This is the fourteenth in my series of posts about the five businessmen the History Channel profiled in a terribly inaccurate and un-historical TV miniseries titled The Men Who Built America. I’m writing these posts in response to several comments and e-mails from TV viewers who have expressed interest in a more accurate version of the story. (Click here to see all Al’s columns on the program and its subjects.)
Post #14: John D. Rockefeller Decides on Oil
In 1863 twenty-four year old John D. Rockefeller entered the industry that would define his life. He was blessed with exceptional foresight, and he predicted several crucial things about the oil business with such confidence that he was able to bet his career on all of them coming true. In each case he was right.
First, at a time when all the world’s known oil reserves were located within a couple hundred feet of ground level in one small part of Pennsylvania, Rockefeller was confident that the supply would continue to grow.
This was far from a universal belief at the time. Many of the drillers and refiners threw together shoestring operations and tried to put as much cash in the bank as possible before the oil ran out and the rigs had to be abandoned. And it wasn’t just wildcat drillers who expected the petroleum industry to be a temporary phenomenon. Even Andrew Carnegie, whose foresight in business matters was generally very good, expected the oil supply to dry up quickly.
Carnegie and a partner actually hired a contractor to dig a big open pit near Titusville. Instead of immediately selling the crude they were getting from their wells, they dumped much of it into the pit. They thought the value of the oil in their reservoir would skyrocket once all the wells dried up. At some point, as successful wells were still springing up and the reservoir was leaking oil back into the ground, Carnegie pumped it out.
Rockefeller, on the other hand, quickly became convinced that God had provided petroleum for mankind to use, and that the blessing would be large and lasting. “(T)hese vast stores of wealth,” he said, “were the gifts of the great Creator.”
Second, he could perceive that refining was the part of the business where the greatest opportunities lay. Rockefeller made up his mind early that drilling for oil was not for him. There was too much risk involved, and success depended entirely too much on luck. By running a refinery, he could concentrate on efficiency and growth while counting on other people to hunt around for the raw material. He had no reason to worry about which drillers succeeded and which ones failed; all that mattered was that some of them were going to succeed.
Third, he could see that oil was eventually going to become a classic commodity market, where efficiency and volume determined the winners.
Armed with these three assumptions, he laid out a plan to dominate the refinery business. It was an audacious goal for a twenty-five-year-old, but his actions at that time indicate that he planned on nothing less than the kind of success he ended up achieving.
When selling a fungible commodity like oil, the largest producer quite often has the best profit margin. Large volumes of business not only allow for economies of scale, they also provide the producer with bargaining leverage. Rockefeller focused obsessively on growth during his early years in the refining business, knowing that becoming the largest refiner would have key advantages over his competitors.
Starting out with very little ready cash, Rockefeller was eager to plow the company’s profits back into the business, while borrowing every dollar he could persuade the banks to lend him to fund still faster expansion. The future mogul spent every dime wisely. Always the careful accountant, he looked at every expense as an opportunity for increased efficiency.
Wooden barrels at $2.50 apiece were a major expense, so he started his own barrel factory and managed to get his unit cost down to less than a dollar. Plumbing contractors were expensive, so he hired his own plumbers, paid them by the hour, and supplied them with piping and other materials that he bought in bulk directly from the manufacturers. Where other refiners focused on kerosene and burned or dumped waste products, Rockefeller reduced waste (and environmental pollution) by aggressively marketing by-products like benzene, paraffin, and petroleum jelly. There was no market for gasoline in this pre-automotive era, but Rockefeller burned it to power his operations.
Soon he had a falling out with most of his partners over the debts he was racking up. He arranged for financing and bought the Clark brothers out. Andrews, the chemist, stayed with Rockefeller’s new company which they called Rockefeller and Andrews and focused on the day-to-day management of the refinery. Soon the two of them took on a third partner, a man named Henry Flagler.
Flagler was another rags-to-riches story like so many in America’s history. His father was a poor Baptist minister who once stirred up a controversy by marrying a black man to a white woman. Henry struck out on his own at age 14, first working in a general store and then making a small fortune trading in wheat and corn.
Rockefeller’s use of credit to expand his business makes an interesting study. In later years, when Standard Oil was established as the dominant company in the refining business, Rockefeller was content to fund the company’s continued growth with re-invested profits. But during the company’s early years he was so eager to borrow that it caused a breach with his partners. The borrowing was not reckless or irresponsible, it was something the future mogul had thought out carefully.
Those of us who are over a certain age can remember the profligate spending of young executives during the “Dot-Com” boom and bust that took place around the end of the twentieth century. Several unprofitable companies that paid over a million dollars per thirty second spot to advertise during the Year 2000 Super Bowl were out of business by the time the 2002 Super Bowl was played.
This kind of recklessness with money would have appalled John D. Rockefeller. He avoided waste in both his business and his personal life. His cost-cutting and operational efficiencies allowed his company to earn healthy profits that grew rapidly month by month. Personally he was so frugal that he continued to live with his mother and siblings while his company was one of the most profitable in the state. Even after his 1864 marriage he and his wife shared a house with his mother for several years. Only in 1868, after the birth of his first child, did he finally buy a new house for his own family and pay for a separate home for his mother.
Rockefeller was willing to borrow money in the early days because he was desperate to become the largest refiner in the area, and eventually in the nation. He understood the advantages that size would bring in selling a fungible commodity like petroleum products, and he was willing to rack up big debts to win the race for growth.
Cleveland area bankers saw Rockefeller and his partners as nearly ideal customers. Every loan was repaid as promptly as clockwork, and the company’s profits and assets were always growing. By the time Rockefeller repaid one loan and applied for another his company would already be able to boast greater collateral, to justify a larger loan.
By December of 1865 and his partners were using all the space available at their original campus, and they opened a second refinery site, which they called the Standard Works. John D put his younger brother William Rockefeller in charge of the new campus. This was not just nepotism; William had already distinguished himself working for another company, earning raises and promotions at a rapid rate, before coming to work for his big brother.
To reduce the cost of his primary raw material, Rockefeller opened a purchasing office near Titusville where his agent bought crude oil directly from the drillers, eliminating the middleman.
Marketing was not neglected either. By the end of the Civil War most of the kerosene produced in the United States was sold in Europe, with the ports of New York being the most direct route. In 1866 John D. sent William to New York to open an export company under the name “Rockefeller and Company.”
With his faith in the future of the industry, Rockefeller made critical investments in transportation infrastructure that the railroads were unwilling to make. These investments included, most critically, his decision to build hundreds of tanker cars that the railroads would be able to use to transport his products. His foresight in this area would pay huge dividends in the future.
Next week’s post will cover JP Morgan’s career from childhood through the Civil War years.
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