World 3.0

by Pankaj Ghemawat

  Updating the analysis to include changes in concentration levels between the late 1990s and the late 2000s, I find that the average five-firm concentration ratio for the eleven industry sample has fallen, from 38 percent to 35 percent. In other words, the increase in average concentration between the 1980s and the late 1990s has been exactly reversed. Figure 5-2 combines these two time periods to depict industry-by-industry changes.

  Note from the figure that carbonated soft drinks, which had a relatively high global concentration level to begin with, reported the greatest increase in global concentration. Otherwise, however, all industries with initial concentration levels above the median reported concentration decreases, and all industries with initial concentration levels below the median reported concentration increases. This suggests that even if the average remains the same, outliers tend to regress back toward it over time. This presents, once again, a more vibrant picture of competition than if the average stayed the same but industries that were already relatively concentrated became even more so.

  Figure 5-2: Changes in five-firm global concentration ratios (C5) since the 1980s

  The soft drink industry, the one exception to that rule, does raise the concern that the preceding conclusions may have been swayed by the sample's bias toward commodities rather than differentiated industries—especially because economists think that differentiated industries offer more room for large companies to dominate small ones by ramping up marketing outlays, and for concentrated industry structures to emerge as a result.11

  To address this concern, I went beyond the eleven industries mentioned above and assembled Euromonitor data for thirty-seven (other) consumer goods industries. I found that the average five-firm concentration ratio did increase slightly—from 32 percent in the early 2000s to 35 percent toward the end of the decade. But this exactly matches the increase experienced by the eleven-industry sample between the 1980s and the 1990s—and since reversed.12 In addition, a recent study of market share changes in more than a hundred categories of food products found that the three-firm concentration ratio was as likely to decrease as to increase.13 Besides, the basic mechanism of concern to economists—increases in advertising outlays squeezing out the smaller players—seems unlikely to apply at a global level given cross-country differences and the consequent dearth of global advertising campaigns in consumer products. None of this creates a strong sense of globalization leading to large increases in concentration in consumer goods industries.

  The technology sector comprises another important area of the economy unrepresented in my original sample of eleven. Here the escalated investment in, say, R&D that might increase concentration does have plausibly global effects for many products (unlike escalated advertising spending). The classic if extreme example is the color film revolution in photography. Opportunities to improve black-and-white film had largely been tapped out by the 1960s as the technology matured. But the increasing consumer preference for color film, which requires physical and chemical interactions of a dozen or more layers of emulsions, triggered an intense R&D race. Kodak, the industry leader, won the race by outspending its competitors. Until the next big technological shift, to digital photography, Kodak and Fuji remained the top two global competitors at the cutting edge of photo technology. Note that while global seller concentration rose, so did global consumer surplus from better picture quality.14

  Of course, what digital photography has since done to film photography is a reminder that the high-tech sector tends to be particularly subject to creative destruction, in which innovations drive economic growth by creating value at the same time that they destroy the value of the sources of market power possessed by established firms (and their workers). In 2005, Kodak still sold $15 billion in film; 2010 sales of film to consumers were projected to be less than $200 million, which would mean nearly a 99 percent drop-off in five years.15 Note that competition of a new kind is what ultimately destroyed Kodak's market power, not competition in kind.

  Competition of new kinds shifts and blurs industry boundaries, complicating attempts to compile meaningful concentration data over time. Still, computations by the Economist indicate that between 1988 and 1998, the top five high-tech companies' combined share of global revenues in each of three broad information industries—long-distance telephony, computer software, and computer hardware—declined by fifteen to thirty percentage points! Since then, based on my work in and knowledge of this sector, long-distance telephony has gotten less concentrated, as have software services, although specific software products and offerings may have become more concentrated. And computer hardware has been transformed beyond recognition by, among other things, integration with communications products, but there is no current counterpart to the way IBM dominated hardware in the era of computer mainframes.

  Of course, we can all think of “exceptions”: high-tech companies that have accumulated significant market shares and, presumably, market power, in specific lines of business in recent years. Dominant positions in information industries are often built on network externalities, which imply that individual willingness to pay for a product or service increases with the number of other people using it (e.g., Google in search or Facebook in social networking).

  Such information monopolies raise real policy issues—as do all “natural monopolies” or situations disposed to winner-take-all outcomes—that will be addressed later in this chapter, when we look at policy responses. But in assessing how concerned to be about such industries, one has to remember to give the process of creative destruction its due. As Joseph Schumpeter put it, “Competition from the new commodity, the new technology, the new type of organization … is as much more effective than the other [competition of the same kind] as a bombardment is in comparison with forcing a door.”16

  In 1998, when the Economist's tech concentration data ends, Microsoft was seen as the big bad wolf, with no major competitor in view. Google wasn't at all visible then since it was literally incorporated in a garage that year. Since then, however, it has replaced Microsoft as the company that makes many nervous. Without being able to predict future disruptions, it's a safe bet that there will be some, especially in the technology-driven part of the economy. These represent competition of a different kind rather than competition in kind—a source of competitive pressure that slips through the nets of concentration measures.

  Beyond Changes in Global Concentration

  The last section should have laid to rest the concern that fewer and fewer competitors are fated to control global markets as a result of global integration. If I wanted simply to debunk World 2.0, we could stop right here. But my objective is more ambitious: to point the way ahead. That means also explaining why we need to move beyond a focus on global concentration levels, and how the World 3.0 notions of cross-country differences and distance sensitivity can help in this regard.

  To understand the limitations of global concentration levels, take another look at figure 5-2, and in particular, at an industry reporting a big decrease, iron ore.17 Despite that, more ink seems to have been spilled about concentration in iron ore than any of the ten other industries in the sample—including carbonated soft drinks, which registered the biggest increase in concentration. Why the asymmetry?

  High and increasing global concentration levels haven't prompted much concern in carbonated soft drinks because, as former Coca-Cola CEO Douglas Daft put it, “No one drinks globally. Local people get thirsty and go to their retailer and buy a locally made Coke.”18 Competition occurs market by market and even if concentration becomes an issue, it does so at the national or regional level, not the global level.

  Iron ore, by contrast, is less sensitive to culture and geography. Indeed, when it comes to sensitivity to language differences and physical distance, iron ore ranks in the bottom quintile of all industries. The top three producers, Vale, BHP Billiton, and Rio Tinto, control 35 percent of world production in 2009 and, more significantly, 61 percent of seaborne trade.19 As a re
sult, this triopoly possesses substantial market power in the globally traded segment, where it has been very aggressive in raising prices. And regulators are the main reason there isn't even more concentration: opposition by the European Commission, among others, helped derail both a hostile takeover bid for Rio Tinto by BHP, and a plan to pool their west Australian assets to save on infrastructure and overhead that might also have made it easier for them to coordinate on higher prices.

  To summarize, global concentration may be high in soft drinks, but concern about it is mitigated by the fact that distance sensitivity tends to be high as well, separating global markets into local markets. Global concentration levels are lower in iron ore (albeit still high in absolute terms), yet spark more concern because distance sensitivity is limited. So instead of looking just at changes in concentration levels, we must look at concentration levels and distance, since the problematic situations are the ones where the global concentration level is high and distance effects are low.

  These and other examples also underline the need to take multiple dimensions of distance into account in deciding whether to calculate concentration at the global, regional, or national levels. (World 2.0 always assumes the first of these possibilities, and World 1.0 the last one.) This, effectively, is what some of the governmental agencies charged with preserving competition—and, particularly, ruling on mergers—have figured out. Thus, the European Commission has historically looked at not just one factor but at several “sources of globalization” and “revealed measures of globalization”20 to define market boundaries. While these are usually presented as a mishmash, table 5-1 regroups them to highlight the correspondence with some of the dimensions of distance presented in the CAGE distance framework in table 3-1.

  Table 5-1: Factors assessed by the European Commission in defining the relevant geographic market

  Cultural distance

  Administrative distance

  Geographic distance

  Economic distance

  Consumer preferences/brand loyalty

  Local specification requirements

  Transport costs

  Potential competition

  Language, culure, lifestyle

  Regulatory barriers to market inter-penetration

  Cross-border import, distribution and marketing infrastructure

  Price differences

  Large market share differences

  Source: Leo Sleuwaegen, Isabelle De Voldere, and Enrico Pennings, “The Implications of Globalization for the Definition of the Relevant Geographic Market in Competition and Competitiveness Analysis,” final report, January 2001.

  U.S. competition policy has historically been even less structured in this regard: a 1996 report by the U.S. Federal Trade Commission concluded that “geographic markets should be defined to include foreign supply response as appropriate, giving due regard both to actual barriers to trade and to the increasing trend towards the globalization of trade and services.”21 While it is hard to argue with the invocation of barriers and levels of cross-border integration, it leaves even more room for discretion—and arbitrariness—in this regard than the European Commission's guidelines.

  What are more interesting are the revised merger guidelines issued in 2010 by the U.S. authorities, which downplay the traditional focus on market definition and concentration levels in favor of evaluation of the likely anticompetitive effects, if any, of proposed transactions on price levels and innovation rates.22 From a globalization-related perspective, these revisions dictate a shift from thinking about how opening up affects industry concentration (the focus of the cartoon with which this chapter began) to how it affects competitive intensity and market outcomes. This is important because competitive intensity can go up at the same time as concentration, rather than being inversely related. An example is provided by the major home appliance industry, in which the five-firm concentration ratio has increased from 30 to 32 percent since 2000. But the relationship between size and performance is even more negative in this sector than in autos, with the two largest players (and consolidators), Whirlpool and Electrolux, lagging most of the other players in the top ten in terms of growth as well as profitability, and depressing overall profitability as well.

  These problems reflect the consolidators' mistaken belief that consumers everywhere will want the same thing—which somehow obscured the reality of still having to offer them thousands of varieties (more than fifteen thousand at one point for Electrolux). Some of the variety reflects significant domestic differences in preference over color, material, size, energy efficiency, noisiness, other aspects of environmental friendliness, basic layout, controls, and so on. But consolidators like Whirlpool and Electrolux face the additional challenges of dealing with the cross-border differences that are summarized in table 5-2.

  Most of these categories are obvious, but the cultural differences, in particular, are worth elaborating. Most obviously, differences in national cuisines significantly impact demand in a number of appliance categories. For example, compared to U.S. refrigerator buyers, Germans want more space for meat, Italians prefer special compartments for vegetables, and Indian families, with a mix of vegetarians and nonvegetarians, require internal seals to stop food smells from mingling. To hold Christmas turkeys, ovens are larger in England than in Germany, where geese are cooked. Germans also don't need self-cleaning ovens since they cook at lower temperatures than the French do. And Indian households tend not to need ovens at all.

  Then there are cultural differences that, while hard to explain, are undeniable, such as the preferences for top-loading washers in some countries and front-loading washers in others. Furthermore, preferences concerning older categories of home appliances are relatively well formed. As one marketing expert put it, “The home is the most culture-bound part of one's life. Consumers in Paris don't care what kind of refrigerator they are using in New York.”23 And note that this discussion has focused on just the cultural differences that affect demand for variety across countries—not all the ones that make cross-border management in this industry challenging (e.g., the linguistic differences underlying the infamous “Nothing sucks like an Electrolux” advertising campaign for vacuum cleaners in the United States).

  Table 5-2: Cross-border differences that drive variety in major home appliances

  Cultural differences

  Administrative differences

  Geographic differences

  Economic differences

  Taste variations

  Electrical standards: plugs, voltages, cycles

  Climate: temperature, sunshine

  Income levels

  Mostly mature products

  Environmental and other regulations

  Bulk or low value-to-weight ratios

  Rate of new household formation

  No cross-border demonstration effects

  Protectionism (e.g., 20% tariffs into U.S)

  Price/availability of substitutes or complements (space, electricity, etc.)

  Given all these differences, markets are still national or regional for most major home appliances—as they still are for many manufactured products and most services, as discussed in chapters 2 and 3. In such situations, concerns about global concentration are unwarranted, whether it is going up or not. But governments have intervened in home appliances to impede not only imports but also takeover attempts by foreign producers, when they should have focused on how opening up influences prices and productivity growth. More appropriate governmental policies are the focus of the next section.

  Toward a More Competitive World

  The chapter began by focusing on global concentration measures of the sort that many proglobalizers as well as antiglobalizers believe are going up as markets become more integrated. The available evidence, while partial, indicates no general tendency of this sort: while some industries exhibit increases in global concentration, others exhibit decreases, leaving average concentration levels (for the sample of industries for which I ha
ve data) more or less unchanged since the 1980s. And looking even farther back in time at the industries for which data are available suggests very steep declines in global concentration since 1950.24 In addition, the fact that executives in autos (and a number of other industries) seem unaware of how concentration has evolved over time within their own industries underlines the point made earlier about data-free discussions of globalization and its effects. Clearly, even partial data are better than none.

  Thinking through how concentration affects market power further narrows the scope of the concentration-related problems that could be caused by opening up. A focus on global concentration fits with a perfectly integrated World 2.0—but not with a semiglobalized World 3.0. Given the general diagnosis of semiglobalization, choosing whether to measure concentration at the global, regional, or national level requires assessing how sensitive a specific industry is to distance of various sorts. Concentration at the global level, as opposed to lower levels of aggregation, is the appropriate focus only when distance sensitivity is low.