Discussion 2-E

Textbook Readings (Page 75-77)

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John D. Rockefeller and the Standard Oil Trust

This is the story of John D. Rockefeller, founder of the Standard Oil Company. It is the story of a somber, small-town boy who dominated the oil industry with organizational genius, audacity, and ruthless, methodical execution. He became the richest man in America and, for a time, the most hated.

Rockefeller’s life spanned nearly 98 years. At his birth Martin Van Buren was president and settlers drove covered wagons over the Oregon Trail. He lived to see Franklin Roosevelt’s New Deal, watch the rise of the Nazi party in Germany, and hear Frank Sinatra and The Lone Ranger on radio.

The historical backdrop of this lifetime is an economy gripped by the fever of industrial progress. Rockefeller built his fortune in an era that lacked many of today’s ethical norms and commercial laws, an era in which the power of a corporation and its founder could be exercised with fewer restraints.

THE FORMATIVE YEARS

John Davison Rockefeller was born July 8, 1839, in a small village in southern New York. He was the second of six children and the oldest boy. His father, William Rockefeller, was an itinerant quack doctor who sold worthless elixirs. He was jovial, slick, and cunning and made enough money to keep the family in handsome style until he had to flee and live away from home to avoid arrest for raping a local woman. After that, he visited only in the dark of night. But he taught young John D. and his brothers lessons of business conduct, especially that sentimentality should not influence business transactions. “I cheat my boys every chance I get,” he once said. “I want to make ‘em sharp.” 1

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John D.’s mother was a somber, religious woman who gave the children a strict upbringing, emphasizing manners, church attendance, and the work ethic. She preached homilies such as “Willful waste makes woeful want.” And she taught charity to the children; from an early age John D. made regular contributions to worthy causes.

Young John D. was not precocious in school. In high school he was an uninspired student, little interested in books and ideas, but willing to work hard. He grew into a somber, intense lad nicknamed “the Deacon” by his classmates because he faithfully attended a Baptist church and memorized hymns. In the summer of 1855 he took a three-month course at a business college in Cleveland, Ohio, and then set out looking for a job. In addition to his formal schooling, he carried the contradictory temperaments of his parents—the wily, self-assured boldness of his father and the exacting, pietistic character of his mother. He internalized both, and the combination was to prove formidable. Here was a man with the precision of an accountant and the cunning of Cesare Borgia.

EARLY BUSINESS CAREER

Rockefeller’s first job was as a bookkeeper at a Cleveland firm where he meticulously examined each bill submitted and pounced on errors. He also recorded every cent he earned and spent in a personal ledger. Its pages show that he was parsimonious and saved most of his $25-a-month salary, but that he still gave generously to the Baptist church and the poor.

In 1859 he formed a successful partnership with two others in the produce business in Cleveland and proved himself an intense negotiator, described by an acquaintance as a person “who can walk right up on a man’s shirt bosom and sit down.” 2  The business boomed from supplying food to the Union army during the Civil War. Although in his early 20s at the time, the steady, unemotional lad was never touched by patriotic fervor. In those days, the law permitted any man of means to pay someone else to serve in his place, and this he did.

BEGINNINGS OF THE OIL BUSINESS

Profits from the produce business were high, and John D. looked around for a promising new investment. He soon found one—a Cleveland petroleum refinery in which he invested $4,000 in 1863. At the time, petroleum production and refining was an infant industry. A new drilling technology had led to an 1859 oil strike in nearby Pennsylvania, followed by a frenzied boom in drilling and refining.

Soon Rockefeller devoted himself to the oil business, and he began to apply his principles of parsimony. One basic principle was to avoid paying a profit to anyone. For example, instead of buying barrels and paying the cooper $2.50 each, Rockefeller set up his own barrel-making factory and made them for $.96. He purchased a forest to make staves from his own trees. Another basic principle was methodical cost cutting. Lumber for barrel staves was kiln-dried before shipment to the cooperage plant. Water evaporated from the wood, making it lighter and lowering transportation costs.

Though obsessed with details and small economies, Rockefeller also proved aggressive in larger plans. He borrowed heavily from banks to expand the refinery. The risk scared his partners, so he bought them out. In 1865 he borrowed more to build a second refinery. Soon he incorporated an export sales company in New York, making the world his market.

DYNAMICS OF THE OIL INDUSTRY

During this early period, the new industry was in a chaotic state. A basic cause was overproduction in the Pennsylvania oil regions, which were the only source of crude oil. The price of crude fluctuated wildly, but was in long-term decline. Each drop in the price of crude oil encouraged construction of new refineries and by the late 1860s refining capacity was three times greater than oil production. This caused vicious price wars. Some refiners tried to stay in business by selling products at a loss to raise cash for continued debt payments. In doing so, they dragged down profit margins for all refiners.

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Rockefeller had the insight to invest in large-scale refineries and, because he cut costs relentlessly, his refineries made money. Yet despite disciplined cost control, the market forces of a sick industry ate away at his net earnings. He believed it was time to “rationalize” the entire industry and stop destructive competition. 3  His method for doing this would be monopoly, his tactics hard-nosed.

ROCKEFELLER’S COMPETITIVE STRATEGIES

Rockefeller used a range of competitive strategies. He was a low-cost, high-volume producer. He used debt financing to expand. He attempted to make his refined petroleum products of high and consistent quality, since fly-by-night refiners turned out inferior distillates. Cheap kerosene with a low ignition point had burned many a home down after exploding in a wick lamp. When he incorporated the Standard Oil Company of Ohio in 1870, the name suggested a “standard oil” of uniformly good quality. He engaged in vertical integration by making wooden barrels. As time when on, he also bought pipelines, storage tanks, and railroad tank cars.

Critical to his success, however, was the art of strong-arming the railroads. In this, Rockefeller was the master. Transportation costs paid to railroads were important to refiners, who shipped in crude oil and then shipped out products such as kerosene or lubricating oil. In the 1860s railroads were highly competitive and often altered shipping rates to attract business. No law prohibited this, and published rates were only the starting point of negotiations.

Railroads often granted rebates to shippers; that is, they returned part of the freight charge after shipment. These rebates were usually secret and given in return for the guarantee of future business. Large volume shippers, including oil refineries, got the biggest rebates. Standard Oil was no exception.

At this time, Rockefeller has been described by biographers as a prepossessing man with penetrating eyes who drove a hard bargain. He would take the measure of a person with a withering stare, and few were his match. He was formidable in negotiations, being invariably informed in detail about the other’s business. And he was still a pious churchgoer who read the Bible nightly before retiring.

Late in 1870 Rockefeller hatched a brazen plan for stabilizing the oil industry at the refining level. In clandestine meetings, he worked out a rebate scheme between a few major refiners and the three railroads going into the Pennsylvania oil regions. They gave this scheme an innocent-sounding name, the South Improvement Plan. In it, the railroads agreed to increase published rates for hauling oil. Then Rockefeller’s Cleveland refineries and a few others would get large rebates on each barrel shipped. For example, the regular rate between the oil regions and Cleveland would be $.80 a barrel and between Cleveland and New York $2.00 a barrel. It would cost a total of $2.80 per barrel for any other refinery in Cleveland to bring in a barrel of crude oil and ship a barrel of refined oil to New York for sale or export. Rockefeller and his accomplices, on the other hand, would be charged $2.80 but then get a rebate of $.90.

In addition, the refineries participating in the South Improvement Plan received drawbacks or payments made on the shipment of oil by competitors! Thus, Rockefeller would be paid $.40 on every barrel of crude oil his competitors shipped into Cleveland and $.50 on every barrel of refined oil shipped to New York. Under this venal scheme, the more a competitor shipped, the more Rockefeller’s transportation costs were lowered. While competitors were charged $2.80 on the critical route (Pennsylvania oil regions–Cleveland–New York), Rockefeller paid only $1.00. Moreover, the railroads agreed to give the conspirators waybills detailing competitors’ shipments; a better espionage system would be hard to find.

Why did the railroads agree to this plot? There were several reasons. First, it removed the uncertainty of cutthroat competition. Oil traffic was guaranteed in large volume. Second, the refiners provided services to the railroads including tank cars, loading facilities, and insurance. And third, railroad executives received stock in the participating refineries, giving them a stake in their success.

The consequences of the South Improvement Plan were predictable. Nonparticipating refiners faced bloated transportation costs and would be uncompetitive. They had two choices. Either they could sell to Rockefeller and his allies, or they could stand on principle and go bankrupt. When they sold, as they must, the flaw in industry structure would be corrected. Rockefeller intended to acquire them, then close them or limit their capacity. This would give him market power to stabilize the price of both crude oil and refined products. And the rebates would be a formidable barrier to new entrants.