The Making of a Monopoly: Standard Oil Company
John D. Rockefeller was a motivated man who set off at a young age to make his fortune. His company, Standard Oil, became world renowned for its fierce competition and eventual domination of the oil industry. As the first of the great trusts, the Standard Oil Trust came to exemplify the form of a monopolistic, industry-dominating company incorporating awesome power over the market, capable of cutthroat competition to achieve its own ends.
In 1863, a young John D. Rockefeller began his career as a merchant in Cleveland, Ohio. When Col. Edwin Drake struck oil in northwestern Pennsylvania in 1859, there was a rush to begin drilling and producing oil, spurring a massive over-production of crude oil. A producing well could create a sudden fortune if the market rate of oil was around $20 per barrel but as new wells were put in, the price fell between $2 or $3 per barrel.
In 1865, Rockefeller and his partner, Samuel Andrews, started a small refinery in Cleveland, Ohio. Rockefeller had chosen to enter the refining industry instead of involving himself in the highly volatile oil production industry. This decision would eventually make him and his future partners very wealthy. The refining industry that Rockefeller entered into was a semi-competitive market with no true leader. Rockefeller & Andrews concentrated on small economies, developing a clientele base and soon opened an export-selling agency in New York headed by Rockefeller’s brother William.
In 1867, Henry
Flagler, son-in-law of rich whisky distiller and salt maker, joined the company, bringing in $70,000 as well as access to more credit. Within two years, Rockefeller, Flagler & Andrews were the biggest refiners in Cleveland, producing 1500 barrels a day. Because of the volume of their shipments, they felt they could ask for special treatment from the railroad, a branch of Vanderbilt’s New York Central system. Flagler devised the transportation agreements, including the rebate and drawback plans, which proved to be pivotal in the success of the company, which would become Standard Oil. They successfully negotiated a reduction in their rates with the railroad thus decreasing their production costs, which allowed them to further increase their volume. By 1870, Rockefeller, Flagler and Andrews had become the largest shipper of oil, producing at 3000 barrels per day.
Also in 1870, the company incorporated as a joint stock company under the name of Standard Oil of Ohio. From the beginning, Standard Oil earned around 100% on their capital investments. In 1868, the first form of industrial combination in the shape of a pool had been formed by the Michigan Salt Association. This would be used as one of a number of examples Standard Oil built their system on.
Despite the gains made by Standard Oil, by 1871, there was complete panic in the refining industry. Most refiners were losing money and profit margins were deteriorating. At this point, Rockefeller began developing what was called “our plan” which was a vast combination, which would eliminate excess capacity and thus suppress the wild fluctuations in price, which caused so much of their turmoil. During this year, Rockefeller and Flagler drew up a list of principal Cleveland refining companies they wanted to participate in their combination. Then Rockefeller went to the other firms to explain how the plan would work. The purchase offers Rockefeller made were usually a third to half the actual cost of the property but Rockefeller would point out it was useless to resist, saying “If you don’t sell your property to us it will be valueless, because we have the advantage with the railroads.” Within three months, Rockefeller had assumed control of all of Cleveland’s oil refining trade, which then constituted 20% of America’s output.
At the same time, the railroads were suffering through their own rate wars, which caused great turmoil in their own industry. They were more than eager to participate in a scheme cloaked by the South Improvement Company, a company which was chartered in Pennsylvania to engage in almost any kind of business. Under the scheme, the railroads and refiners would band together as cartels and divide markets so that rates could be evened out. Central to this scheme was the rebate system devised by Henry Flagler, which became the key to how Standard grew to be the first formidable monopoly this country had ever seen. The rebate system worked as follows: The full price paid to ship a barrel of oil was $2.50. The railroad company’s income was only $1.50 per barrel; the other $1.00 was paid back to Rockefeller as a secret rebate. Moreover the railroads agreed to tell the directors of the South Improvement Company information about their competitors, gathered from their shipping manifests revealing such information as how many barrels were shipping, the quality of the oil shipped, the places of shipment, and the destination. The railroads, in turn, would have their freight “evened” and cut throat competition between them decreased by allotting volume between the various railroads.
It saved the railroads hundreds of thousands of dollars per month in handling costs to deal with larger volumes. But the most important benefit Standard Oil was granted was the railroad shipping price hike for their competitors during the Oil Wars of 1872. Standard Oil was given a “drawback” of a portion of the higher tariff charged his competitors. When these drawbacks became public, they were considered to be among the most despicable of Standard Oil’s practices. (GRAPH #1)
In early 1872, a rumor began
to sweep through the oil regions, a rumor of a “great scheme between the
railroads and the refiners to control the purchase and shipping of crude oil”.
Then came the news of a price hike that doubled the cost of shipping on the
railroads. Of course, the new price did not apply to Rockefeller, due to the
deal that he had with the railroad companies. Independent oil producers in
reaction led demonstrations and refused to ship any oil until the rates were
lowered. For a short time, Standard Oil had to shut down operations due to the
absence of crude oil, but Rockefeller knew that the men would have to come back
to work soon enough. He waited patiently for greed and hunger to break the
enemy’s front.
By April 1872 and after an investigation revealed the rebates and drawbacks system, both the refiners and the railroads felt it was best to dissolve the South Improvement Company. The Oil War was apparently won by the producers but Standard Oil was in a stronger position than ever.
Between the years of 1875 and 1878, Rockefeller continued his campaign to bring selected refiners into the Standard Oil family, attempting to consolidate all of the American refining industry. The Standard Oil’s incredible profits and its economies of scale were shown to the interested refiners along with a promise of untold wealth. But for the refiners that held out, Rockefeller told them either to join and reap the benefits, or go bankrupt. Because his costs were so much lower, no independent could compete with Standard Oil.
If a refiner refused to sell
to Rockefeller, they would face enormous market pressure from Standard Oil
because of its newly found power in the market. Because Standard Oil control of
most the oil industry production inputs it forced its competitors to heel to
their demands. Standard Oil could
afford to slow or stop production of any number of their products in order to
crush or absorb smaller companies. With every competitor eliminated from the
market, Standard Oil’s share of the entire market would become larger. Even if a competitor was not useful as part
of the larger Standard Oil infrastructure, it was sometimes better for them to
just buy and close the plants to eliminate the competition.
After attempting to stop several pipeline developments, Rockefeller saw that this was a more efficient means of transporting oil. If Standard used a pipeline, transportation costs would only be sixteen-cents a barrel $1.25 at that time. Standard Oil began to build pipes as inputs and by 1876 controlled almost half the existing pipelines. By the end of 1878, Rockefeller controlled all the oil gathering pipelines that connected the well to the shipping points and refineries giving him a quasi monopoly over the U.S. pipeline industry.
In 1877, the Bradford
(Pennsylvania) field came in. Suddenly
huge quantities of oil were produced, bringing the same chaos as had occurred
earlier. However, Rockefeller had such
control over the transportation and refining systems that he was able to set his
own price. The independent producers
joined forces to circumvent Standard Oil’s lock on the market by raising money
and building Tidewater Pipe Line, utilizing new technology to pump oil over the
Alleghenies and to Williamsport, Pennsylvania and to the Reading Railroad which
had access to Philadelphia, Trenton, Bayonne and New York City. Standard Oil infiltrated Tidewater through secret stock purchases
gaining a minority interest whereby they were able to cause internal
difficulties. In 1882, Tidewater gave
up and came to agreement with Standard Oil.
After years of “war” against the independents, in 1879, a jury in Clarion County, Pennsylvania indicted John D. Rockefeller and several of his directors for conspiring to gain a monopoly in the buying and selling of crude oil. They claimed that Standard Oil had made it impossible for other companies in the same industries to compete. Rockefeller proposed and got an out-of-court settlement. Nothing really came of the hearings, and in many ways Rockefeller had won the war. Most of the competition had been eliminated and the rebate system continued despite the ruling.
For Rockefeller, the goal
was to control the entire oil business, from the largest refiners down to the
smallest retailers of petroleum products. Some refiners had their own
wholesalers (or jobbers) who sold to
groceries. If for instance a grocer didn’t want to by from Standard Oil, he
would be approached by one of Rockefeller’s “independent sellers” as an
alternative supplier. As he had done before, Rockefeller had secretly bought
his competitor’s companies and continued to use their name to ensure sales.
Because the retailer had no idea that he was buying from the very company he
was trying to avoid, Rockefeller was once again able to make huge profits from
yet another industry.
Another tactic he used for instance was the price for Standard Oil products in one town with a competitor could be sold at cost, while in a nearby town with no competitors, the products could be sold at twice as much. A competitor might also find that their freight costs were raised by the colluding railroads, sometimes doubling or even tripling their previous costs.
In a secret agreement in 1882, the thirty-seven stockholders in the various Standard Oil alliances representing refining, pipelines, buying and marketing oil conveyed their shares “in trust” to nine Trustees that controlled 66% of all the shares. Thus centralized control of the industry was formed, creating the first great Trust. Dodd defended the legal structure and operation of the trust saying it would bring order out of the chaos of the industry. The Trust acted, as a perfected monopoly, which Rockefeller once said, would abolish “ruinous competition”.
By 1878, Standard Oil was
one of the best-managed companies in the world. Their knowledge of worldwide
demand was so great that the company would only produce what was necessary so
as to keep the price of oil at a constant level. But it was always a delicate
game between the courts and public. Rockefellers “plan” had become more real
with every day, but as Standard Oil became more monopolistic, the threat of
court ordered intervention increased with every passing day.
For Standard’s economic theory, the policy of a monopoly was not to increase price to maximum levels, which might invite competition, but to direct their efforts at keeping the profit margin stable even as there are attendant falls in production cost. This is especially effective when there is a rising trend in consumption such as occurred as more widespread marketing and distribution brought products to more consumers and as new uses for petroleum products were developed. It is also debatable whether a monopoly such as the Standard Oil Trust encouraged the development of new technologies within it self as effectively as would have happened in an open market. Rival companies often developed new products or processes in desperate attempts to circumvent Standard Oil. In the end, the goal of the monopoly was increased ownership and financial gain; improvements in products and services to consumers quite often seemed to be accidental by-products.
In 1890, Congress passed the
Sherman Antitrust Act that became the basis of anti- monopoly law in the
U.S. The laws forbid any contract,
deal, scheme, or conspiracy to restrain trade. They also restricted any
conspiracy to secure a monopoly in any industry. Starting in 1901, Theodore
Roosevelt began to criticize Standard Oil’s monopoly power wherever he went,
and in 1906, the federal government encouraged
by now former President Roosevelt filed a federal lawsuit against Standard Oil
Trust. After five years in 1911, Standard Oil Trust was ordered to be split
apart into thirty-three of its most important affiliates, dividing the shares
for all the new companies to the Trust’s shareholders.
After the Standard Oil Trust
was ordered to breakup, Rockefeller chose to hold on to the shares of stock of
the newly formed companies against the advice of one of his advisers. Of all of
Mr. Rockefeller’s business decisions, this was undoubtedly one of his best,
with his net worth doubling in just one year to nine hundred million dollars
(roughly equivalent to nine billion dollars in current dollars).
John D. Rockefeller started
at the bottom of the socioeconomic ladder and grew to be the wealthiest and
most hated man in the world. His philosophy was at first to make money by bring
order to a chaotic oil market, filled with over-production and major
inconsistency in the quality of refined oil. By the time his company was broken
up in 1911, Rockefeller had accomplished his goal but had taken it even
further. What he created had indeed made him money but had at first helped
consumers now hurt millions with the inflated prices that comes with
monopolistically controlled product. His use of many strong-armed tactics and
illegal rebates to gain a monopoly in the oil industry ended up destroying his
image in the public eye and the company that he built.