14. Integration

14. .Integration In the last couple of decades, businessmen have gone in for "industrial integration" as psychiatrists have gone in for "emotional integration." "Integration" means making things one; or in other words putting things to gether, and thus avoiding conflict. Businessmenhave put the same kind of businessesto gether-"horizontal integration," like a string of bak eries, tin-can factories, or roadside eateries. They have put together different functions of the same general line of business--"vertical integration," like an oil well, a pipeline, a refinery, and a service station, or an iron mine, a blast furnace, a rolling mill, and a steel-product warehouse. In recent years,it has been mostly vertical integra tion into which business has entered. Grocery-store men, such as the A&P people, have begun making corn flakes. Shoe manufacturers have opened shoe-stores. Mail-order houses, Montgomery Ward and Sears, Roe buck, for example, have gone into manufacture, on the one hand, and store-distribution, on the other. The original Standard Oil Company was almost entirely in the refining business,but since it was broken up by the Supreme Court into nine companies (and over a score of smaller ones), the successor cODlpanies have expanded "vertically" by choice or the pressure of competitors, 107 108 INTEGRATION back into oil-field production and forward into bulk station distribution, as well as to a small extent into run ning roadside service stations.

In a sense, industrialists have only been, by means of this integration, restoring business to what it used to be. The modern shoe-manufacturer who also runs his retail stores is like the old-time cobbler who used to make shoes in the back of the store and sell them in the front. They both are "integrated"; they both make and sell shoes. The trend in the late nineteenth century was for all the processes of industry to be broken up. Goods went through more and more different hands. The trend in the twentieth century has been for these processes to be put together again, or "re-integrated." Times have changed in the last generation, so far as the achieving of businessunity is concerned. In the gas light and derby-hat days at the turn of the century, the men who brought together competitors made the head lines on the financial pages. Those were the days when J. Pierpont Morgan put together the United States Steel Corporation from a flock of competing steel mills.

Rockefeller had only recently put together the Standard Oil Trust of once-competing oil refiners. The Ameri canCan Company was formed from over 80 little tin can makers. But a budding move to unify a number of competing railroads, for the resultant economies, was nipped in the bud by the Supreme Court. l Those were the days of "horizontal integration" and most of the business was done by Wall Street bankers. But Wall Street, in a growing world, has not grown; horizontal integration is nearly, as the French say, "passe." The twentieth-century form of American industrial integra tion is largely something in which a business saves up its money and buys up other businesses, either as a source INTEGRATION 109 for its raw material, a means for its transportation, or an outlet for its products. But in recent years, the professors and politicians who have attacked "monopoly power," matched prices, ad ministered prices, and price leadership, have also at tacked industrial integration. Perhaps the simplest of their criticisms appears to be the plain charge that in dustry ought to be organized by plants, not by industries.

Thus for instance, an assistant professor of economics of Michigan State College, in the most recent assembly of witnesses against businessas it is now organized, told a Congressional Comlnittee that the unit of technological efficiency is the plant, not the firm.2 "This means," he said, "that while the advantages of a large-scale integrated steel production-unit at Gary or Pittsburgh or Birming ham are evident, there seems no technological justifica tion for the unification of these three functionally separate plant units under the administration of one firm. "In such cases," he said, "the size of present-day firms is explained by conditions of market strategy rather than by the economic dictates of the producing process. . . ." A more dreaded academic critic of business, almost two years earlier, said nearly the same thing.3 "The unit of technological efficiency in modern economic life is the factory, not the firm. l\10st of the huge combinations of modern business.grew in order to achieve the profits of market position, or to provide bankers with new issues to float, not to exploit the technological advantages of scale.... "

But this is a slow ball compared to the fast curves now being pitched against the vertically integrated com panies. It does not take much discernment to see the hole in the the aforementioned arguments. They have about as much relation to industrial planning as an argu110 INTEGRATION ment that in war a brigade, a division, or an army is the unit of technological efficiency has to do with military planning. It cost the North, in the Civil War, four years of war to discover that the unit of technological effi ciency is not the unit of total efficiency; it had at one time six armies deployed under independent generals. The fast curve now being used in the argument against integration is a street-car of an argument called "sub sidy." According to this argument, the profits of a more efficient department of an integrated firm are used to "subsidize" a less efficient department. Thus the books of the big oil companies apparently often show a much better profit on transportation than on market ing.4 The books of A&P show a similarly good-sized profit on its manufacturing, but a razor-thin margin of final profit on its retail stores. And, say the critics, these integrated companies use the profits from their profitable departments to outdo competitors in their unprofitable departments; they have, in short, too much econonlic power.

Of course, to charge that one department is "subsidiz ing" another, one must go to the books of the integrated company. Those books must contain estimates of the prices at which the goods are transferred from one de partment to another. These prices, however,. are of course imaginary, since the goods stay in the same hands, until finally sold to the public. Let us look at a simple illustration. Many farmers run a partly integrated business. A farmer may grow corn, for instance, feed it all to hogs, and sell only the hogs. Or he may feed the corn to chickens and sell only the eggs. Thus he is in part "vertically integrated." In such case he might be content merely to figure his INTEGRATION 111 total costs against his·total receipts. But he might want to go further with his books and learn how much it cost him first to· grow the corn· and second to grow the hogs. He might then find that his corn cost him only 75 cents a bushel to grow but that he was getting the· equivalent of $1.50 a bushel of corn, in the selling prices of his hogs.

To determine whether he was making his profit from his corn-growing or his hog-growing, he would have to put a "book-value" on the com as he tossed it to the hogs. If he followed general accounting practices, he would "carry" his corn on his books at the open market which he would get if he sold it instead of feeding it, or if he bought it instead of growing it. The result may seem at first strange. For if the market price of com were $1.50, this would mean that the farmer was making a large "paper" profit on his corn, but none at all on his hogs. On the other hand if it was as low as 75 cents, it would mean that he was making no profits at all on his corn, but a large profit on his hogs. Thus his paper profits might vanishfrom one side of the busi neSs and appear on the other without his changing a single thing in his way of farming. Obviously this sounds like sheer fiction, but the farmer can find it very useful. For it can tell him where to concentrate. It might tell him, for instance, that it would be cheaper to buy corn than to grow it, or, on the other hand, more profitable to sell his com than to feed it. In one case, he might increase his farrowings, in the other case, his plantings.

Of course, this is a vastly oversimplified picture of an integrated operation. For the integrated operator, many prices are fluctuating at the same time. And for many operators, there is no easy outside market price to use 112 INTEGRATION as a yardstick. Yet this is essentially the way they have to guess, forecast, and run the business. Plainly, however, it would be a rare case indeed in which an integrated company could not be accused of "subsidizing" one department with the profits of another, for all the profits eventually flow into a common pool of the company's over-all earnings. Some departments are· bound to be making more and some less. The people who criticize integration almost invariably do so because it seems to make it harder for the com petitors of certain departments of the integrated com panies. Let us say, for instance, that in the small town of Pleasantville there are two repair garages and an auto mobile dealer. The dealer decides to go into repair work also, since he has some spare space and, perhaps, equipment. This is a midget form of integration. Then if the other two repair garage owners try to prevent or discourage him, because he might hurt their business,this is a microfilm of the Washington attack on integration.

For instance Federal Trade CommissionerJohn Carson recently listed these competitive advantages which he said the major integrated oil companies enjoyed against independent operators: cheaper transport by pipeline and tanker; ready access to supplies, assured by owner ship of crude . . . through crude oil trunklines; assured marketing outlets from a highly integrated nlarketing program ... ; tire, battery and accessory programs which provide a profitable source of income without re quiring proportionate investment; and the opportunity to diversify risks among the various branches of the industry. Many Congressmen sympathize with this view. The Chairman of the House Judiciary Committee, during "anti-monopoly" hearings in 1950, suggested that the big steel-producing companies should be forbidden to go INTEGRATION 113 into the business of fabricating steel. But perhaps the most indefatigable opponent of integrated companies in Congress is Representative Wright Patman of Texas. In 1950 he introduced a bill with the extraordinary title, "A Bill to promote competition [sic] by forbidding manufacturers to engage in retail selling." Under such a sweeping prohibition, unless they were especially ex cepted, electric power companies couldn't both generate and distribute electricity, bakery companies couldn't also run stores, milk companies couldn't run both dairies and milk routes, shoe manufacturers couldn't sell direct throught their own stores, direct selling, such as "From Kalamazoo Direct to You," would be illegal, and even the Fuller Brush man would have to find a new employer.

But Congressmen who want to make vertical com bination illegal may· be wasting their time, or may have had the way already prepared for them. It seems to be already illegal-or dangerously near it-for the Anti trust Division has been for some time arguing that vertical combination, is "per se" or in itself a violation of the Sherman Antitrust Act. And in a series of recent de cisions the Supreme Court has already come within a hair's-breadth of agreeing. It looks as though the officers of most integrated companies are already walking around on borrowed time. A good case could probably be made against them already.by stringing together certain recent statements and remarks of the Supreme Court which are of course automatically now a part of the law. Thus in the Schine case 5 the high Court said, "The concerted action of the parent company, its subsidiaries, and the named officers and directors in that endeavor was a conspiracy which was not immunized by reason of the fact that the members were closely affiliatedrather than independent." That would seem to mean that it is 114 INTEGRATION illegal for the officers of different departments of an in tegrated company to cooperate. If they don't coop erate, however, there's no integration.

In the Paramount case,G the Antitrust Division argued that vertical integration was in itself illegal under the Sherman Act. The Supreme Court would not go that far. But it did say that "the legality of vertical integra tion . . . turns on (1) the purpose or intent with which it was conceived, or (2) the power it creates and the at tendant purpose or intent." From this, it seems a reasonable probability that the Antitrust Division might go into Court and prove a case against any integrated company it saw fit to attack, by the obvious combination of this case, the Tobacco case (power to exclude is a violation), and the Griffith case (intent need not always be proved.) It is, in fact, also a reasonable possibility that a majority of the present Supreme Court might now be willing to agree that verti cal integration is in itself illegal. This is only a surmise. But Justice Douglas, in dissenting in the Standard Oil of California case,7 remarked that "a majority of the Court could not be obtained [in the Paramount case] for hold ing illegal per se the vertical integration in the motion picture industry."

It was Justice Douglas, himself, who had written the majority opinion in the Paramount case. So this sounds as though mighty near a majority of the Court was at that time willing to do so. Since then two new Justices have been appointed, Minton and Clark. Minton wrote the A&P Circuit Court decision which roundly de nounced A&P for the "abuses" of integration (hardly distinguishable,to economists, from the "uses" of integra tion). Clark stepped directly to the Supreme Court bench from the chieftaincy of the Department of Justice~ INTEGRATION 115 So neither is likely to see much good in integration. But perhaps the Department of Justice scored its great est victory against integration in the A&P case. One of its chief charges, accepted by the Circuit Court, was that the profits of A&P's manufacturing and wholesaling were used to "subsidize" or were "siphoned over to" the retailing divisions (and in large part handed on to the consumer) . It called this an "abuse" of integration, but what it successfully criticized seems characteristic of all integrated operations. (The A&P case will be discussed in a later chapter.) Ir. Integrated We Stand Back in 1907, the UnitedStates Commissioner of Corporations made a report on the petroleum industry.