Among the great misconceptions about a free economy is the widely-held belief that “laissez faire” embodies a natural tendency toward monopoly concentration. Under unfettered capitalism, so goes the familiar refrain, large firms would systematically devour smaller ones, corner markets, and stamp out competition until every inhabitant of the land fell victim to their power. Supposedly, John D. Rockefeller’s Standard Oil Company of the late 1800s gave substance to this perspective.
Regarding Standard Oil’s chief executive, one noted historian writes, “He (Rockefeller) iron-handedly ruined competitors by cutting prices until his victim went bankrupt or sold out, whereupon higher prices would be likely to return.”
Two other historians, co-authors of a popular college text, opine that “Rockefeller was a ruthless operator who did not hesitate to crush his competitors by harsh and unfair methods.” That’s what the superficial orthodoxy holds.
In 1899, Standard refined 90 per cent of America’s oil—the peak of the company’s dominance of the refining business. Though that market share was steadily siphoned off by competitors after 1899, the company nonetheless has been branded ever since as “an industrial octopus.”
Does the story of Standard Oil really present a case against the free market? In my opinion, it most emphatically does not. Furthermore, setting the record straight on this issue must become an important weapon in every free market advocate’s intellectual arsenal.
Theoretically, there are two kinds of monopoly: coercive and efficiency. A coercive monopoly results from, in the words of Adam Smith, “a government grant of exclusive privilege.” Government, in effect, must take sides in the market in order to give birth to a coercive monopoly. It must make it difficult, costly, or impossible for anyone but the favored firm to do business.
The United States Postal Service is an example of this kind of monopoly. By law, no one can deliver first class mail except the USPS. Fines and imprisonment (coercion) await all those daring enough to compete.(Editor’s Note: In the years since this article was written, technology in the form of fax machines, overnight delivery services, the Internet and e-mail have allowed the private sector to get around the government monopoly in traditional, first-class mail delivery).
In some other cases, the government may not ban competition outright, but simply bestow privileges, immunities, or subsidies on one firm while imposing costly requirements on all others. Regardless of the method, a firm which enjoys a coercive monopoly is in a position to harm the consumer and get away with it.
An efficiency monopoly, on the other hand, earns a high share of a market because it does the best job. It receives no special favors from the law to account for its size. Others are free to compete and, if consumers so will it through their purchases, to grow as big as the “monopoly.”
An efficiency monopoly has no legal power to compel people to deal with it or to protect itself from the consequences of its unethical practices. It can only attain bigness through its excellence in satisfying customers and by the economy of its operations. An efficiency monopoly which turns its back on the very performance which produced its success would be, in effect, posting a sign, “COMPETITORS WANTED.” The market rewards excellence and exacts a toll on mediocrity. It is my contention that the historical record casts the Standard Oil Company in the role of efficiency monopoly—a firm to which consumers repeatedly awarded their votes of confidence.
The oil rush began with the discovery of oil by Colonel Edwin Drake at Titusville, Pennsylvania in 1859. Northwestern Pennsylvania soon “was overrun with businessmen, speculators, misfits, horse dealers, drillers, bankers, and just plain hell-raisers. Dirt-poor farmers leased land at fantastic prices, and rigs began blackening the landscape. Existing towns jammed full overnight with ‘strangers,’ and new towns appeared almost as quickly.”
In the midst of chaos emerged young John D. Rockefeller. An exceptionally hard-working and thrifty man, Rockefeller transformed his early interest in oil into a partnership in the refinery stage of the business in 1865.
Five years later, Rockefeller formed the Standard Oil Company with 4 per cent of the refining market. Less than thirty years later, he reached that all-time high of 90 per cent. What accounts for such stunning success?
On December 30, 1899, Rockefeller was asked that very question before a governmental investigating body called the Industrial Commission. He replied:
I ascribe the success of the Standard to its consistent policy to make the volume of its business large through the merits and cheapness of its products. It has spared no expense in finding, securing, and utilizing the best and cheapest methods of manufacture. It has sought for the best superintendents and workmen and paid the best wages. It has not hesitated to sacrifice old machinery and old plants for new and better ones. It has placed its manufactories at the points where they could supply markets at the least expense. It has not only sought markets for its principal products, but for all possible by-products, sparing no expense in introducing them to the public. It has not hesitated to invest millions of dollars in methods of cheapening the gathering and distribution of oils by pipe lines, special cars, tank steamers, and tank wagons. It has erected tank stations at every important railroad station to cheapen the storage and delivery of its products. It has spared no expense in forcing its products into the markets of the world among people civilized and uncivilized. It has had faith in American oil, and has brought together millions of money for the purpose of making it what it is, and holding its markets against the competition of Russia and all the many countries which are producers of oil and competitors against American oil.
Rockefeller was a managerial genius—a master organizer of men as well as of materials. He had a gift for bringing devoted, brilliant, and hard-working young men into his organization. Among his most outstanding associates were H. H. Rogers, John D. Archbold, Stephen V. Harkness, Samuel Andrews, and Henry M. Flagler. Together they emphasized efficient economic operation, research, and sound financial practices. The economic excellence of their performance is described by economist D. T. Armentano:
Instead of buying oil from jobbers, they made the jobbers’ profit by sending their own purchasing men into the oil region. In addition, they made their own sulfuric acid, their own barrels, their own lumber, their own wagons, and their own glue. They kept minute and accurate records of every item from rivets to barrel bungs. They built elaborate storage facilities near their refineries. Rockefeller bargained as shrewdly for crude as anyone before or since. And Sam Andrews coaxed more kerosene from a barrel of crude than could the competition. In addition, the Rockefeller firm put out the cleanest-burning kerosene, and managed to dispose of most of the residues like lubricating oil, paraffin, and vaseline at a profit.
Even muckraker Ida Tarbell, one of Standard’s critics, admired the company’s streamlined processes of production:
Not far away from the canning works, on Newton Creek, is an oil refinery. This oil runs to the canning works, and, as the new-made cans come down by a chute from the works above, where they have just been finished, they are filled, twelve at a time, with the oil made a few miles away. The filling apparatus is admirable. As the new-made cans come down the chute they are distributed, twelve in a row, along one side of a turn-table. The turn-table is revolved, and the cans come directly under twelve measures, each holding five gallons of oil—a turn of a valve, and the cans are full. The table is turned a quarter, and while twelve more cans are filled and twelve fresh ones are distributed, four men with soldering cappers put the caps on the first set. Another quarter turn, and men stand ready to take the cans from the filler and while they do this, twelve more are having caps put on, twelve are filling, and twelve are coming to their place from the chute. The cans are placed at once in wooden boxes standing ready, and, after a twenty-four-hour wait for discovering leaks, are nailed up and carted to a nearby door. This door opens on the river, and there at anchor by the side of the factory is a vessel chartered for South America or China or where not—waiting to receive the cans which a little more than twenty-four hours before were tin sheets lying on flat-boxes. It is a marvelous example of economy, not only in materials, but in time and in footsteps.
Socialist historian Gabriel Kolko, who argues in The Triumph of Conservatism that the forces of competition in the free market of the late 1800s were too potent to allow Standard to cheat the public, stresses that “Standard treated the consumer with deference. Crude and refined oil prices for consumers declined during the period Standard exercised greatest control of the industry.”
Standard’s service to the consumer in the form of lower prices is well-documented. To quote from Professor Armentano again:
Between 1870 and 1885 the price of refined kerosene dropped from 26 cents to 8 cents per gallon. In the same period, the Standard Oil Company reduced the [refining] costs per gallon from almost 3 cents in 1870 to 0.452 cents in 1885. Clearly, the firm was relatively efficient, and its efficiency was being translated to the consumer in the form of lower prices for a much improved product, and to the firm in the form of additional profits.
That story continued for the remainder of the century, with the price of kerosene to the consumer falling to 5.91 cents per gallon in 1897. Armentano concludes from the record that “at the very pinnacle of Standard’s industry ‘control,’ the costs and the prices for refined oil reached their lowest levels in the history of the petroleum industry.”
John D. Rockefeller’s success, then, was a consequence of his superior performance. He derived his impressive market share not from government favors but rather from aggressive courting of the consumer. Standard Oil is one of history’s classic efficiency monopolies.
But what about the many serious charges leveled against Standard? Predatory price cutting? Buying out competitors? Conspiracy? Railroad rebates? Charging any price it wanted? Greed? Each of these can be viewed as an assault not just on Standard Oil but on the free market in general. They can and must be answered.
Predatory price cutting is “the practice of deliberately underselling rivals in certain markets to drive them out of business, and then raising prices to exploit a market devoid of competition.” Let’s see if it’s a charge that holds water or just one of those one-liners progressives like to toss out whether the evidence is there or not.
In fact, Professor John S. McGee, writing in the Journal of Law and Economics for October 1958, stripped this charge of any intellectual substance. Describing it as “logically deficient,” he concluded, “I can find little or no evidence to support it.”
In research for his extraordinary article, McGee scrutinized the testimony of Rockefeller’s competitors who claimed to have been victims of predatory price cutting. He found their claims to be shallow and misdirected. McGee pointed out that some of these very people later opened new refineries and successfully challenged Standard again.
Beyond the actual record, economic theory also argues against a winning policy of predatory price cutting in a free market for the following reasons:
- Price is only one aspect of competition. Firms compete in a variety of ways: service, location, packaging, marketing, even courtesy. For price alone to draw customers away from the competition, the predator would have to cut substantially—enough to outweigh all the other competitive pressures the others can throw at him. That means suffering losses on every unit sold. If the predator has a war-chest of “monopoly profits” to draw upon in such a battle, then the predatory price cutting theorist must explain how he was able to achieve such ability in the absence of this practice in the first place!
- The large firm stands to lose the most. By definition, the large firm is already selling the most units. As a predator, it must actually step up its production if it is to have any effect on competitors. As Professor McGee observed, “To lure customers away from somebody, he (the predator) must be prepared to serve them himself. The monopolizer thus finds himself in the position of selling more—and therefore losing more—than his competitors.”
- Consumers will increase their purchases at the “bargain prices.” This factor causes the predator to step up production even further. It also puts off the day when he can “cash in” on his hoped-for victory because consumers will be in a position to refrain from purchasing at higher prices, consuming their stockpiles instead.
- The length of the battle is always uncertain. The predator does not know how long he must suffer losses before his competitors quit. It may take weeks, months, or even years. Meanwhile, consumers are “cleaning up” at his expense.
- Any “beaten” firms may reopen. Competitors may scale down production or close only temporarily as they “wait out the storm.” When the predator raises prices, they enter the market again. Conceivably, a “beaten” firm might be bought up by someone for a “song,” and then, under fresh management and with relatively low capital costs, face the predator with an actual competitive cost advantage.
- High prices encourage newcomers. Even if the predator drives everyone else from the market, raising prices will attract competition from people heretofore not even in the industry. The higher the prices go, the more powerful that attraction.
- The predator would lose the favor of consumers. Predatory price cutting is simply not good public relations. Once known, it would swiftly erode the public’s faith and good will. It might even evoke consumer boycotts and a backlash of sympathy for the firm’s competitors.
In summary, let me quote Professor McGee once again:
Judging from the Record, Standard Oil did not use predatory price discrimination to drive out competing refiners, nor did its pricing practice have that effect. Whereas there may be a very few cases in which retail kerosene peddlers or dealers went out of business after or during price cutting, there is no real proof that Standard’s pricing policies were responsible. I am convinced that Standard did not systematically, if ever, use local price cutting in retailing, or anywhere else, to reduce competition. To do so would have been foolish; and, whatever else has been said about them, the old Standard organization was seldom criticized for making less money when it could readily have made more.
A second charge is that Standard bought out its competitors. The intent of this practice, the critics say, was to stifle competitors by absorbing them.
First, it must be said that Standard had no legal power to coerce a competitor into selling. For a purchase to occur, Rockefeller had to pay the market price for an oil refinery. And evidence abounds that he often hired the very people whose operations he purchased. “Victimized ex-rivals,” wrote McGee, “might be expected to make poor employees and dissident or unwilling shareholders.”
Kolko writes that “Standard attained its control of the refinery business primarily by mergers, not price wars, and most refinery owners were anxious to sell out to it. Some of these refinery owners later reopened new plants after selling to Standard.”
Buying out competitors can be a wise move if achieving economy of scale is the intent. Buying out competitors merely to eliminate them from the market can be a futile, expensive, and never-ending policy. It appears that Rockefeller’s mergers were designed with the first motive in mind.
Even so, other people found it profitable to go into the business of building refineries and selling to Standard. David P. Reighard managed to build and sell three successive refineries to Rockefeller, all on excellent terms.
A firm which adopts a policy of absorbing others solely to stifle competition embarks upon the impossible adventure of putting out the recurring and unpredictable prairie fires of competition.
A third accusation holds that Standard secured secret agreements with competitors to carve up markets and fix prices at higher-than-market levels.
I will not contend here that Rockefeller never attempted this policy. His experiment with the South Improvement Company in 1872 provides at least some evidence that he did. I do argue, however, that all such attempts were failures from the start and no harm to the consumer occurred.
Standard’s price performance, cited extensively above, supports my argument. Prices fell steadily on an improving product. Some conspiracy!
From the perspective of economic theory, collusion to raise and/or fix prices is a practice doomed to failure in a free market for these reasons:
Internal pressures. Conspiring firms must resolve the dilemma of production. To exact a higher price than the market currently permits, production must be curtailed. Otherwise, in the face of a fall in demand, the firms will be stuck with a quantity of unsold goods. Who will cut their production and by how much? Will the conspirators accept an equal reduction for all when it is likely that each faces a unique constellation of cost and distribution advantages and disadvantages?
Assuming a formula for restricting production is agreed upon, it then becomes highly profitable for any member of the cartel to quietly cheat on the agreement. By offering secret rebates or discounts or other “deals” to his competitors’ customers, any conspirator can undercut the cartel price, earn an increasing share of the market and make a lot of money. When the others get wind of this, they must quickly break the agreement or lose their market shares to the “cheater.” The very reason for the conspiracy in the first place—higher profits—proves to be its undoing!
- External pressures. This comes from competitors who are not parties to the secret agreement. They feel under no obligation to abide by the cartel price and actually use their somewhat lower price as a selling point to customers. The higher the cartel price, the more this external competition pays. The conspiracy must either convince all outsiders to join the cartel (making it increasingly likely that somebody will cheat) or else dissolve the cartel to meet the competition.
I would once again call the reader’s attention to Kolko’s The Triumph of Conservatism, which documents the tendency for collusive agreements to break apart, sometimes even before the ink is dry.
A fourth charge involves the matter of railroad rebates. John D. Rockefeller received substantial rebates from railroads who hauled his oil, a factor which critics claim gave him an unfair advantage over other refiners.
The fact is that most all refiners received rebates from railroads. This practice was simply evidence of stiff competition among the roads for the business of hauling refined oil products. Standard got the biggest rebates because Rockefeller was a shrewd bargainer and because he offered the railroads large volume on a regular basis.
This charge is even less credible when one considers that Rockefeller increasingly relied on his own pipelines, not railroads, to transport his oil.
Did Standard Oil have the power to charge any price it wanted? A fifth accusation says yes. According to the notion that Standard’s size gave it the power to charge any price, bigness per se immunizes the firm from competition and consumer sovereignty.
As an “efficiency monopoly,” Standard could not coercively prevent others from competing with it. And others did, so much so that the company’s share of the market declined dramatically after 1899. As the economy shifted from kerosene to electricity, from the horse to the automobile, and from oil production in the East to production in the Gulf States, Rockefeller found himself losing ground to younger, more aggressive men.
Neither did Standard have the power to compel people to buy its products. It had to rely on its own excellence to attract and keep customers.
In a truly free market, the following factors insure that no firm, regardless of size, can charge and get any price it wants:
- Free entry. Potential competition is encouraged by any firm’s abuse of the consumer. In describing entry into the oil business, Rockefeller once remarked that “all sorts of people . . . the butcher, the baker, and the candlestick maker began to refine oil.”
- Foreign competition. As long as government doesn’t hamper international trade, this is always a potent force.
- Competition of substitutes. People are often able to substitute a product different from yet similar to the monopolist’s.
- Competition of all goods for the consumer’s dollar. Every businessperson in competition with every other businessman to get consumers to spend their limited dollars on him.
- Elasticity of demand. At higher prices, people will simply buy less.
It makes sense to view competition in a free market not as a static phenomenon, but as a dynamic, never-ending, leap-frog process by which the leader today can be the follower tomorrow.
The sixth charge, that John D. Rockefeller was a “greedy” man, is the most meaningless of all the attacks on him but nonetheless echoes constantly in the history books.
If Rockefeller wanted to make a lot of money (and there is no doubting he did), he certainly discovered the free market solution to his problem: produce and sell something that consumers will buy and buy again. One of the great attributes of the free market is that it channels greed into constructive directions. One cannot accumulate wealth without offering something in exchange!
At this point the reader might rightly wonder about the dissolution of the Standard Oil Trust in 1911. Didn’t the Supreme Court find Standard guilty of successfully employing anti-competitive practices?
Interestingly, a careful reading of the decision reveals that no attempt was made by the Court to examine Standard’s conduct or performance. The justices did not sift through the conflicting evidence concerning any of the government’s allegations against the company. No specific finding of guilt was made with regard to those charges. Although the record clearly indicates that “prices fell, costs fell, outputs expanded, product quality improved, and hundreds of firms at one time or another produced and sold refined petroleum products in competition with Standard Oil,” the Supreme Court ruled against the company. The justices argued simply that the competition between some of the divisions of Standard Oil was less than the competition that existed between them when they were separate companies before merging with Standard.
In 1915, Charles W. Eliot, president of Harvard, observed: “The organization of the great business of taking petroleum out of the earth, piping the oil over great distances, distilling and refining it, and distributing it in tank steamers, tank wagons, and cans all over the earth, was an American invention.” Let the facts record that the great Standard Oil Company, more than any other firm, and John D. Rockefeller, more than any other man, were responsible for this amazing development.
- If the Standard Oil Company was any kind of “monopoly,” it was not a “coercive” one because it did not derive its high (and temporary) market share from special government favors. There were lots of competitors to it, here and abroad. If it was a monopoly, then it was of the “efficiency” variety, meaning that it earned a high market share because consumers liked what it offered at attractive prices.
- The prices of Standard products (chiefly kerosene in the company’s early history) steadily fell. The quality steadily improved. Total production grew from year to year. This is not supposed to be the behavior of an evil monopolist, who supposedly restricts output and raises prices.
- Accusations against Standard—predatory price cutting, buying up competitors, conspiracy to restrict output and raise prices, securing railroad rebates, etc—sound plausible on the surface but fall apart upon close inspection.
For further information, see:
“John D. Rockefeller and the Oil Industry” by Burton Folsom
“How Capitalism Saved the Whales” by James S. Robbins
“John D. Rockefeller and His Enemies” by Burton Folsom
“A Review of Chernow’s biography of Rockefeller” by D. T. Armentano
“Herbert Dow and Predatory Pricing” by Burton Folsom