Jul 28, 2006 - from coopering and shipowning in the early years of the century to ... intermediate modes of production, or 'quasi-integration', and ..... In the 1820s and 1830s the firm ... of 1835-36 consequent upon the expansion of income from exports ..... Shipbuilding Industry, 1800-50', International Journal of Maritime ...
Business History
ISSN: 0007-6791 (Print) 1743-7938 (Online) Journal homepage: http://www.tandfonline.com/loi/fbsh20
The Expansion and Development of a Private Business: an Application of Vertical Integration Theory Simon Ville To cite this article: Simon Ville (1991) The Expansion and Development of a Private Business: an Application of Vertical Integration Theory, Business History, 33:4, 19-42, DOI: 10.1080/00076799100000127 To link to this article: http://dx.doi.org/10.1080/00076799100000127
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The Expansion and Development of a Private Business: an Application of Vertical Integration Theory SIMON V I L L E
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Australian National University
Competing theories of vertical integration are put to the test in relation to an expanding business enterprise based in the port and industrial town of Sunderland in the first half of the nineteenth century. White's operated one of the largest and most diverse operations in the town, expanding from coopering and shipowning in the early years of the century to include mining, metallurgy, engineering, banking and railways. Recent theoretical work has divided explanations of vertical integration into the categories of market power and allocative efficiency. The current study found efficiency considerations the more important but within this category there was no consistent single explanation. The study also investigates the existence of intermediate modes of production, or 'quasi-integration', and explains why this structure was sometimes preferable to full integration.
The neo-classical view of the firm held that its growth beyond a certain scale was improbable as a result of the assumption of declining returns built into the theory of monopolistic competition.' In recent years institutional economists have rejected this historically inaccurate view of the firm and offered explanations of the growth of the modem large scale corporation and its role in providing a competitive structure for the economy. Their research has focused upon vertical integration as the predominant form of growth for the modem corporation.2 A wide range of more general or specific explanations of vertical integration have been offered. Although some of them are difficult to categorise, the major explanations can be divided into those which view allocative efficiency or market power as the underlying reason for upstream or downstream expansion. Efficiency considerations have yielded a large crop of competing explanations. Market failure explains how the hierarchy of the firm can produce a more efficient mode of operation than the marketplace. Williamson has developed the ideas of bounded rationality and opportunism to show how firms can save on the costs of specifying, negotiating and enforcing contracts if these transactions are internalised within Business History, Vo1.33, No.4, October 1991, pp.19-42 PUBLISHED BY FRANK CASS, LONDON
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the fima. He sought to clarify the incidence of integration: when the assets employed are highly specific and a transaction notably recurrent internalisation is most likely.3 Innovation can spur vertical integration if suitable supplier firms do not exist or will only risk a new product by charging a higher price.4 A second aspect of allwtive efficiency is the concept of technological inseparability. This occurs where adjacent stages of production cannot be performed separately without extra cost. Fuel and transport economies can frequently result from combining these stages on one site.5 In order to avoid complex contractual arrangements single site operations frequently require internalisation within a single firm. Integration may reduce uncertainties associated with information asymmetries. Upstream integration reduces uncertainties regarding the price and quality of inputs.6 Backward vertical integration may also occur if the supplier sets his price above marginal cost to compensate for limited knowledge of downstream product demand.' In general, improved information flows assist more effective forward planning of interrelated investments and improve intertemporal resource allocation.8 The Batter can be related to the economies of speed whereby internalisation enables more efficient administrative co-ordination and therefore more rapid throughput.9 V e r t i d integration to secure improved property rights overcomes w i s d w t i o n by placing effective ownership with those who can use those rights most productively. 10 Market power considerations explain when upstream or downstream expansion is designed to reduce competition and tend to occur where there is a dominant producer or an oligopoly. Strategic behaviour takes many forms. Forward vertical integration avoids a producer substituting an alternative input." Aquiring upstream production can deny inputs to other producers or ensure against the threat of foreclosures by others.12 Integration can restrict entry by new firms. This is most likely where all firms in the industry are already vertically integrated: the new entrant will have to enter in an integrated form which will present problems of greater capital requirements and product differentiation.13 Internalisation permits transfer pricing policies which, by distorting the weaken government anti-trust price of inputs transferred within the h, policies. Downstream integration can facilitate price discrimination in order to take advantage of variations in the elasticity of demand between different markets. l 4 There exist many intermediatestages of operation between the market and the hierarchy.15 Co-operative strategies between firms can take the form of equity or non-equity agreements according to whether one firm has an investment in the other or not and can often be regarded
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expansion until their bankruptcy at the end of 1846. Their enterprise came to include all the major growth sectors in the Sunderland economy particularly colliery ownership, coal fitting, shipowning, shipbuilding, iron manufacture, engineering and glass production. The core of the business continued to be owned and managed by the Whites and a few trusted associates throughout the period. Growth was based on carefully conceived policies of vertical integration and produced a structure far more sophisticated than the 'federation of autonomous offices' by which Chandler characterised enterprises prior to the managerial revolution.27 As a cooper in a major port, John White provided barrels for use on board ships as well as supplying breweries. 'Itadesmen connected with shipping 'frequently employed some of their capital in this line in order to extend their business'.28 In the hope of obtaining more orders, he invested in Sunderland shipping in the 1780s.29 This was on a small scale, for in 1789 he owned just 44 tons of shipping spread across several vessels. Some expansion of his shipping interests followed the outbreak of the French Wars which provided boom conditions for the shipping industry and by 1799 he owned 205 tons.30 TABLE 1 EXPANSION OF WHITE'S BUSINESS ENTERPRISE
-per shipowner mining fitter glass ironworks engineering timber coking banking railways docks Notes: 1. Shipbuilding, insurance, lime, gas and soap were excluded because they were only occasional and intermittent aspects of the firm's business. 2. Andrew White was temporarily an agent in the early 1850s after the firm's bankruptcy. 3. White's banking, docks and railway interests were not part of its private firm but reflected its control of joint stock companies.
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The initial decision to expand into shipowning,therefore9was designed to secure a larger and more stable market for his output and thereby reduce uncertainty regarding orders and improve forward planning. With the good prospects for shipping during the French Wars,White ran down his coopering work to build up his shipping iamvestments. By 1814 John and Andrew White owned nearly 1,500 tons of shipping with a value of nearly $27,000. Cooperage businesses were generally small scale, suggesting that White reinvested windfall profits during the wartime shipping bmm.31 The return to peace in 1815 brought a sustained depression to the British shipping industry that stretched, almost without interruption, into the 1830s.32 White's did not disinvest from the shipping industry but, contrariwise, expanded its shipping fleet throughout the following two decades to become 'about the largest shipowners in the port having scores of boats built for them by nearly every firm of their date'.33 Between 1818 and 1832, the years for which evidence survives, its fleet made a profit in all but one year, 1822, and returned more than five per cent in all but four.% This would appear to confirm the effectiveness of its integration policies, which provided regular cargoes of coal, timber and probably how, engineering and glass products at a time when many fleets were sufferimg from under-utilisation.35 White's was one of the earliest Sunderland firms to invest in steam riverboats. In 1833 it bought a half share in a small steamer of 17 tons, the Paragon, and a half share in the Freedom of 16 tons in 1838.36 These boats were most likely used as intra-port carriers of White's industrial materials and goods, promoting co-ordination of its diverse activities, and finding a further use as tugs to help its firm's sailing vessels into and out of port in adverse conditions. They could also be fuelled from White's mines. Steamboats were in their infancy, and of the few owned at Sunderland, most were in the hands of shipowning h s with no evidence of the emergence of specialist hauliers. This lends some support to the life cycle hypothesis that innovations tend to be pant of a vertically integrated structure. Shortly before 1800 White purchased a colliery producing middle to low quality coal which he was able to secure cheaply because of the limited interest in lower grade coals. He soon encountered difficulties arranging shipments of the coal to London where higher quality grades were preferred. White noticed that there was a ready demand for lower grade coals at the smaller ports in the south of England.37 Realising that most Sunderland shipowners preferred to keep their vessels in the London coal trade, he expanded his fleet from 116 tons in 1798 to 649 by 1806 and began to manage these vessels rather than delegate control
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FIGURE 1
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INTEGRATION OF WHITE'S BUSINESS ENTERPRISE
Coalmining
Steam Boz owning
H
Shipowning
c 5 Shipbuilding
R3
= joint stock companies
26
BUSINESS HISTORY TABLE 2 WHITE'S SHIPPING FLEET, 1786-1845
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Year
Tonnage
Value (f)
Note: T o ~ a g evalues survive for Andrew and John White's tonnage but not for that of Richard, 1825-34, 1836. Consequently, the values are computed from those of John and Andrew accounting for Merent vessel ages by assuming a constant rate of depreciation of 3 per cent per annum.
Source: 'Qne and Wear Archives Department, 73014; 1259.
to another investor.% The process of vertical integration in the coal trade was extended a step further into coal fitting in about 1804-5. The fitter was the middleman between the mine owner a s a d shipowner who arranged the loading of coal onto the vessel. The importance White's attached to coal fitting can be seen from its expansion of this side of the business; by 1817 it was the fourth largest fitting firm in Sunderland.39 White's benefits from downstream integration in the coal trade may be compared with economies of speed because it permitted more rapid throughput and improved administrative co-ordination. It might equally be viewed as a transaction economy since fleet management reduced the costs of finding a suitable market for coal. Transaction cost savings were also achieved by coal fitting. Vessels had to join the 'turn' or queue for coal with one of the fitters on arrival in the river Wear. Waiting one's turn could take several weeks or, occasionally, months.40 Since White's acted as coal fitters, its vessels could jump the queue and receive a cargo immediately. Henry Tanner, another Sunderland entrepreneur, enjoyed
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a similar advantage, as he explained to a Parliamentary committee in 1833:
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as a coal fitter . . . I have a facility of loading my own ships which many of my neighbours are not able to do, and the consequence is that I am able to get a turn for my own vessel, and can despatch her a little quicker than other people who are not so situated . . . despatch is the life of the coal trade.41 In the highly competitive conditions of the early nineteenth century coal trade such benefits put the vertically integrated enterprise at a strong advantage over competitors whose vessels were pushed down the queue. Vertical integration thus resulted from strategic behaviour to increase market power as well as a desire to heighten efficiency. Colliery ownership enabled White's to offer part payment for goods and services in the form of coal.42 Coal was particularly appropriate because of its divisibility and relatively universal requirement. Rope and canvas were used by several firms. White's paid partly in coal for several vessels and in the 1830s supplied iron rails in payment for railway freight charges." Bartering served as a useful form of liquidity in an expanding business. It eliminated several market transactions although this was partially offset by increased transaction costs since payment in materials was not as universally acceptable as coinage or specie. White's coal ownership remained limited until the 1830s suggesting, perhaps, that the transaction economies were less than for coal fitting. One of the drawbacks of vertical integration surrounds the different levels of minimum efficiency of scale of adjacent processes. Colliery ownership and coal fitting are an important example of this. Coal fitting required very little fixed capital and could be pursued efficiently at modest levels of output whilst mining generally experienced economies of large scale production." Moreover, the fixed capital requirements for extensive colliery ownership were probably beyond the means of White's business enterprise in the early years of the nineteenth century. The firm advanced into glass manufacture when it built a flint glass works in 1805. The motives behind the decision to move into glass production are far from clear. Coal was an important input and therefore vertical integration may have produced economies on a simple and highly recurrent transaction. The rapid expansion of Sunderland in the early nineteenth century provided a demand stimulus for a wide range of bottles, while they could be shipped elsewhere in White's expanding fleet. Little is known of the subsequent history of the glassworks although it continued to operate on the same premises, with the quite high rateable value of f150, up to the 1830s when, in 1836, a labour
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force of 110 glass workers in the factory celebrated an expawdon in its operations.45 At the end of the French Wars the coal trade was in a depressed state and probably losing money for White's. Locked into capital investments in mining and shipping which could only be discharged for a low price, the firm sought to diversify its use of both. It began to deploy vessels in other trades, particularly in the carriage of timber. An ironworks provided the opportunity for more effective use of its industrial coa1.46 Shortly after 1815 White's established the Bishopwearmouth Ironworks. By the mid-1820s this had become a substantial iron and engineering w o r k which featured 16 smith shops, a steam foundry, an iron foundry, ovens, kilns and a 'testing machine'. Its size can be indicated by its rateable value of D50 compared with f 10 or E20 for the average h0ouse.~7 The iron industry benefited from an upturn in demand particularly in expanding industrial towns. Technological developments in shipping, mining and dock buikling provided an increased demand for iron products. Production at the Bishopwearmouth ironworks, for example, included chain cables and anchors. In the 1820s and 1830s the firm supplied the River Wear Commission (responsible for administering the river) with piles, screws, bolts, spikes, chains, bars, blocks, shackles and much more, including two beam pumps.48 In the second half of 1834 the firm was paid f1,015 for materials for the construction of local docks which amounted to more than a fXth of the contract work on the project during that period.49 In 1833 White's became the sole patentee for Shalder's fountain water pump in the ports of Sunderland and Seaham and the mining district of county Durham.50 White's experience in these industries provided it with information benefits regarding technology and demand which it could exploit as iron makers. WhiEe vertical integration theory emphasises the role of insufficient information in expansion, the example of White's shows that firms might integrate in order to take advantage of superior information. Downstream growth into engineering was an extension of this policy and was facilitated by technological interdependence associated with the manufacture of engineering products from molten iron which yielded thermal economies from a single site operation. White's supplied the River Wear Commission with several high pressure engines and local railways with iron rails and engines: in 1836 two 85 horsepower engines were supplied to the Durham & Sunderland Railway at a cost of $3,345.51 Significantly, the railway company was controlled by White's. Shipbuilding was not integrated into White's business: it bult a single in each of the years 1796,1811,1812 and 1826, but most of its fleet came from the yards of local builders. White's vessels periodicdly imported
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timber, sometimes on its own account. The River Wear Commission was a convenient outlet taking, for example, 16,000 feet of Wyburg redwood deals in 1823 in connection with dock construction.52 The temptation to expand downstream by building ships was rejected. The set-up costs in terms of fixed capital and technical know-how were considerable, while the benefits were negligible. Sunderland was a rapidly expanding shipbuilding port in the 1820s and 1830s with strong competition among local builders and low profit margins. There was little to fear in terms of the price, quality and regularity of supply. Nor were White's dealings with shipbuilderssufficiently recurrent to suggest transaction cost savings from internalisation. In fact, White's derived transaction economies from its regular patronage of Sunderland shipbuilders, which offered them favourable price and credit terms and trade-in agreements.53 Timber merchanting was also fiercely competitive. John Spence, a Sunderland timber importer and shipowner, observed 'great competition among merchants, they [shipbuilders] can purchase timber cheaper at Sunderland than at any of the neighbouring ports'." Its cheapness derived from Sunderland's position as a coal exporting port as Joshua Wilson, a local merchant and shipowner, explained: In the port of Sunderland there is a large export of coals, there is a freight both ways, and even from America we can get freights lower than to the west coast of England. That gives us very great advantage in the Baltic and Hamburg and . . . in getting timber from the south of England, London . . . and Yorkshire.55 -0-way freighting was available to most Sunderland shipowners, so there was little advantage to White's from internalising merchanting since timber could be bought cheaply from other dealers. As a result, it moved out of timber merchanting in the 1830s.
The decade of the 1830s represents an important turning point in the organisation of White's business. Until then all the lines of its enterprise had been solely owned by the family or in partnership with trusted business associates. Coal mining and fitting, glass manufacture, coopering and timber merchanting had all been owned solely by the Whites. Vessels were sometimes owned in partnership and in the 1820s and 1830s they took on William Kirk, Hugh Panton and Emerson Muschamp as partners in the ironworks. In the 1830s the business was extended in association with several joint stock companies. Sunderland shared in the company boom of 1835-36 consequent upon the expansion of income from exports
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to America in 1835 and the repatriation of investment following the crash of the Spanish security market.56 White's figured in the forefront of local ;.developments by arranging the formation of companies in a series of fields including railways, banking, dock building, soap manufacture and insurance.57 The rising demand for coal provided an alternative avenue of expansion when White's left timber merchanting in the 1830s. Pollard has emphasised that local industries had become 'coal based to an unusually high degree'.Ss Coking coal was in especially high demand for use in industry. Raising the capital required of extensive mine owning was difficult in the early years of the nineteenth century when Mite's resources limited it to a single mine and before the technology existed to tap the richer seams of the Durham coalfield which were set back from the river. Conditions had changed by the 1830s with the coming of the railway, the expansion of the firm and the rising demand for coal. The amount of capital required to build a connecting railway as well as sink the mines, however, remained beyond the means of the largest private Sunderland firms. Table 3, as a rough approximation of their capital structure, indicates the increased capital requirements which the firm faced. To develop its mining interests required a doubling of the fixed capital of the business. White's sold some of its vessels and took on partners in order to reduce the outlay to £50 to S75,000 but even this required an 80 or 90 per cent capital expansion. In addition, a rail link from the pithead to the riverside was needed which would cost almost as much again. The mid-1830s were a time of speculative railway investment spurred by the success of the Liverpool 6 0 Manchester Railway in 1830.59 The solution, therefore, was to divert enthusiastic railway investors into a project of benefit to White's mining interests. The Durham & Sunderland Railway was built in 1836 to form a link between the Wear and settlements to the south of the river. White's bought 5 per cent of the initial capital of £42,000 while business friends such as Dawson, Kirk and Panton also bought shares. Andrew White became a director and it is clear that the Whites and their friends were the organising and galvanising forces behind the building of the rdway.60 Simultaneously, the Whites were buying up mining leases in those areas of the East Durham codfield which the railway would cornea to the port. They calculated the estimated rate of return from individual collieries before buying the lease. Whitwell Colliery, for example, was reckoned to have a profit potential of 14 per cent on capital. In December 1835 they signed a 35-year lease on the coal under Whitwell Grange at a rent of £1,000 per annum. The following August
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TABLE 3
THE CAPITAL STRUCTURE OF WHITE'S IN THE
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Sector
1 Coal Fitting 2 Glass 3 Iron and engineering 4 Shipowning 5 Collieries & coking 6 Railways 7 Banking
Capital Value (f)
2,000 5- 10,000 20- 30,000 28- 36,000 100-150,000 80-100,000 700,000
1830s
White's Share
50-75.000 (50%) 4- 5,000( 5%) unknown
Notes: 1. W A D 209185,Sunderland Parish poor rate books, 1815-19. Cost of keelboats based upon evidence from activities of Michael Henley & Son in S. Ville, English Shipowning during the Industrial Revolution (Manchester, 1987) p.26. 2. Based on size of premises and workforce. W. Brockie, Sunderland Notables (Sunderland, 1894) p.98;W A D 209193-94, Sunderland Parish poor rate books, 1824-31. 3. Sale price in 1842 was 25,750. It was certainly larger in the 1830s. Calculation takes account of level of turnover provided in accounts. TWAD 843189-95. 4. TWAD 1259, Sunderland shipping registers; W A D 73014, Notebooks of Andrew White. 5. Derived from accounts of Whitwell and Croxdale. W A D 73013, Notebooks of Andrew White. 6. W A D 73511,Durham & Sunderland Railway subscription book. 7. Based on the Sunderland Joint Stock Bank and the Newcastle Joint Stock Banking Co. M. Philips, A History of Banks, Bankers and Banking in Northumberland, Durham and North Yorkshire (1894), pp.320, 383.
a 42-year lease was signed for the coal under Newton Hall Estate at £800 per annum. Similar leases were agreed for coal mining at Shincliffe, Brandon, Croxdale, Bowburn, Houghall, Hett, Framwellgate, Iveston and Rodridge.61 Some of these mines proved highly successful. In the first six months of 1842,25,000 tons of coal were moved from Shincliffe and Whitwell alone to the river Wear which amounted to 11 per cent of total coal shipments from the White's also established its own coking facilities and by 1846 its Croxdale colliery alone was producing 46,000 tons.63 The increased coal and coke output provided employment for its shipping and enabled the firm to freight its vessels profitably and competitively on both the outward and homeward passages, while the railways also provided a market for some of White's coal, iron and engineering products. Expansion of its coalmining interests, therefore, produced good returns and improved the co-ordination of the business because of coal's role as an input for other sectors. Quasi-integration with the railway companies might be seen as an example of technological inseparability. The mines could not be effectively exploited by White's without the rail
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link to the port. It is not clear, however, that internalising the railway within the enterprise was essential for exploitation. White's could have operated as rail users. Its influence over its building and operation, however, ensured that it was built along the most favourable route and that there was no threat to the continuation or price of service provided by a supplier acting as a monopolist. Therefore, improving property rights to avoid opportunistic re-contracting was important particularly in light of the large fixed costs invested in the mines and the high degree of asset specificity involved. White's relationship with the Railway Co. was one of intermediate mode since it was neither acting in the marketplace nor internalising within the hierarchy.64 The use of intermediate modes depends upon a range of considerations. Buckley and Casson have suggested that the formation of joint ventures can be attributed to internalisation economies, indivisibilities and obstacles to merger.G This analysis, although dealing with a different form of intermediate mode, is relevant to White's since the heavy capital requirements of the railways were a major obstacle to 'merging' the railway into the enterprise particularly as it was in a new and speculative field.66 Therefore, it operated from a minority but influentid position which ensured that the services suited its mining needs and offered other benefits such as payment of freights in coal and supplying engineering equipment. Of similar importance was the indivisibility of transport production: White's existing operations would have been unable to secure the high level of utilisation necessary to ensure that the railway was profitable and securing economies of scale. Instead, it would have needed to develop into other markets with an inefficiency cost, particularly in terms of managerial disemcpnomies. This confhns the hypothesis that transport systems are frequently run by specialists and may explain why the Durham & Sunderland Railway proved to be an unprofitable venture.67 White's expansion into banking in the 1830s occurred in a similar fashion when it played a leading role in the establishment of a series of local joint stock banks. It subscribed capital to, and was represented on the Boards of, a series of new banks. Andrew and Richard were directors of the Sunderland Joint Stock Bank when it was founded in 1836. Andrew was a director and one of the initial management committee of the Newcastle Joint Stock Banking Co. and Chairman of the Northumberland & Durham District Banking Co., both established in the same year. The details of the policies of these banks were revealed when most of them collapsed in the 1840s amidst allegations of corruption. When the Sunderland Joint Stock bank collapsed in 1851 one local writer explained in dramatic terms
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how the investors had been deceived and defrauded over a number of years by:
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the managing clique of Tartuffes [who] over a series of years employed the capital in their own shipping transactions had fictitious accounts opened - closed these accounts when the speculation that originated them failed . . . released each other from liabilities to the bank . . . made arrangements out of bank funds with their creditors.68 White's and its friends, it appears, used bank money to finance their new collieries in the 1830s.69 In addition, the shipping registers of the port are full of vessels mortgaged to the bank. In the precarious economic conditions of the 1840s many lost their ships to the bank, some of which were sold to White's, probably at a discount, which resold them again. The vessel Whitwell Grange came into White's hands from a bankrupt in August 1842 and was resold within a few days.70 Again, therefore, White's used the intermediate mode of a controlling influence in joint stock companies to the benefit of its core business.71 White's move into banking was a form of backward vertical integration to secure a flow of financial support as an input for the expansion of its mining interests. Since there were many potential suppliers, securing property rights to avoid opportunistic recontracting was unlikely to have been an issue. Instead, transaction cost savings resulted since securing loan support became much easier. What resulted were benefits well beyond this once the firm was again in a position to act opportunistically as agents of the banks. It is not clear whether it set out to act in an opportunistic manner or was initially concerned with efficiency issues. The reasons White's opted for an intermediate position rather than full integration, however, are largely the same as for the railways: the barrier of financial cost and the minimum scale of efficiency required in banking. A similar situation appears to have existed in the formation and operation of the Sunderland Dock Co. although the extant information is much less complete. The company, founded in 1846, included among its initial investors and directors the Whites and their various business partners. Their shares appear to have been paid for by transfers from the Sunderland Joint Stock Bank and the Northumberland & Durham District Banking C0.n The dock would have provided improved turnaround facilities for White's vessels but such hopes were overtaken by the firm's own bankruptcy before the year was out. With the docks, as with the railways and banks, the Whites intended to exploit their information advantages as agents to direct the
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company in pursuit of their own private interests rather than those of the shareholders.73
The position adopted by White's and its business partners in these companies was that of a minority equity holding for a single advity.74 The Whites were anxious to maximise their control over these companies because of their importance to the firm's expansion and profitability. They could increase their influence either by expanding their equity holding or by improving their bargaining power.75 The calculations above on the capital structure implies that a significant increase in White's equity holding would have been improbable. Root has suggested that a firm can increase its bargaining power by making the arrangements more dependent upon the firm's proprietary resources.76 White's proprietary resources were of some value to railway though not banking enterprises but in both cases other firms could act as substitutes. Bargaining power and control could be increased through generating trust and confidence among investors. Increased trust, moreover, would mitigate problems of organisational complexity and dysfunctional interacti0n.n In a recent article, Hutchinson and Nicholas noted that 'the need to assess social factors, including religiorn, family ties and class, in co-operative modes promises a fruitful new approach to inter-firm contracting7.78It is argued here that in order to understand how White's managed to tuna the joint stock boom of the 1830s to their advantage, one has to appreciate the manner in which entrepreneurs were able to dissipate economic power and intluence through a common social value system. The Whites were one of the principal families among an oligarchical elite of entrepreneurs who dominated the politics, economy and society of early Victorian Sunderland- They were bonded together by intermarriage and a common set of values based upon Wesleyan Methodism and Liberal reform politics. Seven of John White's eight children married, each into another family in the group. Kinship ties were reinforced by secret groups and a form of freemasonry revealed by the 'byelaws of the Loyal Andrew White's Lodge of the Independent Order of Oddfellows Manchester The Whites, Dixons, Kirks, Vints, Dawsons, Browns, Muschamps, 'Ihers, Watsons, Pantons and Youngs were all members of the Central Sunderland Wesleyan Society and worshipped together at the same chapel. Politically, they supported the reform wing of the Whig-Liberal Party espousing such causes as electoral reform, free trade and the abolition of income tax. In business they worked in similar fields especially the main staples of shipping, shipbuilding,
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iron and coal production. They frequently conducted business with each other and sometimes went into partnership. White's bought from and sold vessels to other members of the group. The vessel Margaret, built in 1825, was owned by White's with Thomas Dawson who was also mamed to Mary White.m Thomas Young built vessels for White's while Kirk, Panton and Muschamp were partners in the ironworks.81 This common set of values, overlapping interests and kinship connections built up considerable trust between members of the group and therefore reduced transaction costs in terms of specifying, negotiating and enforcing contracts between their firms. White's tendency to exploit arbitrage opportunities and develop new aspects of its business benefited from information pooling within the group. The cohesive nature of the entrepreneurial elite was of critical importance, however, during the joint stock boom of the 1830s. Like White's, many of these families had business interests which stood to benefit from the growth of companies particularly in railway building and banking. Under the leadership of White's, the group floated a range of companies and contributed the first 20 per cent or so of the capital. By taking advantage of their position and reputation as successful local businessmen and by organising publicity through local newspapers and public meetings, they found few problems attracting support from small local investors. Their influence can additionally be linked to their political and religious prominence. The Great Reform Act of 1832 and the Municipal Corporations Act of 1835 significantly increased the political influence of the industrial middle classes in local and national politics. The new town council of Sunderland in 1836 was dominated by the group and a member of the White family held the position of mayor in four out of the first eight years. Not surprisingly, therefore, the Council pursued policies favourable to the interests of the entrepreneurial elite.82 Membership of the council and its committees provided more immediate paybacks for an entrepreneur. Expansion of an enterprise could be orientated towards the supply needs of local government; it was seen above that White's expansion into the timber trade was helped by supplying the River Wear Commission. In addition, Andrew White was elected M.P. for Sunderland in 1837. His speeches indicate his persistent support of the interests of Sunderland industrialists.83 The exercise of influence through religion was more subtle but at least as effective. Wesleyan Methodism found strong support among the lower middle classes, the social group who were most likely to invest in the new joint stock companies and therefore helped to give an aura of respectability to companies floated by entrepreneurs who were also Methodists. The truth, of course, was quite different: the
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evidence from the banking corporations showed that such tmst could be misplaced.84
The decline of White's enterprise was much more rapid than its ascent. The ironworks failed in 1842 at a time of industrial depression in Britain, and was sold in the following year for f5,750which was sufficient to cover its accumulated debts of around 24,500. The 1840swas a difficult decade for the British iron industry and White's interests suffered as a result of reduced demand from local railway and dock building. The supply of cheap Scottish iron by Neilson's 'hot blast' technique continued to expand.= The firm's shipping interests had become negligible by the mid-1840s and is not clear whether it was still producing glass and coal fitting. In 18% the firm collapsed and Andrew and aichard were declared bankrupt. Andrew's active involvement in parliamentary politics had led to neglect of the business at a time of depressed economic conditions.86 By supporting local industrial interests in Parliament while neglecting the progress of his own enterprise he carried the burden of responsibility among the entrepreneurial elite. Moreover, they failed to delegate managerial authority and establish a control system not dependent upon their regular presence. The ignominious collapse of White's banking interests together with the probability of overcommitment in coalmining served the final death knell for the firm. The vertically integrated structure which it adopted played a role in its failure. The high input-output ratios and emphasis upon forward planning and careful resource allocation resulting from the vertical integration of the enterprise emphasised its vulnerability to a weakness in one particular unit of production. Moreover, the complex set of owner relationships at work within the White goup by the 1840s (proprietorships, psartnerships, sixty-fourths and joint stock investors) which was also largely the result of vertical integration policies, might suggest problems of organisational design contributing to its downfall. Finally, the firm's dubious business ethics in the Bate 1830s destroyed much of the trust upon which its quasi-integration policies had been based.
This firm-specificstudy has tested the competing theories of vertical integration against the experience of a rapidly expanding early nineteenth century business involved in the primary, secondary and tertiary sectors.
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The most recent theoretical work has tended to divide the explanations of vertical integration into the broad categories of market power and allocative efficiency with particular emphasis upon the latter as a result of the growth of transaction cost economics. The current study found efficiency considerations the more important but, within this category, there was no consistent principal reason nor was it always possible to distinguish a single explanation of each phase of expansion. Transaction costs and economies of speed explained integration in the coal trade, technological inseparabilities were important in the inclusion of engineering and the life cycle hypothesis in the purchase of steamboats. Lack of market failure explains why the move into timber merchanting was an example of mistaken integration which was reversed in the 1830s. If there was a general theme running through the firm's expansion it was to reduce uncertainty by resolving information impactedness and thereby improve forward planning and intertemporal resource allocation. In the depressed post-war years, backward vertical links of coal, iron and glass removed uncertainty in the supply of shipping freights. While economists have identified the resolution of information asymmetries as a factor in integration, the experience of White's has shown that the reverse can also be the case: integration in order to exploit information advantages. For example, it was able to take advantage of its knowledge of the mercantile marine to exploit the shipping boom during the French Wars while also providing better co-ordination with its coal and coopering interests. The predomination of efficiency considerations was to be expected given the atomistic nature of local industry, although there are also a few examples of market power. White's was able to derive competitive benefits from integrating into coal fitting: there were many other fitters, but they were still far fewer in number than the shipowners whose vessels were competing for coal cargoes. By the second half of the nineteenth century the structure of industry in the North East began to change with the emergence of dominant firms led by entrepreneurs of the calibre of George Hudson and William Lindsay. It would be interesting to compare the current study with work on the later nineteenth century to see how important the changing industrial structure was to explanations of vertical integration. Hannah and Chandler both favoured a transaction cost explanation of corporate growth although their studies were restricted to a survey level of investigation. This study has also addressed the more complex issue of quasi-vertical integration which has been less comprehensively treated in the theoretical literature. White's quasi-integration into banking and railways in the 1830s again emphasises efficiency considerations, particularly those of transaction costs and securing improved property rights. In explaining
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why the firm adopted an intermediary mode, the study of the drawbacks of full integration: high set-up costs and variable levels of scale efficiency between adjacent stages. High set-up ccpsas also help explain the decision not to integrate into shipbuilding at all. The nature of the intermediary mode is also instructive in that it involved a group of family firms or partnerships acting together to adopt a minority but influential position in joint stock companies. Economic theory offers no explicit assessment of how this can come about. The historical evidence, in this case at least, emphasises the significance of m i d value systems in building up trust among the participating entrepreneurs and in engendering confidence amongst the mass of ordinary shareholders. NOTES I would like to thank Associate-Professors Steve Jones and Steve Wicholas and an anonymous referee for comments on various drafts of this paper. 1 For example see E.A.G. Robinson, The Structure of Competitive Industry (1931); N. Kaldor, 'Market Imperfection and Excess Capacity', Economics, new series, Vo1.2 (1935); R. Marris, 'Why Economics Needs a Theory of the F M , Economic J o u d , Vo1.82 (1972). 2 Vertical integration occurs when a firm expands into adjacent stages of production either upstream (backward) or downstream (forward). Horizontal integration occurs when a firm expands along the same stage of production. 3 His transaction cost explanation of vertical integration is developed in detail in O.E. Wiamson, The Economic Institutions of Capitalism (New York, 1985). 4 See M. Silver, Enterprise and the Scope of the Finn (Oxford, 1984) for various examples of this. Related to this is the life cycle hypothesis that the extent of vertical integration accords with the stage of historical development of an industry. See G. Stigler, 'The division of labour is limited by the extent of the market', Journal of Political Economy, Vo1.51 (1959). 5 Williamson concedes that technological inseparabilities can result from energy requirements (coal and oil) which cause production indivisibilities. O.E. Williamson, 'Emergence of the Visible Hand: Implications for Industrial Organisation', in A.D. Chandler and H. Daems (eds.), Munagerid Hierarchies: Comparative Perspectives in the Rise of Modern Industrial Enterprise (Cambridge, MA, 19$0), p.187. l Economics, 6 K.J.Arrow, 'Vertical Integration and Communication', Bell J o z ~ m of Vo1.6 (1975). 7 D.W. Carlton, 'Vertical Integration in Competitive Markets under Uncertainty', J o u d of Industrial Economics, Vo1.27 (1979). 8 See M. Casson, 'The Theory of Vertical Integration: A Survey and Synthesis', Journnl of Economic Studies (1984), pp.13-16 for a good discussion of theories of imperfect information. 9 A.D. Chandler and H. Daems, 'Administrative Co-ordination, Allocation and Monitoring: Concepts and Comparisons', in N. Horn and J. Kocka (eds.), Law and the Formation of the Big Enterprises in the Nineteenth and Early Twentieth Centuries (GSttingen, 1979). This is also dealt with in A.D. Chandier, The Visible Hand (Cambridge, M A , 1977). 10 Wiamson, Economic Institutions, p.27. 11 J.M. Vernon and D.A. Graham, 'Profitability of Monopolisation by Vertical Integration', J o m l of PoIiticaI Economy, Vo1.79 (1971).
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J.S. Bain, Industrial Organisation (New York, l%@. W.S. Comanor, 'Vertical Mergers, Market Power and the Anti-'hst Laws', American Economic Review Vol.57 (1967). O.E. Williamson, 'Transaction Cost Economics: The Governance of Contractual Relations', Journal of Low and Economics, Vo1.22 (1979). Williamson's work originally concentrated upon markets and hierarchies, Markets and Hierarchies: Analysis and Anti-Trust Implications (New York, 1975) but his more recent studies have recognised the importance of intermediary stages. See, for example, Economic Institutions. Casson, 'Vertical Integration', pp.32-3. Ibid., p.40; Williamson, Economic Institutions, p. 130. S. Davies, 'Vertical Integration', in R. Clarke and T. Mdjuinness (eds.), The Economics of the Firm (Oxford, 1987), p.104 refers to the existing empirical literature as 'primitive' and cites the problem of inadequate evidence. L. Hannah, The Rise of the Corporate Economy (1976); Chandler, Visible Hand; idem, Strategy and Structure (Cambridge, MA, 1%2). S.R.H. Jones, 'Technology, Transaction Costs and the Transition to Factory Production in the British Silk Industry, 1700-1870'. Journal of Economic History Vo1.48 (1988); A.M. Carlos and S. Nicholas, '"Giants of an Earlier Capitalism": The Chartered lfading Companies as Modem Multinationals', Business History Review Vo1.62 (1988). D.C. North, Structure and Change in Economic History (New York, 1981) pp.169, 178-9. Similar points are made by E.J. Englander, 'Technology and Oliver Williamson's Transaction Cost Economies', Journal of Economic Behaviour and Organisation Vol. l0 (1988), pp.339-53. S.D. Chapman, 'Financial Constraints on the Growth of the Firm in the Cotton Industry, 1790-1850', Economic History Review 2nd series, Vo1.32 (1979); V.A.C. Gattrell, 'Labour, Power and the Size of the Firm in the Lancashire Cotton Industry in the Second Quarter of the Nineteenth Century', Economic History Review, 2nd series, Vo1.30 (1977). Public Records Office (PRO), Customs 3615; Select Committee on Manufactures, Commerce and Shipping, (PP.VI, 1833), p.718; The Times, 9 Jan. 1854, p.5. PRO, Customs 17/12, -3615; S.C. Manufactures, Commerce and Shipping, p.718; Accounts and Papers, (P.P. LII, 1851), p. 197. M.W. Flinn, The History of the British Coal Industry. Vo1.2: 1700-1830 (Oxford, 1984) pp.218-26; Accounfs and Papers, (P.P. XLIV, 1846), p.103; (LIX, 1847), p.31; (LVIII, 1847-8), p.309; (L, 1849), p.345; (LII, 1850), p.233. S. Ville, 'Rise to Pre-eminence: The Development and Growth of the Sunderland Shipbuilding Industry, 1800-50', International Journal of Maritime History, Vol.1 No. 1 (1989), pp.74-6. W. Brockie, Sunderland Notables (Sunderland, 1894) p.155. Their wealth can be seen from the number of residences they owned around Sunderland which included houses in Denvent Street Ryhope Lane, Norfolk Street, John Street, Frederick Street, Low Row, and Green Street. Rural properties included several lodges and a farm. This is in addition to their commercial and industrial property. Q n e and Wear Archives Department (TWAD) 209194, Sunderland Parish poor rate books, 1825-31, 73014, notebook of Andrew White; Sunderland Herald, 31 Aug. 1. Chandler, Visible Hand, p.7. Anon, The Late Measures of the Shipowners in the Coal Trade (1786) p.4. Figures for shipping tonnages are taken from the port's registry of shipping. TWAD 1259. There is no indication of the value of White's fleet before 1815. From what we know of contemporary shipping values their fleet was probably worth in the range of U-4,000in 1800. See S. Ville, English Shipowning during the Industrial Rkvolution (Manchester, 1987), Ch.2 for a discussion of contemporary shipping values and Ch.6 on the profitability of shipping during the French Wars.
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31 The poor rate books give no indication of a business property owned by W t e ' s or, for that matter, other coopers. TWAD 209182, Sunderland Parish p r rate books, 1797-1800. 32 One contemporary noted, 'a man that has a ship of 24KI tons and nothing else to depend upon is gradually going to ruin'. S.C. Manufactures, Commerce a d Shipping, p.399, evidence of Henry Tanner, Sunderland shipowner and coal fitter. 33 Corder manuscript, Sunderland Central Library, Wear Shipbuilders, Vo1.2, M-Z. 34 TWAD 73014. 35 Michael Henley & Son, specialist shipowners in London, found vessels l i d up for three to six months of the year in the 1820s and profits very hard to come by. Ville, English Shipowning during he Indutrial Revolution, pp.60-1, 180-1. 36 TWAD 1259114, 17. 37 Bmkie, Sunderland Notables, pp.95-6. 38 He first cites himself as a shipowner rather than m p e r in 1799. TWADIlU9. 39 W A D 209184, 85. Sunderland Parish poor rate books, 1805-8, 1814-18. There were between 30 and 40 coal fitters in the port of Sunderland who owned about 250 keels in total. White's had 11. 40 Delays could be particularly lengthy when a large Beet arrived at once, when weather interrupted the supply of coal from the mines or when the 'Limitation of the Vend' was operating. On the Vend see P.M. Sweezy, Monopoly OnQ Competition in the English C o d Trade, 155&1850 (Cambridge, MA, 1938). 41 S.C. Manufocwes, C o m e r c e and Shipping, p.398. It should be noted that not all shipowners were equally well placed to benefit from this transaction economy. Many shipping firms fell below the minimum efficient scale to justify vertical integration because of the smallness of their enterprise or a more differentiated pattern of shipping deployment between a variety of trades. A problem of asymmetric information also existed between local and non-local firms in the north-east coal trade. 42 Brockie, Sunderland Notables, p.%. 43 S.C. Manufactures. C o m r c e and Shiupirx, - - - -p.399; TWAD 73014. 44 See below,*Table4. 45 Brockie, Sunderland Notables, p.98; TWAD 209193, 94, Sunderland Parish poor rate books, 1824, 1825-31. 46 Its vessels frequently shipped wal on the out passage and timber on the return but since these overseas voyages took three to four months White's was able to ship less coal from Sunderland than when it had been in the coastal coal trade. 47 TWAD 209193; Bishopwearmouth Parish poor rate books, 1823-27. 48 White's Durham and Northumberland Directory, 1827-28; WAD 20211746, incoming letters to the River Wear Commission. 49 TWAD U)2rU)61. Contract book for construction of Wearmouth Docks. 50 Sunderland s era id, 31 Aug. 1833, p.1. Its merits are described h detail in the same newspaper, 7 Sept. 1833, 8.4. 51 W A D 73014; 20211746. 52 W A D 20211744, 2029 incoming letters to River Wear Commission. 53 Ville, 'Shipbuilding', p.81. 54 S.C. Manufactures, Co~vpzarceand Shipping, p.417. 55 Select Committee on the Navigation Laws, (P.P. XX pt.2 1847-48) p.317. 56 R.C.O. Matthews, A Study in Trade Cycle History: Economic Flucncatiom in Britain, 1833-42 (1954) p.160. In Sunderland, as elsewhere, there was a concentration of joint stock activity into railways, mining and banking. Ibid., p.208. 57 Regarding the status of the joint stock company before the coming of general limited liability in the 1850s and 1860s, see P. CottreU, Industrial Finance, 18304914: The Finance and Organisation of English Manufoctzuing Industry (1980) pp.39-44. 58 S. Pollard, 'A New Estimate of British Coal Production, 1750-1850', Economic History Review, p.229; UK coal production doubled from 23 million to 47 million tons (metric) between 1830 and 1845 and exports rose from 0.5 million to 2.5
T H E EXPANSION AND DEVELOPMENT O F A PRIVATE BUSINESS 41
59 60
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72 73
74 75
million (B.R. Mitchell, European Historical Statistics, 1750-1970) 1975, abridged edn., pp.185, 232. S. Ville, Transport and the Development of the European Economy, 1750-1918 (1990) pp.115, 117-18. TWAD 73511 Durham and Sunderland Railway subscription book; K. Hoole, A Regional History of the Railways of Great Britain (Newton Abbot, 1965) pp.151-2. White's was also active in the formation of other local railway companies such as the Branding Junction and operated a small private line of its own between 1837 and 1842 which connected with their Bishopwearmouth ironworks. The latter was probably intended to yield transport cost savings. TWAD 209167, Board for the repair of highways, ~isho~wearmouth, 1836-42. TWAD 73014. W A D 20211004, River Wear Commission order book, 1820-44; TWAD 20213275, General Ledger accounts of River Wear Commission, 1837-59. TWAD 73013. Quasi-integration remains relatively neglected in both the theoretical and empirical literature although see F.J. Contractor and P. Lorange (eds.), Co-operative Strategies in International Business (Lexington, MA, 1988). P. Buckley and M. Casson, 'A Theory of Co-operation in International Business' in Contractor and Lorange (eds.), Co-operative Strategies pp.41-2. Also see D. Hutchinson and S. Nicholas, 'Theory and Business History: New Approaches to Institutional Change', Journal of European Economic History, Vo1.17 (1988), who discuss factors in the transition from market to hierarchy by use of intermediate modes. F.J. Contractor and P. Lorange, 'Why Should F i s Co-operate? The Strategy and Economic Basis for Co-operative Ventures', in Contractor and Lorange, Co-operative Strategies, p.16 suggest that co-operative modes are likely in new, uncertain areas with high fixed costs. Casson, 'Vertical Integration', pp.32-3; Hoole, Railways of Great Britain, pp.151-2; W.W. Tomlinson, North-Eastern Railway: Itr Rise and Development (reprint Newton Abbot, 1%7), pp.227-8, 288-91. M. Philips, A History of Banks, Bankers and Banking in Northumberland, Durham and North Yorkshire (1894) pp.319-20,336-41, 383-4. In the case of the Sunderland Joint Stock Bank a policy of 'kite-flying' (juggling accounts) enabled at least f50,000to be siphoned off before 1847, mainly to support colliery development. G.W. Bain, 'Early Days of Banking in Sunderland', Antiquities of Sunderland, 6 (1905 Vol., pp.90-1. White's iron and engineering works also conducted substantial business with these banks, W A D 843189-95. A contrasting situation existed in Scotland, where bank directors were not permitted to be personal borrowers. See C.W. Munn, Clydeside Bank: The First Hundred Years (1988). TWAD 1259119. Little is known of the remaining areas of entrepreneurial activity by the firm and they were probably of minor and temporary importance. These included insurance, soap, gas and lime. TWAD 740138,41, Sunderland Dock Co. cash and ledger books, 1845-56. For recent work on o~cioal-agenttheow see K.J. Arrow. 'The economics of Agency', in J. Pratt add R. kecl;hauser (edk) Principah and kgenrs: The Structure of Business (Boston, MA, 1984) pp.27-51; N. Strong and M. Waterson, 'Principals, Agents and Information', in Clarke and McGuinness (eds.) Economics of the Firm, pp.18-61. J.P. Killing, 'Understanding Alliances: The Role of Task and Organisational Complexity' in Contractor and Lorange (eds.), Co-operative Strategies, pp.56, 62 discusses different forms of inter-firm alliances. F.R. Root, 'Some Taxonomies of International Co-operative Arrangements' in Contractor and Lorange (eds.) Co-operative Strutegies p.75 produces a matrix of the combined importance of equity holding and bargaining power upon control.
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BUSINESS HISTORY Ibid., p.76. Killing, 'Understanding Alliances', p.63. Hutchinson and Nicholas, 'Theory and Business History', p.425. North, Shucfure and Change, pp.40-1, 53, 64 emphasises the heavy influence of moral and ethical codes of behaviour upon transaction costs. He goes on to note that common religious movements have been an effective means of sustaining ideologies that legitimise a particular economic organisation or system. TWAD 73014. W A D 1259. Ibid. Such as a petition to Parliament for the abolition of income tax. TVVAD SDBIAAILIl, Sunderland Borough Council minutes, 1835-47. Examples of speeches in support of the shipping industry can be found in Hansard Parliamentnry Debates, 3rd series, Vol.XLVI1, April-June 1839, col. 736; Vol.XLIV, May-June 1840, col. 181-2; VoLLVII, March-May 1841, col. 166. These issues are discussed in detail in G.E.Milburn, 'Wesleyanism in Sunderland in the Later Eighteenth and Early Nineteenth Centuries', Antiquifies of Sunderland, V01.26 (1974-76). Matthew, Trade Cycle Plistory, pp.157-8. The other financial drawbacks of politics included the absence of remuneration before 1911 and the costs involved in renting an apartment in London and paying election expenses. TWAD 73014.
