6.9 – If all else fails, form a cartel: the Lead Cab Trust
Source: Horseless Age, 24 January 1900.
Despite this the directors were perfectly comfortable paying out a large dividend. For the whole venture to succeed, the operating companies had to run profitably. Should this not happen the only winners would be the original promoters who had sold their stock or received sufficient dividends to more than repay its capital. For the promoters, what was important was that there was at least the illusion of operational success. The operating businesses could continue to run for so long as cash was available to fund the losses, and so long as it was running – and the public was receptive – the illusion of success could be maintained. The operations ultimately failed because of the vehicle’s short battery life and the resultant running costs of the operation. The venture was also tarnished by irregularities surrounding the use of $3m of funds ($220m), including a $2m loan said to have been authorised by an office boy. Moreover, the trade press was not uniformly supportive; articles were written which pointed out the illogicality of running uncompetitive businesses at a persistent loss for any reason other than stock manipulation. Despite this the company managed to achieve a market capitalisation of $20m in 1900 ($1.4bn) before it declined towards receivership seven years later. The underlying nature of many automobile ventures can be gauged from the reminiscences of Hiram Maxim, the head of production at the predecessor of Columbia Motors: “the scheme was a very broad one, promising all manner of possibilities in the way of stock manipulation. Whether it was intended to develop profits out of earned dividends, or by unloading stock on the public, I will not venture to guess. In those days of wild finance, unloading stock upon the public was very fashionable.”⁵⁴
It has to be assumed that many of the promoters exited with substantial profits during this period, and it was certainly the case that legal action followed over the payment of dividends. Whether this was much consolation to the public which lost its investments is another matter.
In 1899 the Electric Vehicle Company acquired from George Selden his American patent on the automobile. Selden had updated his patent as advances took place in Europe, and although he never produced an actual working car, his patent covered the major components of the internal combustion vehicle. Selden did not in any meaningful sense develop the automobile, but he was one of the first to recognise the potential significance of the European advances and take patent protection for them in America. The Electric Vehicle Company had purchased the Selden patents at the instigation of William Whitney, one of the prime promoters of the company. Whitney had enquired about patents “which might cause trouble”, though whether he meant trouble to him or his competitors is not entirely clear. For the rights to his patent, George Selden received $10,000 (nearly $0.75m) and 20% of any future royalties earned from it. The rights to future income received by the Electric Vehicle Company were to be important, given the failure of its operating ventures.
(c) The gasoline-powered vehicle
The early manufacturers of the gasoline automobile came from the same background as their electric and steam contemporaries. They came out of the railroad industry (William Chrysler), the bicycle industry (Alexander Winton, the Duryea brothers), the electrical generation industry (Henry Ford), the electrical parts industry (James Packard), the machinery industry (Ransom Olds) and the horse-carriage industry (Studebaker). All the industries that were either related to, or threatened by, the automobile industry supplied the individuals who were to take the technological leadership from Europe. These names are well known today simply because they survived long enough to record a place in the history books, but in this they were a minority. While the industry was displaying rapid growth it also initially had relatively low barriers to entry.
In the early years the companies that produced automobiles were more assemblers than they were manufacturers. The demand for automobiles verged on a craze, allowing sellers to achieve the best possible sales terms, typically cash on delivery, and often with upfront deposits of 20% or more. For the producers, once the design was completed and tested, the main task was the assembly of standardised parts from a variety of suppliers. Often the credit period from the suppliers was of the order of 30–90 days, and this combination of circumstances effectively allowed a negligible capital cost to the producer if the automobile could be assembled and sold within this period.
With such market conditions it was natural that many new entrants were attracted to the industry. Between 1900 and 1908 nearly 500 automobile manufacturers entered the industry – and more than 250 exited. Within the same period, nearly 100 companies both entered and exited the industry in the same year. This should not be surprising; in the nascent automobile industry, the ability to enter was constrained principally by the question of credibility to the end customer, who could obviously have little experience of the product in question. The general credibility of the gasoline automobile had begun with reports from Europe, and had been enhanced by demonstrations and trials in America. In this regard two important landmarks were the 800-mile Cleveland to New York trips completed by Alexander Winton in 1897 and 1899, and the Detroit to New York trip completed by a curved-dash Oldsmobile four years later.
Both Alexander Winton and Ransom Olds saw big boosts to their sales due to the publicity generated by these trips. In other words, marketing was key in demonstrating to the potential client base that the car would work on a sustainable basis. This underlined the importance both of speed races and endurance trials in the battle to win the public mind. The exploits of Alexander Winton were extended when in 1903 one of his automobiles covered the journey from San Francisco to New York in 63 days. Not to be outdone, a Packard then rose to the challenge, covering the same route in ten days fewer.
Eventually more formalised versions came to the fore, with reliability trials sponsored by Charles Glidden and the Vanderbilt Challenge Cup. These endurance trials and speed races were now no longer items of ridicule, although there were concerns over their safety. By 1905 the gasoline engine automobile was firmly established, and while not all its steam and electric competitors had yet thrown in the towel, the growth rates of the gasoline version soon left the others as little more than niche bystanders. The question was not so much whether the gasoline car was the vehicle of choice; rather, what size the market would eventually become and the structure it would eventually take.
The market begins to form
The structure of the industry in the early years was inherently unstable. The barriers to new entrants were relatively low. The technological hurdle was simply the ability to design and produce an automobile from subcontracted parts. Although this was not a straightforward task it was within the reach of many. The techniques of automobile production were still in their infancy and the process was effectively one of assembly of subcontracted parts. In a period of a relatively benign economic environment, neither were there significant capital hurdles. So long as production could be pre-sold and suppliers were willing to extend credit, the seed capital and the ongoing working capital did not represent an insurmountable obstacle. The risk for new entrants was therefore relatively low, and in an industry that was both growing and attracting attention the result was pretty much what would have been expected.
6.10 – The 80:20 rule at work: automobile sales in the ten eastern states (1905)
Source: US Department of Commerce, Historical Statistics of the United States, Series P318–374. US auto production: data for 1895–1939, US Bureau of Public Roads; data for 1933, National Automobile Chamber of Commerce, Facts and Figures of the Automobile Industry, p. 10.
The industry in America also benefited from the protection from European imports of a 45% ad valorem duty under the Payne-Aldrich tariff. Under such conditions over 500 new automobile manufacturers were attracted into the industry in America in under ten years. Many of these new competitors never produced meaningful numbers of automobiles. Tighter definitions suggest that perhaps 200
companies made serious attempts to build production in America. Interestingly, although there was a large number of entrants and departures from the industry, from the very early days production was concentrated in the top 20% of producers. As can be seen in figure 6.10, the top 18 companies represented roughly 20% of the number of producers and over 80% of the output. This level of concentration was to remain but with two caveats. First, the total number of producers shrank through consolidation and failure. Second, many of the early top 20% of companies were displaced; it was only as demand grew over the next ten years that a ‘top’ place became relatively entrenched.
While the conditions encouraged new entrants, they did not encourage stability. The finances of most companies were extremely fragile unless they were supported by a parent with a steady cash flow from a different line of business. Any downturn in the economy or shock to the financial system would have disastrous effects on a company whose survival depended upon the gap between supplier credit and customer payment.
Notwithstanding these dangers, the industry supported a large number of players in the first decade of the 20th century. Figure 6.10 is not an exhaustive list of the US producers of the time but it gives a clear picture of how fragmented the market was. There were over 80 producers and the average number of cars sold barely exceeded 100.
The impact of Henry Ford
The early battle was fought on two fronts. First the product needed to be developed, and secondly it needed to be marketed. The marketing tools were mainly the use of the press, through speed and endurance trials. This may explain why Henry Ford initially appeared to be caught between the production of racing cars and the development of vehicles for commercial sales. Ford had gained his engineering background working first on steam engines with the Westinghouse Engine Company and later climbing to the post of chief engineer at the Edison Illuminating Company (later Detroit Edison). He had been encouraged in his fixation with the automobile in a meeting with Thomas Edison and spent all his spare time working on a vehicle.
Eventually the manager of the Edison Illuminating Company offered Ford a further promotion to general superintendent, but only on the condition that he gave up his misguided experimentation with the automobile. By this time Ford had a working version of his automobile and through the connections he had established with parties interested in his work he was able to leave the employment of Edison and set up the Detroit Automobile Company in 1899. Notwithstanding that the backers put up capital of $15,000 (over $1million) it was still a brave move by Ford, who left behind secure compensation, worth well in excess of $100,000 in today’s terms. Unfortunately the backers of the venture desired a relatively rapid return, whereas Ford wished to spend substantial time on experimentation. The difference in outlook left the venture in difficulties. Within 12 months Ford had left and the company had folded.
Without backers Ford needed to demonstrate his abilities. His route was to develop a racing car. The industry backdrop was the endurance demonstrations of the cars produced by Alexander Winton and Ransom Olds. Between late 1899 and 1901 Ford conserved his finances by living with his father in an effort to complete his racing automobile. In October 1901 Ford took to the race track against the undoubted favourite and then world speed record holder, Alexander Winton. Twenty-five miles later Ford crossed the winning line, taking the crystal trophy, and perhaps more importantly the $1,000 ($70,000) first prize.
Winning the race against the pioneering Scot had the desired effect and the publicity it generated attracted backers and $30,000 ($2m) for a new company that was named the Henry Ford Company. Unfortunately the disagreements of the previous venture were now repeated. The backers who controlled the company required a production car that could be sold to the public, but Ford wished to work on a racing car. The owners of the company brought in a gentleman by the name of Henry Leland to ensure their wishes were followed and as a consequence Ford left. Leland, a well-known and respected Detroit engineer, then took control of the company and proceeded to produce an automobile called the Cadillac. Henry Ford’s response to again being on his own was to follow the path which had worked for him once before. He built another racing car named the ‘999’ and beat Alexander Winton in another race. In this instance it was the 1903 Challenge Cup.
The result of this new victory was again sufficient publicity to attract potential investors. Ford was approached by a Scotsman named Alexander Malcomson, a powerful and wealthy coal merchant in Detroit. Through Malcomson the funds were raised to form the Ford Motor Company. John and Horace Dodge agreed to assist in the creation of the company by accepting stock in return for the supply of components. Dodge Brothers was a prominent supplier of chassis, engines and transmissions and while the 10% of the company which Ford had to offer them eventually led to recrimination and litigation, without their early support Ford could never have succeeded. In this way Ford managed to raise $28,000 ($1.7m) from Malcomson and the supply of components from the Dodge brothers.
The final result was some way short of the $100,000 and total control that Ford had asked for, but nevertheless the new Ford Motor Company, Ford’s third attempt to set up a viable automobile business, had begun. In addition to funds, Malcomson also provided practical assistance to Ford, through bringing him into contact with James Couzens, his general counsel. Couzens helped Ford in negotiations with suppliers, including the notoriously difficult and blunt Dodge brothers. Couzens himself was sufficiently excited by the prospects for the company that he borrowed enough funds to invest $2,500 ($160,000) in the venture.
In the beginning the whole operation was relatively rough and ready, with engines being loaded on a horse-drawn wagon at the Dodge Brothers factory and moved to the Ford assembly site. The first car, the Model A, retailed at $850 ($55,000) and immediately attracted sufficient demand to keep the workforce fully occupied. A year later the $800 Model C was produced. Despite the company’s apparent success, reflected in its ability to pay a 10% dividend after six months, Ford was again becoming dissatisfied. This time it was the range of models the company was committed to that vexed him. The Ford range included both low-cost, low-margin models and production vehicles which commanded much better margins and higher prices. The Model B car, for example, retailed at $1,000 (over $100,000). Wile there were many manufacturers at the high end of the market, Ford wished to focus on a vehicle that would sit at the most affordable segment of the market.
Malcomson continued to push Ford towards speed trials to maintain the company’s marketing position, including a speed trial across Lake St. Clair. The world land-speed record that Ford achieved, combined with the personal danger he exposed himself to, brought all the publicity that Malcomson had hoped for – and $365,000 ($22m) of sales were recorded in the month of June 1905. Unfortunately for Malcomson, the speed trial was the final straw for Ford and he resolved to control his own destiny. Malcomson wished for high-priced vehicles, Ford the opposite – a view succinctly summed up in the quote: “A car should not have any more cylinders than a cow has teats.”⁵⁵ The battle over product strategy and control ended after an extended stormy period in 1906, with Malcomson selling his shares to Ford for $175,000 (over $10m).
The success of the early models paved the way for the vehicle that became a historical landmark in the automobile industry: the Model T. Before the launch of the Model T in 1908, the industry had remained largely fragmented because of the large number of producers. Although the top producers still accounted for most of the output, their position at the ‘top’ was by no means a secure one despite efforts to force some degree of consolidation and hence stability. Two traditional methods had been employed in this regard. The first was the use of patent protection, the second the use of acquisition. The patent protection route involved the Electric Vehicle Company, which had found that while its vehicles were in secular decline, it did retain one valuable asset: the Selden patent.
Early attempts to consolidate
In 1900 the Electric Vehicle Company sough
t to flex its muscles with regard to the patent it had purchased, and commenced proceedings against the largest gasoline automobile manufacturer, the Winton Motor Carriage Company. The patent was upheld in the lower court, although the strength of the legal decision was open to question, as was its ultimate enforceability. The trade press of the time certainly pointed out that European developments had preceded Selden’s patent by a substantial time period and Winton’s defence cited a long list of precedents, including Lenoir.
Eventually, though, the interests of the two parties began to move together. For the Electric Vehicle Company, an extended period of litigation with an uncertain outcome was not desirable, given that its underlying operating business was haemorrhaging cash. Equally, for Winton and the other manufacturers a negotiated settlement held some attractions. Winton altruistically recounted that he pushed for the creation of a trade body to bring the industry greater credibility and to exclude stock manipulators. This being the case, a strange set of bedfellows was selected. An alternative interpretation would have seen the body as an attempt at creating a form of trust so as to attain some control over pricing in a volatile industry.
6.11 (a) and (b) – Combating the litigation weapon: threats and guarantees
Engines That Move Markets (2nd Ed) Page 27