The Truth About the "Robber Barons"
Mises Daily: Saturday, September 23, 2006 by Thomas J. DiLorenzo
This article is excerpted from chapter 7 of How Capitalism Saved America.]
http://mises.org/daily/2317
The late nineteenth and early twentieth centuries are often referred to as the time of the "robber
barons." It is a staple of history books to attach this derogatory phrase to such figures as John D.
Rockefeller, Cornelius Vanderbilt, and the great nineteenth-century
railroad operators — Grenville Dodge, Leland Stanford, Henry Villard,
James J. Hill, and others. To most historians writing on this period, these
entrepreneurs committed thinly veiled acts of larceny to enrich
themselves at the expense of their customers. Once again we see the
image of the greedy, exploitative capitalist, but in many cases this is a
distortion of the truth.
As common as it is to speak of "robber barons," most who use that term
are confused about the role of capitalism in the American economy and
fail to make an important distinction — the distinction between what might be called a market
entrepreneur and a political entrepreneur. A pure market entrepreneur, or capitalist, succeeds
financially by selling a newer, better, or less expensive product on the free market without any
government subsidies, direct or indirect. The key to his success as a capitalist is his ability to
please the consumer, for in a capitalist society the consumer ultimately calls the economic shots.
By contrast, a political entrepreneur succeeds primarily by influencing government to subsidize
his business or industry, or to enact legislation or regulation that harms his competitors.
In the mousetrap industry, for instance, you can be a market entrepreneur by making better
mousetraps and thereby convincing consumers to buy more of your mousetraps and less of your
competitors', or you can lobby Congress to prohibit the importation of all foreign-made
mousetraps. In the former situation the consumer voluntarily hands over his money for the
superior mousetrap; in the latter case the consumer, not given anything (better) in return, pays
more for existing mousetraps just because the import quota has reduced supply and therefore
driven up prices.
The American economy has always included a mix of market and political entrepreneurs — selfmade men and women as well as political connivers and manipulators. And sometimes, people
who have achieved success as market entrepreneurs in one period of their lives later become
political entrepreneurs. But the distinction between the two is critical to make, for market
entrepreneurship is a hallmark of genuine capitalism, whereas political entrepreneurship is not —
it is neomercantilism.
In some cases, of course, the entrepreneurs commonly labeled "robber barons" did indeed profit
by exploiting American customers, but these were not market entrepreneurs. For example,
Leland Stanford, a former governor and US senator from California, used his political
connections to have the state pass laws prohibiting competition for his Central Pacific
railroad,[1] and he and his business partners profited from this monopoly scheme. Unfortunately,
the resentment that this naturally generated among the public was unfairly directed at other
entrepreneurs who succeeded in the railroad industry without political interference that tilted the
playing field in their direction. Thanks to historians who fail to (or refuse to) make this crucial
distinction, many Americans have an inaccurate view of American capitalism.
How to Build a Railroad
Most business historians have assumed that the transcontinental railroads would never have been
built without government subsidies. The free market would have failed to provide the adequate
capital, or so the theory asserts. The evidence for this theory is that the Union Pacific and Central
Pacific railroads, which were completed in the years after the War Between the States, received
per-mile subsidies from the federal government in the form of low-interest loans as well as
massive land grants. But there need not be cause and effect here: the subsidies were not needed
to cause the transcontinental railroads to be built. We know this because, just as many roads and
canals were privately financed in the early nineteenth century, a market entrepreneur built his
own transcontinental railroad. James J. Hill built the Great Northern Railroad "without any
government aid, even the right of way, through hundreds of miles of public lands, being paid for
in cash," as Hill himself stated.[2]
Quite naturally, Hill strongly opposed government favors to his competitors: "The government
should not furnish capital to these companies, in addition to their enormous land subsidies, to
enable them to conduct their business in competition with enterprises that have received no aid
from the public treasury," he wrote.[3] This may sound quaint by today's standards, but it was
still a hotly debated issue in the late nineteenth century.
James J. Hill was hardly a "baron" or aristocrat. His father died when he was fourteen, so he
dropped out of school to work in a grocery store for four dollars a month to help support his
widowed mother. As a young adult he worked in the farming, shipping, steamship, fur-trading,
and railroad industries. He learned the ways of business in these settings, saved his money, and
eventually became an investor and manager of his own enterprises.[4] (It was much easier to
accomplish such things in the days before income taxation.)
Hill got his start in the railroad business when he and several partners purchased a bankrupted
Minnesota railroad that had been run into the ground by the government-subsidized Northern
Pacific (NP). The NP had been a patronage "reward" to financier Jay Cooke, who in the War
Between the States had been one of the Union's leading financiers.[5] But Cooke and his NP
associates built recklessly; the government's subsidies and land grants were issued on a per-mileof-track basis, so Cooke and his cohorts had strong incentives to build as quickly as possible,
which only encouraged shoddy work. Consequently, by 1873 the NP developers had fallen into
bankruptcy.[6] The people of Minnesota and the Dakotas, where the railroad was being built,
considered Cooke and his business associates to be "derelicts at best and thieves at worst," writes
Hill biographer Michael P. Malone.[7]
It took Hill and his business partners five years to complete the purchase of the railroad (the St.
Paul, Minneapolis, and Manitoba), which would form the nucleus of a road that he would
eventually build all the way to the Pacific (the Great Northern). He had nothing but contempt for
Cooke and the NP for their shady practices and corruption, and he quickly demonstrated a genius
for railroad construction. Under his direction, the workers began laying rails twice as quickly as
the NP crews had, and even at that speed he built what everyone at the time considered to be the
highest-quality line. Hill micromanaged every aspect of the work, even going so far as to spell
workers so they could take much-needed coffee breaks.[8] His efficiency extended into
meticulous cost cutting. He passed his cost reductions on to his customers in the form of lower
rates because he knew that the farmers, miners, timber interests, and others who used his rail
services would succeed or fail along with him. His motto was: "We have got to prosper with you
or we have got to be poor with you."[9]
In keeping with his philosophy of encouraging the prosperity of
the people residing in the vicinity of his railroad, Hill publicized
"The American
his views on the importance of crop diversification to the farmers
economy has always
of the region. He didn't want them to become dependent on a
included a mix of
single crop and therefore subject to the uncertainties of price
market and political
fluctuation, as the southern cotton farmers were.[10] Hill also
entrepreneurs — selfprovided free seed grain — and even cattle — to farmers who
made men and
had suffered from drought and depression; stockpiled wood and
women as well as
other fuel near his train depots so farmers could stock up when
returning from a delivery to his trains; and donated land to towns
political connivers
for parks, schools, and churches.[11] He transported immigrants
and manipulators."
to the Great Plains for a mere ten dollars if they promised to farm
near his railroad, and he sponsored contests for the beefiest
livestock or the most abundant wheat. His "model farms" educated farmers on the latest
developments in agricultural science. All of this generated goodwill with the local communities
and was also good for business.
Hill's rates fell steadily, and when farmers began complaining about the lack of grain storage
space, he instructed his company managers to build larger storage facilities near his rail depots.
He refused to join in attempts at cartel price fixing and in fact "gloried in the role of rate-slasher
and disrupter of [price-fixing] pooling agreements," writes historian Burton Folsom.[12] After
all, he knew that monopolistic pricing would have been an act of killing the goose that lays the
golden egg.
In building his transcontinental railroad, from 1886 to 1893, Hill applied the same strategy that
he had in building the St. Paul, Minneapolis, and Manitoba: careful building of the road
combined with the economic cultivation of the nearby communities. He always built for
durability and efficiency, not scenery, as was sometimes the case with the governmentsubsidized railroads. He did not skimp on building materials, having witnessed what harsh
Midwest winters could do to his facilities and how foolish it was for the NP to have ignored this
lesson. (The solid granite arch bridge that Hill built across the Mississippi River was a
Minneapolis landmark for many years.)[13] Burton Folsom describes Hill's compulsion for
excellence:
Hill's quest for short routes, low grades, and few curvatures was an obsession. In 1889, Hill
conquered the Rocky Mountains by finding the legendary Marias Pass. Lewis and Clark had
described a low pass through the Rockies back in 1805; but later no one seemed to know whether
it really existed or, if it did, where it was. Hill wanted the best gradient so much that he hired a
man to spend months searching western Montana for this legendary pass. He did in fact find it,
and the ecstatic Hill shortened his route by almost one hundred miles.[14]
Hill's Great Northern was, consequently, the "best constructed and most profitable of all the
world's major railroads," as Michael P. Malone points out.[15] The Great Northern's efficiency
and profitability were legendary, whereas the government-subsidized railroads, managed by a
group of political entrepreneurs who focused more on acquiring subsidies than on building sound
railroads, were inefficiently built and operated. Jay Cooke was not the only one whose
government-subsidized railroad ended up in bankruptcy. In fact, Hill's Great Northern was the
only transcontinental railroad that never went bankrupt.
James J. Hill versus the Real Robber Barons
By the summer of 1861, after the Battle of First Manassas, it was apparent to all that the War
Between the States was going to be a long drawn-out campaign. Nevertheless, in 1862 Congress,
with the southern Democrats gone, diverted millions of dollars from the war effort to begin
building a subsidized railroad. The Pacific Railroad Act of 1862 created the Union Pacific (UP)
and the Central Pacific (CP) railroads, the latter to commence building in Sacramento,
California, and the former in Omaha, Nebraska. For each mile of track built Congress gave these
companies a section of land — most of which would be sold — as well as a sizable loan:
$16,000 per mile for track built on flat prairie land; $32,000 for hilly terrain; and $48,000 in the
mountains.[16] As was the case with Jay Cooke's Northern Pacific, these railroads tried to build
as quickly and as cheaply as possible in order to take advantage of the governmental largesse.
Where James J. Hill would be obsessed with finding the shortest route for his railroad, these
government-subsidized companies, knowing they were paid by the mile, "sometimes built
winding, circuitous roads to collect for more mileage," as Burton Folsom recounts.[17] Union
Pacific vice president and general manager Thomas Durant "stressed speed, not workmanship,"
writes Folsom, which meant that he and his chief engineer, former Union Army genera1
Grenville Dodge, often used whatever kind of wood was available for railroad ties, including
fragile cottonwood. This, of course, is in stark contrast to James J. Hill's insistence on using only
the best-quality materials, even if they were more expensive. Durant paid so many lumberjacks
to cut trees for rails that farmers were forced to use rifles to defend their land from the subsidized
railroad builders; not for him was the Hill motto, "We have got to prosper with you or we have
got to be poor with you." Folsom continues:
Since Dodge was in a hurry, he laid track on the ice and snow…. Naturally, the line had to be
rebuilt in the spring. What was worse, unanticipated spring flooding along the lower fork of the
Platte River washed out rails, bridges, and telephone poles, doing at least $50,000 damage the
first year. No wonder some observers estimated the actual building cost at almost three times
what it should have been.[18]
In 1869, after seven years of construction, the two subsidized railroads managed to meet up at
Promontory Point, Utah, amidst much hoopla and celebration. What is not often mentioned,
however, is that after the big celebration both of the lines had to be rebuilt and even relocated in
places, a task that took five more years (into 1874).
The wasteful costs of construction were astonishing. The subsidized railroads routinely used
more gunpowder blasting their way through mountains and forests on a single day than was used
during the entire Battle of Gettysburg.
With so much tax money floating around, the executives of the CP and UP stole funds from their
own companies in order to profit personally, something that would have been irrational for
James J. Hill or any other private, market entrepreneur to do. For example, the UP managers
created their own coal company, mining coal for two dollars per ton and selling it to themselves
for six dollars per ton, pocketing the profits. This crooked scam was repeated in dozens of
instances and would be exposed as the Crédit Mobilier scandal. (Crédit Mobilier was the name of
one of the companies run by UP executives.)
With virtually everything riding on political connections, as opposed to creating the best-quality
railroad for consumers, the UP and CP executives naturally spent an inordinate amount of time
on politics as opposed to business management. While James J. Hill detested politicians and
politics and paid little attention to them, things were very different with the UP. Folsom explains:
In 1866 Thomas Durant wined and dined "prominent citizens" (including senators, an
ambassador, and government bureaucrats) along a completed section of the railroad. He hired an
orchestra, a caterer, six cooks, a magician (to pull subsidies out of a hat?), and a photographer.
For those with ecumenical palates, he served Chinese duck and Roman goose; the more
adventurous were offered roast ox and antelope. All could have expensive wine and, for dessert,
strawberries, peaches, and cherries. After dinner some of the men hunted buffalo from their
coaches. Durant hoped that all would go back to Washington inclined to repay the UP for its
hospitality.[19]
In addition, free railroad passes and Crédit Mobilier stock were routinely handed out to members
of Congress and state legislators, and General William Tecumseh Sherman was sold land near
Omaha, Nebraska, for $2.50 an acre when the going rate was $8.00.
Congress responded to the 1874 Crédit Mobilier scandal by enacting a blizzard of regulations on
the UP and CP that would in the future make it impossible for them to operate with any
semblance of efficiency. Because of the regulations, managers could not make quick decisions
regarding leasing, borrowing money, building extensions of the rail lines, or any other day-today business decision. Each such decision literally required an act of Congress.
Political interference also meant that separate rail lines were required to be built to serve
communities represented by influential members of Congress even if those lines were
uneconomical. No business could possibly survive and earn a profit under such a scenario. The
UP went bankrupt in 1893; the Great Northern, on the other hand, was still going strong. Not
having accepted any government subsidies, James J. Hill was free to build and operate his
railroad in a way that he deemed was most efficient and most profitable. He prospered while
most of his subsidized competitors went bankrupt at one point or another.
Hill continued to show how effective market entrepreneurs could be. Having completed the
Great Northern, he then got into the steamship business in order to facilitate American exports to
the Orient. As usual, he succeeded, increasing American exports to Japan sevenfold from 1896 to
1905. He continued to reduce his rail rates in order to make American exports profitable. Being
an ardent free trader, Hill was a Democrat for most of his life, because the Republican Party
since the time of Lincoln had been the main political force behind high protectionist tariffs. (He
switched parties late in life when the Democratic Party abandoned its laissez-faire roots and
became interventionist, but he considered the Republican Party to be merely the lesser of two
evils.)
Recognizing a market in the American Midwest for timber from the Northwest, Hill convinced
his next-door neighbor, Frederick Weyerhauser, to get into the timber business with him. He cut
his freight charges from ninety to forty cents per hundred pounds, and he and Weyerhauser
prospered by selling Northwest timber to other parts of the country.[20]
Despite the quality services and reduced costs that Hill brought to Americans, he would be
unfairly lumped in with the political entrepreneurs who were fleecing the taxpayers and
consumers. The public eventually began complaining of the monopoly pricing and corruption
that were inherent features of the government-created and -subsidized railroads.
The federal government responded to the complaints with the Interstate Commerce Act of 1887,
which was supposed to ban rail rate discrimination, and later with the Hepburn Act of 1906
which made it illegal to charge different rates to different customers. What these two federal
laws did was to outlaw Hill's price cutting by forcing railroads to charge everyone the same high
rates.[21] This was all done in the name of consumer protection, giving it an Orwellian aura.
This new round of government regulation benefited the government-subsidized railroads at Hill's
expense, for he was the most vigorous price cutter. His trade to the Orient was severely damaged
since he could no longer legally offer discounts on exports in order to induce American exporters
to join with him in entering as foreign markets. He eventually got out of the steamship business
altogether, and as a result untold opportunities to export American products abroad were lost
forever.
The Interstate Commerce Commission soon created a bureaucratic monstrosity that attempted to
micromanage all aspects of the railroad business, hampering its efficiency even further. This was
a classic example of economist Ludwig von Mises's theory of government interventionism: one
intervention (such as subsidies for railroads) leads to market distortions which create problems
for which the public "demands" solutions. Government responds with even more interventions,
usually in the form of more regulation of business activities, which cause even more problems,
which lead to more intervention, and on and on. The end result is that free-market capitalism is
more and more heavily stifled by regulation.
And on top of that, usually the free market, not government intervention, gets the blame. Thus,
all of the railroad men of the late nineteenth century have gone down in history as "robber
barons" although this designation definitely does not apply to James J. Hill. It does apply to his
subsidized competitors, who deserve all the condemnation that history has provided them. (Also
deserving of condemnation are the politicians who subsidized them, enabling their monopoly and
corruption.)
Oily Characters?
Another prime example of a market entrepreneur whom generations of writers and historians
have inaccurately portrayed — indeed, demonized — is John D. Rockefeller. Like James J. Hill,
Rockefeller came from very modest beginnings; his father was a peddler who barely made ends
meet. Born in 1839, he was one of six children, and his first job on graduating from high school
at age sixteen was as an assistant bookkeeper for fifteen cents a day (under ten dollars a day
today, even accounting for nearly 150 years of inflation).[22]
Rockefeller was religious about working and saving his money. After working several sales jobs
by age twenty-three he had saved up enough to invest four thousand dollars in an oil refinery in
Cleveland, Ohio, with a business partner and fellow church member, Samuel Andrews.[23]
Like James J. Hill, Rockefeller paid meticulous attention to every detail of his business,
constantly striving to cut his costs, improve his product, and expand his line of products. He also
sometimes joined in with the manual laborers as a means of developing an even more thorough
understanding of his business. His business partners and managers emulated him, which drove
the company to great success. As economist Dominick Armentano writes, the firm of
Rockefeller, Andrews, and Flagler, which would become Standard Oil,
prospered quickly in the intensely competitive industry due to the economic excellence of its
entire operations. Instead of buying oil from jobbers, they made the jobbers' profit by sending
their own purchasing men into the oil region. They also made their own sulfuric acid, barrels,
lumber, wagons, and 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 has before or since; and Sam Andrews coaxed more kerosene from
a barrel of crude than the competition could. In addition, the Rockefeller firm put out the cleanest
burning kerosene and managed to profitably dispose of most of the residues, in the form of
lubricating oil, paraffin wax, and Vaseline.[24]
Rockefeller pioneered the practice known as "vertical integration," or in-house provision of
various inputs into the production process; that is, he made his own barrels, wagons, and so on.
This is not always advantageous — sometimes it pays to purchase certain items from specialists
who can produce those items at very low cost. But vertical integration has the advantage of
allowing one to monitor the quality of one 's own inputs. It has the further advantage of avoiding
what modern economists call the "hold-up problem." If, say, an electric power plant contracted
with a nearby coal mine for coal to fuel its generating plant, the coal mine might effectively
break its contract at one point by demanding more money for its coal. In such instances the
power plant has the choice of paying up, engaging in costly litigation, or going without the coal
and closing down. None of these options is attractive. But if the power plant simply buys the coal
mine, all of these problems disappear. That is what Rockefeller, the compulsive micromanager,
did with many aspects of the oil-refining business. He reduced his costs and avoided hold-up
problems through vertical integration.
Rockefeller also devised means of eliminating much of the incredible waste that had plagued the
oil industry. His chemists figured out how to produce such oil byproducts as lubricating oil,
gasoline, paraffin wax, Vaseline, paint, varnish, and about three hundred other substances. In
each instance he profited by eliminating waste.
Just as James J. Hill spent the extra money to build the highest quality railroad lines possible,
Rockefeller did not skimp in building his refineries. So confident was he of the safety of his
operations that he did not even purchase insurance.
Rockefeller also made the oil-refining industry much more efficient. There had been vast
overinvestment in the oil industry in its first decades, as everyone had wanted to get rich quick in
the business. Northwestern Pennsylvania, where the first oil well had been drilled, was littered
with oil derricks and refineries of all sizes, many of which were operated by men who really
should have been in another line of work.
Rockefeller purchased many of these poorly managed operations and put their assets to far better
use. There was never any threat that these "horizontal mergers" — the combination of two firms
that are in the same business — would create a monopoly, for Standard Oil had literally
hundreds of competitors, including such oil giants as Sun Oil, not to mention its many large
competitors in international markets.
One of Rockefeller's harshest critics was journalist Ida Tarbell, whose brother was the treasurer
of the Pure Oil Company, which could not compete with Standard Oil's low prices. She
published a series of hypercritical articles in McClure's magazine in 1902 and 1903, which were
turned into a book entitled The History of the Standard Oil Company, a classic of antibusiness
propaganda.[25]
Tarbell's writings are emotional, often illogical, and lacking in any serious attempt at economic
analysis. But even she was compelled to praise what she called the "marvelous" economy of the
entire Standard Oil operation. In a passage describing one aspect of Standard Oil's vertical
integration she wrote:
Not far away from the canning works, on Newtown Creek, is an oil refinery. This oil runs to the
canning works, and, as the newmade 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 newmade 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….
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 …
waiting to receive the cans…. It is a marvelous example of economy, not only in materials, but in
time and footsteps [emphasis added].[26]
Because of Standard Oil's superior efficiency (and lower prices), the company's share of the
refined petroleum market rose from 4 percent in 1870 to 25 percent in 1874 and to about 85
percent in 1880.[27]
As Standard Oil garnered more and more business, it became even more efficient through
"economies of scale" — the tendency of per-unit costs to decline as the volume of output
increases. This is typical of industries in which there is a large initial "fixed cost" — such as the
expense involved in building an oil refinery. Once the refinery is built, the costs of maintaining
the refinery are more or less fixed, so as more and more customers are added, the cost per
customer declines. As a result, the company cut its cost of refining a gallon of oil from 3 cents in
1869 to less than half a cent by 1885. Significantly, Rockefeller passed these savings along to the
consumer, as the price of refined oil plummeted from more than 30 cents per gallon in 1869 to
10 cents in 1874 and 8 cents in 1885.[28]
Because he could refine kerosene far more cheaply than anyone else could, which was reflected
in his low prices, the railroads offered Rockefeller special low prices, or volume discounts. This
is a common, ordinary business practice — offering volume discounts to one's largest customers
in order to keep them — but Rockefeller's less efficient competitors complained bitterly. Nothing
was stopping them from cutting their costs and prices and winning similar railroad rebates other
than their own inabilities or laziness, but they apparently decided that it was easier to complain
about Rockefeller's "unfair advantage" instead.
Cornelius Vanderbilt publicly offered railroad rebates to any oil refiner who could give him the
same volume of business that Rockefeller did, but since no one was as efficient as Rockefeller,
no one could take him up on his offer.[29]
All of Rockefeller's savings benefited the consumer, as his low prices made kerosene readily
available to Americans. Indeed, in the 1870s kerosene replaced whale oil as the primary source
of fuel for light in America. It might seem trivial today, but this revolutionized the American
way of life; as Burton Folsom writes, "Working and reading became after-dark activities new to
most Americans in the 1870s."[30] In addition, by stimulating the demand for kerosene and other
products, Rockefeller also created thousands upon thousands of new jobs in the oil and related
industries.
Rockefeller was extremely generous with his employees, usually paying them significantly more
than the competition did. Consequently, he was rarely slowed down by strikes or labor disputes.
He also believed in rewarding his most innovative managers with bonuses and paid time off if
they came up with good ideas for productivity improvements, a simple lesson that many modern
corporations seem never to have learned.
Of course, in every industry the less efficient competitors can be expected to snipe at their
superior rivals, and in many instances sniping turns into an organized political crusade to get the
government to enact laws or regulations that harm the superior competitor. Economists call this
process "rent seeking"; in the language of economics, "rent" means a financial return on an
investment or activity in excess of what the activity would normally bring in a competitive
market. This sort of political crusade by less successful rivals is precisely what crippled the great
Rockefeller organization.
The governmental vehicle that was chosen to cripple Standard Oil was antitrust regulation.
Standard Oil's competitors succeeded in getting the federal government to bring an antitrust or
antimonopoly suit against the company in 1906, after they had persuaded a number of states to
file similar suits in the previous two or three years.
The ostensible purpose of antitrust regulation is to protect consumers, so on the face of it the
government's case against Standard Oil seems ludicrous. Because of Standard Oil's tremendous
efficiencies, the price of refined petroleum had been plummeting for several decades, generating
great benefits for consumers and forcing all other competitors to find ways to cut their costs and
prices in order to survive. Product quality had improved, innovation was encouraged by the
fierce competition, production had expanded dramatically, and there were hundreds of
competitors. None of these facts constitutes in any way a sign of monopoly.
As happens in so many federal antitrust lawsuits, a number of novel theories were invented to
rationalize the lawsuit. One of them was so-called predatory pricing. According to this theory, a
"predatory firm" that possesses a "war chest" of profits will cut its prices so low as to drive all
competitors from the market. Then, when it faces no competition, it will charge monopolistic
prices.
It is assumed that at that point no other competition will emerge, despite the large profits being
made in the industry. Journalist Ida Tarbell did as much as anyone to popularize this theory in
her book on Standard Oil, in a chapter entitled "Cutting to Kill." To economists, however,
predatory pricing is theoretical nonsense and has no empirical validity, either. It has never been
demonstrated that a monopoly has ever been created in this way. Certainly predatory pricing was
not a tactic used by Standard Oil, which was never a monopoly anyway.
In a now-classic article on the topic in the prestigious Journal of Law and Economics, John S.
McGee studied the Standard Oil antitrust case and concluded not only that the company did not
practice predatory pricing but also that it would have been irrational and foolish to have
attempted such a scheme.[31] And whatever else may be said about John D. Rockefeller, he was
no one's fool.
McGee was quite right about the irrationality of predatory pricing. As an investment strategy,
predatory pricing is all cost and risk and no potential reward. The would-be "predator" stands to
lose the most from pricing below its average cost, since, presumably, it already does the most
business. If the company is the market leader with the highest sales and is losing money on each
sale, then that company will be the biggest loser in the industry.
There is also great uncertainty about how long such a tactic could take: ten years? twenty years?
No business would intentionally lose money on every sale for years on end with the pie-in-thesky hope of someday becoming a monopoly. Besides, even if that were to occur, nothing would
stop new competitors from all over the world from entering the industry and driving the price
back down, thereby eliminating any benefits of the predatory pricing strategy.
Finally, there is a logical contradiction in the theory. The theory assumes a "war chest" of profits
that is used to subsidize the money-losing strategy of predatory pricing. But where did this war
chest come from? The theory posits that predatory pricing is what creates a war chest of
"monopoly profits," but at the same time it simply assumes that these profits already exist!
After examining some eleven thousand pages of the Standard Oil case's trial record, McGee
concluded that there was no evidence at all presented at trial that Standard Oil had even
attempted to practice predatory pricing. What it did practice was good old competitive price
cutting, driven by its quest for efficiency and customer service.
The antitrust case against Standard Oil also seems absurd because its share of the petroleum
products market had actually dropped significantly over the years. From a high of 88 percent in
1890, Standard Oil's market share had fallen to 64 percent by 1911, the year in which the US
Supreme Court reaffirmed the lower court finding that Standard Oil was guilty of monopolizing
the petroleum products industry.[32]
The court argued, in essence, that Standard Oil was a "large" company with many divisions, and
if those divisions were in reality separate companies, there would be more competition. The
court made no mention at all of the industry's economic performance; of supposed predatory
pricing; of whether industry output had been restrained, as monopoly theory holds; or of any
other economic factors relevant to determining harm to consumers. The mere fact that Standard
Oil had organized some thirty separate divisions under one consolidated management structure (a
trust) was sufficient reason to label it a monopoly and force the company to break up into a
number of smaller units.
In other words, the organizational structure that was responsible for the company's great
efficiencies and decades-long price cutting and product improving was seriously damaged.
Standard Oil became much less efficient as a result, to the benefit of its less efficient rivals and
to the detriment of consumers. Standard Oil's competitors, who with their behind-the-scenes
lobbying were the main instigators of the federal prosecution, are (along with "muckraking"
journalists like Ida Tarbell) the real villains in this story. They succeeded in using political
entrepreneurship to hamstring a superior market entrepreneur, which in the end rendered the
American petroleum industry less competitive.
The prosecution of Standard Oil was a watershed event for the American petroleum industry. It
emboldened many in the industry to pay less and less attention to market entrepreneurship
(capitalism) and more to political entrepreneurship (mercantilism) to profit.
During World War I the oil industry became "partners" with the federal government ostensibly to
assure the flow of oil for the war effort. (Of course, in such arrangements the government is
always the "senior partner.") As Dominick Armentano writes:
The Oil Division of the U.S. Fuel Administration in cooperation with the War Services
Committee, was responsible for determining oil production and for allocating crude supplies
among various refiners. In short, these governmental organizations, with the coordinating
services of leading business interests, had the legal power to operate the oil industry as a cartel,
eliminating what was described as "unnecessary waste" (competition), and making centralized
pricing and allocative decisions for the industry [i.e., price fixing] as a whole. Thus, the wartime
experiment in "planning" (i.e., planning by political agents to satisfy political interests rather
than by consumers, investors, and entrepreneurs to meet consumer demand) created what had
previously been unobtainable: a government sanctioned cartel in oil.[33]
After the war, oil industry executives favored extending this government-sanctioned and supervised cartel. President Calvin Coolidge created a Federal Oil Conservation Board that
enforced the "compulsory withholding of oil resources and state prorationing of oil," a
convoluted way of saying "monopoly."[34]
The newly formed American Petroleum Institute, an industry trade association, lobbied for
various regulatory schemes to restrict competition and prop up prices; it did not even pretend to
be in favor of capitalism or free enterprise. The institute even endorsed the use of National Guard
troops to enforce state government production quotas in Texas and Oklahoma in the early l930s.
During the 1930s even more teeth were put into government oil industry cartel schemes. The
National Recovery Act empowered the federal government to support state oil production quotas
to assure output reductions and higher prices. Interstate and foreign shipments of oil were strictly
regulated so as to create regional monopolies, and import duties on foreign oil were raised to
protect the higher-priced American oil from foreign competition.[35]
In 1935 Congress passed the Connally Hot Oil Act, which made it illegal to transport oil across
state lines "in violation of state proration requirements."[36] In the l950s the government placed
import quotas on oil, creating an even greater monopoly power. All of this, you will recall, came
on the heels of the government's antitrust crusade against the Standard Oil "monopoly." Clearly,
the purpose of the political persecution of Standard Oil had been to begin stamping out
competition in the oil industry. That process was continued with a vengeance with forty years of
squalid political entrepreneurship. By the middle of the twentieth century, real capitalism had all
but disappeared from the oil industry.
Vanderbilt Takes on the Monopolists
The battle between market and political entrepreneurs was not confined to the railroad and oil
industries. Indeed, from the mid-nineteenth century onward, this sort of battle marked the
development of much of American industry — the steamship industry, the steel industry, and the
auto industry, to name just a few.
For example, the great steamship entrepreneur Cornelius Vanderbilt competed with governmentsubsidized political entrepreneurs for much of his career. In fact, he got his start in business by
competing — illegally — against a state-sanctioned steamship monopoly operated by Robert
Fulton. In 1807, the New York state legislature had granted Fulton a legal, thirty-year monopoly
on steamboat traffic in New York — a classic example of mercantilism.[37] In 1817, however, a
young Cornelius Vanderbilt was hired by New Jersey businessman Thomas Gibbons to defy the
monopoly and run steamboats in New York. Vanderbilt worked in direct competition with
Fulton, charging lower rates as his boats raced from Elizabeth, New Jersey, to New York City; to
underscore the challenge to Fulton's monopoly, Vanderbilt flew a flag on his boats that read
NEW JERSEY MUST BE FREE. Slowly he was breaking down the Fulton monopoly, which the
US Supreme Court finally ended in 1824, ruling in Gibbons v. Ogden that only the federal
government, not the states, could regulate interstate trade under the Commerce Clause of the
Constitution.[38]
As the cost of steamboat traffic plummeted because of deregulation, the volume of traffic
increased significantly and the industry took off. Vanderbilt became the leading market
entrepreneur in the industry, but he would continue to face government-subsidized competitors.
For example, steamship operator Edward K. Collins convinced Congress that it needed to
subsidize the transatlantic steamship business to compete with the Europeans and to create a
military fleet in case of war. In 1847 Congress awarded Collins $3 million, plus $385,000 per
year. Sitting on these fat subsidies, Collins had little incentive to build his ships efficiently or to
watch his costs once they were built. Instead of focusing on making his business more efficient,
Collins spent lavishly on lobbying, including wining and dining President Millard Fillmore, his
entire cabinet, and many congressmen.[39]
Like James J. Hill in the railroad industry, Vanderbilt did not shy away from competing against
his heavily subsidized rivals. Not surprisingly, these government-supported rivals ultimately
could not keep up with Vanderbilt, in large part because the stifling regulations that were
inevitably attached to the government subsidies made these steamship lines remarkably
inefficient. By 1858, Collins's line had become so inefficient that Congress ended his subsidy,
and he promptly went bankrupt. He could not compete with Vanderbilt on an equal basis.
The Real History
The lesson here is that most historians are hopelessly confused about the rise of capitalism in
America. They usually fail to adequately appreciate the entrepreneurial genius of men like James
J. Hill, John D. Rockefeller, and Cornelius Vanderbilt, and more often than not they lump these
men (and other market entrepreneurs) in with genuine "robber barons" or political entrepreneurs.
Most historians also uncritically repeat the claim that
government subsidies were necessary to building America's
transcontinental railroad industry, steamship industry, steel
industry, and other industries. But while clinging to this "market
failure" argument, they ignore (or at least are unaware of) the
fact that market entrepreneurs performed quite well without
government subsidies. They also ignore the fact that the
subsidies themselves were a great source of inefficiency and
business failure, even though they enriched the direct recipients
of the subsidies and advanced the political careers of those who
dished them out.
Political entrepreneurs and their governmental patrons are the
real villains of American business history and should be
portrayed as such. They are the real robber barons.
At the same time, the market entrepreneurs who practiced genuine capitalism, whose genius and
energy fueled extraordinary economic achievement and also brought tremendous benefits to
Americans, should be recognized for their achievements rather than demonized, as they so often
are. Men like James J. Hill, John D. Rockefeller, and Cornelius Vanderbilt were heroes who
improved the lives of millions of consumers; employed thousands and enabled them to support
their families and educate their children; created entire cities because of the success of their
enterprises (for example, Scranton, Pennsylvania); pioneered efficient management techniques
that are still employed today; and donated hundreds of millions of dollars to charities and
nonprofit organizations of all kinds, from libraries to hospitals to symphonies, public parks, and
zoos. It is absolutely perverse that historians usually look at these men as crooks or cheaters
while praising and advocating "business/government partnerships," which can only lead to
corruption and economic decline.
Thomas DiLorenzo is professor of economics at Loyola College and a member of the senior
facultyof the Mises Institute. Send him mail. Read his articles. Comment on the blog.
This article is excerpted from chapter 7 of Professor DiLorenzo's book, How Capitalism Saved
America: The Untold History of Our Country, from the Pilgrims to the Present (Crown
Forum/Random House, 2005).
Notes
[1] Burton W. Folsom Jr., Entrepreneurs vs. the State: A New Look at the Rise of Big Business in
America, 1840 — 1920 (Herndon, VA: Young America's Foundation, 1987), 22.
[2] Albro Martin, James J. Hill and the Opening of the Northwest (New York: Oxford University
Press, 1976), 411.
[3] Ibid., 4l0.
[4] Albro Martin's James J. Hill and the Opening of the Northwest is an excellent biography of
Hill, as is Michael P. Malone's James J. Hill: Empire Builder of the Northwest (Norman:
University of Oklahoma Press, 1996). Hill also wrote an autobiography, Highways of Progress
(New York: Doubleday, 1910).
[5] Malone, James J. Hill, 36.
[6] Ibid., 37.
[7] Ibid.
[8] Ibid., 53
[9] Folsom, Entrepreneurs vs. the State, 27.
[10] Ibid., 90.
[11] Ibid., 91.
[12] Ibid., 99.
[13] Ibid., 28.
[14] Ibid.
[15] Malone, James J. Hill, 102.
[16] James Stover, American Railroads (Chicago: University of Chicago Press, 1961), 67.
[17] Folsom, Entrepreneurs vs. the State, 18.
[18] Ibid., 19.
[19] Ibid., 20 — 21.
[20] Ibid., 34.
[21] Ibid., 35.
[22] Grace Goulder, John D. Rockefeller: The Cleveland Years (Cleveland: Western Reserve
Historical Society, 1972), 26 — 27. See also Allan Nevins, Study in Power: John D. Rockefeller
(New York: Scribner's, 1953).
[23] Folsom, Entrepreneurs vs. the State, 84.
[24] Dominick Armentano, Antitrust and Monopoly: Anatomy of a Policy Failure (New York:
Wiley, 1982), 58.
[25] Ida Tarbell, The History of die Standard Oil Company (New York: Peter Smith, 1950).
[26] Ibid., 240, cited in Armentano, Antitrust and Monopoly, 65 — 66.
[27] Armentano, Antitrust and Monopoly, 58.
[28] Ibid., 59.
[29] Nevins, Study in Power, vol. 1, 296.
[30] Folsom, Entrepreneurs vs. the State, 87.
[31] John S. McGee, "Predatory Price Cutting: The Standard Oil (N.J.) Case," Journal of Law
and Economics 1 (October 1958): 144 — 58.
[32] See Armentano, Antitrust and Monopoly, 68 — 73.
[33] Ibid., 74.
[34] Ibid., 75.
[35] Ibid.
[36] Ibid., 76.
[37] Folsom, Entrepreneurs vs. the State, 2.
[38] Ibid.
[39] Ibid., 7.
Standard Oil Trust
The saga of Standard Oil ranks as one of the most dramatic episodes in the history of the U.S. economy.
It occurred at a time when the country was undergoing its rapid transformation from a mainly
agricultural society to the greatest industrial powerhouse the world has ever known. The effects of
Standard Oil on the U.S., as well as on much of the rest of the world, were immense, and the lessons that
can be learned from this amazing story are possibly as relevant today as they were a century ago.
Beginnings
Standard Oil Company was founded by John D. Rockefeller in Cleveland, Ohio in 1870, and, in just a
little over a decade, it had attained control of nearly all the oil refineries in the U.S. This dominance of
oil, together with its tentacles entwined deep into the railroads, other industries and even various levels
of government, persisted and intensified, despite a growing public outcry and repeated attempts to break
it up, until the U.S. Supreme Court was finally able to act decisively in 1911.
John Davidson Rockefeller was born the second of six children into
a working class family in Richford, (upstate) New York in 1839. In
1853, the family moved to a farm in Strongsville, Ohio, near
Cleveland. Under pressure from his father, Rockefeller dropped out
of high school shortly before commencement and entered a
professional school, where he studied penmanship, bookkeeping,
banking and commercial law.
In 1859 Edwin Drake struck oil in Titusville, in western
Pennsylvania. This triggered an oil rush to the region and marked
the start of oil as a major industry in the U.S. The Titusville
discovery led to the swift ascent of a major new industry based
largely on the use of kerosene for lighting. Oil refining became
largely concentrated in Cleveland because of its proximity to the oil
fields of Western Pennsylvania, its excellent (and competitive)
railroad service, its availability of cheap water transportation (on
adjacent Lake Erie) and its abundant supplies of low cost immigrant
labor.
It was also in 1859 that Rockefeller started his first business. With $1,000 he had saved and another
$1,000 borrowed from his father, and in partnership with another young man, Maurice B. Clark, he set
up a commission business that dealt with a variety of products including hay, grain and meats.
After the outbreak of the Civil War in 1861, Rockefeller hired a substitute to avoid conscription, as was
not uncommon among Northerners in those days. Although the war initially disrupted the economy, it
soon began to stimulate development in the North, and this appears to have been an important factor in
Rockefeller's sudden and spectacular success.
1
Rockefeller was immediately attracted to the oil business, and in 1863, at the age of 24, he established a
refinery in Cleveland with Clark and a new partner, Samuel Andrews, a chemist who already had several
years of refining experience. Fueled by the soaring demand for oil and Rockefeller's ambition, this
refinery became the largest in the region within a mere two years, and Rockefeller thereafter focused
most of his attention on oil for the next three decades.
In 1870, Rockefeller, together with his brother William, Henry Flagler and Samuel Andrews, established
the Standard Oil Company of Ohio. This occurred while the petroleum refining industry was still highly
decentralized, with more than 250 competitors in the U.S.
Strategy
The company almost immediately began using a variety of cutthroat techniques to acquire or destroy
competitors and thereby "consolidate" the industry. They included:
(1) Temporarily undercutting the prices of competitors until they either went out of business or
sold out to Standard Oil.
(2) Buying up the components needed to make oil barrels in order to prevent competitors from
getting their oil to customers.
(3) Using its large and growing volume of oil shipments to negotiate an alliance with the
railroads that gave it secret rebates and thereby reduced its effective shipping costs to a level far
below the rates charged to its competitors.
(4) Secretly buying up competitors and then having officials from those companies spy on and
give advance warning of deals being planned by other competitors.
(5) Secretly buying up or creating new oil-related companies, such as pipeline and engineering
firms, that appeared be independent operators but which gave Standard Oil hidden rebates.
(6) Dispatching thugs who used threats and
physical violence to break up the operations of
competitors who could not otherwise be
persuaded.
By 1873 Standard Oil had acquired about 80 percent of
the refining capacity in Cleveland, which constituted
roughly one third of the U.S. total. The stock market crash
in September of that year triggered a recession that lasted
for six years, and Standard Oil quickly took advantage of
the situation to absorb refineries in Pennsylvania's oil
region, Pittsburgh, Philadelphia and New York. By 1878
Rockefeller had attained control of nearly 90 percent of
2
the oil refined in the U.S., and shortly thereafter he had gained control of most of the oil marketing
facilities in the U.S.
Standard Oil initially focused on horizontal integration (i.e., at the same stage of production) by gaining
control of other oil refineries. But gradually the integration also became vertical (i.e., extended to other
stages of production and distribution), mainly by acquiring pipelines, railroad tank cars, terminal
facilities and barrel manufacturing factories.
Successes
The company continued to prosper and expand its empire, and, in 1882, all of its properties and those of
its affiliates were merged into the Standard Oil Trust, which was, in effect, one huge organization with
tremendous power but a murky legal existence. It was the first of the great corporate trusts.
A trust was an arrangement whereby the stockholders in a group of companies transferred their shares to
a single set of trustees who controlled all of the companies. In exchange, the stockholders received
certificates entitling them to a specified share of the consolidated earnings of the jointly managed
companies. The concept of a trust was first proposed by Samuel Dodd, an attorney working for Standard
Oil. In the case of Standard Oil, a board of nine trustees, controlled by Rockefeller, was set up and was
given control of all the properties of Standard Oil and its numerous affiliates. Each stockholder received
20 trust certificates for each share of Standard Oil stock. The trustees elected the directors and officers
of each of the component companies, and all of the profits of those companies were sent to the trustees,
who decided the dividends. This arrangement
allowed all of the companies to function in
unison as a highly disciplined monopoly.
Since its earliest days, the U.S. oil industry had
been well aware of the power of monopoly and
its huge profits potential. Although the
seemingly erratic fluctuations of oil prices had
convinced many refiners to try to restrict
output in a joint effort, these attempts never
lasted long because the incentives to cheat
were so great. However, the unified
organization of the trust finally made the
disciplined regulation of production levels
possible, thereby giving its owners complete
control over prices.
The massive and unprecedented profits of Standard Oil were made possible by (1) this control over
prices (and the consequent ability to set prices at levels that would maximize profits), (2) the huge
economies of scale attained from the control of almost all oil refined in the U.S. and (3) the ability to
pressure railroads and other suppliers of goods and services into giving them bargain rates.
3
However, even this unprecedented wealth and power was not enough. Rockefeller and Standard Oil
needed ever more. The company thus expanded into the overseas markets, particularly Western Europe
and Asia, and after a while it was selling even more oil abroad than in the U.S. Moreover, Rockefeller,
in addition to his role as the head of Standard Oil, also invested in numerous companies in
manufacturing, transportation and other industries and owned major iron mines and extensive tracts of
timberland.
The astonishing success of Standard Oil encouraged others to follow the Rockefeller business model,
particularly in the booming final decades of the 19th century. Trusts were established in close to 200
industries, although most never came close to Standard Oil in size or profitability. Among the largest
were railroads, coal, steel, sugar, tobacco and meatpacking.
The Media
This trend went far from unnoticed by the general public. In fact, it led to widespread disgust and
revulsion, not only among the many people who had their businesses or jobs wiped out by the ruthless
predatory tactics of the trusts, but also by countless others who were affected by the increased costs and
reduced levels of service that often resulted from the elimination of competition.
The monopolization of the economy also became a major topic for the print media, which helped to
create a widespread awareness not only of the effects of this consolidation but also of the techniques that
were being used to attain it, including the extensive use of fraud, political corruption and physical
violence.
The media attack on monopolies and corruption reached a peak from 1902 to 1912, which is often
referred to as the muckraking decade. That period saw the publication of more than a thousand articles
providing detailed accounts of the economic and political corruption caused by big business, especially
the trusts.
Particularly noteworthy among the muckrakers was Ida M. Tarbell,
whose 1902 series of articles detailed the ruthless business tactics
of Standard Oil and its abuse of natural resources. This series was
subsequently published in book form as the classic The History of
the Standard Oil Company. Another equally influential classic was
Upton Sinclair's The Jungle, which was released in 1906 and
exposed the corrupt and highly unsanitary practices of the
meatpacking industry. Among the many other topics covered by
the muckrakers were patent medicines, corruption in the U.S.
Senate, and racial discrimination.
Government Intervention
In spite of the outraged public sentiment, it took the government a
long time to take effective measures to deal with the abusive tactics
by Standard Oil and other monopolies. The strong desire on the
4
part of the monopolies for preventing government intervention together with their pervasive influence
undoubtedly played a major role in this delay.
As an example of the difficulties which the government faced, Standard Oil executives and their friends
were extremely uncooperative at judicial inquiries (such as the Hepburn Committee, which investigated
railroad rate discrimination and whose 1880 final report helped bring about the adoption of the federal
Interstate Commerce Act in 1887). In fact, they regularly contested the validity of such proceedings and
frequently even refused to attend them. Their evasive and condescending responses to questions during
the hearings confirmed their attitude of being above the rule of law, thereby further enraging the public.
The vehement opposition to the trusts, especially among farmers who protested the high charges for
transporting their products to the cities by railroad, finally resulted in the passage of the Sherman
Antitrust Act in 1890. This was the first measure enacted by the U.S. Congress to prohibit trusts.
Although several states had previously enacted similar laws, they were limited to intrastate commerce.
The Sherman Antitrust Act, in contrast, was based on the constitutional power of Congress to regulate
interstate commerce. It was passed by an overwhelming vote of 51-1 in the Senate and a unanimous vote
of 242-0 in the House, and it was signed into law by President Benjamin Harrison.
The Sherman Antitrust Act authorized the Federal Government to dissolve the trusts. It began with the
statement: "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of
trade or commerce among the several States, or with foreign nations, is declared to be illegal." And it
established penalties for persons convicted of establishing such combinations: ". . . shall be punished by
fine not exceeding $10,000,000 if a corporation, or, if any other person, $350,000, or by imprisonment
not exceeding three years, or by both said punishments, in the discretion of the court." However, the
Act's effectiveness was at first limited because of loose wording together with intense political pressure
from the trusts.
Subsequently, in 1892 the Ohio Supreme Court declared the Standard
Oil Trust to be an illegal monopoly and ordered its dissolution.
Although the trustees superficially complied, this decree had little
overall effect because they retained control through their positions on
the boards of the component companies. Standard Oil was
subsequently reorganized in 1899 as a holding company under the
name of Standard Oil Company of New Jersey. That state had
conveniently adopted a law that permitted a parent company to own
the stock of other companies.
The Sherman Antitrust Act's effectiveness was at first limited because of loose wording and ferocious
opposition from the big industrial combinations. However, the situation began to change starting in 1898
with President William McKinley's appointment of several senators to the U.S. Industrial Commission.
The Commission's subsequent report to President Theodore Roosevelt laid the groundwork for
Roosevelt's famous and feared trust busting campaign.
Despite this reputation, Roosevelt, who became president in 1901, actually preferred regulation to
dismantling, and he attempted to steer a middle course between the socialism favored by some reformers
5
and the laissez faire approach advocated by the Republicans. His hand was strengthened by an
increasingly outraged public, which, although leery of government intervention in the past, had become
far more supportive of it because of the seemingly endless growth in the numbers and power of the
monopolies. And the highly publicized philanthropic activities of some of the industrial barons did little
to stop this momentum for reform.
Several steps were taken by Roosevelt during his first term that proved highly successful despite
intensive efforts by big business to block them. They included:
(1) Convincing Congress to establish a Department of Commerce and Labor, the first new
executive department since the Civil War, in order to increase the federal government's oversight
of the interstate actions of big business and to monitor labor relations.
(2) Setting up the Bureau of Corporations in the new department in order to find violations of
existing antitrust legislation. The Bureau soon began investigations into the oil, steel,
meatpacking and other industries.
(3) Instructing his attorney general to launch a total of 44 lawsuits against what were determined
to be harmful business combinations, among which was the Standard Oil Trust.
Court Decisions
In a seminal decision, the U.S. Supreme Court in 1904 upheld the government's suit under the Sherman
Antitrust Act to dissolve the Northern Securities Company (a railroad holding company) in State of
Minnesota v. Northern Securities Company. Then, in 1911, after years of litigation, the Court found
Standard Oil Company of New Jersey in violation of the Sherman Antitrust Act because of its excessive
restrictions on trade, particularly its practice of eliminating its competitors by buying them out directly
or driving them out of business by temporarily slashing prices in a given region.
Coincidentally, 1911 was also a pivotal year
for the petroleum industry in another respect.
It was the year in which the U.S. market for
kerosene (until then the main product from
oil refining) was surpassed by that for a
formerly discarded byproduct of the refining
process -- gasoline.
In its historic decision, the Supreme Court
established an important legal standard
termed the rule of reason. It stated that large
size and monopoly in themselves are not
necessarily bad and that they do not violate
the Sherman Antitrust Act. Rather, it is the
use of certain tactics to attain or preserve such position that is illegal.
6
The Court ordered the Standard Oil Trust to dismantle 33 of its most important affiliates and to
distribute the stock to its own shareholders and not to a new trust. The result was the creation of a
number of completely independent (although eight of them retained the phrase Standard Oil in their
names) and vertically integrated oil companies, each of which ranked among the most powerful in the
world. This decision also paved the way for new entrants into the industry, such as Gulf and Texaco,
which discovered and exploited vast new petroleum deposits in Texas. The consequent vigorous
competition gave a big impetus to innovation and expansion of the oil industry as a whole.
The trusts presented a superficially strong case for their activities. They claimed that their consolidation
actually provided a net benefit to the public by reducing costs, and thus prices, through the elimination
of duplicate and inefficient facilities and through economies of scale attained from larger volumes of
output. They also contended that the greater volumes of output made it possible to finance larger and
more efficient production facilities and to devote more funds to research and development.
Although there was some truth to these arguments, at least initially, they failed to take into consideration
the huge detrimental effects on the economy and society resulting from the long-term (four decades in
the case of Standard Oil) absence of free market competition (i.e., the market mechanism). Monopolies
often do reduce the prices and improve the quality of their products in their early stages when they are
trying to eliminate the competition. But history has proven time and time again that they lose their
incentive to do so after the competition gets exterminated; in fact, they then have a very powerful
incentive to increase prices and reduce quality. Free competition, in contrast, serves to minimize prices
and maximize quality over the long run, and it thus results, at least in many respects, in what economists
term an efficient allocation of resources for the economy as a whole.
Another major disadvantage of monopolies is their tendency to stifle innovation. Not only do they lose
much of their motivation to develop and deploy new and improved technologies as a result of the loss of
competition, but monopolies also often make vigorous efforts to prevent existing or potential
competitors from bringing their innovations to market because of the threat that it poses to their
dominance. Although it is easy for monopolists to create the illusion that they are major innovators,
technological advance in monopolistic industries is often substantially less than what would occur in a
more competitive environment. Innovation is generally regarded as one of the keys (if not the key) to
economic growth, and thus its suppression will likely have a deleterious effect on the economy as a
whole, even though such effect might not be readily apparent to the general public.
Philanthropy
As is often the case even with the most heinous of human activities, there was another, starkly
contrasting side to the unabashed greed and callousness of some of the great monopolists. Rockefeller
became another of the great American philanthropists. To many this seemed to be a dramatic and
puzzling contradiction for a ruthless monopolist who never hesitated to use any means, no matter how
illegal or immoral, to crush his competitors. In fact, Rockefeller's belief in the importance of charitable
activities actually started very early, with his regular donations of part of his income to his church and
charities when he was earning money as a boy. He once wrote: "I believe it is every man's religious duty
to get all he can honestly and to give all he can."
7
Consistent with this conviction, Rockefeller began reducing his workload at Standard Oil in the 1890s in
order to devote more of his time to philanthropy. Subsequently, in 1910 he announced his retirement so
that he could devote full time to this activity, which he pursued with great passion for his remaining 26
years.
Rockefeller gave away the bulk of his fortune in ways designed to
do the most good as determined by careful study and with the
assistance of expert advisers. For example, he established several
major charitable organizations (including the Rockefeller Institute
for Medical Research, the General Education Board, the
Rockefeller Sanitary Commission and The Rockefeller
Foundation) and played a pivotal role in the establishing and
funding of the University of Chicago (which remains one of the
leading U.S. universities). The sum of his donations to these and
other causes were more than $500 million (of an estimated peak net worth of nearly one billion dollars)
during his lifetime, and the total of his and his son's donations was in excess of $2.5 billion by 1955.
The two photographs on this page represent some of his
philanthropy in (top) Metropolitan Opera in Lincoln Center and
(bottom) and J.D. Rockefeller attending graduation ceremonies
at University of Chicago which he founded with $80 million in
1891.
Several explanations have been proposed for the massive public
service and charitable activities of the great corporate robber
barons. Many contemporaries of Rockefeller and Carnegie
believed that they were really just egotists who craved the
favorable attention that they received from donating money and
delighted in having prestigious institutions and thousands of buildings named after them.
Another explanation is that these activities were largely a public relations ploy and thus a good business
investment. That is, they were techniques for deflecting attention from the harmful effects of the
monopolies and for staving off the increasingly serious attempts to curtail their power or even break
them up.
Still another explanation is that such activities were a form of atonement for their feelings of guilt about
their business activities. This is certainly consistent with the apparent religious convictions of
Rockefeller and others and with their possible consequent fear of eternal punishment in an afterlife.
Perhaps there is some truth to all of these explanations.
By the time of his death in 1937, Rockefeller's remaining fortune, largely tied up in permanent family
trusts, was estimated at $1.4 billion, while the total national GDP was $92 billion. It is estimated that he
would be worth $150 billion today. This was probably the greatest amount of wealth that any private
citizen had ever been able to accumulate by his own efforts.
8
SOURCE: Retrieved from the internet, April 2010. Largely from: October 12, 2006. The Linux
Information Project.
9
Standard Oil Trust
The saga of Standard Oil ranks as one of the most dramatic episodes in the history of the U.S. economy.
It occurred at a time when the country was undergoing its rapid transformation from a mainly
agricultural society to the greatest industrial powerhouse the world has ever known. The effects of
Standard Oil on the U.S., as well as on much of the rest of the world, were immense, and the lessons that
can be learned from this amazing story are possibly as relevant today as they were a century ago.
Beginnings
Standard Oil Company was founded by John D. Rockefeller in Cleveland, Ohio in 1870, and, in just a
little over a decade, it had attained control of nearly all the oil refineries in the U.S. This dominance of
oil, together with its tentacles entwined deep into the railroads, other industries and even various levels
of government, persisted and intensified, despite a growing public outcry and repeated attempts to break
it up, until the U.S. Supreme Court was finally able to act decisively in 1911.
John Davidson Rockefeller was born the second of six children into
a working class family in Richford, (upstate) New York in 1839. In
1853, the family moved to a farm in Strongsville, Ohio, near
Cleveland. Under pressure from his father, Rockefeller dropped out
of high school shortly before commencement and entered a
professional school, where he studied penmanship, bookkeeping,
banking and commercial law.
In 1859 Edwin Drake struck oil in Titusville, in western
Pennsylvania. This triggered an oil rush to the region and marked
the start of oil as a major industry in the U.S. The Titusville
discovery led to the swift ascent of a major new industry based
largely on the use of kerosene for lighting. Oil refining became
largely concentrated in Cleveland because of its proximity to the oil
fields of Western Pennsylvania, its excellent (and competitive)
railroad service, its availability of cheap water transportation (on
adjacent Lake Erie) and its abundant supplies of low cost immigrant
labor.
It was also in 1859 that Rockefeller started his first business. With $1,000 he had saved and another
$1,000 borrowed from his father, and in partnership with another young man, Maurice B. Clark, he set
up a commission business that dealt with a variety of products including hay, grain and meats.
After the outbreak of the Civil War in 1861, Rockefeller hired a substitute to avoid conscription, as was
not uncommon among Northerners in those days. Although the war initially disrupted the economy, it
soon began to stimulate development in the North, and this appears to have been an important factor in
Rockefeller's sudden and spectacular success.
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Rockefeller was immediately attracted to the oil business, and in 1863, at the age of 24, he established a
refinery in Cleveland with Clark and a new partner, Samuel Andrews, a chemist who already had several
years of refining experience. Fueled by the soaring demand for oil and Rockefeller's ambition, this
refinery became the largest in the region within a mere two years, and Rockefeller thereafter focused
most of his attention on oil for the next three decades.
In 1870, Rockefeller, together with his brother William, Henry Flagler and Samuel Andrews, established
the Standard Oil Company of Ohio. This occurred while the petroleum refining industry was still highly
decentralized, with more than 250 competitors in the U.S.
Strategy
The company almost immediately began using a variety of cutthroat techniques to acquire or destroy
competitors and thereby "consolidate" the industry. They included:
(1) Temporarily undercutting the prices of competitors until they either went out of business or
sold out to Standard Oil.
(2) Buying up the components needed to make oil barrels in order to prevent competitors from
getting their oil to customers.
(3) Using its large and growing volume of oil shipments to negotiate an alliance with the
railroads that gave it secret rebates and thereby reduced its effective shipping costs to a level far
below the rates charged to its competitors.
(4) Secretly buying up competitors and then having officials from those companies spy on and
give advance warning of deals being planned by other competitors.
(5) Secretly buying up or creating new oil-related companies, such as pipeline and engineering
firms, that appeared be independent operators but which gave Standard Oil hidden rebates.
(6) Dispatching thugs who used threats and
physical violence to break up the operations of
competitors who could not otherwise be
persuaded.
By 1873 Standard Oil had acquired about 80 percent of
the refining capacity in Cleveland, which constituted
roughly one third of the U.S. total. The stock market crash
in September of that year triggered a recession that lasted
for six years, and Standard Oil quickly took advantage of
the situation to absorb refineries in Pennsylvania's oil
region, Pittsburgh, Philadelphia and New York. By 1878
Rockefeller had attained control of nearly 90 percent of
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the oil refined in the U.S., and shortly thereafter he had gained control of most of the oil marketing
facilities in the U.S.
Standard Oil initially focused on horizontal integration (i.e., at the same stage of production) by gaining
control of other oil refineries. But gradually the integration also became vertical (i.e., extended to other
stages of production and distribution), mainly by acquiring pipelines, railroad tank cars, terminal
facilities and barrel manufacturing factories.
Successes
The company continued to prosper and expand its empire, and, in 1882, all of its properties and those of
its affiliates were merged into the Standard Oil Trust, which was, in effect, one huge organization with
tremendous power but a murky legal existence. It was the first of the great corporate trusts.
A trust was an arrangement whereby the stockholders in a group of companies transferred their shares to
a single set of trustees who controlled all of the companies. In exchange, the stockholders received
certificates entitling them to a specified share of the consolidated earnings of the jointly managed
companies. The concept of a trust was first proposed by Samuel Dodd, an attorney working for Standard
Oil. In the case of Standard Oil, a board of nine trustees, controlled by Rockefeller, was set up and was
given control of all the properties of Standard Oil and its numerous affiliates. Each stockholder received
20 trust certificates for each share of Standard Oil stock. The trustees elected the directors and officers
of each of the component companies, and all of the profits of those companies were sent to the trustees,
who decided the dividends. This arrangement
allowed all of the companies to function in
unison as a highly disciplined monopoly.
Since its earliest days, the U.S. oil industry had
been well aware of the power of monopoly and
its huge profits potential. Although the
seemingly erratic fluctuations of oil prices had
convinced many refiners to try to restrict
output in a joint effort, these attempts never
lasted long because the incentives to cheat
were so great. However, the unified
organization of the trust finally made the
disciplined regulation of production levels
possible, thereby giving its owners complete
control over prices.
The massive and unprecedented profits of Standard Oil were made possible by (1) this control over
prices (and the consequent ability to set prices at levels that would maximize profits), (2) the huge
economies of scale attained from the control of almost all oil refined in the U.S. and (3) the ability to
pressure railroads and other suppliers of goods and services into giving them bargain rates.
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However, even this unprecedented wealth and power was not enough. Rockefeller and Standard Oil
needed ever more. The company thus expanded into the overseas markets, particularly Western Europe
and Asia, and after a while it was selling even more oil abroad than in the U.S. Moreover, Rockefeller,
in addition to his role as the head of Standard Oil, also invested in numerous companies in
manufacturing, transportation and other industries and owned major iron mines and extensive tracts of
timberland.
The astonishing success of Standard Oil encouraged others to follow the Rockefeller business model,
particularly in the booming final decades of the 19th century. Trusts were established in close to 200
industries, although most never came close to Standard Oil in size or profitability. Among the largest
were railroads, coal, steel, sugar, tobacco and meatpacking.
The Media
This trend went far from unnoticed by the general public. In fact, it led to widespread disgust and
revulsion, not only among the many people who had their businesses or jobs wiped out by the ruthless
predatory tactics of the trusts, but also by countless others who were affected by the increased costs and
reduced levels of service that often resulted from the elimination of competition.
The monopolization of the economy also became a major topic for the print media, which helped to
create a widespread awareness not only of the effects of this consolidation but also of the techniques that
were being used to attain it, including the extensive use of fraud, political corruption and physical
violence.
The media attack on monopolies and corruption reached a peak from 1902 to 1912, which is often
referred to as the muckraking decade. That period saw the publication of more than a thousand articles
providing detailed accounts of the economic and political corruption caused by big business, especially
the trusts.
Particularly noteworthy among the muckrakers was Ida M. Tarbell,
whose 1902 series of articles detailed the ruthless business tactics
of Standard Oil and its abuse of natural resources. This series was
subsequently published in book form as the classic The History of
the Standard Oil Company. Another equally influential classic was
Upton Sinclair's The Jungle, which was released in 1906 and
exposed the corrupt and highly unsanitary practices of the
meatpacking industry. Among the many other topics covered by
the muckrakers were patent medicines, corruption in the U.S.
Senate, and racial discrimination.
Government Intervention
In spite of the outraged public sentiment, it took the government a
long time to take effective measures to deal with the abusive tactics
by Standard Oil and other monopolies. The strong desire on the
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part of the monopolies for preventing government intervention together with their pervasive influence
undoubtedly played a major role in this delay.
As an example of the difficulties which the government faced, Standard Oil executives and their friends
were extremely uncooperative at judicial inquiries (such as the Hepburn Committee, which investigated
railroad rate discrimination and whose 1880 final report helped bring about the adoption of the federal
Interstate Commerce Act in 1887). In fact, they regularly contested the validity of such proceedings and
frequently even refused to attend them. Their evasive and condescending responses to questions during
the hearings confirmed their attitude of being above the rule of law, thereby further enraging the public.
The vehement opposition to the trusts, especially among farmers who protested the high charges for
transporting their products to the cities by railroad, finally resulted in the passage of the Sherman
Antitrust Act in 1890. This was the first measure enacted by the U.S. Congress to prohibit trusts.
Although several states had previously enacted similar laws, they were limited to intrastate commerce.
The Sherman Antitrust Act, in contrast, was based on the constitutional power of Congress to regulate
interstate commerce. It was passed by an overwhelming vote of 51-1 in the Senate and a unanimous vote
of 242-0 in the House, and it was signed into law by President Benjamin Harrison.
The Sherman Antitrust Act authorized the Federal Government to dissolve the trusts. It began with the
statement: "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of
trade or commerce among the several States, or with foreign nations, is declared to be illegal." And it
established penalties for persons convicted of establishing such combinations: ". . . shall be punished by
fine not exceeding $10,000,000 if a corporation, or, if any other person, $350,000, or by imprisonment
not exceeding three years, or by both said punishments, in the discretion of the court." However, the
Act's effectiveness was at first limited because of loose wording together with intense political pressure
from the trusts.
Subsequently, in 1892 the Ohio Supreme Court declared the Standard
Oil Trust to be an illegal monopoly and ordered its dissolution.
Although the trustees superficially complied, this decree had little
overall effect because they retained control through their positions on
the boards of the component companies. Standard Oil was
subsequently reorganized in 1899 as a holding company under the
name of Standard Oil Company of New Jersey. That state had
conveniently adopted a law that permitted a parent company to own
the stock of other companies.
The Sherman Antitrust Act's effectiveness was at first limited because of loose wording and ferocious
opposition from the big industrial combinations. However, the situation began to change starting in 1898
with President William McKinley's appointment of several senators to the U.S. Industrial Commission.
The Commission's subsequent report to President Theodore Roosevelt laid the groundwork for
Roosevelt's famous and feared trust busting campaign.
Despite this reputation, Roosevelt, who became president in 1901, actually preferred regulation to
dismantling, and he attempted to steer a middle course between the socialism favored by some reformers
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and the laissez faire approach advocated by the Republicans. His hand was strengthened by an
increasingly outraged public, which, although leery of government intervention in the past, had become
far more supportive of it because of the seemingly endless growth in the numbers and power of the
monopolies. And the highly publicized philanthropic activities of some of the industrial barons did little
to stop this momentum for reform.
Several steps were taken by Roosevelt during his first term that proved highly successful despite
intensive efforts by big business to block them. They included:
(1) Convincing Congress to establish a Department of Commerce and Labor, the first new
executive department since the Civil War, in order to increase the federal government's oversight
of the interstate actions of big business and to monitor labor relations.
(2) Setting up the Bureau of Corporations in the new department in order to find violations of
existing antitrust legislation. The Bureau soon began investigations into the oil, steel,
meatpacking and other industries.
(3) Instructing his attorney general to launch a total of 44 lawsuits against what were determined
to be harmful business combinations, among which was the Standard Oil Trust.
Court Decisions
In a seminal decision, the U.S. Supreme Court in 1904 upheld the government's suit under the Sherman
Antitrust Act to dissolve the Northern Securities Company (a railroad holding company) in State of
Minnesota v. Northern Securities Company. Then, in 1911, after years of litigation, the Court found
Standard Oil Company of New Jersey in violation of the Sherman Antitrust Act because of its excessive
restrictions on trade, particularly its practice of eliminating its competitors by buying them out directly
or driving them out of business by temporarily slashing prices in a given region.
Coincidentally, 1911 was also a pivotal year
for the petroleum industry in another respect.
It was the year in which the U.S. market for
kerosene (until then the main product from
oil refining) was surpassed by that for a
formerly discarded byproduct of the refining
process -- gasoline.
In its historic decision, the Supreme Court
established an important legal standard
termed the rule of reason. It stated that large
size and monopoly in themselves are not
necessarily bad and that they do not violate
the Sherman Antitrust Act. Rather, it is the
use of certain tactics to attain or preserve such position that is illegal.
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The Court ordered the Standard Oil Trust to dismantle 33 of its most important affiliates and to
distribute the stock to its own shareholders and not to a new trust. The result was the creation of a
number of completely independent (although eight of them retained the phrase Standard Oil in their
names) and vertically integrated oil companies, each of which ranked among the most powerful in the
world. This decision also paved the way for new entrants into the industry, such as Gulf and Texaco,
which discovered and exploited vast new petroleum deposits in Texas. The consequent vigorous
competition gave a big impetus to innovation and expansion of the oil industry as a whole.
The trusts presented a superficially strong case for their activities. They claimed that their consolidation
actually provided a net benefit to the public by reducing costs, and thus prices, through the elimination
of duplicate and inefficient facilities and through economies of scale attained from larger volumes of
output. They also contended that the greater volumes of output made it possible to finance larger and
more efficient production facilities and to devote more funds to research and development.
Although there was some truth to these arguments, at least initially, they failed to take into consideration
the huge detrimental effects on the economy and society resulting from the long-term (four decades in
the case of Standard Oil) absence of free market competition (i.e., the market mechanism). Monopolies
often do reduce the prices and improve the quality of their products in their early stages when they are
trying to eliminate the competition. But history has proven time and time again that they lose their
incentive to do so after the competition gets exterminated; in fact, they then have a very powerful
incentive to increase prices and reduce quality. Free competition, in contrast, serves to minimize prices
and maximize quality over the long run, and it thus results, at least in many respects, in what economists
term an efficient allocation of resources for the economy as a whole.
Another major disadvantage of monopolies is their tendency to stifle innovation. Not only do they lose
much of their motivation to develop and deploy new and improved technologies as a result of the loss of
competition, but monopolies also often make vigorous efforts to prevent existing or potential
competitors from bringing their innovations to market because of the threat that it poses to their
dominance. Although it is easy for monopolists to create the illusion that they are major innovators,
technological advance in monopolistic industries is often substantially less than what would occur in a
more competitive environment. Innovation is generally regarded as one of the keys (if not the key) to
economic growth, and thus its suppression will likely have a deleterious effect on the economy as a
whole, even though such effect might not be readily apparent to the general public.
Philanthropy
As is often the case even with the most heinous of human activities, there was another, starkly
contrasting side to the unabashed greed and callousness of some of the great monopolists. Rockefeller
became another of the great American philanthropists. To many this seemed to be a dramatic and
puzzling contradiction for a ruthless monopolist who never hesitated to use any means, no matter how
illegal or immoral, to crush his competitors. In fact, Rockefeller's belief in the importance of charitable
activities actually started very early, with his regular donations of part of his income to his church and
charities when he was earning money as a boy. He once wrote: "I believe it is every man's religious duty
to get all he can honestly and to give all he can."
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Consistent with this conviction, Rockefeller began reducing his workload at Standard Oil in the 1890s in
order to devote more of his time to philanthropy. Subsequently, in 1910 he announced his retirement so
that he could devote full time to this activity, which he pursued with great passion for his remaining 26
years.
Rockefeller gave away the bulk of his fortune in ways designed to
do the most good as determined by careful study and with the
assistance of expert advisers. For example, he established several
major charitable organizations (including the Rockefeller Institute
for Medical Research, the General Education Board, the
Rockefeller Sanitary Commission and The Rockefeller
Foundation) and played a pivotal role in the establishing and
funding of the University of Chicago (which remains one of the
leading U.S. universities). The sum of his donations to these and
other causes were more than $500 million (of an estimated peak net worth of nearly one billion dollars)
during his lifetime, and the total of his and his son's donations was in excess of $2.5 billion by 1955.
The two photographs on this page represent some of his
philanthropy in (top) Metropolitan Opera in Lincoln Center and
(bottom) and J.D. Rockefeller attending graduation ceremonies
at University of Chicago which he founded with $80 million in
1891.
Several explanations have been proposed for the massive public
service and charitable activities of the great corporate robber
barons. Many contemporaries of Rockefeller and Carnegie
believed that they were really just egotists who craved the
favorable attention that they received from donating money and
delighted in having prestigious institutions and thousands of buildings named after them.
Another explanation is that these activities were largely a public relations ploy and thus a good business
investment. That is, they were techniques for deflecting attention from the harmful effects of the
monopolies and for staving off the increasingly serious attempts to curtail their power or even break
them up.
Still another explanation is that such activities were a form of atonement for their feelings of guilt about
their business activities. This is certainly consistent with the apparent religious convictions of
Rockefeller and others and with their possible consequent fear of eternal punishment in an afterlife.
Perhaps there is some truth to all of these explanations.
By the time of his death in 1937, Rockefeller's remaining fortune, largely tied up in permanent family
trusts, was estimated at $1.4 billion, while the total national GDP was $92 billion. It is estimated that he
would be worth $150 billion today. This was probably the greatest amount of wealth that any private
citizen had ever been able to accumulate by his own efforts.
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SOURCE: Retrieved from the internet, April 2010. Largely from: October 12, 2006. The Linux
Information Project.
9
Case Directions
Begin your case with names of everyone working on the case, name of case, and date submitted. I prefer
the font to be Calibri or Times Roman size 11 or 12. Use 1 ½ inch margins all around. Number each
major question. It should be submitted via Blackboard assignments drop box.
Questions to answer and explain about the Standard Oil case (do not relate to modern times). You may
want to include diagrams as needed.
1. What part of the overall strategy was the most critical to success?
o Why was Standard Oil Trust able to become so profitable?
o How was the firm’s expansion financed?
o Discuss the role of first movers in their strategy.
o Discuss the role of defensive strategy.
2. Discuss diversification in terms of:
o portfolio planning model (BCG matrix)
o vertical and horizontal integration
o economy of scope and size
o synergies realized
3. Discuss mergers and acquisitions in terms of:
o what were the important mergers & acquisitions
o what types of mergers were used
o what were important motives
4. Discuss the role of corporate governance
o What type of corporate structure do you think they used
o How does “the trust” differ from a corporate board?
5. Did the monopoly justify the means?
o Why was J. D. Rockefeller a villain or hero?
o Were other entities selfish in this breakup?
1
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