Technology: Its effect on firm size and scope

One of the forces behind American prosperity in the Gilded Age was the great vertical integration of the steel industry by the great industrialist Andrew Carnegie, who first coined and implemented the term. By owning every part of the supply chain, from coal extraction to the actual manufacture of steel to the transportation of the metals, Carnegie was able to cut cost of his steel drastically and thus dominate the market. Up until the 1980s, Carnegie’s business model was to be followed by great corporations like IBM.

But this business model did not last long. For years, businesses have been trying to find ways to lower their firm’s cost curve by acquiring their suppliers and the next line of corporations in the supply chain, making production of goods less costly among a larger spectra of goods in the production process.

When the third world nations opened and liberalize, they had a huge cost advantage over the much vertically integrated firms of the west, cheap labour. These made producing in the market cheaper than ever before. The firms, in their never-ending quest for cost minimization, swarmed into the third world countries and contracted firms inside the country or partnered with them, and integrated them to the supply chain.

So instead of just buying from the market, why don’t the big firms just set up factories in these nations and from there start vertically integrating? Investing in the third world countries I believe involves huge investment and a good amount of risk, while some countries like China have protectionist way of doing things that made transaction costs prohibitive.

What is the role of ICT in all this? ICT greased the machinery of vertical disintegration in a way that it made coordination among parts of the supply chain seamless. Dell seemed to have pioneered this kind of vertical disintegration.

Famous economist Thomas L. Friedman, in investigating how Dell assembled his computer found out that Dell has seven ‘assembly’ factories around the world and a huge swath of suppliers around it. As the orders for computers come in, suppliers are given what parts and quantities to delivery every ninety minutes to the assembly factory. This kind of precision in quantity of goods to delivery gives Dell a lot of flexibility in its production.

Traditionally, companies would just contract a supplier to supply a fixed number of parts per year for instance. A sudden decrease in demand would endanger the firm. So this was the perfect setup because this kind of precision brought about by ICT reduces this risk.

ICT also redefined what the limits firms could outsource products to. In America, when you go on the phone to talk to have assistance to just about any product, you’re most likely to be answered by Filipinos or Indians working dead hours to man these trunk lines. Two decades ago that kind of intercontinental communication was prohibitively expensive that it was cheaper to hire Americans to man the phones. Now, fibre optics laid out across oceans and the sophisticated architecture harnessing its power has brought costs down allowing for a huge expansion of scope.

Also, ICT is an event unto itself yet its effect ripple across industries. However, it would take a lot of investment for giant firms specializing in one industry to operate ICT on their own so they just cut off and delegate a part of their production process to a tech-firm. The tech-firm would be more efficient at it because they already have the knowledge and could do it better than the firm. This is a win-win because everybody could focus to what they do best and profit at the same time.


Raphael Jambalos


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