the decision by the defense establishment to split what was then the communications network of the Advanced Research Project Agency (ARPA) into two pieces. One piece was a military network aimed at continuing ARPA’s mission to create a communications system capable of functioning in a nuclear war. The second piece emerging from this split, however, was a nonmilitary communications system envisioned to serve a community of university and academic researchers. Placed under the administration of the National Science Foundation (NSF), this research-oriented communications network soon spawned numerous other civilian networks that together became the basis for the “network of networks” at the core of the Internet. Second, in the mid-1980s personal computers were transformed into devices that could interconnect and communicate via local area networks (LANs). Although this development removed some of the individual autonomy of personal computers, it created the foundations for a networking infrastructure based not on mainframes or even minicomputers, but on devices with potential for widespread use. After the mid-1980s, as PCs and PC-oriented workstations became interconnected mostly within firms, and as these local area networks proliferated, an expanding population of nonmilitary networks based on microcomputers created a new foundation for the Internet project. The networking of PCs and workstations was therefore a critical step in enabling the Internet to become widely accessible as a mass-based communications infrastructure. The third set of contingent events was the creation of two critical technological breakthroughs in the area of networking software—the World Wide Web and the Internet browser—that could be used in conjunction with personal computers. The most immediate impact of these two breakthroughs was to make the Internet far more accessible as a communications medium to both society and the business public. These tools, however, had an even greater impact in shaping a particular trajectory of growth and technological development. The creation of the Web and the Internet browser established a foundation—a technological paradigm—for an entirely new “ecology” of firms to emerge and develop myriad other Internet applica-

144 The Internet tions and products, from software, search engines, and portals to routers and broadband equipment that facilitated ease of Internet use (Hunt and Aldrich 1998; Kenney 2001). Fueled by venture capital, this swarming phenomenon of new technologies, created primarily by start-ups along with incumbents such as America Online, promoted a dramatic expansion in the number of new Internet users. In developing new tools for easy Internet access and use, these builder firms established an environment for a community of business users to emerge and experiment with the new Internet infrastructure as the communications element of a system for buying and selling goods and services. Dell Computer was among these early users. The final element contributing to the transition of the Internet to an infrastructure for commerce was political. By 1994, policy makers, influenced by a deregulatory free-trade environment, provided the first signals that rules for deployment and use of the emerging Internet infrastructure would be market-driven and would follow the lead of businesses. Although these rules are still evolving, both infrastructure providers and business users had a reasonably clear picture that the Internet was evolving along a market-driven, commerce-oriented pathway. Despite the fact that commerce appears as a phenomenon on the Internet only in 1995–96, the contours and contingencies producing this phenomenon began in the 1960s with the advent of the Internet itself.

Internet Origins and Architecture The Internet is a communications network of a unique type.6 It is most commonly depicted as a network of different communications networks. Nevertheless, it is perhaps more accurate to describe the Internet as a set of software overlays onto existing communications networks.7 On the basis of these software overlays, along with sets of common standards, the Internet is able to connect millions of different computers and communications devices. In this way it represents the convergence of computer and communications technologies. Although the backbone for Internet traffic incorporates existing telephone and cable television lines along with high-speed fiber optic lines connected by routers, the architecture of this network of networks represents an important departure from earlier communications systems. In earlier systems, communication occurs over dedicated connections from one point to another through a central switch. The Internet, by contrast, is based on decentralized and distributed nodes of computers all connected without a centralized point. This decentralized architecture derives from the Internet’s origins within

The Internet 145

the U.S. defense establishment. The Defense Department and its allied institutions, notably the RAND Corporation, were intent on responding to the development of Soviet military technologies in the aftermath of the Sputnik launch. What concerned the military above all was Soviet nuclear capability. Underlying the design of decentralized and distributed nodes was the idea that such an architecture, unlike centralized switching, would be able to withstand a nuclear strike.8 Military involvement affected not only the architecture of the Internet as a communications network but also the time lag that occurred between initial development of the packet-switching technology and eventual commercial use. Although the Internet was operating by 1969, it was only in the early 1990s that the network assumed its role as a system for mass communications and commerce. Prior to that time, it was a relatively obscure invention that, in its initial phase of expansion outside the defense establishment, was used by university researchers and not really commercialized in any significant way. Expansion and interoperability, however, would gradually occur in this military- and research-dominated environment. arpa and the internet As a first step in the Internet project, the Department of Defense created the Advanced Research Project Agency with a mandate to keep the United States ahead of the USSR in key defense and communications technologies. In 1962, ARPA formed the Information Processing Techniques Office (IPTO) to fund computer science research oriented toward promising military applications. By 1966 the director of IPTO, Bob Taylor, had begun to work on the problem of how to connect different mainframe computer systems so that these systems could share data and thus communicate with one another. ARPA allocated $1 million to Taylor to find a solution to this problem (Hafner and Lyon 1996, 12–13). A critical step in this effort emerged in 1967, when ARPA computer scientists developed the idea of inserting a subnetwork of smaller computers between the host mainframes, a concept later known as Interface Message Processors, or IMPs (Rosenzweig 1998, 1532). Once this idea of a network within a network was in place, ARPA eventually awarded a $1 million contract in 1967 to the computer consulting company of Bolt, Beranek and Newman (BBN) to develop the initial architecture for the ARPA network or ARPANET. Nevertheless, the contract for creation of the initial ARPA network had several other important antecedents that established some of the most important conceptual foundations for the nascent network (Rosenzweig 1998). The most important contributions came from Paul Baran, an engineer at the

146 The Internet Rand Corporation, and Donald Davies, a British physicist. In confronting the problem of how the U.S. government could maintain its communications capability following a nuclear exchange with the Soviet Union, Baran conceived of a communications network unlike telephony or even telegraphy that sent message traffic through dedicated physical lines. Critical to his concept was the idea of breaking communications messages into discrete “message blocks” that could be sent individually and reassembled at the reception point. He further proposed a system without centralized gateways, in which the switching nodes are decentralized, enabling messages to be rerouted in the event some nodes are incapacitated. Working independently of Baran but along a similar path, Davies focused his concerns on interactive computing and increasing the number of users who could access information from mainframe computers. In pursuing this aim, he developed a concept similar to Baran’s and gave “message blocks” the name “packets.” This idea of packet switching, in which data traffic is broken into discrete pieces through digital technology, sent through multiple paths instead of dedicated lines between two points, and finally reassembled at an end point, is the fundamental idea of Internet technology (Rosenzweig 1998, 1533). The first phase of the IPTO project aimed at creating a network of users at ARPA-funded university sites based on the concept of packet switching. The firm of BBN was responsible for developing the Interface Message Processors to enable the packet switching to operate between the four initial sites chosen for the project. These sites included the University of California at Los Angeles, the University of California at Santa Barbara, Stanford Research Institute, and the University of Utah. By 1970, these sites were expanded to include MIT, Harvard, and the University of Illinois. The following year, fifteen additional computer science centers funded by IPTO were connected to the ARPANET. This very modest pattern of growth in the number of host computers connected to ARPA continued throughout the decade so that by 1979 there were sixty-one such hosts (Tehan 2001; Kenney 2001, 16). By 1972, ARPA had demonstrated the feasibility of packet switching while creating a nationally extended though limited and little-used network (Rosenzweig 1998, 1536). An important dilemma, however, remained unresolved. As local area networks emerged alongside and independent of the ARPANET, computer scientists at ARPA realized that they confronted a problem similar to what they had to overcome in 1967 with incompatible computers. This time the problem was how to connect incompatible networks—not just incompatible computers—to one another. From this challenge of “inter-networking” came the project that would launch the Internet (Rosenzweig 1998, 1536).

The Internet 147

infrastructure standards Robert Kahn, a computer engineer who had moved from BBN to ARPA, spearheaded this “Internetting Project” to enable computers on different networks to communicate uniformly with one another and with the ARPA network. Kahn relied upon another computer scientist, Vinton Cerf, to help devise a standard language for packet-switching technology. Cerf and Kahn pointed out how previous language protocols for packet switching had addressed only the problem of communication on the same network. Their efforts introduced the idea of a protocol for communication on “different packet-switching networks” that became the basis for a new standard language called Transmission Control Protocol, or TCP (Zook 2001, appendix B). By 1977, ARPA began the first demonstration of the TCP idea in linking its three packet-switching networks. One year later, the new inter-networking protocol was divided into two parts and renamed TCP/IP. TCP consisted of the host-to-host linkages, whereas IP, standing for “Internet Protocol,” referred to the network-to-network links. A standard had developed for interconnection between computers operating on different networks. One of the most critical developments in the ascendancy of TCP/IP as the standard for Internet communication was support for the new protocol by the U.S. Defense Department. When ARPA came under more direct control of the Defense Department through the Defense Communications Agency (DCA) in the mid-1970s, the need for a standard communications language was paramount. As a consequence, the Department of Defense adopted the TCP/IP standard in 1980. The following year the Defense Department required all ARPANET hosts to implement the TCP/IP standard. This standard, however, did not go unchallenged. European telecommunications companies pushed an alternative standard to TCP/IP, the x.25. Nevertheless, support and funding by the Defense Department for TCP/IP enabled the American protocol to prevail over the European alternative in this battle of standards. In March 1981, the DCA provided an even more powerful incentive for adopting the TCP/IP standard when it initiated the requirement that all ARPANET hosts implement the protocol by January 1983 (Zook 2001, Appendix B). The creation and adoption of the TCP/IP standard and the requirement for its use by the DCA provided a powerful catalyst for growth of the ARPA network since, with the new language, different networks could connect to it.9 One source of growth was university computer science departments that sought access to the ARPA network. As the number of university-based users increased, however, the DCA decided in 1983 to separate military and

148 The Internet academic users by splitting the ARPANET into two networks. One network, MILNET, was for the military. The other was a residual ARPANET oriented toward civilian users in which the National Science Foundation began to play a major role.10 This civilian-oriented ARPANET attracted users from a second source of growth, the local area networks of business firms. As personal computers expanded in workplaces during the mid-1980s, and as networking of PCs became practical in 1985 with the introduction of the Intel 80386 microprocessor, the number of local area business networks expanded and emerged as a new source of demand for access to the ARPANET. Alongside LANs based on workstations, the growth of PCbased local area networks resulted in an increase in the number of networks connecting to the ARPANET. In 1982, the ARPANET consisted of fifteen networks. By 1986, the ARPANET included over four hundred networks (Zook 2001, Appendix B). This increase in the number of networks connected to the ARPANET was also reflected in a more dramatic increase in the number of network host computers. In 1984, host computers numbered slightly over one thousand but increased fivefold to a little over five thousand by the end of 1986 as new networks became connected to the ARPANET. The final years of the decade, however, witnessed the first growth spurt in the number of host connections as local area networks multiplied. By 1990, the Internet comprised roughly 313,000 host computers (Table 5.1). Nevertheless, while the number of Internet host computers was increasing and expanding the network, the number of actual users was still confined to a relatively limited community of academics and research scientists. Besides the connections of certain local area networks, the Internet had no real commercial characteristics. The transformation of the Internet into a commercial space, as well as a space of mass use, still awaited two crucial developments—the World Wide Web and the Mosaic, and later the Netscape Internet browser. These two elements would serve as the prelude for the Internet becoming a commerce system.

The Web, the Browser, and Web Commerce The breakthrough of the Web consisted of three critical Internet building blocks: hypertext markup language (HTML) to provide a format for Internet communication; hypertext transfer protocol (HTTP) to provide a guide for sending and receiving Internet communication; and the uniform resource locator (URL) to denote locations for finding information on the Internet. The creation in 1990 and release in 1992 of these elements was the work of computer scientists at the CERN European particle physics laboratory in Geneva under the direction of Tim Berners-Lee. Their efforts rep-

The Internet 149 table 5.1 Number of Host Computers Connected to the Internet, 1982–1990

Hosts

1982

1984

1986

1988

1990

235

1,024

5,089

56,000

313,000

source: Internet Software Consortium, http://www.isc.org/ds/host-count-history.html

resented a first step in making the Internet accessible for widespread use beyond technological elites (Weintraut 1997, xxic). The basic idea behind the Web and its relationship to the Internet is perhaps still best captured by Berners-Lee himself: The Web is an abstract, imaginary space of information. On the Net, you find computers. On the Web you find documents, sounds, video—information. On the Net, the connections are cables between computers. On the Web, connections are hypertext links. The Web exists because of programs which communicate between computers on the Net. The Web could not exist without the Net. The Web made the Net useful because people are really interested in information, not to mention knowledge and wisdom, and don’t really want to have to know about computers and cables. (quoted in Griffiths 2001)

Perhaps the most enduring contribution of the Web is that it provided the technical foundation for development of Web browsers, most notably Mosaic, and myriad other applications promoting both widespread use and eventually commerce on the Internet. The origins of the Mosaic browser derive from the NSF Supercomputing Center at the University of Illinois and two students working there, Marc Andreesen and Eric Bina, who began to explore ways of making the Web easier to navigate (Ceruzzi 1999, 303). By 1992, the two had written an early browser program they called Mosaic, which simplified use of the Web, and the two circulated this browser software freely over the Web itself. As a result, thousands of copies came into use and the number of individual Internet users climbed dramatically, from roughly one hundred thousand individual users worldwide in 1993 to approximately 3 million in 1994. In 1994, Jim Clark, the founder of Silicon Graphics Company, approached Andreesen, and the two created the start-up known as Netscape Communications that successfully commercialized subsequent versions of the Mosaic browser. In concert with the Web, the Netscape browser opened a new pathway of access to the Internet. Internet activity, which had expanded impressively after release of the Mosaic browser in 1993, exhibited an explosive increase in the number of individual users, expanding from 3 million in 1994 to 26 million the following year. These increases would con-

150 The Internet table 5.2 Estimated Number of Individual Internet Users Worldwide, 1993–2001 (millions)

Internet users

1993

1994

1995

1996

1997

1998

1999

2000

2001

.1

3

26

45

69

129

185

423

513

source: U.S. Department of Commerce, The Emerging Digital Economy (Washington, D.C.: Secretariat on Electronic Commerce, 1998), 7; U.S. Department of Commerce, Digital Economy 2000 (Washington, D.C.: Economics and Statistics Administration, Secretariat on Electronic Commerce, 2000), 5; www.zooknic.com note: The number of users in 1993 comes from U.S. Department of Commerce 2000, but Zook believes the number to be higher than 100,000.

tinue in the years following (Table 5.2). In addition to individual use, the Internet during these years was also becoming a magnet for institutional use, including businesses, educational establishments, and myriad different organizations. As a result, the number of Internet domain name registrations increased dramatically, paralleling the expansion pattern for individual users (Table 5.3). In the aftermath of the hugely successful introduction of the Netscape browser, which enabled the base of individual Internet users to expand, the company began work on a series of applications intended as a bridge from the browser to business. Netscape called this orientation “Integrated Applications” (I-Apps). The firm began to ship these commerce-enabling tools in 1995. The I-Apps, later renamed Commercial Applications, were among the first efforts at creating tools for Internet commerce (Reid 1997, 48). They were developed to enable businesses to sell goods or services through an Internet-based communications and transaction system. Two of the initial IApps, the I-Store and the Merchant System, were designed to create a catalog-type purchasing environment including an on-line infrastructure for clearing credit card transactions. The difference between these applications and catalogs, however, was that, instead of the mail or the telephone, the communications infrastructure for this type of buying and selling was the Web. This concept of commerce enabled by the Internet held enormous promise owing to the Internet’s strength as a “pulled” information channel (Reid 1997, 48). This potential was based upon the perception of parallels between pulling information supplied from a source on the Internet and buying goods sold by a vendor. If information could be pulled from the Web by Internet users, it seemed a short step to the idea first of substituting saleable goods for information, then replacing the concept of Internet

The Internet 151 table 5.3 Internet Domain Name Registrations, 1992–2001 (thousands)

Registrations

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

5

10

46

120

488

1,301

2,154

7,052 18,649 30,090

source: eMarketer, The e-Commerce B2B Report (New York: eMarketer, 2001); www.zooknic.com/domains/ counts.html note: Domains include .com, .net, .org, and .edu.

“user” with the concept of “buyer,” and finally changing the action of pulling information with a different type of action—a transaction. The challenge was how to shift this process of buying and selling in the physical world on to the Web infrastructure. The foundations for such a transition, however, were already beginning to emerge by 1994–95 in terms of users, both individual and firms, and applications. Internet traffic was continuing its dramatic rise with millions of new users, including businesses, emerging on the Internet, taking advantage of an explosion of new Web portals, search engines, and an array of Web-hosting services. Second, the proliferation of Web-based transaction applications being developed not only by Netscape but by numerous other software providers supplied tools for the Internet to become a business space for buying and selling (Kenney 2001, 23–24). Owing to these trends, the years 1993–95 demarcate the early commercial phase of Internet development and separate it from the precommercial, so-called B.C. (before commercialization) stage of the Internet (Weintraut 1997, xxxv). During this period, tools in the form of commerce-enabling Web applications stemming from the breakthroughs of Netscape created a more viable infrastructure for business activity and contributed to the overall build-out of the Internet infrastructure. These tools and the build-out of the Internet infrastructure enabled the burgeoning community of Internet users to orient to the Web in a commercial way. It is important to emphasize, however, that commercial use of the Internet and mass use did not evolve in opposition to one another. Both mass use and commercialization evolved more or less in tandem. In this environment, business firms, both start-ups and incumbents, began to create Web sites to take advantage of this business orientation of the Internet during this critical period of early commercialization. As a result, the number and percentage of .com Web sites, which was very small in 1993, started to rise dramatically in the next couple of years. By the beginning of 1996, Web sites associated with business firms represented roughly half of the sites on the Web. This percentage would in-

152 The Internet table 5.4 Growth in Percentage of .com Web Sites, 1993–1996

% of .com Web sites

June 1993

Dec. 1993

June 1994

Dec. 1994

June 1995

Jan. 1996

1.5%

4.6%

13.5%

18.3%

31.3%

50.0%

source: Mathew Gray, MIT, http://www.mit.edu/people/mkgray/growth/

crease even more dramatically by the time the decade came to a close (see Table 5.4). This period of rapid expansion in 1993–96 marked the beginning of the critical build-out stage for the Internet as an infrastructure for business (Weintraut 1997, xxxv). During this period of rapid build-out, the number of domain name registrations (a different measure than Web sites) in the .com, .net, and .org domains increased from roughly ten thousand in 1993, to two hundred thousand in 1995, to 1.5 million in 1997 (eMarketer 2001). During this same time period, the number of Internet host computers skyrocketed from 1.3 million in 1993 to 16.1 million by 1997.

Internet Commerce and Government Policy While the various Web-hosting and commerce-enabling applications for the Web began to appear in 1994–96, allowing the Internet to become viable as an infrastructure for commerce, and while early experiments in Internet buying and selling began to emerge by 1995, commerce on the Internet raised numerous legal and political issues for policy makers. If the phenomenon of Internet commerce was to become accepted and expand, it would require a rule-making framework to set standards for the conduct of buying and selling on this infrastructure. Rules on such issues as intellectual property, privacy, content distribution, and taxation of Internet transactions are still evolving as part of an ongoing process to create a uniform commercial code for Internet activity throughout the world.11 Two early sources, however, signaled businesses on the commercial direction of policy making for the Internet. One source was the Telecommunications Act of 1996. The other was a position paper released by the Clinton Administration in 1997 entitled Framework for Global Electronic Commerce.12 Although the Telecommunications Act of 1996 aimed at governing construction and deployment of telecommunications networks and providing new rules for the conduct of firms involved in infrastructure build-out, its impacts on the Internet were far-reaching. The Act in many ways affirmed that the world of data networking that had been emerging as early as the 1970s was different from telephone service and should be regulated

The Internet 153

differently (Bar et al. 1999, 2). The primary objectives of the 1996 act were twofold. First, the Telecommunications Act aimed to strengthen the already evolving convergence of communications and computer networking technologies that was providing the catalyst for Internet development and legitimize this convergence as public policy. Second, it sought to open competition for construction of the Internet infrastructure and to create open access to the network in contrast to the closed networks created by monopoly telephone companies. The pathway to these aims in terms of general policy was deregulation. The Act established a deregulatory environment for the telecommunications market, allowing firms from myriad different sectors, many of which were formerly precluded from involvement in telecommunications activities, to compete in expanding the build-out and interoperability of the Internet infrastructure. While the law focused on the infrastructure, its impacts were just as critical to the emerging community of business users. The legislation provided users with signals that the infrastructure would not operate haphazardly and arbitrarily but would expand in accordance with certain rules. If users were to conduct business over the Internet, they had to know that a framework was in place to promote the technologies enabling this infrastructure to extend its reach and become more interoperable. In a sense, the policy enabled users themselves to play a major role in driving the Internet revolution (Bar et al. 1999). Similarly, the Framework document gave businesses signals that Internet commerce not only would be encouraged but would actually receive special dispensations such as tax relief. The document outlined five major principles in which the government affirmed its interest in providing a predictable legal environment for Internet commerce. Nevertheless, the authors of the Framework were careful to specify that government involvement in establishing certain rules for these activities would not compromise the interests of business firms in a market environment relatively free of government oversight. Such involvement was to be one where government would not lead but would follow the practices and precedents—including the standards— established by businesses. In many ways, the document followed in spirit the deregulatory emphasis of the Telecommunications Act. Government was going to implement a more market-driven and less-regulated environment for the new activity. These principles were already the de facto policy of the administration before the document was released.

The Internet Retail Space As the foundations for an increasingly interoperable and commerce-enabled Internet infrastructure emerged in 1994–95, fueled by an explosion of ven-

154 The Internet ture capital investments in start-ups creating ever more applications and networking gear for the Internet, and as the signals for a favorable policy environment began to take shape more clearly, business users began a process of experimentation in buying and selling on the Internet. Most of these early firms engaging in selling products and services on the Internet were themselves venture-funded start-ups that began to sell a range of different consumer-oriented items to retail customers. In the process, these companies were pioneering new models of consumer-oriented Internet retailing. By far the most compelling of these early experiments in Internet retailing emerged in the form of a Seattle-based bookseller, Amazon.com. amazon and internet market space Amazon.com created the first large-scale business using the Internet as a communications infrastructure for retail transactions, initially selling books and later a wide array of different products to consumers. The firm established a Web site for Internet sales in July 1995 and became a billion-dollar seller of books over the Internet in a little over three years. During this period, Amazon succeeded in creating the most recognizable brand name in Internet commerce, one that rivaled the brand names of the world’s largest firms (Dodge 2001, 167). Its growth paralleled the expansion of the Internet itself. The sources for Amazon’s business model were twofold. The first was the enormous increase in the number of Internet users. The second was the availability of commerce-enabled Web tools developed by various software firms in the wake of Netscape’s successful Web products. Company founder Jeff Bezos provides a revealing admission of how he developed the idea for selling books over the Internet from these two sources: Two years ago [1994] nobody knew how many people were on the World Wide Web, but what was noticed was that Web usage was growing at 2,300 percent a year. I started thinking about what kinds of opportunities are there going to be in this new Web space. It was clear that the Web technology, even though it was rudimentary, would support primitive interactive retailing. I thought that the content areas were going to be very crowded, and it wasn’t clear what the revenue model was to make money off of content, so transactions-based business made sense to me (Southwick 1996).

From this rapidly expanding population of Internet users, coupled with the new commerce-oriented Web tools, Bezos successfully reconceived the notion of what is perhaps the most fundamental element in economic activity, the notion of a market. In grafting the Internet on to the notion of a market, the pioneering bookseller had created the idea of a selling space with boundaries of an indeterminate nature. The challenge confronting Amazon

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was how to use the Internet to sell in this market space and how to generate a profit from this new method of sales. The economic rationale for Bezos was that in reaching this market through the Internet and eliminating the costs of stores and employees the process of selling could be made more efficient and hugely profitable. By taking customers’ orders directly over the Internet and by eliminating the overhead costs associated with physical retailing, Amazon aimed to undercut prices of retail bookstores by marking up book prices from publishing houses at a fraction of the normal markup rate for retail stores. In addition, Amazon counted on creating a more convenient and efficient sales channel to its customers through Internet communications. It represented an experiment in seeking profit from communicating across a new type of space. internet efficiency, internet geography The business model devised by Amazon took advantage of the Internet in two fundamental ways. First, Amazon used the Internet to create certain types of market efficiencies. Second, the technology of the Internet enabled Amazon to reshape market geographies. It was the latter, however, that actually enabled the former. Changes in geography served as a new route to efficiency. The business model of Amazon provided one of the earliest and most powerful lessons in the way commerce on the Internet began to transform the concept of markets as territorial entities. This change in the geography of markets, in turn, had profound consequences in terms of redefining pathways to efficiency and profit making. The book business, and the way this business was transformed by Amazon, provides a compelling illustration of how this transformation in market geography changes the profit-making environment for firms. A bookstore represents a business with a market shaped most fundamentally by the concept of place. For the most part, customers of bookstores reside in the same geographical locale as the bookstore itself. While large bookstores might service long-distance customers and possess a more geographically dispersed customer base, in general the bookstore and its market share the same locality. Furthermore, in addition to bookstores, numerous types of businesses operate in this manner, their market and customer base conditioned by territorial boundaries. What the Internet as a commerce system did for Amazon, along with other Internet sellers, was to open the territorial boundaries that circumscribed and even protected the markets of established businesses. At the same time, the Internet subjected incumbent stores to competition from Internet firms located outside the market area. Early Internet auto retailing, flower selling, even the Internet grocery business provided examples of how the

156 The Internet territorial shape of markets for certain types of economic activity can change. In this sense, Internet retailing emerged little different than the innovation of mail-order catalogs pioneered by Montgomery Ward and Sears Roebuck in the late nineteenth century. These mail-order houses invaded the protected markets of retailers especially in rural areas and small towns, undercutting local merchants with low prices achieved through enormous volumes and economies of scale.13 Admittedly, the Internet did not dissolve distance as a factor in producing and trading, as many of its earliest disciples claimed it would. Internet merchants, Amazon among them, could not neglect the logistical challenge of warehousing inventory and delivering products to geographically dispersed customers. These Internet sellers turned to third-party logistics providers to manage warehouses and to the overnight-package-delivery industry, the “Airline of the Internet,” to provide the fulfillment for delivering goods ordered through the new communications infrastructure (Lappin 1996).14 Nevertheless, despite Internet technology’s inability to completely dissolve distance as a factor in business activity, this new infrastructure, much like earlier communications technologies, did provide the tools for firms to reshape the organization of territory for economic activity. By enabling firms to reach customers in geographically distant locales, the Internet redefined the meaning of economic territory and market space. Amazon used this space-transforming attribute of the Internet to accomplish a decisive efficiency objective. The firm took advantage of Internet communication to locate and reach an enlarged population of buyers for its product. In this way the firm relied on Internet technology to overcome one of the primary obstacles to efficient markets, the problem of incomplete information—the so-called problem of information asymmetry—in this case, incomplete information on the location of customers. Furthermore, the technology provided the firm with a channel of communication to reach this newly discovered customer base. In addition, Amazon used the Internet as a transaction-processing technology, enabling the firm to create greater levels of efficiency in the market by reducing its costs of transacting. Consequently, by using Internet communications to pioneer a more effective mechanism for matching buyers to Amazon as seller, and by using the Internet to process transactions from this newly created base of buyers in a much more automated and less expensive way, Amazon uncovered a new route to efficiencies in economic space. In this way, geography transformed though Internet communication provided a platform for efficiency. In addition to reconfiguring the market geography of buying and selling and redefining routes to efficiency, the most enduring impact of Internet sellers such as Amazon, despite its inability to turn a profit, was to legitimize the viability of business models for transacting and selling over the Internet.

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Although these early Internet-based selling models emerged primarily in the retail channel, where products moved from firms to consumers, forms of Internet retailing pioneered by firms such as Amazon also influenced the selling channels of nonretail businesses. Among these firms, Cisco Systems was arguably the most pioneering. It began selling its networking equipment to its business customers over the Web beginning in the second half of 1996. By the end of the year, Cisco had booked $100 million in Internet sales, which expanded to $1 billion in 1997 (U.S. Department of Commerce 1998, A3–11). Dell was also involved in these early efforts of manufacturers to develop Internet sales channels. By the late 1990s, numerous other firms whose customers were actually other businesses began to follow the example of Cisco—and Dell—in developing the capacity to sell over the Internet. This sales activity marked the beginning of a far more significant trend on the Internet, interfirm sales, where businesses buy and sell among themselves in what is commonly referred to as the business-to-business space. Within this space most of the value in the economy is created. It is also within this space that firms, especially manufacturers, confronted an enormous challenge as well as potential opportunity. This challenge focused on using the Internet to reorganize entire value chains for products, from procurement of supplies through manufacturing and assembly and finally distribution. Within a year after the initial explosion of Internet retailing firms in 1996–97, venture capitalists began financing companies with business models aimed at enhancing the efficiency of interfirm activity through Internet communications (Figure 5.1) (Kenney 2001, 36). As early as 1998, despite continued media attention on Internet retailing and firms such as Amazon, nearly 80 percent of Internet commerce was occurring between companies (Business Week, June 22, 1998, 130; Tedeschi 1999). In the process, the business-to-business space had emerged as the next wave of commerce on the Internet.

The Internet Business-to-Business Space While the business-to-business space on the Internet is distinct from Internet retailing, there are ways in which the precedents of Internet selling became models for reorganizing interfirm activity through the Web. The reason for this bridge between Internet retailing and the reorganization of interfirm value chains through Internet communications is that efficiency in the value chains for manufacturing and efficiency in retailing, despite obvious differences, share certain underlying similarities. Taken in its entirety, the value chain in manufacturing products involves an enormous amount of transacting in order to connect the creation of products with their sale and

158 The Internet Number of IPOs

Amount Raised

300

30

250

25

200

20

150

15

100

10

50

5

0

0 1980

1985

1990

1995

2000

figure 5.1 Number of Venture-Backed Initial Public Offerings and Amount Raised, 1978–2000 source: Mathew Zook, “The Geography of the Internet Industry: Venture Capital, Internet Firms, and Regional Development” (Ph.D. diss., Department of City and Regional Planning, University of California, Berkeley, 2001). Reprinted by permission.

consumption. Not only are there numerous transactions between different firms involved in this circuit from production to consumption. There are transactions within the boundaries of the same firm as part of the creation and distribution process. Transacting—trade—is therefore a fundamental element even in production. This shared characteristic between manufacturing and retailing—the process of transacting—is what enabled Internet retailing to provide certain precedents for the idea of enhancing the manufacturing process through Internet communication. If retailing could be made more efficient through Internet communication as firms such as Amazon were seemingly demonstrating, it seemed logical that opportunities existed to render interfirm trade, that is, entire business-to-business supply chains and production networks,

The Internet 159 table 5.5 Estimated Levels of Internet Commerce, 1996–2001 ($ billions)

Retail Business-to-Business

1996

1997

1998

1999

2000

2001

0.24 0.51

2.5 8.0

5.1 17.1

18.0 52.9

33.0 226.2

65.0 448.9

source: eMarketer, The e-Commerce B2B Report (New York: eMarketer, 2001); Forrester Research; NUA Internet Surveys.

more efficient in much the same way (Poirier and Bauer 2000). Such Internet-driven forms of enterprise between firms represented a new frontier in supply chain management and Internet commerce (Table 5.5) (Anderson and Lee 1998; Adhikari 1998). Indeed, certain manufacturers, notably Cisco Systems and General Electric, as well as Dell Computer, began to experiment in 1996–97 not only with Internet sales channels but also with ideas for reconfiguring the supply chain component of their business (U.S. Department of Commerce 1998). Such efforts by firms at reorganizing the procurement process through Internet communication, however, posed much more complex operational and organizational challenges than those faced by retailers using the Internet to recast retail sales channels. This complexity stems from the dominant role of interfirm activity in the economy itself. Roughly three-quarters of the transactional activity in the economy occurs along networks linking firms.15 Fulfillment of final demand to consumers represents but a small fraction of the transactions taking place between myriad firms that go into the creation of products and services. Reorganizing these linkages between companies through Internet communications effectively transforms the entire system of interfirm relationships in the economy. This dominance of interfirm trade in the economy and the potential efficiency gains from recasting this trade through the Internet are what attracted the efforts of venture capitalists, start-up firms, and existing companies to develop Internet-based business models for supply chain activity. In the process, the business-to-business space became the most coveted area of Internet commerce. In order to understand these efforts, however, it is critical to examine the foundations of interfirm value chains themselves. interfirm value chains The basic activities of firms in procuring, creating, and selling products and services take place in networks known as value chains (Porter, 1985).16 Each individual firm has its own value chain that defines the boundaries be-

160 The Internet tween it and other firms and reveals how the economic activity in the network—procurement, production, and selling—is organized. The manner in which firms organize and perform these various functions within their value chains is the source of the firm’s profitability and competitive advantage. What occurs along these networks is a process of value creation whereby goods and services move between different firms, or between different units of the same firm, and in this process of movement become transformed. Through the activities of initial concept, design, procurement, fabrication, marketing, distribution, and final sale, firms at these adjacent steps modify the attributes of goods and services, imbuing them with more value. Built in to each of these activities, however, is not only human labor. The various steps in the value-creation process also include an element basic to the labor process itself, the element of knowledge transfer, or information sharing. As products are transformed at adjacent steps in value chains, they are imbued with value measured by increments of time and information. Because the economic activity in value chains is essentially an information-and-knowledge-processing activity, communication is fundamental to the activity in value chains (Bar 2001, 36).17 The interfirm (and intrafirm) networks along which value chain activity takes place are, in effect, information and communications networks. Inputs of time and information added by firms to products or services to increase their value as they circulate within value chains are of two types. One type occurs on the production side of value chain activity. This input changes the properties of goods and services directly and involves the addition to the product or service of new materials or new knowledge and information. The other type of value-creating input occurs on the circulation side of the value chain. Often referred to as “the gains of trade,” this type of input adds value indirectly to a product or service by facilitating how products or services move through the various steps in the value chain creating value from what geographers term a change in location. Value on the circulation side is generated from information used to rationalize how products or services circulate from conception, to creation, to consumption. Despite these distinctions, inputs, whether on the production side of the value chain or on the circulation side, share a common and fundamental characteristic. Both types of inputs add value to goods and services by imbuing them with new knowledge and information through a process of communication. On the production side, communication transmits information that becomes embedded within products. On the circulation side, communications transmits information embedded within processes. As a result, communications-enhancing technologies provide a primary route for efficiency gains in the process of value creation. The Internet is currently providing such a pathway.

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internet value chains In reconfiguring distances between economic actors and reshaping market geographies, the Internet is recasting efficiency in value chains and enabling firms to reorganize business models as a result of three primary attributes (Malone,Yates, and Benjamin 1994, 67–68). These attributes of the Internet are (1) the digital communication effect, which refers to the larger volume of information that can be exchanged between businesses in less time at less cost; (2) the digital brokerage effect, referring to the number of alternative transactions that can be considered by firms in less time at less cost; and (3) the digital integration effect, referring to changes in the organization of businesses processes occurring at the interface of adjacent value-added stages of the value chain.18 All of these attributes enable firms to decrease the unit costs of coordination within value chains, including the costs of information processing and communication in tasks such as selecting and interacting with suppliers, settling contracts, scheduling and budgeting activities, and tracking flows of materials as they circulate from suppliers through production to final marketing. On the basis of these attributes, two different business models deriving from two types of firms emerged and began to recast interfirm value chains through Internet communication. The first model derived from the efforts of existing firms aiming to rationalize their procurement systems through Internet communication. In this business model, existing companies used the Internet to locate and negotiate with a far larger number of suppliers than was possible before Internet communication. The other business model that emerged in the Internet business-to-business space resulted from the growth of an entirely new business phenomenon, the so-called Internet market maker. Taking advantage of the Internet’s communications and brokerage effects, these start-ups created Web-based, on-line exchanges for aggregating and consolidating buyers and sellers in supply chains for entire industries or product groups (Business Week, March 13, 2000; Tedeschi 2000). In what was perhaps a paradox, these market makers involved in creating online exchanges emerged as new intermediaries aiming to reorganize interfirm buying and selling through the Internet and secure revenues from transactions. Among the companies in the first category, General Electric was arguably one of the earliest and most pioneering in developing a Web-based business model for procurement. As early as 1996, GE had already developed a pilot Internet-based procurement system for its lighting division using an extranet developed by GE Information Services. One year later, eight of GE’s operating divisions had implemented this on-line procurement system for some of their part and supply purchases (U.S. Department of Commerce 1998).

162 The Internet By the end of 1999, the company had managed to convert all twelve of its operating units to on-line purchasing. GE referred to its on-line procurement system as TPN, or “Trading Process Network.” The goal of GE’s network was to create efficiencies in procurement by relying on the capacity of Internet communication to aggregate large numbers of suppliers through the digital communication effect and create an auction environment with this extended group as a result of the digital brokerage effect. This process of market enlargement for supply sources, however, derived not only from the Internet’s communications effect in reaching large numbers of suppliers simultaneously but also from the Internet’s capacity to store, duplicate, and send information. These characteristics enabled GE to change the way it organized the work for sending out bid specifications, thereby taking advantage of the Internet’s digital integration effects. Bid specifications, including blueprints that formerly had to be copied and processed individually and then distributed to eligible bidders, were able to be stored digitally and sent as Web-based documents. Because the former process was complex and time-consuming, GE normally sent out bid packages to only two or three suppliers at one time. Through the Web, this process of sending bid specifications to suppliers was simplified to the extent that numerous suppliers were able to bid on GE projects. Suppliers registered to be on the network, enabling GE to reach this wider base of firms, in turn, providing GE with the opportunity to create on-line reverse auctions to drive down prices. The firm, in effect, was able to gain efficiencies in procurement by extending the market for suppliers and using this extended market to obtain the lowest possible component prices. The Trading Process Network helped GE to reduce the time required to identify suppliers, prepare bid requests, negotiate prices for parts, and award a procurement contract by 50 percent (U.S. Department of Commerce 1998, A3–27). By enlarging its market for suppliers and by enabling the firm to change certain operations in the procurement process, the Internet, through its communications, brokerage, and integration effects, has provided firms such as GE with cost savings in its supply chain. In many ways, the aims of the independent exchanges established in the Internet business-to-business space by start-up firms are similar to the trading network created by GE. These exchanges seek to create cost savings and efficiencies for firms by aggregating and consolidating buyers and sellers through the Internet’s communications and brokerage effects. The difference, however, between these exchanges and the Web-based trading network of GE is one of control. Whereas GE built an Internet business model in which it controls its own Internet procurement space, in the on-line exchanges, the business model and structure of control is different. With names such as e-steel.com, Chemdex.com, and PlasticsNet.com, these new firms

The Internet 163

created a business model in the early days of business-to-business Internet commerce based upon the idea of consolidating and aggregating buyers and sellers within industries while seeking to exercise some control over the transactions between these actors in order to generate revenue (Economist, June 26, 1999, 23). Thus, while the element of efficiency through aggregation and consolidation runs through both models, the on-line exchange is based on the idea of an intermediary exercising control over the activity and generating revenue from the transactions it orchestrates. In some ways, these intermediaries represented a type of gold rush in the business-to-business space of Internet commerce. Funded heavily by venture capital, these start-ups exhibited an explosive growth in number, especially after 1998. There were an estimated 250 of these exchange sites in early 1999. By the beginning of 2000, the number had expanded to roughly one thousand, while the amount of venture capital in these new companies increased from $1.8 billion in 1998 to $23.4 billion in 2000 (eMarketer 2001; Business Week, October 9, 2000). Many of these exchanges operated in the same industry. Metalsite and esteel competed against one another to organize transactions between steelrelated firms. Other sites such as VerticalNet and FreeMarkets organized buying and selling between firms in a range of related industries. What was similar in these start-up sites was their aim to attract established firms to their exchanges. Predictions about a massive migration of interfirm trade to these independent exchange sites, however, proved erroneous. Many of the existing firms, after initially experimenting with these exchanges, later abandoned them, preferring to establish their own sites rather than relinquish control to an intermediary (Kenney 2001, 37). Furthermore, these start-ups also suffered from the effects of the Internet downturn beginning in the spring of 2000. After their extremely buoyant start, in which over one thousand of these exchanges had emerged in the first quarter of 2000, by October of the same year roughly 90 percent were out of business with the survivability of the remaining independent Internet exchanges very much in doubt (Business Week, October 9, 2000).19 Many firms that tried using them at the outset of the Internet boom realized that relinquishing control to an intermediary was not in their interests (Business Week, December 4, 2000). Although Dell was among the existing manufacturing firms that experimented with independent Internet exchange sites such as FreeMarkets for procuring certain types of components, the PC maker largely abandoned these exchanges as a viable Internet supply chain strategy. Dell had a far different idea of how it could use the Internet in its business model. Despite the initial success of models for Internet commerce developed by firms such as General Electric, which essentially duplicated the

164 The Internet independent exchanges without relinquishing control, Dell rejected this brokerage-oriented approach to the Internet. Aggregations of myriad unknown firms through the Internet’s brokerage effects and transactions with such agents through markets, supposedly made much more efficient and free through this process of aggregation, had little to offer the PC maker as a way of making its supply chain system more efficient. For Dell, it was the need for strategic relationships with supply chain partners that played the decisive role in how the firm would deploy the Internet in its procurement, production, and distribution system. Dell would use the Internet as a mechanism to control these relationships and shape the creation of efficiency and competitive advantage in its procurement, production, and distribution organization.

chapte r

6

Global Reach The Business Organization of Dell Computer

The Internet offered a logical extension of our direct model. . . . This became the key to what I call a virtually integrated organization. Michael Dell Let’s face reality. If my largest customer had a new requirement, I’d listen to them. Michael Dell

The Internet as Process Innovation On the walls of a stairwell near the entry to the Dell Computer Corporation Tofper Manufacturing Center in Austin hang two large arrangements of picture frames, aligned row upon row, each frame encasing a patent awarded to the world’s largest PC firm. Embedded in this display is a story with an unmistakable aim. Represented in each frame is an idea. On the basis of merit—and a property right conferred by government—each of these ideas has ascended to a privileged status reserved for the phenomenon known as innovation. The “wall of patents,” as it is referred to by Dell, is a metaphor intended to convey Dell’s story as an innovative firm. Dell Computer has emerged as one of the most innovative firms of the current period on the basis of a process for producing, buying, and selling. This process-oriented route to profit, in turn, rests on three fundamental elements: (1) a different relationship with the customer that involves the practice of selling direct, absent intermediaries; (2) the notion of customization for the specific needs of end users and building customized products in high volume; (3) the use of the Internet by Dell to reorganize not only its system of direct sales but, more significant, the procurement and assembly opera-

166 Dell Computer tions underlying mass customization. By grafting its system of custom direct sales and procurement on to the Internet infrastructure, Dell has transformed these activities, creating what is arguably the most innovative procurement, production, and distribution organization ever built.1 Although it manufactures computers, Dell accumulates profit as a logistics firm. It is an organization of knowledge and routines extracting surplus not from production, but by managing the movement of product and information flows along a globally dispersed network of companies engaged in the various operations of producing and marketing finished PCs. As Dell’s vice president for manufacturing emphasizes, “We are not experts in the technology we buy. We are experts in the technology of supply chain integration. We have created this expertise with the Internet at its core” (vice president, interview, July 18, 2001).2 (See the appendix at the end of this chapter for a list of those interviewed both within and outside of Dell.) In this role as a logistics company, Dell’s most revered accomplishment consists of the degree to which it is able to balance supply and demand of product flows among the firms in this global commodity chain. “Supply and demand balancing,” insists this same Dell vice president, “is one of the most important capabilities at Dell” (vice president, interview, May 24, 2001). The key to this core capability in material balancing, however, lies in Dell’s capacity to process Internet information flows that it uses to manage the external capabilities of other firms. This mastery over material balance flows and Internet information flows has enabled Dell to create an organization differentiated from its competitors by the degree to which it has succeeded in accomplishing a singular aim: accelerating speed and compressing time in the movement of materials as they pass through the adjacent steps of customer order, procurement, production, and final product delivery (Curry and Kenney 1999). The most visible benchmark of this core capability in material balancing focuses on the levels of inventory Dell maintains. In 1994, when Dell launched its Internet strategy, it carried an average of thirty-two days of inventory in its procurement and production chain. By 1997, as Dell began to deploy the Internet more fully in its supply chain operations, the figure had shrunk to thirteen days. In mid-2002, Dell was carrying four days of inventory, while at the same time, Compaq, the firm Dell surpassed in becoming the world’s largest PC maker, held six weeks of inventory (Cook, interview, May 17, 2002; Business Week, June 17, 2002). In order to achieve this level of balance in demand and supply conditions, Dell has had to complement its Internet-based logistics activity with a different type of organizational relationship between itself and the other firms in its network. While this form of organization shares the dis-integrated interfirm structure of the networks organized by other PC makers, it

Dell Computer 167

differs in the degree to which its operations and its relatively small number of partner firms are functionally integrated by means of Internet communications. Dell refers to the structure of organization deriving from these collaborative relationships between formally separate firms as virtual integration. Although nominally separate, Dell and the firms making up its virtually integrated organization do not produce finished PCs on the basis of arm’slength interactions mediated through markets and the price system. On the contrary, Dell organizes highly structured relationships of collaboration between itself and its network partners on the basis of its power to manage and control these other firms through what Coase (1937) describes as “planning,” Williamson (1975) as “hierarchies,” and Chandler (1977) as the “visible hand.” Such mechanisms of control, typically associated with vertical integration, are in fact integral to Dell in securing the collaboration from its interfirm partners necessary to organize its high-velocity supply, production, and distribution chain and build custom-configured PCs in high volume on a just-in-time basis. The Internet plays a vital role in reinforcing Dell’s capacity to control these collaborative relationships.3 The Internet has provided Dell with the tools to create its own Web-based communications protocols as the foundation for collaboration with suppliers and logistics partners. The latter have little choice but to accept these protocols and integrate their operations around them if they want to remain within the PC maker’s organization. Dell, in effect, has successfully exploited the Internet infrastructure in creating a system of collaboration for suppliers and logistics providers that uses Internet technology as terms for entry into its network. In this way, Internet communication has enabled Dell to secure the benefits of organizational control associated with actual integration without its costs. Dell’s interfirm network, with its operational attributes of time compression in material balancing and its organizational attributes of virtual integration, is also creating a distinct geographical pattern of economic activity. This pattern is marked by the interplay of two spatial tendencies operating simultaneously, one of geographical spread, the other, concentration. Long distances separate the different regions where Dell has located its build-toorder operations. Long distances also separate Dell’s build-to-order operations from the locations of its key suppliers. On the other hand, Dell concentrates its build-to-order operations in selected localities where it organizes critical relationships of proximity between certain key nodes and activities in its network. Dell itself is the agent in creating these relationships, most notably in its requirements that suppliers maintain either factories or supply hubs within twenty minutes’ driving distance of Dell assembly sites. In this way, Dell is not only influencing the location patterns of firms in the

168 Dell Computer concentrations of high technology where it operates. Dell is also providing a compelling picture of how its Internet-based build-to-order innovation is concentrating and spreading the geography of economic activity across regions while defining processes of economic globalization as they actually occur on the ground. This Internet-driven, virtually integrated organization enabled Dell by 2001 to become the world’s largest and arguably most competitive PC maker. Perhaps more important, most other major PC firms have attempted to imitate aspects of Dell’s Internet-based business system. As Robert Cihra, computer analyst for ING Barings, prophetically affirmed just prior to the announced merger of Hewlett-Packard and Compaq, “the number one issue on the mind of virtually every major PC vendor is defense against Dell, and for Compaq, IBM, and HP, ‘Dell’ has truly become a four-letter word” (Cihra, interview, August 8, 2001). How Dell ascended to this position is the story told in this chapter. This chapter profiles the key operational, organizational, and geographical elements of Dell’s Internet-based procurement, production, and distribution organization.4 In organizing this profile, this chapter focuses on a recent supply chain integration project implemented at Dell known as DSi2. This project, touted by Dell as “the single biggest change in the Dell business system” is more accurately the culmination of an ongoing process of experimentation with the Internet that began in the mid-1990s and is still continuing (vice president, interview, June 5, 2001; interview, August 24, 2001).Yet at the same time the project represents the conquest of new terrain in the PC maker’s ongoing effort at recasting time and distance to become more profitable. The chapter is organized historically. Within this historical account of Dell’s ascendancy, however, are themes that tell a contemporary story of economic development. How the structure of the PC industry came into being; how Dell’s early business model challenged the competitive foundations of the industry; how Dell used the Internet to transform its original business model and create a uniquely innovative business organization; how, in assuming a position of competitive superiority and diffusing among other firms, this virtually integrated organization has changed the PC industry; and how the attributes of this innovative organization are redefining the territorial structures of the global economy are the contours of the story that follows.

Competition and the PC Before Dell When Dell Computer began operations in 1984, the PC industry, though still very young, had already developed an industrial structure with clearly

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defined terms of entry and competition and a dominant system of value creation and profit making. These attributes would provide Dell with opportunities for innovation on the basis of a very different vision of how to compete and make profit. In order to grasp both the initial phase of innovation at Dell, when the PC maker developed its custom direct business model, and the second phase of innovation, when the firm adapted this business model to the Internet, it is essential to identify the salient attributes of the industry as it evolved since the commercialization of the personal computer. ibm and the pc In the aftermath of initial commercialization of the personal computer in the mid to late 1970s, the most profound impact on the PC industry resulted from IBM’s decision in July 1980 to enter the personal computer market. In making this decision, the world’s largest mainframe computer maker committed to bringing a personal computer to market within one year. Despite its expertise in computing, such a goal was a formidable challenge. “The only way to get into the PC business,” explained William Lowe, director of the PC project for IBM, “was to go out and buy part of a computer company or buy both the CPU and software . . . because we can’t do this within the culture of IBM” (quoted in Langlois 1992b, 21). Consequently, the strategy pursued by IBM to develop the product within such a short time frame consisted of outsourcing component production and marketing the product through existing independent retail channels. This strategy enabled IBM to bypass its own traditional business model of using internally developed technology and its own internal sales force. In this sense, the IBM PC was a striking example of reliance on external capabilities to build a product and bring it to market (Langlois 1990, 1992b). While this production and selling system proved enormously successful for IBM, the impact on the rest of the industry derived from the firm’s competitive ascent and the resultant influence of its business model as a competitive standard for other PC firms. In this way, IBM was decisive in shaping the development of a production and selling system that would influence the way PCs were built and marketed for the next two decades. Dell would exploit the opportunities for new entrants created by the ascendant IBM business system and the inefficiencies in the marketing element in entering the industry and challenging the competitive standards on which the industry was based. Although in creating this system IBM drew upon internal sources for keyboards and circuit boards, most suppliers were firms outside of IBM. Tandon made disk drives; Zenith furnished power supplies; Epson made printers; SCI Systems, a contract manufacturer based in Alabama, stuffed the circuit boards; and China Picture Tube, part of the Taiwanese electronics

170 Dell Computer firm Tatung, made the monitors. The computer was assembled in Boca Raton, Florida, from these components. For distribution, IBM decided to market its PC primarily through retail computer outlets rather than its own sales agents. It even solicited input from the largest dealer, ComputerLand, on how best to accomplish this aim. In pursuing this marketing strategy through independent retailers rather than relying on its own sales organization, IBM successfully elevated the role of distribution as an element of competition in the overall value chain for the PC. Within the context of this strategy to rely on external capabilities, two procurement decisions by IBM stand out in terms of their impact on the development of the industry: the sourcing of the microprocessor and the operating system software.5 In shopping for a microprocessor rather than developing one of its own, IBM decided to use a sixteen-bit processor from Intel, the 8088, rather than the eight-bit processors used in existing PCs. Although this processor did use eight-bit external buses for which there existed supporting chips, the decision meant that the IBM PC could not use operating systems linked to 8-bit processors. Consistent with its strategy to use the market for necessary technology, IBM turned to the small Seattlebased software company active in the earlier phase of the PC industry, Microsoft, for the operating system. Microsoft, in turn, purchased a system from another software supplier, made some small modifications to it, and sold it to IBM. The product was known as PC-DOS. In a decision with profound implications, IBM allowed Microsoft to license the operating system to other PC makers as MS-DOS without having to share royalties. In purchasing the microprocessor from Intel and allowing Microsoft to license the operating system, IBM effectively ceded control of the two most critical elements of the PC architecture. The IBM PC had essentially evolved on the basis of an open and largely modular architecture and a global sourcing system for that architecture.6 Despite IBM’s having lost control over the architecture of its PC, and despite the lack of significant technological advance in the product, the IBM personal computer was hugely successful. Demand for the PC exceeded its own sales forecasts by 500 percent as the 13,533 units shipped during the final months of 1981 were far short of supplying the large backlog of orders (Langlois 1992b, 23). By 1983, IBM had captured almost 20 percent of the world PC market, with roughly 750,000 units shipped out of a worldwide total of 3.9 million (Langlois 1992b, 23; Steffens 1994, 167). Its expansion effectively pushed growth rates throughout the entire industry (Table 6.1). From a position as a relatively late entrant, IBM catapulted to a position just behind Commodore as the world’s second-largest PC maker.

Dell Computer 171 table 6.1 The Early PC Market in the United States, 1976–1983

Units sold (thousands) Value ($ millions)

1976

1977

1978

1979

1980

1981

1982

1983

17

41

121

181

246

380

792

1,764

36.0

74.5

223.8

302.5

495.0

936.9

2,002.3

4,718.0

source: John Steffens, Newgames: Strategic Competition in the PC Revolution (Oxford: Pergamon Press, 1994), 90– 126, 167.

large firms, suppliers, and clones Three critical developments followed from IBM’s success that affected the competitive structure and the development trajectory of the PC industry. First, IBM’s entry compelled other large companies from the office products and consumer electronics industries to enter the PC marketplace. These entrants included Xerox, Hewlett-Packard (HP), Texas Instruments, Zenith, DEC, and Wang Laboratories. This group also consisted of numerous foreign firms, among them NEC, Sanyo, Hitachi, Toshiba, and Fujitsu from Japan and Philips and Olivetti from Europe. Nevertheless, these firms exhibited widely varying levels of success. NEC, HP, Toshiba, Fujitsu, and Olivetti were able to gain between 4 and 9 percent of the U.S. market for differently priced PCs (Steffens 1994, 177). Other firms, most notably Xerox, were surprising failures in the PC market. Despite the qualified success of some of these large firms, however, by the beginning of 1984, IBM, Apple, and Tandy still dominated the PC market in the United States. Second, the growing demand for the product, coupled with the PC’s nonproprietary architecture, created an enormous market opportunity for suppliers of components, peripherals, and parts. An entire industry of specialized suppliers emerged to exploit these opportunities linked to the fortunes of the IBM PC. In addition, in launching its PC on the basis of highvolume production, IBM provided many of these component vendors with opportunities to scale their operations from the outset. As a consequence, these firms were able to develop production efficiencies and cost advantages very early after entry into the industry. Firms most notably in Taiwan but also in Singapore and South Korea entered this market and became skilled producers of these components.7 “IBM put its suppliers into the high-volume business,” and in the process “so bore their start-up and learning costs” (Ferguson and Morris 1994, 52). By the mid-1980s, Singapore and South Korea along with Taiwan had emerged as major world centers of production for the industry (Table 6.2).

172 Dell Computer table 6.2 Computer Hardware Production in East Asia, 1980–1990 ($ millions)

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Taiwan

Singapore

South Korea

80 110 170 430 1,040 1,260 1,739 2,890 4,001 5,046 5,886

— — 147 530 1,066 1,194 1,914 2,928 4,503 5,368 6,974

9 31 47 207 428 579 880 1,459 2,431 3,180 3,073

sources: Jason Dedrick and Kenneth L. Kraemer, Asia’s Computer Challenge: Threat or Opportunity for the United States and the World? (Oxford: Oxford University Press, 1998), 321;Young-Ja Bae, “Globalization, Institutions, and Industry Development: A Case Study of the Personal Computer Industry in Korea and Taiwan” (Ph.D. diss., University of North Carolina, Chapel Hill, 1998), 79, 148; Singapore Economic Development Board.

Finally, and perhaps most significant, demand for the PC, which IBM was not able to supply until eighteen months after it introduced the product, created an enormous market opportunity for other producers to clone IBM’s machine. The expanding supply base along with the PC’s open architecture provided these aspiring PC makers with a foundation for copying and building the product. The one potential hurdle for PC makers—duplication of the IBM input/output system software known as BIOS, which enabled the PC to transmit and receive data—proved far from insurmountable. Firms such as Compaq successfully reverse-engineered the BIOS specs in a way that insulated them from copyright and patent infringement regulations. Because of the market in components that had developed from IBM’s reliance on external capabilities, all that the clone makers needed to duplicate the PC was to buy the 8088 microprocessors from Intel, the MS-DOS from Microsoft, and the remaining hardware components from the expanding base of supplier firms. Furthermore, the interests of clone makers actually converged with those of Intel and Microsoft, whose fortunes were dependent more on an expansion in the number of PCs than on any one-way relationship with IBM. By 1983, Compaq was the largest among nearly one

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hundred clone makers that emerged in the wake of the IBM PC’s success. Two years later this upstart was fifth-largest firm in the PC industry and was ascending rapidly. Hundreds of other firms would soon follow, supported by a base of specialized suppliers numbering in the thousands (Dedrick and Kraemer 1998, 56). open standards and modularity IBM’s decisions to outsource most components of the PC and relinquish control over the microprocessor and operating system created a product architecture based on relatively open standards that had three enduring impacts on the nature of competition in the industry. First, open standards for PC components enabled the PC to become an increasingly modular product. Second, this attribute of modularity—the ability of PCs to be assembled from standardized components “much like Legos”—provided the foundations for PCs to be custom-produced in high volume (Langlois 2001, 26). Third, and perhaps most decisive, modularity and standardization diminished the role of technology as an element of competition in the PC industry and elevated the role of efficiency in procurement, production, and distribution of the product. Modularity, in effect, was the critical precondition of Dell Computer’s business model. The modular character of the PC diverged dramatically from the era of central computing that preceded it, during which mainframes and minicomputers produced by firms such as IBM or DEC had been proprietary “closed systems.” The architectures of these systems were largely incompatible with those produced by other vendors. As a result, firms producing mainframes and minicomputers tended to be highly integrated. Because these systems were closed and proprietary, firms building them had to produce components in-house and scale the production of these components sufficiently to achieve cost-efficient internal scale economies. Nevertheless, this integration did not include all computer components. Mainframe and minicomputer firms integrated vertically with respect to components of high value to reduce their risk and increase their control over production of computer systems. The openness of the IBM PC, by contrast, meant that firms defined standards for interoperability between different components more or less publicly and collectively. Such agreement on standards is basically “unsponsored,” arising de facto in a competitive environment, and is distinct from standards agreements that are negotiated and implemented by statute or political authority (David 1987; David and Greenstein 1990). As a result of this market-driven process of agreement, third-party vendors could design and build components on the basis of publicly defined standards that would operate together as a system. This openness enabled different hardware and

174 Dell Computer software firms to produce compatible and interchangeable components that could be integrated into the PC as a system created by the efforts of numerous separate firms. Assembled from components available in the market produced by a variety of firms, the IBM PC enabled a base of suppliers and imitators to proliferate. Although the microprocessor and operating system markets became virtual monopolies dominated by two firms, Intel and Microsoft, the remaining hardware segments of the industry evolved into extremely competitive businesses. Production of these components by the mid-1980s had already become a dis-integrated global activity, driven by the process of standardization and modularity established by IBM protocols. As a result, the industry became one of horizontal partnerships instead of vertical integration marked by the emergence of a large concentration of producers in East Asia. This industry structure created an entirely new set of management challenges for PC builders as coordination of the production system for PCs moved from inside to outside the boundaries of the firm (Langlois 1990, 1992b). At the same time, products built by different companies were virtually identical in terms of technology. The personal computer was, in effect, a product of globally organized interfirm production networks in which productive capacity, and to some extent even innovative capacity, had migrated to new areas of the world. The result was an industry of fundamentally similar products. From the outset, design and production of the PC’s standardized modular components evolved on the basis of the relationship between three basic elements making up personal computer systems: (1) semiconductor and microprocessor families, (2) operating and input/output systems, and (3) applications software (Steffens 1994, 121). Changes in any one of these elements created incentives for changes in the others. As these elements evolved, the result was a transformation in the hardware architecture in which these elements were housed. While all three elements were critical in promoting ongoing changes in the PC, the dominant driver in transforming the personal computer was the continuous improvement in semiconductor and microprocessor technology. Known as Moore’s Law, these advances doubled the number of transistors packed into microprocessors every twelve to eighteen months and forced the costs as a measure of performance for computing to plummet. From 1982 to 1998, the estimated cost per million instructions per second fell by a factor of five hundred (Rowen 2000, 194). Such changes in performance and cost resulted in average annual rates of decline in prices for microprocessors per transistor of 35 percent from 1985 to 1996, while for memory chips the decline was 20 percent over the same period (Curry and Kenney 1999, 11). This pattern of change enabled Intel, with a dominant position in

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the market for microprocessors, to set the key standards for the ongoing changes in PC hardware (Dedrick and Kraemer 1998, 73). Other components, however, most notably hard disk drives, developed along a similar trajectory. The average annual rate of decline in the price per megabyte of storage for hard drives from 1980 to 1989 was 30 percent. Such expansion in the capabilities of computer components compelled PC hardware firms to develop new generations of personal computers at regular and ever-shorter intervals (Steffens 1994, 151). As PC firms developed new products, however, the price for these products typically declined between 20 and 41 percent per annum over the life of each new PC model (Berndt and Griliches 1993; Curry and Kenney 1999, 12). As a product in a state of ongoing technological change, yet evolving along a pathway of modularity and standardization, the PC was susceptible to competitive pressures deriving not only from technology but also from the interplay of two fundamental variables, price and time (Curry and Kenney 1999). As soon as a new product iteration came to market, it was under constant downward price pressure, its value shrinking with the passage of time in anticipation of the next wave of new processing technology and application software. With technological change a constant and with price and time emerging more as the defining elements of the market environment for the PC, terms of competition for PC makers actually shifted away from technology to a very different aspect of the PC value chain. As product performance became increasingly standardized within the supply base and from one PC company to the next, and as product differentiation became difficult to sustain, distribution emerged as a primary competitive factor within the PC value chain (Steffens 1994, 259). This emphasis on distribution, in turn, would eventually elevate the role of logistics as a competitive variable in producing and selling PCs. Again, the legacy of IBM was a critical factor in this shift in the way it established competitive standards of the indirect channel. the indirect channel By 1983, the PC market in the United States reflected eight identifiable channels of distribution to end users (Steffens 1994, 160). These channels included (1) office products dealers; (2) value-added resellers and systems houses; (3) manufacturers’ own office retail stores; (4) wholesalers; (5) mail orders; (6) mass merchandisers; (7) direct sales primarily by the sales forces of larger PC makers, including IBM; and (8) computer specialty dealers. Of these, computer specialty dealers were overwhelmingly dominant, primarily because of the influence of IBM. By this time, PC makers had adopted IBM’s emphasis on the professional retailer as the preferred channel of distribution. In order to attract customers, especially business customers, com-

176 Dell Computer puter firms had to ensure that their sales channels had the same standards as those of the industry leader (Steffens 1994, 197). This indirect channel also represented a route to legitimacy for clone makers, notably Compaq. The decision by IBM to use professional retailers as its primary distribution channel and the influence of IBM on the rest of the industry changed the way many PC makers deployed resources. PC firms made investments in relationships with resellers and dealers and in marketing activities to support these relationships on the assumption that intermediaries provided manufacturers with better access to nationwide sales. PC makers in effect veered away from the earlier technology bias and toward a new emphasis on marketing and distribution activity (Steffens 1994, 197, 269). By 1984, this indirect channel of selling computers through intermediaries emerged as a defining element in establishing terms of competition in the industry. To compete, firms had to rely on these intermediaries. While there was value added to the PC by these entities as the product circulated from the manufacturer to the customer, there was also the inefficiency of an excess number of actors. So dominant was this system that even by 1987, with Dell and Gateway already selling direct, specialty computer dealers still accounted for 56 percent of total shipments, while collectively the various indirect channels accounted for 80–90 percent of all PC sales (Steffens 1994, 260). As a consequence, the idea of capturing the value created by intermediaries in the PC production and distribution chain presented a compelling potential opportunity for PC firms. entrepreneurial opportunity To capture the value created from intermediation in the PC value chain, the entrepreneurial firm had to reconceive and transform the relationships between four key elements at the core of the indirect system of distribution: (1) forecasting market demand; (2) building according to demand forecasts; (3) “pushing” finished inventory from the factory into the distribution and sales channel; and (4) waiting for customers to make purchases. While these attributes functioned together in creating a production and distribution system, demand forecasting served as the foundation for the other three and the source of the leakage in value from PC firms. Dependent on accurate forecasting of future demand, PC firms were vulnerable to the problem of unsold goods when forecasts went awry. At the same time, they were susceptible to missed opportunities when forecasts underestimated the market. Even with the best demand projections, however, the indirect push system of production was beset with an intractable problem for the PC manufacturer—the need to purchase and hold stocks of components and subassemblies in order to build finished systems and fill quotas for distribution outlets. Such challenges are not unique to the PC industry. They are

Dell Computer 177

symptomatic of all industrial activities that rely on demand forecasting and the sale of finished goods through intermediaries. These problems for the PC maker stemming from the forecasting system and the indirect channel, however, became exacerbated by the nature of technological advance in the personal computer itself. Driven by incessant advances in processor technology and software applications and the resultant shortened product life cycles, the PC is susceptible to ongoing downward price pressure as it circulates through adjacent stages of the value chain. Once assembled, the PC is constantly losing value because its components depreciate as time passes in anticipation of the next wave of technical improvements. These two characteristics—constant technical improvements and simultaneous downward pressure on PC prices—give the personal computer a perishable-like quality, similar to the products of industries such as fashion and even food (Kraemer, Dedrick, and Yamashiro 1999, 3; Kenney and Curry 2000a, 5).8 For this reason, the indirect channel of distribution was particularly well suited as a target for competitive challenge in the PC industry. This perishable-like quality of the personal computer and the depreciation in value of the product over time exposes PC firms to an especially vexing problem—the problem of inventory. If the product is held for any appreciable length of time in inventory, it is depreciating in value. Such a problem becomes increasingly acute for the PC maker at the stages in the value chain where the product moves from the final assembly point through the channel and eventually into the hands of the customer. Frequently, the period of time between final assembly and sale to the customer ranged from three to four months. During this time, the components in the PC, most notably the central processing unit, hard disk drives, and DRAMs would depreciate in value such that the selling price, by the time the system was actually purchased, would have to be lowered. This increment of time in the channel, in effect, represented a sizable loss for the PC maker. For this reason, competition in the PC industry as early as the mid-1980s began to evolve decisively along the path of speed and time (Curry and Kenney 1999).9 Such a shift created an opportunity for innovation focusing on the logistics of building the PC and distributing the product to the final customer. Any strategy for decreasing the period of time in inventory at each step in the value chain, especially between final assembly and sale, and accelerating the speed at which the build process and final marketing occurred held enormous potential as a business model in the industry. Already by 1984, the structure of the PC industry created opportunities for a business model based on speed and time. First, the industry was already organized on the basis of decentralized and globalized subcontractors. Virtually all computer makers had access to and were subcontracting from this

178 Dell Computer supply base located in East Asia, Japan, and the United States. Second, the PC components produced by this supply base had evolved into highly modular and increasingly standardized items. With uniform design, engineering, and technology, components were easily accessible to PC makers. Differences in the product from one firm to the next, whether branded or cloned, had narrowed so dramatically that, with the exception of Apple, design, technology, and engineering were of secondary importance as terms of competition in the industry. What differentiated these products were brand names. Nevertheless, even the IBM brand failed to stem the ascendancy of clones, most notably Compaq, but also the nonbranded clones. In effect, the PC had become a standardized commodity. It was built from components purchased from an accessible base of suppliers and distributed through a channel of actors that functioned on principles of demand forecasting and accepted the accumulation of inventory as inevitable. Admittedly, the process required enormous logistical coordination to build the product from this existing base of firms and market it successfully through the existing distribution channel.Yet, in evolving with an increasing emphasis on logistics and distribution, the PC industry was vulnerable to change from a business model challenging the principles upon which the prevailing system of logistics and distribution was organized. That challenge would emerge in 1984.

The Genesis of Dell A single core concept served as the inspiration for Dell Computer: “Sell computers directly to the end customer. Eliminate the resellers’ markup and pass those savings on to the customer” (Dell and Fredman 1999, 12).10 The target of Dell’s business model was thus not the technology of the PC but instead the industry’s indirect channel of distribution. A different relationship with the customer provided the underlying foundation for this business model. This relationship was the source of innovation at Dell and the catalyst for transformation in the company’s logistics-oriented production and distribution system. custom direct Michael Dell began his business in late 1983 by upgrading IBM personal computers from his dorm at the University of Texas and selling the customized PCs directly to businesses. In Dell’s own words, the superiority of these two notions—direct selling and customization—was obvious. What was less clear to Dell was the reason why existing computer firms were not producing and marketing their products in this way. Dell achieved several advantages from customized producing and direct

Dell Computer 179

selling. The most decisive advantage derived from the elimination of intermediaries in the PC value chain. Such disintermediation not only enabled Dell to capture that portion of the value taken by PC wholesalers in the process of distribution but also was critical in compressing time in the cycle of PC production and distribution itself and capturing greater levels of value by increasing the velocity of moving products from order through final sale. Second, the relationships with final customers built through direct selling provided Dell with a platform for one of the most important sources of sales in the industry, repeat sales. Because the technology of the PC was changing so rapidly, and because the product life of the PC was so short, customers buying a machine at any given moment were the best prospects for future sales. Furthermore, by eliminating product in the channel, Dell was in a position to offer its customers the latest technology without having to send products through a lengthy distribution process. Third, in producing PCs only after receiving orders, Dell avoided the inventory problems associated with faulty demand forecasting. Finally, in purchasing components and building finished systems only after receiving orders and payment from customers, Dell was able to carry a negative cash conversion cycle. It took possession of the customer’s money before paying its suppliers, thereby funding its own operating expenses. Excess inventory held by distributors of certain PC makers provided Dell with an early source of low-priced PCs from which the firm could turn a profit. Especially important was the “IBM gray market,” consisting of unsold PCs at certain dealers. “We would buy these stripped-down computers,” admitted Dell, “and sell them for a profit” (Dell and Fredman 1999, 14). In addition, Dell’s fledgling firm capitalized on another fortuitous opportunity to seed the business. An open bidding process in the State of Texas for PC hardware enabled Dell to compete for public contracts with more established firms. In winning several of these bids, Dell obtained a source of revenue to supplement its base of individual sales and began to grow rapidly. By early 1984, Dell was selling fifty thousand to eighty thousand dollars per month to customers in the Austin area. In May, Dell incorporated the firm. By the beginning of the following year, the company was building computers under its own brand name—PC’s Limited. Dell admitted to taking advantage of the three primary characteristics of the PC industry structure in entering the market relatively easily and building computers under its own brand. First, according to Dell, the burgeoning base of PC suppliers, both in the United States and in East Asia, provided the firm with access to the technology and engineering necessary to build the product (Dell and Fredman 1999, 23–24). Second, many of these components had become so technologically standardized that assembly into finished PCs had become a relatively low-skill activity requiring limited in-

180 Dell Computer Indirect Channel of the PC Industry

Suppliers

PC Maker

Distributors

Integrators, Resellers, Retailers

Final Customer

Dell’s Direct Channel

Suppliers

Dell

Final Customer

figure 6.1 Schematic Outline of PC Channels source: Adapted from Kenneth L. Kraemer, Jason Dedrick and Sandra Yamashiro, Refining and Extending the Business Model: Dell Computer Corporation (Irvine: University of California, Irvine, Center for Research on Information Technology and Organizations, 1999). Reprinted with permission.

vestment in training a highly skilled workforce. Finally, related to the modular nature of PC components, Dell was able to exploit new technologies in “chip sets” that combined the roughly two hundred semiconductor chips required to make an Intel 286-based PC into five application-specific integrated circuits (ASICs). This modification in semiconductor design simplified PC design. As a result, Dell was able to employ an engineer in the Austin area, Jay Bell, to design a 286-based PC. The firm had its own product with technology as good as any other company. It had a brand name. Perhaps most important, PC’s Limited had a uniquely competitive business model for selling its product. While other firms had to forecast the product configurations and quantities demanded by customers and accept the consequences of inaccurate forecasting, Dell took a different route to sales. It knew the configurations and quantities to build because its customers told them and Dell produced only from orders received. The company did not stock the reseller and retail channel (Figure 6.1). Dell also made a critical decision on the type of customer it wanted to reach—corporate customers. Although the corporate market was difficult to sell as a start-up, Dell hired an aggressive sales force to secure such accounts. Ironically, however, it was a technical breakthrough that enhanced its credibility as a formidable competitor in the PC industry and facilitated its ability to reach this market. At the end of 1985, Dell made a decision to try to build the world’s fastest PC. At the time, IBM was building a six-megahertz machine with an Intel 286 processor priced at $3,995. Dell aimed at designing a twelve-megahertz 286 PC. In early 1986, the company successfully built and tested a twelvemegahertz PC running on a 286 processor. It priced this breakthrough prod-

Dell Computer 181 table 6.3 Early Sales and Profit of Dell Computer, 1985–1990 ($ millions)

Net sales Net profit

1985

1986

1987

1988

1989

1990

6.2 .3

33.7 .7

69.5 2.2

159.0 9.4

257.8 14.4

388.5 5.1

source: Dell Computer Corporation, 1989 Form 10-K, Item 6, p. 23; Dell Computer Corporation, 1991 Form 10-K, Item 6, p. 16.

uct at $1,995. In March 1986, Dell took the product to Comdex, the largest computer show in the world, which landed PC’s Limited on the cover of PC Week. Subsequently, Martin Marietta, Burlington Northern, and Price Waterhouse bought systems from Dell’s company. By February 1987, 85 percent of the output from PC’s Limited was being sold to the business market (Lewis, 1987). With its mostly corporate accounts, Dell created what is termed a “closed-loop” relationship with customers that the PC maker exploited as a source of outreach for new sales. Owing to the ongoing breakthroughs in processing speed that made the PC such an ephemeral product, coupled with the interests of firms in upgrading equipment to take advantage of these improvements, Dell’s closed loop with its customers created an ideal marketing channel for new sales. Nearly two-thirds of its revenues were coming from existing, mostly corporate customers (Economist, March 2, 1991). Using phones and faxes as the communications infrastructure for its direct channel with customers, PC’s Limited grew impressively during its early years. Between its first and second year, Dell’s firm increased sales almost tenfold, from $650,000 in 1984 to $6.2 million in 1985. Expansion continued during the remainder of the 1980s. In 1988, PC’s Limited generated a market capitalization of $34.2 million through an initial stock offering. The stock split during the first year of public operations and continued to split in the years thereafter. By the end of the decade, Dell Computer, as the company had been renamed, had generated sales of $258 million (Table 6.3). Despite predictions that its business model would fail, Dell was generating nearly $400 million in revenues by 1990 and had become the twentiethlargest PC firm in the world (Table 6.4). This rapid growth, however, came with certain costs. In emerging among the twenty largest PC firms, Dell experienced its first setback in 1990 as profits fell for the first time, from $14 million the previous year to $5 million. Ironically, this drop in profitability occurred as a result of problems with component inventory. With sales expanding dramatically, Dell found it more

Seattle Korea Japan Taiwan

Silicon Valley

Austin

US-Mexico Border

Assembly site Major supply site Supply flow

map 6.1 The Dell Business Enterprise, 1990

© Jeremy Shaw

Malaysia Singapore

Dell Computer 183 table 6.4 PC Firms Ranked by PC Revenues, 1990 Rank 1 2 3 4 5 6 7 8 9 10

Firm IBM Apple NEC Compaq Toshiba Olivetti Fujitsu Packard Bell Groupe Bull Commodore

Rank

Firm

11 12 13 14 15 16 17 18 19 20

Intel Tandy Acer Hitachi Siemens / Nixdorf AT&T Seiko Epson Hewlett-Packard Unisys Dell Computer

sources: John Steffens, Newgames: Strategic Competition in the PC Revolution (Oxford: Pergamon Press, 1994), 335; Jason Dedrick and Kenneth L. Kraemer, Asia’s Computer Challenge (Oxford: Oxford University Press, 1998), 57; Paul Pinella, “The PC Big 50 1990,” Datamation, December 1, 1991, 42.

difficult to keep in balance the two elements of its business model—low inventory and mass customization—which in other business systems are generally irreconcilable. Volume in Dell’s build-to-order direct system had thus reached a certain threshold where parts for orders had to be stored, revealing the vulnerability of the company’s business model in a high-volume setting. In addition to high volumes, these problems were traceable to the geography confronted by Dell in organizing supply chain operations for its system of mass customization. Long-distance linkages between suppliers, located primarily in East Asia but also Mexico and the United States, and assembly in Austin characterized the geography of this network (Map 6.1). Problems in coordinating the transport of these components over distance and accounting for the variation in component delivery lead times from suppliers conspired to push up inventory levels. Numerous separate warehouses in Austin, where these components were stored before assembly, exacerbated the complexities of the different lead time delivery schedules. “To our stunned belief,” writes Dell about the period around 1990, “we had quickly become known as the company with the inventory problem” (Dell and Fredman 1999, 37). tactical shift Dell attempted to remedy these inventory problems after 1990, as well as expand sales, by implementing two related and perhaps surprising modifica-

184 Dell Computer table 6.5 Computer Firms Ranked by World Market Share, 1994 Rank

Firm

Units (000s)

1 2 3 4 5 6 7 8 9 10

Compaq Apple IBM Packard Bell NEC Hewlett-Packard Acer Toshiba Fujitsu Dell

4,799 3,957 3,937 2,473 1,941 1,903 1,451 1,442 1,441 1,152

Market Share (%) 10.0 8.3 8.2 5.2 4.1 4.0 3.0 3.0 3.0 2.4

source: Gartner Group / Dataquest.

tions in its custom direct business system. First, Dell began to use a key actor in the indirect channel, value-added resellers (VARs), to reach certain business customers (Aragon, 1998). Second, Dell supplemented this approach to partnering with the VARs with an extensive program to market its computers through large retailers. The company negotiated deals with computer superstore CompUSA, big box retailer Price Club, office supply franchise Staples, and electronics chain Circuit City. These stores agreed to sell Dell PCs at the company’s direct prices. Indeed, as a result of these moves, Dell’s sales continued to expand. By 1994, the firm had generated annual revenues of just under $3 billion. Furthermore, with a world market share of 2.4 percent, Dell had ascended into the ranks of the world’s largest PC firms. Shipping over a million units, it now occupied the position of the world’s tenth-largest PC maker (Table 6.5). Nevertheless, this period of growth and ascendancy into the top ranks of PC firms also marked a negative milestone in the company’s brief history. Although Dell’s sales had expanded impressively, and although by 1994 it had become even more of a presence in the world PC industry, the company was not able to sell profitably through the intermediaries of the indirect channel. Its cost of sales rose dramatically, consuming profitability. Whereas in fiscal year 1991 Dell’s cost of sales were 66 percent of its total sales, by fiscal year 1994 the figure had risen to 85 percent (Dell Computer Corporation, 1994 Form 10-K, Item 6, pp. 13–14). Furthermore, its tactical shift into the indirect channel, though it expanded sales, exacerbated its difficulties with component procurement and excess inventories.

Dell Computer 185

As a result, Dell suffered its first quarterly loss during this period. For its fiscal year ending January 30, 1994, Dell reported a net loss of $35.8 million on its $2.9 billion in sales, the first and only annual loss, to date, reported by Dell (Dell Computer Corporation, 1994 Form 10-K, Item 6). Rising costs linked to larger-than-expected inventories in its procurement chain, a failed program with VARs, and too much product in the retail channel created the first significant crisis at the company (Wood 1993; Aragon 1998). Consequently, in early 1994, Dell made two critical strategic decisions. First, the company decided to abandon its experiment with resellers and concentrate on its origins as a direct seller. Second, and perhaps more significant, Dell began to experiment in adapting its custom-direct business model to an entirely new communications infrastructure—the Internet.

The Internet Dell’s Internet-driven business organization has taken shape in two overlapping and still ongoing phases. In the first phase, Dell used the Internet to transform its system of selling and order intake with its customers, enabling the PC maker to become one of the early pioneers of Internet commerce. The second phase consists of Dell’s deployment of the Internet to reorganize its procurement planning and the logistics of assembly and product delivery. Its aim in this second phase is to link its Internet-based system of customer order intake to an Internet-enabled process of procurement, production, and distribution with suppliers and logistics providers. What has occurred alongside this deployment of the Internet is an extraordinarily sharp acceleration in growth. From 1994 to 2001, revenues increased at Dell almost ten times, demarcating this period of sales growth from the early years of the 1990s while productivity per employee, measured by the differential rates of growth in sales and employment, also expanded dramatically (Figures 6.2 and 6.3). This period marks Dell’s ascent to the very top ranks of the PC industry. In addition to sales growth, this integration around the Internet has recast Dell in three profound ways. Operationally, Dell has used the Internet to create more rapid cycles in its system of pulling components from suppliers. In a build-to-order environment where PC systems are produced and delivered at rates that match the rate of sales, Dell has been forced to implement these compressed cycles precisely because of its explosive revenue growth after 1994 (Albers 2000, 3). In this sense, sales growth and time compression in procurement and assembly have been mutually reinforcing. Organizationally, in extending the Internet backward into its supply chain, Dell has created a new form of business enterprise with its interfirm partners to manage the more rapid cycles in its build-to-order system. This form of enterprise

186 Dell Computer Sales ($ billions) 35 30 25 20 15 10 5 0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

figure 6.2 Dell’s Growth Before and During the Internet Period source: Dell Computer Corporation, Form 10K, 1992, 1996, and 2001.

relies on strategically organized relationships, not markets, as a basis of collaboration. Finally, Dell has created a distinct form of territorial organization in the places where it has established its build-to-order operation. In these places, physical proximity between supply sources and assembly sites, strategically imposed by Dell on its network partners, has resulted in a set of territorial relationships between operations and actors that are shaping the attributes of a new generation of industrial districts. These industrial districts, in turn, are helping to define the actual character of global production ensembles in the contemporary economy. While these attributes emerged most sharply following implementation of the DSi2 project, they began to take shape alongside Dell’s initial experiments in on-line selling, and deployment of the Web in supply chain management, and enterprise resource planning. on-line selling Dell had a decided advantage over other PC firms in selling its products over the Internet. Unlike the indirect channel of its competitors, Dell’s direct sales path was more easily adaptable to the direct links between manufacturers and customers characteristic of Internet selling. In this way, Internet selling represented a logical extension of the disintermediation at the core of Dell’s direct business model. Unlike its competitors, Dell did not confront the problem of alienating channel partners through direct Internet sales, and it was not impeded by the legacy of the indirect selling system. As a consequence, Dell was one of the first large manufacturers to set up

Dell Computer 187 Multiple of 1994 amount

12 Sales

10

Employees

8 6 4 2 0

1994

1995

1996

1997

1998

1999

2000

2001

figure 6.3 Growth of Dell Sales and Employment, 1994–2001 (1994 = 1.0) source: Dell Computer Corporation, Form 10K, 1996 and 2001.

a Web site in 1994. The following year, customers were able to configure systems and obtain price quotes from Dell.com. By June 1996, Dell was the first firm in the PC industry to sell systems over the Internet. Within three months, Dell had become one of the largest Internet commerce firms. By the end of 1996, when Amazon.com was selling $15 million worth of books per quarter, Dell was already selling PCs over the Internet at a rate of $1 million per day equal to roughly $90 million per quarter, or six times the sales volume of Amazon (Table 6.6). Six years later, Dell was the largest online retailer of goods, accounting for 22 percent of all Internet retail sales (Tedeschi 2002). In expanding its Internet sales as well as increasing its total sales, Dell admittedly benefited from a mutually reinforcing relationship between the Internet and the PC. The expansion of the Internet as a communications revolution created a corresponding surge in demand for PCs as the device of choice for access to the Web. While the entire PC industry prospered from this relationship, Dell as an on-line seller profited from this innovation in two ways. It was able to take advantage of the increasing interest for Internet access not only as a demand stimulant for its own PCs but also as a means of scaling its system of order intake and innovating its sales system to meet this surge in demand. Nevertheless, while this transition to on-line selling succeeded in lowering Dell’s administrative costs per order from roughly $50 to $5, this innovation represented a relatively small portion of the overall operation. Beyond order intake on the front end of the value chain lies a more complex set of

188 Dell Computer table 6.6 Daily Internet Sales of Dell Computer (End-of-Year Totals), 1996–2001

Daily sales ($ millions) % of total Internet sales

1996

1997

1998

1999

2000

2001

1 7%

3 14%

11 32%

20 40%

40 50%

50 57%

source: www.Dell.com, Speech Archive of Michael Dell.

operations and relationships between Dell and its suppliers. These relationships and their integration with the customer would become the focus for the second phase of Dell’s Internet innovation.11 the beginning of the “second web revolution” By extending the Internet from the point of sale into the logistics of procurement and assembly, Dell’s “second Web revolution” represents a more far-reaching set of transformations than the Internet innovations focused on sales. In this second phase, the company has become an innovator in the realm of business-to-business Internet commerce. Dell refers to this type of Internet activity, linking itself to its customers, suppliers, and logistics partners, as e-commerce. As a logical extension of Internet-driven efficiencies in the process of order intake and sales, the second phase of Internet deployment at Dell represents the continuation of a single overriding concern—diminishing inefficiencies in the value chain associated with time. This preoccupation with time, in turn, compelled Dell to focus on ways of using Internet communication to enhance what is perhaps the company’s most critical capability— balancing demand and supply in a build-to-order environment. Dell’s effort to rationalize the process of demand and supply balancing had as its operational objective the compression of time at every stage of the procurement and build process in which product was held in inventory and acceleration in the number of inventory turns or cycles. Strategically, the company’s aim was to bring demand and supply into balance within a much tighter time frame by using Internet-generated information and communication as a substitute for inventory. This aim of compressing time in the process of demand and supply balancing is what drove Dell’s Web experiment upstream into supply chain management and enterprise resource planning. Dell dubbed this initial effort at integrating the Internet into the procurement and build processes the Genesis Project. Launched in 1994, Genesis aimed to create a standardized system of data management for all aspects of the Dell operation, using the Web as an information and communications infrastructure. Procurement planning, pro-

Dell Computer 189

duction schedules, order intake, product delivery, and accounting, along with the logistics linking these activities, were to share this common information platform. The project, however, did have a clear and measurable performance goal: to reduce the inventory problems that had emerged at Dell during the previous four years. Central to the project was a Web-based information system for enterprise resource planning designed by software firm SAP. The SAP/R3 platform was intended to enable enterprise resource planners to identify how the impacts of an order ripple throughout the entire operation. Functionally, its aim was to create simulations for balancing procurement levels, coordinating production schedules, and adjusting financial balance sheets. Two problems emerged with this project (King 1997). First, the SAP system had difficulty accommodating Dell’s regional organizational structure. Adopted in 1995, Dell’s regional organization hinged on the idea of dividing the world into regions and establishing expansion sites for final assembly that would process orders and sell to customers in the region where the assembly site was located. The SAP/R3 system was unable to manage these multiple assembly facilities. Second, the project did not appear sufficiently scalable to handle the growth rate at the company (Koncaba, interview, July 27, 2001). Genesis had been conceived in 1994, when Dell was a $3 billion firm. By the time Dell actually abandoned the still-unfinished effort in 1997, its sales volumes had quadrupled to roughly $12 billion. Furthermore, Dell had already concluded that the SAP/R3 architecture, with its large centralized database, was incompatible with one of Dell’s newer aims. Dell was committed to running a more flexible and less rigid system of enterprise resource planning on its own servers. This aim was incompatible with the structure of the SAP/R3 system. According to Jerry Gregoire, chief information officer at Dell in 1997, “having a full SAP suite and all of these tightly integrated applications going into the company at the same time didn’t make as much business sense as it did before” (quoted in King 1997). Nevertheless, one critical achievement emerged from this early effort at integrating the Internet into procurement and production. From 1994 until cancellation of the project in 1997, Dell did succeed in accomplishing its primary goal of decreasing inventory. By 1997, Dell had once again assumed leadership on this metric within the PC industry (Table 6.7). The company was also growing faster than its competitors in the PC industry. By 1997 Dell had become the third-largest PC firm in the world, surpassing such firms as Apple and Hewlett-Packard (Table 6.8). Despite cancellation of the SAP project, Dell would continue experimenting with the Internet for enterprise resource planning over the course of the next two years. During this period, Dell (along with Cisco Systems) became known as the firm with the most advanced Internet-based system

190 Dell Computer table 6.7 Days’ Supply of Inventory at Dell and Compaq, 1994–2001

Dell Compaq

1994

1995

1996

1997

1998

1999

2000

2001

32 67

21 59

16 44

13 32

8 29

6 31

5 36

4 42

sources: Dell Computer Corporation, 10-K Reports various years; Compaq Computer, 10-K Reports various years; Robert Cihra, The PC Industry, ING Barings Furman Selz, 1998; “HP and Compaq: It’s Showtime,” Business Week, June 17, 2002, p. 77.

for supply chain management. Nevertheless, as Michael Dell admits, these early efforts at Web-based supply chain management were still very much a process of trial and error in trying to create Internet links between Dell and its suppliers (Dell and Fredman 1999, 190). Furthermore, the company confronted the problem of trying to standardize competing, and not always compatible, information and communications platforms in terms of phones, faxes, and the Web. By the end of 1999, Dell had decided to embark on a far more ambitious project for integrating the Internet into its operation.

Dell’s i2 Business Organization Dell embarked on the DSi2 project with the idea of building its business “with the Internet at its core” (vice president, interview, May 24, 2001). In a strategic sense, the aim of the project was to enable Dell’s demand and supply planning, parts procurement, build-to-order production schedules, customer order intake, and product delivery processes to operate on a single but flexible Internet-based information platform. As a practical matter, this aim involved transitioning aspects of these operations still being conducted through phone, fax and even e-mail on to the Web. In addition, this project was designed to get all of Dell’s geographical regions to use this common Web-based information and communications system. Perhaps most important, the project reflected an effort to link itself more systematically with its supply chain and logistics partners. Although Dell developed some of its own proprietary software for the program, it turned to the supply chain firm of i2 to provide the overall architecture for the Web-based information system. The DSi2 initiative utilizes Web-based communication to address what Dell considers the most formidable challenge in its build-to-order business model—the challenge of supply and demand balancing in an environment of fluctuating customer orders over time. Although some form of supply and demand balancing confronts all manufacturers, most companies address

Dell Computer 191 table 6.8 Computer Firms Ranked by World Market Share, 1997 Rank 1 2 3 4 5 6

Firm Compaq IBM Dell Hewlett-Packard Packard Bell / NEC Gateway

Units (thousands)

Market Share (%)

10,596 6,958 4,464 4,297 4,116 3,261

13.1 8.6 5.5 5.3 5.1 3.7

source: Gartner Group / Dataquest.

this problem through inventory management. If orders spike upward at any one time, firms rely on inventory to balance the fluctuation. Dell, however, has rejected this approach as incompatible with its build-to-order pull system. It relies instead on what is called “burst capacity,” or what in more common parlance is termed “speed-up” to deal with ever-fluctuating demand.12 This strategy utilizes a small amount of unused capacity within the procurement and production process as a safeguard against large increases in demand at any one moment. When such increases occur, this unused capacity is deployed. In order to work in a build-to-order environment, however, burst capacity has to extend beyond Dell into the supply chain. Consequently, DSi2 is effectively a merger of the Internet and burst capacity extended throughout the Dell organization. The project is built around Internet communication to link the planning and logistics of procurement, assembly, and distribution for balancing supply and demand in close to real time. It also incorporates burst capacity, deployed throughout Dell and its supply chain and logistics partners, to deal operationally with unexpected increases in demand. Through this combination of informational and operational innovation, DSi2 has enabled Dell to drive down inventory while balancing the seemingly incompatible goals of customization and high volumes.13 The DSi2 project has two principal elements: global supply planning and demand fulfillment. The first, as its name implies, focuses on planning processes, and the second is concerned with the execution and logistics of moving parts and semifinished and finished goods through the Dell procurement, production, and distribution organization. This separation of planning from execution is one of the biggest changes implemented by the DSi2 project (Cook, interview, June 14, 2001).

192 Dell Computer operations: global supply planning Global supply planning involves two types of planning processes. On the one hand, it involves the creation and management of data and information used to forecast general demand parameters for components. Second, and perhaps more significant, global supply planning is a system of information exchange between Dell and its component suppliers to coordinate the process of ordering and procurement of components. The innovative advance in this process hinges on the way Dell has deployed Web-driven communication, configured through the i2 modules as well as its own software, to create an automated procurement system in which Dell is functionally integrated with its parts suppliers and logistics providers. This integration with suppliers through the Internet has resulted in a more centralized and standardized process for procurement planning. Global supply planning centralizes Dell’s inbound planning activity in the company’s worldwide procurement organization in A