45-855 Railroads, The First Big Business: Topic 4

4. Railroads as Big Business
   
   
1. Rival Transportation Systems: 1800-1840
   
   

1. The Turnpike Era: 1800-1820 – By 1800 there were about 20,000 miles of post roads in the United States. These were federally subsidized (the subsidy was not very great) roads used to deliver the mail (in the same sense that the superhighway system – "Defense" highways -- built by General Eisenhower were used to move armies around the U.S.!). Article I, Section 8, Paragraph 7 gives Congress the power to establish a Post Office and Post Roads.
   
   
1. These were not high quality roads. Independent local construction companies built and maintained them and they were largely financed by labor services.
   
   
2. The British blockade of the U.S. coastline south of New London, Connecticut during the War of 1812 had the effect of highlighting the need for a better internal road network.
   
   

3. This helped stimulate the construction of privately financed turnpikes. By 1830 almost 12,000 miles had been constructed. Some were very well constructed and were "macadamized".
   
   
4. Most of the turnpikes went bankrupt and even the well-built and well managed ones only had a return of 3 to 4 percent on invested capital. The charges to shippers were high running about 12 to 17 cents per ton-mile. Long distance traffic was the chief source of revenue because rates were too high for short distance traffic.
   
   

5. Transportation costs from Buffalo to New York City in 1817 when construction began on the Erie Canal were three times the market value of a bushel of wheat and six times that of a bushel of corn. Small wonder that upstate New York commodities were not being shipped in large quantities to New York City!
   
   
2. Canals: 1825 – 1840
   
   
1. The Erie Canal – The completion of the Erie Canal in 1825 dramatically lowered transportation costs and set off a canal building boom. The annual net gain on the Erie Canal over its first decade of operation, 1826 – 1835, was about 8 percent of its total construction cost per year! The Erie Canal helped make New York City such a large trading center that it accounted for 50 percent of all U.S. foreign trade and duties collected. Small wonder then that it touched off a canal building boom in the U.S.
   
   

2. The Canal Building Boom – From 1815 – 1834 $58.6M was spent on canal construction of which $41.2M were public funds. From 1834 – 1844 $72.2M was spent of which $57.3M were public funds. And from 1844 – 1860 $57.4M was spent of which $38.0M were public funds.
   
   

1. The problem was that the Erie Canal was the only one that made money! Geography had been kind to New York State. The Mohawk river valley ran from the flat lands near the Great Lakes to the Hudson River so that the Erie Canal only required 655 feet of lockage over its entire length!
   
   
2. In contrast, the Philadelphia Business and Political leaders were faced with the horrendous task of building a canal across Pennsylvania which would require 3,358 feet of lockage and a four mile tunnel to get canal boats to Pittsburgh. The tunnel was totally impractical so a portage railroad had to be constructed to get the barges between Hollidaysburg and Johnstown. By this time, 1825, steam locomotive power was successfully used on a railroad line in England (27 September 1825, the Stockton and Darlington Railroad). There was a debate about whether or not to build a railway but the canal supporters won. Construction began 4 July 1826.
   
   
3. The Pennsylvania Canal was a huge financial disaster. The "Main-Line" cost about $33M to build with interest costs of $43.5M for a total of $76.5M. Revenue was only $8M and the whole system was eventually sold for $11M making the total loss to Pennsylvania taxpayers $57.5M!
   
   
3. The Western Canals – Other than the Erie Canal, the eastern canals had little long run impact upon the economy. What did have a big impact on the economy were the canals built in the West from 1845 – 1860. These canals which were built in Ohio, Indiana, and Illinois diverted freight traffic out of the north-south river system and into the Great Lakes. The Great Lakes had been made navigable by a series of canals the connected them. The most important of these were the Welland Canal from Lake Ontario to Lake Erie bypassing Niagara falls, built in 1833, and the Sault-Saint Marie or "Soo" Canal built in 1855 that linked Lake Superior and Lake Huron. This latter canal allowed Duluth, Minnesota and Thunder Bay, Ontario to be ports and provided an outlet for the grain of the Dakotas and abundant minerals in Minnesota and the upper Peninsula of Michigan. The effect upon New Orleans was dramatic. In 1835 70 percent of Western exports of flour, 98 percent of corn, and 95 percent of whiskey went through the port of New Orleans. By 1860 the percentages were 22, 19, and 40, respectively.
   
   
2. The Early Railroads
   
   
1. Earliest Steam Railroads – The first regularly scheduled public steam train ran on the Stockton & Darlington Railroad in England on 27 September 1825. The first regularly scheduled public steam train to run in the U.S. was in Charleston, South Carolina on 25 December 1830. However, that August, the Tom Thumb made a 13 mile run from Baltimore to Ellicott’s Mills pulling a single car carrying the Directors of the B&O. Almost a year later, on 9 August 1831 the DeWitt Clinton pulled a train between Albany and Schenectady, New York. In another landmark, the John Bull went into service on the Camden & Amboy on 12 November 1831. A mechanic, Isaac Dripps, working for the C&A modified the British built locomotive so that it had a tender (a first) and a play in the leading axle so that it handled curves better. Later he invented the two-wheeled "cow catcher" on the front of the locomotive which not only helped the locomotive navigate curves but also helped with stray cows on the tracks. (The C&A also pioneered the "T" rail which became the standard railroad rail.)
   
   

2. The Early Railroad Corporate Charters – Railroads were a unique form of "highway" and no one knew when they first began as businesses how they were to so sharply diverge from turnpikes and canals. When the B&O first opened for business anyone was allowed to use the tracks for a fee. Wagons equipped with the proper wheels and pulled by horses were used on the tracks. It soon became obvious to everyone that this model was not going to work. Even with occasional sidings, wagons met going in opposite directions and there was nowhere to "pull over" as there was on a canal or on a turnpike. It quickly became apparent that railroads had to both own the right-of-way (the highway) and the rolling stock used on the highway.
   
   
1. Railroad corporate charters were granted by the States. In the beginning, this required special legislation but later on general laws were enacted that set up a formal administrative procedure to grant articles of incorporation. The transcontinental "Pacific" railroads were the only ones to receive charters from the Federal Government.
   
   
2. Recall that a Corporation is a fictitious person created by law and endowed with many of the functions of a human being. Normally a corporation is an aggregate of persons and has an existence independent of its members. It may possess property and a treasury distinct from its members, and debts due to or by the corporation are not debts due to or by the individuals composing it. Corporations can sue and be sued and they can be criminally prosecuted, fined, and dissolved by the sovereign. In U.S. law the Supreme Court has extended portions of the Bill of Rights to corporations (e.g., within limits, freedom of speech).
   
   
3. The early railroad charters were very loosely written and gave the corporation great leeway. The charters usually set the number of directors, the amount of capital stock (this was oftentimes way out of line with the size of the railroad), the borrowing authority (usually very vague and subject to great abuse in the 19^th Century), annual reports, the description of the route along with the required crossings.
   
   
4. Most importantly, and the reason why railroads were very unusual, the State would grant the railroad the power of eminent domain (that superior dominion of the sovereign power over property within the State which authorizes it to appropriate it for public use). Without such power, the railroad could not construct its line over the best possible route without being blackmailed by property owners. However, it was a two edged sword as it made the railroads politically vulnerable to those who lived along its right-of-way.
   
   
3. The Railroads Eclipse the Canals – By 1840 there was about 3000 miles of railroad trackage in the United States – almost the same mileage as the canals. By the Civil War about $1.2B (1909 $$) had been invested in the railroads of which about 25 to 30 percent was government funds. By 1849 freight receipts exceeded passenger receipts.
   
   
3. The Railroad Decade: 1850-1860
   
   
1. Between 1850 and 1860 22,500 miles (36,000 km) of railroad line were built increasing the total mileage from 7,500 in 1850 to 30,000 in 1860 (in kilometers 12,000 and 52,000 respectively). Of the total built in this decade, 10,000 miles (16,000 km) were built in the Midwest.
   
   
2. In 1849 Chicago only had one short line. By 1854 Chicago was the leading rail center in the U.S. In 1856 a railroad bridge is built across the Mississippi river at Rock Island between Iowa and Illinois allowing the shipment of Midwestern grains directly to Chicago via rail.
   
   
3. Before 1850 the great majority of the agricultural products of the Mississippi valley went south through New Orleans (see above). By 1860 the railroads had largely taken over this traffic from the Mississippi river and the western canals. By 1860 Illinois, Indiana, and Wisconsin replace Pennsylvania, New York, and Ohio as the leading wheat growing states.
   
   
4. The railroads quickly become the dominant form of transportation. Reasons:
   
   
1. Greater Speed – For the first time in human history man is able to travel faster than a galloping horse on land.
   
   
2. Open Year Around – Railroads could run in the rain, snow, ice and cold. Consequently, goods could be shipped year around anywhere in the country so that businesses could now run year around as well.
   
   
3. Less Transshipment – Before the railroads, getting a shipment of supplies for a dry goods business in Cleveland, Ohio was a formidable task. The goods first had to be purchased from wholesalers in New York City. Then transportation to Cleveland had to be arranged. Typically this meant shipping the goods up the Hudson River on a steamboat to the entrance of the Erie Canal. The goods would then be transferred to a canal boat for shipment to Buffalo. From Buffalo they would be transferred to another steamboat for the trip across the lake to Cleveland. If the business was inland from Cleveland, they the goods would have to be unloaded in Cleveland and transferred to wagons for the journey inland. Arranging these complicated shipments – my example is a simple one – was a job for experts. Both James J. Hill and John D. Rockefeller were commission merchants early in their illustrious business careers.
   
   
4. Concentrated Responsibility – This is just another aspect of the previous point. Shippers could deal with a single freight agent and arrange to ship their goods over long distances.
   
   
5. As the railroads grew ever larger, they captured an increasing percentage of the freight business and their productivity grows by leaps and bounds. In the 1830s freight rates were about $.075 per ton mile and passenger rates were about $.05 per mile. By 1859 these rates had fallen to $.0258 and $.0244 respectively. During this period the 8-wheel freight car is introduced, rail weights increase from 13.5 pounds per foot to 59.5 pounds per foot (still iron rails – steel rails began to be used extensively in the 1870s), locomotives got larger, and overall, the capital/output ration goes form 10:1 to 5:1.
   
   
6. By 1860 on the eve of the Civil War rail passengers could travel from St. Louis to Boston in 48 hours or from New York to Charleston, South Carolina, in 62 hours.
   
   
4. The Trunk Lines as Big Business
   
   
1. You cannot point to a specific date and say "that was the first big business". Like most things, they emerged slowly with much trial and error but clearly by the early to mid 1850s the great Trunk Line Railroads – the New York Central, the Pennsylvania, the B&O, and the Erie – were big businesses with recognizably "modern" management structures.
   
   
2. In 1851-52 The Erie reached Dunkirk, New York, the Pennsylvania reached Pittsburgh, PA, and the Baltimore & Ohio reached Wheeling, WV. In 1856 the Pennsylvania RR acquired working control of the 468 mile long Pittsburgh, Ft. Wayne, and Chicago Railroad giving the Pennsylvania a continuous route from Philadelphia to Chicago.
   
   
3. By 1856 telegraph control of railroad operations became widespread. In the beginning, the telegraph companies were independent companies that paid for the privilege of putting their poles along the railroad’s right-of-way. Some railroads took over the telegraph operations themselves while others continued to contract the service out. Every railroad station had a telegraph operator.
   
   
4. The trunk lines that were completed by the mid-1850s were literally forced to pioneer what became new ways of corporate management. No railroads before this period had the traffic volume and/or mileage to raise complex administrative problems.
   
   
5. In 1855 before the Pennsylvania acquired the PFW&C, it cost about $2M to run the railroad. In comparison, the largest comparable non-railroad businesses were the huge New England textile mill complexes and they were only about $.3M to run the largest of these mills. By the late 1880s the Pennsylvania employed over 50,000 men – an order of magnitude change from businesses before the Civil War.
   
   
6. The trunk line railroads were spread over a vast territory. Shops, terminals, stations, warehouses, office buildings, telegraph lines, bridges, roadbeds, all had to be administered and maintained.
   
   
7. Coordination was complex. Every day stations loaded different amounts of freight and every day there was a variety of traffic that had to be dealt with. Cargoes were unpredictable – it could come from anywhere and go anywhere.
   
   
8. Consequently, short run decisions had to be made daily (accepting and directing large quantities of freight daily); and long run decisions had to be made about what level to set freight rates (see Topic 6).
   
   
9. With such complexities, complex organizational structures evolved to handle them. Consider the textile mill – the works could be viewed within an hour and decisions could be made slowly. In contrast, the railroad was spread over a large area and weeks were required to view all of the physical plant. Decisions had to be made quickly – the condition of the freight and the safety of passengers required it. Consider a canal – it was also spread over a large area but the canal did not run, maintain, or repair the equipment used upon it! The locks could run, ceterius paribus, independently, and barge speed was slow.
   
   
10. For these reasons, the B&O, the Erie, and the Pennsylvania all made important contributions to the science of modern management. Between them they fashioned the earliest large-scale administrative structure in American business.
    
    
5. Management Innovations of the Trunk Line Railroads
   
   
1. The earliest railroads used the same simple form of business organization that almost all other businesses used at that time – the unified or entrepreneurial form of organization. This was the traditional owner-controlled facility in which the owner made the day-to-day operational decisions and set long term goals.
   
   
2. The B&O was the first to separate the management of financial and accounting activities from those of moving trains and obtaining traffic. This change was due to the fact that the sheer volume of transactions grew so large that it became a formidable management problem – conductors, freight agents, station agents, and so on, brought in a river of coin. No other business had ever seen this massive volume of transactions.
   
   
3. In the 1850s Daniel McCallum of the Erie Railroad perfected the operations department (responsible for moving trains and obtaining freight and traffic business) and devised the system of information flows using the telegraph. He was the first to clearly define the duties and responsibilities of the executive and administrative officers on a large railroad and to spell out the lines of authority and communication between the various officers of the road. Part of this scheme was a detailed system of information that flowed upward through the organization using the telegraph.
   
   
4. Brief summary of McCallum’s organizational structure for the transportation department: At the top was the General Superintendent. Underneath him were
   
   
1. Masters of Engine and Car Repairs – Responsible for the condition of locomotives and shops.
   
   
2. Car Inspectors
   
   
3. General Freight Agent – Supervision of freight charges and the setting of freight rates. He negotiated contracts with shippers and handled loss and damage claims.
   
   
4. General Ticket Agent – Supervised all passenger ticket matters and negotiated ticket arrangements with other railroads.
   
   
5. General Wood Agent – Responsible for supplying the wood for the locomotives and for storing it along the road.
   
   
6. Superintendent of Telegraph – Responsible for the construction and maintenance of telegraph lines and for the telegraphers.
   
   
7. Foreman of Bridge Repairs – Inspected and was responsible for the repair of bridges
   
   
8. Division Superintendents – These men were in charge of day to day operations on about 125 miles of road (determined by natural geographic boundaries). Underneath them would be the station managers, the division level officers corresponding to those at the headquarters – a) to g) above.
   
   
5. In the 1870s Albert Fink of the Louisville & Nashville perfected a detailed cost accounting system that was widely copied throughout the American railroad industry. Fink’s system made control through statistics a reality. Fink’s system had 75 specific categories (some of which were totals) divided into 4 general areas:
   
   
1. Movement Expenses – These were largely variable costs dealing with the movement of trains.
   
   
2. Station Expenses – These were partly variable and partly fixed costs. The stations always had to be manned regardless of traffic but the greater the traffic the greater the number of laborers needed to load and unload freight.
   
   
3. Maintenance of Road – These were variable costs but with a floor. That is, because of weather, regardless the level of traffic, a minimum of maintenance had to be done. However, as the traffic increased so did the wear and tear of the road.
   
   
4. Interest – This was a fixed cost.
   
   
6. Fink devised elaborate formulas to precisely calculate the ton-mile cost corresponding to these four categories. This allowed him to at a glance tell which portions of the railroad were costing more to operate than other portions and the reasons for the costs. This system was very influential and widely copied by other railroad managers.
   
   
7. By the 1880s the operations department was split into the transportation department that handled the movement of trains and the traffic department that was responsible for obtaining business. This produced the three great functional departments: Finance, Transportation, and Traffic.
   
   
8. These three departments coupled with the line and staff form of organization invented by J. Edgar Thomson of the Pennsylvania Railroad, plus Fink’s cost accounting system, created the standard railroad management structure that was to last well into the 20^th Century.
   
   
9. This form, known as the U-Form, spread rapidly to other industries becoming the de facto standard. This form of management set up functional departments in centralized offices with middle managers responsible for the specified functions. The line and staff form ensured that staff managers at the central offices received information flows from the line officers in charge of running the day to day functions of the business. This information flow was used to create overviews of the entire organization that allowed for greater statistical control and increasing efficiency in the operations as well as provided for efficient long range planning. All of this was pioneered by the railroads.