The Myth of the Robber Barons

by Burt Folsom

  Schwab's personal life, more than disputes over policy, seems to have led to his downfall at U. S. Steel. He showed he had the values of a dissipater as well as those of an entrepreneur. When Carnegie was in control, Schwab consciously restrained his extravagant tastes; Carnegie deplored living beyond one's income, gambling, and adultery. But out from under Carnegie's grip, Schwab engaged in all three and almost ruined his marriage and his career. In New York City, Schwab built a gargantuan mansion, which consumed one whole block of the city and $7 million of his cash. He also gambled at Monte Carlo, which made bad newspaper copy and cost him credibility. Finally, he had an affair with a nurse, which resulted in a child. Though Schwab hid this from the press, he could not do so from his wife, Rana. The strain from his adultery, combined with the pressure of Monte Carlo, the expense of Riverside, and the barbs from Elbert Gary wrecked Schwab's health. He went to Europe to recover and, in 1904, resigned as president of U. S. Steel. 16

  Schwab, the man who said, "I cannot fail," seemed to have failed. He was depressed for months. Even Carnegie repudiated Schwab and this added to the pain. During his troubles he had insomnia, he lost weight, his arms and legs were regularly numb, and sometimes he fainted. His wife forgave him for his adultery and this no doubt eased the strain; but she was still not happy because she wanted a child of her own and never did have one. She didn't covet the extravagant life, so dear to her husband, and she spent many lonely days at Riverside.17

  Schwab was out at U. S. Steel, but he already had the makings for a comeback. When he was president of U. S. Steel, Schwab had bought Bethlehem Steel as a private investment. He was criticized for this, especially when he merged Bethlehem Steel with some unsound companies into an unprofitable shipbuilding trust. This merger eventually collapsed; and when Schwab stepped down at U. S. Steel, he still had Bethlehem Steel as his own property. The demotion from being president of a company worth over one billion dollars, to being president of one worth less than nine million dollars, would have embarrassed some men, but not Schwab. He would have full control in running the company and would succeed or fail on his own abilities.18

  Before Schwab took over Bethlehem Steel, its future had not looked promising. It had been founded in 1857 and soon produced rails for the Lehigh Valley Railroad. This was more than coincidence because entrepreneur Asa Packer, who had built the Lehigh Valley Railroad, held a large interest in what was then Bethlehem Iron. Packer, a Connecticut Yankee, had the vision and ability to promote both of these investments and make them profitable. His rise from carpenter to railroad tycoon had made him a legend in Pennsylvania; he was worth $17 million by the late 1870s. When he died in 1879, his sons, sons-in-law, and nephews took over his investments, but did not have the success that Packer did. The Lehigh Valley Railroad floundered and went into receivership in the Panic of 1893. Bethlehem Iron almost shared the same fate.19

  Led by Philadelphians and the Packer group, Bethlehem Iron became very conservative after Packer's death. The younger leaders single-mindedly produced rails, even though (1) Carnegie was doing it cheaper, and (2) they had the expense of importing most of their iron ore from Cuba. They escaped a price squeeze in 1885 when, reluctantly, they shifted from making rails to making military ordnance, which commanded a higher price per ton than rails. Such an imaginative strategy, as one might expect, did not originate within the Packer group; in fact, they resisted it until declining profits on rails presented them with no alternative.20

  The wise, if belated, switch from rails to gun-forgings and armor plate led to profits because Bethlehem Iron was the only bidder on its first government contract for ordnance in 1887. Other contracts were forthcoming and Bethlehem Iron "established a reputation for quality and reliability," if not for aggressiveness and efficiency. Regarding the last, its operations were so inefficient that the company in 1898 hired Frederick W. Taylor, master of scientific management, to suggest ways of improving worker productivity. Yet the Packer group soon became hostile to Taylor's cost-cutting ideas. Of one suggestion to reduce the number of workers handling raw materials, Taylor observed that the owners "did not wish me, as they said, to depopulate South Bethlehem." He further commented, "They owned all the houses in South Bethlehem and the company stores, and when they saw we [Taylor and his assistants] were cutting the labor force down to about one-fourth, they did not want it." They also rejected Taylor's suggestions to standardize job functions and give raises to key personnel.21

  Surviving, then, on government contracts, Bethlehem ton stumbled into the twentieth century—a profitable operation in spite of itself. In the midst of this conservatism, Schwab came to Bethlehem in 1904 and boldly announced that he would "make the Bethlehem plant the greatest armor plate and gun factory in the world." Taking the helm, Schwab "backed Bethlehem with every dollar I could borrow." This backing included buying new branch plants and closing unprofitable ones, getting new contracts by selling aggressively, and reorganizing the company as Bethlehem Steel. Planning for the future, Schwab bought large tracts of land for the company east of South Bethlehem. He also bought or leased more ore land and mechanized the company's Cuban iron fields to spur production there.22

  Schwab's entrepreneurship clashed with the Packer group's cautiousness right from the start. As one historian said, "Many of the veteran Bethlehem executives preferred the old, pre-Taylor and pre-Schwab way of doing things. They resented Schwab; he was an intruder." Soon after arriving in South Bethlehem, Schwab ousted the inbred Packer group from authority. In the new president's remarkable words, "I selected fifteen young men right out of the mill and made them my partners." Two of these "partners" were Eugene Grace, the son of a sea captain, and Archibald Johnston, a local Moravian. They later became presidents of Bethlehem Steel.23

  After reorganization Schwab wanted to diversify his company and challenge U. S. Steel. To do this, he began making rails and moving Bethlehem Steel away from its dependence on government contracts. Schwab adopted open-hearth technology because it produced better rails than the Bessemer system did. As historian Robert Hessen notes:

  U. S. Steel, the nation's largest rail producer, did not follow Schwab's lead; it would have had to replace its Bessemer facilities with open hearth equipment. Being a late starter, Bethlehem enjoyed a dear advantage: with no heavy investment in obsolete equipment to protect, it could adopt the newest and most efficient technological processes.24

  Schwab's reorganization of the Cuban ore mines also improved Bethlehem's competitive position at the expense of U. S. Steel.

  Cuban ore was richer in iron and lower in phosphorus than was the Mesabi range ore used by U. S. Steel. It also had another advantage: it contained large amounts of nickel, so that Bethlehem could produce nickel steel at no extra cost. For a ton of iron Bethlehem's cost was $4.31; U. S. Steel's was $7.10.25

  Now that Schwab was running an efficient diversified company he turned his attention to cutting costs. He reasoned that workers would work harder if they knew it would directly result in a raise. Therefore, he set up a bonus system for productive laborers, foremen, and managers throughout the company. As Schwab described it, "Do so much and you get so much; do more and you get more— that is the essence of the system." At U.S. Steel, by contrast, Gary tied bonuses to the overall profitability of the company, not to individual performance. Under that system, Schwab noted, a worker could toil hard and creatively and receive no reward.26

  Schwab wanted bursts of creative energy and he paid the highest salaries in the industry to get them. When Eugene Grace proved himself, Schwab made him president of the company, regularly paying him salary and bonuses of over one million dollars per year. This was twice as much as Gary earned at U.S. Steel. Gary could never understand Schwab's philosophy of cutting costs. It didn't seem logical to pay bonuses in order to lower expenses and increase profits. But Schwab showed that this worked, and Bethlehem Steel's sales grew from $10 million in 1904 to $230 million in 1916. During these same years, the company's stock increased in value fr
om $20 to $600 per share.27

  Schwab's biggest move at Bethlehem was his challenge to U.S. Steel in the making of structural steel. Here he focused on an innovation in making the steel beams that went into bridges and skyscrapers. Schwab had been listening to Edward Grey, who had an idea of making steel beams directly from an ingot as a single section instead of riveting smaller beams together. Grey claimed that his invention provided "the greatest possible strength with the least dead weight and at the lowest cost."28

  The other steelmakers rejected Grey's theory; but Schwab was eager to try it even though it would cost $5 million to design the plant, build the mill, and pay Grey's royalties. The problem was that the experts were so skeptical that Schwab had trouble raising money. In fact, he almost backed out but then jumped back in with the statement: "If we are going bust, we will go bust big." He staked his own money, and that of his company, on the Grey beam, but still he needed more. So Schwab buttonholed wealthy investors for large personal loans and then, through remarkable salesmanship, persuaded his major suppliers, the Lehigh Valley and the Reading Railroads, to give him credit on deliveries of the new steel. Schwab then aggressively recruited big contracts for the "Bethlehem beam": the Chase National Bank and the Metropolitan Life Insurance Company in New York were among them. The experiment worked. This cheaper and more durable beam quickly became Schwab's greatest innovation and he captured a large share of the structural steel market from U. S. Steel.29

  Schwab's actions had consequences for the American steel industry. From 1905 to 1920, Bethlehem Steel's labor force doubled every five years. By contrast, U. S. Steel often stagnated; one officer noted after Schwab left that "works standing idle have deteriorated.. .the men are disheartened and a certain amount of apathy exists."By the 1920s, the chagrined leaders at U. S. Steel secretly began making Bethlehem beams; as an official there observed, "The tonnage lost on account of competition with Bethlehem... is ... ever increasing We are obliged to sell.. .at unusually low prices in order to compete." Schwab discovered their ploy, however, and forced U. S. Steel to pay him royalties for making his Bethlehem beams.30

  Schwab had transformed Bethlehem Steel. Even before World War I his company had become the second largest steelmaker in America. The New York Times praised Bethlehem Steel as "possibly the most efficient, profitable self-contained steel plant in the country." By 1920, it employed 20,000 people in the Lehigh Valley and was among the largest enterprises in the world. In 1922, it absorbed Lackawanna Steel, the company that launched America's rail-making industry seventy-five years earlier.31

  During World War I, Schwab's abilities were needed by the U. S. government. In April, 1918, one year after America entered the war, victory was uncertain. Delays in shipping cargo and troops from America to Europe threatened the Allies with defeat. More ships were needed; but in the U.S. shipyards few ships were forthcoming. Within the Wilson administration some blamed the owners of the shipyards; others blamed the workers; still others blamed radical unions. In the midst of this fingerpointing, Franklin K. Lane, the Secretary of Commerce, posed a solution:

  The President ought to send for Schwab and hand him a treasury warrant for a billion dollars and set him to work building ships, with no government inspectors or supervisors or accountants or auditors or other red tape to bother him. Let the President just put it up to Schwab's patriotism and put Schwab on his honor. Nothing more is needed. Schwab will do the job.

  That month Schwab became Director-General of the Emergency Fleet Corporation for the U. S. government. In his investigation, he discovered cases of laziness, incompetence, work slowdowns, and poor coordination of the ship building. As usual, though, Schwab said, "The best place to succeed is where you are with what you have." He quickly rearranged incentives: he eliminated the "cost plus" system whereby shipyards were paid whatever it cost them to build ships plus a percentage of that as a profit. Instead, Schwab tied profits to cost-cutting by paying a set price per ship. Cost overruns would be paid by the shipbuilders who would have to be efficient to make a profit. As usual, bonuses were part of the Schwab formula. He paid them, sometimes out of his own pocket, to those shipbuilders who exceeded production.32

  Schwab enjoyed being a showman, so he went to the shipyards himself: he rallied the workers, praised the owners, and even drew applause in a speech to the Industrial Workers of the World, a radical union. Never one to ignore symbols for achievement, Schwab had Rear Admiral F. F. Fletcher head a group to award flags and medals to plants and workers whose work had been outstanding. By the fall of 1918, ships were being completed on time and even ahead of schedule. President Wilson and the leaders of the Shipping Board were astonished with the change and gave Schwab the credit. Carnegie, in the last year of his life, called it "a record of accomplishment such as has never been equaled."33

  Not all of Schwab's dealings with the federal government were so productive. The armor-plate business is an example of this. The making of military equipment—armor plate for ships, gun forgings, ordnance, and shrapnel—brought Schwab into regular contact with government purchasers. Throughout his career, Schwab had problems with these government contracts. Even at Carnegie Steel, Schwab had quarreled with government officials over allegedly defective armor plate; the issue never was amicably settled.34

  The problem began in the 1880s when various officials began urging the United States to build a large Navy. At the time the American steel companies were mostly making rails, so President Cleveland and others began urging someone to diversify. Making military equipment was complicated and expensive, however; only reluctantly did Bethlehem Iron and Carnegie Steel shift into ordnance. Had the government not promised them Navy contracts they would not have switched.35

  Four things in the military supply business made for tension between the federal government and the steel companies. First, the federal government was the largest and sometimes the only buyer of military equipment; the government's notions of quality sometimes differed from that of the producers. Often both sides had legitimate points of view. Second, since the demand for military equipment was limited and the costs of building a factory to produce it were high, only U. S. Steel, Bethlehem Steel, and later Midvale Steel made armor plate. The potential for either a monopoly or for price-rigging bothered some government officials. Third, a ton of military equipment was more expensive to make than a ton of rails or a ton of structural steel; some purchasers thought that $450 for a ton of armor plate was price-gouging if rails sold for only $25 per ton. Finally, the ordnance producers sometimes made lower bids on foreign contracts than they did on domestic ones. To some in the American government, this was evidence they were being overcharged; to the steel companies, lower bids meant they had to cut their profit margin to almost zero to overcome tariffs in foreign countries. Also, when American needs were low, the steel men argued they had to get foreign business to keep their factories operating.36

  The government's solution to these four problems was to threaten to go into the military supply business and build an armor-plate factory with federal funds. Schwab countered that the government would not be able to make armor plate cheaper than he could. After all, Bethlehem had a veteran work force, a good bonus system, and could buy materials more cheaply in bulk. Any vertically integrated company would have an advantage over companies purchasing supplies in the open market. A government factory, Schwab insisted, would waste the taxpayers' money.37

  If Schwab had been a mediator, not a participant, he might have been able to settle this dispute. Part of the problem was the same as that of the low productivity of the American shipyards during World War I: misdirected incentives. When the Navy department took bids for contracts from the three steel companies, it naturally accepted the lowest bid. But then the Navy official went to the two higher bidders and offered them part of the contract if they would agree to accept the lowest bid. He did this so that all three could survive; that way, with three producers, a future monopoly of ordnance would be prevented. The problem i
s that this strategy gave the three companies an incentive to collude and fix prices high. Why should they bid low if all of them would get part of the contract anyway? A winner-take-all approach would have provided an incentive for lower bidding, but the Navy department was unwilling to do this. Not surprisingly, then, year after year the steel companies submitted nearly identical bids for military equipment.38

  This problem reached a crisis point during the Wilson administration. In 1913, Josephus Daniels, Wilson's Secretary of the Navy, and Ben Tillman, Senator from South Carolina, investigated the armor business. Both men urged Wilson to back a government armor plant. They held hearings in Congress on the armor business but did not like what they heard. The leaders of the three steel companies all said their bids were reasonable. In fact, Schwab submitted figures showing that he and the others charged less for armor plate than did England, France, Germany and Japan. If others didn't believe it, then let the Federal Trade Commission look at the accounts and fix a price. Daniels and Tillman rejected this. They were convinced that the government could make armor plate cheaper. The head of the Bureau of Ordnance estimated that $10.3 million would build an armor plant and that plate could be made for less than $300 per ton, instead of $454 per ton, which was a typical bid from the steel companies.39

  In 1916, then, Daniels and Tillman began the campaign to convince Congress to spend $11 million for an armor factory. In the Senate, Tillman argued that the government would save money and would no longer be at the mercy of identical bids from the "greedy and hoggish" steel companies. President Wilson backed Tillman and said, "I remember very well my promise to help all I could with the bill for the construction of an armor plant and I stand ready to redeem my promise."40