TECHNOLOGY AND SCALE

Technological change also contributed to the pressures on the vertically integrated corporation. In the 1960s and 1970s, new technologies of manufacturing—such as the use of computer numerically controlled machines, robots, and flexible manufacturing systems—were developed.²⁴ Because these technologies were flexible, intermediate-goods manufacturers did not have to be locked in to large production runs for a single customer. Independence became less hazardous. Moreover, flexible production systems require fewer machines to accomplish a given set of tasks. Studies show that the average size of plants in industries adopting flexible manufacturing technologies fell faster than in other industries.²⁵ The reduced scale of even intermediate-goods production further reduced the barriers to creating and financing such ventures.

Improvements in information technology reduced the costs of exchanging information with entities outside the firm. With product specifications becoming easier to transmit, and bids becoming easier to collect and adjudicate, the costs of transacting with outsiders fell. While the cost of communicating within firms fell at the same time, allowing the efficient size of the firm to expand, studies show that the use of information technology in the manufacturing sector has tended, on net, to be associated with smaller average firm size.²⁶

Technology is also making redundant certain assets that hitherto had given incumbent firms a comparative advantage. Consider the recent history of the record companies.²⁷ In early 2000, there were four major firms in the record industry. Among them, they accounted for 80 percent of sales. This is down from six large firms as recently as 1998. The increasing concentration of the industry is, paradoxically, not a result of growing scale economies. In responding to a question about whether the merger of Time Warner and EMI’s record business was tightening the merged firm’s control over the industry, the president of Time Warner said, “The ability to control is gradually being eroded by the diminishing barriers to getting into this business.”²⁸ Of course, given the concerns of antitrust authorities, it would have been hard for him to agree with the premise of the question, but there may well be truth in the statement.

To see why, consider the primary functions of a record company. They are to find music artists, make tapes or CDs, distribute them, and market them. Historically, small firms found the artists but then passed them on to the majors when the artists became successful, since the majors enjoyed scale economies in the other three functions. The Internet, however, has changed matters. The record company no longer has to manufacture tapes and CDs and then distribute them through thousands of retail outlets. Instead, it only has to store the music on its Web site and allow it to be downloaded on payment of a fee. This completely changes the functions of production and distribution and makes scale economies irrelevant. As for the last function, that of marketing, the Internet label can target people interested in its brand of music through E-mail and the Internet much more cost-effectively than can a major through bricks-and-mortar retail stores. As the chairman of Warner Music put it, “The role of traditional distribution is clearly going to decline. And if there was anything the record companies had, it was a distribution network.”²⁹

Of course, as with every fear or hope associated with the Internet, there may be an element of hyperbole in the last statement. The general point, however, is the following: Large firms hitherto had the advantage that they serviced a large market and therefore could use very specialized resources profitably. As flexible modern technology allows small firms to replicate the specialized resources of incumbent large firms (for example, the distribution system) at low cost, a key source of comparative advantage for the large firms evaporates. Technology thus contributes to leveling the playing field between the entrenched large and the upstart small.