Andrew Carnegie was a brilliant businessman and, in many ways, an innovator as well. He is often given credit for creating the concept of vertical integration, sometimes termed vertical combination. In vertical integration a company manufactures and also distributes its products, which provides nearly total control over the creation of products. Pabst Brewing Co., for instance, owned not just breweries but also saloons where its beer was sold and forests to harvest the wood to make barrels.
Carnegie didn’t invent vertical integration, however. He was actually against the entire prospect at first. It was Henry Clay Frick who persuaded Carnegie to appreciate the value of vertical integration.
In the early 1890s Frick had begun promoting the purchase of iron mines in the Mesabi Iron Range in northwest Minnesota. The area possessed ore of superior quality. Owning the ore mines, Frick reasoned, would cut independent ore suppliers out of the equation and reduce the cost of making steel. Most of the mines in the Mesabi area were owned by one family, the Merritts, who also owned a railroad system to carry ore from their mines to an immense wooden dock in nearby Duluth, a growing city at the western tip of Lake Superior. From there Merritt ore could be delivered to any point fed by the Great Lakes waterways.
A businessman from Pittsburgh, Henry W. Oliver, was at the time speculating in iron. He visited the Merritts and their operation in 1892 and purchased one of their ore deposits. Oliver tried to entice his colleague Carnegie into investing in the Mesabi Range, but the steel magnate turned him down cold. Carnegie didn’t like Oliver, nor did he trust him. Carnegie once wrote to Frick, “Oliver’s ore bargain is just like him—nothing in it. If there is any department of business which offers no inducement, it is ore. It never has been profitable, and the Mesabi is not the last great deposit that Lake Superior is likely to reveal.”
While Carnegie balked at Oliver’s entreaties to invest in Mesabi ore, Frick jumped at the chance. Frick understood the potential value of investing in the area and purchased stock on his own, separate from his boss, Carnegie. Frick also knew that the richest man on Earth, John D. Rockefeller, was preparing to invest heavily in Mesabi ore. If Frick didn’t invest, Rockefeller would take over everything. Rockefeller could see the value of owning the ore mines even if Carnegie couldn’t. “I was astonished,” Rockefeller said, probably aiming mostly at Carnegie, “that the steelmakers had not seen the necessity of controlling their ore supply.”
The president of the Merritt’s company at the time, Lon Merritt, met with Rockefeller in the summer of 1893. The company had taken a terrible hit during the Panic of 1893, a stock market crash that stemmed from the nation turning from a gold-and-silver standard to a gold-only standard, and was barely hanging on. Rockefeller and Lon Merritt finally decided to consolidate their mining interests in the area into a single company, Lake Superior Consolidated Mines. Rockefeller infused $2 million in the company to support the new venture, but it wasn’t enough. By February 1894 the Merritts, unable to meet their debt obligations, were forced to sell all of their stock in the company to Rockefeller.
Frick’s investments, on the other hand, were paying off handsomely. Frick tried again to persuade Carnegie to partner with “Rockafellow” in a Mesabi Range venture. (Carnegie commonly misspelled his competitor’s name, and Rockafellow was a favorite.) When Rockefeller first purchased the Merritt holdings, Oliver had grown fearful that he would continue buying mines throughout the region, including his own, so he contacted Frick and Carnegie.
Carnegie had heard enough. Regardless of his anathema toward Mr. Oliver, Carnegie hated Rockafellow more. He also finally recognized the value of the offer. He grabbed half of the stock in Oliver’s mining company for $500,000, knowing that he owned the steel mills that could make immediate use of ore. Rockefeller owned no such mills and knew that he would be forced to sell whatever Mesabi ore he mined to Carnegie, a less than ideal arrangement. The conditions proved ripe for an agreement.
At Carnegie’s request Oliver and Frick began negotiations with Rockefeller’s team, with Carnegie telling Frick, on October 27, that the “Rockafellow negotiation should be hastened and proposition got for our consideration.” Carnegie grew anxious, though, and didn’t quite trust his negotiators to close the deal. He wrote directly to Rockefeller three days later to do it himself.
Our people have been conferring with your Mr. Gates upon an alliance which would give us all the ores we can use from your properties. The differences between the two seems to have been so great as to cause a failure of the negotiations. They came to see me today and explained these differences, which do not seem to me too irreconcilable, if both parties realized, as I do, the mutual advantage of such an alliance, and were prepared to meet each other halfway. When Mr. Gates submits the matter to you, as I suppose he will, and you concur in this, I believe you and I could fix it in a few minutes, and I shall be very glad to go and see you if you think it worth while to take the matter up. It is a big operation, and needs to be looked at in a broader light than either Mr. Gates or Mr. Leishman, perhaps, are justified in taking.
The two giants finally came together and joined Oliver in an agreement. Oliver would mine the ore. Rockefeller’s ships and railroads would transport all ore from the Lake Superior region. Carnegie’s operations would then produce steel from the ore. Rockefeller and Carnegie agreed never to compete with one another; Rockefeller would not enter into the steel business, and neither man would lease or purchase new mines in the Mesabi region for the fifty-year term of the agreement.
Carnegie had at last seen the true value in vertical integration. By controlling the flow of ore from the mine to the mill, Carnegie could “figure the cost within a trifle and take contracts ahead without danger.” In a letter to his cousin in 1898 Carnegie said, “It is clear to me that profit is to be made in steel manufacturing only by the concerns which do every step in the process themselves.”
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