18 Seeking an advantage

E. H. Harriman and the Union Pacific represent the power of concentration in its highest phase. In the furthermost corners of the earth men are working for the benefit of Union Pacific and E. H. Harriman. The secret of it all is that the genius of Mr. Harriman has created a railroad system upon which more than its due portion of the traffic of the world must center. He has made the Union Pacific the main artery of commerce across the continent and he is reaping the reward of his foresight.

—Wall Street Journal, December 11, 1905

The mighty Pennsylvania Railroad took immense pride in calling itself the standard railroad of the world, but its officers were never so arrogant as to believe that they had nothing more to learn. They were always on the lookout for new ideas and techniques and kept a close watch on what other roads did. In 1908 the Pennsylvania sent a two-man team to inspect the Union Pacific. Their report, based on careful observation, carried a weight of authority far beyond public tributes in newspapers and magazines. It was the opinion of experts, it was private, and it was glowing in its praise of what Harriman had done.¹

Such praise did not come easily to officers of eastern railroads, who tended to view western roads with an air of condescension if not disdain. But the Union Pacific possessed an organization the officers described as “departmental at the top and divisional at the bottom, there being a striking similarity between their organization and our own.” Harriman made it the blueprint for a new and daring vision of how a railroad should be run and the instrument for his obsessive effort to create the perfect machine.

Much of what Harriman accomplished was the brilliant execution of existing ideas. In the case of organization, however, he carved out an original path that many railroad managers rejected as foolhardy. Nor was he ever content with his organization. To keep abreast of what was going on, he sent officers to tour other roads as the Pennsylvania did. As an industry steeped (some would say trapped) in tradition, railroads were not noted for their receptivity to innovation. Harri-man sought to impress on his officers something even more basic than change: a higher learning curve.

The key to any organization lies in the quality of the men who run it. As Mohler and Frederick D. Underwood demonstrated, good men had a way of drifting into Harriman’s orbit and staying there until he used them up. Harriman drove his officers mercilessly but gave them free rein to show what they could do. He combed the ranks of every road he acquired for its best talent. Within a few years after the Southern Pacific deal, several of its officers had moved to higher ranks within the parent Union Pacific.²

Aware that Hill had a reputation for cashiering older hands when they no longer measured up, Harriman told a reporter with relish, “When I take charge of a property I don’t discharge the old men to make room for my pets. I don’t have any pets. The way to reward faithfulness is not by discharging the old hands.” But the reporter also knew Harriman’s reputation for scourging a president or vice-president in tones that others would not use on an office boy. He concluded that the Union Pacific men “don’t dislike Harriman like the Great Northern men dislike Hill. The trouble seems to be that everybody is afraid of Harriman.”³

The perfect machine required three elements: the right organization to realize its full potential, the right men to make it run smoothly, and the right systems to maximize its efficiency. Harriman toiled incessantly to create a structure that delegated authority while still enabling him to keep his finger on everything that happened. The first step flowed out of the Metropolitan Club pact with Hill (see Chapter 15). Although nothing came of the provision to create uniform methods of management and accounting, Harriman at least got Hill’s grudging consent to delegate all traffic matters. The authority vested in John Stubbs and Darius Miller made them traffic czars who bypassed the presidents of individual lines and reported directly to Harriman and Hill. Both men operated out of Chicago even though all the lines served by Stubbs lay west of the Mississippi River.

Two aspects of this arrangement disturbed traditional railroad men: centralizing so much authority in the hands of an officer outside the regular organization and locating that officer off the lines he supervised. Stuyvesant Fish shook his head at what he called a “novel experiment”; another, less tactful president sneered that no road could be run by two heads and, in an obvious jab at Harriman, grumbled that big systems should be “operated by men on the ground and not by financial people a thousand, or perhaps three thousand, miles from the seat of war.”⁴

When Harriman acquired the Southern Pacific in 1901, the parent Union Pacific had a typically small organization. The board, vice-president, secretary, treasurer, and general counsel were in New York and the rest of the officers in Omaha. Once Harriman decided to unify the central commands of both systems, he revamped the management into six departments: executive, legal, traffic, accounting, treasury, and operating. The executive officers remained in New York and the railroad men in Omaha except for Stubbs.⁵

Traffic genius: J. C. Stubbs, the gaunt, schoolmaster-looking executive who came from the Southern Pacific to become traffic manager for the Harriman’system. (Southern Pacific photo, Union Pacific Museum Collection)

Harriman also extended the authority of Erastus Young, the Union Pacific’s curmudgeonly auditor, over all the lines, brought William Mahl of the Southern Pacific to New York as comptroller for the combined systems, and turned the assistant secretary into a director of purchases. He summoned to New York as counsel Robert S. Lovett of the Southern Pacific, who became Harriman’s closest confidant along with vice-president W. D. Cornish. Himself a lawyer, Cornish proved an invaluable cog in Harriman’s machine. He was the perfect antidote to his truculent superior, a smooth diplomat who knew how to compromise and pacify when the occasion demanded.⁶

Once the departments were in place, Harriman took his boldest gamble. In 1904 he moved Kruttschnitt to Chicago as director of maintenance and operations for the combined systems. Railroad men gasped in bewilderment at this latest heresy. Harriman had placed the two most critical functions of a railroad, operations and traffic, in the hands of officers located hundreds of miles off the line and beyond the jurisdiction of the roads’ presidents.

The men on the hot seat made the oddest of couples: the gaunt Stubbs, whose pinched, bespectacled expression gave him a professorial air, and the slow- moving Kruttschnitt, a walrus of a man who looked like a butcher. Stubbs had come to the Central Pacific shortly after it opened in 1869 and had been in charge of transcontinental traffic for a quarter-century; no one knew its complexities better. Kruttschnitt was a native of New Orleans who had earned a degree in civil engineering just in time to catch the depression of the 1870s. He did not land a railroad job until 1878, when he hooked on with a road that Huntington later leased. By 1900 he had risen to vice-president and general manager of all Southern Pacific lines. Already he had become a pioneer in the creation and use of statistics.⁷

Kruttschnitt and Stubbs were as dry and phlegmatic as Harriman was dynamic. “Harriman was rich in vision, in imagination,” recalled the banker Frank Vanderlip. “There was in him something of the quality which a poet brings to his work. But Kruttschnitt had absolutely no imagination. His implements were facts; he was a living index of all railroad facts.” All of Harriman’s officers shared certain qualities invaluable to him: intelligence, loyalty, dedication to duty, and a voracious appetite for work. Harriman might complain that Stubbs, Mahl, or Kruttschnitt lacked vision, but he appreciated how their dutiful, plodding ways provided the raw materials that enabled his own imagination to soar. They were the ideal complement to Harriman’s occasional tendency to let enthusiasm run away with his judgment.⁸

Harriman’s new organization forced officials at every level to adjust their thinking radically. Railroad men were accustomed to hard work but not to fresh approaches. Mahl, who preferred Huntington as a boss, grumbled that Harriman did not develop men but rather shoved them about like pawns on a chessboard. Vanderlip conceded that “Harriman had the philosophy, the methods of an Oriental monarch.” Those who had the stamina and ability to endure the grind flourished; those who balked or faltered in their traces were soon cut loose. Harriman played no favorites, but he did practice the survival of the fittest. The weeding out began early and claimed as one of the first casualties Charles M. Hays, president of the Southern Pacific.⁹

No road had a more unsavory reputation than the Southern Pacific. Company officials had long enriched themselves by investing in local land and oil companies that fed on inside information from the railroad. In March 1901, only a month after Harriman had finalized the acquisition, the novelist Frank Norris immortalized the road in The Octopus as a choking monopoly whose powerful tentacles swarmed deep into California politics and the pockets of shippers. Hays tried earnestly to undo this reputation, but his desire to manage the company his own way ran afoul of Harrimans plans to centralize functions like traffic and accounting outside the presidents authority. After one clash Hays resigned in a huff, then regretted his impulsiveness and begged to be reinstated. But Harriman let him go even though he had no replacement in mind.¹⁰

Schiff, who had just sailed for Germany, was uneasy over rumors that Felton was to succeed Hays. He urged Harriman not to make the change “until the right man has been found in Feltons place. The responsibility for the Alton's success will long stick to us, whether we wish this or not, & we can therefore not afford to take any chances as to its physical management.” Harriman agreed entirely and made a wholly unexpected choice for the Southern Pacific: himself. The arrangement was temporary, he explained, with Kruttschnitt handling the real work as his assistant.¹¹

Schiff nearly gagged on the news. “The present state of affairs is unjust both to you and the Company,” he sputtered. “I know of no other Company which so greatly needs a strong local management than the Southern Pacific.” He stressed how unpopular the company was, how its officials were reputed to be lining their pockets at its expense, and how rival roads posed a constant menace. “From one end to the other of the system, a watchful eye is needed urgently & constantly,” he pleaded. Where would Harriman find time to deal with these problems? “The existing situation fills me with anxiety and misgivings,” Schiff concluded, “& I would not be loyal to you if I did not express this to you in entire frankness.”¹²

But Harriman made the arrangement permanent. He realized that no traditional railroad president could feel comfortable in an organization where authority for so many key functions lay outside the traditional channels. The obvious solution was to make himself president and put operations in the hands of capable vice-presidents. This became clear when Horace Burt, that most dutiful of workhorses, finally wore down under the strain of Harriman’s demands. Although he quit two years after Hays did, critics pointed at parallels between the two cases and circulated stories about how Harriman had forced Burt out by subjecting him to a series of humiliations.¹³

The climax occurred in the fall of 1903, when Harriman and W. L. Park met Burt in Cheyenne. The dispute with the shopmen still raged, and Harriman wanted to look into their complaints that his order abolishing piecework had been ignored. Burt still smarted from the order itself and was mortified at being suspected of disobeying it. When Harriman left for the shop, Burt grabbed Park and walked him up and down the platform. “When Mr. Harriman comes back to his car I am going to tender him my resignation,” he confided. “I want you to know it now, so that later it cannot be said that I was dismissed.” Park tried to dissuade him, but Burt only muttered, “I cannot be humiliated this way. These men around us know what is going on.” Shortly afterward Harriman returned from the shop and gave Burt another tongue-lashing. That night he received the presidents resignation.¹⁴

Several years later, when Harriman made what proved to be his last trip over the road, he fell into a reminiscent mood one night and told Park his side of the story. He denied firing Burt and gave him full due for the reconstruction work. But Burt, like many officers, never fully understood what Harriman was trying to do. He often had to force new ideas on Burt and sometimes new equipment even when the road was swamped with business. The struggle wore both of them down, Harriman always pushing and Burt resisting. Their parting had been friendly by Burts own admission.¹⁵

After Burt’s departure, Harriman assumed the presidency just as he had with the Southern Pacific. The following year he created Kruttschnitt’s position as director of maintenance and operations for both systems. This arrangement eased the tidy minds of rail managers somewhat; on paper it preserved the chain of command by allowing Kruttschnitt to report to the president of both systems. But no organizational chart obscured the main point: the Harriman’system was unique not merely in its structure but in having Harriman at its top.

Nor did any chart obscure the way Harriman’shattered tradition in tackling the problem of organization. For years thoughtful railroad managers had debated whether to arrange their structures by departments or divisions. Most companies used the former, which organized the road by function and gave each department authority over the entire system. This highly centralized structure grew unwieldy as the system expanded and stunted the development of young officers, who tended to curry to superiors rather than rely on their own initiative.¹⁶

The divisional approach carved the system into separate spheres managed by officers who were held responsible for the performance of their domain. It was a horizontal rather than vertical structure which the Pennsylvania Railroad had pioneered as early as the 1870s with striking success. Except for the Burlington, surprisingly few other roads had adopted it even though their systems grew ever larger and more unwieldy to manage. The divisional method had its own shortcomings. Fierce rivalries tended to develop among the division heads, whose primary aim was often to make an impressive showing for their own realm without concern for the performance of the overall system.

These rivalries had ruined the Union Pacific’s first experiment with the approach in the 1880s. Harriman devised a modified divisional system that tried to eliminate this flaw; the result was what the Pennsylvania’s observers described as departmental at the top and divisional at the bottom. Stubbs and Kruttschnitt presided over the combined systems. While the vice-president and general manager of each major road had his own staff officers, two of these officials—the chief engineer and the superintendent of motive power—reported directly to Kruttschnitt.¹⁷

Beneath these officers six general managers presided over twenty-six division superintendents, each of whom ruled what amounted to a “separate but miniature railway.” The division superintendents wielded the same authority in their domain as the vice-president did over the entire road, and they bore full responsibility for the results. Harriman also took care not to let his two chief officers become desk jockeys. He prodded Kruttschnitt not to turn his office into a “correspondence bureau” and urged him to get “out over the various lines and keep things smooth.”¹⁸

Fifteen years earlier, in seeking a new organization for the Illinois Central, Harriman had insisted on making officers fit the plan and not the reverse. Now he could finally practice what he had preached by shuffling his officers to fit the new structure. The able Mohler was brought to Omaha to take charge of the Union Pacific, with the veteran E. E. Calvin replacing him on the Navigation line. C. H. Markham took Kruttschnitt’s post as operating head of the Southern Pacific. W. H. Bancroft remained in charge of the Short Line but had his jurisdiction extended to all lines west of Green River, Wyoming. These were all men on whom Harriman could rely; in later years Mohler and Calvin rose to the presidency of the Union Pacific and Markham of the Illinois Central.¹⁹

The new organization enabled Harriman to accelerate his program of integrating every aspect of operations across the systems. All four major lines got the same operating rules. Uniform standards were devised for car and engine construction as well as other equipment, enabling Harriman to buy in bulk for all four lines at once. Centralized purchasing and common standards lowered unit costs, slashed inventories, made interchange of equipment easier, and cut downtime on equipment by making parts more available. Harriman hounded every officer to find new ways of “handling the largest possible business at the least possible cost.”²⁰

TABLE 1. Comparative Data on Selected Western Railroads, 1892 and 1902

Kruttschnitt, the walking encyclopedia, needed little prodding. Once arrived in Chicago, he plunged joyfully into the creation of a clearinghouse to pool all cars on the Harriman lines as if the equipment was owned in common. This too was heresy to traditional railroad officers, who were loath to see their cars go even to other lines in the system. Harriman attacked this parochialism and demanded that officers use cars to full capacity. To wring the most use out of every locomotive, Kruttschnitt devised a formula for loading trains based on tonnage rating, tractive power, and speed. Heavier cars were put on longer runs to maximize their capacity, and shipments were combined to save equipment.

Every innovation became the stuff of statistics, which flowed into Krutt-schnitt’s office in unprecedented volume to monitor the system’s efficiency. He calculated that the new system saved more than fifty-three million miles of empty car hauls in the first two years alone. Hauls grew longer, trainloads heavier, speeds slightly higher, and operating ratios lower. The Harriman roads spent more per mile on maintenance than any other western road between 1900 and 1909 yet managed to drive the operating ratio down, as Table 1 illustrates.²¹

Harriman pored over these statistics and attached special importance to average receipts and costs per ton-mile as well as trainload figures. The numbers revealed to him patterns of strength and weakness, beacons for his probing mind to follow. He not only did things by the numbers but used the numbers to show what he did. Once during an interview he hauled out a typewritten sheet of data on the Union Pacific and rattled off some figures. “As he read from it,” wrote the surprised journalist, “I realized it was the apologia pro vita sua.”²²

“But the public assails and attacks you and impugns your motives and accuses you of all sorts of things,” ventured the interviewer when Harriman had finished. “Doesn’t the thanklessness of the job ever embitter you?”

In reply Harriman merely slapped the sheet of statistics and said defiantly, “That remains.”

The numbers revealed something else about Harriman, something far more important to him than public adulation because it demonstrated in the clearest possible terms that his policies worked. Within a few years of acquiring his Pacific systems and pouring huge sums into modernization, he transformed them into two of the most lucrative cash cows in American business. The results of his management were not merely impressive; they were spectacular.

The swiftness with which this transformation occurred became apparent only in retrospect. Most observers saw vast amounts of money flowing into improvements but were slow to grasp how great a difference in performance it would make. In 1898 the Union Pacific's earnings amounted to $32.6 million gross and $13.1 million net. Over the next six years trainloads nearly doubled. Earnings rose steadily to $67.3 million gross and $30.3 million net in 1906, an increase of 106 and 131 percent. Once set in motion, the machine rolled relentlessly onward, its efficiency increasing every year as new betterments and equipment came on line. One analyst shook his head in wonder at how commonplace it had become “to see the gross and net earnings of the Harriman lines increase month by month at a phenomenal rate.”²³

To provide funds for this work, Harriman’steadfastly resisted the clamor for dividends until he was convinced their time had come. After grudgingly paying the company's first dividend on common stock in 1900, he managed to hold the rate at 4 percent until July 1905, when it was advanced to 5 percent. A few months later Harriman let it go to 6 percent amid demands for still more. The stock also marched upward, crossing 50 in 1900 and climbing past 195 by 1906, when it became the bluest of blue chips. Awed observers saw the Union Pacific system transformed into a giant funnel across the heartland through which poured the swelling bounty of California, the Northwest, and the Orient. By 1906 Omaha had emerged as a grain and meatpacking center boasting seven new elevators in less than two years.²⁴

The same pattern unfolded on the Southern Pacific. Between 1901 and 1906 the flood of traffic, coupled with increased efficiency, sent gross earnings up 37 percent and net earnings 33 percent. Harriman gave the system a careful inspection during the spring of 1902 and concluded that still more money had to be spent on betterments. His decision rankled stockholders hoping for dividends, especially one who had become the road’s largest shareholder outside Union Pacific circles and its champion in the market.²⁵

In the autumn of 1901 Harriman had received several visits from the crafty James R. Keene inviting him to join a pool to boost the price of Southern Pacific stock. Harriman could greatly aid the cause, Keene added, by relenting on his dividend policy. Harriman responded by giving Keene his standard lecture on why the Southern Pacific needed more outlays for improvements instead of dividends. The pool went ahead without him, buying stock at prices below 70, but its efforts were stymied by Harriman’s stand on dividends. When Harriman reaffirmed that policy during his inspection tour in 1902, Keene countered by having his son-in-law, the broker Talbot J. Taylor, issue a glowing analysis of the Southern Pacific as “an almost inconceivably rich and powerful corporation,” but the ploy was too transparent and made little impression.²⁶

Harriman knew this game, had seen it many times on Wall Street. Men like Keene and Gates were called “strikers” because they were always looking to hit some company for quick speculative profits. He was not surprised when Keene tried another tack that fall by sending lawyer Edward T. Lauterbach to warn Otto Kahn that a suit was planned to remove the Union Pacific from the management of the Southern Pacific. The hostile suit could be avoided, Lauterbach suggested, if the Southern Pacific declared a 4 percent dividend or Harriman bought the pools holdings. Kahn replied curtly that nobody was interested in buying the pools stock and that dividends were a matter of policy, not negotiation.²⁷

Once Harriman made it clear to Wall Street that he had no intention of paying a dividend, Southern Pacific stock tumbled to a low of 56 by December. For months he dodged Lauterbach’s efforts to see him. Finally, the lawyer in desperation asked a mutual friend to tell Harriman that the proposed suit would be disastrous to his interests and that Keene was willing to drop it if Harriman would buy the pool’s stock. Keene offered a sliding scale: a price around 70 for the 105,000 pool shares and 78 for his own 70,000 shares. Harriman’spurned the offer, saying icily that he had nothing to fear from Keene, and he continued to duck Lauterbach’s every attempt to see him. A frustrated Keene then tried to enjoin the Southern Pacific annual election on the grounds that the Union Pacific had no legal right to vote the shares it owned. He also asked that the managements of the Union Pacific and Southern Pacific be separated, adding piously that if the courts refused, “justice is dead in America.”²⁸

Unmoved by the threats, Harriman vowed to fight the suit and ruled out any change in dividend policy until the attack on the management ceased. The corporate charter of the Southern Pacific resided not in California but in the sleepy Louisville, Kentucky, suburb of Beechmont, whose 150 residents were treated to a brief media circus as lawyers invaded the town to do battle. After Harriman and Kahn detailed Keene’s blackmail efforts, the court dissolved the injunction and ruled in Harriman’s favor in the suit. Keene and his friends took heavy losses in selling off their shares.²⁹

Harriman’succeeded in routing Keene’s raid, but the damage done was far greater than anyone realized. In their argument Keene’s lawyers had denounced Union Pacific control of Southern Pacific as a direct violation of the Sherman Act. This was the critical issue in the Northern Securities case, on which the Supreme Court had yet to rule. Keene’s foray had poked another large nose under a very fragile tent and linked the Union Pacific-Southern Pacific combination to it. In time nearly every man on Wall Street would regret that the issue had ever been raised.³⁰

Nor was that the only embarrassment. In the heat of battle Harriman had resorted to selling three hundred thousand shares of Southern Pacific stock controlled by the Union Pacific to William Rockefeller with a proviso that Rockefeller could sell them back to the company a year later. The object was to put enough stock beyond the reach of Keene’s injunction to carry the election. It was, Harriman explained, “a protective measure, pure and simple,” but it came back to haunt him. Investigators later jumped on the $187,500 commission paid Rockefeller for his services and charged that the real reason for the sale was to “show that the Union Pacific was not controlling a parallel and competing line.”³¹

For the moment, however, Harriman had things his own way. Once Keene had been routed, the Southern Pacific continued its improvements program unopposed. Not until August 1906, more than five years after first gaining control of the Southern Pacific, did Harriman pay the first dividend on common stock. From then on, the dividend became as regular as the growth of earnings derived from an expanding business and remarkable operating efficiency.³²

Neither threats nor criticism had deflected Harriman from his original goal. “The Harriman regime has been a drastic one,” concluded one analyst. “The task… was the reconstruction of the Southern Pacific, without expanding fixed charges. To that task the management bent all its efforts, without regard to stockholders, petitions, threats and constant mutterings of discontent. This five years of Harriman autocracy… has been one of the most striking epochs in the history of American railroads.”³³

And one of the most ironic as well. An earlier generation of rail leaders had been roundly condemned for lining their pockets by paying dividends that had not been earned, taking it out of the road’s hide by skimping on maintenance or fudging accounts. Harriman was attacked for pursuing exactly the opposite course: putting the road in superb condition at the expense of dividends even though the Union Pacific (and through it himself) would be the chief beneficiary of any dividends paid by the Southern Pacific.

Harriman had led the rail industry into a new era, shown open minds the path to the future. To those who opposed him he offered the same answer he had given the interviewer: a wave of an arm at the Southern Pacific and a defiant, “That remains.”