How did consolidation affect the railroad industry and influence modern business practices?

John Pierpont (J.P.) Morgan (1837-1913) was an “American financier and banker who dominated corporate finance on Wall Street throughout the Gilded Age.” He headed the banking firm that became J.P. Morgan and Co., and led the wave of industrial consolidation in the United States that spanned the late 19th and early 20th centuries. He was so successful at developing and financing these consolidations that the process became known as “Morganization.”

In effect, Morgan “reinvented how monopolies could be created.” He eliminated competition by  buying up smaller companies, lowering prices until competitors went bankrupt trying to compete, then buying up those bankrupt competitors and slashing the workforce behind the company while reducing wages. These actions maximized the profits of the monopoly. Morgan eventually took control of large parts of three major industries – railroads, electricity and steel. His focus on efficiency and modernization revolutionized the U.S. business landscape. Morgan’s industrial consolidations led to the creation of General Electric, International Harvester and U.S. Steel, among others.

Morgan’s first target was the U.S. railroad industry, which will be the focus of this FreightWaves Classics article. He began by taking over small underfinanced companies, streamlined their management and operational efficiency, and then combined the companies into a dominant player. 

Please note that the tactics Morgan and others used in the 40-year period between 1870-1910 could not be used now; most would be illegal. But there were few laws or regulations at that time to stop consolidations and monopolies. 

And without condoning Morgan’s methods, his practices generally built companies that led their industries for decades. In addition, instead of participating only as a financier, Morgan’s hands-on management and business practices helped key industries reorganize, leading to greater efficiency.

Because of the legacy of his father and his own work, Morgan had strong ties to wealthy Europeans, many of whom were interested in investing in U.S. railroads. While Morgan was able to raise large sums in Europe, he fought speculators interested only in profit. He had a vision of an integrated transportation system.

In addition, the solid growth of these industries and specific companies resulted in the successful transformation of the U.S. from a debtor nation to a creditor nation. In the process, J.P. Morgan & Co. (along with Morgan’s partners) built an estimated net worth of over $22 billion.

Consolidating railroads

The world’s first railroads that used mechanically powered locomotives began in Great Britain in the 1820s. The first railroads in the United States started shortly thereafter. By 1880 the nation had “17,800 freight locomotives carrying 23,600 tons of freight, and 22,200 passenger locomotives.” During the last decades of the 19th century railroads were the largest business enterprises in the United States. In addition, except for the agricultural sector, the U.S. railroad industry was the nation’s largest employer. 

The spread of railroads generated rapid industrial growth, as well as creating a culture of engineering excellence and the modern system of management. The railroads also opened hundreds of millions of acres of farmland that led to agricultural mechanization, which led to lower costs for food and all goods and created a huge national sales market. 

However, railroads were so successful that by the 1870s there were too many competing for too-little freight and passengers. The massive overexpansion led to cut-throat competition. Morgan became deeply involved in the reorganization and consolidation of many financially troubled railroads; he gained control of significant portions of these railroads’ stock and eventually controlled one-sixth of all U.S. rail lines. 

In 1869 Morgan gained control of the Albany and Susquehanna Railroad from two of the largest “robber barons” of the era – Jay Gould and Jim Fisk. 

Morgan’s railroad portfolio grew larger in 1877; after the death of his father, Cornelius Vanderbilt, William H. Vanderbilt sought to sell his family’s holdings in the New York Central Railroad (NYC), one of the four major eastern railroads. Morgan’s firm handled the sale of the NYC stock, which took several years; this resulted in Morgan becoming a director of the railroad.

In 1885 Morgan reorganized the New York, West Shore & Buffalo Railroad; he then leased it to the New York Central. Also in 1885, Morgan brokered an agreement between the NYC and the Pennsylvania Railroad, which were two of the largest railroads in the country. That agreement defused a potentially destructive rate war and rail-line competition between the two railroads.

Overbuilding and duplication of services by the railroads damaged profitability. To reduce the financially harmful competition, Morgan held a meeting in 1885 of key railroad executives. By threatening to block their access to investment capital Morgan convinced them to end the rate wars and other destructive policies.

Then in 1886 he reorganized the Philadelphia & Reading Railroad (Reading Lines), and in 1888 he reorganized the Chesapeake & Ohio Railroad. In the course of reorganizing railroads Morgan generally stabilized their finances. However, as part of the corporate restructurings, Morgan was elected to their boards of directors, which helped him to amass great influence over them. 

Morgan’s control of railroading moved westward in the 1880s; he negotiated financing for the Great Northern and the Northern Pacific railroads, two rival transcontinental lines that ran across the northern tier of the country. 

Following the Financial Panic of 1893 he reorganized several more of the nation’s leading railroads, including the Southern Railroad, the Erie Railroad and the Northern Pacific. Perhaps more importantly, Morgan helped influence the railroad industry to adopt the standard gauge width of track, which facilitated interchange among the various railroads. 

By gaining control of much of the stock of the railroads that he reorganized, Morgan became one of the world’s most powerful railroad tycoons. He controlled approximately one-sixth of all the railroad trackage in America by 1902.

The Interstate Commerce Act

Morgan, Cornelius Vanderbilt, Jay Gould and others became wealthy through their ownership interests in various railroads, many of which were interstate lines. Responding to various monopolistic practices and other excesses of key railroads (and their owners), Congress passed the Interstate Commerce Act and created the Interstate Commerce Commission (ICC) in 1887 to regulate the railroads. 

The ICC was the nation’s first regulatory agency. You can read more about the ICC in previous FreightWaves Classics articles (click here, here and here). 

With the establishment of the ICC, Morgan arranged conferences in 1889 and 1890 of major railroad presidents “to help the industry follow the new laws and write agreements to maintain” the “public, reasonable, uniform and stable rates” mandated by the ICC. The conferences were the first of their kind; competing lines working together was unheard of. As a result of Morgan’s conferences there were more consolidations of key railroads during the early 20th century. 

Trust-busting

The Panic of 1893 was the largest economic depression in U.S. history at that time. It was the result of overbuilt rail lines, as well as poor railroad financing; these began a series of bank failures, which then led to railroad failures. Twenty-five percent of U.S. railroads, controlling over 40,000 miles of track, failed by mid-1894. Among the failed lines were some of the biggest railroads, including the Northern Pacific Railway, the Union Pacific Railroad and the Atchison, Topeka & Santa Fe Railroad. Acquisitions of the bankrupt railroads led to further consolidation of the industry and those who owned it. By 1906, two-thirds of U.S. rail mileage was controlled by seven entities. The New York Central, the Pennsylvania Railroad and Morgan had the largest portions.

The last major event in Morgan’s railroad chapter took place in 1904. As noted above, one of the casualties of the 1893 depression was the Northern Pacific Railway. It went bankrupt; the bankruptcy meant that the company’s bonds were worthless; this subsequently left the railroad debt-free, which spurred a complex financial battle to control the railroad. 

Morgan, New York financier E. H. Harriman and St. Paul, Minnesota-based railroad builder James J. Hill colluded in 1901 to reduce expensive competition in the Midwest. The three created the Northern Securities Company so that they could consolidate the operations of three of the Midwest’s major railroads – the Northern Pacific Railway, the Great Northern Railway and the Chicago, Burlington and Quincy Railroad. This holding company controlled the three major transcontinental railroads from Chicago to the Pacific Northwest. 

However, President Theodore Roosevelt opposed the Northern Securities Company and its purpose. Roosevelt led the trust-busting movement, and he considered the merger as anti-consumer and a violation of the previously seldom-enforced Sherman Antitrust Act of 1890.

Roosevelt ordered the U.S. Department of Justice to sue to break up the Northern Securities Company in 1902. This led to a Supreme Court decision in 1904 that dissolved the Northern Securities Company. The railroads were separated under the decision. Although Morgan did not lose any money because of the actions of Roosevelt and the Supreme Court, it negatively impacted his political and business reputation.