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Losing to Win: U.S. Steel's Pricing, Investment Decisions, and Market Share, 1901–1938

Published online by Cambridge University Press:  03 March 2009

Thomas K. McCraw  and
Forest Reinhardt
Thomas K. McCraw
Affiliation:
Straus Professor of Business History, Harvard University, Boston, MA 02163.
Forest Reinhardt
Affiliation:
Ph.D. candidate in Business Economics, Harvard University, Cambridge, MA 02138.
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Abstract

U.S. Steel held two-thirds of the American market in 1901, but by the 1930s its share had dropped to one-third. Such a decline is consistent with the economic theory of oligopoly pricing and capacity expansion, but the available data offer limited opportunities for formal testing of hypotheses. A close examination of U.S. Steel's early history leads us to argue that Chairman Elbert Gary's desire for price stability, his fear of antitrust litigation, and shortcomings in the firm's organizational capability constrained it from the unbridled pursuit of discounted profits that the economic theory assumes.

Type
Articles
Information
The Journal of Economic History , Volume 49 , Issue 3 , September 1989 , pp. 593 - 619
Copyright
Copyright © The Economic History Association 1989

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References

1 Livesay, Harold C., Andrew Carnegie and the Rise of Big Business (Boston, 1975), pp. 116–17,150.Google Scholar On Carnegie Steel, see also Wall, Joseph Frazier, Andrew Carnegie (New York, 1970);Google Scholar and Bridge, James Howard, The Inside History of the Carnegie Steel Company (New York, 1903).Google Scholar For Charles Schwab's favorable predictions of the results of the merger, see Schwab, Charles, “What May Be Expected in the Iron and Steel Industry,” North American Review, 172 (05 1901), pp. 655–64.Google Scholar

2 Baker, Ray Stannard, “What the U.S. Steel Corporation Really Is, and How Lt Works,” McClure's, 18 (11 1901), p. 6. Many other accounts of U.S. Steel take the same awestruck tone. The U.S. District Court's opinion in the antitrust case of 1915 begins as follows: “The subject-matter of the litigation is of such magnitude and complexity, and the record is of such size, that the effort to set bounds to this discussion has not been easy.” See United States v. United States Steel Corporation et al., District Court, New Jersey, 223 Federal Reporter (1915), p. 58. On the first page of a three-part 1936 Fortune series, one reads: “It is extremely difficult, if not impossible, to visualize the workings of the Steel Corporation as a whole.” See “orhe [United States Steel] Corporation,” Fortune, 13 (Mar. 1936), p. 59.Google Scholar

3 Much was made in the American popular press about the size, overcapitalization, and antitrust implications of the merger. Nor was the reaction confined to the United States alone. Britain's Iron and Coal Trades Review, for example, was quoted in The Iron Age, 67 (Mar. 14, 1901), pp. 2–3, to the effect that U.S. Steel would be too “vast… cumbersome … unnatural and … subversive of public and vested interest” to survive.Google Scholar

4 See Stigler, George J., “The Dominant Firm and the Inverted Umbrella,” Journal of Law and Economics, 8 (10 1965), pp. 167–72.CrossRefGoogle Scholar For elaborations and some differing views, see Parsons, Donald D. and Ray, Edward John, “The United States Steel Consolidation: The Creation of Market Control,” Journal of Law and Economics, 18 (04 1975), pp. 181–219;CrossRefGoogle Scholar and Burton, Michael E., “The 1901 Establishment of the U.S. Steel Corporation: For Monopoly and/or Efficiency?” (Ph.D. diss., University of California at Los Angeles, 1985).Google Scholar

5 Under the Pittsburgh-plus system, prices of steel products of different locales were standardized through the device of adding phantom freight charges from the “basing point” of Pittsburgh, regardless of where the products had actually originated. Later a few other basing points were added.Google Scholar

6 U.S. Steel represented a combination of combinations, climaxing a series of mergers of about 180 iron and steel companies existing in the late 1880s into nine very large firms in the late 1890s, and finally into one giant holding company in 1901. The U.S. Steel merger was part of a great wave of combinations in many industries, a movement that began in 1895, peaked in 1899, and finally ended in 1904. During this period, more than 1,800 manufacturing firms merged into 157 consolidated corporations. Many of these, such as General Electric, National Biscuit, and International Harvester, dominated their industries for generations to come and, like U.S. Steel, became household words in American society.Google Scholar The standard work is Lamoreaux, Naomi R., The Great Merger Movement in American Business, 1895–1904 (New York, 1985).CrossRefGoogle Scholar

7 The best original documentary sources are U.S. Department of Commerce and Labor, Report of the Commissioner of Corporations on the Steel Industry, 3 parts (Washington, DC, 1911 to 1913); U.S. House of Representatives, Hearings before the Committee on Investigation of the United States Steel Corporation, 8 vols., 62nd Cong., 2nd sess. (Washington, DC, 1911), the Stanley Committee hearings: U.S. House of Representatives. Report on the Investigation of the United States Steel Corporation, 3 parts. 62nd Cong., 2nd sess. (Washington, DC, 1911), the Stanley Committee report; and the voluminous records of the antitrust case cited in fn. 2. The availability of this copious primary data goes far to offset the disadvantage that U.S. Steel's corporate archives remain closed to independent scholars.Google Scholar

8 United States v. United States Steel Corporation (1915), p. 90.Google Scholar

9 Ibid., pp. 78, 90–91.

10 Ibid., p. 95.

11 Ibid., pp. 88–89.

12 Ibid., p. 95. Although the court drew a distinction between the old competition and the new, its remarks on prices, on pp. 88–89, downplay the market power U.S. Steel possessed. The concurring opinion partly alleviated this apparent contradiction.

13 Ibid., pp. 165–66, 172. The reference in the last sentence of this quotation is to the 1911 cases against Standard Oil and American Tobacco.

14 Roughly speaking, the metallurgical content of tinplate is about one percent tin, which accounts for about 15 percent of the final product's price.Google Scholar

15 United States v. United States Steel Corporation et al., District Court, New Jersey (1912–1915), Transcript of Trial Testimony, pp. 4882–83.Google Scholar

16 Hessen, Robert, Steel Titan: The Life of Charles M. Schwab (New York, 1975), pp.186–87.Google Scholar

17 For a discussion of the Gary dinners and their aftermath, see Robinson, Maurice H., “The Gary Dinner System: An Experiment in Cooperative Price Stabilization,” The Southwestern Political and Social Science Quarterly, 7 (09 1926), pp. 137–61.Google Scholar

18 See, for example, The Iron Age, 87 (June 8, 1911), pp. 1404–7, for a summary of Gary's testimony before the Stanley Committee; and The Iron Age, 89 (Feb. 29, 1912), pp. 540–41. Gary's proposals along this line did not often sit well with other steel executives. See editorial in The Iron Age, 87 (June 15, 1911), p. 1446.Google Scholar

19 Hidy, Ralph W. and Hidy, Muriel E., Pioneering in Big Business, 1882–1911 (New York, 1955), pp. 28, 117–18, 194.Google Scholar

20 Hessen, Steel Titan, p. 187.Google Scholar

21 Gaskins, Darius W. Jr, “Dynamic Limit Pricing: Optimal Pricing Under Threat of Entry,” Journal of Economic Theory, 3 (09 1971), pp. 306–22;CrossRefGoogle ScholarKamien, Morton and Schwartz, Nancy, “Limit Pricing and Uncertain Entry,” Econometrica, 39 (05 1971), pp. 441–54;CrossRefGoogle Scholar and Kamien, Morton and Schwartz, Nancy, Dynamic Optimization: The Calculus of Variations and Optimal Control in Economics and Management (New York, 1981), pp. 206–11.Google Scholar See also Yamawaki, Hideki, “Dominant Firm Pricing and Fringe Expansion: The Case of the U.S. Iron and Steel Industry,” Review of Economics and Statistics, 67 (08 1985), pp. 429–37.CrossRefGoogle Scholar

22 Tirole, Jean, The Theory of Industrial Organization (Cambridge, MA, 1988), contains numerous examples and comprehensive bibliographies.Google Scholar

23 One implication of both dynamic limit pricing theory and of game-theoretic models of investment is that higher barriers to entry should lead to higher profits for the dominant firm, slower declines in its market share, or both. Steel is ordinarily regarded as having substantial barriers to entry. Comparative work on turn-of-the-century mergers, however, shows that barriers to entry in steel were not especially high and that U.S. Steel's loss of market share was not atypical of that of contemporary trusts. Richard Caves, Michael Fortunato, and Pankaj Ghemawat have used the qualitative analytic framework provided by dynamic limit pricing to investigate the declining market share of major trusts of the early twentieth century. They have shown that a sample of 34 ompanies with a mean market share of 69 percent in 1905 had dropped by 1929 to a mean of 45 percent. They examined the effects of entry barriers, profit levels of the largest participant in each industry, and erosion of market share experienced by each dominant firm. As one might predict, they found that trusts protected by high entry barriers maintained higher profits, slower erosion of market share, or both. The table below shows some of their findings for U.S. Steel and the other 33 companies studied: Google Scholar See Caves, Richard E., Fortunato, Michael, and Ghemawat, Pankaj, “The Decline of Dominant Firms, 1905–29,” Quarterly Journal of Economics, 99 (08 1984), pp. 523–46.CrossRefGoogle Scholar The quoted data come not only from that article but also from the working papers behind it, which are available from its authors. The last line of numbers listed is a measure of one kind of entry barrier. The authors also examined others, including degree of vertical integration, presence of patent protection, capital investment required for a plant of minimum efficient scale, and so on. For most of these categories, barriers in the steel industry were lower than average. Less recent but still useful literature on the subject includes Worcester, Dean A. Jr, “Why ‘Dominant Firms’ Decline,” Journal of Political Economy, 65 (08 1957), pp. 338–46;CrossRefGoogle ScholarLivermore, Shaw, “The Success of Industrial Mergers,” Quarterly Journal of Economics, 50 (11 1935), pp. 68–96;CrossRefGoogle Scholar and Jones, Eliot, The Trust Problem in the United States (New York, 1921).Google Scholar

24 Testimony of Elbert Gary, United States v. United States Steel Corporation, p. 4757.Google Scholar

25 Quoted in Tarbell, Ida M., The Life of Elbert H. Gary: The Story of Steel (New York, 1925), pp. 123–24.Google Scholar

26 Quoted in The Iron Age, 77 (Mar. 29, 1906), p. 1117.Google Scholar

27 See Wiebe, Robert H., “The House of Morgan and the Executive, 1905–1913,” American Historical Review, 65 (10 1959), pp. 49–60;CrossRefGoogle Scholar and Wiebe, Robert H., Businessmen and Reform: A Study of the Progressive Movement (Cambridge, MA, 1962), chap. 4. Gary's anxious state of mind in the 1906 to 1908 period is vividly recalled in a long retrospective interview he gave with Bureau of Corporations investigators on Oct. 6, 1911. See the interview transcript in the Bureau's records, Steel Investigation, File 1940–1, National Archives, Washington, DC.Google Scholar

28 An editorial in The Iron Age, 81 (Feb 13, 1908), p.518, complained: “The scope and severity of laws to regulate business have vastly increased within a few years, and if the growth of legislation continues it will be a comparatively short time until every man who conducts an industry or business will be technically, at least, a law breaker.” On the agitation within Congress, especially the powerful Hepburn Bill of 1908,Google Scholar see the middle chapters of Sklar, Martin J., The Corporate Reconstruction of American Capitalism. 1890–1916: The Market, the Law, and Politics (Cambridge, 1988).CrossRefGoogle Scholar

29 Quoted in Tarbell, Life of Gary, pp. 257–58. See also Bureau of Corporations Interview with Gary cited in fn. 27.Google Scholar

30 The contemporary press reporting of the District and Supreme Court decisions in 1915 and 1920, like the texts of those opinions, makes much of the decline of U.S. Steel's market share and the rise of competitors' share. See, for example, Wall Street Journal, June 4, 5, and 7, 1915; Commercial and Financial Chronicle, June 5, 1915, pp. 1860–61, 1873–75; The Iron Age, June 15,1915, pp. 1299–1321; Literary Digest, June 12, 1915, p. 1386; Literary Digest, Mar. 13, 1920, pp.17–18; Wall Street Journal, Mar. 2 and 3, 1920; and New York Times, Mar. 2, 3, and 4, 1920.Google Scholar

31 The Iron Age, 95 (June 10, 1915), pp. 1302–4.Google Scholar

32 A different focus altogether is evident in Parsons and Ray, “The Creation of Market Control.” They are preoccupied with the company's control of ore, its building of market power, and foreign trade. We believe that control of ore was less important than they argue (partly because the company divested very substantial portions of its ore interests), and that the company did not possess as much market power as their argument implies.Google Scholar

33 Chandler, Alfred D. Jr, Strategy and Structure: Chapters in the History of the American Industrial Enterprise (Cambridge, MA, 1962);Google Scholar and Chandler, Alfred D. Jr, The Visible Hand: The Managerial Revolution in American Business (Cambridge, MA, 1977).Google Scholar

34 “Bethlehem Steel,” Fortune, 23 (Apr. 1941), p. 62. The same article contains the following comment about the reasons why U.S. Steel allowed Bethlehem to prosper through such deals as access to Minnesota iron ore: “The answer is that however much U.S. [Steel] disapproved of Bethlehem's upsurge, it was too big to become any bigger, for political and operating reasons. Judge Gary simply had to sit back in a forbearing, Christian manner and offer Bethlehem his blessing” (p. 144). For an insightful analysis of U.S. Steel's first three decades, see “The [United States Steel] Corporation” (cited in fn. 2).Google Scholar

35 Chandler, Alfred D. Jr, Scale and Scope: The Dynamics of Industrial Capitalism (Cambridge, MA, forthcoming).Google Scholar

36 In 1911, Gary told Bureau of Corporations investigators “that he had been criticized sharply by his own presidents [of subsidiary companies], because they claimed that this plan [of price maintenance] was practically building up the Steel Corporation's competitors, inasmuch as the fair maintenance of prices by the Steel Corporation and the frequent failure to observe the schedule[d] prices by its competitors enabled such competitors to enlarge their proportion of the business (I have this sentence noted as ‘confidential’) [wrote the Bureau of Corporations investigator]; but Judge Gary said further that in his opinion the Steel Corporation from the start had too great a proportion in tubes, wire, and tin plate, and that it was his policy to let their proportion in those lines of the business be reduced.” See interview citation in fn. 27.Google Scholar

37 Although cross-national comparisons are not central to our argument, we note that steel giants which merged more recently in other countries have lost share as well. In Britain, 14 companies combined in 1967 to form British Steel. The new firm had a total work force of 257,000 and a domestic market share of about 70 percent. By 1980, its share had dropped to only 48 percent. It recovered to 59 percent in 1983, by which time total employment had shrunk to about 80,000, less than one-third the original total. See Sara Coles, The British Steel Corporation, 1967–1983 (n.p., Dec 1983). In Japan, the controversial merger during 1967 to 1970 of the two leading companies, Yawata and Fuji, to form Nippon Steel was also followed by loss of market share: in pig iron, from 45 percent in 1967 to 38 percent in 1984; in raw steel, from 36 to 28 percent; in hot rolled finished steel, from 37 to 31 percent.Google Scholar See Kawasaki, Tsutomu, Japan's Steel Industry (Tokyo, 1985), p. 698. These figures pertain to total production, not to the domestic market alone as in the case of British Steel.Google Scholar

38 Scitovsky, Tibor, Human Desire and Economic Satisfaction: Essays on the Frontiers of Economics (New York, 1986).Google Scholar

39 United States Steel Corporation, Annual Report 1901 (New York, 1902), p. 14.Google Scholar

40 The company, while criticized for its “overcapitalization,” was also praised for its adherence to the “Policy as to Prices” in the face of very high demand for steel in 1901 to 1902. See, for example, The Nation, Mar 13, 1902, p. 205: “The Steel Corporation started with a heavy [financial] strain on its resources. It is very fortunate for the company that this year's market for its products should have developed demands far beyond what the most sanguine prophet could have foreseen. It is still more fortunate that this tidal wave of prosperity in the iron trade should have failed to sweep away the company's managers from their original position as to prices.”Google Scholar

41 In 1920 Gary was still evangelizing on the virtues of stability: “We think stability in business is of the highest importance and that every man, to the extent of his opportunity and ability, and even at some sacrifice, is obligated to assist in stabilizing and maintaining prices on a fair and sane level. The producer, consumer and workman will be benefited by this attitude”; The Iron Age, 106 (Nov. 25, 1920), p.1428. The context was Gary's announcement that U.S. Steel would not increase prices despite increases in its costs. His obsession with stability almost never wavered, and can be followed in detail over a 20-year period in his many appearances before congressional committees and in his speeches, many of which were published in the Proceedings of the American Iron and Steel Institute, of which he was the perennial president. The Bureau of Corporations Records (National Archives) also has a broad collection of Gary's speeches to other groups.Google Scholar

42 The evidence of U.S. Steel's attempts to stay out of trouble with the government is overwhelming. For example, an editorial titled “The Steel Corporation Helps Its Competitors,” The Iron Age, 88 (Aug. 24, 1911), praised U.S. Steel for its actions during a strike in Britain that led to a shortage of tin in the United States: “If the United States Steel Corporation had chosen to use all its advantages for its own purposes and to ignore its competitors the opportunity here existed for reaping important benefits. This would have been ordinary commercial selfishness, and would by no means have been illegal restraint of trade. The Steel Corporation chose to do otherwise, however, and thus signally manifested its liberality and magnanimity.”Google Scholar

Gary and others were in fact shocked when the antitrust case was actually brought against them. As the prominent banker Frank Vanderlip wrote privately in 1911, “The Steel people, however, have been hopeful up to the last that this would not happen and have tried to do everything possible to avoid it and to bring themselves in line with official opinions.” Quoted in Sklar, The Corporate Reconstruction, p. 375, fn. 71. See also the Gary interview with Bureau of Corporations officials cited in fn. 27.