Fin-tech

FEW industries involve as much drama and risk as whaling did. The last voyage of the Essex, which inspired Herman Melville’s classic, “Moby Dick”, and is the subject of a new film, “In the Heart of The Sea”, gives a sense of the horrors involved. The ship left Nantucket in 1819 and sailed for over a year before being destroyed by a whale it was hunting. The 20 crew members survived the sinking, but found themselves adrift in the Pacific in three longboats, with little food and no water. Three opted to stay on a desert island, from which they were rescued three months later, on the verge of starvation. The others sailed on, hoping to reach South America but dying one by one. At first the survivors buried the dead at sea; then they resorted to eating the corpses of their crewmates. When they ran out of bodies, they drew lots to decide whom to shoot and eat. Only five of the 17 were eventually rescued. By then, they were so delirious that they did not understand what was happening.

The only reason that anyone could be induced to take part in such a dangerous business was the fabulous profit that could be made. Gideon Allen & Sons, a whaling syndicate based in New Bedford, Massachusetts, made returns of 60% a year during much of the 19th century by financing whaling voyages—perhaps the best performance of any firm in American history. It was the most successful of a very successful bunch. Overall returns in the whaling business in New Bedford between 1817 and 1892 averaged 14% a year—an impressive record by any standard.

New Bedford was not the only whaling port in America; nor was America the only whaling nation. Yet according to a study published in 1859, of the 900-odd active whaling ships around the world in 1850, 700 were American, and 70% of those came from New Bedford. The town’s whalers came to dominate the industry, and reap immense profits, thanks to a novel technology that remains relevant to this day. They did not invent a new type of ship, or a new means of tracking whales; instead, they developed a new business model that was extremely effective at marshalling capital and skilled workers despite the immense risks involved for both. Whaling all but disappeared as an industry after mineral oil supplanted whale oil as a fuel. But the business structures pioneered in New Bedford remain as relevant as they ever were. Without them, the tech booms of the 1990s and today would not have been possible.

Most historians trace the origins of the modern company back to outfits like the Dutch East India Company and its British equivalent. These were given national monopolies on trade in certain goods or with certain places. This legally buttressed status allowed them to fund themselves by selling shares to the public, helping to get stockmarkets off the ground. The managers of these multinational enterprises were professionals with only small ownership stakes. Lower-level employees generally had no shareholding at all.

By eliminating dependence on individual owners or managers, these entities became self-perpetuating. But their monopolies also embroiled them in politics and led inevitably to corruption. Both the British and Dutch versions ended up requiring government bail-outs—a habit giant firms have not yet kicked.

The whaling industry involved a radically different approach. It was one of the first to grapple with the difficulty of aligning incentives among owners, managers and employees, according to Tom Nicholas and Jonas Peter Akins of Harvard Business School. In this model, there was no state backing. Managers held big stakes in the business, giving them every reason to attend to the interests of the handful of outside investors. Their stakes were held through carefully constructed syndicates and rarely traded; everyone was, financially at least, on board for the entire voyage. Payment for the crew came from a cut of the profits, giving them a pressing interest in the success of the voyage as well. As a consequence, decision-making could be delegated down to the point where it really mattered, to the captain and crew in the throes of the hunt, when risk and return were palpable.

At the top of the New Bedford hierarchy was an agent or firm of agents like Gideon Allen, responsible for the purchase and outfitting of the ship, the hiring of the crew and the sale of the catch. To give them an incentive to cut the best deals possible, the agents put up a big share of the investment. Those with the best reputation received better terms from the other investors. Captains, who ran the show while the ship was at sea, often put up capital as well. A similar system of incentives is used in the riskier reaches of the investment-management business today, notes Mr Nicholas.

Investors received half to two-thirds of the profits. The rest was divided among the crew in what was known as the “lay” system. A captain might get a 12th lay (one-twelfth of the remaining profit). In Melville’s novel, Ishmael, who was new to the business, was originally offered a 777th lay but managed to haggle a 300th. Although that would probably have proved a paltry amount, it was a stake nonetheless, and set a benchmark for future pay. Ishmael’s friend Queequeg, a cannibal from the South Sea islands, got a 90th lay because he had experience with a harpoon. Demand for experienced crewmembers was so high that the Essex’s ill-fated captain, George Pollard, was immediately given a second command on the ship that rescued him (which sank as well).

Every participant wanted to bring in returns quickly, but there were no artificial deadlines—nothing resembling what is now called “quarterly capitalism”. When whales became rare in accessible places, the crews from New Bedford extended their search to every corner of every ocean, however many years that took.

Safety in numbers

To ensure that they were not ruined by a few disastrous voyages, the whaling firms invested in multiple expeditions at the same time, much as the venture capitalists of today “spray and pray”. A study published in 1997 concluded that, of the 787 boats launched from New Bedford during the 18th century, 272 sank or were destroyed. The firm that belonged to George Howland was not atypical: of its 15 ships, between four and nine were at sea at any given moment. One was sunk by a whale, three lost at sea, two burned by their crews, one destroyed by a Confederate gunboat during America’s civil war and five abandoned in Arctic ice. Yet Howland died a millionaire in 1852.

It helped that most of the whalers of New Bedford were strict Quakers, who prized frugality and shunned ostentation. This helped them not only husband their own capital, which was needed to finance voyages, but also to win over other investors. Hetty Howland Green, one of the richest agents, was said to have made her own shoes and to have owned only one dress.

It also helped that they were open-minded: they readily employed anyone who could contribute to their ventures. Perhaps the single most important technological innovation used by New Bedford’s whaling fleet was the “Temple Toggle”, a harpoon tip devised by Lewis Temple, a former slave from Virginia.

But the whalers’ main asset was their business model. In the 1830s, the legislatures of six American states approved charters for whaling corporations giving them the right to raise capital by selling shares to the public—much the same corporate structure as the Dutch and British East India Companies. None of the six survived the 1840s. “The diffuse ownership structure of the corporations, and the reduced stakes held by their managers, likely diminished the incentives for the managers to perform their role diligently,” concludes Eric Hilt of Wellesley College. Given the expense of buying, outfitting and launching a boat into the perilous ocean, the link between risk and reward needed, it seems, to be tighter.

The lay system could work to the crew’s disadvantage, however. In an effort to reduce claims on the crew’s share of the profits, ruthless captains were said to abandon men on the trip home. (Similar shedding of employees is not unheard of at contemporary tech startups before a big payout.) Other schemes existed to cheat crew members, such as forcing them to buy clothing at inflated prices or to pay usurious interest on advances on their pay. And open-mindedness went only so far: although black sailors were not discriminated against in terms of pay, they were treated less well in other respects, receiving less food and worse quarters.

Yet the New Bedford system was undeniably effective. It soon emptied the oceans of whales, even as other lucrative opportunities emerged for daredevils determined to strike it rich, such as the California gold rush. “The same industrial growth that initially supplied markets and profits for whaling activity ultimately yielded opportunities more attractive than whaling to local capital,” wrote David Moment, a student at Harvard Business School, in 1957. In short, with returns dwindling, the crews and the capitalists turned to other ventures. But the business practices they developed are used in high-risk, high-return industries to this day.