The End of Power (32 page)

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.
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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.

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 about 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.
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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.

Disruptive technologies began to appear in almost every industry. Small-scale solar, wind, and biomass energy plants are bringing electricity to vast populations that have never had it, lifting lives, promoting the development of small-scale industry, and challenging the dominance of traditional utilities. Miniaturization and portability have changed manufacturing in marvelous ways—and, in the process, have lowered barriers to entry that once seemed immutable. In some industries it is no longer necessary to build very large facilities to gain an interesting market share. While mini breweries will not displace the likes of Heineken and mini steel mills will not overtake a giant like ArcelorMittal, smaller firms such as these are now able to capture sufficient market share in their geographical areas to introduce more competition in markets where choices have been limited. And as noted above, financing for good business ideas has become more available thanks to fundamental changes in the financial industry. In most countries, access to capital is no longer the insurmountable barrier to the creation or expansion of a new company as it once was.

The ramifications are nearly endless, ranging from staffing requirements to insurance costs to the ability to move operations from site to site quickly. Containerization has streamlined shipping and allowed efficient, reliable intermodal transportation of goods of all kinds. In 2010, the volume of container traffic was more than ten times that in 1980.
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Almost all of the technologies that we either see in museums (the steam engine) or take for granted (the radio) represented a disruption in their time. But today's technological revolution is unequalled in scope, touching almost every human activity in the world at dizzying speed.

Looking further, we find that almost every major change in the way we live today, relative to even just a generation ago, spells the erosion of barriers to entry. Indeed, the
More, Mobility
, and
Mentality
revolutions and their degrading effects on the power of incumbents are clearly visible in the business world. The examples are many: The integration of the world's
capital markets by wire transfers and electronic banking have changed the way capital is allocated and moved worldwide. Whole new cultures of investment—from venture capital and angel investors to micro-lending—have taken hold and connect money with users near and far. Migration has transported business knowledge and practical experience in ways that regulatory change and investment incentives cannot rival. It has also created world-spanning financing networks across diasporas as well as niche markets for entrepreneurs attuned to community needs.

The combination of these forces is what sets apart today's convulsions of capitalism from those that preceded them. There is more of everything, it moves wider and faster, and people's expectations have dramatically changed. A global market; the largely unfettered movement of vast sums of money, goods, brands, technology, and talent across borders and uses; the rise in value of knowledge and branding relative to natural resources and physical equipment; the emergence of credit in places where it was once scarce or nonexistent—all of these are among the now-familiar forces that have reshaped national economies. In so doing, they have not just changed the playing field on which businesses compete. They have also thrown open competition to new players, ushering in credible and savvy rivals that barriers of regulation, resources, knowledge, capital, or reputation had long kept out. As those barriers have grown porous, the conditions have emerged for fragmentation and displacement of traditional players in the long term, even though short-term trends in some industries and countries seem to point toward concentration.

Of course, this general trend admits exceptions. But a quick look at some of the most daunting past deterrents to competitive entry reveals the thoroughness of the underlying transformation.

In 2007, News Corporation, controlled by Rupert Murdoch, achieved a long-held goal when it bought a hallowed property, the
Wall Street Journal
, for $5.6 billion. A few weeks earlier, Google had purchased the Internet ad–serving firm DoubleClick (founded in 1996) for $3.1 billion and Microsoft had bought the even less-known ad-serving firm aQuantive (founded in 1997) for $6.3 billion. While the venerable
Journal
with its seasoned journalists, bureaus, presses, portfolio of buildings, and fleet of trucks (all assets owned by the Dow Jones company) sold for a hefty sum, a pair of
online advertising firms with just the briefest of histories and virtually no physical assets whatsoever sold for a combined total almost twice as high.

An artifact of an overheated, bubble market for Internet properties? Indeed, Microsoft announced a $6.2 billion write-down of its aQuantive purchase in 2012
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—but that's only part of a continuing story that found another, more recent expression in the 2012 purchase by Facebook (itself an Internet creation of recent vintage and of staggering valuation) of In-stagram, a company with a dozen employees and no revenue, for $1 billion. For that money, Facebook could have bought the
New York Times
, Peet's Coffee, Office Depot, or Cooper Tire & Rubber, to name just a few companies with a similar valuation.