Historic market cycles in the world automotive industry

Their explanation in the light of Hirschman’s theory of industrial development and Gort and Klepper’s industrial lifecycles

Scientific Essay , 2009 , 21 Pages

Business economics - Operations Research

The economic theory of industry lifecycles is a standard tool to explore the historic development of specific industries. Its basic idea is that an industry develops according to a typical, sequential pattern of emergence, rise, maturing and finally decay. This article compares conventional industry lifecycle theory as represented by the seminal approach of Gort and Klepper (Gort / Klepper 1982) with an alternative explanation of industry evolution, i.e. the application of Hirschman’s theory of economic development (Hirschman 1958; Hirschman 1968) to specific industries. The world passenger car industry and its long-term history serve as the case of empiric reference. The analysis is non-technical and rests on a limited set of macroscopic parameters (number of manufacturers, market entry and exit, output) in the World’s regions (Europe, the Americas, Asia including Oceania).

Contents

1. Introduction

2. A brief introduction to industry lifecycle theory
2.1 The approach of Gort and Klepper to the industry lifecycle
2.2 Hirschman’s alternative approach to industrial development

3 Lifecycles in the world automotive industry
3.1 Europe
3.2 The Americas
3.3 Asia

4 Learning effects in the world passenger car industry

5 Summing up

References

1 Introduction

The economic theory of industry lifecycles is a standard tool to explore the historic development of specific industries. Its basic idea is that an industry develops according to a typical, sequential pattern of emergence, rise, maturing and finally decay. This article compares conventional industry lifecycle theory as represented by the seminal approach of Gort and Klepper (Gort / Klepper 1982) with an alternative explanation of industry evolution, i.e. the application of Hirschman’s theory of economic development (Hirschman 1958; Hirschman 1968) to specific industries. The world passenger car industry and its long-term history serve as the case of empiric reference. The analysis is non-technical and rests on a limited set of macroscopic parameters (number of manufacturers, market entry and exit, output) in the World’s regions (Europe, the Americas, Asia including Oceania).

After more than 120 years it is a fair question where the automotive industry stands in its lifecycle – irrespective of the convulsions of the current demand crisis. Under the impression of lifecycle theory one may hypothesize that the automotive industry has already reached its dawn. At least in the Western hemisphere, most markets for light motor vehicles have reached a state of saturation. The multiplicity of manufacturers and technological approaches, which characterized the automotive industry’s pioneer days, has long given way to a small number of giant corporations (Möser 2002: 35ff.).

Products differ mainly because of marketing efforts but not so much because of truly new ideas for vehicle concepts or technology. There are scholars who consider motor manufacturing to be among the lead sectors in the “Age of Mass Production” or the “Fourth Long Wave” of technological change. The “Fourth Long Wave”, however, ended back in the 1990s to give way for the “Age of Microelectronics and Computer Networks” which are supposed to be leading technologies for the 21st century.^[1] Reason enough to hypothesize that the automotive industry has passed its pinnacle.

However, this is not the whole story. There are still emerging automotive markets (e.g. in Asia) where motorization is progressing, where new markets are being created and where new manufacturers are entering business. It might well be that a rejuvenation of the automotive industry is taking place there – a rejuvenation which is closely connected to the emergence of newly industrializing economies.

2 A brief introduction to industry lifecycle theory

Cycle patterns of economic development are quite an old topic in economic theory and statistics. Prominent ideas of macro-cycles or “long waves” which drive secular ups and downs of the World’s commercial activity have been brought forward by Kondratieff (Schumpeter 1954: 1158) (with the automotive industry being part of the fourth Kondratieff which peaked in the 1960s) (Freeman / Soete 1997: 19; Nefiodow 1998: 157). More detailed studies focusing on the historic cycles which specific industries go through have been introduced to economics, e.g. by Burns (Burns 1934) or Fabricant (Fabricant 1940). Kuznets’s seminal work on industrial evolution depicts the paths of specific industries’ historic development by means of logarithmic functions (Kuznets 1967).

In the 1980s, management theory and sociologists transformed the concept of the learning curve into a theory of industry lifecycles by stressing the idea that, in the course of time, agents learn about generally accepted ways of developing, producing and marketing specific goods. A sort of commercial orthodoxy evolves which typically coincides with increasing capital endowments and economies of size. Commercial orthodoxy reflects the progressing maturity of an industry. A prominent example for the application of such approaches to the automotive industry was Abernathy’s analysis of the productivity-dilemma, i.e. the trade-off between increasing capital intensity and a decreasing propensity to innovate (Abernathy 1978). The merit of these approaches has been to include the behavior of economic agents into the hitherto more or less descriptive analysis of the industry lifecycle. Nevertheless, in terms of methodology they are eclectic and mono-causal.

2.1 The approach of Gort and Klepper to the industry lifecycle

In a seminal paper on “Time paths in the diffusion of product innovations” Michael Gort and Steven Klepper brought forward a truly comprehensive economic theory of the industry lifecycle (Gort / Klepper 1982). In a nutshell, this approach assumes that the longer a company remains in business, the more it learns about efficient production and at any point of time older firms face a higher likelihood to further remain in business than younger ones.

Gort and Klepper identified five typical stages of the industry lifecycle:

(I) A creative entrepreneur enters the stage with an innovative product. If his marketing efforts are successful and the product finds its market, other agents will be ready to imitate the product
(II) In the next phase the number of producers steeply increases due to the market entry of imitators
(III) Later, the net entry rate approaches zero. The number of new entrants tends to be more or less equal to the number of companies which already have to go out of business
(IV) New entries are outnumbered by market exits in the next phase. The total number of producers begins to decrease (“industrial shake out”)
(V) Finally, the total number of producers stabilizes at a comparatively low level and remains constant as long as market fundamentals do not change

As time elapses and an industry moves through this standard scheme stage by stage, the nature of knowledge changes which is relevant for setting up efficient, state-of-the-art processes for manufacturing and product development. During the early phases of new industries, almost all the necessary knowledge may be acquired from outside sources, e.g. from scientific institutions or publications. Despite of being highly sophisticated in many cases, it is transferable and explicit. As products and processes mature in the course of time, the focus shifts towards “know-how” or implicit knowledge which is not easily transferable. Now, successful companies will excel through the fine tuning of efficient processes and intricate marketing strategies. The underlying knowledge may no longer be acquired from outside sources but rather needs to be internally accumulated by (time consuming) experience.

The more an industry’s knowledge focus shifts from explicit to implicit knowledge, the more are new entrants in disadvantage compared to more experienced incumbents. The likelihood that new entrants make profits which are sufficient to survive decreases over time and with it decrease incentives for market entry. Consequently, the number of new entries shrinks and more market exits occur until some kind of an equilibrium number of producers is reached.

Put into a total-market perspective, the maturing of an industry over its lifecycle has far reaching consequences. Maturing is almost inevitably associated with a loss in competitive diversity and an increase in homogeneity: The number of independent suppliers shrinks and with it decreases the degree of competitive, technical and aesthetical differentiation. Fehl emphasizes that any industry’s economic viability depends on the degree of diversity which it is able to bring about compared to other industries (Fehl 1983; 1986a; 1986b). If diversity falls below a certain threshold, competition within the affected industry will become sluggish and tacit collusion tends to be the dominant mode of behavior. The more sluggish competition becomes, the less is the industry able to attract new capital investment. Incumbents begin to invest their returns in other industries instead of spending on their home turf, e.g. for R&D or for new installations. Institutional investors’ attention tends to shift to other opportunities outside the industry, too. As a consequence, the rate of innovation begins to decline and once this happens consumers are to turn away from the industry’s products sooner or later since there are other, more attractive opportunities to spend money. Now, the industry begins, metaphorically speaking, to die – i.e. its share in the overall value added that an economy produces declines and its relevance gradually decreases.

Against this backdrop, one finds industry lifecycle theory in analogy to the lifecycle entropy of individual biological beings (Wuketits 1986: 180 ff.). The entropic moment enters the Gort-Klepper framework through the assumption that imitation of state-of-the-art products and processes becomes more difficult over time. It rests on the idea that the focus of relevant technological and commercial knowledge shifts from explicit to implicit or to “tacit” knowledge (Polanyi 1966).

However, Fehl maintained that within open social systems any entropic tendency in reality is countervailed by human creativity which, through innovative market forces and entrepreneurial arbitrage, injects new diversity and keeps the market process far away from any (entropic) equilibrium (Fehl 1983: 78 ff.). In this view, economic evolution is a principally open future process which follows no determined course (Fehl 2005: 82f.). A comprehensive theory of economic development that rests on the idea of economic development as a principally open future process which is driven by the pervasive activation of entrepreneurial and dis-equilibrating forces has been developed by Albert O. Hirschman (Pies 2006: 4). In the following paragraphs we propose to adapt Hirschman’s theory of economic development to the level of the evolution of specific industries – i.e. the world passenger car industry as case of reference – and to compare it to the Gort-Klepper type industry lifecycle.

2.2 Hirschman’s alternative approach to industrial development

Based on the approach of Gort and Klepper, the historic evolution of a number of industries has been analyzed so far, mostly in the form specific country studies. Among these are analyses of the US and the German automotive industry (e.g. Klepper / Simons 1997; Dreßler 2006). This article chooses an alternative, cross country perspective. By doing so, it opens the field for an application of Hirschman’s theory of economic development to a specific industry.

Albert O. Hirschman’s theory maintains that the development of industrial activities in certain countries or regions shows a different historic Gestalt depending on whether the country / region is subject to early, late or very late industrialization (Hirschman 1958: 8 ff.; Hirschman 1968). Early industrialization (e.g. in historic England) rely on the rather cumbersome process of accumulating an initial capital stock and attaining basic knowledge about how to run industrial processes. Late industrializing countries (e.g. historic Germany or the USA) dispense of a good part of the pre-work done in early industrializing countries and resort to experiences already made by others. Late developers oftentimes are able to jump with both feet in advanced technologies and manufacturing processes while early movers remain bogged down to activities that have passed their prime. Hence, late industrialization may unfold with particular élan and progressiveness. Finally, there are the very late industrializing countries (e.g. today’s emerging markets in Asia). Here, the process is dominated by import substitution, i.e. the substitution of imported manufactured goods by domestically produced goods.

It is important to understand that industrialization through import substitution (ISI) typically begins with consumer goods. Import substitution of consumer goods, however, in most cases rests on imported inputs and machines. The entire affair of ISI is, according to Hirschman, much more sequential and tightly staged than early or late industrialization. The ISI-process is comparatively smoother, less disruptive and less learning intensive than other ways to industrialize.

Hirschman had in mind the industrialization of entire economies. We try to adapt his theory to the purpose of analyzing the lifecycle of specific industries like the automotive sector. It is justified to make this transposition since Hirschman in fact explored the meso-level in economics, that is the dynamics of sub-sets of interacting agents (Calafati 2000: 7 f.). Meso-economics in this respect are mostly applied to analyze the distribution of incentives and development impulses between different groups of economic actors either within a geographical or a sectoral perspective. Hence, Hirschman’s paradigm of thought may be used to explore the historic evolution of specific industries.

The Hirschman paradigm of the industry lifecycle is sequenced as follows: Early entrants (e.g. the European pioneer companies in the automotive industry) invent the product and build up the initial manufacturing processes. Late entrants (e.g. American car manufacturers) build on this basis but are more bullish on advancing productivity and on expanding the market. Very late industry entrants (e.g. Asian car manufacturers) finally adopt the achievements of their predecessors through ISI and eventually apply them to new markets.

The Hirschman paradigm contrasts the Gort-Klepper paradigm: The latter paradigm much more emphasizes the role of tacit knowledge (whose accumulation is biased in favor of early entrants). Since late and very late entrants tend to be less efficient than their predecessors, the know-how of producing and marketing any specific good increases incrementally over time but it also becomes more rigid and reinforces established ways of doing things. In other words, increasing efficiency and early success are being rewarded and reinforced under the Gort-Klepper paradigm but simultaneously lay the ground for technical and competitive conservatism at later stages of the lifecycle. Imitation becomes more expensive as time elapses and the pool of potential new entrants decreases successively.

The Hirschman paradigm is much more open in this respect and emphasizes the role of imitation for industrial development. Imitation of products and processes established elsewhere keeps the industry lifecycle open for further development. In a free trade world, imitation by new entrants may also evoke new competitive pressure on incumbents even at historically late stages of the industry’s time path – either through price pressure or superior product policies. Good examples for this are the Japanese and Korean motor manufacturers who have seriously challenged the market position of European and American incumbents since the 1970s (Maynard 2003; Neumann 1996). This occurrence has not only widened consumers’ choice but also spurred incumbents’ efforts and occasionally renewed their competitive élan (Ingrassia / White 1995).

Hence, as long as markets are open, there are countervailing, cross-regional powers to the maturing of an industry and there are forces which inject new levels of competitive diversity. This effectively reinforces the respective industry’s overall prosperity - irrespective of the stage of its lifecycle. There is no ex ante determined “rise and fall” under the Hirschman paradigm. Instead it rests on the assumption that imitation is easy and not too costly and that there is a pool of potential new market entrants.

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^[1] The first long wave of technology was brought about by the Industrial Revolution with the production of textiles as a lead industry (1780s – 1840s). The second wave appeared with the age of steam power and railways (1840s – 1890s), the third with the age of electricity and steel (1890s – 1940s). The age of mass production with automobiles and synthetic materials as lead industries began in the 1940s (Freeman / Soete 1997: 17 ff.).

• Author: Peter Engelhard (Author)
• Publication Year: 2009
• Pages: 21
• Catalog Number: V139262
• ISBN (eBook): 9783640486878
• ISBN (Book): 9783640486748
• Language: German
• Tags: Historic, Their, Hirschman’s, Gort, Klepper’s