The Standard Oil and John D. Rockefeller Saga Pt. 1

If there's one thing I learnt from the story of Standard Oil and John D. Rockefeller, it's that your business can become extremely profitable if you're crazy about efficiency.

Standard Oil is the progenitor of nearly every prominent American oil company today. Companies such as Exxon, Mobil, Chevron, Marathon, BP, and more all have their origins linked to the most powerful company of the 20th century.

At the height of its glory years, Standard Oil was worth over $1 trillion - adjusted for today's economic conditions. But many don't know the true story behind how John D. Rockefeller transformed Standard into the monopolistic giant it became.

Journalists labelled him as evil, greedy, a thief, etc. Meanwhile, others portrayed him as a business genius, the pioneer of modern capitalism, a Christian philanthropist, etc. Just what exactly should we believe?

Well, let's dig into the story to find out.

Planting The Seeds

"I'm sorry, son. It's the end of the road for you. Ehmm… You're becoming a man, and it's time to start contributing to the family."

I imagine those were the words William A. Rockefeller uttered to his 16-year-old son, John D. Rockefeller when informing him that he would stop school.

The year is 1855 when young Rockefeller received this sad news. Without school, all the dreams and roadmap he had envisioned for his whole life were about to crash.

However, undeterred in his quest for knowledge, Rockefeller enrolled in a three-month summer business course at Folsom's Commercial College to study bookkeeping.

This love for finance came from an experience when he was 13 years old.

Rockefeller worked with a potato farmer for 10 hours a day for several weeks. After saving all of his little wages, he realised that he could generate the same income by lending $50 at a 7% annual interest rate in New York, as he could earn from 100 days of backbreaking potato harvesting.

After the training, Rockefeller started seeking job opportunities. With his new bookkeeping knowledge, he understood that companies with good credit ratings were probably financially healthy. So he made a list of all the top ones in Cleveland and targeted them. But it is difficult to get into such companies when you are so young and have zero work experience.

As you would predict, they all rejected him initially... until his persistence gave in, and Hewitt & Tuttle, a food commodities trading firm, hired him as a junior bookkeeper on September 26th, 1855. Rockefeller would celebrate this day as 'job day' for the rest of his life.

Work began at Hewitt and Tuttle. Rockefeller, with his love for finance, rose quickly through the ranks in his first year, receiving almost a 50% salary increase in the process—from $26 to $50.

While working here, he observed the business procedures and learned from his duties, which included negotiations and calculations of transportation costs. Rockefeller was obsessed with the numbers and how they affected the business.

After three years of experience at Hewitt and Tuttle, Rockefeller started looking towards establishing his own food commodities trading firm when Maurice B. Clarke offered him the opportunity of a partnership.

And so the firm of Clarke and Rockefeller began.

In the first year, business was terrible, and the capital-intensive nature of commodities trading at the time ate deep into their pockets.

Before they could settle down, the American Civil War erupted in 1861. This was a sign from the universe to quit the business. But Rockefeller wasn't looking to give up yet.

While his compatriots were serving in the war, he exploited a loophole in the law that exempted heads of families from fighting in the army. After all, his father had somewhat left the family responsibilities to him at this point.

Soon, in 1862, the Union Army needed large quantities of food and supplies for their troops. And guess which firm was poised to capitalise on this? Clarke & Rockefeller.

The war drove up demand and prices for food commodities, causing them to rake in huge profits. For comparison, in 1862 they made about $17k, which was 4× all the money they've made since the business began.

With such impressive profits, Clarke and Rockefeller began searching for alternative investments to invest some of their profits. And this is where it all begins to get interesting.

The Smell of Oil

In 1863, news of the crude oil boom in Titusville, Western Pennsylvania, started reaching other parts of America. People would drill oil from the ground, refine it in the same place using coal, and extract kerosene, which they would take to other cities to sell.

In the thick darkness of the night, kerosene became the new source of light.

Initially, whale oil was the primary means of getting light at night. But the price was super expensive and somewhat reserved for rich folks, considering the process of getting it.

With the dawn of industrialisation and increased commerce, kerosene became the dominant source for powering lamps in factories and homes.

Clarke and Rockefeller decided to speculate on oil by trading it in addition to food commodities.

Around this time, people started realising that they didn't have to refine crude oil in the same place where they drilled for it. They could take the oil to the cities and set up a refining location to extract the kerosene right there, where people needed it.

Samuel Andrews, a friend of Clarke who knew how to refine oil, came up with the idea of Rockefeller and Clarke setting up their own refinery in Cleveland.

While Clarke wasn't that interested, Rockefeller was beginning to see a future in the oil business. As a result, they invested $4k into building the refinery while also bringing in the two brothers of Clarke into the business. And away with food commodities trading. Who needs that when you've got oil?

As Andrews devised innovative ways of running the technical side of the refinery, Rockefeller unleashed his business side in management. He began aiming for maximum efficiency in how they managed the business, from operations, factory arrangements, deals with contractors, A/B testing, etc.

The goal was to run the business as lean and efficient as possible to improve their profit margins. He hated middlemen, wasted disorder, or anything that could grip down on profits.

This was unlike most other refineries at the time.

The oil business was in its infancy, and for most people, it was a gold rush. Nothing was professional at the time. They would blow up holes in the ground in search of oil, and if they found any, they didn't even care about efficiency. It was all about making quick profits. This attitude caused high volatility in oil prices.

But Rockefeller was thinking long-term. He initially avoided the drilling business because of the inherent risk of not discovering oil after investing; it was a game of luck. Instead, he allowed others to carry that risk while he focused on buying the oil from them and refining it.

When others were hurriedly selling off in downtimes, their business efficiency enabled them to maintain high profitability, which in turn allowed them to keep buying and holding longer than competitors.

Rockefeller employed techniques that saw him win negotiations to buy oil at the lowest possible price almost all the time. He always got the best of the bargain.

As profit kept increasing, Rockefeller was reinvesting it back into the business.

But some brothers weren't totally happy with this way of doing business.

Maurice Clarke and his brothers still viewed the business through the lens of merchant trading. To them, it was all about buying and selling quickly to make profits.

Clarke wasn't into all the reinvesting their profits thing and tying up much capital in the business. But Rockefeller wasn't only reinvesting their profits. Heck, he constantly took large loans from banks to fuel growth.

This wasn't how they started. Who was Rockefeller to decide for them?

But young Rockefeller had already been baptised into the life of an oil man.

Rockefeller decided to end the partnership. He went to a local paper and placed a notice that there would be an auction of the assets of the partnership, including the refineries.

It would be like a bidding war where one party tries to buy the other's 50% stake in the business. Whoever is willing to pay more gets the whole business.

The odds favour the Clarke brothers. It's three against one. I believe they must have thought that the young lad was playing right into their hands.

But what they didn't know was that Rockefeller had already leveraged his relationships with banks to line up enough financing in advance.

On the D-day, I think you already know who won. Rockefeller bought out the Clarke brothers 50% share for about $72.5k—more than he planned to pay.

In 1865, the Civil War ended and the American economy began taking on a new shape. Soldiers returning from the war were going over to work in factories, drilling, industry, and the like.

Commodities trading were for babies.

Industrialisation, urbanisation, and oil were fuels for the new America. Prices of whale oil had doubled, as no one was thinking about killing whales in the face of a life-changing war. Kerosene became the prominent light-giver. And Rockefeller was well-positioned to profit from it.

No More Restrictions: Vertical Integration to Economies of Scale

As the sole boss, Rockefeller started some sophisticated business practices that would define the future of business as we know it today.

Oil refining at the time usually required contracting with other firms to get plumbers and blacksmiths to build and lay pipes from the wells to depots. Rockefeller decided to employ their own plumbers and blacksmiths instead of paying so much money to contractors.

Again, instead of paying other companies for wood to make barrels, they buy and plant their own forests. As a result, they could cut down the trees and build the barrels themselves. Owning the trees also enabled them to treat the wood to make it lighter and cheaper to ship back to their refineries.

They also negotiated favourable deals with landowners where the oil was drilled. All of these enabled them to have huge control over the costs of running the business. But this was only the beginning. Rockefeller now has his eyes set on dominating the oil business and becoming the sole supplier of kerosene to the world.

In December 1865, his brother, William Rockefeller Jr., joined the business, and they set up a second refinery in Cleveland. With the foundation set, it was time to announce themselves to the world.

The refining process of oil at the time was poor, and on several occasions, the houses of people caught fire from buying poorly refined kerosene. Rockefeller saw this as an opportunity for a name change and to show people what their refineries stood for—setting industry standards.

In 1866, he changed the name of the company to the "Standard Oil Corporation." And another boom in business.

They extended footing into the international market and started exporting 2/3 of their oil overseas while selling 1/3 locally.

Around this time, while competitors were dumping the oil byproduct, gasoline (petrol), in rivers, Standard Oil discovered that they could use it to power their refineries instead of spending money on coal. On the side, they sold other byproducts like petroleum jelly, tar, paraffin wax, and naphtha.

To prevent oil from spilling all over the trains, Standard Oil invented metal storage tanks for storing and distributing their products instead of the regular open wooden boxes.

The oil industry was theirs for the taking.

As business prospered, investors couldn't help but offer Rockefeller financing to supercharge growth. And he happily grabbed it, but not without bargaining for very low interest rates.

Stephen Hackness, a rich financier, decided to invest $100k in Standard Oil. But on one condition.

To watch his investment, he proposed that his relative, Henry Flagler, another finance freak, join the company as treasurer. Although strange, Rockefeller agreed to his terms, and Flagler became the new treasurer of Standard Oil.

In less than a few months after joining, Flagler aimed for his first major hit in the company when he took over negotiations with the railroads responsible for shipping Standard's oil.

At the time, shipping oil through railroads was one of the major cost drivers for the refining business.

Earlier, Rockefeller had found a way to reduce costs by using specific routes during the summer and winter. However, Flagler had a better way.

He went over to the Lake Shore Railroad and proposed a deal that would see Standard Oil receiving about a 70% discount on shipping rates if they could provide a large amount of oil shipments daily. But there's one tiny problem.

It was impossible for Standard to have such a huge volume of shipments daily. Or is it really?

Flagler went over to other competitors bringing oil from Titusville to Cleveland and proposed to them that they pull their shipments together with Standard Oil in exchange for a 71% discount on shipping fees. No one in their right mind would reject such a deal.

They shook hands. And with the deal, Cleveland overtook Pittsburgh to become the number one oil refining city in America.

Due to the efficiency of its refineries and the Lakeshore deal, Standard Oil was able to gradually reduce the price of its kerosene from 58 to 26 cents between 1865 and 1870.

As a result, Standard Oil became the darling of consumers as they kept providing steadily improving kerosene quality at a decreasing price, extending the day across thousands of homes—even in poor neighbourhoods. Competitors in Cleveland couldn't keep up with their efficiency or price reductions.

But Rockefeller wasn't satisfied.

Standard had grown bigger than just one state. It was time to expand into all of America and capture every part of the growing oil market. But not in the America of the 19th century.

Let's Begin a Monopoly, Shall We?

You see, at this time in the U.S., a company couldn't operate or own assets in other states. There was no legal framework for running a national corporation, as every company was limited to its state of incorporation.

Coupled with this, it would take an immense amount of capital to expand an oil company into all of America. One that a private company couldn't afford at the time.

Rockefeller has to give up his ambition. There was no way they could come up with such an amount of capital or operate outside the borders of Ohio.

"Impossible is a myth."

But not so fast. Henry Flagler came up with an idea.

Drawing inspiration from the Dutch East India Company, Flagler suggested they turn Standard Oil into a joint-stock company. This would enable them to sell shares to raise huge capital and easily bring strategic partners into the business. Boom!

On January 10, 1870, Rockefeller abolished the former Standard Oil partnership and incorporated the Standard Oil Company of Ohio as a joint stock company. The company was capitalised with about $1 million of liquid assets.

It was unheard of. Very few American companies could boast of such an amount of capital at the time. This was mind-blowing! I know it may appear normal in the 21st century, but companies like Standard Oil are part of the reason we even structure companies this way today.

With the capital problem solved, Rockefeller and his associates were left with one problem - navigating the state limitation.

Let's crack the code.

Since Standard Oil can't operate outside Ohio or own shares in companies in other states, they came up with the scheme of creating a trust.

They structured the trust in a way that it would hold shares of different companies all around the country. Following the law, these different companies operate only in their states and do not own shares in other companies outside their states of incorporation.

The trust would have a set of trustees that decide what the companies under the trust do and how they communicate with each other. These trustees can be executives of other companies, which the law doesn't prevent.

With the creation of the trust, the trustees designated the individual shareholders of Standard of Ohio as the beneficiaries of all the dividends coming from these other companies.

This was also in accordance with the law at the time, as Standard Oil of Ohio had no direct affiliation with the trust.

And guess who the trustees were? You guessed right. Rockefeller and his pals.

But they didn't establish the trust immediately.

Knowing they could implement this model when the time came, they were able to secretly expand into other states and retain total control.

They now had the leverage to extend the same growth playbook they used in Cleveland into other parts of America.

To ensure all of the capital goes into expanding the business, Rockefeller instructed that none of them take a salary for the first year. Instead, they would receive payments in the form of dividends and the potential appreciation of their stocks.

This was another "industry first" that Standard Oil pioneered. It was the first time a company would be using equity as an incentive/payment for employees, partnerships, or acquisitions.

All of these new schemes and concepts catalysed a mind-blowing growth for Standard Oil, that, at the end of the 1st year of this new system (1870), they paid 105% in dividends to shareholders, reinvested heavily in the business, and acquired several other firms in the process.

That is, from the $1 million invested in the business, shareholders received over $1 million as dividends, while there was still lots of cash lying around to fuel acquisitions and growth. If this isn't growth at the speed of light, then I don't know what it is.

And they are doing all of these while providing the cheapest and highest quality kerosene on the market.I f you were a competitor at the time, you would definitely hate Rockefeller for this.

But they haven't seen anything yet.

Uncapped Growth: Horizontal Integration

To drive down the price of their refined oil further and eliminate competition, Standard Oil and a few other key oil companies pitched the formation of a sort of cartel to the executives of Pennsylvania, New York, and Erie Railroads.

This 'company cartel' would be known as the South Improvement Company (SIC).

At the time, profits for the railroad companies were quite unpredictable due to the boom-and-bust nature of carts and oil shipments.

Through the South Improvement Company (SIC), they would help the railroad companies implement a fixed, expensive shipping rate and bring in loads of daily shipments.

In return, all oil companies that were part of the SIC, including Standard Oil, would get huge rebates for shipping and also receive a share of the profits from the expensive rates competitors pay the railroads for their oil shipments.

If this happens, it's game over for any other player in the market.

However, as word got into the streets about this scheme, competitors sparked a protest all around America. As the heat got worse, the railroads considered backing out of the arrangement.

Rockefeller and Flagler decided to come up with an even more brilliant—maybe dreadful—strategy to gain a monopoly over the oil business.

In February 1872, they decided to pay an unpleasant visit to the other refineries in Cleveland that were part of the earlier Lakeshore Railroad deal. They broke the bombshell news to them that they were calling it off.

Standard Oil doesn't need the deal again because it has grown to the point where its shipments exceeded the minimum amount to guarantee the 71% shipping rate discounts.

At this time, business was poor for most of these other refineries as the price of oil continued its volatility. Without the Lakeshore Railroad deal, they are screwed. And this was exactly what Rockefeller and Flagler wanted.

Rockefeller made an offer to buy them out.

And his offer was 25–50% of the original building cost of the refineries. They were going out of business anyway; why pay more?

But he didn't plan to sack the owners and executives of the refineries. Instead, he incentivised them with stocks to keep working under him.

He had a pretty convincing offer. I imagine it went somewhat like this:

"Your refineries are going to perform far better as part of Standard Oil. But I don't want you to be jobless. Continue working on your refineries that will become mine, and enjoy all the huge upside from the appreciation of our stocks. It's a win-win."

It was almost like he was helping them out because, considering the steady growth of Standard Oil, they would make more profits from those stocks than from years of running their own refineries.

In the space of six weeks (February to April 1872), Standard Oil acquired 22 out of the 26 other refineries in Cleveland in what became known as the Cleveland Massacre.

After leveraging on the proposed South Improvement Company to buy out the refineries, they abandoned the partnership. The public hated the SIC, and they'd already gotten what they wanted, so why do it?

Not a single barrel of oil was shipped through the South Improvement Company.

Soon, they expanded into other northeastern regions of the U.S. and absorbed several oil refineries. By 1877, Standard Oil controlled about 90% of the oil business in America.

Crude oil has become synonymous with Standard Oil. But Rockefeller wasn't even ready to stop here.

Total Dominance

While Standard had established several deals and processes that had granted them a monopoly over the oil industry, they needed to control one more strategic part of the oil business to crown their dominance - distribution.

And who controls distribution? The railroad companies.

If the railroad companies decide to go back on their agreement and increase rates, it would affect Standard's vision of "cheap kerosene-high profits.

As a result, Rockefeller and the crew decided to propose a deal to the railroad companies that would allow Standard Oil to build all the tank cars they needed for their railroads. In return, Standard would lease it to them at an almost negligible rate.

It seemed like a great deal for the railroads. They don't have to take on the capital expenditures of building all of these tank cars. Standard was offering to help them for almost nothing. Deal done!

However, Rockefeller and his crew had a plan.

Since Standard Oil now owned almost all the tank cars of the railroads, they could ensure they got heavily discounted shipping rates (rebates).

And if the railroad companies refused, Standard could send them out of business by taking back all the tank cars.

Now, would you still call it a good deal for the railroads?

Business domination complete! No, not yet.

At the time, the primary means of transporting oil was either by railroads or water. Workers would usually build short-distance pipelines—one mile at most—from the oil wells to the railroads' depots.

After pumping the oil through pipes, they would load it in the tank cars, which would eventually take it to the refineries for processing through railways.

But people started thinking about a better way of transporting oil through long-distance pipelines.

To get one over Standard Oil, most of the other oil companies that weren't yet in the pocket of Rockefeller came together to form the Tidewater Pipeline Company in 1877. They decided to build a 110-mile pipeline from Titusville to Williams Port, Pennsylvania.

When the news of this development reached Standard Oil, Rockefeller and his crew knew that, for the first time, they were facing an innovation that could crumble their dominance.

They tried their best to fight the pipeline construction with all they had, but it was to no avail.

In 1879, the pipeline went live, and it was way more efficient and less expensive than railroad oil transportation. Standard, you're no longer in control! Lol

Rockefeller had a comeback in the works.

The Tidewater pipeline was just transportation via one route. And the railroad that operated along this line was under the control of Standard Oil via their earlier tank car deal.

What if they forced the railroad that moved along this route to reduce their shipping rates to the point that it became financially unwise to use the pipelines? Okay, let's do it.

Everyone abandoned shipping via the pipelines and flooded the railroads with their shipments.

As a result, the Tidewater Pipeline Company began running at a heavy loss. They were about to go out of business.

You can't mess with the king of modern capitalism and go scot-free. The only option now for the Tidewater Pipeline Company was to surrender or risk going out of business.

In March 1880, they sold a minority stake in the company to Standard Oil.

With access to the Tidewater pipeline and its design, Standard Oil copied the system and built four additional long-distance pipelines connecting to four different cities. But on what land?

There were only a few land routes that could house dedicated long-distance pipelines across several cities. And Standard Oil doesn't own them. It belonged to the railroad companies.

Oh, Standard already has them in its clutches.

For the umpteenth time, Standard Oil exercised its leverage over the railroad companies by demanding land rights to build pipelines alongside their rail lines. This is like Apple asking Google to help them distribute iPhones.

And build it they did, further improving their distribution efficiency and, in turn, lowering kerosene prices.

In 1882, they implemented the trust, which allowed them to effectively and efficiently control all of their companies and investments across America.

It was over. Standard Oil had officially become the sole supplier of kerosene to all of America and a large part of the world. No one could stop them.

They had strategic leverage over every single part of the supply chain, from production to refining, distribution, retail, etc.

In the 1880s, Standard Oil had over 100,000 employees—the first time for a single company to do so—and paid an annual dividend to shareholders of around 50% to 200%.

Standard was gradually becoming as big as the U.S. government. They could become the rulers of the American economy if something wasn't done. Something weighty that could flip the script—a revolutionary change or government intervention.

In the 1880s, one Senator John Sherman of Ohio, was seeking re-election into office. As was their practice to maintain a sort of political leverage, Rockefeller became a major supporter of his campaign, both in cash and in kind.

But this simple little act may change everything forever.

Rockefeller was about to make his first blunder. Would he escape from the consequences?

Find out in Part II.

My Two Cents

• Efficiency is the king of huge upsides in every business. Rockefeller wasn't tired of reducing operating costs, even when they seemed low.

• You can't run a successful business empire alone. Standard Oil's continued success wasn't just because of Rockefeller. Samuel Andrews, William Rockefeller Jnr, and Henry Flagler among many others played crucial roles.

• Impossible is a myth. You just have to keep thinking while implementing.

Some Interesting Finds I Came Across

Warren Buffet's speech at Notre Dame

Nicolas Cole on Becoming a Better Writer

Greg Isenberg on Building Cash-Flowing Internet Companies

Sources:

Breaking The Standard: The True Mechanism Utilised by the Standard Oil Company

The History of Standard Oil by Idar Tarbell

Vindicating Capitalism: The Real History of the Standard Oil Company

Standard Oil (Wikipedia)

John D. Rockefeller

Standard Oil 1 (Acquired Podcast)

Titan: The Life of John D. Rockefeller, Sr

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