by Naim, Moises
Globally, industry concentration levels vary a great deal by sector. The diamond industry remains tightly driven by the dominant player, De Beers, which asserts prices and governs the flow of rough diamonds to the enterprises that cut and finish them. De Beers’s 60 percent of the rough-diamond market gives it an overwhelming lever on prices. In the computer chip business, one manufacturer, Intel, controls 80 percent of the market for CPU processors. Other industries in which concentration is high enough to rouse the attention of American or European antitrust agencies are crop seeds (where Monsanto and DuPont dominate), payment networks (where Visa and MasterCard reign), and of course Internet searches (where Google accounts for 63 percent of search activity in the United States—and 90 percent of search growth).
But other industries have become less concentrated despite years of apparently aggressive merger activity. In fact, as business professor and author Pankaj Ghemawat argues in World 3.0, “In most situations, globalization appears to promote more competition, not more concentration.”14 A salient example is automobiles. Industry data show that the top five motor vehicle manufacturers worldwide accounted for 54 percent of production in 1998, and only 48 percent—a small but significant decrease—in 2008. Expanding the analysis to the top ten manufacturers still showed a decrease in concentration. The trend is long-standing. In the 1960s the top ten manufacturers accounted for 85 percent of the world’s car production; that share is now down to about 70 percent. In part, the increased fragmentation of the market reflects the emergence or global spread of new players from countries like Korea, India, China, and elsewhere.15 In 2011, for example, Hyundai was not only the world’s fifth-biggest automaker but also its most profitable.16 In looking at concentration among the top five companies across eleven industries from the 1980s to the 2000s, Ghemawat found that the average five-firm concentration ratio had fallen from 38 percent to 35 percent; that decline is even more pronounced if we reel the numbers backward to the 1950s.17
THE POWER AND PERIL OF BRANDS
Many long-cherished corporate names have performed sudden vanishing acts. Once-prestigious names in retail, banks, airlines, even technology—remember Compaq?—are receding into faint memories. On the other hand, some of the world’s most ubiquitous brands barely existed a few years ago, such as Twitter, founded in 2006. As consumers, we have largely grown accustomed to such trends. Indeed, consumers have been the inadvertent agents of some of this turnover, which has been partly driven by an increase in the rate and impact of brand disasters—incidents that shake the reputation of a company and its products to the core, causing share prices to plummet and consumers to flee. A study conducted in 2010 found that whereas two decades ago companies faced an average 20 percent chance of encountering a “corporate disaster” for their reputation in a five-year period, that chance is now 82 percent.18 Is this because oil spills, failing brakes, and impolitic statements are four times more common today than twenty years ago? No, but their diffusion and reach are faster and far greater, and their louder echo often portends grave consequences.
In this context it should come as no surprise that the most visceral indicator of economic power—individual wealth—is subject to quick changes as well. (Since 2012, Bloomberg News has provided a daily ranking of the world’s top twenty billionaires, updated daily at 5:30 P.M. New York time.) The number of billionaires in the world has soared in recent years; it reached a record 1,226 in 2012.19 A growing proportion are Russians, Asians, Middle Easterners, and Latin Americans. Interestingly, the billionaire who gained the most wealth between 2007 and 2008, Indian industrialist Anil Ambani, was also the one who lost the most the next year (though he still ranked 118 in 2012).20 According to a 2012 study by wealth intelligence firm Wealth-X, between mid-2011 and mid-2012 Chinese billionaires lost almost a third of their combined wealth.21
No one is shedding any tears for the plight of the mega-rich. But the turbulence in the world’s wealth rankings rounds out a picture of insecurity at the top of the business world—whether of bosses, corporations, or brands—that is heightened relative to any time in recent memory, in a business arena that is more global and diverse than at any time in the past.
The turmoil at the top makes an odd contrast with the widely prevailing idea that we live now in an era of unprecedented corporate power. The boom of the 1990s doubtless brought fresh glamour and prestige to corporate careers, and the rise of the high-tech economy created a new generation of business heroes out of the chiefs of Apple, Oracle, Cisco, Google, and the like, as well as superstar players in the world of securities and banking. In Europe, regulatory reforms, privatization, and the creation of a single market gave birth to new corporate icons. Swashbuckling billionaires emerged in Russia, and former Third World nations once derided as recesses of state control and poverty produced burgeoning business empires, brands, and tycoons. Critics from the Left raised alarm at the new dominance of capital. Boosters praised it. But no one disagreed that it existed.
The global recession and financial crisis have done little to clarify our picture of corporate power. On the one hand, the need for governments to rein in unbridled corporate behavior again became apparent. But so did the notion that certain businesses—banks, insurers, automakers—were “too big to fail”; they could not be allowed to go out of business without immense adverse regional, national, or even global consequences. Some, like General Motors and Chrysler, were saved by government intervention. Others, like Lehman Brothers, were allowed to go under. Banks deemed too shaky to survive were sold to larger ones, creating ever-larger behemoths and bolstering claims of critics who saw power concentrating in a tight-knit, untouchable financial elite. Unquestionably, corporate giants exist today on a scale barely imaginable a few decades ago. Some industries have consolidated a great deal. And clearly antitrust and other key regulations, whether in North America, Europe, or elsewhere, have fallen behind some of the tools and techniques that businesses—especially in finance—employ on a daily basis.
So which is our reality? Unbridled corporate power that foists costs and liabilities on governments and taxpayers while preserving high pay and profits for executives—or insecure business leaders constantly at risk of being squeezed by new entrants and technologies, thwarted by reputational disasters, scrutinized by market analysts, and ultimately removed by rebellious shareholders and impatient boards? In other words, what is happening to the power held by large corporations and their top executives?
MARKET POWER: THE ANTIDOTE TO BUSINESS INSECURITY
To understand the fundamental forces that are transforming corporate power in the twenty-first century, we need to explore a concept that was introduced in Chapter 2: market power.
Pure economic theory assumes cutthroat competition, which means that upheaval is the normal state of affairs in capitalism inasmuch as competition kills some companies and rewards others. The ideal state known as “perfect competition” leaves no space for monopolies, cartels, or a small number of dominant companies to prevail, let alone endure for years.
Reality is obviously different: some companies persist while others go under; legendary investors and executives rule for decades while others vanish as fast as they appeared; some brands seem to be ephemeral artifacts of passing fashion while others are able to outlast any number of technological transformations, market expansions and contractions, and management changes. Some large companies make it impossible for others to compete in their market, and small groups of companies in the same sector collude to extract the most profits for the longest possible period of time. Also, the very nature of some sectors where low barriers to entry are the norm facilitates the entry of new competitors (restaurants, garments); in others the barriers are so high that it is very hard for new companies to challenge the incumbents (steel mills, mobile telephony).
In other words, capitalist business contains a wide variety of patterns and expectations that manifest themselves in the symbolic language of our investor and consumer society. They
produce enduring competitive oppositions (Boeing versus Airbus, Coke versus Pepsi, Hertz versus Avis); they turn brand names into vernacular common nouns (Xerox, Hoover, Kleenex); they invest some (Rolex, IBM) with prestige and others (Timex, Dell) with practicality. When they obliterate, they do so ruthlessly. Be it Pan Am, Woolworths, Kodak, or Wang—the end of a corporation, whether dissolved or absorbed into another, is a vanishing act.
What stokes this constant motion of symbols, products, people, and names is in large part the day-to-day action of sellers and buyers in the market—as well as risk-taking, accidents, mistakes, happenstance. But it is also power. And this is where market power comes in: it is the power that dwells in being able to charge prices for products and services that are above marginal cost, and hence generate and sustain extra profits, without ceding market share. The more market power a company possesses, the more autonomously it can set its own prices without worrying about rivals. The more market power is present in a given sector or marketplace, the more entrenched its industry structures and the more static its league tables.
In real life, products are not interchangeable, and even when they are, they are differentiated by brands and promoted by advertising. In real life, companies do not have access to the same information. They do not enjoy the same laws and rules for running their operations or solving disputes, the same tacit or overt backing from governments, or the same access to precious resources. Intellectual property restrictions carry rather different weight in Switzerland than they do in China. A US firm with a large “government affairs” division dedicated to lobbying politicians in Washington, a Russian company founded by an oligarch with personal friendships in the Kremlin, and an Indian company finding its way through the tangle of decades-old licensing and bureaucratic requirements face drastically different regulatory environments from one another, let alone from a startup seeking to enter an industry for the first time. Companies also differ with respect to the internal resources they have to train personnel and develop new products. All of these differences in business scope, resources, and operating environment affect the cost of doing business, decisions to expand, and the choice of whether to take on an activity in-house or to farm it out to a supplier or contractor. In short, they produce the structure of industries.
A whole field of economics—industrial organization—arose almost a century ago to make sense of industry structure and explain what made it change, or not change. As discussed in Chapter 3, the field drew on the insight of Ronald Coase, the British economist who in 1937 first propounded the notion that transaction costs helped to explain why firms and industries took particular shapes.22
Individually or together, the companies that dominate a particular industry or marketplace spend a great deal of their energy working to keep things that way. For a company, the aim is to present a unique and attractive selling proposition—one that is hard for any other to imitate, or replicate. It can protect that position by means of exclusion and by means of collusion. Exclusion might involve driving out competitors by undercutting them on price, pulling ahead of them on quality or product innovation, or deluging the market with advertising. Collusion could take the form of setting up obstacles that make it difficult or impossible for a new competitor to enter—in particular, when the companies that dominate a space tacitly (or overtly) coordinate pricing and sales strategies or technology standards, or use public relations campaigns and industry associations to argue for regulations that give them shelter. Whatever enabled incumbents to exclude and collude also limits the horizon for new competitors, and therefore creates barriers to entry that could be insurmountable.
This explains why economists who seek to identify market power at work often move past the numbers to investigate the more qualitative question of how daunting the barriers to entry are in a given field. There are quantitative measures of market power as well, but they are hard to use.
More useful are the measures that economists use to determine market power in a given industry rather than at the level of an individual firm. A variety of such measures are available. A simple one is the top-firms concentration index, which adds up the total market share of the leading firms (the top four, five, or ten in sales or assets, for example) in a given industry or economy.23
But market power goes beyond concentration alone. In some highly regulated economies or industries, relatively small companies might benefit from market power simply by being inside the fence of government protection or political favor. Think, for example, of a taxi company that has the exclusive rights to service passengers arriving to a specific airport. Likewise, the simple presence of industrial concentration does not necessarily mean that the firms act as an oligopoly, using overt or tacit collusion to keep prices high; the competition between them might be intense and vicious. Other factors that contribute to market power, such as the ability to lobby for favorable treatment and laws, do not stem directly from industry concentration. A trade association that represents a scattered industry (e.g., accountants or dentists) might achieve lobbying results as successful as those of one acting on behalf of a concentrated industry (e.g., cement or basic telephony).
To understand the workings of market power, therefore, a single quantitative measurement is not enough. Rather, the extent of market power and, with it, the stability of an industry’s structure and the advantage of shelter that its dominant firms enjoy are best gauged by looking at the presence and effectiveness of barriers to entry. And when we do this, a salient trend quickly becomes clear: across the board, the traditional barriers to entry that shaped industry structure for the better part of the twentieth century have grown porous or fallen altogether.
Axioms of corporate organization have been overturned. As a result, market power is no longer what it used to be. The antidote to business insecurity and instability is losing its effectiveness. And the advantage long considered to be built into corporate scale, scope, and hierarchy has been blunted, or even transformed into a handicap.
BARRIERS ARE DOWN, COMPETITION IS UP
The classic barriers to entry in business are well known. Size, for example, prevents smaller companies from taking on larger ones. And economies of scale make it cheaper to mass-produce items, justifying such innovations as the large-scale modern factory and the assembly line. When a few, large manufacturers are able to capture a large portion of the market, they can spread their total fixed costs (administration, for example) over a large number of units, thus lowering the average cost of each individual unit.
A related set of barriers originates in economies of scope. Experience in related but not identical businesses can give a company an advantage that its rivals lack. For instance, a company that has large contracts to supply airplanes to the air force will have enormous advantages when competing in the market for passenger airplanes. While economies of scale are a function of volumes, economies of scope emerge when a company is able to use its unique knowledge and core competencies in different markets. Access to scarce resources, such as mineral deposits, fertile soil, or abundant fisheries, becomes a barrier when potential competitors can’t access similar resources. Capital is of course another obstacle. Launching a new airline or a telephone or steel company requires huge capital expenditures that few newcomers can afford. Technology is another common barrier to competition: a formula, manufacturing process, or any form of exclusive intellectual capital not available to would-be competitors also dampens competition. The same is true for a brand name: competing with Coke and Pepsi is hard not just because of their size but also because their products enjoy enormous brand appeal.
And then there are the rules: the laws, regulations, ownership codes, tax policies, and all the other requirements to operate in a given location and industry. All these (and many variations—there is no single standard list of every barrier to entry in business) typically entrench the position of dominant firms in any given industry and hold new entrants at bay.
Which brings us to the core question ab
out the transformation of power in the business world: What might cause barriers to entry to suddenly fall and thus make long-entrenched companies more vulnerable to power-loss? One obvious answer is the Internet. Examples of how it has helped to dislodge established monopolies are as legion as the possibilities of the medium itself. In fact, few sectors have been untouched by the revolution in information and communication technologies.
Yet, as is also the case in other arenas discussed here (politics, war, etc.), beyond the information revolution there are forces at work that have altered the way power is acquired, used, and lost in the business world.
In the last three decades, for example, government actions have drastically altered long-fixed business structures. Margaret Thatcher and Ronald Reagan launched a wave of policy changes that spurred competition and changed the way of doing business in a variety of sectors from telephones and air travel to coal mining and banking. Starting in the late 1980s, developing countries from Thailand to Poland to Chile implemented their own revolutionary economic reforms: privatization, deregulation, trade opening, elimination of barriers to foreign investment, freer currency trading, financial liberalization, and a host of other competition-boosting changes. The development of the European Union with its opening of internal borders, new regulatory apparatus, and the introduction of the euro has had a huge impact on the competitive landscape, as has the expansion of global and regional trade agreements.
These policy initiatives have had at least as much impact in changing the global business environment as the advent of the Internet. Indeed, some analysts attribute as much as one-quarter of postwar trade growth in the advanced economies to policy reform, primarily in the form of tariff cuts.24 The integration into the global economy of China, India, and other large markets that had been kept relatively closed by protectionist and autarchic economic policies brought billions of new consumers and producers into world markets. These epochal policy shifts were amplified by other revolutions in technology; together they led to a world in which the old barriers to entry could no longer protect incumbents from the assaults of new challengers.