Herbert Dow and Predatory Pricing
Making the Best Product at the Lowest Price Beats Price Fixing
MAY 01, 1998 by BURTON FOLSOM
Filed Under : Statism
One of the sacred cows of statism is the idea that government needs to protect us from predatory price-cutting. Large corporations, according to this argument, have big advantages in the marketplace. They can cut prices, drive out their competitors, then raise prices later and gouge consumers. Antitrust laws are needed, so the argument continues, to protect small businesses and consumers from those corporations with large market shares in their industries.
The story of Herbert Dow, founder of Dow Chemical Company, is an excellent case study for those who think predatory price-cutting is a real threat to society. Dow, a small producer of bromine in the early 1900s, fought a price-cutting cartel from Germany. He not only lived to tell about it; he also prospered from it.
Born in 1866, Dow was a technical whiz and entrepreneur from childhood. His father, Joseph Dow, was a master mechanic who invented equipment for the U.S. Navy. He shared technical ideas with Herbert at the dinner table and the workbench in their home in Derby, Connecticut. He showed Herbert how to make a turbine and even how to modernize a pin factory. Whether Herbert was selling vegetables or taking an engine apart, his father was there to encourage him.
Dow’s future as an inventive chemist was triggered during his senior year at the Case School of Applied Science when he watched the drilling of an oil well outside Cleveland. At the well site he noticed that brine had come to the surface. The oil men considered the oozing brine a nuisance. One of them asked Dow to taste it. “Bitter, isn’t it,” the driller noted. “It certainly is,” Dow added. “Now why would that brine be so bitter?” the driller asked. “I don’t know,” Dow said, “but I’d like to find out.” He took a sample to his lab, tested it, and found it contained both lithium (which helped explain the bitterness) and bromine. Bromine was used as a sedative and also to develop film. This set Dow to wondering if bromine could be extracted profitably from the abundant brine in the Cleveland area.
The key to selling bromine was finding a way to separate it cheaply from brine. The traditional method was to heat a ton of brine, remove the crystallized salt, treat the rest with chemicals, salvage only two or three pounds of bromine, and dump the rest. Dow thought this method was expensive and inefficient. Why did the salt—which was often unmarketable—have to be removed? Was the use of heat—which was very expensive to apply—really necessary to separate the bromine? And why throw the rest of the brine away? Were there economical methods of removing the chlorine and magnesium also found in brine? The answers to these questions were important to Dow: the United States was ignoring or discarding an ocean of brine right beneath the earth’s surface. If he could extract the chemicals, he could change America’s industrial future.
After graduation in 1888, Dow took a job as a chemistry professor at the Huron Street Hospital College in Cleveland. He had his own lab, an assistant, and time to work out the bromine problem. During the next year, he developed two processes—electrolysis and “blowing out.” In electrolysis he used an electric current to help free bromine from the brine; in blowing out he used a steady flow of air through the solution to separate the bromine. Once Dow showed he could use his two methods to make small amounts of bromine, he assumed he could make large amounts and sell it all over the world.
The next 15 years of bromine production were a time of testing for Dow. He started three companies. One failed, one ousted him from control, and the third, the Dow Chemical Company, struggled to survive after its founding in Midland, Michigan, in 1897.
The bromine market seemed to have potential, but Dow never had enough money because nothing ever worked as he expected it to. Electrolysis was new and untested. His brine cells were too small, and the current he passed through the brine was too weak to free all the bromine. When he strengthened the current, he freed all the bromine, but some chlorine seeped in, too. Instead of being frustrated, Dow would later go into the chlorine business as well. After all, people were making money selling chlorine as a disinfectant. So could Dow. Meanwhile, the chlorine and bromine were corroding his equipment and causing breakdowns. He needed better carbon electrodes, a larger generator, and loyal workers.
Dow found himself working 18-hour days and sleeping at the factory. He had to economize to survive, so he built his factory in Midland with cheap local pine and used nails sparingly. “Crazy Dow” is what the Midland people called him when he rode his dilapidated bike into town to fetch supplies. Laughs, not dollars, were what most townsfolk contributed to his visionary plans. To survive, Dow had to be administrator, laborer, and fundraiser, too. He looked at his resources, envisioned the possible, and moved optimistically to achieve it.
For Dow Chemical to become a major corporation, it had to meet the European challenge. The Germans in particular dominated world chemical markets in the 1800s. They had experience, topflight scientists, and monopolies in chemical markets throughout the world. For example, the Germans, with their vast potash deposits, had been the dominant supplier of bromine since it first was mass-marketed in the mid-1800s. Only the United States emerged as a competitor to Germany, and then only as a minor player. Dow and some small firms along the Ohio River sold bromine, but only within the country.
About 30 German firms had combined to form a cartel, Die Deutsche Bromkonvention, which fixed the world price for bromine at a lucrative 49 cents a pound. Customers either paid the 49 cents or they went without. Dow and other American companies sold bromine in the United States for 36 cents. The Bromkonvention made it clear that if the Americans tried to sell elsewhere, the Germans would flood the American market with cheap bromine and drive them all out of business. The Bromkonvention law was, “The U.S. for the U.S. and Germany for the world.”
Dow entered bromine production with these unwritten rules in effect, but he refused to follow them. Instead, he easily beat the cartel’s 49-cent price and courageously sold America’s first bromine in England. He hoped that the Germans, if they found out what he was doing, would ignore it. Throughout 1904 he merrily bid on bromine contracts throughout the world.
A Visit from the Cartel
After a few months of this, Dow encountered in his office an angry visitor from Germany—Hermann Jacobsohn of the Bromkonvention. Jacobsohn announced he had “positive evidence that [Dow] had exported bromides.” “What of it?” Dow replied. “Don’t you know that you can’t sell bromides abroad?” Jacobsohn asked. “I know nothing of the kind,” Dow retorted. Jacobsohn was indignant. He said that if Dow persisted, the Bromkonvention members would run him out of business whatever the cost. Then Jacobsohn left in a huff.
Dow’s philosophy of business differed sharply from that of the Germans. He was both a scientist and an entrepreneur: he wanted to learn how the chemical world worked, and then he wanted to make the best product at the lowest price. The Germans, by contrast, wanted to discover chemicals in order to monopolize them and extort high prices for their discoveries. Dow wanted to improve chemical products and find new combinations and new uses for chemicals. The Germans were content to invent them, divide markets among their cartel members, and sell abroad at high prices. Those like Dow who tried to compete with the cartel learned quickly what “predatory price-cutting” meant. The Bromkonvention, like other German cartels, had a “yellow-dog fund,” which was money set aside to use to flood other countries with cheap chemicals to drive out competitors.
Dow, however, was determined to compete with the Bromkonvention. He needed the sales, and he believed his electrolysis produced bromine cheaper than the Germans could. Also, Dow was stubborn and hated being bluffed by a bully. When Jacobsohn stormed out of his office, Dow continued to sell bromine, from England to Japan.
Before long, in early 1905, the Bromkonvention went on a rampage: it poured bromides into America at 15 cents a pound, well below its fixed price of 49 cents and also below Dow’s 36 cents. Jacobsohn arranged a special meeting with Dow in St. Louis and demanded that he quit exporting bromides or else the Germans would flood the American market indefinitely. The Bromkonvention had the money and the backing of its government, Jacobsohn reminded Dow, and could long continue to sell in the United States below the cost of production. Dow was not intimidated; he was angry and told Jacobsohn he would sell to whomever would buy from him. Dow left the meeting with Jacobsohn screaming threats behind him. As Dow boarded the train from St. Louis, he knew the future of his company—if it had a future—depended on how he handled the Germans.
On that train, Dow worked out a daring strategy. He had his agent in New York discreetly buy hundreds of thousands of pounds of German bromine at the 15-cent price. Then he repackaged and sold it in Europe—including Germany!—at 27 cents a pound. “When this 15-cent price was made over here,” Dow said, “instead of meeting it, we pulled out of the American market altogether and used all our production to supply the foreign demand. This, as we afterward learned, was not what they anticipated we would do.”
Dow secretly hired British and German agents to market his repackaged bromine in their countries. They had no trouble doing so because the Bromkonvention had left the world price above 30 cents a pound. The Germans were selling in the United States far below cost of production, and they hoped to offset their U.S. losses with a high world price.
Instead, the Germans were befuddled. They expected to run Dow out of business; and this they thought they were doing. But why was U.S. demand for bromine so high? And where was this flow of cheap bromine into Europe coming from? Was one of the Bromkonvention members cheating and selling bromine in Europe below the fixed price? The tension in the Bromkonvention was dramatic. According to Dow, “The German producers got into trouble among themselves as to who was to supply the goods for the American market, and the American agent [for the Germans] became embarrassed by reason of his inability to get goods that he had contracted to supply and asked us if we would take his [15-cent] contracts. This, of course, we refused to do.”
The confused Germans kept cutting U.S. prices—first to 12 cents and then to 10.5 cents a pound. Meanwhile, Dow kept buying cheap bromine and reselling it in Europe for 27 cents. These sales forced the Bromkonvention to drop its high world price to match Dow and that further depleted the Bromkonvention‘s resources. Dow, by contrast, improved his foreign sales force, often ran his bromine plants at top capacity, and gained business at the expense of the Bromkonvention and all other American producers, most of whom had shut down after the price-cutting. Even when the Bromkonvention finally caught on to what Dow was doing, it wasn’t sure how to respond. As Dow said, “We are absolute dictators of the situation.” He also wrote, “One result of this fight has been to give us a standing all over the world. . . . We are . . . in a much stronger position than we ever were.” He added that “the profits are not so great” because his plants had trouble matching the new 27-cent world price. He needed to buy the cheap German bromides to stay ahead, and this was harder to do once the Germans discovered and exposed his repackaging scheme.
The bromine war lasted four years (1904–08), when finally the Bromkonvention invited Dow to come to Germany and work out an agreement. Since they couldn’t crush Dow, they decided to at least work out some deal so they could make money again. The terms were as follows: the Germans agreed to quit selling bromine in the United States; Dow agreed to quit selling in Germany; and the rest of the world was open to free competition. The bromine war was over, but low-priced bromine was now a fact of life.
Dow had more capital from the bromine war to expand his business and challenge the Germans in other markets. For example, Dow entered the dye industry and began producing indigo more cheaply than the dominant German dye cartel. During World War I, Dow tried to fill several gaps when Germany quit trading with the United States. Aspirin, procaine (now better known by its trademark name, Novocain), phenol (for explosives), and acetic anhydride (to strengthen airplane wings) were all products Dow began producing more cheaply than the Germans did in the World War I era. As he told the Federal Trade Commission when the war began, “We have been up against the German government in competition, and we believe that we can compete with Germany in any product that is made in sufficient amount, provided we have the time and have learned the tricks of the trade.”
Move to Magnesium
Dow’s favorite new chemical from the war was magnesium. Magnesium, like bromine and chlorine, was one of the basic elements found in Michigan brine. Dow hated throwing it away and had tried since 1896 to produce it effectively and profitably. As a metal, magnesium was one-third lighter than aluminum and had strong potential for industrial use. Magnesium was a chief ingredient in products from Epsom salts to fireworks to cement.
Unfortunately for Dow, the Germans had magnesium deposits near New Stassfurt. So while he was struggling, the Germans succeeded in mining magnesium and using it as an alloy with other metals. In 1907, they had formed the Chloromagnesium Syndikat, or the Magnesium Trust.
Even before the war, Dow began pouring more capital into magnesium, but only during the war did he begin selling his first small amounts. After the war, Dow still could not match Germany’s low cost of production, but he refused to give up. Instead, he plowed millions of dollars into developing magnesium as America’s premier lightweight metal. Part of his problem was the high cost of extracting magnesium; the other problem was the fixation most businessmen had with using aluminum.
The Germans had mixed feelings as they watched Dow struggle with magnesium. On one hand, they were glad to still have their large market share. On the other hand, they were nervous that Dow would soon discover a method to make magnesium more cheaply than they could. Their solution was not to work hard on improving their own efficiency, but to invite Dow to join them in their magnesium cartel and together fix prices for the world.
In a sense, of course, the Germans were paying Dow the strongest compliment possible by asking him to join them, not fight them. What’s interesting, though, is that through the battles with bromine, indigo, phenol, aspirin, and procaine, the Germans persisted in their strategy of using government-regulated cartels to fix prices and control markets. They continued to believe that monopolies were the best path to controlling markets and making profits.
Dow must have been flattered by the German offer, but he refused to join the Magnesium Trust. He had already shown the world that his company—by trying to make the best product at the lowest price—could often beat the large German cartels. Predatory price-cutting, the standard strategy of the German chemical cartels, failed again and again. By using the strategy, the Germans unintentionally helped the smaller Dow secure capital, capture markets, and deliver low prices for his products around the world.