In defense of Standard Oil

Recently I appeared in a panel discussion where the subject of “robber barons” arose. I attempted to correct the rendition of the historical record that was given, but I didn’t do a very good job. Below, Alex Epstein does a much better job.

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.

Rockefeller’s goal in expanding was to become more and more efficient, improving his competitive advantage with ever-lower but still-profitable prices. He knew he didn’t “control” the market and thus couldn’t get away with high prices. This truth was painfully reinforced in the early 1870s when Rockefeller foolishly agreed to join two oil-refining cartels (the South Improvement Company and the Pittsburgh Plan) designed to suppress output and drive up prices; both were quickly competed out of existence. Since a private company, unlike a government-granted monopoly, couldn’t force competitors out of the market, customers could and would go elsewhere the second they found a better deal from clever competitors.

Offering the best deal is how Standard maintained a 90% market share for two decades, from 1879 to 1899, despite strong competitive challenges and an ever-changing market. New, formidable competitors from Russia to Pennsylvania were emulating Rockefeller’s methods; pipelines became a leading form of oil transport; crude supplies appeared to be running short; and the electric light bulb emerged as a fundamental challenge to kerosene oil lamps. Rockefeller’s response was more innovation and efficiency, including millions invested in scientific research to make high-sulfur oil, plentiful but previously useless, usable.

By 1907, four years before Standard Oil’s breakup, the company’s market share had fallen to 68%, partly because the rest of the oil industry had learned a lot from Standard about oil refining and efficiency. Rockefeller had not stopped competition — he had raised the bar by creating a modern, scientific oil company before anyone else did.

In the process, he had enriched tens of millions of lives by bringing affordable illumination to homes and businesses across the country. If Standard Oil is the textbook example of the kind of company antitrust laws are supposed to punish, what does that say about antitrust laws? As Google, Apple, and other highly successful companies are targeted for antitrust prosecution, this question is as relevant today as it was a hundred years ago.

Originally at Vindicating Standard Oil, 100 years later.

Alex Epstein is a fellow at the Ayn Rand Center for Individual Rights, focusing on business issues. The Ayn Rand Center is a division of the Ayn Rand Institute and promotes the philosophy of Ayn Rand, author of “Atlas Shrugged” and “The Fountainhead.”