The Cigarette Century Page 5
Using cigarette cards and other techniques, Duke parlayed a growing advertising budget into dominance of the cigarette trade. One journalist in 1907 described him as “always an aggressive advertiser, devising new and startling methods which dismayed his competitors . . . always willing to spend in advertising a proportion of his profits which seemed appalling to more conservative manufacturers.”58 The cigarette industry would set unprecedented ratios of promotion costs in relation to sales.59 In 1889, for instance, Duke’s American Tobacco spent $800,000 on advertising, compared to sales of $4 million to $4.5 million.60 In this respect—as in others—Duke anticipated central elements of twentieth-century marketing, not only of the cigarette, but of numerous other goods in a burgeoning consumer culture. Novelty and innovation became characteristic elements of cigarette marketing. In 1884, Duke purchased 400,000 chairs emblazoned with advertisements for his products that he freely distributed to retailers. Soon, billboards and buildings throughout the states carried cigarette ads, studding urban and rural landscapes with towering promotions. Not only did such expenditures help recruit new smokers, high promotion costs quickly became an important barrier to new firms introducing competitive products.61
Duke also believed that, to reach its massive potential, the mechanized cigarette required a new system of industrial organization. The construction of the tobacco trust at the turn of the century—as well as the rise of a vertically integrated industry—would mark a central innovation in the history of industrial capital. Historians of American business and enterprise often point to the tobacco industry to demonstrate this important watershed in American economic and social history. These last decades of the nineteenth century saw intensive efforts on the part of businesses to use consolidation to gain control over the vagaries of production and markets. Just as Duke had instituted critical technological and marketing innovations, he now turned to radical organizational initiatives to disarm his competitors and build a massive industry. It is this organizational vision that ultimately earned him a place in the pantheon of American business leaders.62
Duke began to express interest in purchasing his competitors as early as 1887. His first entreaties were met with a measure of derision; Duke had yet to achieve dominance in a highly competitive industry, and few took him seriously. But by 1889, he was spending unprecedented sums to advertise his products, as well as aggressively lowering their price. His pricing policies helped him achieve his ultimate goal of moving his principal competitors (who did not know of his advantageous arrangements with the Bonsack Company) toward consolidation into a trust.63 In part because the cigarette was so difficult to differentiate and so ephemeral, it was (and would remain) more sensitive to general price trends than many other products. Duke came to see powerful advantages in consolidation and monopoly: the ability to avoid price competition would be crucial to the ultimate success of the industry and the cigarette. He pursued increasingly thin profit margins in order to bring competitors into the fold.
In January 1890, Duke forced the other four major producers to join a consortium named the American Tobacco Company, under his leadership. Duke explained in retrospect that he felt that
in selling our business to the American Tobacco Co. in connection with the other manufacturers we would get a good organization of people who would be of assistance in conducting the business, and then besides that I expected to make a profit by it because you can handle to better advantage a large business than a small business.64
The newly formed American Tobacco Company was capitalized at $25 million; American Tobacco and Allen & Ginter each received $7.5 million in stock; Kinney received $5 million; and W.S. Kimball & Company and Goodwin & Company split the final $5 million. With Duke at its helm, American Tobacco could immediately claim 90 percent of all cigarette sales in the United States. The “Tobacco Trust,” as it quickly became known, had established a virtual monopoly—five fierce competitors joined under Duke’s organizational iron will. In the last years of the nineteenth century, the Tobacco Trust aggressively acquired independent firms, closing their plants and consolidating machinery, inventory, and products.65
The development of such trusts, most powerfully symbolized by John D. Rockefeller’s Standard Oil Trust, marked concerted efforts on the part of industrialists to limit competition and the vagaries of the markets. But they also offended powerful political and cultural sensitivities about the values of competition, markets, and economic opportunity. Duke would insist that such structures were simply devised to rationalize the complex tasks of production and marketing. As he secured virtually absolute control over the cigarette market, prices to consumers actually fell due to new economies of scale and production. But in a political culture with a deep historical antipathy to monopoly and “restraint of trade,” such trusts would not escape the attention of legislators and the courts. Their social and economic impact would become perhaps the central debate in the American polity at the turn of the twentieth century.
The Tobacco Trust facilitated Duke’s aggressive program of consolidation and integration of the industry. Once it was set up, Duke fought with the other owners over his plans to control plug, smoking, and snuff tobacco as well. He developed a series of departments, each charged with selling its particular form: cigarettes, smoking tobacco, small cigars, and others. Salesmen for each department competed for customers from the same retailers. Duke saw this decentralization as beneficial to the Tobacco Trust. It reflected his view that no one—not even Duke himself—could predict what form future tobacco consumption would take.
The trust realized impressive economies of scale. Duke and his competitors had been single-function enterprises, concerned only with making and selling the end product.66 Growing and processing of tobacco on the front end and retail distribution on the back end were left to independent entrepreneurs. Duke was the first to take steps—even prior to the Bonsack machine—to establish a fully integrated industry. He now radically reordered the entire business to assure continuity and managerial control.
With the consolidation enabled by the Tobacco Trust, whole manufacturing was concentrated in large plants, and the industry developed an extensive buying operation under what became known as the Leaf Department. An even more extensive sales department eagerly sought the command of new markets. All were committed to high volume “throughput,” from agriculture through production to sales.67 The Tobacco Trust also brought to an end most competitive bidding at the famed tobacco auctions. Farmers were forced to take American Tobacco’s offer as the Tobacco Trust came to dominate all purchasing.68
By creating selling and distribution offices in key cities, Duke developed a national network to market and distribute his products. He staffed each office with a manager, a salesman who would focus on the city, and another salesman who would service surrounding towns. These quickly became the basis of a national sales force. Together, these three departments—audit (which oversaw accounting and cost control), leaf, and retail markets—assured the movement of cured tobacco from warehouse to factory to sales. Individuals with specific expertise headed each department. The audit department, for example, introduced innovative accounting procedures that would later be utilized by many other industries.69 The success of Duke’s enterprise, which became a model for other industries, rested on salaried executives who could assure the efficient functioning of their aspect of the business as well as tight coordination with other departments and activities—in short, he invented the middle manager. These middle managers were a critical component of the emergence of a new middle-class culture. The social constituencies that would form the basis of the consumer culture now worked inside the tobacco industry.70
Just as Duke worked to get the bugs out of the Bonsack machine and assure continuous production, he now sought to eliminate inefficiencies and uncertainties inherent in vertical integration. If the last years of the nineteenth century have been aptly described as a “search for order,” nowhere was this clearer than in the radica
l reorganization of big business.71 And no one was a more inventive practitioner of corporate rationality than Duke. Vertical coordination assured that factories operated at full capacity. Further, it promised consistency of quality and timeliness of shipping and sales, crucial in an age prior to packaging, when the shelf life of tobacco products was short.
Duke’s vertical consolidation sought to eliminate middlemen at every level. Wholesalers, jobbers, and others not only cut profits, they created inefficiencies. According to Duke, if something was part of the process of producing cigarettes, it must be done within the company structure. The complexities of legal relationships and liabilities in fashioning mergers and acquisitions soon prompted him to add a legal department to assure in-house counsel. Finally, he understood the utility of locating his central office in New York City, the capital of rising national commerce. With this move, Duke overtly recognized that ready access to capital was more crucial to building an international business than proximity to growers or processors. Tobacco was a crop; American Tobacco was a corporation.
Duke had never been regional in his business aspirations, nor would he stop at national boundaries. Even before the formation of the Tobacco Trust, Duke insisted that “the world is now our market for our product.”72 In the early 1880s, he sent one of his senior colleagues, Richard Wright, around the world in search of new markets for his tobacco products. In the context of extending the Tobacco Trust, he now eagerly sought to take over expanding world markets. He established subsidiaries in Canada and Australia, and then turned his attention to Japan and China. In response to high tariffs on American products in Japan, Duke purchased a controlling interest in Murai Brothers, a Japanese firm.73 Soon, American Tobacco developed extensive interests in China as well.
In 1901, Duke traveled to Great Britain in yet a further attempt to expand the global reach of the Tobacco Trust. He purchased Ogden’s Limited, one of the major British tobacco companies, and embarked on a full-scale trade war with the recently constituted Imperial Tobacco. By now, well versed in such combat, Duke soon turned his adversary into a partner. Duke and Imperial created British American Tobacco in a “global agreement” in which Duke controlled two-thirds of its stock and Imperial one-third; both sides agreed not to threaten each others’ domestic markets. With this agreement in hand, American Tobacco had worldwide dominance of the tobacco markets well within its grasp. Again, yet another of the critical structural elements of tobacco production and sales in the new century was effectively realized.74
But the Tobacco Trust’s focus was not solely on cigarettes. In spite of the phenomenal success of the cigarette following the introduction of the potent combination of mechanization and aggressive sales promotion, as late as 1904, cigarettes still constituted only approximately 5 percent of the American market in tobacco products. Few observers at the time could have predicted that this somewhat idiosyncratic product would soon become so embedded in the cultural life of the new century. This unpredictability explains Duke’s obsession with bringing all tobacco products under the Tobacco Trust’s control. The consuming public was fickle, and regardless of fad, he wished to control the product of the moment. “We wanted to have a full variety . . . of the different styles of tobacco. . . . If one style [of tobacco product] went out of fashion we would have another style ready for the public to take up.” It was his aggressive move to consolidate all tobacco under his aegis that ultimately made the Trust so vulnerable to regulation and judicial dissolution. For all of Duke’s business brilliance, he never trusted the potential of his most modern product.75
Duke’s only failure came when he attempted to integrate the cigar industry into his increasingly extensive fold. Cigars, he found, fit poorly with his system of mechanization, standardization, and national marketing; cigarettes would come to be defined by uniformity and mass production; cigars could not be easily mass-produced. Production of cigars would remain labor intensive, skilled work; they continued to be distributed in small quantities to specialized dealers. This distinction in consumption patterns defines a key difference between the nineteenth and twentieth centuries.76 The cigar represented tobacco consumption of the past, and the cigarette heralded the future. For Duke, who had transformed his father’s plug business into a multinational giant, it was all just tobacco. His aggressive moves to incorporate the full range of tobacco products would ultimately bring him into conflict with the federal government.77
The financial success of the Tobacco Trust was nothing short of spectacular. From the original capitalization of $25 million in 1890, assets grew to $350 million by 1910. As economist Richard Tennant put it, “the fruits of monopoly were enjoyed.”78 Every $1,000 invested in 1890 (held without reinvestment of dividends) brought in a profit of $35,000 by 1908.79 Moreover, the trust succeeded in precluding new entries into the market.
The formation of the Tobacco Trust in 1890 was part of a national industrial merger movement. The growth of giant corporations inspired a combination of awe and loathing. The Tobacco Trust—and ongoing issues of industrial collusion and competition—reflected a deep ambivalence within the American polity between appreciating the decided advantages of big business and recognizing its costs to innovation and entrepreneurship. 80 For a nation with deep commitments to a free market, monopolies threatened higher prices and the end of innovation.81 Perhaps if the tobacco monopoly had been the only one, public and political concern would have been more muted. But Rockefeller’s oil trust (which Duke so admired) and numerous others in railroads, copper, lumber, and other crucial industries created intense concerns about the concentration of capital.82
Trusts aroused political and cultural anxieties about the character of big business and the American economy. As corporations sought control over the variables of the market—especially in a time of periodic and intense economic downturns—Congress and the courts sought to limit the consolidation of corporate power. The central point was not the regulation of products like the cigarette, but rather the very structure and arrangements of corporate capitalism. Generally, the courts, especially the Supreme Court, found in favor of promoting competition. Although the Court was loathe to dictate corporate structure, it did—utilizing the Interstate Commerce Clause of the constitution—assert authority over how such organizations promoted or inhibited the movement of goods from state to state.
The American Tobacco Trust and the Sherman Antitrust Act were both created in 1890, one by an industrial mastermind, the other by Congress. It would be almost two decades, however, before they would collide. By the time the Department of Justice indicted American Tobacco in violation of the Sherman Act in 1907, the combination controlled not only 80 to 90 percent of the cigarette trade, but also 75 to 85 percent of all other forms of tobacco use—everything except the recalcitrant cigar business. Duke not only brought all tobacco products into the combination, he added companies producing licorice paste for flavorings and tin foil for packaging. Under President Theodore Roosevelt, the Bureau of Corporations documented the actions and activities of the Trust in excruciating detail. When the Department of Justice undertook antitrust litigation against American Tobacco, it was one of the three largest companies in the United States. The other two were Standard Oil and U.S. Steel.83
In 1908, the Department of Justice filed a suit in equity against the American Tobacco Company, alleging violation of the Sherman Antitrust Act. Some sixty-five companies and twenty-nine individuals, led by Duke, were named in the suit. Under Roosevelt’s watchful eye, the government insisted on the dismemberment of the trust. The federal court in which the case was initially heard found American Tobacco guilty of violating the antitrust statute, but it exempted United Cigar Stores, British American Tobacco, and Imperial from prosecution. American Tobacco was banned from interstate trade pending the restoration of “competitive conditions.” Both sides appealed to the Supreme Court.
In May 1911, the Supreme Court found the American Tobacco Company to be in violation of the Sherman Antitrust Act
and ordered the company dissolved. On the same day, using similar logic, it issued its decision breaking up the Standard Oil Trust. Both decisions rested squarely on the newly instantiated principle of what the Court called “the rule of reason.” Given the vague language of the statute, the Court would now assert the government’s regulatory authority over the excesses of trust building. The decision closely narrated the construction of the trust:The history of the combination is so replete with the doing of acts which it was the obvious purpose of the statute to forbid, so demonstrative of the existence from the beginning of a purpose to acquire dominion and control over the tobacco trade . . . by methods devised in order to monopolize the trade by driving competitors out of business.
The Court described the Trust as “ruthless” in its design. As Chief Justice Edward Douglas White explained:We think the conclusion of wrongful purpose and illegal combination is overwhelmingly established by the following considerations [including] the gradual absorption of control over all the elements essential to the successful manufacture of tobacco products, and placing such control in the hands of seemingly independent corporations serving as perpetual barriers to the entry of others into tobacco trade.84