Dynamic Explanation of Industry Structure and Performance
Cotterill
failure of shareholder elected boards to discipline top
management for poor performance. Good management
drives out bad management or so the claim goes. We
will critique and expand this theory to explain how
financial capitalists created market power to benefit
investors. Examples of financial as opposed to industrial
capitalists include J.P. Morgan at the beginning and
Harry Kravis at the end of the 20th century.
Demsetz, however, would have us look beyond the
contributions of agency theory and allocate some effort
to neoclassical theory, especially when analyzing
vertical organization issues. He argues that:
The focus in this effort has led to the neglect of
information problems that do not involve agency
relationships... Should agency problems be the primary
guide to understanding vertical integration? Perhaps, but
consider, for example, the role of "expertise.".The
manufacturer of commercial aircraft possesses specialized
knowledge that can be extended at little cost into the
business of maintaining older aircraft. Vertical
integration of these two businesses is, therefore, a
practical possibility. Vertical integration of aircraft
manufacturing and airline transportation, on the other
hand, is more difficult. Effective vending of airline
transportation to the general public requires operational
and marketing know-how not normally part of the
knowledge needed to manufacture aircraft. The difficulty
this poses does not depend on agency problems. .The
focus on agency relationships has also led to neglect of
some useful neoclassical theorizing. The successive-
monopoly problem, price discrimination, and price
controls, as examples, offer motives for vertical
integration not involving agency problems. (Desmetz,
1997, p. 428)
In this paper we honor Demsetz's call for a refocus
upon neoclassical theory to explain some critical issues
in the vertical organization and performance of the
economy. This approach yields new insights and
advances new models to analyze the impact of market
power. Specifically we go beyond the analysis of
market power within an industry such as food retailing
or a food processing industry to consider the
implications of market power in successive industries in
a market channel. Implications include the need for
vertical coordination rather than arms length pricing in a
wholesale market to improve market performance; hence
an explanation for the decline of wholesale markets and
the rise of Efficient Consumer Response (ECR) and
category management. Successive monopoly or
oligopoly also has a heretofore unrecognized impact on
farm to retail price transmission, and in most cases
reduces vertical pricing efficiency. With the exception
of McCorriston, et al. (1998), Cotterill (1998, 2000) and
Dhar and Cotterill (2000), no one has specified formal
economic models to analyze the impact of
noncompetitive market channel structures, i.e. market
power at one or more stages of the system, on price
transmission.
Finally this paper is also more general in the
tradition of Mason and Hoffman. The next section will
review, for want of a better term, Krondriatiff cycles
(Schumpeter, 1935), in the organization of the food
sector during the 20th century.2 The sector has
experienced growth and transformation in response to
"waves" in the advance of basic human knowledge, as
well as secondary waves in culture, social organization,
and public policy. One of the organizing themes of this
conference is that the consumer has and will continue to
shape the organization of the food system. Well, yes and
no. As we will see this is true to the extent that one
equates the evolution of the consumer with economic
growth and cultural shifts observed during the 20th
century. There are however many other equally
important, and in certain situations more critical,
determinants of the organization and performance of the
food sector. Demand, one half of the Marshallian
scissors, must be augmented by supply side phenomena,
including the status of competition, technology, and
public policy to have a complete picture.
The third section of this paper reviews the relatively
sparse neoclassical work on the vertical organization of
market channels. We develop a more general
framework. The remaining sections of the paper analyze
2 Schumpeter explains long waves of economic progress as
follows: "Historical Knowledge of what actually happened at
any time in the industrial organism, and of the way in which it
happened, reveals first the existence of what is often referred
to as the "Long Wave" . It has been worked out in more
detail by Kondratieff, and may therefore be called the
Kondratieff Cycle. Economic historians of the nineteenth
century have unconsciously and independently testified to the
reality of the first of these waves our material allows us to
observe, viz., the cycle from about 1783 to 1842, the
"industrial revolution," .The years 1842-1897 are readily
interpreted as the age of steam and steel, particularly as the
age of the railroadization of the world. This may sound
superficial, but it can be shown in detail that railroad
construction and work incident to it, connected with it, or
consequential upon it, is the dominant feature both of
economic change and of economic fluctuations during that
time. . Future historians finally will find no difficulty in
recognizing the initiating importance of electricity, chemistry
and motor cars for . the third Long Wave, which rose about
1897." (Schumpeter, 1935). Today we are clearly at the
beginning of the "internet wave" an event probably equal in
importance to the railroad wave and automobile/electricity
wave.
Food Marketing Policy Center Research Report No. 53