A vertically integrated firm is one in which each stage of the production process, from the production of raw materials to the marketing of the final product, is managed by different departments within one firm. In the latter part of the nineteenth century, industry after industry came to be dominated by giant vertically integrated firms. For example, Gustavus F. Swift and his brother Edwin, after experimenting with the shipment and storage of refrigerated meat, formed a partnership in 1878 that grew over the next two decades into a huge, integrated company. Its major departments—purchasing, processing, marketing, and accounting—were controlled from the central office in Chicago. Other meatpackers, such as Armour and Morris, built similar organizations, and by the late 1890s, a few firms dominated the meatpacking industry with highly centralized, bureaucratic managements. In a similar manner, James B. Duke set out in 1884 to establish a national, even worldwide, organization to market his machine-made cigarettes. In 1890, he merged his company with five competitors to form the American Tobacco Company. Less than 15 years later, American Tobacco, after a series of mergers, achieved a monopoly in the cigarette industry.
In steel, the Carnegie Company had by the early 1890s consolidated its several manufacturing properties into an integrated firm that owned vast coal and iron deposits. As the Carnegie interests grew, other businesspeople were creating powerful steel companies. In 1898, the Federal Steel Company was formed under the auspices of J. P. Morgan and Company. Its integrated operations and products greatly resembled those of the Carnegie Company, but it had the further advantage of having a close alliance with the National Tube Company and the American Bridge Company, producers of finished products. The National Steel Company, created by W. H. Moore, was the third largest producer of ingot and basic steel shapes and was closely connected with other Moore firms that made finished products: the American Tin Plate Company, the American Steel Hoop Company, and the American Sheet Steel Company. When Carnegie, strong in coal and (through his alliance with Rockefeller) iron ore, threatened to integrate forward into finished products, he precipitated action toward a merger by the Morgan interests. The result was the United States Steel Corporation, organized in March 1901 with a capital stock of more than $1 billion (about $200 billion in today’s money using the wages of production workers as the inflator) and, by a substantial margin, the largest corporation in the world. Controlling 60 percent of the nation’s steel business, United States Steel owned, in addition to its furnaces and mills, a large part of the vast ore reserves of the Lake Superior region,
50,000 acres of coking-coal lands, more than 1,100 miles of railroad, and a fleet of lake steamers and barges. While protecting its position in raw materials, the corporate giant was then able to prevent price warfare in an industry typified by high fixed costs.
The severe depression of 1893 brought all acts of combination to a virtual standstill. With the return of prosperity late in 1896, however, a new momentum developed. Between 1898 and 1904, more than 3,000 mergers were effected. In the four years before 1903, companies accounting for almost one-half of U. S. manufacturing capacity took part in active mergers, most of them vertically integrating.
Why did these giant, vertically integrated firms come to dominate so much of American manufacturing? Why, to use the provocative terms of Alfred Chandler (1977), did the visible hand of the giant corporation replace the invisible hand of the market? Chandler’s answer starts with technology. Factories constructed to take advantage of continuous-flow technologies minimized costs of production when they could operate continuously; any interruption of the inflow of raw materials or the sale of the final products sent costs upward. Thus, to minimize costs, managers needed to schedule flows with meticulous care. Having raw materials and the process of
Andrew Carnegie, a great salesman, built an integrated steel firm that combined with the Morgan and Moore interests to form the United States Steel Corporation in 1901. At that time, he sold out and became one of the world’s leading philanthropists.
Distributing the final product under their complete control therefore allowed them to minimize costs. When a continuous-flow technology did not exist, the profits expected from vertical integration often proved chimerical. American Tobacco is a good example. A new machine, the so-called Bonsack machine, could produce good cigarettes with a continuous-flow technology. As a result, American Tobacco was able to build a vertically integrated firm that monopolized the cigarette industry. Conversely, no machine could be constructed that could produce good cigars on a continuous-flow basis, and American Tobacco’s efforts to monopolize the cigar industry failed. Of course, minimizing costs was not the whole story. If a firm was successful in building a monopoly position in an industry, it could increase its profits further by restricting output and raising prices. As Naomi Lamoreaux (1985) has shown, monopoly profits were an important part of the story.
Continuous-flow facilities were being built elsewhere, but the process went further and faster in the United States. The United States led the way in the development of these giant corporations, in part because of its huge internal market, a market that was continually expanding due to the population growth and urbanization. Another reason, as Gavin Wright (1990) stressed, is that the successful new technologies required abundant natural resources: coal, iron, copper, petroleum, agricultural products, and so on. And abundant natural resources were America’s great comparative advantage. Finally, as B. Zorina Khan and Kenneth Sokoloff (2001) showed, America’s patent system, which made it relatively inexpensive (compared with other industrial countries) for inventors to protect their intellectual property, also contributed to the surge in industrial activity.
World History
