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Standard Oil: A Centennial Evaluation (Part I: John D. Rockefeller’s entrepreneurial genius)

[Yesterday (May 15) was the 100th anniversary of the U.S. Supreme Court decision [Standard Oil Co. of New Jersey v. United States finding John D. Rockefeller's company guilty of restraint of trade and monopolizing the petroleum industry. The court’s remedy was to affirm a lower court decree effectively dividing Standard Oil into several competing firmsdissolution of Standard Oil. This post, taken from Robert Bradley's Oil, Gas and Government: The U.S. Experience, summarizes the manifold contributions of John D. Rockefeller to a fledgling, powerhouse industry. Documentation for the points and quotations below can be found on pp. 1089–1094.], 221 U.S. 1 (1911)]

A resume of the contributions of Standard Oil prior to its court-ordered dissolution in 1911 offers an illuminating glimpse into entrepreneurship, the market process, and consumer service therein.

Rockefeller and the management team at Standard Oil can be credited with accelerating the maturation of the kerosene age in petroleum. Their entrance in the 1870s found an infant industry prone to cyclical growth, undercapitalization, and coordination problems. Explained Williamson and Daum:

Lack of balance between various segments of the industry appeared to be chronic; crude production, refinery capacity and throughput, and market demand were rarely in equilibrium. First, production would outrun throughput by refineries; the manufacturing capacity would exceed either current crude production or the rate at which refined products could be absorbed by the market. These more or less continuous maladjustments were reflected in wide fluctuations in prices of crude and refined products.

Within the free-market environment, company and industry problems invited profitable solutions, and Rockefeller proved to be the right man at the right place and time. Standard strategically bypassed the unstable exploration and production phase, where drilling was risky and production often exceeded storage and demand capabilities, and concentrated instead on the manufacturing phase. Demand for refined products was solid and growing, and the lure of a big strike would keep the drillers busy; Rockefeller’s plan was to concentrate in the middle with storage, transportation, and refining to lower cost and add value to the oil. The refining phase, in particular, was in need of great improvement. Summarized John McLaurin:

The first refineries were exceedingly primitive and their processes simple. Much of the crude was wasted in refining, a business not financially successful as a rule until 1872, notwithstanding the high prices obtained. Methods of manufacture and transportation were expensive and inadequate. The product was of poor quality, emitting smoke and unpleasant odor and liable to explode on the slightest provocation…. Railroad-rates were excessive and irregular…. The cost of transportation and packages had been important factors in crippling the industry.

Rockefeller clearly recognized the “manifold economies,” to borrow biographer Allen Nevin’s term, associated with large size. Contracting in bulk lowered input prices and transportation rates. Diverse plant locations reduced the business risks of fire and explosion. Improvements in distillation technology steadily lowered unit costs. Integration into complementary phases (barrel making, pipelines, wagon production, storage, loading facilities, marketing) internalized profits and trimmed costs. By-products that other refiners treated as waste Rockefeller found uses for. Literally hundreds of by-products were distilled from each barrel of oil. Opportunities for efficient operation were discovered and implemented that set industry standards in favor of the consumer.

Internal efficiency was matched – and indeed fostered – by Standard’s emphasis on cost accounting. Lewis Galantiere credits Standard with many advances in “that most baffling and fascinating department of business, corporate accounting.” Even the smallest of items, including refinery bung (which had the value of a clothespin) did not escape attention on the financial ledgers. Quarterly reports for internal planning and annual financial statements were pioneered. With accurate and timely information, necessary adjustments could be made to changing market conditions.

As one of the first big businesses, Standard also pioneered major innovations in management organization. The trust arrangement created by Standard became a model for other large businesses. Middle management was inaugurated to provide the crucial link between field and plant activity and the New York office. Specialists were assigned to advisory committees to meet with senior management on important projects. A judicious mix of autonomy and coordination among managers attracted top talent and kept turnover low. Standard employees, as a whole, were a competent and content lot. Company critic Ida Tarbell had only praise for Standard’s work force.

From Mr. Rockefeller himself… to the humblest clerk in the office of the remote marketing agency, everyone worked. There was not a lazy bone in the organization, not an incompetent hand, nor a stupid head. It was a machine where everybody was kept on his mettle by an extraordinary system of competition, where success met immediate recognition, where opportunity was wide as the world’s craving for a good light to cheer its hours of darkness.

The influence of Standard Oil on the oil industry in the 1870-1911 period can only be described as positive. Although not significantly involved in production until the late 1880s, Standard directly influenced wellhead activities. As the leading crude purchaser, Standard refused to buy excess crude created by production sprees. This discipline was manifested by voluntary proration in the Pennsylvania fields in the 1880s. Although not always dominant, a stabilizing influence was exerted on the upstream market by Standard. Noticed Ida Tarbell:

The force of the combination has been greater because of the business habits of the independent body which has opposed it. To the Standard’s caution the Oil Regions opposed recklessness; to its economy, extravagance; to its secretiveness, almost blatant frankness… farsightedness… and… almost quixotic love of fair play. The Oil Regions had, besides, one fatal weakness – its passion for speculation. Now, Mr. Rockefeller never speculates. He deals only in those things which other people have proved sure.

Once Standard was committed to exploration and production, cost-saving techniques were implemented. Because Standard built facilities for crude storage and pipelines, often on short notice, more crude oil found a market. Reduced transportation costs allowed refineries to be situated in consumer markets instead of the oil regions. For many refiners who wanted to sell out, Standard was a ready buyer offering cash or stock. Rockefeller purchased inefficient “teakettle” refineries if only to close them down to rid the market of excess capacity. As discussed in chapter 22, consumers benefited from increasing volume, uniform quality (hence the company name), and declining prices. In virtually every petroleum sector, Standard contributed technical, managerial, and entrepreneurial improvements.

The success of Standard resulted in sizable profits, which furthered the company’s winning ways. The absence of corporate taxation allowed Standard an unmatched pool of retained earnings to use for introducing the latest technology to existing operations, capitalizing on market opportunities by purchasing undervalued or undercapitalized firms, and financing new projects. From the 1870s through dissolution, Standard internally financed all projects and was free of bankers and other financiers. The entrance of Standard into undeveloped Kansas in 1895 to drill wells, lay pipeline, construct storage, and build refineries, for example, was as much a boon to the state as it was profitable to Standard – all made possible by yesterday’s earnings.

The contributions of Standard can be appreciated by imagining their absence. Greater industry instability, higher cost refining, less disciplined crude output, fewer crude outlets, and fewer consumer markets can be imagined in the absence of Rockefeller and the Standard plan. The advantages of large-scale integration surely would have been recognized; as McLean and Haigh state, “A failure to move in that direction might have represented a lack of business foresight,” but the assumption that the thousands of opportunities would have been as fully and masterfully exploited without the entrepreneurial genius of Rockefeller or the scale of economies of Standard is doubtful.

2 comments

1 rbradley { 05.16.11 at 12:44 pm }

Just saw this piece from the Mises Institute blog on the same subject:

http://mises.org/daily/5274/100-Years-of-Myths-about-Standard-Oil

2 Alex Epstein { 05.16.11 at 1:15 pm }

I wrote a short piece for The Daily Caller on the anniversary:
“Vindicating Standard Oil, 100 Years Later”
http://dailycaller.com/2011/05/13/vindicating-standard-oil-100-years-later/

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