Maastricht University SBE International Business History Assignment 1 by JP
Industial Characteristics and their Impact on the Oil Industry in History
In the transformation from an agrarian commercial economy into a modern industrial enterprise, industrial activities played a central role. This industrialization of different economies changed various industries enormously. Therefore, many opportunities for existing and new firms were created. To benefit from these opportunities companies had to take into consideration the different characteristics of the newly constructed industries. This paper will focus on the oil industry and on some of its market characteristics. For that reason, an interesting question to answer is: what industry characteristics need to be considered to generate the possibilities for a supplier to be active in the oil industry and to succeed there?
2. Industry Characteristics
The first characteristic that played a significant role in the industrialization process is the economies of scale and scope. According to Chandler (1994), especially in capital intensive industries economies of scale had a great impact, in which investments in new facilities greatly increased the ratio of capital to labor. As a result of this, the costs of produced goods decreased considerably. It made it possible for firms to operate their production facilities at their minimum efficient scale. Economies of scope refer to lowering average production costs by manufacturing multiple products. The next characteristic relates to companies who were the first to operate in an industry. They could gain a first mover advantage by the three pronged investment. This consists of investments in production facilities, marketing and distribution, and organizing the management structure. The third characteristic a market could face is the barriers of entrance. These are obstacles, such as investments, competitor’s economies of scale or highly integrated distribution networks, a newcomer faces when entering a market. The fourth characteristic is the industry’s potential for expansion abroad. This potential has a major influence in gaining a larger market share and to increasing sales by investing internationally. The last characteristic this paper focuses on is mergers and acquisitions, since these can turn industries into monopolies or oligopolies. These formal agreements make it possible to reduce output, set prices, and allocate regional markets.
3. How the Characteristics are seen in the Oil Industry
The five characteristics identified are crucial elements of the oil industry. In this paper, the timeframe for discussion is set to be at 1911. This is important as throughout the course of history, different market characteristics came to be of importance in the oil industry. In 1911, it should be noted that the industry has just seen its biggest monopoly firm- Standard Oil Trust being dissolved by the Sherman Antitrust Act which greatly diminished the economic power of the market leader. Coupled with the decrease in demand for Standard Oil’s main product, kerosene (the demand switched to gasoline due to the uprising of the automobile industry), and with the new sources of supply in Texas and California, the market came to witness the formation of oligopoly in the industry after years of monopolistic rule. As a result, several big firms (for example, Standard Oil, The Texas Company, Gulf Oil and Associated Oil) form the oligopoly.
Economies of scale and scope contribute largely to how successful a firm could be in the oil industry. Often, coupled with the first mover advantage, the firm could gain substantial market share. For example, when the new oil sources were discovered in Texas, firms which were fast enough to invest in building big refineries of optimal sizes (and take advantage of the economies of scale), and also quick to invest other aspects of the three-pronged investment like distribution and marketing efforts, became the market leaders in that region of United States. Being of a huge size and the first mover in the industry contributes to having the large barriers to entry for new entrants. Entrants would think twice before challenging the market power of the firms. Furthermore, as mentioned, in the time of 1911, the market was dominated by the oligopoly. They competed mainly through product differentiation and efforts into research and development in coming up with new processes that would make their production more efficient. Also, they competed for market share primarily through establishment in new geographical areas. For example, Texas and California companies mainly reached into the northern and eastern regions, while the former Standard companies explored into areas out of their original marketing regions stated by the dissolution act (Chandler,1994).