Engines That Move Markets (2nd Ed)

by Alasdair Nairn

  The Brush stock market bubble

  The private sector lost no time in exploring the possibility of developing a profitable alternative to the gas monopolies. To take advantage of the potential profits to be earned in Great Britain, Charles Brush established the Anglo-American Brush Electric Light Corporation in 1880. By early 1882 more than £9m had been raised in Britain to supply electric lighting, both by subsidiaries of the corporation and other companies, most notably the Hammond Company. The equivalent fundraising today would be roughly $3.5 billion!

  This laid the foundation for the so-called ‘Brush Bubble’, which was to burst 12 months later in 1883 after it became apparent that arc lighting was unable to compete commercially with gas lighting. The bubble, which led to rapidly rising share prices of the electric arc companies, was inflated by the positive sentiment surrounding their future and by anticipation of the potential demise of the gas companies’ monopoly position. Contemporary financial commentaries reveal a mounting enthusiasm for the new threat to gas lighting. The shares of the Anglo-American Brush Electric Light Corporation had risen sevenfold over this short period, while those of the Hammond Company had more than quadrupled. The case for investing in these two concerns came from their licensing arc lighting technology to regional operating companies. Large numbers of these regional companies had been launched on the back of the overpowering enthusiasm for electricity in general, and arc lighting in particular. Typically, the companies were named after the geographic region for which they had the rights to the Brush technology. There were therefore companies such as the Yorkshire Brush Company, and the Warwickshire Brush Company, very similar to Brush franchises in the USA such as the California Electric Company.

  Helping to generate end demand for a product was not a new business strategy even in the 1800s. Before installing arc lighting, a large amount of initial capital was required to fund the cost of the necessary infrastructure. If co-funding could help Brush expand the potential market, then the returns to his manufacturing concerns would increase accordingly. His decision to help establish the operating companies was assisted by the fact that the level of excitement in the market caused the share prices of the operating companies to rise immediately to a premium, based solely on the expectation of future profits. The Brush investment not only assisted product sales; it also brought an instantaneous capital return from the share premium – or this is how it would have seemed at the time.

  4.3 – Scientific acclaim for a new technology that failed: the case of Brush lighting

  Source: Scientific American, 15 January 1881.

  The key question was whether the new technology would actually prove to be a cost-efficient advance on the existing system of gas lighting. With the excitement of the era and the appearance of almost instantaneous profits, it was taken as read that arc lighting would eventually prevail. Those who doubted this were derided as unimaginative and unable to understand the implications of the technological change which had taken place, much as was to happen in the Internet bubble more than 100 years later.

  Among all the excitement, some among the financial community did retain a veneer of restraint. There were references to the “greed of promoters”, and to the possibility that speculators or those seeking instantaneous profits on new issues, “the mere premium-hunting class”, were inflating prices. It was often explicitly acknowledged that the volume of new issuance was likely to saturate the market. Even so, a recurrent theme was that, notwithstanding any excesses, the prospects for electric light were so strong that profits would inevitably result.

  4.4 – Another false start: investor acclaim for arc lighting

  Source: Money Market Review, 12 November 1881.

  Human nature being what it is, investors readily interpreted these warnings to mean the share prices would continue to rise, though maybe not as fast as they had up to that point. Reinforcing this message were supposedly cautionary notes that were likely to have the exact opposite effect. For example: “A telegram has been received this week from New York stating that the 200 dols. shares of the original American ‘Brush’ Company actually command 7,000 dols. In other words, 40 pounds sterling is actually worth 1,400 pounds sterling!”

  The roots of arc lighting’s failure

  The gas lighting industry had not been idle in the face of the threats posed by electric arc lighting. In 1886, the incandescent gas mantle was developed and patented by Carl Auer von Welsbach. This dramatically upgraded the quality of gas lighting and was to help sustain the competitiveness of the gas lighting industry into the 20th century. For the most part, the sites where arc lights had been tried returned to gas lighting. Arc lighting simply could not provide the correct type of light on a reliable and commercial basis. Companies such as the American Brush Company and its British sister, the Anglo-American Brush Electric Company, gradually disappeared from sight, either going into liquidation or being acquired by their incandescent competitors.

  Other early pioneers of arc lighting survived, mainly as a result of discovering that developmental work done to assist with lighting also had alternative applications. Thus gas lighting comfortably saw off the competitive threat of the arc light, underlining how existing participants in an industry always react to an external threat. Threatened companies usually seek to upgrade their existing product and reduce its price. On some occasions, this is sufficient to retain the market. In others, the technological gap remains too large and the incumbent company either goes out of business or embraces the new technology itself. Whatever the result, forecasts of profitability for a new technology often overstate its real economic potential, as they ignore the fact that there will be a competitive response. For new entrants, finances are invariably limited, and the inevitable competitive response produces worse-than-expected cash flow. As a consequence, even when the technology actually does prove to be superior, receivership and bankruptcy are still frequently the result.

  History records that investors lost huge sums of money by investing in the arc lighting companies. The losses were not a result of a misguided view of electrical light as providing a prospective technological breakthrough. Eventually that breakthrough came. The problem was that this branch of the technology could not provide the type of light required for widespread use, nor could it compete commercially, even in smaller specialist segments of the market.

  Whether arc lighting might have eventually become viable against gas lighting will never be known, because arc lighting was itself supplanted by a superior electrical lighting technology. The arc lighting companies were aware of these threats. They knew there would be competition to replace gas lighting. They were conscious of the need to see off the threat of incandescent lighting. They were encouraged, however, by the prevailing body of evidence which supported the view that light could not be subdivided – something which, if true, meant that the incandescent lamp was doomed to failure. (Subdivision here refers to the dilution of the intensity of light.)

  Arc lighting established a firm beachhead on the strength of its early successful deployment, and in public the arc lighting companies continued to point to the inroads the technology had made and to reiterate the scientific obstacles to development of alternatives. This was to prove a dangerous strategy, as it encouraged competitor companies to put their energy and resources into the development of subdivided light. They were eventually successful, sealing the fate of those companies who had either spurned this track, or followed it only halfheartedly. The eventual fate of the Brush Company was to be bought by Thomson-Houston, one of its competitors in this new field, which had scrambled to obtain access to incandescent lighting.

  4.5 – New technology’s practical ability questioned, old technology triumphant

  Source: Commercial and Financial Chronicle, Investors’ Supplement, 28 December 1878.

  Next step: the incandescent lamp

  In 1848 Joseph Swan had successfully demonstrated the principle of an incandescent carbon filament lamp. An incandescent elec
tric lamp produces visible light when its filament is heated to ‘incandescence’ by the flow of electricity. Unfortunately, the absence of a suitable power source and the inability to create the necessary sustained vacuum within the lamp meant that it was effective only as a demonstration. It was fully 30 years later – following two further inventions, the mercury pump (1865) and the dynamo (1871) – before Joseph Swan was able to demonstrate to the Newcastle-upon-Tyne Chemical Society a practical example of the incandescent lamp he had proposed so many years before. This lamp had distinct advantages over arc lights in that it did not carry the same intensity of light and was much more suitable for domestic purposes.

  In 1879 Swan marketed his first lamp at 25 shillings each, equivalent to $500 today, and one year later applied for his first patent. In the US, Thomas Edison had followed a similar path. He filed in both the USA and the UK a patent on his incandescent carbon filament lamp. A dispute over patents in 1881 was eventually solved by merging the UK companies of the two inventors. The Edison Electric Light Company merged with the Swan Electric Lighting Company to form Edison and Swan United Electric Company. By 1881, improved production methods had allowed the price of the Swan lamp to fall, albeit to the still sizeable outlay of 5 shillings per lamp ($80).

  While the incandescent lamp might have fallen in price and now represented the main threat to gas lighting, it was not a unified and obviously successful competitor. There were questions about the durability and cost of the lamp itself. An internal battle about the most suitable power source raged among its proponents. A layman would have had little chance of predicting the outcome to the debate; both sides had supporters who rank as historical figures in the field of physics.

  In the establishment camp, which favoured the existing direct current (DC) power source, were individuals such as Thomas Edison, Rookes Crompton and Lord Kelvin. Against them stood equally imposing figures such as George Westinghouse and Sebastian de Ferranti. The debate took place on more than one level. There was the scientific level with the presentation of papers to learned and august professional bodies. There was also a battle for public perception. As in any technology battle, the participants required constant injections of new capital. Without a perception of success, this capital was unlikely to be forthcoming, so maintaining optimism was vital. Luckily, this was something which Edison, for one, fully understood.

  Thomas Edison enters the field

  Although the development of electric light does not begin or end with Thomas Edison, he is undoubtedly the central figure in the story and one of the technological giants of the 19th century. He was a prolific inventor, with more than 1,000 patents to his name. Most of the leading financiers of the day, including Gould, Morgan and Rothschild, were involved in ventures of his in some shape or form. Many of these were commercial failures, but others were not. His lighting company eventually was to become General Electric, while many electric utilities in the USA began by franchising his technology, and still bear his name today.

  The rave reviews for arc lighting, together with the associated fields of electric motors, may have stimulated Edison to devote his energies to finding a practical electric light source. He set himself the target of producing an incandescent lamp that could overcome the intensity and cost problems associated with arc lighting. Edison was aware of the published work of Joseph Swan and the advances that had taken place in incandescent lighting. He was also aware of the attention arc lighting had been attracting, although his fascination with electricity did not extend to a belief in the commercial viability of arc lighting technology. When Edison visited what was then the most advanced electric arc lighting system in the USA, at a copper and brass manufacturing centre in Ansonia, Connecticut, he bluntly told his host: “I don’t think you are on the right track.”³²

  Fortunately, Edison was more interested in creation than in criticism. He returned home to his New Jersey research laboratory, Menlo Park, and focused on proving his point. Five days later, he wired William Wallace, the owner of the plant in Ansonia, for an electrical generator, with the message: “Hurry up the machine. I have struck a bonanza.”³³ Edison subsequently filed a patent ‘To Subdivide the Electric Light’, and followed this with other filings to help with the vacuum and other practical issues for the lamp. In his own inimitable fashion, Edison publicised his findings with extravagant claims that the popular press was only too happy to repeat.

  Very little Edison said to the press was un-newsworthy. In his interview with a New York Sun reporter, he effectively predicted the end of gas lighting and its replacement with electric lighting, and set out how it might be done in lower Manhattan. During his interview, he not only implied that the theoretical issues had all been resolved, but also that the new invention was ready for practical demonstration and introduction. In reality, Edison would have known that extensive developmental work was still necessary. It is likely that he was simply proselytising based on his earlier successes in transforming theoretical breakthroughs into commercial reality. It is also likely that his difficulties in raising funding for these breakthroughs convinced him of the need to give out only positive information. Whatever his motivation, it had the desired effect. The flow of capital was maintained.

  4.6 – The power of the new: Edison announcement panics gas share prices

  Source: New York Herald, 12 October 1878.

  The response to Edison’s announcements was not uniformly positive. Many people, no doubt recalling the early claims for arc lighting and the subsequent resilience of the gas lighting industry, may have viewed Edison as just another challenger who was destined to fall by the wayside. The main problems were the technical hurdles that remained to be overcome. Perhaps as important, though, was the difficulty of competing against an industry – gas lighting – that had sunk large amounts of capital into its own technology and was bound to react by improving service and reducing costs. After all, this had been sufficient to see off the threat from arc lighting and there was nothing to suggest that incandescent lighting would be any different. The prevailing sentiment was one of confidence in the future of the gas industry. According to the financial press, “smart money” would use only share price weakness to accumulate positions.

  Maintaining an interest in both camps: diversifying risk

  Many strategic investors in the gas industry did not take such a sanguine view. The Vanderbilts, for example, had been heavily involved with Western Union, and had thus experienced at firsthand both the threats and opportunities posed by technological innovation. As well as their railroad and telegraph interests, they were substantial investors in gas companies. When news of Edison’s discovery reached them, they reacted quickly. On 25 September 1878 their business manager was dispatched to meet Edison and acquire an interest in this new competing technology. Within a month, a new company with a proposed capitalisation of $300,000 ($50.5m) had been formed. Edison was to receive $150,000 ($25.25m) in phases, in return for 50% of his interest. The Vanderbilt family made their investment through Western Union, so as to avoid undermining publicly their existing gas company interests. Edison received an initial tranche of $30,000 ($5.5m) on 12 October 1878. Undoubtedly, the manner in which Jay Gould had outmanoeuvred the Vanderbilts to acquire Edison’s patents on the Quadruplex telegraph was a factor in their speedy response to this title. Combined with the fall in gas company share prices, knowledge of Edison’s efforts reinforced the need to take appropriate steps.

  The rapid incorporation of the Edison Electric Light Company can be seen as an urgent response by the financial world to the opportunities and threats of the incandescent lamp as an alternative form of lighting. It was symptomatic of the time that sentiment could be easily jolted by scientific progress (or the lack of it). While Edison was highly respected, and his is the principal name that history records, there were other eminent scientists who commanded a similar level of respect and who did not always agree with Edison. In contemporary accounts, Edison was admired less as a pure scientist
and more as a “master mechanic”, or someone who “simply made practicable what other men invented”.³⁴

  For Edison, the painstaking and frustrating work of development was only now beginning. He had two principal barriers to overcome. Firstly, he had to come up with a cheaper filament than platinum, one which demonstrated the same resistance to combustion as platinum did. Secondly, he had to devise an electric motor to run the lamps. He also had to maintain the confidence of his investors and the general public. The investors believed they were investing in a pretty much completed product. William Vanderbilt, for example, told his son-in-law Hamilton Twombly, the president of Western Union, “I understand all serious difficulties have been overcome. He has discovered the means of giving an electric light suitable for every means at a vastly reduced cost.”³⁵

  Edison might have sincerely believed in his ability to solve the outstanding problems, but there was no guarantee that his backer would not be scared into withdrawing support before a solution was reached. The simplest way to avoid the issue arising was to pretend that there were no problems.