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Business News/ Companies / The growing clout of superstar companies

The growing clout of superstar companies

Though companies like Apple have led to technological and economic progress, their growing dominance could stifle innovation in the future

Only eight nations in the world have governments that generate as much revenue as Walmart Inc. does. Photo: iStockPremium
Only eight nations in the world have governments that generate as much revenue as Walmart Inc. does. Photo: iStock

Since the 2007-10 financial crisis, many writers have attempted to document and analyze the growing inequality among households in the US and elsewhere. Thomas Piketty’s Capital in the Twenty-First Century, Matt Taibbi’s The Divide: American Injustice in the Age of the Wealth Gap, and Joseph E. Stiglitz’s The Price of Inequality: How Today’s Divided Society Endangers Our Future were all New York Times best sellers.

No equivalent literary sub-genre has examined a related and similarly important sort of inequality: the growing dominance of industries and economies by superstar firms, and the implications of this dominance for technological, social, and economic progress.

“Superstar," an idea first applied to companies by the late University of Chicago economist Sherwin Rosen, is an especially apt term for organizations such as Apple, Google, Facebook, Amazon, and Microsoft, with whom nearly everyone is familiar and upon which many of us rely on a daily basis. These companies and others like them have helped to engineer dramatic changes in the way residents of developed countries live, work, communicate, and socialize. But while it may be indisputable that superstar firms have been a force for technological and economic progress, there is a creeping concern that their growing dominance could stifle innovation and progress in the years ahead.

When he first explored the “economics of superstars" (both a description of his idea and the title of his paper) 36 years ago, Rosen argued that modern technologies would make it possible for the superstar performers in any industry to greatly expand the scope of their market while reducing market opportunities for everyone else. Winners would take all (or take most) of the value created. The technological advantages that Rosen presciently described were in the costs of replication, search, and delivery. Digitization has reduced the incremental cost of replication and delivery to virtually zero, and specialized intermediaries such as Google, YouTube, Amazon, and Alibaba have made it easier to find what one is looking for at great speed and at very low cost.

More than 30 years after the publication of Rosen’s paper, academic literature is illuminating how superstars affect the rest of the economy. The empirical data presented in several papers of recent years have helped answer a series of important questions, including how much economic power superstar firms command, where their advantages come from, and what role they play (if any) in exacerbating income inequality across households.

For most of the 20th century, firms with “scale and scope"—companies such as General Electric and General Motors—dominated the US economy. In 1990, however, two management gurus, the late C.K. Prahalad of the University of Michigan and London Business School’s Gary Hamel, asserted that the era of conglomerates was over. Size, they said, would cede advantage to agility and entrepreneurship. As Prahalad and Hamel’s mantra of core competencies spread, large firms such as AT&T were broken up and many firms across the world were privatized.

Twenty-seven years later, size is back. According to the McKinsey Global Institute, 10% of the world’s listed firms generate 80% of all global profits. Firms with at least $1 billion in revenue now account for 60% of total global revenue and 65% of market capitalization. The pursuit of size has led to a rapid rise in mergers and acquisitions: according to the Institute of Mergers, Acquisitions and Alliances website, the number of deals grew from 26,845 in 1997 (with a value of $1.83 trillion) to 48,825 in 2016 (with a value of $3.62 trillion).

The standard metric of monopoly power is the concentration ratio, or the share of the market accruing to the top four (or 20) firms. In a 2017 paper, MIT’s David Autor, Christina Patterson, and John Van Reenen, along with University of Zurich’s David Dorn and Harvard’s Lawrence F. Katz, compute the four- and 20-firm concentration ratios for six sectors of the US economy: manufacturing, wholesale trade, retail trade, services, finance, and utilities and transportation, for 1982–2012. Together, the six sectors account for 676 industries, nearly 4 million companies, and 80% of total private-sector employment.

The author and his co-authors find that the four- and 20-firm concentration ratios have been trending upward in all sectors—and in some of them, quite sharply upward. The four-firm concentration ratio rose by approximately 15 percentage points in retail trade and by more than 10 percentage points in finance.

Crucially, the upward trend in concentration ratios is pronounced for revenue than for employment. Superstar firms are generating more revenue without increasing their employee base by much.

Superstar firms have proven to be especially adept at exploiting the killer combination of demand-side network externalities—forces that make a product or service’s consumer appeal increase as its user base grows—and supply-side economies of scale. Apple has a 20% share of the smartphone market but captures 92% of the industry’s operating profit. Daily, Google processes 3.5 billion searches; Facebook has 1.32 billion active users—together taking in, some estimates say, 60% of all digital advertising revenue.

Importantly, superstar firms excel in their use of the structured and creative management/organizational practices that large and complex projects require.

In 2010, the US Census Bureau conducted its first management and organizational practices survey MOPS. Nearly 40,000 manufacturing firms took part in MOPS, which had 36 multiple-choice questions on their management practices (processes for setting targets, monitoring performance, and providing incentives), organizational practices (structure, span of control, and the use of information), and basic characteristics (the number of managers and non-managers, educational attainment of managers, and union participation).

Stanford’s Nicholas Bloom, Massachusetts Institute of Technology’s Erik Brynjolfsson and Van Reenen, Lucia Foster and Ron Jarmin of the US Census Bureau, and Tel Aviv University’s Itay Saporta-Eksten analyzed this data set by constructing an aggregate score for each firm’s answer to the 36 questions (normalized to a 0–1 scale). The results show there is enormous dispersion in the quality of management and organizational practices across US firms.

Only 18% of establishments employed at least 75% of the structured management practices included in the survey; 27% of establishments adopted less than 50%. The superstar firms that got the highest scores on the adoption of structured management practices significantly outperformed those with lower scores. Even small improvements in management led to significant increases in profits and firm valuation.

In 1990, GM, Ford, and Chrysler had combined annual revenues of $250 billion, a combined market capitalization of $36 billion, and an employee base of 1.2 million. In 2016, the five tech superstars—Google, Apple, Amazon, Facebook, and Microsoft—cumulatively had annual revenues of $559 billion, a market capitalization of more than $2 trillion, and an employee base of 660,500.

Jae Song of the Social Security Administration, Stanford’s Bloom and David J. Price, Fatih Guvenen of the University of Minnesota, and Till von Wachter of University of California at Los Angeles estimate that about one-third of the growth in income inequality across US households since 1980 can be explained by the gap between compensation for employees at the superstar firms relative to their counterparts working elsewhere.

This kind of sway over aggregate income trends brings us back to the huge power that superstar companies wield today. That power can be, and often is, put to excellent use: these companies have the gumption to make the moon-shot investments that even modern-day governments are loath to make. They have the organizational ability to mobilize resources from across the world at warp speed and the management skills to coordinate complex projects. But they also have the incentive and the power to thwart competition and influence the rules of the game.

As Chicago Booth’s Luigi Zingales has noted, only eight nations in the world have governments that generate as much revenue as Wal-Mart does. The largest corporations command resources—money and manpower—that make them more than a match for virtually any governmental agency, let alone their smaller competitors, consumer advocacy groups, or other organizations whose aims may run counter to these corporations’ pursuit of increased profits and market share.

Even if superstars exerted no direct influence on government—and there is plenty of evidence that they do, even in relatively well-functioning democracies, through lobbying, media influence, political contributions, and other means—their power could still work in opposition to a healthy economy. The bigger a company is, the more easily it can gobble up nascent competitors, or take anti-competitive measures against them—for instance, starving them by driving up the cost of materials. Low prices, high wages, and high-quality goods and services are the product of competition between healthy rivals; if one market participant reaches an unassailable point of power, it can create distortions that make everyone worse off. © 2018 Chicago Booth Review. All rights reserved.

Ram Shivakumar is adjunct professor of economics and strategy at Chicago Booth.

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Updated: 14 Feb 2018, 05:49 AM IST
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