Legend has it that he wrote it in pencil on a slip of paper, perhaps still sweaty from a round of golf. Just one number: $480,000,000. While the fragment has been lost to history, we know J.P. Morgan received it that same day, December 13, 1901. There was no real negotiating, the Wall Street tycoon agreed to the asking price immediately. The final meeting between buyer and seller took just fifteen minutes. At its conclusion, Morgan thrust out his hand and said the famous words: “Mr. Carnegie, I want to congratulate you on being the richest man in the world.”
Not bad for the son of a destitute Scottish weaver. Twelve-year-old Andrew Carnegie arrived in New York City penniless, in 1848. His extraordinary rise to the pinnacle of society is one of the great American success stories—second only to that “First American” himself, Benjamin Franklin. But while Franklin disdained wealth and retired from business as soon as he felt financially secure, Carnegie would pursue it with an unrelenting passion. It was that motivation and instinctive drive to succeed, born in the so-called “Gilded Age,” that would inform later generations of American entrepreneurs and establish foundational business practices we still use today.
A Disruptive Technology
As is so often the case, it started with innovation. In the post-Civil War 1860s, Carnegie was doing well enough, dabbling in telegraphy (he was an accomplished wire operator during the war), oil investments, and even a sleeping car company, but these were mere doubles and triples. In 1872 he met the British inventor Henry Bessemer and everything changed. The Bessemer process dramatically reduced the time required to convert iron to more malleable steel. This wasn’t just another technological advancement, it was disruptive, and Carnegie recognized it immediately. From that time on, he knew his fortune would be made in steel.
His first mill, located at the old Braddock battlefield site outside Pittsburgh, was a marvel for the time, capitalized with almost $1 million. The investment was a major gamble because in 1873 the country was entering one of the worst recessions in its history. The “Long Depression” lasted five years but in hindsight, it may have been the secret to Carnegie’s success.
Costs, Scale and Survival
Steel producers faced intense competition for a dwindling number of railroad contracts causing declining margins that eventually turned red. Only the most conscientious businessman could survive in such an environment. With an almost fanatical attention to expenses and recordkeeping, Carnegie always knew what he could bid and still make money. As one of his executives put it, “Carnegie never wanted to know the profits. He always wanted to know the costs.” At the same time, the depression caused a fall in raw material prices. In 1876 he claimed to be producing steel rails for $50 per ton and selling at $65—a thirty percent markup.
He was keenly aware of the crucial difference between fixed and variable costs. While other mills reduced production and laid off workers during the depression, Carnegie insisted on keeping the mills operating and accepted whatever orders covered equipment costs and overhead. “Don’t be greedy,” he told one subordinate, “small profits & large sales” were what mattered. Every new sale grew his market leverage and boosted economies of scale.
One of the largest variable expenses in steel production would be in an area where he could exert some control—wage labor. Nineteenth-century Robber Barons have been rightfully condemned for their callous labor practices and Carnegie fought unions as ruthlessly as any of them. His worst moment came at his Homestead Mill in 1892 when the forced lockout of Amalgamated Association members resulted in violence and the death of several workers. Breaking the union helped Carnegie thrive during the next great recession, and when it was over, in 1897, his companies produced half the steel in America.
The Power of Vertical Integration
All Carnegie’s nickel-and-dime cost-trimming tactics paled in comparison with his grand strategy: vertical integration. He knew intuitively that controlling the supply and distribution chain meant the ability to manage both productive efficiency and prices. He invested up and down its length starting with raw materials like iron ore and coal. He acquired blast furnaces manufacturing iron and rolling mills producing rails. Carnegie’s most famous deal was the phased acquisition of Henry Clay Frick’s coke company, a move that guaranteed access to the most crucial energy source required in mill production (the two magnates would come to despise each other after the Homestead fiasco). Eventually, in the 1890s, he even invested in finished steel goods, the last link in the supply chain. More than anyone else, Andrew Carnegie invented the business conglomerate.
His sale of Carnegie Steel to J.P. Morgan in 1901 was part of a great merger wave instigated by the famous Wall Street banker. Morgan believed competition was ruining American industry (or, more importantly in his mind, business owners) and the only remedy was massive consolidation in every industry that mattered. But his self-serving justification for the benefits of corporate monopolies arranged by financiers like himself violated basic capitalist, free market principles and they were eventually eliminated (at least in theory) by anti-trust laws.
What This Means for Owners and Advisors
Carnegie’s program of practical business integration changed American industry. Today, M&A transactions can be a legitimate growth strategy for expansion-minded business owners. But they require forethought, discipline, and attention to detail.
- Acquisitions must be rationalized economically and should always be based on a well-defined business purpose.
- Product, vendor, and geographic diversification help mitigate business risk.
- Synergies enhance value through productive efficiencies, redundant cost elimination, and economies of scale.
- Successful business combinations require consideration of non-financial matters, including cultural fit and marketplace reaction.
PCE acts as a trusted partner and skilled team member advising business owners, boards of directors, and other executives throughout the consolidation process. Our professionals possess the knowledge to perform all the critical functions required to bring your transaction to a successful close.
Steven G. Krug, PhD, CFA, is a Director in PCE’s Valuation Group, specializing in valuations for financial reporting, transactions, tax and estate planning, ESOPs, and litigation support. His PhD in history informs his perspective on the evolution of American finance and capital markets.
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