All six of the successful pioneering trusts of the 1880s had been formed to concentrate and rationalize production. During the 1890s the number of consolidations increased rapidly. At the same time the motive for merger changed. Many more were created to replace the association of small manufacturing firms as the instrument to maintain price and production schedules.
The change reflected political and legal developments that occurred in the latter part of the 1880s. Most important were, on the one hand, the protests against the trade associations and trusts that culminated in 1890 in the passage of the Sherman Antitrust Act, and, on the other, the efforts of the manufacturers that led to the New Jersey general incorporation law for holding companies.39 Following the advice of their lawyers, many of the existing associations, as well as the few existing trusts, incorporated themselves as holding companies. At first most of the new legal consolida- tions continued to operate as cartels with the holding company’s board merely setting price and output quotas for the subsidiary companies. But as the decade of the 1890s passed, many legal consolidations embarked on a strategy of centralization and integration.
A second reason for the increasing number of mergers after 1890 was the growing market for industrial securities. New York City had been since the 1850s one of the world’s largest and most sophisticated capital markets. Until the late 1880s, however, industrialists found little need to market large blocks of stocks. They raised the funds they required from local commercial banks. Nor did security dealers have much interest in industrials. By the early 1890s, however, railroad financing no longer offered the opportunities for profit it had earlier. The handling of railroad securities had become concentrated in the hands of a relatively few pow- erful Wall Street houses. Bankers, brokers, and investors were looking for new securities to buy and sell.40 The manufacturers who organized the trusts were surprised by Wall Street’s interest in obtaining their trust certificates. After 1890 buyers continued to take the securities of the new holding companies. Manufacturers soon realized that they could use the growing market as a source of funds for working and investment capital. They were also quick to appreciate that the demand for industrial securities enhanced the market value of their own companies. Expanded demand for industrial securities permitted manufacturers to obtain a handsome rate of exchange when they completed a merger by turning over the stock of their little-known small enterprises for that of a nationally known holding company. At the same time financiers began to take sizable blocks of stock as payment for arranging and carrying out a merger. Both manufacturers and financiers quickly learned how to profit from the actual process of legal consolidation.
The mergers of the 1890s came in two waves. One occurred between 1890 and 1893. The other and much larger surge began as the country re- covered from the depression of the middle years of the decade. Beginning in 1898 it lasted until the end of 1902. The first wave, resulting from the legal attack on combinations, the passage of the Sherman Act, and the revisions of the New Jersey law, lasted as long as times were prosperous. Hans Thorelli lists the names of 51 holding companies or “tight combina- tions” formed between 1890 and 1893.41 With the coming of the depression of 1893 the number of new mergers fell off sharply. Only 27 occurred for the next three calendar years, 1894 through 1896.
Then came the nation’s first great merger movement. For 1898 Thorelli lists 24 legal consolidations. In 1899 the number shot up to 105—a number that almost equaled the total number (108) of all legal consolidations given by Thorelli for the years between 1890 and 1898. During the following three years the number dropped off, but remained substantial with 34, 23, and 26 for the years 1900, 1901, and 1902. For 1903 Thorelli records the names of only 7 tight combinations. The records cited by Thorelli are supported by Ralph Nelson’s broader statistical study of firm disappearances. For example, his tables show that disappearance of firms through merger rose from 26 in 1896 to 69 in 1897, to 303 in 1898, to 1,207 in 1899.42 For the next three years they ran 340, 423, and 370. In 1903 they dropped back to 79. By 1903 the merger movement had clearly run its course.
The sudden upsurge of mergers in 1899 reflected both the conditions of the nation’s financial markets and the Supreme Court’s interpretation of the Sherman Act. In the E. C. Knight case, a suit the federal government brought against the American Sugar Refining Company, the court’s decision, handed down in 1895, appeared to sanction the legality of the New Jersey holding company.43 It did so by making a sharp distinction between manufacturing and commerce and by declaring that a manufacturing corporation (as opposed to a combination of separate manufacturing firms) was beyond the reach of the Sherman Act. Then the Supreme Court in 1897 in the Trans-Missouri Freight Association case and in 1898 in the Joint Traffic case (involving the Eastern Trunk Line Association), and in 1899 in the Addyston Pipe and Steel case, ruled clearly and precisely that any combination of business firms formed to fix prices or allocate markets violated the Sherman Antitrust Act. After 1899 lawyers were advising their corporate clients to abandon all agreements or alliances carried out through cartels or trade associations and to consolidate into single, legally defined enterprises.
Financiers and speculators were delighted with the court’s rulings. In the prosperous years of the late 1890s, the capital markets had become buoyant.44 Investors, investment bankers, brokers, and promoters of all types continued to look for new opportunities to obtain or to market new security issues. Industrial mergers appeared to be the most promising. The performance of railroads was improving but their business remained spoken for. In the years immediately after 1898, the leading promoters of industrial mergers were financiers and speculators who were not yet closely involved with railroads. They included the Moore Brothers (W. H. and J. H.), Charles R. Flint, and John W. Gates. They had instructed manufacturers on the procedures of mergers in the early 1890s and had little difficulty in convincing other businessmen to do the same later in the decade. Whereas the mergers before 1897 had been initiated primarily by the industrialists themselves, many more were now instigated by the financiers and speculators.
By 1903 the market for industrial securities had become satiated. In- vestors, financiers, and bankers were becoming troubled by the poor per- formance of a number of the new consolidations. A few had already undergone further financial reorganizations. Then, as the number of mer- gers dropped off, a circuit court decision in April 1903 in the Northern Securities case upheld in the next year by the Supreme Court indicated that the holding company might be vulnerable under the Sherman Act. The decision which ordered the dissolution of the Northern Securities Company (the company formed to hold the stock of the Northern Pacific and the Great Northern railroad companies) did not overrule its decision in the Knight case. It did not declare the holding company illegal. Each holding company accused of violating the Sherman Act would be tried on the merits of the case. Nevertheless, it showed that the holding companies were clearly not immune from prosecution. Corporation lawyers began to advise their clients to eliminate constituent companies and place all their facilities in a single operating company.45 Such a centralized enterprise could hardly be defined as a combination in restraint of trade, even if it might be accused of restraining trade.
Legal reasons were, however, of much less importance than business reasons in bringing administrative centralization. Whether the motive for forming legal consolidations had been to maintain and strengthen cartels or to profit financially from the process of merger, mergers quickly found themselves in financial difficulties if they remained merely holding com- panies. The depression of the 1890s had demonstrated how hard it was for a number of small, single-unit enterprises operating under a single legal roof to become viable business enterprises unless they were centrally controlled. If a loose knit holding company maintained prices at a level that provided even a reasonable margin of profit, competitors appeared. Often these competitors were the same manufacturers who had sold out to the trust. And if that company attempted to maintain its horizontal combination by cutting prices or buying out competitors, the price was high. The financial failures of the National Cordage, American Biscuit, United States Leather, National Wall Paper, National Starch, and the successors to the whiskey trust emphasized the costliness of a strategy of horizontal combination and the ineffectiveness of the holding company in carrying out that strategy. On the other hand, the financial success of Standard Oil, American Cotton Oil, National Lead, as well as American Tobacco, Quaker Oats, Singer Sewing Machine, Otis Elevator, the meat packers, and other integrated enterprises made clear the value of consolidating and centralizing the administration of their manufacturing facilities and moving forward into marketing and backward into purchasing and control of raw materials. The financial problems of several of the mergers occurring affter 1897 reinforced these business lessons.
Some of the new horizontal combinations learned these lessons even more quickly than had Standard Oil and American Cotton Oil in the 18 80s. Others, in the fashion of American Sugar Refining, moved slowly from horizontal combination to administrative centralization and to vertical integration. Others never made the transition at all.
The National Biscuit Company provides a particularly revealing example of a legal consolidation that realized the need for a change in strategy. That company, formed in 1898, was a merger of three regional consolidations— New York Biscuit, American Biscuit and Manufacturing, and the United States Baking Company. At first the new firm carried out the policies of its predecessors, but it soon decided that they did not pay. In its annual report for 1901 the company outlined the reasons for its shift:
This Company is four years old, and it may be of interest to shortly review its history … When the company started, it was an aggregation of plants. It is now an organized business. When we look back through the four years, we find that a radical change has been wrought into our business. In the past, the managers of large industrial corporations have thought it necessary, for success, to control or limit competition. So, when this company started, it was believed that we must control competition, and that to do this we must either fight competition or buy it. The first meant a ruinous war of prices and great loss of profits; the second, constantly increasing capitalization. Experience soon proved to us that, instead of bringing success, either of these courses, if perservered in, must bring disaster. This led us to reflect whether it was necessary to control competition . . . We soon satisfied ourselves that within the company itself we must look for success.
We turned our attention and bent our energies to improving the internal management of our own business, to getting the full benefit from purchasing our raw materials in large quantities, to economizing the expense of manufacture, to systematizing and rendering more effective our selling department, and above all things and before all things, to improving the quality of our goods and the condition in which they should reach the consumer . . .It became the settled policy of this company to buy out no competition.46
In carrying out these plans the company’s senior executives imitated the example of Quaker Oats and Pillsbury Flour. They shifted from producing in bulk for the retailers’ cracker barrels to making distinctive packaged goods using the brand name “Uneeda Biscuit.” “The next point,” the same annual report continued, “was to reach the consumer. Knowing that we had something that the consumer wanted, we had to advise the consumer of its existence. We did this by extensive advertising.” For this service the company relied on the services of an experienced advertising agency, N. W. Ayer & Son.47 As it built its global marketing and purchasing organizations, it continued to carry out a policy of “centralizing” manufacturing in a small number of very large plants. After 1900 National Biscuit continued to compete in the new manner, relying on brand names, advertising, and scale economies. Its marketing organization and policies reduced unit costs and created barriers to entry. Its major competitors became comparable integrated enterprises, operating either on a regional or, like the Loose- Wiles Biscuit Company, on a national scale.
In corn products the integrated enterprise came only after a series of lamentable financial failures. The organizers of the leading mergers in that industry remained wedded to the concept of horizontal control. Sig- nificantly, those that favored the older strategy had a close association with Havemeyer and his fellow advocates of horizontal combination in sugar, while those who began to argue for vertical integration had had their business training at Standard Oil. The Corn Products Company, formed in 1903, was a merger of two unsuccessful combinations and three independent companies.48 The combinations were the reincarnation of National Starch, originally formed in 1890 and financially reorganized in 1900, and the Glucose Refining Company, established in 1897 by the Matthiessen brothers, leading sugar refiners who had long been associated with American Sugar. Of the three independents, the largest and most successful was the New York Glucose Company headed by E. T. Bedford, who had spent many years as a senior executive in Standard Oil’s overseas marketing office.49 Despite the lack of success of the earlier consolidations and against the strong opposition of Bedford, C. F. Matthiessen as president of Corn Products continued to bear the costs of horizontal combination. Finally, in 1906, the merger was forced to undergo still another financial reorganization, which led to its reformation as the Corn Products Refining Company. Bedford then became its president. He immediately built up the enterprise’s purchasing and sales organizations, moved aggressively into European and other overseas markets, and instituted new policies of packaging, branding, advertising, volume purchasing, and scale economies. The Corn Products Refining Company, the successor to four failures, quickly became, by the definition of a careful student of the merger movement, an “outstanding success.”50 Again the cost savings and barriers to entry raised by the strategy of vertical integration paid off.
By adopting such a strategy, Corn Products, like Distillers-Securities, turned failure into success. Most of the mergers that were unable to make such a transition failed. Some were liquidated after their first or second receivership. Others dissolved themselves before financial disaster struck. Thus the directors of the National Wall Paper Company, formed in 1892, agreed in 1900, “That the company be dissolved, and the factories be re- turned to their original owners or sold to the highest bidders.” They had decided “that the manufacturer of wall paper is so dependent on such peculiar circumstances that independent plants can be operated to better advantage than can many plants under one control.”51
The experiences of these companies suggest that successful mergers met two conditions. They consolidated production, centralized its administra- tion, and built their own marketing and purchasing organizations. And they operated in industries where technology and markets permitted such integration to increase the speed and lower the cost of materials through the processes of production and distribution. For these reasons the long- lived mergers came to cluster in the same industries in which the first large integrated enterprise appeared in the 1880s.
Source: Chandler Alfred D. Jr. (1977), The Visible Hand: The Managerial Revolution in American Business, Harvard University Press.