Scholarly Debate on the South Improvement Company’s Role in the Cleveland Massacre

The elements of the Grinnell standard for what constitutes an illegal monopoly are: (1) the possession of monopoly power in the relevant market and (2) the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident. (U.S. v. Grinnell, p. 570-571). Given the significant role the history of the Standard Oil Company has on our anti-trust law, it is helpful to have a clear picture of the actions taken by that company prior to it being broken up by the Supreme Court. This paper will specially address Standard’s acquisition of its competing refineries in Cleveland which occurred during a 6 week span in early 1872; a period referred to as the Cleveland Massacre.

Several explanations have been offered in an attempt to understand how Standard Oil was able to acquire all its competing refiners in the Cleveland area. The prevailing explanation comes from Elizabeth Granitz and Benjamin Klein’s 1996 article which credits the role of the South Improvement Company (SIC). However a recent paper by Geroge Priest refutes this explanation and opts for a less nefarious explanation where it simply was the inevitable result of a depressed market resulting from overproduction that would benefit from combination. Hanging in the balance of these competing narratives is how Standard’s early growth should be viewed by anti-trust law. The former, a clear violation while the latter perhaps is better seen as the result of historical accident and business acumen described in the Grinnell standard.

Granitz and Klein’s analysis places principal emphasis on the timing of the Cleveland acquisitions. They all occurred in the three month period after the SIC charter was executed and before it was abandoned by the railroads. Such a sudden and complete trend cannot be coincidence and no major events occurred in the industry during that time other than the SIC. Furthermore, testimonials of some of the refiners that sold to Standard cited explicitly the impending threat posed by the SIC to their businesses as reasons for selling. (Granitz & Klein, p. 15).

Additional support comes from the common monopoly economics principle of free riding. There is usually a faction of firms that continue to operate in the same space as a monopoly firm rather than sell out because they can take advantage of monopoly pricing in the market. However there were no free riders in Cleveland, a point Granitiz and Klein contend bolsters the case that these firms were coerced by the specter of the SIC. Since part of the SIC scheme was to charge much higher rail shipping rates to the non-participating refiners, these firms must have decided that whatever profit there was to gain from the monopoly pricing, it wouldn’t be enough to offset the steep hikes in shipping costs. (Granitz & Klein, p. 16).

Finally, Granitz and Klein contend that the officers of the railroads actively pressured Standard’s competition to sell out. They suggest that the railroads had a strong incentive to help Standard and the other participating refiners to increase their local market shares. If each refining market had significant independent refiners, it would be too tempting for the three railroads to cheat on the SIC agreement by offering the independents reduced rates. This would lead to more railroad rate wars; the situation the SIC was designed to prevent. The stronger the position of the participating refiners, the less beneficial it would be the cheat on the agreement since it wouldn’t be worth cheating to do business with a handful of independents. (Granitz & Klein, p. 17).

Priest begins his critique of Grantiz & Klein’s analysis by pointing out that none of the other refiners in other cities used the SIC as leverage to buy out their competition. As Priest demonstrates in his paper, eliminating competition through combination was attempted at every stage of production in the oil industry and Rockefeller wasn’t the only one to understand the merits of amassing a refining cartel. However none of the New York, Philadelphia or Pittsburgh refiners in the SIC attempt to make acquisitions in their markets. (Granitz & Klein, p. 523).

Priest proceeds by asking why - if receiving drawbacks from the inflated prices paid by non-participants was a central component of the SIC - would Standard seek to frustrate this by eliminating these companies through acquisition. The SIC included a two-tiered benefit from the refiners. First they would pay a discounted rate for their own shipments in the form of rebates and second they would share in the profits of increased rates to the non-participants by collecting drawbacks. Grantiz and Klein never showed definitively that Standard was better off immediately buying its competitors rather than simply collecting the drawbacks for a period and then buying them out. (Priest, p. 524).

Similarly, Priest finds it hard to agree with Granitz and Klein that representatives of the railroads actively lobbied the non-participants to sell since a monopoly refiner would inevitably curtail kerosene production in order to stabilize price. This would result in fewer railroad shipments, a situation the railroad must have anticipated. (Priest, p. 524).

Priest points out that it is not clear from the SIC charter that the drawbacks were ever distributed to the refining companies. There is no language in the documents specifically detailing how the drawbacks should be distributed amongst the refiners. Indeed it’s possible that they never reached the refining companies at all but rather were pocketed by Rockefeller and the other executives personally. The drawbacks were going to be paid in the form of dividends to the shareholders of the SIC. However Standard Oil and the other refining companies were not the shareholders, instead it was the executives personally who held the shares. Thus it’s possible that the executives pocketed the drawbacks, leaving only the rebates for the refining companies which greatly reduce the competitive advantage provided by the SIC. Therefore it would be difficult to argue that the entire Cleveland industry would sell out on the prospect of Standard receiving only rebates, especially since rebates were not uncommon at the time. (Priest p. 525- 526).

Finally, Priest offers evidence that membership to the SIC was not as exclusive as others have characterized. The SIC’s main organizer apparently indicated the agreement would ultimately be available to the entire refining trade. Furthermore, from the plain terms of the agreement between the SIC and the railroads, any refiner who shipped one the same terms, i.e. distributed their shipments amongst the participating railroads at the percentages set by the SIC, would be entitled to earn rebates. If it was indeed the case that the SIC was open to the trade at large, the argument that Standard’s Cleveland rivals sold out for fear of exclusion for the SIC is unsustainable. (Priest, p. 527).

Instead of pressuring their competition to sell on the prospect that in a few short months, the SIC would reduce the value of their business to zero, Priest suggests that Rockefeller was simply able to convince them consolidation into a single enterprise would be mutually beneficial. In 1872, Cleveland refining was in a deadly nosedive due to gross overproduction. Standard was the largest refiner and with operations in many of the stages of production, it was also the most efficient. Thus, according to Priest, Rockefeller was simply able to convince his competitors that it made logical business sense to join him. He offered stock in Standard Oil and often gave them executive positions. It was the natural progression of the industry, rather than the end result of a diabolical plot of collusion. (Priest, p. 545 – 546).

Elizabeth Granitz & Benjamin Klein, Monopolization by “Raising Rivals’ Costs”: The Standard Oil Case, 39 J.L. & ECON. 1 (1996)

George L. Priest, Rethinking the Economic Basis of the Standard Oil Refining Monopoly: Dominance Against Competing Cartels, 85 S. Cal. L. Rev. 499 (2012)

United States v. Grinnell Corp., 384 U.S. 563, 570–71 (1966).

-- TylerConway - 03 Feb 2013