Innovation, Networks, and Vertical Integration

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Innovation, Networks, and Vertical Integration
  Innovation, Networks, and Vertical Integration byPaul L. RobertsonDepartment of Economics and ManagementUniversity CollegeUniversity of New South Wales, ADFACampbell, ACT 2600 AustraliaandRichard N. LangloisDepartment of EconomicsThe University of ConnecticutU63 Storrs, CT 06269-1063 USAJanuary 1994Forthcoming in  Research Policy An earlier version of this paper was presented at the Euro-Conference on Evolutionary andNeoclassical Perspectives on Market Structure and Economic Growth, held in Athens on September24-25, 1993; at the Columbia University workshop on Comparative Corporate Governance, IndustrialOrganization, and Competitive Performance, November 22, 1993; and to seminars at the AustralianNational University and the University of Manchester. We particularly wish to thank DavidAudretsch and Dick Nelson for their help and encouragement .  2 ABSTRACT A central debate in industrial policy today is that between proponents of large verticallyintegrated firms on the one hand and those of networks of small specialized producers on theother. This paper argues that neither institutional structure is the panacea its supportersclaim. The menu of institutional alternatives is in fact quite large, and both firms andnetworks — of which there are several kinds — can be successful, growth-promotingadaptations to the competitive environment. Industrial structures vary in their ability tocoordinate information flows necessary for innovation and to overcome power relationshipsadverse to innovation. The relative desirability of the various structures, then, depends onthe nature and scope of technological change in the industry and on the effects of variousproduct life-cycle patterns. The principal policy conclusion of this analysis is that thegovernment's role ought to be facilitating rather than narrow and prescriptive, allowing scopefor firms to develop organizational forms that are best adapted to their particularenvironments.  1  Introduction. The debate over the institutional forms most conducive to economic growth has intensified inrecent years. In the mid-1980s, Michael Piore, Charles Sabel, and Jonathan Zeitlinchallenged the notion that the growth of large businesses in twentieth-century Britain and theUnited States had been either necessary or desirable. On the basis of developments inContinental Europe, they have contended that communities of skilled craftsmen are ascapable of generating high standards of living as are giant, vertically integrated firms (Pioreand Sabel 1984; Sabel and Zeitlin 1985; Sabel et al.  1987; Sabel 1989). Moreover, theyclaim, small firms are more flexible and thus better adapted to engendering and adoptinginnovations. To take advantage of these capabilities, they recommend reorienting theAmerican economy towards small, craft-based firms that operate in a cooperativeenvironment. Michael Best (1990) has reinforced this call, questioning the efficiency of bothvertically integrated Western firms and Japanese networks and arguing instead for the growthof geographical concentrations of small firms organized cooperatively along the lines of the“Third Italy.” 1 Other writers believe that large vertically integrated firms are in the best position todevelop and exploit innovations. In contrast to Piore and Sabel and Best, William Lazonick contends that economies of scale will remain overwhelmingly important and that small firmswill not be able to compete effectively in many areas. As a result, Lazonick believes, growthmust be based on giant organizations that are able to combine strategic flexibility with accessto economies of scale. But to survive, such organizations must have “privileged access to   1 The “Third Italy” is the area of northeast Italy centering on the regions of Emilia-Romagna and Tuscany. Although anumber of substantial cities — such as Bologna, Modena, Florence, and Reggio-Emilia — are in the area, much of the industry is located in smaller towns that specialize in the production of various items including ceramic tiles,textiles, and machine tools. These local industries are frequently organized in government-sponsored cooperativesthat provide access to cheap capital and to services in marketing, accounting, etc. Initiative in design and otherfields, however, is retained by the member firms, that are commonly family-owned and have twenty or feweremployees. See also, Lazerson (1988), Brusco (1982), and Hatch (1987).  2 resources,” including control of marketing and the supply of inputs, in order to provide thesecurity to justify investments in large production facilities (Lazonick 1990 and 1991a).Richard Florida and Martin Kenney also believe that a high degree of verticalintegration is desirable, but stress the need to coordinate basic research and developmentactivities with product development and manufacturing in order to gain maximum benefitsfrom scientific and engineering breakthroughs (Florida and Kenney 1990a). Florida andKenney and Lazonick are critical of Piore and Sabel and of current American developmentsin Silicon Valley and along Route 128 in Massachusetts because, they claim, small firmscannot fully realize the potential that seminal discoveries offer. As a result, well-articulatedJapanese and Korean industrial conglomerates are appropriating the bulk of the benefits of American discoveries and, increasingly, are themselves making the important breakthroughson which future growth will be based (Florida 1990a, ch. 6). 2 An intermediate position has been staked out by Michael E. Porter. Porter believesthat, in order to be successful in international markets, firms must first develop the knack of competing domestically. To achieve this, he advocates a high degree of rivalry among firmsin their home markets. He also cites the importance of networks of suppliers to provideinexpensive and flexible access to inputs (Porter 1990). And, like Piore and Sabel, Porterbelieves that geographic concentrations of producers can increase productivity by enhancingaccess to knowledge and other factors of production. Although Lazonick (1991b) hascriticized Porter's support for a high degree of domestic competition and networks of supportfirms, it is clear that, in contrast to Piore and Sabel, Porter is not advocating theestablishment of ateliers when economies of scale are present.   2 This chapter is reproduced in Florida and Kenney (1990b). See also, Lazonick, (1991b).  3 There appear to be two basic differences between Porter and Lazonick. First, Porterbelieves that the American economy is large enough in most industries to justify competitionamong several large firms, while Lazonick supports monopolies or very tight oligopolies inthe domestic economy. To Lazonick, the most important rivalry is on the international stageand industries on the national level should conserve their strength for competition with firmsfrom other countries. Second, Porter believes that an extensive web of outside suppliers andregional agglomerations of producers provide flexibility to cushion downturns and givebroad access to technical improvements, whereas Lazonick emphasizes the security thatarises from maintaining resources under centralized control.Prescriptions for government industrial policy also vary among analysts. Lazonick (1990, 1991a, 1991b), for example, contends that governments should promote centralizationand concentration to permit firms to meet competitive challenges from large foreign firms.Piore and Sabel (1984) and Best (1990), on the other hand, recommend that governmentsactively support the growth of small firms and industrial districts by generating policies thatsimultaneously promote competition and cooperation. Finally, Porter (1990) believes thatgovernments should emphasize the creation of environments that encourage domestic andinternational competition by promoting technological change, but that governments are ingeneral ill-equipped to provide detailed economic direction.All of these authors are grappling with the same problem of locating the patterns of industrial and firm organization that are most efficient in permitting a nation to innovate andgain or maintain productive superiority. 3  They have nevertheless reached a variety of    3 Lazonick, Piore and Sabel, Best, and Florida and Kenney are also explicitly interested in finding ways of providingmore interesting work, greater job stability, and better wages for the industrial labor force than currently prevails inthe United States. In general, they recommend that this can be accomplished by increasing the intellectual content of factory employment and the scope for decision-making available to individual workers. Florida and Kenney, forexample, “see the Japanese model as a successor to fordism that uses new organizational forms to harness theintellectual as well as the physical capabilities of workers.” (1991, p. 383.) Here, however, we concentrate on theauthors' proposals concerning firm and industrial organization.
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