It seems fitting that while the key to managing huge military organizations was first found in Prussia, the key to managing large business organizations was first discovered in the United States. For business, the rapid growth of railroads in the 1850s was the equivalent of Napoleon's Grand Army -- the railroads revealed the inability of traditional organizational principles to cope with large-scale enterprises. The crisis appeared in dramatic fashion: Small railroads made profits while the big railroads lost money.
In 1855 Daniel C. McCallum, general superintendent of the Eric Railroad, pointed out that the reason his line and other large lines such as the New York Central, the Pennsylvania, and the Baltimore & Ohio were in financial distress was a problem of management. He wrote:
"A superintendent of a road fifty miles in length can give its business his professional attention and may be constant]y on the line engaged in die direction of its details; each person is personally known to him, and all questions in relation to its business are at once presented and acted upon; and any system however imperfect may under such circumstances prove comparatively successful." (Chandler, 1962)
These comments recall the spectacular ease with which Napoleon dealt with grave military disadvantages when he had only seventy to eighty thousand troops to maneuver on a single, cormpact battlefield. But, McCallum continued, when one attempts to manage a railroad "five hundred miles in length a very different state exists. Any system which might be applicable to the business and extent of a short road would be found entirely inadequate to the wants of a long one." For want of an adequate organizational system, McCallum argued, the large railroads faced financial failure.
McCallum quickly moved to install a management system to replace the overloaded manager. He broke his railroad into geographical divisions of manageable size. Each was headed by a superintendent responsible for the operations within his division, Each divisional superintendent was required to submit detailed reports to central headquarters, from where McCallum and his aides coordinated and gave general direction to the operations of the separate divisions. Lines of authority between each superintendent and his subordinates and between each superintendent and headquarters were clearly laid out. In sketching these lines of authority on paper, McCallum created what might have been the first organizational chart for an American business (Chandler 1962). Soon the other great railroads copied the Erie's system, enabling the big railroads to function as effectively as small ones. As a result, railroads rapidly became the largest industrial companies of that time,
The railroads had two direct effects on other industrial firms. First, they made it possible for other firms to grow by using rail shipments to reach national rather than just local markets. Rail shipments could carry goods across the nation and bring needed supplies from far away. Second, the railroads provided a first crude organizational model for operating large firms. As other kinds of firms grew, they adopted the idea of divisions, but as we shall see, these were based on functions rather than geography. As they grew, new industrial firms created functional divisions that controlled each step in production through a process called vertical integration. These two features of industrial firms came to dominate organizational theory for many decades.
The story of Gustavus Swift, who built a huge meat-packing firm in the 1870s and 1880s, reveals how the new industrial organizations came into being. Swift was a wholesale butcher in New England who moved west to Chicago in the 1870s. The population was concentrated in the East, while the herds of livestock were concentrated on the Great Plains, and getting the meat to market was a cumbersome and inefficient process that depended on the uncoordinated services of small, specialized local firms. Swift was determined to bring order and efficiency to the process by controlling each step from ranch to retail store. In 1878 he made an experimental shipment of meat from Chicago to the East, using the newly invented refrigerator car. The success of this experiment encouraged Swift and his brother Edwin to found Swift & Co. But they still faced vast problems. Shipping refrigerated meat east required refrigerated storage facilities at the other end; so Swift built them. Then the meat had to be sold; so Swift hired a sales crew and set up a distribution system in each major city. Local butchers tried to prevent the sale of his western meat in eastern markets, even claiming that it was unhealthy to eat "meat killed more than a thousand miles away and many weeks earlier (Chandler 1962). Massive advertising was required to convince consumers that Swift meat was safe. Soon Swift built additional packing plants in St. Louis, Omaha, St. Joseph, St. Paul, and Fort Worth.
Then Swift turned his attention to making supplies of meat dependable. He organized stockyards to purchase large numbers of animals on a regular and orderly basis. Finally he branched out to make use of animal byproducts by entering the leather glue, fertilizer, and soap businesses.
Swift & Co. became a vertically integrated company: It controlled each step in the process of bringing meat products to the consumer. Although Swift did not raise cattle, the company took over at the point of sale and conducted each step thereafter: buying, packing, shipping, and marketing. Furthermore, each of these steps was the province of a different division of the company. That is, rather than creating geographic divisions, as the giant railroads had done, Swift based its divisions on different functions. In fact, Swift broke up its organizational divisions in the same way that the Industrial Revolution had divided the labor of workers into a few specific production steps. Just as each worker on an assembly line performed only one or a few specialized functions, each division of large industrial firms handled only one aspect of the industry.
Swift had a marketing division, a meat-packing division, a purchasing or stockyards division, a shipping division, a sales division, and an advertising division. Each of these divisions was headed by a manager to whom subordinate managers reported; each manager reported to and received directions from corporate headquarters. As Moltke's General Staff mastered large armies, vertical integration and functional divisions under centralized command made it possible to create and operate huge business firms.