In Standard Oil Co. of New Jersey v. United States, 221 U.S. 1 (1911) the Supreme Court of the United States found Standard Oil guilty of entering into contracts in restraint of trade and monopolizing the petroleum industry through a long convoluted series of anticompetitive actions. The court’s remedy was to affirm a lower court decree effectively dividing Standard Oil into several competing firms.
The end of the nineteenth century was a period when the general public perceived that economic power had become consolidated in the hands of a few “trusts” in key industries, like oil, steel, and tobacco. For example, federal authorities estimated that Standard Oil controlled over 75 percent of the oil production in the United States by 1906. What was not clear to everyone was the role of competition in the growth of the trusts. Did they grow from too little competition or from competition that was too fierce?
Much of what people believed about the role of competition in general and the Standard Oil Trust in particular was epitomized in the expose by the famous “muckraker” (investigative journalist), Ida M. Tarbell. In her 1904 book The History of the Standard Oil Company, Tarbell fueled negative sentiment toward John D. Rockefeller, Sr. and his company. Tarbell dug into public documents across the country that described instances of Standard Oil’s strong-arm tactics against rivals, railroad companies, and others that got in its way. She reviewed testimony in court and before Congressional committees, as well as copies of pleadings in lawsuits. She talked to people inside the company and those who had competed against Standard Oil. And she succeeded in gaining their trust – a step where others had failed. She excoriated Rockefeller’s “ruthless tactics” and “destructive effect” on smaller oil businesses. Her father and brother both had small oil companies that had not successfully competed with Standard Oil.
But was Standard’s monopoly achieved by anything other than rough and (sort of) fair competition that benefited the consumer? Ida Tarbell wrote that Standard Oil’s “predatory” prices undercut the prices her father and brother charged, driving them out of business. Was that “predatory”? Or was Standard merely more efficient, being able to make money at prices below the Tarbells’ costs, but still in excess of its own costs?
It is useful to examine how the Standard Oil Trust grew to dominate the oil industry. Predatory price-cutting does not explain how a seller would acquire the monopoly in the first place. A study by John S. McGee, “Predatory Price Cutting: The Standard Oil (N.J.) Case,” 1 J. Law & Econ. 137 (1958) showed that the Standard Oil group seldom if ever charged prices below its own costs. McGee found that the record did not indicate that predatory price-cutting forced any refiner to sell out, nor that it was used to depress asset value of any of the more than one hundred and twenty refineries it purchased. In fact, “Chicago School” Economists say there is very seldom a case of genuine predatory pricing (i.e., charging prices below one’s own long term marginal costs).
Research showed that Standard’s most effective method of growth was simply by merger with and acquisition of competitors. Rockefeller demonstrated to the small competitors that they could make more money by selling to him than by competing with him, so he gradually took over much of the competition. Further, Standard’s usual practice was to employ the managers and owners of the firms they absorbed.
As McGee acknowledges, to maintain that predatory pricing was not a factor in Standard Oil’s monopolization is not to justify the rise of the monopoly. Monopolies generally are harmful for consumers because they have an incentive to restrict their own production to maximize profits and sell (fewer) goods at the so-called monopoly price rather than at a competitive (lower) price.
In the late nineteenth century, the disadvantages to consumers posed by monopolies were fairly well understood, but the processes by which they arose were not. The Sherman Act, passed in 1890, prohibited “contracts and conspiracies in restraint of trade” and “monopolization.”
In November 1906 the government brought a bill of complaint under the Sherman Act against the Standard Oil Trust. The bill itemized an assortment of alleged grievances containing some enlightened and some misguided economic policy. The Complaint contained many allegations of ruthless tactics, rebates, and vertical integration. One of the key “ruthless tactics” consisted of charging low (but as McGee demonstrated, not predatory) prices.
The case reached the Supreme Court in 1910 and was decided in 1911. The case is particularly interesting because it shows a court wrestling with only partially understood and not well-articulated economic concepts, and yet formulating what proved to be a workable legal principle (the “rule of reason”) and coming away with a sound decision.
The record on appeal was monumentally voluminous — 22 volumes comprising over 12,000 pages. Moreover, even though the facts were relatively uncontested, the parties’ characterization of them could hardly be more contradictory. In Chief Justice Edward D. White’s words:
. . . on the one hand, with relentless pertinacity and minuteness of analysis, it is insisted [by the government] that the facts establish that the assailed combination took its birth in a purpose to unlawfully acquire wealth by oppressing the public and destroying the just rights of others, and that its entire career exemplifies an inexorable carrying out of such wrongful intents, since, it is asserted, the pathway of the combination, from the beginning to the time of the filing of the bill, is marked with constant proofs of wrong inflicted upon the public, and is strewn with the wrecks resulting from crushing out, without regard to law, the individual rights of others.”
Yet, he observed:
On the other hand, in a powerful analysis of the facts, it is insisted [by Standard Oil] that they demonstrate that the origin and development of the vast business which the defendants control was but the result of lawful competitive methods, guided by economic genius of the highest order, sustained by courage, by a keen insight into commercial situations, resulting in the acquisition of great wealth, but at the same time serving to stimulate and increase production, to widely extend the distribution of the products of petroleum at a cost largely below that which would have otherwise prevailed, thus proving to be…a benefaction to the general public….”
Just what was Standard Oil accused of doing? Again, Justice White:
Without attempting to follow the elaborate averments on these subjects spread over fifty-seven pages of the printed record, it suffices to say that such averments may properly be grouped under the following heads: rebates, preferences and other discriminatory practises [sic] in favor of the combination by railroad companies; restraint and monopolization by control of pipelines, and unfair practises [sic] against competing pipelines; contracts with competitors in restraint of trade; unfair methods of competition, such as local price-cutting at the points where necessary to suppress competition; espionage of the business of competitors, the operation of bogus independent companies, and payment of rebates on oil, with the like intent; the division of the United States into districts and the limiting of the operations of the various subsidiary corporations as to such districts so that competition in the sale of petroleum products between such corporations had been entirely eliminated and destroyed, and, finally, reference was made to what was alleged to be the ‘enormous and unreasonable profits’ earned by the Standard Oil Trust and the Standard Oil Company as a result of the alleged monopoly, which presumably was averred as a means of reflexly [sic] inferring the scope and power acquired by the alleged combination.”
The Court’s task was to determine whether those facts fell within the rather vague statutory terms “contract or conspiracy in restraint of trade” or “monopolization.”
The Court began by analyzing what those terms meant under English Common Law. Under common law, “monopoly” referred only to the grant by the sovereign of an exclusive right to ply a trade. Parliament later prohibited kings from granting monopolies because they resulted in the evil of “undue enhancement of price.” White observed, “It is remarkable that nowhere at common law can there be found a prohibition against the creation of monopoly by an individual.”
The Court ruled that the Sherman Act should not be so narrowly read. Instead, its prohibition should apply to any contracts “which gave rise to a harmful result….” But how could the court know which contracts caused such harm? It said:
. . . not specifying but indubitably contemplating and requiring a standard, it follows that it was intended that the standard of reason which had been applied at the common law, and in this country, in dealing with subjects of the character embraced by the statute, was intended to be the measure used for the purpose of determining whether, in a given case, a particular act had or had not brought about the wrong against which the statute provided.” [Emphasis added.]
Recognizing that all contracts, to some extent, restrain the parties from conducting business as they did pre-contract, the Court went on to say:
The statute, under this view, evidenced the intent not to restrain the right to make and enforce contracts, whether resulting from combination or otherwise, which did not unduly restrain interstate or foreign commerce, but to protect that commerce from being restrained by methods, whether old or new, which would constitute an interference that is an undue restraint.”
The Court further recognized that the statute did not prohibit monopoly per se, only monopolization. It left room for monopolies to arise “naturally” and relied on freedom of contract to curb monopoly power:
[A]lthough the statute…makes it certain that its purpose was to prevent undue restraints of every kind or nature, nevertheless, by the omission of any direct prohibition against monopoly in the concrete, it indicates a consciousness that the freedom of the individual right to contract, when not unduly or improperly exercised, was the most efficient means for the prevention of monopoly, since the operation of the centrifugal and centripetal forces resulting from the right to freely contract was the means by which monopoly would be inevitably prevented if no extraneous or sovereign power imposed it and no right to make unlawful contracts having a monopolistic tendency were permitted. In other words, that freedom to contract was the essence of freedom from undue restraint on the right to contract.”
The Court had to deal with two previous cases, United States v. Freight Association, 166 U.S. 290, and United States v. Joint Traffic Association, 171 U.S. 505, in which the Sherman Act was enforced without recourse to the newly articulated “Rule of Reason.” Both cases involved blatant price fixing arrangements among ostensible competitors. The court explained that the nature of the contracts at issue was such that they were always illegal: “… they were clearly restraints of trade within the purview of the statute.…” The Court ruled that some contracts, by their very nature, violated the rule of reason. In effect, it created a class of contracts that later cases would call “per se illegal.”
Applying the law to the facts of the Standard Oil case, the court used language referring to “intent.” Later explication of the case has minimized the subjective intent of the parties, and focused on the objective intent or purpose of the contractual provisions:
…the unification of power and control over petroleum and its products which was the inevitable result of the combining in the New Jersey corporation by the increase of its stock and the transfer to it of the stocks of so many other corporations, aggregating so vast a capital, gives rise, in and of itself, in the absence of countervailing circumstances, to say the least, to the prima facie presumption of intent and purpose to maintain the dominancy over the oil industry….”
The real thrust of the opinion is that what we now call horizontal mergers and acquisitions are illegal if they entail substantially all the existing competition. In fact, you don’t want anyone to have enough of the productive capacity of the industry to have an incentive to restrict its own production. (OPEC provides a modern example of an oligopoly that sometimes can make more money by producing less.)
The Standard Oil case is still one of the principal pillars of antitrust law despite some misconceptions regarding its holding. A few observations about what the case did not hold are pertinent.
The bill complained of Standard’s vertical integration into railroads and production of crude oil. The court used language of intent, and found that “As substantial power over the crude product was the inevitable result of the absolute control which existed over the refined product, the monopolization of the one carried with it the power to control the other.” It seemed to imply that vertical integration was suspect, but what it actually said was that horizontal control of the entire industry at one level of production and distribution was the principal cause of the economic evils before it. Modern economic analysis shows that the trust didn’t need to control production of crude oil because it controlled refinement. Vertical integration has had a complicated history in antitrust law — far beyond the scope of this essay. The enduring power of the Standard oil case redounds primarily from its holding as to horizontal acquisitions.
The principal evil of monopoly described by the court was the “undue enhancement of price.” It did not seem to be aware that underlying cause of a monopolist’s ability to enhance price is its ability to limit production, and thus limit the supply of goods available. Nevertheless, the rule of reason has come to be a test of whether the contracts tested under it have the effect of restricting production.
And what of the rough and ready tactics, bribery, and intimidation described by Ida Tarbell and referred in the bill of complaint? The Court did not need to rely on those allegations in its ruling, and simply elided over them. The case is more powerful because it holds that horizontal mergers, acquisitions, and non-compete agreements that create substantial market power are illegal even if they are executed in a gentlemanly manner. Dirty pool tactics were later dealt with in 1914 when Congress passed the Federal Trade Commission Act, which proscribed “unfair methods of competition” and authorized the FTC to interpret and enforce the statute.
John D. Rockefeller, whose net worth would have been $318.3 billion in current dollars according to Forbes Magazine, spent the last 40 years of his life in retirement. His fortune was mainly used to create the modern systematic approach of targeted philanthropy with foundations that had a major effect on medicine, education, and scientific research. His foundations pioneered the development of medical research, and were instrumental in the eradication of hookworm and yellow fever. He is also the founder of both The University of Chicago and Rockefeller University. He was a devoted Northern Baptist and supported many church-based institutions throughout his life. Rockefeller adhered to total abstinence from alcohol and tobacco throughout his life.
This essay is dedicated to the fond memory of Edward H. Levi, former Attorney General of the United States and former Provost of the University of Chicago, who grilled the author unmercifully on the Standard Oil case in class in 1967.
Author: James A. Broderick, University of Chicago Class of 1967