Backfires in Nevada : Arco’s Low Prices Buy Problems

LAS VEGAS — It was bold and risky stuff when Atlantic Richfield blew up its credit card on television in 1982, slashed prices and set up shop as the K mart of the gas pumps. The rest, they say in this rough-and-tumble business, is history.

In California, the world’s biggest gasoline market, Arco’s cut-rate prices drove up its share of sales by 70%. From fourth place, Arco clawed its way past Unocal, Shell and Chevron to the top of the heap. Best of all, Arco did it with fewer stations. Profits eventually spurted, and shareholders raved.

“It changed the way gasoline is sold all over the country,” said Scott T. Jones, a former Arco planning executive who heads the energy research group at Wharton Econometric Forecasting Associates in Bala Cynwyd, Pa. “And the winner in all this has been the consumer.”

Big Gain in Sales

If so, Nevada was doubly blessed. Arco was particularly successful there, expanding sharply and posting a nearly tenfold gain to at least 23% of sales. In Las Vegas, where tourists have better places to spend their money, the share captured by Arco’s bargain-basement gasoline prices last year hit 30% or more.

Far from applauding this purported blow against high prices, however, the state of Nevada greeted Arco with a knuckle sandwich.

It was served up by one of Arco’s own dealers who did not like the new order of things and who ran an imaginative campaign that--with Arco’s unintended help--persuaded state legislators and practically everyone else that the big oil company from Los Angeles was up to no good.

Accused of Arrogance

Accused of corporate arrogance and of scheming to run the state’s small gasoline dealers out of business, the nation’s eighth-largest oil firm limped out of Nevada last year after the Legislature first cited the company and its lawyer for contempt and then overwhelmingly enacted a law that took a meat ax to Arco’s company-operated stations in the state.

“It was a bad show by Arco,” said Michael O’Callaghan, the former governor of Nevada who, as chief executive of the Las Vegas Sun newspaper, took to writing front-page editorials beating the oil company about the head. “They donned a cloak of purity, but they had just walked through a mud puddle.”

He was referring to what became known as the “smoking gun”--a confidential Arco planning document written in 1982 that some thought contradicted the company’s public denials of predatory intentions. It has since become popular reading among corporate conspiracy buffs throughout the country.

A rocky tale of grass-roots political triumph and of miscalculations by a large, remote corporation, the donnybrook in Carson City, Nev., has given new impetus to efforts to rein in the retailing behavior of the big oil companies.

Switching their attention to Congress and the legislatures in California and Washington, the opponents of Big Oil hope their Nevada triumph is only the beginning. Otherwise, they charge, the cheap gasoline of today will give way to exorbitant prices tomorrow. Arco and the oil companies’ regional lobbying arm, the Western Oil & Gas Assn., have begun a counteroffensive to avert any more legislative defeats.

“It’s the hottest issue in the business right now,” said Trilby Lundberg, publisher of the Lundberg Survey, the leading oil marketing research firm.

To critics, the Arco blitz offers a fresh look at an old problem: the perceived power of major oil companies--those that own crude oil, refineries and service stations--to drive out competition and control markets.

Independents Were Losers

Nevada was not only an embarrassing episode for Arco, but it called attention to the losers in the company’s winning gasoline strategy. Its jump in sales largely spared the Chevrons and Shells of the world and came almost entirely at the expense of smaller independent operators, some of whose remains are strewn like cattle skulls across the Western states.

In Nevada and the other Western states where Arco operates, the main legal issue is whether Arco used predatory wholesale pricing--that is, offered gasoline to dealers at a price calculated to drive others out of business. The idea would be to get rid of the competition, positioning oneself to raise prices later from the lofty market perch gained in the meantime.

It is a charge that has gotten nowhere to date.

A Los Angeles jury rejected such complaints by two Arco gasoline distributors last year, a federal judge recently dismissed an antitrust suit against Arco by the independent chain USA Petroleum, and the Federal Trade Commission took no action after an informal inquiry into Arco’s tactics. The company has also received a clean bill of health from the state attorney general in Washington, and his counterpart in Nevada sees “not enough evidence” of illegal behavior.

Citing the pro-consumer effect of Arco’s prices and the crowded nature of the gasoline market, regulators say it would be difficult to prove predatory pricing. But FTC staff members unsuccessfully urged an investigation, voicing the same concerns as dealers. Some argue that the antitrust enforcement climate is so lax that the most blatant corporate behavior gets by.

Arco is particularly suspect, an FTC economist wrote, because its Alaska-based self-sufficiency in crude oil gives the company “no incentive to keep prices low after the independents have left the market. . . . The higher the retail price of gasoline, the more its reserves are worth.”

“I wouldn’t pay one bit of attention to what government agencies have or haven’t done,” said Maxwell Blecher, a veteran Los Angeles antitrust lawyer who is appealing the dismissal of the suit against Arco by USA Petroleum. “It took the Nevada Legislature to act while the federal government sat on its fanny.”

Meanwhile, testifying last month at a legislative hearing in Sacramento was none other than Jack (The Giant Killer) Greco. He is an amiable Las Vegas Arco dealer, credentialed teacher and Realtor, and weekend barbershop vocalist who earned his nickname from the local press for his success in taking on the oil industry.

Limit Put at 15

Operating out of a mobile home office that he drove to Carson City each week, Greco prevailed with legislation last June freezing the number of service stations that a major oil company can both own and operate in Nevada and limiting the total to 15. The limit affected only Arco, which had 30 and must find dealers to lease half of them.

Similar laws are in effect in five Eastern states, enacted years ago in times of soaring prices. The laws either raised prices further or lowered them, depending on whose study is believed.

But the story does not start at Greco’s Arco, a small station in a tired section of Las Vegas. It begins at Arco Plaza in downtown Los Angeles where, as spelled out in the company’s previously secret documents, the price-cutting strategy was mapped out six years ago.

Emerging from a prolonged period of federal price controls, Arco executives called a Jan. 26, 1982, meeting of the top-level strategic planning unit and laid out the company’s prospects in a new era of declining gasoline demand and price-consciousness by motorists.

Arco saw its chief threat as the independent gasoline marketers. Despite the demise of many small mom-and-pop dealers or small chains, the emergence of larger independents--typified by Southland Corp., whose 7-Eleven food stores have also become a big peddler of gasoline--has been cutting into the market share of the major oil companies since 1968.

So Arco would play hardball on price. Retreating from the East Coast altogether and consolidating operations in five Western states, Arco would cancel the availability of costly credit and turn its relationship with dealers upside-down.

Burdened with thousands of service stations at choice sites worth far more than the rents that dealers were paying, Arco and other oil companies were also discouraging sales by linking rent to volume: The more gallons a dealer sold, the more rent he had to pay. To correct this, Arco imposed rents based on the land’s value. To meet the sharply higher rent, dealers would have to sell a lot more gasoline. And to make that possible, Arco offered its dealers the best prices in town.

Price War Avoided

From Arco’s standpoint, it worked phenomenally. The greatest fear--that Chevron or some other oil giant would follow suit and touch off a bloody price war--never materialized. Motorists began lining up at Arco stations. Without credit, dealers took in so much cash that they had to make several daily trips to the bank. And Arco was moving oil.

Indeed, the five states where Arco operates--California, Arizona, Nevada, Oregon and Washington--are the only region in the country where the majors as a group are gaining ground on the independents. The reason is Arco.

“Before I knew it,” Greco recalled of the spring and summer of 1982, “I was 8-10 cents below the independents. My volume went from 60,000 to 300,000 gallons a month. We all had to get new safes to keep all the money.”

But anyone who thinks this was the best of all worlds for Arco and its dealers does not know the gasoline business. There might be less love lost between oil companies and their dealers than between any other business partners on Earth.

The dealer ranks claimed that Arco was setting out to get rid of some of its own dealers and replace them with company-operated stores whose pricing policies it can control. Since Arco’s new marketing plan was implemented, Arco has sharply increased the proportion of shops run by its own employees, even while acknowledging that they are less profitable than those run by dealers leasing the stations.

Then, Arco allegedly used its swollen ranks of company-operated stores to drive out independent dealers.

George D. Babikian, the president of Arco Petroleum Products Co. and the man credited with implementing the 1982 marketing plan, attributed all the grumbling to laziness among a handful of dealers who would rather be shielded from competition than run a hectic, high-volume business. In part, he said, it is a normal reaction to the big rent hikes.

“Five to 10 percent of our dealers today dislike us vehemently,” Babikian said matter-of-factly. “If your rent went from $1,000 to $4,000 or $5,000 a month, put yourself in the mind of a dealer: What would your reaction be?”

Paul J. Richmond, a company lawyer who was cited for contempt by the Nevada Legislature for refusing to turn over Arco documents, derisively suggests what dealers really want: “The best possible scenario would be to have one big Arco station in the middle of Las Vegas, and you would be that dealer.”

Document Discusses Departures

But the so-called “smoking gun” document, which Arco tried to keep secret, discussed the wholesale departure of dealers that it expected to result from the new marketing plan and the higher rents:

“There will be a knee jerk reaction and a howl when rents are raised for some by factors of three and four. . . . What happens to the 700-800 stations that dealers would leave? Most would have to be closed permanently or become company operated. Here again the risk of political interference arises, but the lower prices afforded to consumers by these company operated stations (at independent prices) should prevail over dealer resistance.”

It also contains language that some took to mean that, indeed, Arco planned to wait until the dust settled and then raise prices: “There will be a discontinuity period where profits will be lower. . . . Depending on the degree and rapidity of competitive attrition, a lasting period of quite acceptable profitability could ensue.”

Another section lays out a scenario in which “product prices (are) increased after (a) period of losses.”

Conceding that the language “can be read either way,” Arco said its document was only addressing the possible outcomes of a high-risk move. Far fewer than 700 to 800 dealers bailed out, Babikian said. Arco said the number of company-operated stores rose to about 30% of the stations it owns because the company has been expanding by building costly stations with AM-PM convenience stores.

Everyone agrees that the number of company-run shops is coming down. Arco said that was the intent all along as it found dealers to lease the new AM-PM stores. Greco said it is a company retreat after the uproar in Nevada, where the number is dropping by 15 because of legislative fiat.

In a complex and secretive industry where such statistics and pricing data are difficult to sort out, “it’s hard to get the full picture,” said Greg Giordana of the Nevada attorney general’s office. Added Lundberg: “Nobody can solve the riddle because nobody has all the books.”

The main public concern is the effect of Arco’s onslaught on the independent dealers, a feisty bunch. They own their stations and land and might sign contracts with one brand supplier this year, another the next. Others operate entire chains of stations, buying gasoline from refineries that might themselves be independent or owned by major oil companies.

Historically the lowest priced and most innovative dealers, their turf was directly invaded by Arco. The company’s strategy of abandoning credit meant it was not challenging the other majors so much as becoming, in style, another independent. By Babikian’s own estimate, about two-thirds of Arco’s gains in the market came from the ranks of independents.

These operators are part of the lore of the highway and in California are represented by the quaintly titled Serve Yourself and Multiple Pump Assn., headed by 76-year-old Paul T. Erdos of Los Angeles. The group’s name reflects pride at two of the independents’ “firsts”--self-service and the station with several pumps.

Innovations Cited

“Every innovation came from us, starting with the nine-tenths,” boasted Erdos, referring to the posting of prices at 79.9 cents or 83.9 cents a gallon. “We figured out that nine-tenths was almost a penny, and pretty soon the majors followed us. We were the first to put canopies over the pumps instead of just the sky for a roof. We were the first ones who posted prices on a big post.”

Erdos and other critics of the major oil companies paint a future in which roadside service is a thing of the past because Arco is leading a trend to high-volume, low-price stations staffed solely by clerks behind bulletproof kiosks--except for the ones selling milk.

At the mention of Arco, Erdos rattled off the names of more than a dozen of his members who he said have either failed or “sold out under duress” because they could not match the oil giant’s prices.

“It’s a disaster,” he said. “The country can’t afford predatory marketing of Arco’s type. The thinking consumer will say, ‘When Arco’s competition is gone, then what? They can price as high as they want.’ The independents were the ones that kept the market honest.”

It was a show of solidarity by Arco dealer Greco and some of his independent competitors last winter that commanded the attention of Nevadans and drove Arco crazy.

To dramatize Arco’s allegedly predatory prices, Greco offered to sell gasoline from his own pumps to independent dealers. He claimed that he could buy gasoline so cheaply from Arco that he could sell it at “cost plus a penny” to his own competitors for a dime per gallon less than they could buy it wholesale.

“Within 48 hours, we had orders for 7 million gallons a month,” Greco claimed.

While television cameras rolled, independent station owners lined up their 10,000-gallon tankers at Greco’s Arco and started sucking gasoline out of his underground tanks. Greco began ordering more gasoline from Arco to meet the demands of his competitors, an odd bit of business for sure. “Instead of giving me the golden nozzle award,” he said, “Arco canceled those orders and ran me out of fuel.”

Arco officials questioned Greco’s motives and suggested his gripe with Arco had its roots in an unrelated business dispute. “When I realized that I myself was part of this plan to eliminate competition in Nevada,” Greco said, “I tried to stick my foot into their machinery. I was doing it more as a citizen than as a businessman.”

Arco’s market leverage could be limited, opponents believed, with a divorcement law that would deprive it of company stores. Newspaperman O’Callaghan arranged a private debate in his office on the issue between Greco and Arco’s agents. The loser, as determined by Callaghan, was Arco.

“Arco had me pretty well sold at first, but I had them all in and it wasn’t a very good show,” O’Callaghan said. “Arco was arrogant, putting down Greco. I was searching for the truth, but all I was getting was a lot of denials and puff. I wasn’t looking at it from a political viewpoint. I was looking at the possibility that some little people were getting ripped off. I’m no economist, but I’m a consumer. Are we just gonna have one guy handling oil from the wellhead to the gas station?”

Industry on Trial

Big Oil has no constituency to speak of in Nevada--no refineries and little oil production, for example--and might have suffered the burden of its own historical baggage. Though Arco was the target while Chevron, Texaco and the rest dodged the fray, the industry itself was on trial as well.

One lawmaker was a retired Unocal distributor who delivered a speech attacking oil companies. Another comes from the mining town of Yerington, where Arco closed down a copper mine in the late 1970s and threw some people out of work. O’Callaghan was running the California region for the U.S. Office of Emergency Preparedness in 1969 when an oil platform managed by Unocal spilled 20,000 barrels of crude oil into the Santa Barbara Channel.

“I ran into those Unocal guys at Santa Barbara, and they were arrogant,” O’Callaghan said. “That’s what these Arco guys reminded me of.”

Babikian conceded the general point: “We’re the ones responsible for divorcement passing in Nevada.”

Whether the Arco system goes too far or is just an example of hard-nosed competition, the company seems to be trying, in its way, to mend fences in Nevada. In addition to trying to head off legislation elsewhere, the company hopes to reverse the Nevada law.

Among other things, the firm has made several well-publicized charitable donations in the state, including a $5,000 gift to the Nevada Assn. for the Handicapped. The association’s Michael O’Callaghan Building is named for the Arco nemesis and boss of the Las Vegas Sun who lost a leg in the Korean war and is a leader in the handicapped community.

An Arco spokesman confirmed that there was a big increase in corporate gifts in Nevada last year, to about $55,000. But he said that was part of a policy change to spread more corporate largess to all its marketing areas outside California, not just Nevada.

“We learned long ago you can’t buy political support that way,” the official said.