The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supercompany

by Charles R. Morris

  Alfred Chandler famously argued that the entities that survived the Great Merger Movement—about a third failed within just a few years—did so because they achieved significant operational efficiencies through vertical integration. In some instances, that is certainly true, as in the DuPonts’ rollup and rationalization of the national explosives industry. But in most cases, the evidence for efficiency is ambiguous at best. The surviving entities certainly used lots of competitive techniques that had little to do with efficiency, like achieving raw material monopolies, buying out competitors, or using market power to punish distributors who carried competitive products. In the case of U. S. Steel, however, even Chandler conceded that the combination had nothing to do with efficiency.

  The Birth of Big Steel

  Morgan came late to industrial securities. His relation with Thomas Edison led him to sponsor the 1892 General Electric consolidation,* but that was exceptional. The Morgan bank was completing its first two steel deals when Henry Frick floated the idea of a Carnegie Steel buyout in late 1898, but Morgan chose to pass on the opportunity. He must have kicked himself, for he ended up paying twice as much a little more than two years later.

  A 1911 congressional investigation accurately summed up the U. S. Steel transaction: “[T]he United States Steel Corporation, in buying the Carnegie Company, paid not only for tangible assets, but also—and very liberally—for earning power, and, perhaps more important still, for the elimination of Mr. Carnegie.” The three primary steel makers (rails, beams, and unfinished steel) in the U.S. Steel consortium were Carnegie, Federal, and National. Carnegie had about 42 percent of their combined capacity, while Federal and National roughly split the remainder. But the final deal valued each ton of Carnegie Co. capacity at $105, compared to $55 for Federal and only $31 for National. More than 60 percent of the Carnegie purchase price, moreover, was paid in first mortgage gold bonds, whereas shareholders in all the other companies got only stock. Since the bonds traded at a much higher price than the stock, the true per-ton consideration paid for Carnegie was six times that paid for Federal and nine times the price for National. There was no way to justify that premium, the committee staff suggested, except as “the price of peace”—in effect as a bribe to get Andrew Carnegie out of the business.

  Elbert Gary, the corporate lawyer who ran U. S. Steel, freely conceded the point. Gary had been counsel to Illinois Steel, Carnegie Steel’s largest competitor during the 1897–98 rail price war, and became president of Federal Steel, a Morgan consolidation that included Illinois, after impressing Morgan with his work on the merger. Harking back to the searing experience of the rail war, Gary said:

  I believe, perhaps, if unrestricted and unchecked destructive competition had gone on, the Illinois Steel Co. would undoubtedly have been driven out of business, and perhaps, I might say more. I do not say it with a view of casting any reflection upon anyone’s management, but it is not at all certain that if the old management or the management which was in force at one time had continued the Carnegie Co. would have driven entirely out of business every steel company in the United States.

  The U. S. Steel deal, he summed up, was a necessary action to “prevent utter demoralization and destructive competition such as used to prevail.”

  Carnegie, in fact, had not started the 1897 price war—a smaller rail maker, Lackawanna Steel, had—but Carnegie needed little excuse to go to war since he had long been restive over Frick’s and Schwab’s willingness to abide by pool arrangements. Through 1897 Carnegie Steel drove rail prices down to their lowest level ever, below most other steel companies’ production costs, and still made record profits. A strong railroad recovery, however, spurred a wave of new construction; steel prices and volumes rose very strongly for the next two years, bailing out the whole industry, and leading to the reinstatement of the pool.

  To Carnegie’s dismay, almost all of the companies used their boom profits to make major plant investments. Walter Scranton, the head of Lackawanna, called the rail fight “an object lesson” and built a brand-new plant on the Buffalo lake shore. John W. Gates, then president of Illinois Steel, told his shareholders in 1898 that the company could no longer “do business on the basis of large profits for comparatively small tonnage. . . . We must meet competition and reduce the cost of production to the minimum.” By joining in the Federal Steel merger, Illinois Steel also acquired substantial ore and transport resources to cut further into the Carnegie cost advantage. Carnegie himself lamented in 1899: “The autumn of last year seemed as good a time to force [a list of steel companies] out of business as any other. It did not prove so. The boom came and cost us a great deal of money.” Available data and other reports suggest that by then Federal Steel, and several others, like Jones & Laughlin, were catching up to Carnegie in the productivity race.

  Rising volumes and soaring prices and profits brought peace to the steel industry in 1898 and 1899, until a sharp market break in 1900 triggered the events that led to the formation of U. S. Steel. But this time the battle would be over finished steel products, not primary steel, and once again it was Carnegie’s competitors who threw down the gauntlet, leaving him little choice but to respond.

  Morgan’s National Tube merger in early 1899 rolled up 85 percent of the country’s steel tube and pipe makers and, along with the rapid-fire mergers in hoops, tin plate, sheet steel, and wire and nails, completely changed the profile of finished steel-making. All of the big new combines were near-monopolies, but none was as powerful as it looked on paper. The nineteenth-century “axiom” (Schwab’s word) that bigger was always more efficient was approximately true in only a handful of the biggest industries. Finished steel wasn’t one of them: economies of scale in wire-making, or hoops, or tin plate weren’t nearly sufficient to lock out new price-cutting market entrants. It was mostly primary steelmaking that enjoyed big economies of scale, because of the huge fixed cost of continuous-process integration of the ore to steel cycle. It is no accident that the few finished products that required massive investment, like rails, ship plate, and structural beams, were all made by the primary steel companies.

  To protect their near-monopolies in finished steel, therefore, all the consolidations felt pressured to integrate backward into primary steel. National Steel was organized by the Moores expressly to feed their three finished steel companies; Gates had planned his own steel production for his wire and nail combine from the start; and National Tube started laying out its own steel plants as soon as it built its massive new tube works. In the meantime, in view of the financial relationships among Gates, the Moores, and Morgan, all of the combines made either National or Federal Steel their primary steel vendors of choice. Every one of these moves cut into Carnegie Steel’s order book; in short, apparently without giving the matter much thought, Morgan and the Moores had positioned themselves as Carnegie’s biggest and most aggressive competitors.

  The strategy was grossly misconceived on almost every count. Given the relatively modest investment required to enter most finished steel businesses, it would always be easier for the primary steel companies to integrate forward into wire, hoops, or tubes. And by using their new finished lines to sop up surplus primary steel capacity, they would have the luxury of selling below cost and killing off independents at will. (It was very expensive to idle a blast furnace, but a tin plate “dippery” could be turned on or off any time.) The notion that nail-makers or pipe-makers could compete by integrating backward was, frankly, nuts—the more so since the post–1897 boom in steel plant investment had left the country with surplus capacity.* Charles Coster and Robert Bacon were the Morgan partners driving the strategy, but Morgan himself was very involved. One historian called National Tube his “favorite child.”

  Worse than thoughtless, the challenge to Carnegie was sloppy. When the British expert, Stephen Jeans, toured American steel facilities at the turn of the century, he was extremely impressed with most of the works he visited. But he made a notable exception of Morgan’s Nation
al Tube works—although it was the largest tube works in the world “by far,” he thought it lacked “that method and order” he expected in a modern plant. Similarly, the Moores’ National Steel consolidation appears to have been far less efficient than either Federal or Carnegie Steel, and was assigned a correspondingly low price in the U. S. Steel rollup. These were lambs fecklessly poking sticks at a lion, and had only themselves to blame if they were eaten.

  As the boom rolled into 1900, Carnegie Steel’s order books were so full that Carnegie could do little but grumble about Morgan’s and the Moores’ moves. But the market break in the spring put him on the war path. The distractions of the Frick ouster were over, and with Schwab in charge, and the boom ending, it was time to teach the world another lesson about competition. Receiving a pessimistic note on new business from Schwab in early June, Carnegie responded by urging a start on a tube plant: “Your cable of 2nd did not surprise me. It seems to me that . . . a struggle must ensue among producers for orders. . . . The sooner you scoop the market the better.” Schwab was ready; as he reported to the board the next month:

  I do not see that there is anything left for us to do but to build a hoop and wire mill. The American Steel & Wire Co. have served notice on us for cancellation of their contract with us. The American Steel Hoop Co. are buying but little from us. With the loss of customers we have sustained it will leave us in a position to have no four inch billets to make. There does not seem to be any other place at present to place them. . . . [W]e formerly sold to the constituent companies of American Steel & Wire Co. and the American Steel Hoop Co. from 30,000 to 35,000 tons of billets a month.

  Carnegie wanted to push ahead on every front, even if it meant giving up the interest payments on his bonds. What really excited him was the tube plant, to be built at Carnegie Steel’s Lake Erie ore port facilities at Conneaut on the Pennsylvania/Ohio border. Designed by Schwab for continuous process flow from the ore dock to the finished product, it promised to be the most advanced finished steel operation in the world. Not only would he get maximum efficiency in ore and coke handling, and exploit a brand-new tube-making technology, but he could fully utilize his large Pittsburgh-Great Lakes railroad investments. Even better, fifteen years after the fact, Carnegie could finally get even with Morgan for the Corsair insult, for he had worked out a deal with George Gould, Jay’s son, for a competitive rail line from Carnegie’s Lake railroad to the east coast. Crushing Morgan’s steel combines and striking a blow at the hated Pennsylvania at the same time! Heaven rarely gift-wrapped such opportunities.

  Here’s how Carnegie described Conneaut to the investigating committee on steel a decade later (picture him perched at the witness table, savoring the moment, glowing with red-cheeked good humor):

  MR. CARNEGIE: [I]t did not require much consideration to let us see that if we . . . put a modern steel plant there, the ore would come there and be dumped from the boat right in the furnace yard. And Mr. Schwab drew up plans. The mill was 1,100 feet long . . . with all new, modern machinery, no men hardly, all rolls conveying the masses without hand labor, all that. . . . [A]nd I said: “Schwab, what difference can you make?” and he said, “Mr. Carnegie, not less than $10 a ton. . . .*

  THE CHAIRMAN: Was anything ever said about this great steel plant . . . and the tremendous advantages you had?

  MR. CARNEGIE: We bought the land and that was known.

  THE CHAIRMAN: And you knew what you were going to do.

  MR. CARNEGIE: Yes; indeed we did. [Laughter]

  THE CHAIRMAN: There has been some intimation that, even with your sanguine temperament, and your long experience, that the Carnegie works, like Napoleon at Waterloo, were face to face with a combination so extensive, so manned by men so experienced and sustained by resources so tremendous . . . that perhaps you escaped destructive competition by retiring from the field. Was it possible for Carnegie Co. to have met these combined forces?

  MR. CARNEGIE: Nonsense. [Laughter] Why did Morgan send word to me that he would like to buy me out?

  THE CHAIRMAN: I understand that he was uneasy about the condition of your health, and gave that as a reason.

  MR. CARNEGIE: I was still able to take sustenance. [Laughter]

  The board of Carnegie Co. voted to proceed with the Conneaut plant at a meeting on November 12, 1900. Carnegie attended in person—a rare event in those days—presumably to shore up any waverers. And there were indeed some waverers, especially among the old-timers, who had thought that the reorganization as Carnegie Co. barely eight months past had finally brought them to port, into the long-promised land of dividends and honey; yet here was the old man once more, competitive juices in full sap, ready to plunge them into a world of spending and strife. Schwab was an enthusiast, at least openly—as he wrote Carnegie on January 24, 1901:

  I really believe that for the next 10 years the Carnegie Company will show greater earnings than will the others together. A poor plant makes a relatively better showing in prosperous years. Then we will advance rapidly—Others will not. I shall not feel satisfied until we are producing 500.000 tons per month [about double their 1900 rate] and finishing same. And we’ll do it within 5 years—Look at our Ore & Coke as compared with the others. If you continue to give me the support you have in the past we’ll make a greater industry than even we ever dreamed of.—Am anxious to get at Conneaut—Are finishing plans rapidly & will be ready for a start in the spring.

  When Morgan heard what Carnegie was up to, he glumly remarked that “Carnegie is going to demoralize railroads just as he has demoralized steel.”

  Pierpont Morgan’s buyout of Carnegie and the organization of U. S. Steel is an oft-told story. Although steel and railroad men clamored for Morgan’s intervention, he did not make a direct approach to Carnegie, possibly because he expected a hostile reception. Historians have speculated that the Carnegie-Schwab competitive flurry was partly maneuvering to extract a blockbuster offer from Morgan. But if anyone was playing a double game it would have been Schwab: he had shown himself as more than a little two-faced during Frick’s ouster, brimming with unctuous compliments and gratitude toward Frick one day, and voting for his ouster the next, albeit with profuse apologies.

  The catalytic event was a speech Schwab gave at the University Club in New York on December 12, 1900. Morgan was in attendance, as was Carnegie, although Carnegie left early. Schwab laid out a blueprint for a future steel industry that could be taken as a leitmotiv for the new century, an intellectualist vision of a vast, unified machinery for making and delivering steel products—one of the first fully worked out conceptions by a knowledgeable insider of the organizational ideals that inspired Socialists, Progressives, and technocrats, and obviously some leading businessmen, at the hinge of the new century. Schwab envisioned a top-down rationalization of the entire industry “in a scientific manner,”* eliminating competition, and assigning all production among specialist factories distributed for least-distance transport of ore, coke, primary steel, and finished product. No wasteful competition or duplication of effort, just pure, frictionless efficiency.

  Morgan loved it. For his entire career he had pursued a barely articulated ideal of “cooperation,” some workable alternative to a perpetual state of “ruinous competition”; and here, rather than just a glimpse of light through a keyhole, was the vision whole. He spoke briefly to Schwab and asked for a later meeting, which turned out to be an all-nighter at Morgan’s house shortly after the new year. Besides Morgan and Schwab, there were Gates and Bacon, so Schwab was clearly consorting with the enemy. They apparently worked out the outline of a deal, and, a few days later, Schwab gave Morgan a detailed memorandum on the targets for the merger, and the prices that should be paid. “I knew exactly what each one was worth,” he later recalled. “Nobody in the world helped me with that list.” Morgan was ready to go, so long as Schwab could reel in Carnegie. On the question of Schwab’s capacity for dissimulation, note that his January 24 letter to Carnegie about crushing the competition ca
me more than two weeks after his meeting with Morgan.

  Schwab first conferred with Carnegie’s wife, who advised him to broach the question on the golf course, when Carnegie was always in a good mood, and he put the proposition to Carnegie at the end of January. Carnegie thought about it overnight, and said he wanted $400 million—$160 million in gold bonds for the Carnegie Co. gold bonds, plus $240 million in U. S. Steel stock for the $160 million of Carnegie stock—a 1.5/1 exchange. Thinking about it some more, he added $80 million for “Profit of past year and estimated profit of coming year,” bringing the total to $480 million.* He penciled those numbers on a notepad and gave them to Schwab to bring to Morgan.

  There was more than a little flummery in the profit forecast. Carnegie had fully expected to make $40–50 million in steel profits in 1900; being Carnegie, he bragged widely of the prospect, and enshrined the $40 million profit claim in his Autobiography. The “$80 million” seems strongly to imply that the company had made $40 million in 1900 and would again in 1901, and historians have repeated the $40 million for 1900 ever since. In actuality, the company made between $29 million and $31 million in 1900. (There are gaps in the second half data for some of the non-steel holdings; see Appendix I.) More important, its second half earnings slumped to only about $6 million. In effect, Carnegie was forecasting $50 million in earnings for 1901, which from a half-year base that low was absurd. Carnegie’s exaggerations once again highlight the ambiguous position of Schwab, who obviously knew the correct numbers. Psychologically, at this point, his allegiance must have already shifted to Morgan. One cannot imagine that when he transmitted Carnegie’s note he did not disclose the real state of affairs, if indeed he had not yet done so. Morgan wouldn’t have cared. The U. S. Steel deal was about fending off catastrophe—better to get cheated than to die. And in any case, Morgan and Schwab would have assumed that once they controlled the industry, they could set prices to generate whatever profits they needed.