This is the twenty-first in my series of posts about the five businessmen the History Channel profiled in a terribly inaccurate and un-historical TV miniseries titled The Men Who Built America. I’m writing these posts in response to several comments and e-mails from TV viewers who have expressed interest in a more accurate version of the story. (Click here to see all Al’s columns on the program and its subjects.)
Post # 21: Tom Scott’s Business Goes Up in Flames
Thomas Alexander Scott is an important figure in American business history, known both for his role as executive of the Pennsylvania Railroad (or “Pennsy,” as it was commonly known) and for his early mentor-ship of Andrew Carnegie. Scott was the railroad’s vice president for fourteen years, and took over as president upon the death of J. Edgar Thompson in 1874.
Scott showed sober judgement and good foresight throughout most of his career, but in his later years he seems to have developed a streak of arrogance that led him into a couple of strategic blunders that damaged his company and his reputation. The first cost him a fortune and damaged his friendship with Carnegie, and the second pitted him disastrously against John D. Rockefeller, the Standard Oil Company, and a mob of angry proletarians.
Scott was born in 1823 in eastern Pennsylvania. His career started when he was ten years old and his father died, leaving behind a widow, eleven children, and very little money. Thomas had already been working full time for seventeen years when he was hired as a station agent for the Pennsylvania Railroad at the age of twenty-seven.
By the early 70’s Scott had the world by the tail. He was second in command at the world’s largest corporation, the Pennsylvania. His investment portfolio was enviable; in addition to his Pennsylvania shares he held stock in most of Andrew Carnegie’s companies, all of which did business with the Pennsy, and all of which were thriving.
In 1872 Scott joined forces with other eastern Railroad industry investors to take over the Texas and Pacific Railroad Company (the “T&P”). The road amounted to little more than a government land grant stretching from western edge of Louisiana border through Texas, New Mexico, and Arizona to San Diego CA. When Scott took over the line it had no trains and no tracks.
The business model followed by most American railroad companies from the end of the Civil War through most of the year 1893 was to borrow money and spend it laying down as much new track as possible. Scott and his partners were following this model with the acquisition of the T&P. Once the road was built it would make greatly increase the Pennsylvania’s territory. Through a connecting line that he controlled between Texas and St. Louis he would be able to tie the T&P to the Pennsylvania and run a truly transcontinental system to rival the Union Pacific.
Despite its obvious potential, the T&P was a money pit in 1872. Scott and his partners would have to finance every inch of track they laid with borrowed money until an infrastructure that could start generating some revenue was in place. After investing a quarter of a million dollars at Scott’s urging, Andrew Carnegie became concerned about the company’s tenuous financial situation and refused to invest or lend any more money. He also refused to accept a management position.
In September of 1873 a similarly over-leveraged railroad failed in the northern United States, defaulted on its debts, and caused the default and bankruptcy of the bank that had been extending it credit. This first disaster started a chain reaction of railroad and bank failures that changed the business model of American railroads overnight.
With their credit dried up and their business temporarily reduced by a general economic depression, railroad companies focused on attracting business to the roads they already had. Scott was prepared to follow this new strategy for the Pennsy, which operated on highly profitable routes between western agricultural lands, the oil wells and refineries of Pennsylvania, and the population centers of the eastern seaboard.
The T&P, however, still had no established routes to operate. When the crisis hit, Scott found himself badly over-extended in the south. He again turned to Carnegie for help, asking him to co-sign for the large loan he was trying to get from Junius and JP Morgan to keep track construction going in Texas. Despite their longtime friendship, Carnegie refused. The Texas and Pacific Railroad was forced to declare bankruptcy.
Scott never forgave Carnegie for refusing to co-sign for him, and the subject continued to be a sore one for Carnegie long after Scott’s death in 1881.
Scott’s next major blunder came after he had taken over as president of the Pennsylvania. The year was 1877, the year Cornelius Vanderbilt died. The nation’s economy was growing, and the railroads were hauling more tons of freight than ever before, even though they still weren’t laying new tracks to any great extent. The state of Pennsylvania was still the only place on earth were petroleum was being pumped from the ground, and shipments of crude oil and refined kerosene were a cash cow for the Pennsy.
John D. Rockefeller’s Standard Oil Company was by far the largest refinery company in the world. Under Rockefeller’s leadership the refinery business had become so efficient, and kerosene so affordable, that whale oil had become obsolete. In one of those interesting little footnotes to history, Rockefeller and his management team probably saved several whale species from extinction.
Standard owned or controlled refineries all around the eastern United States, including several in Pittsburgh, but the company’s largest and most lucrative operations were in Cleveland.
Scott and the Pennsy had a history of clashing with Rockefeller and then making peace; as far back as 1868 newspapers had carried accounts of someone in the Pennsy management claiming that the whole city of Cleveland would be “wiped out as a refining center as with a sponge.” Rockefeller’s response in ’68 had been to boycott the Pennsy, make other arrangements to get crude from the Pennsylvania wells, and ship all his refined products via the two other railroads that served Cleveland.
The 1868 conflict quickly blew over; as soon as Scott and Thompson realized their plans weren’t going to work they came back to Rockefeller asking for, and eventually getting, a share of his business. The 1877 attack on Rockefeller’s company, however, was a different matter. It backfired in ways that did long-term damage to the railroad. The difference was mob violence that caught both Rockefeller and Scott by surprise.
In 1877 the Pennsy, operating through a subsidiary company the Empire Transportation Company, bought up several smaller refineries and operated them in competition with Standard Oil. Empire also started construction on a pipeline network to channel crude oil from new oil fields away from Rockefeller’s refineries to its own. The railroad gave preferential freight rates to it’s Empire refineries to give them an advantage over Rockefeller’s.
In the spring of ’77 two thirds of the oil the Pennsy carried was still coming from Standard, although clearly the company intended to make their own refinery output grow as fast as possible. Rockefeller warned Scott that if the railroad continued to function as a direct competitor, he would begin to treat it as such.
When Scott ignored his threat, Rockefeller boycotted the Pennsylvania, shutting down all his refineries in Pittsburgh. He ordered his operations in Cleveland and elsewhere to increase output to make up for the lost Pittsburgh production. He negotiated with railroads owned by William Vanderbilt and Jay Gould, both of whom were eager to help, for advantageous freight rates.
Having the most efficient organization in the industry, Rockefeller then brought to bear the most powerful weapon anyone can have in a commodity market; the lowest production cost. He cut prices in Empire’s target markets to levels low enough to force Empire and the Pennsylvania to lose money on every sale, but still high enough for Standard to make a profit.
The loss of Standard’s business forced Scott to reduce the number of trains in operation. The revenue the Pennsy was able to make hauling grain and other products went to subsidize money-losing shipments of Empire kerosene. To cut costs, Scott laid off hundreds of workers, and cut wages by twenty percent for those he still employed. He even tried to increase the work load on each employee by running longer trains.
The Baltimore and Ohio Railroad, a much smaller road that also served the Pittsburgh area, suffered as much as the Pennsy from Rockefeller’s shut-down of his Pittsburgh refineries. When the B&O imposed the same layoffs and wage cuts as the Pennsylvania, its workers went out on strike, followed in short order by the Pennsy workers. (The B&O and the Pennsy were the only railroads serving Andrew Carnegie’s steel mills, so for the duration of the strike Carnegie couldn’t get raw materials in or products out.)
If the worker’s had just been patient, it’s probable that Scott would have capitulated both to them and to Rockefeller after a time. The Pennsylvania’s stockholders could not have enjoyed watching their trains sit idle while the competition made enhanced profits. At some point Scott might well have ended the feud with Standard Oil, restored the workers’ wages, and resumed full scale operations.
Unfortunately for all concerned the workers allowed their rage to get the better of them. They burned down hundreds of tanker cars, over a thousand freight cars, and two or three dozen buildings, including at least one that was full of National Guard soldiers at the time. They even found some way to destroy over a hundred locomotives.
When the soldiers tried to fight their way out of the burning building armed strikers opened fire, and many men were killed on both sides.
When the mayhem was over Scott belatedly opened negotiations with Rockefeller in an attempt to get the trains he still had left back on the tracks. Rockefeller agreed to buy the Empire Transportation division from the railroad, re-open his Pittsburgh refineries, and resume doing business with the Pennsy. Scott’s company was so badly damaged that they had to suspend their dividend and negotiate a large emergency loan from the JP Morgan just to stay in operation.
Left-leaning historians like Eric Foner have celebrated nineteenth century union violence as a pathway to workers’ rights, but in the case of the 1877 railroad strike violence was a lose-lose proposition. The strikers killed or wounded in gun battles were not the only workers who suffered as a result of the violence. Having lost so much expensive infrastructure, the Pennsylvania was in no position to resume carrying the volume of freight, or employing the number of workers, of its pre-strike days. Through arson and vandalism the workers had literally destroyed their own jobs on a long-term basis.
The only real winners were Gould, Vanderbilt, and the Pennsy’s other competitors. With the Pennsylvania no longer able to serve its customers, the other railroads stepped in. Scott, somewhat surprisingly, kept his job as president of the railroad, but the company he led would never again be as dominant as it had been.
The workers’ willingness to destroy the very facilities where they had been making a living was something American businessmen would remember. Companies started taking steps to protect their property during strikes. Henry Clay Frick, a self-made millionaire in the coal business, was clearly paying attention; fifteen years later he would face a similar situation as the manager of Andrew Carnegie’s Homestead steel mill. The Homestead strike ended up being almost as violent as the ’77 railroad strike, but Frick did manage to keep his workers from destroying the factory that employed them.
Next week’s post will be about Carnegie’s negotiations with the Pennsylvania in the 1880’s.
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