Thursday, October 06, 2005

The original network boom

For most of history, shoppers had little choice but to take what local retailers might make available in a limited family or township affair. Retail was the tail-end of a supply-chain that involved traveling caravans which would collect and trade goods in one place and carry them to another for sale; towns would grow up around markets and fairs, where a few townspeople might work as traders and shopkeepers. This was fine when work was long, with personal needs and resources limited. The first great network bubble changed all that – the losers were banks and stock markets, the winners were shoppers.

On Black Thursday, September 18, 1873, the New York banking house of Jay Cooke and Company, the financier of the Northern Pacific Railway, collapsed. The enormous cost of the Civil War, excessive railway building, inflated credit, speculation, overexpansion and capital outlays for new farmland provided a crises. In a domino effect, railroad bankruptcies and bank failures followed. Over 18% of the country’s railway mileage was in the hands of receivers, iron and steel works were devastated, and business failures led to massive layoffs. Wages plunged by 25%. Over the next four years, business failures reached $775 million ($155 billion in today's dollars) and the number of unemployed rose to nearly three million (in a country of 45 million).

It didn’t end there. Railroads burned money on a colossal scale. Textile mills, the country’s largest manufacturers, rarely cost more than $1 million ($18million today) whereas the capitalization of the four big east-west trunk lines – Pennsylvania, Erie and Northern Pacific, New York Central, and Baltimore & Ohio – reached $140 million (over $25 billion today). E.H. Harriman, the boldest proponents of the spend-money-to-make-money strategy, pored a rousing $240 million ($4.8 billion today) into expanding and modernizing the Southern Pacific Railroad. Three months after President Grover Cleveland began his second Democratic term in 1893, railway overexpansion provoked a cascading collapse of the economy that , until the 1929 Wall Street Crash, was known as the Great Depression.

The 1893 slump brought down the Erie, other debt-ridden railroads, and 600 banks. It embittered the already discontented farming regions, and exhausted the silver-mining states. During this period, farmers in rural America had been forced to buy their goods from local general stores, which could more or less charge what they pleased. In 1891, for example, the wholesale price of a barrel of flour was $3.47 whereas the price at retail was at least $7—a 100% markup. Farmers formed protest movements, such as the Grange, in opposition to high prices and "profiteering by the middleman."

Despite great losses (or more exactly because of them) a well-developed network of rails lay waiting for innovators to come up with uses for them. One entrepreneur recognized the potential of this network early on. Richard Sears was an agent of the Minneapolis and St. Louis Railway station in rural Minnesota. Sears's job as station agent left him considerable spare time, which he used to sell miscellaneous items to the local farmers. Cheap watches, which broke often, were one of his most successful products, mainly because they were sold "satisfaction guaranteed or your money back." To service his watches, Sears teamed with watch repairman Alvah C. Roebuck to form Sears, Roebuck and Co.

Sears rode thepopulist theme of protest movements like the Grange; by "cutting out the middleman" he was able to successfully expand his product line from watches to provide whatever the farmers needed. He used volume buying, railroads, and the post office to undercut prices at the general stores. Sears prospered by using inexpensive railroad networks to overcome the monopoly the general stores held on location. Success spawned new technology. For example, New England entrepreneur Frederic Tudor, the world’s ‘Ice King,” grew rich through winter harvest of thousands of tons of ice from lakes all across the North East, using horse drawn cutters and steam powered lifts to move the blocks into huge warehouses. He supplied the ice for boxcars full of frozen meat and vegetables for transport around North America, the Caribbean, South America and the Far East.

A century later, companies like Amazon, eBay and eTrade were able to similarly profit from the massive investments in telecommunication bandwidth that led to the dot-com crash and the demise of giants like Enron and WorldCom that ultimately paid for their overexuberant network building.

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