The Mergers of the 1880s

During that formative decade of the 1880s a very small number of manufacturers first moved from cartels to legal consolidations. All the successful mergers of that decade went beyond legal consolidation to administrative centralization. Not all, however, went the whole course— that is, moved beyond administrative centralization of processing facilities to vertical integration.

Despite widespread use of the term trust (as distinguished from a trade association or holding company), I have been able to identify definitely only eight that were formed to operate in the national market.7 Two—the cattle and cordage trusts—were short-lived. The other six—petroleum, cottonseed oil, linseed oil, sugar, whiskey, and lead processing—came to dominate their industries for decades. Though few in number, these suc- cussful trusts, all in refining and distilling industries, pioneered in new legal and administrative techniques and are thus of great historical interest.

These processors, the first to grow large by merger, were those who had processes and products less technologically revolutionary than those manufacturers who attained great size in the same decade by internal growth. The latter built their modern business enterprises in response to the marketing needs resulting from adopting a new high-volume technol- ogy or from marketing a technologically complex product. In the refining and distilling industries new technologies of production evolved quickly but less suddenly than in those processing tobacco, matches, and cereals. Their products remained technologically simpler than those of the ma- chinery makers, and they had little difficulty in marketing them through the existing wholesaler network. Those enterprises, therefore, did not feel the same pressures to integrate forward.

During the 1850s and 1860s the spread of the railroad and telegraph networks and the growing availability of coal to provide heat and fuel for machines permitted many small firms to adopt the new large-batch and continuous-process refining and distilling methods. Soaring output soon drove down prices. By the 1870s processing enterprises using these methods of production were under intense pressure to maintain profits by limiting production and controlling processes.

The first merger, or legal combination of many small manufacturers, came in the United States in the petroleum industry, the industry which by 1870 had most effectively perfected the new high-volume, capitalintensive technology. By the end of the 1870s the leading processors under the guidance of the largest refiner, the Standard Oil Company, had created one of the strongest industrial cartels in the nation.8 It was so effective that its members no longer felt the need of the services of a trade association to administer it. The formation of the Standard Oil Trust was not, then, inspired by a need to tighten control over the members of the existing Standard Oil “alliance,” as it was then called. It was rather the response to an opportunity to increase profits through concentration and centralization of production and then vertical integration. Yet the new giant legally and administratively centralized enterprise did not evolve from a carefully planned strategy but from short-term reactions to changing technology and markets.

In 1872, when their industry was little more than a decade old, the leading petroleum refiners decided on a strategy of horizontal combination. To control increasing output and decreasing prices they formed the National Refiners Association. John D. Rockefeller, whose Standard Oil Company operated in Cleveland, Ohio, the largest refinery in the nation, encouraged the creation of the refiners’ association and became its first president. The association failed to maintain control of price or production. Such federations, Rockefeller quickly came to believe, were mere “ropes of sand.” He and his associates then decided to obtain the cooperation of its rivals by relying on the economic power provided by their high-volume, low-cost operation. They began by asking the Lake Shore Railroad to reduce its rates from $2.00 to $1.35 a barrel on Standard Oil shipments between Cleveland and New York City if Standard provided sixty carloads a day, every day. The road’s general manager quickly accepted, for assured traffic in such high volume meant he could schedule the use of his equipment much more efficiently and so lose nothing by the reduced rate. Indeed, the general manager, somewhat gratuitously, offered the same rates to any other oil refiner shipping the same volume.

The Standard Oil Company then invited the leading refiners first in Cleveland and later in other refining centers to join in benefiting from these rate agreements. The control of transportation provided a weapon to keep out new competitors and a threat to prevent those who joined Standard from dropping out of the cartel. Even so, Rockefeller and his associates in the Standard Oil Company—his brother William, Henry M. Flagler, Oliver H.Payne, and Steven V. Harkness—took the precaution of exchanging Standard Oil stock for that of their allies. By 1876 there were more than twenty-five firms in the Standard Oil group.9 By 1880, when the number had reached forty, Rockefeller and his four associates held four-sevenths of the securities of the alliance’s members. Representatives of these firms met regularly to set price and production schedules, but there was no central board with the power to administer the operations of the constituent companies or to make plans and allocate resources for the alliance as a whole.

In 1881 the alliance controlled close to 90 percent of the country’s refining capacity and had demonstrated its willingness to use its economic power ruthlessly.10 Any time its members desired, they could easily crush the remaining few small refiners making kerosene or any of the growing number of competitors producing lubricants and other specialized products.

In Europe the discovery of the Russian oil fields by the Caspian Sea posed a long-term competitive threat. This was a serious challenge, for in 1880 Europe still took 70 percent of all the illuminating oil processed in the United States.11 To maintain their share of that market the Americans would have to reduce costs in producing and distributing kerosene. Yet in 1881 the threat was still a distant one. The railroad connecting Baku to the Black Sea was not scheduled for completion until 1883. After that, rivals needed time to set up production and distribution facilities. In fact, the competition in the European markets from Russian oil did not become serious for Standard Oil until the late 1880s.

Technology rather than markets triggered the decision of the Standard Oil alliance to solidify legal control and to centralize its management. The critical technological innovation was the long-distance crude oil pipeline.12 It created cost-cutting opportunities that required the alliance as a whole to make centralized investment decisions.

From the very beginning of the industry, pipelines had gathered stored crude oil at railheads and terminals. But the construction of the first long- distance pipeline was not begun until 1878. Then it was built by producers of crude oil to break Standard’s hold on railroad transportation. These producers formed the Tidewater Pipeline Company that initially built a line to connect the oil regions of western Pennsylvania (at that time still the only major source of crude oil in America) with the Reading Railroad. Since that road did not carry oil, it had no arrangement with the Standard alliance. Despite all the efforts of the Standard Oil Company to halt its construction, the pipeline was completed in July of 1879. The Tidewater company then pushed its pipeline on to the coast. At first that company sold to refiners in New Jersey and Pennsylvania, but soon it built refineries of its own.

Once the long-distance pipeline had proved itself, Rockefeller and his associates moved swiftly. Pipelines, they realized, transported crude oil far more cheaply than railroads did. The lines also provided excellent storage. Their existence made possible the scheduling of a much greater and steadier refinery throughput than was possible using rail shipments. Moreover, because the pipeline could carry crude oil to processing facilities but not refined products to markets, the completion of long-distance lines called for relocation of refinery capacity at centers close to the market, particularly at the ports where ships loaded the refined products’ for the great European markets.

The allies’ initial move was to construct their own pipelines from western Pennsylvania to Cleveland to the west and to New York and Philadelphia on the coast. This required setting up a new large corporation, the National Transit Company, to build and operate the crosscountry pipelines and to consolidate and operate the existing gathering and storage lines. Capitalized at $30 million (an impressive investment when the Standard Oil Company itself was capitalized at only $3.5 million), National Transit took over the stocks and properties of the pipeline companies controlled by members of the Standard Oil group and then began construction of a huge interregional pipeline network. The legal vehicle for this new pipeline company was a catchall charter issued by the Pennsylvania legislature ten years earlier that permitted the holding of stock in out-of-state companies. Originally obtained by Tom Scott in 1871 for possible use in the building of the Pennsylvania’s railroad system, it had been forfeited by the road and much later purchased by Standard’s lawyers from a state bureau.13

The next step—that of consolidating refining capacity in order to take advantage of the new pipeline network—proved more difficult. The owners of the forty enterprises forming the alliance now required a central authority to decide what refineries to close down, which ones to modernize, and where and when to build new ones.14 To provide the necessary legal vehicle, their lawyers searched without success for another catchall charter similar to that used for the pipeline. At that moment, too, the Pennsylvania legislature was attempting to put a tax on the assets, including capital stock and dividends, of Standard Oil of Ohio as a “foreign” firm operating in Pennsylvania. As protests against Standard’s power were growing, Rockefeller and his associates did not relish the legislative battle required to get a special holding-company charter.

Then the sharp mind of Standard’s legal counsel, S. C. T. Dodd, con- ceived of the new trust form of organization. By the agreement signed on January 2, 1882, the shareholders of the forty companies exchanged their stock for certificates in the new Standard Oil Trust. The trust instrument authorized an office of nine trustees to “exercise general supervision over the affairs of the several Standard Oil Companies.”15 At the same time state- chartered subsidiaries were formed to take over the properties of the alliance operating in one state. As local enterprises, they were not subject to restrictions or excessive taxes levied on “foreign” corporations, similar to those Pennsylvania was seeking to place on Standard Oil of Ohio.

As soon as the new trust had set up its headquarters at 2 6 Broadway in New York City, the trustees began to consolidate refinery capacity.16 Between 1882 and 1885 the trust reduced the number of refineries it operated from fifty-three to twenty-two. Over two-fifths of the trust’s output came to be concentrated in three huge new refineries at Bayonne, New Jersey, Philadelphia, and Cleveland. The economies permitted by the greatly expanded volume and carefully scheduled throughput cut the average cost of producing a gallon of refined oil from 1.5^ to 0.5^, and the costs in the great new refineries were still lower. The administration of the refineries became centralized at 26 Broadway through creation of a committee for manufacturing and a supporting set of staff offices. In addition, committees and staff offices were set up to supervise packaging and transportation.

The coordination of throughput from the crude oil wells through the pipelines to the refineries became the responsibility of the Joseph Seep Agency. The former purchasing agent for Standard Oil of Ohio, it now handled all the buying of crude oil for the trust.17 Because it purchased in such large quantities, it by-passed the oil exchanges, where crude oil had been bought and sold since the beginning of the industry. Because it purchased directly from crude oil producers, the exchanges went out of business in the 1890s.

Once the new trust completed its consolidation of refining, it moved into marketing.18 Not planned when the trust was first formed, this move was primarily a response to the need to assure a steady flow of the high- volume output from the new centralized refining facilities to the consumer. The decision to go into marketing was also affected by the increasing power of the wholesalers of refined products. After 1875 the tank car began to replace the barrel and can for long-distance shipments of kerosene and other refined products. By doubling the load a train could pull, the tank car required wholesalers to increase storage facilities. Those wholesalers who invested in new equipment were able to sell at a much greater volume and cut their unit costs. Their new facilities not only gave them an advantage over small competitors but also put them in a better position to bargain with the trust. Moreover, many large wholesalers preferred to market their own brands, mixing kerosene from Standard with that of small independents. So their existence prevented Standard Oil’s maintenance of the quality of its product as well as control over its price. A further argument for direct marketing was that it would improve the accuracy and lower the cost of market information.

The executive committee of the trust decided to build its marketing organization first at home and then abroad. In 1885, the committee set up two wholly owned sales subsidiaries—Continental Oil and Standard Oil of Kentucky. In 1886 it began to buy out the leading wholesalers. By the early 1890s it had a national sales organization managed through regionally defined subsidiaries. In 1888 it set up the wholly owned Anglo- American Petroleum Company to market in Britain; built a fleet of steam tankers for trans-Atlantic transportation; and then formed a joint venture with two German distributors to sell in central and western Europe.19

The process of vertical integration was completed in the late 1880s when Standard Oil began to produce its own crude oil. The move was a defensive one, largely in response to the changing supply situation.20 Up to the late 1880s the Standard Oil alliance and then the trust felt little need to control its own crude oil supplies. There was always plenty available. As production declined in the Pennsylvania fields, the producers for the first time appeared to have a chance to control output and price. At the same time, the opening of new fields, which had been discovered near Lima, Indiana, raised the possibility of having the source of supply fall into the hands of a small number of crude oil producers. The Standard Oil trustees waited almost two years after the trust built pipelines into the Lima fields before they began to buy oil-producing properties. Then the trust moved quickly. Within three years Standard Oil was extracting 25 percent of the nation’s crude oil.

By the early 1890s Standard Oil had become a fully integrated enterprise. Within a decade it had moved from a strategy of horizontal combination to one calling for legal consolidation, administrative centralization, and then vertical                  integration.    As    the    firm    centralized    the    administration    of production and moved into new functions, its senior executives, the trustees, hired large numbers of middle managers to supervise and co- ordinate its many operating units. By the 1890s the large central office at 26 Broadway (whose activities are described in Chapter 13) coordinated flows of petroleum from the crude oil fields of Pennsylvania and Indiana through the processes of refining to markets in all parts of the nation and the world. In the next two decades challenges to Standard’s dominance came from other integrated enterprises. In Europe, the threat of competition finally materialized in the rise of major integrated enterprises managed and financed by such powerful business families as the Nobels and the Rothschilds. In the United States, the Tidewater Company, the consolidation of crude oil producers that built the long- distance pipeline, had made a deal as early as 1883 with the trust to divide pipeline shipments from the Pennsylvania oil regions to the coast. Tidewater continued to build its refining capacity, setting up in 1888 the largest refinery in the world at Bayonne, New Jersey.21 It sold its product at home through its own marketing organization, but relied on Standard to market from 50 to 75 percent of its exports abroad.

A more serious domestic challenge to Standard came when the produc- tion of crude oil in the Pennsylvania oil fields had fallen off enough to permit the producers there in 1895 to combine to form the Pure Oil Com- pany. That firm constructed a new transregional pipeline to Marcus Hook, Pennsylvania, on the Delaware River, built refineries there, and then set up its own marketing organization, which concentrated on the European market.22 Within a decade of its founding the Pure Oil Company was an effective integrated competitor. By 1911, when Standard Oil was broken up by a Supreme Court decision, there were already at least eight other integrated American oil companies competing with Standard for national and international markets (see table 7 ).

Of the five other successful trusts, three—cottonseed oil, linseed oil, and lead processing—followed Standard Oil’s example. Within less than a decade of their formation they had become fully integrated enterprises. The other two—sugar and whiskey—immediately consolidated production facilities and did their own purchasing, but did not move into marketing. They clung to the strategy of horizontal combination much longer than the other three.

Formed in 1884, the American Cotton Oil Trust had by 1889 consolidated production into seven refineries. (Seven more were added when the consolidation expanded in 1890.)23 It also had obtained four soap works and four lard works. By 1889 it had an extensive buying network for purchasing cottonseed directly from farmers along the railroads of the south. By that same year it controlled some fifty cotton gins and fifty-two crude oil mills used in the initial processing. In the 1880s the trust also moved into transportation, acquiring a fleet of tank cars. By 1891 it owned and operated 326 tank cars. After 1890 it expanded its marketing organization of sales offices and storage facilities overseas. In 1892 the company had a tanker constructed and a major depot built at Rotterdam in order to exploit the large German market for margarine and food oils. By the early 1890s, the company was producing not only cottonseed oil and cake for cattle feed and fertilizer, but its own brand of “cottonlene” food oil and “Gold Dust” washing powder, lard, margarine, and soap. Then, to make use of the marketing organization it had developed to sell fertilizers, it purchased eight potash mines. Thus, by the early nineties the cotton oil trust had become a full-line, integrated, giant enterprise whose operation required the services of many salaried middle and top managers.

From 1888 on, the American Cotton Oil Company had strong competi- tion from the Southern Cotton Oil Company, which also quickly became an integrated, full-line enterprise.24 These two firms continued to dominate their industry until well into the twentieth century. Their competition, particularly in the European markets, came from large integrated British and Continental companies—Lever, Jurgens, and Van den Burgh. At home the competitors were Procter & Gamble and Armour, Swift, and other large meat packers who produced lard, soap, and fertilizers.

The National Lead Trust began to follow the same strategy of Standard Oil when William Thompson left the Standard Oil Trust to become the president of National Lead in June 1889.25 The lead trust formed in 1887 was a merger of a large number of lead-processing firms, and it continued to concentrate on the chemical processing rather than the fabrication of lead. It soon produced 80 percent of the country’s white lead capacity, 70 percent of red lead, 60 percent of lead acetate, and 15 percent of its linseed oil, and became the country’s leading producer of paint. However, it accounted for less than 10 percent of the output of sheet lead, lead pipe, and other fabricated lead products. After consolidating production, Thompson, who had headed Standard’s Domestic Trade Committee, began to build a national and global sales organization. At the same time he consolidated purchasing, setting up a special department to buy flaxseed for its linseed oil operation. Then he had the enterprise’s smelting and refining works at Socorro, New Mexico, enlarged. From the early 1890s on, National Lead continued to dominate the industry, getting some competition from another trust, National Linseed.

The linseed oil trust was never as successful as the initial mergers in petroleum, cottonseed oil, and lead.26 One reason was that it was smaller and had a less diversified product line than National Lead. Another was that it did not have the large markets, especially overseas, and ample sources of supply that Standard Oil and American Cotton Oil enjoyed. It did consolidate the original forty-nine mills that went into the merger. It came to own over forty storage elevators, a fleet of tank cars, and a number of tank stations, and it set up a number of branch sales offices. However, limited supplies of flaxseed led to speculation in the purchasing of its raw materials, and twice in the nineties such purchases almost ruined the enterprise. Only after the financial and administrative reorganization of the company in i 898, when it became the American Linseed Company, did it begin to achieve financial success. The appointment of Frederick T. Gates, Rockefeller’s financial adviser, as its president and John D. Rockefeller, Jr., as a board member suggests that the Standard Oil experience may have been put to use in improving the performance of the reorganized company.27

In these four industries—petroleum, cotton oil, linseed oil, and lead processing—the leading mergers had by the 1890s adopted a policy of vertical integration and were soon competing with two or three other large vertically integrated enterprises. Two other trusts formed in the processing industries in the 1880s—the whiskey and sugar trusts—abandoned their strategy of horizontal combination only after it had proved itself increasingly costly and unproductive. The corporate successors to the whiskey trust, the Distillers Corporation, had by the early 1890s con- centrated production so that eighty small plants had been reduced to twenty-one larger ones,28 but they continued to operate with little overall control. Although the enlarged units permitted some reductions in costs, the enterprise kept prices high and so encouraged competition to grow. In 1895, just bere it went into receivership, the company decided to spend a million dollars to build a selling organization in the urban east, its primary market. Only after passing through receivership did the company begin to alter its basic strategy. It first centralized the administration of its productive facilities, and then in 1898 purchased two leading liquor wholesalers. These wholesalers and the manufacturing enterprise were consolidated in 1903 into the Distillers-Securities Corporation. This integrated enterprise remained the largest distiller in the nation until the passage of the Eighteenth Amendment in 1919 drastically curtailed that trade.

The sugar trust also consolidated production and purchasing after its formation in 1887.20 As in whiskey, such consolidation brought lower unit costs by making possible economies in the operation of the larger refineries. Once this was done, its most domineering founder, Henry O. Havemeyer, concentrated on using this economic power to drive out competitors by price cutting, exploiting railroad rebates, controlling sup- plies, and making rebate arrangements with wholesalers—all methods that the Standard Oil group had made notorious in the 1870s. Nevertheless, competition grew, particularly at those times when American Sugar made the error of raising the profit margin. Its share of the market fell from 75 percent in 1894 to 49.3 percent in 1907 and then by 1917 to 28 percent.30 Even before 1900 two large competitors had appeared.31 One was Federal Sugar Company, which provided an east coast refinery and marketing outlet for Claus Spreckels, the foremost Hawaiian and west coast sugar grower. The other operated a refinery set up by Arbuckle Brothers, one of the country’s largest wholesale grocers, which wanted control over its own sugar supplies.

When beet sugar first came into production at the end of the 1890s, Havemeyer aggressively continued his strategy of horizontal combination. His company soon had control or near control over the largest of the new beet sugar companies, including American Beet Sugar formed in 1902, Great Western Sugar in 1903, and Utah-Idaho in 1907.32 In the same years Havemeyer came to invest on a much smaller scale in the Cuban-Ameri- can Sugar Company.33 Even so, neither Havemeyer nor his company had the resources needed to buy out new refining enterprises in Hawaii, Cali- fornia, Baltimore, and New Orleans.

During these years, the directors and managers of American Sugar were becoming increasingly unhappy with Havemeyer’s expensive strategy of buying out competition. It cost the company over $20 million between 1902 and 1907. On Havemeyer’s death in 1907 they shifted from horizontal combination to vertical integration. By 1909, when the federal government brought an antitrust suit against the sugar company, it had already begun to sell its holdings in other companies, to build up its own marketing organization, and to develop its own brand, Domino. By 1917 there were six large independent integrated sugar companies in the top 236 American manufacturing firms (see Appendix A), competing with each other in the modern oligopolistic way. In sugar, the concepts of a powerful entrepreneur delayed, but only by a few years, the shift from horizontal combination to vertical integration, and with it the coming of oligopolistic competition among a few large integrated firms.

Although the six trusts of the 1880s in the high-volume process indus- tries were destined to dominate their industries for decades, the other two quickly failed. The American Cattle Trust, formed in 1887 as a means to give western cattlemen bargaining power with the Chicago packers, never got much beyond the organizing stage.34 The trust purchased the Morris packing plant in Chicago, bought large feeding farms, and made contracts with the French and Belgian governments for canned beef. But as such an enterprise was in no way able to combine the advantages of mass production with those of mass distribution, it soon collapsed and was liquidated in the summer of 1890.

The National Cordage Association used the trust form to attempt to maintain an existing cartel.33 It moved to centralize purchases and control sales, but it made no attempt to consolidate and centralize the administra- tion of its constituent cordage and twine companies, nor did it try to con- solidate or reorganize production facilities. The cordage trust (which be- came a New Jersey holding company in 1890), unlike the trusts in the processing industries, had to borrow large amounts of working capital because four-fifths of its production went into binder twine and therefore cash flowed in only at harvest time. With no economies of speed resulting from consolidation and with recurring heavy demands for working capital, the new enterprise had difficulty in making a return on the large amount of capital obtained to carry out its continuing strategy of buying out competition—a strategy that was weakened when a number of manu- facturers who had joined the merger used their payments as capital to start new companies. In May 1893 the cordage company’s sensational financial failure helped to precipitate the panic that ushered in the depression of the middle 1890s. Later attempts to revive the consolidation on a sound financial basis failed.36 The cost-cutting advantages of consolidation and integration were few in the cordage industry.

The story of the trusts formed in the 1880s has been told in some detail, for they define the basic pattern of growth of the many mergers that fol- lowed. After 1890 the most successful mergers were in industries where technology and markets permitted reduction in costs. They became suc- cessful, however, only after their directors abandoned the costly strategy of horizontal combination for one of vertical integration—that is, after production facilities had been consolidated, their administration cen- tralized, marketing and purchasing organizations built, and a staff of man- agers recruited to supervise, monitor, and coordinate these many different operating units.

The route to growth affected both the financing and the management of the new enterprises. Corporations that had integrated forward and backward without taking the merger path had been self-financed. But in these early mergers that had moved beyond legal consolidation the process of rationalization and concentration often called for the rebuilding as well as the reorganization of a major portion of their productive facilities. Such rebuilding, like the merger itself, required sizable amounts of capital. Except at Standard Oil and its smaller competitors who had an exception- ally high volume of production and global markets, current cash flow could not provide needed funds for industrial reorganization.

These early mergers were, then, the first American enterprises not in- volved in transportation, communication, or finance to go to the capital markets for funds. This need was one reason that the trusts, except for Standard Oil, quickly transformed themselves into corporations once the revision of the New Jersey statutes made this possible. Not only did the legal status of the holding company appear to be much sounder than the trust, but the investors preferred corporate securities to trust certificates.37 Four of the reorganized trusts (American Cotton Oil, American Sugar, National Lead, and National Cordage) issued two types of securities: preferred stock based on earning capacity and secured by fixed assets and common stock based on anticipated growth in earnings resulting from the consolidation. The first was aimed to appeal to the conservative investor, the second to the more speculative one. And in going to the capital mar- kets, the organizers of the first industrial mergers relied on the services of such leading railroad investment banking firms as Winslow, Lanier; Kidder, Peabody; August Belmont; and Poor and Greenough.38

This process of financing resulted in a significant difference in the relationship of owners and managers. Those firms that initially became large through internal expansion continued to have the stock ownership closely held by the founder, a few associates, and their families. On the other hand, the sale of securities to provide fixed and working capital for the new mergers further spread the ownership of capital stock, which the formation of the merger had already begun to disperse. Top executives in the central office of the first type were nearly always major stockholders or personally close to such stockholders; but those in the second type became salaried managers who held only a small amount of the total stock and had little personal acquaintance with the scattered owners. It was in the latter case that the separation of ownership and control first appeared in the United States in business firms other than the railroad and the telegraph.

Source: Chandler Alfred D. Jr. (1977), The Visible Hand: The Managerial Revolution in American Business, Harvard University Press.

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