Dynamics of Competition. In the late 1800s railroads were not like any other business. They required enormous outlays of capital to complete initial construction and consumed more money to keep trains running. In fact, a railroad’s fixed costs ran high: no matter how much freight a railroad was shipping, it had to pay for track and engine maintenance, as well as salaries for thousands of workers, not to mention the costs of servicing the debt incurred to build the line in the first place. In other words, it cost nearly as much money to run empty trains as it did to run full ones. And no railroad could afford to shut down operations for any period of time. Therefore when a railroad faced competition for traffic, it usually became desperate and began to cut rates—either directly or by offering large shippers rebates. In fact, from a manager’s point of view, it often made sense to charge shippers less than it actually cost the railroad to ship their goods, in order to attract or keep business from competitors. By the 1890s railroad competition had grown fierce indeed. Though farmers and small businessmen loudly accused the railroads of monopolizing transportation to markets, the railroads frequently found themselves locked into ruinous competition with each other.
Feverish Construction. Over the course of the 1880s new railroad construction occurred at a frantic pace. Approximately 71,000 miles of track were laid over the decade; in 1887 alone, 12,876 miles were built, more than any other year in the nation’s history. By this point the railroad network in key regions was becoming overbuilt; financial speculation was driving construction, and competing lines were racing to put down track in order to lay claim to the best sites. Coupled with the fundamental operating dynamics of railroad finance, this reckless expansion set off major financial turmoil in the industry—turmoil that reverberated throughout the national economy. In the wake of the Panic of 1893, nearly two hundred railroads went into receivership, representing forty-one thousand miles of track and about $2.5 million of capital. By 1895 one-third of the nation’s railroad mileage was in bankruptcy.
System Building. Meanwhile, beginning in the 1870s, two lines, the Pennsylvania Railroad and the Baltimore & Ohio Railroad, completed the country’s first integrated systems—in each case connecting a web of small feeder lines with large trunk lines that ran for thousands of miles and linked cities in the Northeast and Midwest, the heart of the nation’s burgeoning industrial economy. Before this development, many had predicted that any railroad running more than five hundred miles would be too expensive to build and too complicated to run. However, the successful expansion of the Pennsylvania and the B & O signaled the future of the industry. Only the right conditions for consolidation were needed for other system builders to follow the example.
Gould. In the competitive chaos railroad managers struggled to make profits and gain control of the industry. In the 1880s they tried repeatedly to implement regional associations in efforts to set profitable rates and allocate traffic between competitors. However, these efforts lacked effective enforcement mechanisms and repeatedly broke down until a leading railroad magnate decided to voice his opinion. Jay Gould, who had driven much of the aggressive expansion of the previous decades, attended meetings of railroad investors convened by financier J. P. Morgan in 1888 and 1890. At these meetings he urged the formation of a central railroad cartel to set rates and distribute shipping among the various roads.
“Morganization.” By 1890 many railroad owners and investors distrusted the financier who had driven so much of the competitive construction he now decried. Only Morgan held the financial prestige and credibility needed to pull off the ambitious task of reorganization. Therefore it was Morgan, with the millions of dollars of investment capital he and his affiliates controlled, who dominated the consolidation and reorganization of the nation’s railroads, adopting a strategy that became known as “Morganization.” Taking advantage of spreading railroad collapses, Morgan acquired bankrupted roads, infused them with enough new capital to survive, implemented strict cost cuts, and oversaw agreements with competing lines to reduce unnecessary competition. He then set up mechanisms to control the company—typically a voting trust of investors — for a period of years following reorganization to ensure that agreements were observed. Using variations of this essential formula, Morgan built the Southern railway system and reorganized and revitalized the Erie, Philadelphia & Reading, Northern Pacific, and other major lines. This consolidation of railroads during the 1890s moved the industry out of financial devastation and into the twentieth century.
Vincent P. Carosso, The Morgans: Private International Bankers, 1854-1913 (Cambridge, Mass.: Harvard University Press, 1987);