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Tuesday, March 4, 2014

Automotive History I: Setting Standards

This is the first of a series of posts tracing the history of the automotive industry from an economics perspective. I'm a member of the Business History Conference, the Society of Automotive Historians and the Industry Studies Association [at least when I remember to pay my dues].

The early history of the industry offers many lessons for – or at least reveals common dynamics of – start-ups in an era of uncertainty about technology, vehicle use, customer base, distribution channels and revenue streams. In the background are common analytic issues: the setting of standards, the entry/exit process, and the eventual coalescence – not finalized until the 1920s – around organizational structures that dominate the industry today. We are again at a point of rapid technological change; will we see a similar upheaval? I argue no, because most pieces of the industry will not be affect. It will however take several posts to reach a point where I can make that case on the basis of evidence and models.

Early Entry: The Plaything Era

Early entry reflected uncertainty about what sort of power plant might be practical. We thus saw steam cars – the Stanley Hotel in Estes Park, Colorado had a pair in operation – and electric cars, which in the US outsold internal combustion and steam vehicles as late as 1903. This is because it was uncertain what the market for cars would actually be, or whether there would be enough of one for substantial commercial production. Electric cars appealed to women in the US upper class, who would promenade with their electric cars in resort towns. Steamers could substitute for coaches. Internal combustion engines were loud, and used unfamiliar fuels and demanded new maintenance skills. Of course, that made them interesting playthings for monied men, perhaps akin to a Tesla today. Cars also had entertainment value; road races featured prominently. Henry Ford first gained public notice not for making cars but for racing them.

But how to make money? How to distribute? With volumes initially small, manufacturers tended to advertise (including through racing) and to sell direct to final purchasers. Collecting money was then an issue, for while you might be able to receive a deposit in advance, reasonable buyers would not want to pay until a working vehicle was delivered. Now when cars remained playthings for the well-to-do, the "working" part was less critical; that was the coachman's job.

Initially, those who made cars purchased all components, and then assembled them. Machine shops abounded, at least in some parts of the country, so at least in low volumes you could find someone who'd make what you needed. So was making components where the money lay? Or coming up with a good coach to show off your contraption (and hide the unseemly innards)? [We did see "Body by Fisher" but to my knowledge there was no successful branding by gasoline engine manufacturers, only later on by diesel engine makers. The challenge there was also collecting bills. But in any case one implication of this was that you did not need much physical capital in order to declare yourself in business as a carmaker. You typically did have to build a demonstration vehicle, and then try to use that to garner PR. Winning a race helped, suggesting that you knew how to design one that wouldn't instantly shake itself apart or blow a piston.

Such uncertainty – drivetrain, vehicle layout, revenue model, distribution model, assembly versus parts – led to much entry and exit, as is typical of new markets. Glenn Carroll and Michael Hannan spearheaded a literature in this vein – see their The Demography of Corporations and Industries, Princeton University Press, 2000. Until the "how to" gets settled, there's lots of entry and lots of failure. Over time a standard business/product model gains acceptance. Of the new entrants who use that model, a few are in addition well-managed and lucky (e.g., in access to finance and not launching as the economy is about to enter a recession). Such firms grow, entry becomes harder and may cease, exits rise; the industry hits maturity with a greater or fewer number of incumbents, depending on economies of scale in production, branding and all that. In general, those with the wrong model get weeded out quickly; those who through luck or prescience or because they could at least observe what didn't work end up surviving, and the longer you survive, the more likely you are to stay in business. Carroll, Hannan and their followers show such patterns across a wide array of industries, from life insurance to ... yes, autos.

Entry and Exit Studies

The most recent paper in this literature is Cabral et al., which pulls together various strands. Did automotive firms locate in Detroit due to the richness of the industrial infrastructure, such as the presence of carriage makers and suppliers? Did they group because of the size of the local market? Did they group because of a process of spinoffs? Initially the industry was scattered, with sizeable groups of firms in New York, Indianapolis and Detroit, among other locations; over time the field was whittled down. So why did firms develop in those locations, and why did one location in particular do well? Cabral and his co-authors draw upon the work of Klepper and others to discuss "natural" location, market size, the presence of firms in related industries, the presence of firms in the same industry, and the role of spin-offs in new entry.

Market sized played little role, and the presence of other auto firms (and hence shared local suppliers) was even less important. On the other hand, early centers seemed to benefit from the presence of a large carriage industry, with both the know-how for building 4-wheel vehicles, and a knowledge of distribution mechanisms. William Durant, the founder of General Motors, had his start there. Then there were spinoffs, especially after the early years, when experienced managers left to form new ventures. General Motors is also an example of that.

By World War I the internal combustion engine was the clear winner, as was a 4-wheel layout with the engine in front, rather than (say) the 3-wheel vehicles that dominated the automotive market in Japan in the 1950s, and are ominpresent in the Philippines and other developing country markets today. Many other innovations were by that point also standard. More in later installments; marketing and finance follow.

Boschma, Ron A. and Wenting, Rik (2004). The spatial evolution of the British automobile industry: does location matter? Industrial and Corporate Change, 16(2), pp. 213-238.

Cabral, Luis, Zhu Wang and Daniel Yi Xu (2013). Competitors, Complementors, Parents and Places: Explaining Regional Agglomeration In The U.S. Auto Industry. National Bureau of Economic Research. NBER Working Paper 18973.

Cantner, Uwe, Dreßler, Kristina and Krüger, Jens J. (2006). Firm survival in the German automobile industry. Empirica, 33, pp. 49-60.

Klepper, Steven (2002). The Capabilities of New Firms and the Evolution of the US Automobile Industry. Industrial and Corporate Change, 11(4), pp. 645-666.

Klepper, Steven (2002). The Capabilities of New Firms and the Evolution of the US Automobile Industry. Industrial and Corporate Change, 11(4), pp. 645-666.

Klepper, Steven (2007). Disagreements, Spinoffs, and the Evolution of Detroit as the Capital of the U.S. Automobile Industry. Management Science, 53(4), pp. 616-631.

Rosegger, Gerhard and Baird, Robert N. (1987). Entry and Exit of Makes in the Automobile Industry, 1895-1960: An International Comparison. International Journal of Management Science, 15(2), pp. 93-102.