PLANNING, REGULATION, AND COMPETITION 63 It is also significant that the Swedish Kal-Do process, another oxygen steelmaking technique, was innovated in the United States by Sharon Steel-a company which accounted for 1.3 per cent of total United States steel capacity and ranked thirteenth among ingot producers. Finally, it is clear that despite Big Steel's decade of rationalization, the technological avalanche of the oxygen converter could not be stopped. Thus, current estimates indicate that by 1975 some 45 per cent of the United States steel production will come from oxygen vessels and that the open-hearth will be displaced as the workhorse of the steel industry: TABLE IV.-TOTAL U.S. PRODUCTION OF STEEL INGOTS FOR 1963 AND FORECASTS TO 1975 Source: Battelle Memorial Institute, "Technical and Economic Analysis of the Impact of Recent Developments in Steelmaking Practices on the Supplying Industries," Oct. 30, 1964, p. X-3. Moreover, it is ironic that this comprehensive modernization will be taking place during a period of substantial "unused"-or more accurately, economically "unusable"-capacity. Thus, in 1964, the American steel industry was installing oxygen converters at a frenetic pace while using only some 75 per cent of existing facilities and this in a banner year for steel production. Obviously, as the Wall Street Journal observed, the increase in ingot capacity came "because of mill efforts to lower costs and not from any lack of raw steel." The industry was mothballing some 7 million tons of open-hearth capacity, reclassifying it as "standby capacity" with the intention of dismantling much of it "before long." " Similarly, the Iron and Steel Engineer found it significant that much of the projected new oxygen capacity will in many cases "be used to replace existing workable capacity. Companies are being forced to the process in order to compete, and also perhaps in some cases to develop their know-how. The low capital cost and the savings in operating costs more than overbalance any considerations to continue operating existing equipment." " In sum, given the steel industry's record of innovation with respect to oxygen steelmaking, it seems reasonable to suggest that Big Steel is neither big because it is progressive nor progressive because it is big. II The invention of the oxygen converter, and the history of its innovation, assume particular significance because of the periodic-indeed endemic-complaints by the steel industry about its unreasonably low rates of return and, consequently, its inability properly to finance replacement, expansion, and modernization. While these profit grumbles can be traced back at least to 1939," they have, if anything, been voiced with increasing persistence (and forte voce) since then. In 1958, for example, Robert Tyson, Chairman of the Finance Committee of U.S. Steel, argued that steel industry earnings of 13.9 per cent on net assets were really subaverage because of a substantial deficiency in recorded depreciation." In the industry's dispute with President Kennedy in 1961, U.S. Steel used profits as a percentage of sales-probably because the President had 45 Jan. 4, 1965, p. 4. The Wall Street Journal also reported new oxygen capacity of 10.2 million tons, projected by U.S. Steel, Republic, Inland, and Wheeling, commenting that "Mills generally put in the new furnaces to cut costs rather than expand capacity. Oxygen furnaces turn out a batch of steel in 40 minutes, compared with six hours for even the fastest open-hearth furnaces. Capital expense per ton of capacity is lower, too, running around $12 to $15 compared with $30 to $35 for an open-hearth." January 7. 1965, p. 1. Jan. 1963, p. 171 (emphasis supplied). Precisely how much open-hearth capacity— even if equipped with oxygen lances--is obsolete is a closely guarded industry secret. See Kaplan, Dirlam, Lanzillotti, Pricing in Big Business (Washington: Brookings, 1958), p. 169. 48 Steel and Inflation: Fact vs. Fiction (New York: Public Relations Dept., U.S. Steel Corp., 1958), p. 37. 64 PLANNING, REGULATION, AND COMPETITION relied upon a net worth measure. When the 1962 showdown came, U.S. Steel and its fellow oligopolists emphasized the "financial squeeze;" as in 1958, the high cost of "modernization" was not only mentioned, but made a key point in the attempt to justify a price increase." When, in 1964, the steel industry again came into conflict with the White House and the Council of Economic Advisers' guidelines, it once again fell back on an inadequate return on investment to support its price increase.53 If the industry added a net of 40 million tons of the "wrong" capacity during the 1950 decade; " if the gross addition to capacity during the period amounted to 49 million tons; "if the industry could have begun to adopt the oxygen process as early as 1950; if this revolutionary steelmaking process would have provided the industry with substantial savings both in capital investment and operating costs does it not follow the Big Steel's profit grumbles are in part the result of self-inflicted injury? The rough magnitude of the "improvement" in the industry's level of profits, and the availability of financial resources for replacement and modernization-assuming the industry had followed a policy other than one of suicidal investment-shall now be sketched in rudimentary outline. According to the theory of replacement economics," a new technique should be substituted for an old one whenever present value of the firm would be greater after the substitution. To make a precise comparison of present values would entail detailed knowledge not only of the immediate outlay on the new process and the cost of capital (to be used as a discount rate), but also of future patterns of operating receipts and expenditures and the net scrap values of presently used and substitute equipment. Obviously, we do not have this information for each steel company. But when there exist operating savings after depreciation from a new process sufficient to cover a reasonable return on the capital required for the new process, it may be assumed that a more precise present value comparison would also show the rationality of substitution. The investment in the old machines is, of course, sunk, and both return on and depreciation of this sunk capital may be disregarded in computations. Earlier discussion has indicated that the operating savings resulting from use of the oxygen converter may reasonably be taken to be $5 per ton. While a single figure is, of course, subject to qualification, it does not appear that $15 per ton is a serious underestimate of the investment that would have been required in the years 1950-60 to install oxygen convertors in United States mills. Unless the cost of capital to steel companies was as high as 33 per cent during this period, they could have shown a clear gain by replacing open-hearth with oxygen capacity. Note that this comparison disregards advantages of the BOP process such as superior quality control and lower plant space requirements. A complete substitution could have been easily achieved by 1961. The industry's cash flow during the years 1950-60 was $14.6 billion. To put in operation 87 million tons of oxygen capacity-the approximate amount necessary to produce the steel made in 1960 by open-hearth facilities-would have required an outlay of no more than $1.3 billion or about 12 per cent of the industry's actual capital 49 See "Dear Mr. President pp. 2, 7, and also speeches by Senators Gore and Kefauver. Congressional Record, Aug. 15, 1961. 50 See "The Steel Price Rise: A Matter of Necessity," a statement by Leslie B. Worthington, President of U.S. Steel, April 10, 1962, p. 3, and "In the Public Interest" remarks by R. M. Blough, Annual Meeting of Stockholders. U.S. Steel, May 7, 1962. Blough stressed the rise in costs, the decrease in profit margins as a per cent of sales, and the rising costs of replacement and "modernization." 61 See R. M. Blough, "My Side of the Story," Look, Jan. 29, 1963, p. 21. There he states that the proposed "very small increase would have made it possible for U.S. Steel to invest in modern plants and equipment and eventually allow us to compete more effectively with foreign steel imports." See statements quoted in New York Times, Section III, Nov. 1, 1964, pp. 1 and 12. Mr. Block of Inland Steel said that "The clear fact is that we do not make a satisfactory return on the vast sums of money invested in the industry." C. M. Beeghly, chairman of Jones & Laughlin, asked for a "competitive return on investment." 53 Business Week, Nov. 16, 1963. pp. 144-46. 54 Forbes, Jan. 1, 1963, p. 31. Drawing on capacity data of the American Iron & Steel Institute, the Office of Business Economics, Department of Commerce, places the net increase at 48.6 million tons (Joint Economic Committee, Steel Prices, Unit Costs, Profits, and Foreign Competition, 88th Congress, 1st Session, 1962. p. 193). The Bureau of Labor Statistics Background Statistics, brought up to April 1963, Table 2a, also indicates a 48 million ton increase in capacity-with identical figures taken from the AISI. 65 Cp. Morris A. Copeland. Our Free Enterprise Economy (New York: Macmillan, 1965), pp. 181-209. While his illustrations are simplified, Copeland presents the fundamental elements of capital cost. timing of expenditures and receipts, and their discount to present value, clearly and forcefully. PLANNING, REGULATION, AND COMPETITION 65 expenditures of $11 billion. These expenditures included purchase of new and modernization of old open-hearth furnaces. Assuming the substitution to have been made, we can recompute the rate of return that the basic steel industry could have earned on the equity in 1960. If 87 million tons of steel had been produced by the oxygen process, total operating savings of $432 million could have been realized. After-tax profits would therefore have been $216 million higher. Net worth could have been reduced by as much as $1.7 billion-the difference between the investment required for 87 million tons of open-hearth capacity, and the same amount of oxygen converter capacity. Given an expansion in net profit and a decrease in equity of such magnitudes, the industry's computed return on net worth in 1960 would have been in the neighborhood of 11.6 per cent, instead of the 7.6 per cent it actually realized an increase of some 65 percent in profits." This computation is set forth only for illustrative purposes, but it shows the "ball-park" boundaries wherein a meaningful rate of return for the steel industry may lie. If the assumptions were changed, the magnitude of the difference between actual and potential returns would also be changed. For instance, if the entire open-hearth capacity of 122,000,000 tons had been replaced by oxygen converters, investment and net worth would have dropped by almost $2.5 billion. The computed rate of return would have been still higher." On the other hand, to the extent that the steel companies carried their open-hearth production assets at less than original cost of installation at 1960 prices, the adjusted rate of return would be less. One further observation might be made regarding the steel industry's persistent complaint that it is earning less than a satisfactory return. Comparisons of return on net worth with averages for manufacturing industry during the years 1947-63 do show a deficiency for steel. The industry, therefore, had additional reason to replace existing plant with less costly production facilities. It would also have been rational for the industry to have reduced its total capital investments, whereas it did just the opposite. III Our review of the circumstances of invention, and the pace and sponsorship of innovation, of the most revolutionary cost-saving development in steelmaking since the Siemens-Martin furnace has, we believe, raised serious doubts concerning the universality of the "Schumpeter" hypothesis. If the hypothesis is to have general validity, it must be demonstably applicable to the most important inventions in concentrated, oligopolized industries. But the history of the development of the oxygen process shows just the opposite. In the first place, the invention was neither sponsored nor supported by large, dominant firms. Nor were these firms leaders in introducing the revolutionary development. Their indifference is explicable either on the grounds of ignorance or delinquency, and the first of these alternatives must be rejected almost summarily. In view of the wide publicity given to the Leoben conference of 1951, the thousands of articles on oxygen and steelmaking in technical and trade journals, and U.S. Steel's assertion that it is aware of every new development in the industry, it is incredible that the engineers of Big Steel were unaware of the Austrian breakthrough. Second, it was a small firm that first innovated the new process in the United States, and it was other small firms that followed its lead. We submit that this consequence should not be entirely unexpected because it may well be that the structural and behavorial characteristics of oligopolized industries prevent the dominant firms from pioneering. Instead, the small firms may be the innovators because, unlike their giant rivals, what they do in the way of cost reductions is unlikely to cause so violent a disturbance of the status quo. Hence, based on the steel industry experience, it seems as reasonable to assume that innovation is sponsored by firms in inverse order of size as it is to assume the contrary. (In fact, we would hazard a guess that inquiry into innovation in other industries According to financial data for firms accounting for 93 percent of basic steel production in 1960. stockholders' equity was shown as $10.2 billion, and net income at $767 million. With the adjustments noted above, income and equity would have been $983 million and $8.5 billion, respectively. The Iron Age Annual Review Number, Jan. 1962. 57 Substantial asset write-downs would necessitate readjustment of surplus and perhaps even capital accounts of some firms; but this would not alter the currently realized rate of return. 66 PLANNING, REGULATION, AND COMPETITION might turn up the same conclusion; for instance, the most important breakthrough in petroleum refining techniques since cracking itself—the development of catalytic cracking-was innovated by a small, maverick major. Only after Sun Oil had given positive evidence of its commitment to the Houdry process were its billion-dollar giant rivals willing to venture into the area to develop competing processes.) Third, our assessment of the consequences of the lag in United States adoption of the oxygen process has shown that the steel industry's complaint about inadequate profits and lack of modernization funds have been sadly exaggerated. Had the dominant steel firms seized the initiative, and carried out a genuine modernization program in the 1950's, their earnings would have been substantially higher and their depreciation and replacement requirements appreciably lower-due to much lower operating costs per ton of ingot capacity and lower depreciation and replacement costs on a lower investment base. Until the steel industry restates its accounts to reflect the efficiencies that have been possible for at least the past fifteen years, little credence should be given to its plaintive pleas for higher prices or profits. Finally, there is another implication to our study of the steel industry's curious inversion of the source of innovation. It has often been assumed that, if homogeneous oligopolies do not compete in price, their leading members compete in innovating-and that the public thereby benefits as much as, if not more than, it would by price competition. Yet the oxygen converter history reveals the steel oligopoly as failing to compete in strategic innovations. What benefits, then, remain for large size in steel? MICHIGAN STATE UNIVERSITY. NOTE.-The response of the United States Steel Corporation to the criticism of the American steel industry contained in the testimony of Dr. Mueller and Dr. Adams at the June 29, 1967, hearing, and in appendix C to that hearing, next above, will be found in appendix VIII to part 1 of these ("Role of Giant Corporations") hearings, printed in part 1A, at pp. 868-872.-Committee editor. APPENDIX XI COMMENTS ON AND ANSWERS TO THE SUBCOMMITTEE'S "SIXTEEN MAJOR QUES TIONS" FROM THE UNITED AUTOMOBILE, AEROSPACE, AND AGRICULTURAL IMPLEMENT WORKERS OF AMERICA-UAW A. LETTER DATED JANUARY 7, 1972, FROM C. L. COBURN, DIRECTOR, RESEARCH DEPARTMENT, UAW, TO SENATOR NELSON, CHAIRMAN, SUBCOMMITTEE ON MONOPOLY INTERNATIONAL UNION, UNITED AUTOMOBILE, AEROSPACE, AND AGRICULTURAL IMPLEMENT WORKERS OF AMERICA-UAW, Detroit, Mich, January 7, 1972. Hon. GAYLORD NELSON, Washington, D.C. DEAR SENATOR NELSON: This is in response to a number of questions which you have raised in the Senate concerning the hearings of the Subcommittee on Monopoly of the Senate Small Business Committee, on Corporate Secrecy, in which you indicated you would appreciate hearing the views of the public. We live in a time of the increasing emergence and expansion of the multiindustrial and multinational corporations, which now dominate not only many key industries in the United States, but in many cases virtually the entire economies of allied and friendly nations upon whose cooperation the security of our country and ultimately of the entire world may well depend. Some of these corporations control annual revenues in excess of the budgets of all but a handful of the largest nations in the world. Yet their decisions as to the planning of their operations, the location of their plants, the development and allocation of resources over which they have control and the nature, quality and pricing of their products are normally made in the deep secrecy of corporate board rooms to which even affected governments, including agencies of the United States government, have little or no access. Among the five million or more men, women and children represented by the members of our Union, the UAW, for example, there is scarcely an aspect of their lives, from the way in which they earn their living-including the level of their living standards-to the quality of products available to them as consumers, and indeed the whole quality of the lives they live, which is not directly affected by such corporate decisions. And as it is with the UAW, so it is with the vast majority of the people of America and throughout the free world. Even the opinions on private and public matters of many people may be subject all unknowingly to the influence of these great corporations, not only through the power they exert as purchasers of advertising and sponsors of programs in the media, but because the media themselves generally come within the corporate structure. Indeed, the success or failure of the government's own economic and social programs may depend on the completely independent, private and secret decisions made by the managements of a few corporations. The growth in wealth and power of the modern corporation as we know it stems essentially from the First Industrial Revolution and the widespread application of power to machinery, which made possible the beginnings of the modern factory system. It was assisted, especially in Great Britain and the United States, by general acceptance by lawmakers and the courts of two particular social theories-the principle of laissez-faire, that the public interest is best served by allowing each person the widest possible freedom to pursue his own private interest-and the concept of the corporation as a "person", with virtually all the rights and freedoms-including those rights of personal privacy-guaranteed to individuals. 1 The text of the 16 major questions will be found in part 2 of these hearings, at p. 1045. |