The Evolution of the Automobile Industry: Innovations of a Few and Subsequent Oligopoly

Formation

Austin Glan

During the early 1900s the automobile industry was rapidly evolving into one of the
premier organizations of the time. This development can be accounted for by the increases in
technology and innovations in the logistics of the business, as well as increases and changes in
consumer demand. Consequently, the development of the automobile industry led to a select few
firms that were in control of the market or in other words an oligopoly.313 The development of the
automobile industry truly shaped the American economy and has had a lasting impact on our
culture.
Automobile makers were once among the most profitable and cost efficient
companies in existence. They perfected the art of specialization and have influenced a number of
technological advancements in their industry and throughout the business world. However, the
business layout that many of the top automotive makers follow was not always the norm. In the
early stages of the industry it was commonplace for the same company to manufacture the car and
then turn around and sell it to consumers directly off of the production line.314 This concept seems
peculiar compared to the way business is done today, but this goes to show the process of
producing and distributing automobiles has evolved tremendously since its conception in the early
1900’s. Some of the most important changes to the business models included: manufacturing
processes were consolidated and perfected, logistics of the business shifted, executives instituted
improvement processes, and the consumer preference changed. The ones that were in a better
position to adapt to the changes in the market thrived and those that did not or could not suffered.
This led to another major development of the auto industry: the creation of an oligopolistic system
among the three major producers, General Motors, Ford, and Chrysler.315 This paper will delve
into the specific changes that occurred during the development of the industry that were
economically driven as well as the pros and cons of the oligopoly that resulted.
The automobile industry in its early stages was primitive compared to the complex system
of manufacturers and dealerships that exists today. Hochfelder and Helper examined the shifts that
occurred in the early 1900s that eventually led to the vertical integration of the industry. 316 In the
beginning, the design of the cars being produced was handled primarily by those in charge of the
physical car company; however these companies did not have the necessary machinery or parts to
construct their designs. The common practice was to hire machinists to produce the key
components of the car such as the, “motor, carburetor, transmission…and axles.”317 Cars and their
necessary mechanisms were in their early stages of development. Luckily, the creativity of
machinists and fabricators made it possible for the logistics of the car to become a reality.318
Without innovations in the components the automobile would not have been able to be produced
313
An oligopoly is a situation in which a select few firms dominate an industry, hold a large portion of the market
share of the industry, and make it difficult for new firms to enter the industry.
314
Marx 1985, 465.
315
Bresnahan 1987, 457.
316
Vertical Integration is a situation when a firm expands its operations to include the manufacture of the supply
inputs needed to produce their final product.
317
Hochfelder and Helper, 1996, 42.
318
Ibid, 39.

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economically. Once the technology advanced, it spread throughout the fabricators of the time and
became common knowledge. It is only after this point that the relationships between designers and
manufacturers began to change, becoming “short-term contracts [with] their respective
responsibilities…spelled out on a single page.”319 With only a certain number of skilled machinists
and only a few methods of production, it was nearly impossible to produce a unique automobile.
This made it difficult for the products of one company to stand out compared to their competition,
as Hochfelder and Helper cite from the trade press of the day.320 The limited number of fabricators
also introduced another problem: the absence of mass production. When outsourcing all of the
labor for machining essential parts for automobiles, it becomes challenging to maintain a steady
supply for a rising demand.321 These issues led the pioneers of the industry to race towards a more
economical method of production, vertical integration.
The explosion of the market in the early 1900s forced automakers to change their approach
to production. Automobile production in the United States went from 4,000 units in 1900 to almost
two million in 1920.322 Sloan argues that automakers were constantly trying to evolve and strived
to achieve, “a closer corporate relationship.”323 This increase in demand pushed automakers to
become more efficient; one way of doing this was to vertically integrate their systems. Obtaining
the machinists and fabricators became necessary for producers such as Ford and General Motors
in order to be successful. It became a situation of survival of the fittest, and only those companies
large enough to buy out the companies producing the essential parts would be able to produce the
cars. The market that this created, an oligopoly, will be addressed later in the paper. Before the
inception of vertical integration, it was possible for producers, “with little knowledge of
automotive design to bring their cars to market.”324 However, according to Hotchfelder and Helper
the increases in demand and the number of machinists being bought out made it more difficult for
small producers to enter the market. Producers who placed the supply chain of their parts into their
company profile were able to match the demand of the consumer and further developed the
industry.325 After automakers addressed the issue of increasing demand in the market by
introducing the machinist into their companies a new issue arose, logistics.
Before 1929, car makers’ main concern, according to Marx was production but that quickly
shifted to distribution once, “[p]roduction capacity…exceeded demand.”326 Producers rushed to
meet the consumer demand for “greater vehicle performance, comfort, and reliability.”327 This led
to advances in technology and a more improved automobile, but also a surplus of older models
that were traded in. Consumers who had purchased automobiles in the early stages of production
wanted newer and more improved models, as a result a supply of used cars flooded the market
after they traded in their older models for the newer. This led to what Marx refers to as the creation
of the franchise system in place today. The automobile producer grants access for a retailer to
market and sell their cars on their own property, commonly referred to as a dealership.
Manufacturers found it necessary to acquire a middleman because “consumer demands became

319
Marx, 1985, 466.
320
Hochfelder and Helper, 1996, 39-43.
321
Marx, 466.
322
Ibid, 469.
323
As cited in Hochfelder and Helper, 1996, 46.
324
Hochfelder and Helper, 49.
325
Ibid, 49.
326
Marx, 470.
327
Ibid, 471.

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harder to predict, especially by those removed from the immediate consumer contact.”328 The
acquisition of the supply chain by the designers, the need to keep up with changing consumer
demand, and the influx of used cars created a two-sided system that consisted of manufacturers
who create all of the parts and produce the vehicle and distributors who deal with the sale of new
and used cars. This system made it easier for automakers to supply their products to consumers,
improving the logistics of the business.
Another area that further developed the industry was that of innovations in the logistic and
technical processes that automakers such as General Motors and Ford established. Economic
managers of the industry attempted determine the consumer demand and matching their supply
and price in a manner that maximizes profits. Henry Ford is revered as one who ingeniously
changed the manufacturing process of automobiles to a way that made mass production possible.
Raff credits Ford with abolishing the artisanal method, where parts are specifically made elsewhere
and shipped in to be assembled. He states that Ford’s development of the assembly line effectively
created the need for parts to be made in the factory and to be semi-universal so that a limited
number of machines were required to fit all of the parts of the car together. 329 Raff states this
assembly line mentality also made workers more productive since “wandering around the plant”
was no longer necessary.330 The introduction of the assembly line and the resulting focus around
efficiency streamlined the production process and made it easier for firms to keep up with
increasing consumer demand.
The other way producers improved their overall profitability was through their managerial
approach, in particular the way the firms gather and interpret information on the supply and
demand necessary to turn a profit. Knight argues that determining this information is directly
associated to “the existence and the size of firms.”331 One way that Norton found firms, in
particular General Motors, gain a competitive advantage is by forecasting. Williamson argues that
“information impactedness (sic) problem…observational economies…the convergence of
expectations…and veracity risk,” are issues that firms should focus on when determining the
economics of their business.332 Williamson suggests that if a company is effective in forecasting
that in turn they will “increase profits.”333 Norton focuses on the changes that Alfred P. Sloan
introduced into General Motors’ business model in order to better forecast the automobile market.
Essentially the reforms that Sloan introduced can be summarized as better forecasting in terms of
rates of return and market share, inventory, synchronization, and retail demand changes. Through
forecasting, Sloan and General Motors were able to determine that there was a lag time between
when the firm discovered the consumer preference and when they were able to create a product to
match. In order to account for this, Sloan adopted a multi-divisional corporate organization in
which different departments were in charge of different aspects of the business. Norton suggests
Sloan founded the idea that firms should monitor the consumer demand in the market and adjust
the business accordingly, a revolutionary business idea for the automobile industry. These changes
propelled General Motors into one of the top car producers of the mid-1900s.334 Norton states that,
“GM achieved one of the most remarkable performances in the annals of American enterprise.”335

328
Marx, 473.
329
Raff, 1991, 726-727.
330
Ibid., 728.
331
As cited in Norton, 1997, 246.
332
As cited in Norton, 1997, 246.
333
Ibid., 247.
334
Norton, 1997, 248-259.
335
Ibid., 258.

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Norton proposes the idea that Sloan used a basic economic theory, supply and demand, to
transform the business practices that car producers used to maximize their efficiency and in turn,
their profits.
The processes that the executives of both Ford and General Motors implemented were not
“the product of a grand plan;” rather, they were responses to the ever-changing American economy
and consumer market regarding automobiles.336 The early changes regarding vertical integration
and franchise development, the process improvements of assembly lines and forecasting, and
everything in between can be traced to one common factor: consumer demand. Before World War
II, the norm for automobiles was big and luxurious and in turn expensive. However, Lawrence
White points out that, “[f]or the entire post-war period the subject of small cars…[had] been one
of active concern to the American automobile industry.”337 American’s became less concerned
with the size of the car and more with the cost of the car after the Second World War. White
explains that the consumer demand was shifting towards a smaller more cost effective car, to the
dismay of the automakers of the time.338 They were using the forecasting techniques set forth by
General Motors to try to meet the demand for the smaller more economical car; however this
proved more difficult than anticipated. White describes the issues faced by the producers as
essentially a time lag, which was still an issue even with the introduction of Alfred Sloan’s
innovations. By the time the automakers detected a change in the demand for small cars it was too
late due to the fact that designing and producing a car to fit the consumer demand immediately
was not feasible. By the time they had a design produced, the demand had shifted back away from
the smaller cars, frustrating the developers; this issue is one of the reasons they were hesitant about
entering the market.339 The big three automakers (Ford, General Motors, and Chrysler) did not
want enter the small car market because they saw smaller cars as less profitable.340 This leads to
one of the most intriguing aspect of the development of the automobile industry, the formation of
an oligopolistic system.
This shift towards a market where only a small number of sellers control the market can be
traced back to the formation of the auto industry itself. Hochfelder and Helper’s article on the
development of vertical integration makes it clear that the firms that had sufficiently large amounts
of capital to acquire the machining firms for their own uses thrived. They were able to “establish
great control over price, quality, and delivery of important parts.”341 Smaller firms that did not
have the necessary capital or power to influence the machining firms suffered losses and were
dissolved from the market. The power of the oligopolists was even further extended with the
introduction of the process improvements of the major firms. Raff substantiates this claim when
explaining Chrysler’s strategy, stating that they (along with Ford and General Motors) were able
to adjust to the changing consumer demand while the smaller firms with less forecasting power
could not keep up. This resulted in even fewer firms able to compete in the automobile market.342
White argues one of the reasons that the big three car companies were hesitant to enter the small
car market was that they each wanted to ensure that “the market was large enough to support all
three producers profitably.”343 This corresponds with one of Bresnahan’s explanations of the

336
Marx, 1985, 472.
337
White, 1972, 179.
338
White, 184.
339
Ibid., 185.
340
Ibid., 180.
341
Hochfelder and Helper, 1996, 49.
342
Raff, 1991, 724.
343
White, 1972, 179

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“1955 price war” among the automakers: they were engaging in “collusive behaviors.” 344 Such
behavior is a defining characteristic of an oligopoly, when a select few firms that are not
necessarily working together, but do have control of the market because of competitive advantages.
Bresnahan does not confirm that there was in fact collusion among Ford, General Motors, and
Chrysler but he does note that General Motors, in particular “enjoyed either a cost or quality
advantage.”345 It is reasonable to assume that that advantage was shared (perhaps to a lesser extent)
by both Ford and Chrysler to form an oligopoly.
Bresnahan does not conclude that an oligopoly, by its strict definition, was in place in the
automobile industry during its time of development in America. However, it is evident that there
were barriers to entry for smaller firms; the big three firms had the capital to control the machining
firms, and their executives developed forecasting methods that gave them a competitive
advantage.346 The barriers to entry are easy to detect from the beginning of the automotive market
and the common processes and improvements that the big three shared resulted in the profitability
and sustainability of their companies. This is not suggesting that it was impossible for smaller
firms to do business in the marketplace, but it is reasonable to conclude, based on the evidence,
that the big three automakers shared common business practices that made it difficult for other
companies to become profitable.
The automobile industry is constantly evolving and adapting to consumer demands.
Hochfelder, Helper and Marx all addressed the ways the business practices of production and
distribution have drastically changed. Automakers are constantly shaping their manufacturing and
business processes to more accurately fit the market as well as reduce costs and maximize
profits.347 White’s article suggests that they adapted to the consumer demands of the time, and
shifted their production in order to secure the market. General Motors, Ford, and Chrysler did this
more efficiently than the competition and reaped the benefits.348 However, in the process of doing
so, they created an oligopoly that discouraged competition through barriers to entry, argued
implicitly by nearly all the authors cited in this paper. This paper has delved into the economic
reasoning behind the motives of the automotive industry’s changes and adaptations. Further
research could better address additional sources of the oligopoly formation, or whether or not there
is truly an oligopolistic system in place. Raff references a famous quote by General Motor’s Alfred
Sloan, that they would create a “car for every purse and purpose.” This captures the mentality
behind the development of the automobile industry.349 After its inception, the automobile industry
exploded and not only had a lasting effect on the American economy, but also on how business is
conducted in America.

344
Bresnahan, 1987, 458.
345
Ibid., 477.
346
Bresnahan, 1987, 477-479.
347
Norton, 1997, 278.
348
White, 1972, 191.
349
Raff, 1991, 742.

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