Highly concentrated markets are bad for consumers and bad for investors
Market power that’s concentrated in the hands of a few big companies is bad for consumers, bad for productivity and terrible for investors, says Merryn Somerset Webb.
More than half of the packaging rubbish mucking up the UK's beaches and rivers comes from ten companies. That's the conclusion of research from marine conservation charity Surfers Against Sewage.
One-quarter of it comes from Coca-Cola and PepsiCo alone, with Mondelez International (owner of Cadbury), McDonald's, Nestl and Suntory pretty close behind.
This has caused some outrage and no end of demands for behavioural change. Not only must all of us get a grip on our own rubbish disposal, says the charity's chief executive, but the "companies must invest more in the redesign of packaging [and] alternative ways of product delivery".
All quite right, of course. But for investors the ugly piles of branded litter suggest something else: that the markets for not-very-good-for-you processed foods and drinks are incredibly concentrated too concentrated for those of us who believe that competition is the route to successful capitalism. If they weren't, there is no way that ten companies could account for 50% of litter.
Other research backs this up. The latest issue of the Barclays' Gilt Equity Study notes that in the US in particular "aggregate and industry-level measures of market concentration have risen sharply since the millennium". This is not just confined to the technology sector, since the same study found increased concentration in 75% of the sectors it examined.
Andy Haldane, chief economist at the Bank of England, notes that if you use the extent to which companies are able to mark up prices as a proxy for market power, you can see something similar across the G7 economies. Since 1980, average mark-ups have risen significantly in every G7 country, by between 30 and 150 percentage points. Those mark-ups are concentrated "among internationally-operating firms, who perhaps benefit disproportionately from global network economies of scale and scope".
In almost any sector you will find that the rise of the platform business, the global nature of the production process and the effects of low interest rates have combined to produce a couple of very dominant companies, which it is almost impossible to challenge.
Why does it matter?
Back to Barclays. "Companies with market power can extract additional profits by raising prices, suppressing wage growth and discouraging market entrants," it says. Such companies can also just buy out new entrants if they look like they might be a threat. But that's not all. This rise in concentration can also reduce investment and hence productivity too. If you control a market your incentive to improve your systems or product is limited.
Once that has happened, it begins to affect the wider economy and then public policy. Mr Haldane notes that "when companies have a significant degree of market power, the level of output produced is likely to be below the social optimum, creating an incentive for monetary policy to try to offset that by running the economy hotter [being biased towards inflation]".
All this isn't just theoretical. It is happening in practice too. Barclays has a new measure it is using to look at whether concentration is hitting competition. It uses three metrics: investment, labour share (how much of the GDP pie accrues to workers relative to capital) and business dynamism (measured by the number of new businesses and flotations and how often employees move both geographically and between companies).
All of these metrics have declined since 2000, in sync with the rise in concentration. Job churn has fallen 20% since 2000, for example. There are other causes of some of these things demographics affect dynamism but still, the more a sector has seen rising concentration, the sharper the declines have been. The more powerful companies are, the less they pay, the less they invest and the less dynamic and innovative they appear to become.
This might have been bad news for workers. Over the past decade some of the world's biggest companies have effectively become labour monopsonies (a single powerful buyer that controls the market) as the marginal buyer they set the price and set it low. The share of national income that goes to labour (as opposed to capital) in the US has therefore been falling, from 64% in 2000 to 56% by 2016. Seeing as it hasn't fallen below 60% since at least the 1940s, that's a big deal, and an obvious driver behind recent concerns about income and wealth inequality.
It has not necessarily been bad news for investors. If you hold the kind of firms we are talking about here you will have reaped significant rewards already. This kind of thing shoves up profit margins and seems to keep them there.
Note that while analysts constantly expect average profits of, for example, S&P 500 firms to fall a bit, they never seem to. Nine out of ten companies have reported their first-quarter results so far, and average earnings are up 2.2%, against analyst forecasts suggesting a fall of 2.5%. This is one of the reasons everyone frequently gives to justify very high stock market valuations: if margins are never going to revert to the mean, why should stock market prices?
The trouble for investors
The problem for investors, at least is that after many years of paying no attention at all to this stuff, politicians are suddenly focused on it and are even talking about doing something about it.
There is talk of increasing the scrutiny of mergers and acquisitions and of much tighter antitrust legislation. One of the odd things of the past decade has been a fall in antitrust activity even as concentration has risen, says Barclays. You might also see more of the kind of regulation around data and infrastructure sharing that forces big firms to share the resources that keep them dominant. Or you could see a rise in taxation in an attempt to remove from big firms the outsize profits they make from the monopsonies.
Tariffs could be part of this. Force the firms that have made such hay out of globalisation to bring their supply chain home, says Charles Gave of Gavekal, an investment research firm, and they will have to compete for labour in the tight US market. That re-localisation will change the whole dynamic, eventually restoring "the long-lost conditions of optimum economic growth", he says.
All this might sound complicated and uncertain, and it is. But there is a clear message from it. The superstar firms of the past few decades might soon begin to get the beginnings of their comeuppance. Ten years ago, you might have been wise to buy the firms with the brands that created the most beach litter. Today, you should look for those that create less rubbish and those that, with a little regulatory assistance, will be their new competitors.
This article was first published in the Financial Times