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Standard Oil: A Centennial Evaluation (Part III: Monopoly, Monopoly Profits, Subterfuge, and Obstructionism Reconsidered)

[Ed. note: This post, taken from Robert Bradley's Oil, Gas and Government: The U.S. Experience, rebutes the textbook criticisms of the business practices and economic consequences of the Standard Oil Trust. Part I summarized the manifold contributions of John D. Rockefeller to a fledgling, powerhouse industry. Part II provided a critical interpretation of rebate and other 'unfair' practices of Rockefeller's Trust. (Documentation for this post can be found on pp. 1099–1103.)]

If Standard is labeled a monopoly because of its large market share, a liberal application of the “single seller” criterion, it should be recognized that outside of oil tariffs that Standard neither wanted nor needed, Standard was a free-market, not a governmental, monopoly. Standard had to continually offer quality products at competitive prices to gain and keep its dominant market share. Lewis Galantiere observed with puzzlement that “this monopolist always produced as if he had competitors,” incognizant of the fact that without domestic barriers to entry (such as restrictive charters or siting permits), competition is omnipresent whatever the number and size of individual firms. This is because entrepreneurial ideas, awaiting fruition with the emergence of profit opportunities, can never be monopolized.

Standard Oil had competitors throughout its history–and increasingly so in the period of its antitrust troubles. In 1904, Standard’s twenty-three refineries, although claiming over 80 percent of the market, competed against seventy-five independents. By 1908, the number of independent refineries swelled to 125; three years later, the total was 147.

Potential entrants were virtually as important as actual entrants. In the 1880s and 1890s, Standard’s efficient performance kept would-be competitors on the sidelines and encouraged consolidation. This resulted from a competitive process entirely consistent with the market virtue of lowest cost provision of goods and services. There was also substitute competition; Standard’s kerosene had to compete with coal gas and electricity in the all-important illuminant market. As John Chamberlain stated:

Buyers always liked the company’s product – they proved by rushing to substitute petroleum kerosene for the old coal-oil and whale-oil illuminants. And buyers did not have any particular reason to complain of Standard’s pricing policy; not only did kerosene cost less than older fluids, but it had to meet the competition of the Welsbach gas burner and Mr. Edison’s carbon-filament electric light bulb. Standard could not have imposed a lighting monopoly even if it had tried.

Critics seized upon Standard’s dividend policies to assert that monopoly profits were made at the expense of consumers. Product margins increased over time, it was noted, and profits were unequaled as a percentage of capital.

Several observations can be made in regard to these facts. One, Standard’s declared capital value was notoriously understated, as much as several hundred percent. But more important, profits in a free market are a positive indication of economic performance. The higher the profits, other things being equal, the better the entrepreneurial correction between consumer demand and resource deployments. Profits won by Standard were available to other entrepreneurs, yet Standard prevailed and many independents did not. With anti-Standard sentiment spread by competitors and their political and academic allies, consumers had an extra reason to rethink product allegiance, but they remained with Standard. Higher profits from artificially high prices, on the other hand, would have opened the door to other firms.

Standard entered into agreements to “restrict” competition. For example, Standard initiated agreements with producers to reduce output to “marketable” quantities. Such agreements, however, far from fostering monopoly waste (less output at higher prices), promoted prudent resource management given the relative scarcity of refining capacity compared with crude production.

On the refining side, Standard on different occasions tried to rationalize rivalry by entering into output and pricing agreements with fellow refiners. Some agreements proved their market mettle by lasting; many proved artificial and collapsed under the weight of self-interest. The South Improvement Plan in 1872 was a bust as were the Petroleum Refiners Association and the Central Refiners Association cartels several years later.

Other Complaints: Subterfuge

Gathering information on a competitor is part of the process of rivalry. According to Hidy and Hidy, “spying” had been a practice common in all phases of the oil business since the early days.

Whether or not such action turns from legal to illegal depends on the facts. Trespassing and contract-breaking to gain information are clearly invasion; they are matters of tort law and may require restitution from the victimizer to the victim. Regulatory considerations have no role to play. John Archbold, the president of Standard Oil, answered a government accusation that his company used such questionable competitive methods by declaring that it was not company policy, and “I would be only too thankful to have any such case brought to our attention.”

Use of hidden companies to give the impression of distinct competition, where, in fact, there was only one general firm in a geographical area, was a marketing practice used by Standard and other companies. Bad public relations spawned by Standard’s competitors and their allies, and prosecution by state governments in response to local opinion, encouraged hidden control by Standard. The practice, in other words, was more defensive than offensive. When this practice was found to be controversial, Standard discontinued its use in 1906. Still, front companies still faced the same competitive pressures of the market that all other companies did – substitution and new entry.

Obstructionism?

Obstructionist practices, the most notorious being strategically purchased land rights-of-way to block construction of competing pipelines, are a flagrant example of unbridled rivalry within the competitive process. As with the other complaints, it was not a practice unique to Standard. But given the practice, it can be “competitively” overcome. “Self-help” alternatives are to beat the would-be obstructionist to the right-of-way or secure alternative routing. Another free-market solution is to sanction a homestead theory of property rights to weaken the ability to obstruct. Tunneling below or bridging above the impasse can be sanctioned under homestead law, whereas under prevailing law both actions are considered trespass.

Not all critics of Standard have decried the company’s ethics. Many have praised them. John Ise commented that Standard established “standards of business practice which were in some ways among the highest of the time.” Standard, in fact, was a rare example of an oil company that did not seek government favor but only grudgingly used the political process to repel threatening intervention designed by rivals. Unlike other trusts of the time, such as sugar and steel, Standard sought neither tariff protection nor subsidies, nor entry restrictions, price floors, nor public-land grants. On this score Standard towered not only above companies of its time but above the vast majority of future companies as well.

Ethical judgments of certain business practices employed by Standard are beyond the scope of economic evaluation, but one pertinent observation can be made. To the extent consumers and fellow firms resent particular business practices, a negative intangible is created that penalized the guilty firm in subtle but real ways. As the nation’s largest business entity and a pioneer in many areas, Standard undoubtedly entered the realm of the extralegal and controversial, which brought on problems. But this was part of entrepreneurial learning and the market’s discovery process. It was not grounds for government intervention that would impede the competitive discovery process and create unforeseen problems.

Note: This series ends Thursday with a final look at the Standard Oil Trust (Part IV).

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