Chapter II: The Secret Rebate

How has this vast combination been built up? There are those who will tell you that it has been accomplished because John D. Rockefeller was thrifty; there are others who are persuaded by the Standard’s Press Bureau to believe that it is due to the Standard’s economies in production and improvements in transport. Neither of these agreeable theories can explain the mystery, because most of these improvements were invented and first adopted by others, and Mr. Rockefeller’s savings would not have enabled him to get control of 80 per cent. of the American oil refining business in ten years. The truth is that the secret rebate trick is the foundation of this great monopoly, and this it is now proposed to prove from official sources.

The introduction of the secret railway rebate or discrimination may or may not have been due to Mr. John D. Rockefeller’s inventive genius--it is not absolutely proved to have been so--but the Report of the United States Government Commissioner of Corporations (Mr. J. R. Garfield) on the Transport of Petroleum, dated May 2, 1906, shows that at any rate the Standard Oil Company made the practice so much its own that it may fairly be regarded as its special system. On page 1 of the report this is made perfectly clear:--

The general result of the investigation has been to disclose
the existence of numerous and flagrant discriminations by the
railroads in behalf of the Standard Oil Company and its affiliated
corporations. With comparatively few exceptions, mainly of other
large concerns in California, the Standard has been the sole
beneficiary of such discriminations. In almost every section of the
country that Company has been found to enjoy some unfair advantages
over its competitors, and some of these discriminations affect
enormous areas.

Not only has this resulted in great direct pecuniary advantage in
transportation cost to the Standard, but it has had the far more
important effect of _giving that Company practically unassailable
monopolistic control of the oil market_ throughout large sections of
the country.

Of course, it was just as iniquitous for an American railroad company, with its Government charter, to discriminate in favour of a large customer as it would be for an English one, or for a Government Department, say the Post Office, to sell stamps to a favoured few under their face value. The very secrecy with which the discrimination was invariably surrounded both by the railroads that granted it and the consignors who received it proves clearly that its illegality and injustice were recognised on both sides. It was only gradually that the matter of these secret rebates leaked out, about a couple of years before Mr. Rockefeller consolidated all his refining interests into the Standard Oil Company, of Cleveland, Ohio, where much of the oil-refining business was then carried on. This was in June, 1870. The capital of the new concern was $1,000,000, the parties interested in it at that date being John D. Rockefeller, Henry M. Flagler, Samuel Andrews, Stephen V. Harkness, and William Rockefeller. Before this time Rockefeller’s striking success, which was at first attributed mainly to his extraordinary capacity for bargaining and borrowing, had not only attracted the attention of other Cleveland refiners, but raised their suspicion. They argued that they bought crude oil pretty nearly as cheaply as he, refined it as economically, and sold it at the same price. Yet they could not make money at anything like the same rate. There was only one explanation of it; he must be getting cheaper rates of transport from the railroads.

The matter was tested, and found to be so. Mr. Alexander, of the well-known refining firm of Alexander, Scofield & Co., Cleveland, stated on oath before the Committee of Commerce of the United States House of Representatives in April, 1872, that in 1868 or 1869 he went to the Erie Railroad management and said: “You are giving others better rates than you are us. We cannot compete if you do that.” The railroad agent, Mr. Alexander further testified, did not attempt to deny the allegation, but simply agreed to give Mr. Alexander a rebate also. This was 15 cents (7½d.) a barrel on the regular published rate of 40 cents (1s. 8d.) on all oil brought to Cleveland from the wells. A crude oil shipper, W. H. Doane, made a similar complaint, without mentioning names; and the complaint was stopped by a 10 cents (5d.) reduction per barrel. The method of granting these rebates was significant. The full published rate was paid as usual by the shipper, then at the end of each month, on forwarding vouchers for the amount of oil shipped, he received in cash from the railroad company his 15 cents or 10 cents rebate per barrel, as the case might be. This, I take it, was a precaution to conceal the granting of the rebate by keeping documentary evidence on hand that each shipper had duly paid the same fixed rate.

Later on, in 1880, General J. H. Devereux, who had granted secret rebates as vice-president of the Lake Shore Railroad in 1868, offered a defence of his conduct by means of an affidavit which he made in the case of the Standard Oil Company _v._ William C. Scofield et al. in the Court of Common Pleas, Cuyahoga County, Ohio, November 13, 1880. This affidavit states that “such rates and arrangements were made by the Pennsylvania Railroad that it was publicly proclaimed in the public print in Oil City, Titusville, and other places, that Cleveland was to be wiped out as a refining centre as with a sponge;” that the Cleveland refiners, some twenty-five in number, expressed their fears to him that they would have to give up their business in Cleveland; but that the Standard Oil Company made him a definite proposal to guarantee the Lake Shore Railroad a consignment of sixty carloads a day in return for a rebate of 10 cents on the 42 cents per barrel rate; and that, as this proposal “offered to the railroad company a larger measure of profit than would or could ensue from any business to be carried under the old arrangements,” it was accepted by him. This was a pretty open confession. One might be permitted to think that, as the Lake Shore Railroad’s profit and immunity from competition was thus secured, it would have been in a position to extend the reduced rate to the other refiners also, and thus carry out its duty as a “common” carrier. But it is obvious that it was the essence of its agreement with the Standard Oil Company to give that firm an advantage over its competitors. The cloven hoof is apparent in the excuse tacked on at the end of the affidavit that “this arrangement was at all times open to any and all parties who would secure or guarantee a like amount of traffic.” It was certainly not open in the sense of being published; it was only avowed by the affidavit in 1880, when the unjust discrimination had worked long enough to set the Standard Oil Company definitely ahead of all competition.

It is one of the Standard Oil Company’s most usual contentions that it has reduced the price of illuminating oil to the consumer. Any one who takes the trouble to study the matter from the beginning will see that the Company’s primary object, on which it concentrated all its early efforts, has always been _to raise the price for the consumer_. By 1870 the general competition among oilmen, together with the vast additional supplies of oil discovered, had brought prices down enormously since the time oil was first struck in 1859. Whereas Mr. Rockefeller had received on an average 58¾ cents (2s. 5½d.) a gallon for the oil he exported in 1865, the year he went into business, in 1870 he received only 26⅜ cents (1s. 1¼d.). It was proved beyond doubt by competent testimony during the Missouri suit of the United States _v._ the Standard Oil Company of New Jersey that a wholesale price of 1 cent (½d.) a gallon allows an excellent margin of profit for an oil refiner. But in 1870 everybody in the American oil trade simply despised an “honest livelihood.” They were “out for the dollars,” to use Mr. H. H. Rogers’s expressive indication of his own intentions before the Industrial Commission in 1899. When Mr. J. J. Vandergrift, one of the Standard Oil directors, was questioned under oath as to what they meant to do, he replied, “Simply to hold up the price of oil--to get all we can for it.” And Mr. Rogers declared to the Industrial Commission in 1875 that “oil to yield a fair profit should be sold for _25 cents_ per gallon!”

Prices being “ruinously low” from the oilman’s point of view, Mr. Rockefeller and his friends came forward with a scheme, in January, 1872, for the purpose of holding them up. They had originated the idea among themselves of the industrial “trust,” and the date is consequently a momentous one in the world’s commercial history. This, the first of all industrial trusts, was originally floated by taking over the charter of an existing company, the South Improvement Company, a name which had no earthly connection with that company’s object, but was an excellent one for Mr. Rockefeller’s purpose, as his object had to be strictly concealed in order to be workable. This object, as may be gathered from the text of the contract secretly signed by the Company and the railroads on January 18, 1872, was to destroy the business of all others than itself who engaged at any time in the refining trade. The railroads were to carry the South Improvement Company’s products for such lower rates than those of other firms as would inevitably cause the latter to come a financial cropper. The consideration held out to the railroads for this service was an all-round rise in freight rates of about 100 per cent. and the abolition of competition among themselves by fixing the proportion of oil freight each road was to get, or to be paid for whether it got it or not. The discrimination in favour of the South Improvement Company was to be effected by a secret return to it of from 25 to 50 per cent. of _all the money paid to the roads for oil freight either by itself or by any firm or company in the trade_. How this iniquitous idea could ever have been developed, much less acted upon, it is difficult to imagine from a bald recital of the facts. But the railroads, I find from evidence before the Hepburn Committee in 1879, either believed, or affected to believe, that the South Improvement Company represented practically the whole oil trade, _was_ the oil trade in fact; other firms were, or were to be regarded as, merely unrecognised, unqualified practitioners, who carried on their avocation at their own risk and peril, and whom society could not take into account in making its arrangements.

Whatever the genesis of the idea, there could be no doubt as to its efficacy in disposing of a trade rival when reduced to practice. Suppose a competitor consigns as much freight as yourself, with a 50 per cent. rebate to you and a 50 per cent. drawback paid to you as an involuntary bounty by the competitor, you can regard a 100 per cent. rise in freight rates with equanimity, for it leaves your expenditure under this head exactly what it was before, to say nothing of the bounty, while your competitor pays exactly twice as much as he used to do. While in this position he can be reduced to a state of hopeless impotence by price-cutting, which can be effected at relatively small expense. On the supposition that the competitor’s consignments bulk larger than yours, the bounty received from them becomes larger, till a point is arrived at when your own shipments cost you nothing at all, and you are in the enviable position not only of carrying on business without working expenses, but of being paid handsomely by your rivals for doing so. Something like this _reductio ad absurdum_ in trading must have been actually approached in the case now under consideration, for as a matter of fact the South Improvement Company did not control one-tenth of the refining business of the United States when its contract was signed by and with the railroads on January 18, 1872. Mr. W. G. Warden, of Philadelphia, secretary of the South Improvement Company, admitted to the Congressional Investigating Committee which sat in March and April following that the aggregate refining business of the United States amounted to from 45,000 to 50,000 barrels daily capacity, while the stockholders of the South Improvement Company when formed owned a combined capacity of not over 4,600 barrels--less than one-tenth. This they increased, as we shall see, _in three months time_, to a capacity of one-fifth.

The stockholders in the South Improvement Company held shares as follows:--

Wm. Frew, W. P. Logan, and J. P. Logan, of Philadelphia, 10 shares
each; Chas. Lockhart and Richard S. Waring, of Pittsburg, 10
shares each; W. G. Warden, of Philadelphia, and O. F. Waring, of
Pittsburg, 475 shares each; Peter H. Watson, of Ashtabula, Ohio,
100 shares; H. M. Flagler, O. H. Payne, John D. Rockefeller and Wm.
Rockefeller, of Cleveland, and J. A. Bostwick, of New York, 180
shares each; total, 2,000 shares of $100 dollars each, of which the
Standard Oil interests held 900. The contract was signed on behalf
of the Company by P. H. Watson, president, and on behalf of the
railroads as follows: Pennsylvania, J. Edgar Thompson, president; New
York Central, Wm. H. Vanderbilt, vice-president; Erie, Jay Gould,
president; Atlantic and Great Western, General Geo. B. McClellan.

How completely the railroads were got to play the game of Mr. Rockefeller and his friends is made still more evident by two other clauses of the contract. The first is Section 8 of Art. 2, by which the railroads contracted to send each day to the South Improvement Company manifests on waybills of all petroleum shipped over the roads, which manifests

shall state the name of the consignor, the place of shipment, the
kind and actual quantity of the article shipped, the name of the
consignee, and the place of destination, with the rate and gross
amount of freight and charges.

This, of course, gave the South Improvement Company a full knowledge of everybody else’s business--just what Mr. Rockefeller strove after from beginning to end of his career--and also ensured the due payment of the drawbacks by the roads. The other provision I refer to was contained in Art. 4, whereby each railroad was bound to co-operate

_as far as it legally might_ to maintain the business of the South
Improvement Company against loss or injury by competition, to the
end that it may keep up a remunerative and so a full and regular
business, and to that end shall lower or raise the gross rates of
transportation over its railroads and connections, as far as it
legally may, for such times and to such extent as may be necessary
to overcome such competition, the rebates and drawbacks to be varied
_pari passu_ with the gross rates.

This makes it clear that Art. 3, providing that

rebates hereintofore provided may be made to any other party who
shall furnish an equal amount of transportation and who shall possess
and use works, means, and facilities for carrying on and promoting
the petroleum trade equal to those possessed and used by the South
Improvement Company,

is a mere blind. The South Improvement Company was to be maintained at all costs and against all comers by whatever juggling with the rates should become necessary for the purpose.

It was admitted by members of the South Improvement Company, who appeared before the Investigating Committee appointed by Congress in March, 1872, that the discrimination would have turned over to the Company fully $6,000,000 (£1,200,000) annually on the carrying trade, while the railroads expected to make about $1,500,000 (£300,000) more than on the previously existing rates. The Company would thus make four times as good a bargain as the railroads. It is difficult to see how shrewd business men like the railroad directors could be led into a bargain in which they were so obviously bested. Another point the railroad directors had to consider in the interest of their shareholders was this. The avowed object of the South Improvement Company was to restrict the output of refined oil in order to raise its price. The interest of the railroads was obviously that the prices of oil should be kept low, so that the refiners would be compelled to ship the largest possible quantity. The interests of the shippers and of the railroads which received the shipments were thus diametrically opposed. The former wanted smaller consignments at higher prices, and the latter larger consignments at no matter what price. How the railroad officials could be induced to sign a contract binding them to help in the diminution of their own freights it is difficult to see.

Mr. Frank Rockefeller, brother of John D. Rockefeller, testified before a Congressional Committee on July 7, 1876, that it was his impression at the time that the rebates went into a pool and were divided up between the Standard Oil Company and the railroad officials. He mentioned four of the latter by name, and two of them instantly sent a denial to the Press. Mr. Frank Rockefeller’s evidence--omitting the portion in which he mentions names--is reproduced in the late Mr. George Rice’s well-known pamphlet on the Standard Oil Railway Discriminations (p. 25), as follows:--

By the Chairman:

_Q._ What do you mean by the pool--a pool amongst the railroads or
amongst the oil men?

_A._ I don’t give this as a positive fact, but as I understand
the arrangement, the New York Central, the Erie, the Atlantic and
Great Western, the Pennsylvania Railroad, the Cleveland, Columbus
and Cincinnati, and the Baltimore and Ohio roads have a pool--are
combined for the purpose of shipping oil, and oil only--and in this
pool the Baltimore and Ohio gets a certain number of barrels to go
over its road, the Lake Shore so many to go over its road, and the
Pennsylvania Company so many to go over its road, from different
points in the country, and on the oil that is shipped over these
roads by the pool and the Standard Oil Company there is a rebate or a
drawback from the shipment of so much, which is put into this pool,
over whichever road the oil may go, and that rebate is divided up
between the Standard Oil Company and the railroad officials.

_Q._ The railroad officials, do you say?

_A._ So I understand it. I don’t say that of my own knowledge.

_Q._ Then it does not go to the railroads themselves?

_A._ No, sir.

_Q._ But to the railroad officials?

_A._ To the railroad officials.

There the matter was left by the Committee of Congress, and there it must be left perforce. If the allegation is true, it would explain how the railroad directors could be induced to sign such a bad bargain for the railroads, and if false, it can presumably be refuted by an exhibition of the railroad accounts.

THE RAILROADS AND THE PIPE LINES

“A dollar in those days (1871) looked as large as a cart wheel.”

JOHN D. ROCKEFELLER _in_ “_Random Reminiscences_.”