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Frank Albert Fetter.

Source book in economics, selected and ed. for the use of college classes online

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The Bureau has presented the cost data, combined for a
number of companies, in two forms for each product: (1) It
gives first the average book cost thereof; (2) it has then de-
ducted the average intermediate "transfer" profits, thus show-
ing the revised cost.

One of these companies, the United States Steel Corpora-
tion (hereafter referred to as the Steel Corporation), has also
large intercompany profits on transportation, chiefly in carry-
ing its ore on its own railroads. In the Steel Corporation's



COST OF PRODUCTION IN THE STEEL INDUSTRY 249

costs, wliich are given later, these ''transportation" profits
are also deducted; but not here. Only the Steel Corporation
has such profits to any considerable degree, and to deduct
them in the present combined figures would give an average
for all companies which would be true neither for the Steel
Corporation nor for the other concerns.

Cumulative effect of cost of ore. A fundamental fact
is the cost and profit on ore. Ore is the raw material for
iron and steel, and its costs have an underlying and cumulative
effect through all stages of production and ultimately on the
prices of the finished product. The report shows that there
were high intermediate profits on ore going into pig iron,
with marked cumulative effect on all finished products.

Cost of steel rails. It is impossible to give here the de-
tailed cost figures of the full report. Simply the general
principles are stated, the nature of the information, and its
more striking relations to the public interest. An illuminating
view of costs in general, however, can be had from an outline
of steel-rail production and costs.

Starting with the chief raw materials, ore and coke, the
"book cost" of ore for the five-year period was $2.64. The
only "transfer" profit in the cost of ore itself was an in-
tercompany royalty of $0.02 per ton, leaving a net average
cost of ore of $2.62.

For Connellsville coke, the principal kind used, the cost
was $1.43 (net ton), with no intermediate profits.

Passing now to the next step, Bessemer pig iron. Inter-
mediate profits in ore and in coke, as they go into pig iron,
are large. Furthermore, these costs, profits, and freights to
the furnace are multiplied because it takes about 1.8 tons of
Bessemer ore and over 1 net ton of coke for 1 ton of pig
iron. The average book cost of the ore for 1 ton of pig iron
was $7.36; coke, $3.81; and limestone, $0.43. The so-called
"cost above materials," necessary for converting that ore into
pig iron, was : Labor, $0.73 ; other operating cost, $0.80 ; and
depreciation and general expense, $0.76. The total makes a



250 COST OP PRODUCTION IN THE STEEL INDUSTRY

book cost of pig iron of $13.89. Taking out now the transfer
profit, $1,79, there is left a net cost of $12.10.

Advancing to Bessemer rail ingots, there appears a book cost
of $17.59. All the preceding intermediate profits, however,
have been carried forward in the book cost of the raw ma-
terial, pig iron. Thus, the total "transfer" profits for ingots
were $1.84, leaving a net ingot cost of $15,75.

For heavy Bessemer rails, finally, the book cost was $21.27.
This is based on the book cost of ingots. The final transfer
profits were $2.47. Deducting these leaves $18,80 as the re-
vised cost. The total difference is thus a very considerable
amount. About one-fourth of this revised cost was for labor
in all stages of production, as appearing directly in the cost
sheets.

In the text, the general principles and form of presentation
for other products are the same as for rails.

Rail investment. The relation of these integration profits
to entire integration investment may be roughly illustrated
here. The price of Bessemer steel rails has been fixed for over
10 years at about $28 a ton. The cost, eliminating transfer
(but not transportation) profits, is $18.80 per ton. This
leaves a margin of $9.20. The total mining and manufactur-
ing investment (excluding transportation properties) actually
behind this steel-rail production, from ore to rails, is from $80
to $55 a ton. On this investment the margin, $9.20, represents
a profit of from about 11 to 17 per cent. The margin between
revised cost and price must in this way be distributed over
the entire investment thus attributable to the product in ques-
tion.

Large and small companies; billets. A significant fact is
the difference between the costs of large companies, which are
well integrated, and small companies, which are not. A good
example here is Bessemer billets. In this product interme-
diate profits have also accumulated through ore, coke, pig
iron, etc. For the group of large companies the book cost of
billets was $19.89; for small companies, $22.54. The dif-



COST OF TRODUCTION IN THE STEEL INDUSTRY 251

ferenee was $2.65, But now taking out transfer profits, the
cost for large companies was $17.56 and for small companies
$21.69, a difference of $4.13 between the two. The large
companies represented here included the Steel Corporation,
the Republic, Lackawanna, and Jones & Laughlin steel com-
panies.

Part of this difference in favor of large companies must, of
course, cover a greater investment, due to higher integration ;
part is due to superior efficiency resulting from such integra-
tion; but part represents also monopolistic control, especially
in ore.

In so far as this difference means a larger per cent, of re-
turn on each dollar of investment, it is a real difference in
industrial position between the two groups. This difference
must be considered in any public action affecting both classes
of companies.

Other products. The Bureau has not attempted to revise
these costs beyond the simpler finished products. As the
elaboration increased, the difficulties of revision increased dis-
proportionately. The chief intermediate profits, however, are
in the raw materials, ore and coke, and certainly largely in-
cluded in the pig iron. Accordingly, they are necessarily car-
ried forward into all finished steel products.

A broad survey of "book costs" of steel products can,
however, be obtained from the following table. These costs
have not been revised, and therefore include considerable trans-
fer profits.

UNBEVISED BOOK COSTS.

Products. Total cost.

Open-hearth billets $20.87

Universal plates 21.82

Structural 26.52

Merchant bars 28.12

Wire rods 27 21

Bright coarse wire (net tons) 29.12

Black sheets (net tons) 39. .37

Tin and terne plate 71.23



252 COST OF PRODUCTION IN THE STEEL INDUSTRY

Integration costs of United States Steel Corporation. For

the foregoing combined costs of a number of concerns the
Bureau computed the revised costs. But for the Steel Cor-
poration the Bureau received, from the Corporation itself, its
book costs of various products and the record which it kept
of its own intermediate profits on such products for the year
1910.

Its intermediate profits are the highest and its net costs are
the lowest. This fact, and its unique character and domina-
ting position, make the costs of this Corporation a matter
of public importance.

The Steel Corporation is by far the most highly integrated
concern in the industry. It not only makes pig iron, steel,
and most of the various rolled products, besides some more
elaborated articles, but it also mines its own ore and coal,
produces its own coke, and does all this more completely than
any competitor. Finally, it links up its ore mines with its
furnaces by its own rail and vessel lines and dock companies.
In its control of ore railroads, both north and south of the
Lakes, it stands in a class by itself. For this reason its "trans-
portation" profits, as well as transfer profits, are here de-
ducted to show its net or "integration" costs.

The results of this integration and of the Corporation's
position in the industry are shown by its total integration
costs, as follows:

Integration cost of ore, when mined and transported to lower
Lake ports, $2.40. The book cost was $2.88.

Bessemer pig iron, integration cost, $10.21. The book cost
was $14.39. Included in both cases is an item of general
expense and depreciation — "additional costs" — approximated
at $0.50.

Bessemer rail ingots, integration cost, $12.77. Book cost,
$17.45. (Including in both cases "additional costs" ap-
proximated at $0.60.)

Heavy standard Bessemer rails, integration cost, $16.67.
Book cost, $21.53. (Including in both cases "additional



COST OF PRODUCTION IN THE STEEL INDUSTRY 253

costs" approximated at $1.30.) The difference here, $4.86,
is about equally divided between transportation profit and
transfer profit. This division for rails gives a general idea of
the importance of transportation profits.

These integration costs are the lowest in the domestic in-
dustry. They can not, however, be compared with the com-
bined figures previously given for 1902 to 1906, because of
the difference in the kinds of profit eliminated, the difference
in dates, and the difference in companies.

The intermediate profits which were eliminated to reach
these low costs are the largest per ton in the industry. But
they must be set against the most extensive investment per
ton of product. The margin between these costs and selling
prices must cover a return on all the agencies of mining,
transportation, and manufacture, from the ore and coal to
the finished product,

Profits on railroads and ore reserves. The most significant
profits were those on ore and on railroad transportation. In
so far as the Steel Corporation enjoys monopolistic power,
it lies chiefly in these two factors.

The Bureau's revisions indicate a rate of profit of about
10 per cent, (for the period 1902 to 1906) on the average
total investment of the Steel Corporation in ore (as estimated
by the Bureau in Part I of this report, already issued).
Whether such a rate of return is reasonable in itself is not
of first importance. The essential fact is that 10 per cent,
profit is earned on the whole ore holding. Thus, while earn-
ing 10 per cent., the Steel Corporation can also carry a vast
ore reserve far in excess of its present requirements and so
large as to have distinctly monopolistic features, can exercise
on the entire industry the undefined but real power that such
concentration of the ultimate resource must give, and can
assure itself of the certain increment of value that will in-
evitably occur with the diminishing of our available ore supply
so long as the existing conditions of concentration are allowed
to continue.



254 COST OF PRODUCTION IN THE STEEL INDUSTRY

The ore rates on its two ore railroads have been excessive.
In so far as they exceed a reasonable return, they not only
benefit the Corporation by a high profit on the ore of other
shippers, but correspondingly handicap the business of such
competitors, who must ship over these roads. These rates
were reduced in November, 1911.

Such control of public agencies of transportation by an in-
dustrial corporation carries with it just such possibilities of
abuse, and raises the question whether the public interest in
this industry does not require a segregation of the ore railroads
of the Steel Corporation.

Very respectfully,

Herbert Knox Smith,
Commissioner of Corporations.

The President.



THE STANDARD OIL TRUST

[The Standard Oil Company was one of the first corporations to
organize in the form of a "trust" in the legal sense. The great wealth
of its chief stockholders and its large measure of monopolistic control
have made it, in the popular mind, the typical "trust." May 2, 1906,
the Commissioner of Corporations issued a report on the Transporta-
tion of Petroleum, and May 20, 1907, a report of nearly 1400 pages on
the Petroleum Industry, most of it relating to the Standard Oil Com-
pany. A few comparatively brief extracts from the later report are
here given to illustrate the evidence as to the sources of this company's
monopoly power. A number of uncomplimentary adjectives have been
omitted in order that they may not distract the student's attention
from the statements of facts. The first part of the selection is from
Part I, pp. xv-xx of the Report.]

Its dominant position. In 1904 the Standard Oil Company
and affiliated concerns refined over 84 per cent, of the crude
oil run through refineries; produced more than 86 per cent,
of the country's total output of illuminating oil; maintained
a similar proportion of the export trade in illuminating oil;
transported through pipe lines nearly nine-tenths of the crude
oil of the older fields and 98 per cent, of the crude of the
mid-continent, or Kansas-Territory field; secured over 88 per
cent, of the sales of illuminating oil to retail dealers through-
out the country, and obtained in certain large sections as high
as 99 per cent, of such sales. It also controlled practically
similar proportions of the production and marketing of gaso-
line and lubricating oil. While handling a much smaller pro-
portion of the oil, both crude and refined, in the Gulf and
California fields, this fact has little significance as to its con-
trol of illuminating oil, gasoline, and lubricating oil, for the
reason that the crude of those particular fields produces a

255



256 THE STANDARD OIL TRUST

comparatively small per cent, of these products and is used
mostly for fuel.

The Standard has as its only competitors in the refining
business about seventy-five small refineries, whose total con-
sumption of crude oil is less than that of a single one of
the Standard, to wit, the Bayonne refinery, and less than one-
fifth of the Standard's total consumption. Over fifteen of
these competitors are dependent for their supply of crude
oil upon the Standard's pipe lines, and are so restricted by
this dependence as to be capable of little effective competition
or growth. In the pipe-line business of the eastern and mid-
continent fields it has up to the present but one compet-
itor of any significance — the Pure Oil Company — and that
competitor's pipe-line business is not more than one-twentieth
of that of the Standard. , . .

History of form of organization. Starting with the
partnership of Rockefeller, Andrews & Flagler, formed in
1867, in 1870 these interests took the corporate form of the
Standard Oil Company of Ohio, with a capitalization of $1,-
000,000. At that time they controlled not over 10 per cent,
of the refining business of the country. Within ten years
from that date the process of combination under these in-
terests had been so rapid that they admittedly controlled from
90 to 95 per cent, of this branch of the oil industry, and their
control of the pipe-line business had increased with equal
rapidity. This commanding position having been gained, in
1882 they concentrated their holdings under the Standard
Oil Trust, which included the entire stock of fourteen com-
panies and a majority interest in twenty-six additional con-
cerns. The capitalization of the trust was $70,000,000 and
the appraised valuation of its property over $55,000,000,
Nine individuals, acting as trustees of the trust, owned to-
gether on that date more than $46,000,000 out of the $70,-
000,000 of the trust certificates issued. . . .

In 1892, as a result of a legal attack on this form of
organization, the trustees announced that the trust would be



THE STANDARD OIL TRUST 257

dissolved, and a process of so-called dissolution took place.
This in no way, however, affected the original control of the
aforesaid individuals over the entire concern, because the
stocks of each of the various subsidiary corporations were
not returned to their original holders, but were allotted to
the holders of trust certificates on a pro rata basis, with the
result that the trustees, who had previously held the majority
of the trust certificates, now held a majority interest in each,
one of the constituent companies.

In 1898 contempt proceedings were started against the
Standard Oil Company of Ohio on the ground that it had not
withdrawn from the trust. Thereupon, pending the decision,
these interests selected the Standard Oil Company of New
Jersey as a holding corporation for the constituent Standard
companies, and increased its common stock to $100,000,000 for
that purpose. This company then gave its own stock in ex-
change for the stocks of such companies. This change, like
the previous one of 1892, as was its obvious purpose, left the
monopoly power of the Standard capitalists undisturbed. The
same group of men who had been holders of a majority of
the trust certificates, then of a majority of the stocks in the
subsidiary companies, now became holders of a majority of
the stock of the controlling New Jersey company.

The outstanding stock of this company is about $98,000,-
000. It controls at least 10 refining companies, 4 lubricating-
oil companies, 3 crude-oil producing companies, 13 pipe-line
and other transportation companies, 6 marketing companies,
16 natural-gas companies, and 15 foreign concerns, besides
having close afSliations with a considerable number of other
concerns. . . .

Relations to railways. It is of the utmost importance to
indicate clearly those fundamental facts that form the basis
of the Standard's power. The monopoly of this concern has
never rested on ownership of the source of supply of crude
oil. Not over one-sixth of the total production of crude in
the country in 1905 came from wells owned by the Standard



258 THE STANDARD OIL TRUST

interests. It cannot be too strongly emphasized that its
growth and present power rests primarily on the control of
transportation facilities in one form or another. Additional
means of domination have been found in local price discrim-
ination and other unfair competitive methods in the sale of
products, as well as in the elimination of the jobber; but
throughout its entire history the factor of transportation has
been the keystone of its success.

The . . . railway discriminations obtained by the Standard
in its earlier years as against its competitors did more than
all other causes together to establish it in its controlling posi-
tion. Later, when the rebate, per se (that is, the actual,
physical repayment of part of the freight rate), was sub-
stantially abandoned, the Standard was able, by compelling
the cooperation of the railroads, to establish in place thereof
a system of secret or open discriminations in rates in its own
favor, covering almost the entire country and of such a nature
that throughout large sections it could sell and make a profit
on oil at prices which left no profit for competitors. The
existence of many such important railway discriminations was
set forth in full in the report of the Commissioner on the
Transportation of Petroleum, in May, 1906; and as a result of
that report all the secret rates which had been discovered
were discontinued, and the discriminations in open rates have
largely been abandoned.

Pipe-line system. This system of railway discriminations
allowed the Standard to control substantially that link in
the business that lies between the refinery and the consumer.
By means of its great pipe-line system it also controls the
gap between the producer of oil and the refinery. It has
now a pipe-line system of more than 40,000 miles, covering
completely the Appalachian, Lima-Indiana, Illinois, and mid-
continent fields, with great trunk lines running to the sea-
board and to the great markets and distributing centers where
its largest refineries are located. All attempts on the part
erf others to construct competing pipe lines have been . . ,



THE STANDARD OIL TRUST 259

opposed by the Standard, and usually with success. By
means of . . . litigation and preempting of right of way, by
the aid of railroads which refused rights of way across their
lines and adjusted their rates so as to injure competing pipe
lines, by paying local discriminating premiums for crude oil
in the limited areas reached by rival lines, the Standard has
been able to practically prevent the rise of any efficient com-
petitor in the pipe-line business from the older fields to the
Atlantic seaboard or has destroyed or absorbed rivals already
established.

Having thus established and maintained its monopoly of the
pipe-line business, it has in substance refused to act as a com-
mon carrier or to transport and deliver oil for independent
producers or to independent refineries, and, where making any
rates at all for such transportation, has made them at least
as high as the railroad rate between the same points, although
the cost of pipe-line transportation is very much less.

The economy of pipe-line transportation as compared with
that by rail is a vital consideration. A refiner wholly de-
pendent on railroads for his crude supply cannot hope to
become a factor of much importance in the industry. This
imperative condition of rail-transportation costs has fixed
the location of most independent refineries near the oil fields
and has restricted most of their sales of the refined products
to the comparatively small adjoining sections. On the other
hand, the Standard 's comprehensive pipe-line system has given
it the choice of strategic positions for its refineries near to
the largest distributing and exporting centers of the coun-
try.

Conditions making price discrimination possible [Part II,
pages 27-29]. The methods of marketing oil products lend
themselves to this practice of price discrimination. Illumina-
ting oil and gasoline — and the same is in less measure true of
other petroleum products — are not to any large extent sold
at central markets or through jobbing concerns independent
of the refiner. The Standard Oil Company sells most of its



260 THE STANDARD OIL TRUST

illuminating oil and gasoline in the United States directly
to retail dealers at their own towns. They are largely de-
livered to retail dealers at their own stores by means of tank
wagons. Consequently the prices of oil and gasoline are in
general purely local prices. The retail dealer is ordinarily
not familiar with prices charged in other towns or in central
markets, but even if he were he could not take advantage
of lower prices prevailing elsewhere to buy oil there and bring
it into his own town. The cost of transporting oil in barrels,
particularly in less than carload lots, is higher than in tank
ears. Moreover, tank-wagon delivery is so much more con-
venient than barrel delivery that the retail dealer is ordinarily
unwilling to buy barrel oil even at a lower price.

The Standard Oil Company has established the system of
tank-wagon delivery in the larger towns in all parts of the
United States and in a large proportion of the smaller towns
in the more populous sections. ["Of the towns in which
deliveries of oil by tank wagon were reported, such deliveries
were made by the Standard Oil Company or some affiliated
concern in 97.7 per cent." Part I, page 20,] The business
of its competitors is largely confined to a limited area and to
a limited number of towns within that area. In towns and
sections where there is no competition the Standard can
charge monopoly prices, and by reason of the high prices thus
obtained it can afford to reduce prices in competitive areas
and towns to a point which leaves no profit for the independ-
ent concern.

Independent concerns are compelled to confine their busi-
ness to a limited area and usually to a limited number of places
in such area, first, by reason of the fact, already stated, that
delivery in barrels is either more expensive or less satisfactory
than delivery by tank wagons ; and second, because the limited
volume of their business does not permit them to establish tank-
wagon delivery in many places, since, in order to reduce the
cost of tank-wagon delivery to a reasonable amount per gallon,
it is necessary that a concern should secure a considerable



THE STANDARD OIL TRUST 261

volume of business in each town it enters. Only a concern
with enormous capital could afford to establish a marketing
system in competition with that of the Standard throughout
the entire country and thereby force the Standard, if it de-
sired to cut prices, to sacrifice profit on its entire business.

It • is clear from these considerations that the Standard
has an enormous advantage over any of its competitors in the
marketing of oil. By a vigilant policy of aggressive attacks
on competitors competition is kept strictly localized and scat-
tered, and thus easily controlled. The Standard can make
huge profits on its total business while reducing the profits



Online LibraryFrank Albert FetterSource book in economics, selected and ed. for the use of college classes → online text (page 20 of 30)