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Hackernoon logoMore or Less Competitive? by@arnoldkling

More or Less Competitive?

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@arnoldklingArnold Kling

There are many indicators of consolidation in U.S. businesses. Big firms are getting bigger, and small firms are falling by the wayside. This is a very important trend to discuss. Does it mean that competitive forces in the economy are weakening? Or are we seeing the outcome of a more competitive economy, one that makes the winners stand out from the losers?

Indicators of consolidation

In February, author Jonathan Tepper posted an essay that gave some examples of consolidation.

Two corporations control 90% of the beer Americans drink.
When it comes to high-speed internet access, almost all markets are local monopolies; over 75 percent of households have no choice with only one provider.
Four airlines completely dominate airline traffic, often enjoying local monopolies or duopolies in their regional hubs. Five banks control about half of the nation’s banking assets.
Many states have health insurance markets where the top two insurers have 80–90% market share. For example, in Alabama one company has 84% market share and in Hawaii one has 65% market share.
Four players control the entire US beef market.
After two mergers this year, three companies will control 70 percent of the world’s pesticide market and 80 percent of the US corn-seed market.

One can easily come up with other examples. The five largest banks now hold over 40 percent of deposits. Google and Facebook have 60 percent of the digital advertising market. Apple and Samsung have 70 percent of the U.S. smartphone market. In the retail sector, the stock market has declared Wal-Mart and Amazon the winners while pronouncing other well-known retailers the losers.

Economic Consolidation on the Electoral Map

Consolidation also is evident if we look at the U.S. economy from a regional perspective, and this can be illustrated relative to a map of electoral politics. Mark Muro and Sifan Liu of the Brookings Institution compared the economic output of counties that voted differently in the last national election.

with the exceptions of the Phoenix and Fort Worth areas and a big chunk of Long Island Clinton won every large-sized county economy in the country. Her base of 493 counties was heavily metropolitan. By contrast, Trumpland consists of hundreds and hundreds of tiny low-output locations that comprise the non-metropolitan hinterland of America, along with some suburban and exurban metro counties

If you weight each county by the market value of its output, then in the 2000 election Democratic Presidential candidate Al Gore won the “economy vote” by 54 % to 46 % (although in the electoral college he lost to George W. Bush). Sixteen years later, even though Hillary Clinton captured a dramatically smaller number of counties than Mr. Gore, she won the “economy vote” by a landslide: 64 % to 36 %.

The point I am trying to make is about economics, not politics. Grouping the county output data in this way shows a dramatic consolidation of economic activity, primarily in coastal cities.

Deaths among firms outnumbered births

Yet another indicator of consolidation comes from trends in business dynamics. The Economic Innovation Group reports,

Something jarring occurred with the onset of the Great Recession which threw the cycle of creation in the economy dramatically out of balance. For the first time, the United States experienced a collapse in new business creation so severe that companies were dying faster than they were being born.
The number of businesses being added to the economy has ground to a halt over time. During the recovery period from 2010 to 2014, the economy added just over 100,000 firms. Compare that to a prior era — the recovery from 1983 to 1987 — when the size of the national economy was much smaller than it is today and the United States generated an increase of nearly half a million new businesses.

On U.S. stock markets, the number of listed companies has been declining, and the average size of listed companies has grown. After reaching a peak in 1996, “the number of domestic US-listed public companies decreased precipitously through 2003, with almost 2,800 companies lost because of M&A activity and delistings.

These indicators depict a business environment in which: leading firms and leading regions are getting stronger; other firms and other regions are getting relatively weaker; and newer firms are having a harder time breaking in. In a word, consolidation.

Possible Explanations for Consolidation

Why are we seeing this phenomenon of consolidation? There is no answer that stands out to me as definitive. As of now, I can only offer some possibilities.

  1. Perhaps government has become more tolerant of mergers. If we were looking for hard evidence for this, we would list mergers that are allowed today that would have been blocked in the past. My guess is that one can find evidence like this in the banking industry, certainly in comparing the environment in 1970 with what we see today. But I am less confident that one could make a hard case that in other industries the government used to take a much harder line against mergers.
  2. Perhaps the cost of regulatory compliance has gone up. For example, in health care, the cost of meeting requirements for electronic medical records, compliance with privacy standards, and other regulations have substantially raised the overhead cost of operating a medical practice. As a result, doctors are abandoning solo practices or small groups in order to affiliate with larger group practices or with hospital-based clinics. Increased regulatory compliance costs also could be a factor in consolidation in banking and in fewer firms seeking to be listed on public stock exchanges. However, consolidation also is taking place in other sectors that have not been hit by a surge of new regulations.
  3. Network and bandwagon effects. Businesses that are embedded in the Internet tend to benefit from network and bandwagon effects. The more people that use Facebook or Google, the more value that those firms can offer to additional users and to advertisers. Network and bandwagon effects tend to create markets in which winners take most.
  4. Perhaps globalization plays a part. It could be that we are seeing the emergence of large new enterprises just as in the past, but now more of them are located outside the United States. As some parts of China and other fast-growing countries climb the economic ladder, parts of the U.S. economy slip down a rung or two.
  5. Globalization also gives an advantage to firms that can best manage the opportunities and challenges represented by multinational operations. Some firms are more adept than others at international branding, outsourcing, and supply-chain management. These firms grow stronger, while their less-agile competitors suffer. For example, Wal-Mart has crushed the competition from mom-and-pop stores, in part because of its use of global supply chains.
  6. Another factor separating winners and losers may be the increased importance of computer software. The strategic utilization of software becomes crucial when software is eating the world, as Marc Andreessen put it. Firms led by executives who quickly grasp the business implications of software and the Internet will win, and other firms will lose.

I am inclined to think that software is the most important factor driving the consolidation of recent decades. Mastery of computer systems is vital in today’s competitive environment. One can observe vast differences across firms, or even across divisions within firms, in their ability to incorporate software effectively.

Humans and computers still do not communicate naturally with one another. Achieving alignment between business operations and computer systems is a challenge.

Consider Amazon’s use of the “promise method” for software development, in which the team responsible for developing a module must first document what the inputs and outputs of the module will be before they write any code. This approach is what allows Amazon to divide work into small teams, avoiding the entanglement that afflicts most information technology projects with endless meetings and other costly overhead.

But such disciplined software development requires a disciplined business environment surrounding it. The main reason that most companies use a “code and fix” cycle for software development is that humans naturally use a “code and fix” approach to life in business. Rather than defining clear, specific objectives, we start out with a vague idea and refine it as we go. Not many executives appreciate the burden that is imposed on software teams by “code and fix” business practices.

My hunch is that companies that achieve alignment between business processes and computer systems have powerful advantages over competitors who are less successful at creating such alignment. This drives a big wedge between winners and losers. I suspect that it is a major reason for consolidation.

Implications

Do indicators of consolidation show us that the economy is getting less competitive or more competitive? The answer depends on which explanation(s) you believe to be most important. For example, if network effects or weak resistance to mergers are the main factors, then the winners from consolidation are quasi-monopolists that may be overly insulated from competition. On the other hand, if the winners are firms that have figured out how to develop and deploy software more effectively than their rivals, then the growth of those firms at the expense of rivals just shows us that the force of competition is doing its work.

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