Through the early 1860s, Austria maintained hope of retaining leadership in Germany because the smaller states preferred weak Austrian leadership to Prussian domination. Nonetheless, by mid-1864 Franz Joseph realized that war was inevitable if Austrian leadership was to be preserved.

The immediate cause of the Seven Weeks' War between Austria and Prussia in 1866 was Prussia's desire to annex the Duchy of Holstein. Austria and Prussia had together fought a brief war against Denmark in 1864 to secure the predominantly German duchies of Schleswig and Holstein for Germany. Pending final decision on their future, Prussia took control of Schleswig, and Austria took control of Holstein. In April 1866, however, Prussia plotted with Italy to wage a two-front war against Austria that would enable Prussia to gain Holstein and Italy to gain Venetia. Although Austria tried to keep Italy out of the war through a last-minute offer to surrender Venetia to it, Italy joined the war with Prussia. Austria won key victories over Italy but lost the decisive Battle of Königgrätz (Hradec Králové in the presentday Czech Republic) to Prussia in July 1866 (see The Habsburg Military , ch. 5).

Defeated, Austria agreed to the dissolution of the German Confederation and accepted the formation of a Prussian-dominated North German Confederation, which became the basis of the German Empire in 1871. The south German states--Bavaria, Baden, Württemberg, and Hesse-Darmstadt--were accorded an "independent international existence" and, in theory, could have gravitated toward Austria. Nevertheless, their military and commercial ties to Prussia militated against such an outcome. The province of Venetia, Austria's last Italian possession, was transferred to Italy.

Data as of December 1993