Vindicating Standard Oil, 100 years later

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Alex Epstein
President, Center for Industrial Progress
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      Alex Epstein

      Alex Epstein is President of the Center for Industrial Progress and author of The Moral Case for Fossil Fuels, which comes out today from Portfolio/Penguin.

Sunday marks the 100th anniversary of the Supreme Court ruling that found Standard Oil guilty of violating the Sherman Antitrust Act. As punishment, the world’s largest and most successful oil company was broken into 34 pieces.

Ever since, Standard Oil has served as the textbook example of why we need antitrust law. The Court’s decision affirmed a popular account of Standard Oil’s success, first made famous by journalists Henry Demarest Lloyd and Ida Tarbell. In the absence of antitrust laws, the story goes, Standard attained a 90% share of the oil-refining market through unfair and destructive practices such as preferential railroad rebates and “predatory pricing”; Standard then leveraged its unfair advantages to eliminate competition, control the market, and dictate prices. In Lloyd’s words, Standard was “making us pay what it pleases for kerosene.”

Was it? In 1865, when Rockefeller’s market share was still minuscule, a gallon of kerosene cost 58 cents. In 1870, Standard’s market share was 4%, and a gallon cost 26 cents. By 1880, when Standard’s market share had skyrocketed to 90%, a gallon cost only 9 cents — and a decade later, with Standard’s market share still at 90%, the price was 7 cents. These data point to the real cause of Standard Oil’s success — its ability to charge the lowest prices by producing kerosene with unparalleled efficiency.

John D. Rockefeller had a rare business mind. He was at once a visionary, foreseeing a world in which his kerosene illuminated millions of homes, and an accountant obsessed with day-to-day penny-pinching. Upon buying his first refinery in 1863 at the age of 23, Rockefeller started optimizing every part of his business, from his storage facilities to his refining methods to the number of non-kerosene-refined products (waxes, lubricants, etc.) that could be squeezed from every barrel.

In pursuit of efficiency, Rockefeller employed then-rare business strategies such as vertical integration and economies of scale. For example, by purchasing his own forest and producing his own barrels, Rockefeller lowered per-barrel costs from $3 to $1 while increasing reliability and quality. To transport oil, Rockefeller obtained large rebates from railroads, not through corrupt conspiracies (the typical explanation) but by dramatically lowering the railroads’ costs. Where others offered railroads unreliable, highly variable traffic, Rockefeller offered guaranteed daily fleets of Standard-owned tank cars, loaded and unloaded by Standard-provided facilities, for straight-line trips from Cleveland to New York. The Lake Shore Railroad’s James Devereux testified that Standard Oil lowered transport costs from $900,000 to $300,000 a trip.

Rockefeller was simply a man ahead of his time — and his competition. In the 1860s, refining was a comfortable business; high demand for kerosene plus low supply of refining capacity made for hefty profit margins, even for outfits with mediocre efficiency. Rockefeller, foreseeing that refining capacity would grow to meet demand, was prepared for much lower prices; others weren’t. By 1871, refining capacity exceeded oil production, and three-quarters of the industry was losing money.

Rockefeller saw an opportunity to buy out competitors and put their talent and assets to more efficient use. Rockefeller would typically show his books to a prospect, wait for him to be “thunderstruck” (as one observer put it) by Standard’s efficiency, and then make a reasonable offer. If a target resisted, Rockefeller would win over their customers by charging a low price that was profitable for Standard but extremely unprofitable for others.

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  • russcelt

    “A lie told often enough becomes truth” — Vladimir Lenin quotes (Russian Founder of the Russian Communist Party, leader of the Russian Revolution of 1917, 1870-1924)

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  • toomuchinfo

    Nice reminder on a great american. Here’s a ditty he wrote:

    I was early taught to work as well as play,
    My life has been one long, happy holiday;
    Full of work and full of play-
    I dropped the worry on the way-
    And God was good to me everyday

    Where did so many americans pick up the entitlement disease? I’m just grateful that geniuses still want to work. (FB not included.)

  • bassboat

    The Sherman anti-trust act is unconstitutional in my opinion. If we have a free economy a business should be able to get as large as it wants. The economies of scale will produce lower prices. If a company abuses their position they will pay for it with competition that will expose their faults. This law needs to be challenged. Why should AT&T have to get an ok from the government to purchase T-Mobile? That is ridiculous.

  • http://www.facebook.com/people/MaryAnn-DeRaad/1165436422 MaryAnn DeRaad

    The only people who benefit from antitrust laws are the lawyers and regulators!