Greg Ip reports in the Wall Street Journal:
The same factors that make companies so vital and valuable to customers can also raise barriers to entry. That, in turn, may deter technological innovation, which could be a contributor to the slowdown in growth of productivity, or output per worker, in the last decade.
Marriage is in the air in corporate America. Mergers and acquisitions this year are on track to match the record set in 2007. Merger talks have been under way among the nation’s five largest health insurers by revenue.
This wave could represent both a revival in business confidence and something more troubling: a decline in competition as market power becomes concentrated in the hands of fewer companies.
Competition forces companies to invest in new products and new capacity to hold on to customers and capture new ones. Less-intense competition may thus explain some of the puzzles that hang over the U.S. economy.
Profits are at or near all-time highs, both as a share of economic output or relative to assets. And the cost to borrow has seldom been lower. In a perfectly competitive world, firms ought to exploit those cheap borrowing costs to add profitable new capacity and products, until all the added competition pushes profits down.
That’s not happening, at least not yet. While capital spending has steadily risen from its recessionary trough, it remains—at 114% of cash flow—well below prior peaks of 142% in early 2008 and 157% in 2000.
The main reason companies are reluctant to invest is that economic growth has been sluggish, and looks to remain so. In such an environment, a merger may be a more logical way to grow than adding capacity.
Yet companies may also feel less compelled to invest because they face less pressure from competitors. This may seem at odds with the stream of startups garnering multibillion-dollar valuations from venture capitalists or on the stock market. But Silicon Valley is not typical.
Across the country, the rate of new-business formations has been trending down for decades. According to Census data, the number of new firms in 2012 was equal to just 8% of the total, slightly below the number that closed. While that “entry rate” was up from the 2010 trough, it remains well below the levels that prevailed until the recession hit in 2007.
Like capital spending, startups have suffered from the moribund business climate. But weak startup activity could be both a cause and a consequence of market concentration. If barriers to entry have risen, fewer new firms will attempt to break in. And with fewer new firms, incumbents’ positions become more unassailable.
While the most comprehensive data on market concentration is available only until 2007, it supports the picture of ebbing competitive vigor. That year, the four biggest firms controlled at least half of the market in 40% of individual manufacturing sectors, up from 30% in 1992, according to Rineesh Bansal of Deutsche Bank: “The story of American business over the last generation…is one of declining competition.”
Since 2008, a wave of mergers has left the four largest U.S. airlines in control of 85% of domestic air travel, compared with 60% in 1999, Mr. Bansal says. By comparison, the four largest in Europe control less than 40% of intra-European travel. That, he says, explains why capacity has risen sharply in the last decade in Europe while it’s declined in the U.S. Fares have also risen by less in Europe, and profit margins are just a third of what U.S. carriers enjoy.
Last week, the Department of Justice said it was investigating whether airlines had colluded to restrain capacity growth and keep ticket prices up. The airlines say they compete vigorously, pointing out that fares are lower than in 1999 when adjusted for inflation.
What could explain growing market concentration? John Kwoka of Northeastern University says that in the past 20 years, the Federal Trade Commission has become less likely to challenge mergers in industries with five or more big competitors, while maintaining stiff scrutiny where just a handful of competitors prevail. Rising regulatory burdens, for example on banks, may also favor big firms, since they can spread a fixed compliance cost across more customers.
Several features of today’s fastest-growing industries naturally generate just a few dominant players. One is economies of scale: It costs a lot to build and maintain a popular Internet search engine, and almost nothing to add a user. Another is network effects: The more customers a social network like Facebook has, the more valuable it becomes to other customers. Yet another is the prevalence of intellectual property and proprietary standards, which govern how well one company’s product works with another’s.
The same factors that make these companies so vital and valuable to customers can also raise barriers to entry. That, in turn, may deter technological innovation, which could be a contributor to the slowdown in growth of productivity, or output per worker, in the last decade. Decreased competition could also aggravate inequality by enriching industry incumbents, their shareholders and employees, at the expense of smaller fry.
Thus, finding a way to rejuvenate competition could have widespread benefits. The answer isn’t just tougher antitrust oversight, since mergers can be good for customers and innovation, but for policy makers to take into account how any new policy or rule helps or hurts new entrants to an industry.
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