One important thing I’d include: while adding more people (i.e. more than two) creates the possibility of individuals becoming worse off, it also very quickly removes most of the incentives for strategic negotiation behavior (i.e. hiding information, faking skill, threatening to blow up islands, etc). Even with just a dozen people/islands, multiple people have to form a cartel in order to achieve high price for a particular good, and it only takes one defector to break a cartel.
In general, yes, but there can be other factors that reduce the possibility to interact with many possible partners.
Geographical local monopolies—there are thousands of islands in the ocean, but most of them are too far from your home. You could replace your nearest trade partner with someone further away, at an extra cost; and if your nearest trade partner pushes you too far, you will do it. But within that interval, the negotiation is important.
Upfront transaction costs—even if the trade partners are equivalent, but it is costly to start interacting with another one (you have to do a complicated background check, you need to adapt to their specifics), this again creates an extra cost of switching, and an interval within which it is about negotiation.
Both can apply at the same time.
There is also a gray line between “cartel” and “people doing the same thing, acting selfishly, but updating on their competitors’ past actions”. To make it simple, imagine that that a fair price for a ton of bananas is $100. (Fair price = what would be the market balance if anyone could trade with anyone, in a world with zero transaction costs.) But there is a $8 cost for trading with someone who is not your geographically nearest trade partner. In this situation, the banana buyers can individually precommit to buy at e.g. $95, because they know that you will prefer to sell them for $95 rather than sell someone else for $100, pay $8 for transit, and only keep $92.
Now imagine the banana buyers have a website, where they publicly share their experience. (This is perfectly legal, right?) And there is this highly upvoted article called: “Don’t buy bananas for $100, you can get them for $95 using game theory”. It becomes common knowledge that the banana sellers suck at negotiation (they don’t have an analogical website), and that most banana buyers only pay $95. -- Armed with this knowledge, you can now precommit to only pay $90 for a ton of bananas next year, because now it is known that the best price your neighbor can get from anyone else is $95.
How many iterations can happen, depends on the exact shape of diminishing returns. For example, even if I was willing to pay $100 for my first ton of bananas, but using my power of precommitment I already got them from my neighbor for $85, I am probably not willing to pay $100 for the second ton of bananas. Suppose the second ton of bananas is only worth $90 to me. But to obtain it, from someone who is not my neighbor, I would have to pay $85 + $8, which is more. So I will not defect against the new equilibrium. -- Here I act almost like a cartel member (my first ton of bananas is worth $100 to me, and at the end I only buy one ton, and yet I precommitted to not pay more than $85), but I am still only following my selfish incentives, and at no point I am sacrificing a potential extra profit in favor of keeping the balance.
I feel like I am reinventing here the Marxist class conflict, in a more general form, with emphasis on sharing negotiation tactics. The essence is that one side shares their negotiation tricks, which work individually even if no one else is using them (this is what makes it not a cartel), but quickly become a new standard if shared; and the new standard—and the common knowledge thereof—becomes a more powerful leverage (this is what makes it cartel-like in effect) in the following iteration of negotiation. The power to say: “Yes, you noticed that I am using this dirty trick against you, but we both know that all my competitors use exactly the same trick, so you cannot punish me by switching to another. And it is perfectly legal, because we coordinated this publicly. Your side as a whole sucks at negotiation, my side successfully turned it into a global leverage, and you as an individual face an uphill battle here.”
What we see in reality is that companies tend to consolidate into bigger and bigger conglomerates.
It’s easy to see why.
As small companies compete, you naturally get market leaders. As these companies get larger they become more efficient at producing goods and services. They invest in mass production techniques in order to produce goods more cheaply than their competitors. They buy raw materials at cheaper prices because they buy in bulk. They expand specialization amongst their workforce. The bigger they get, the easier it is to make money.
When two market leaders merge they achieve massive economies of scale. This forces others to merge in order to compete, leading to ever greater concentration. Monopolies often buy their rivals.
It’s not a matter of being “evil”, it’s just a natural outcome of capitalism. If they don’t, a competitors will.
What we see in reality is that companies tend to consolidate into bigger and bigger conglomerates.
It’s easy to see why.
I recently finished reading a book on theory of the firm, a branch of economics which studies where the boundaries of companies end up and why they end up there. For instance, why do companies in-house some functions and outsource others? What’s the equilibrium number of companies in an industry? Why don’t companies end up larger or smaller than observed?
Based on that background knowledge… your empirical claim here is true only in a relatively narrow subset of industries, and the “easy to see why” part is just wrong.
There are many industries where companies do not tend to consolidate, and even in industries where companies do consolidate there’s usually an equilibrium with new companies constantly entering the industry. Larger companies are not always more efficient at producing goods and services—size introduces inefficiencies of its own, and industries vary in the extent to production costs decrease at scale (sometimes production is cheaper at smaller scale!).
On the “why” side of things, there’s no inherent reason why large-scale production has to take place within a single company—many of the benefits of scale can be achieved via multiple independent companies pooling resources (as is commonly the case in e.g. the finance industry). This was the first and primary insight which really kickstarted the theory of the firm—why do some industries see a few giant companies, rather than many smaller companies with resource-pooling agreements? Presumably there are trade-offs between the overhead of contracts and the overhead of company management, and those trade-offs are exactly what the theory of the firm studies.
Restaurants, car dealerships, spas and hair salons, construction, plumbers and electricians, doctors and lawyers. Every industry dominated by small businesses.
Even in some of the sectors you list—like automotive manufacturing—we haven’t seen much net consolidation. We haven’t seen a lot of new entrants, but’s it’s not like the number of car manufacturers is rapidly decreasing either. It’s at an equilibrium, and that equilibrium has a lot more than just one company—which is not something you’d see if economic forces generally favored consolidation.
Restaurants, car dealerships, spas and hair salons, construction, plumbers and electricians, doctors and lawyers.
What you are saying is that services can be provided by small companies.
Fair enough.
But we still can see consolidation there.
Starbucks uses a tactic known as ‘clustering’. They’ll build several cafes right in the same area to obliterate competition. This costs a lot of money, but they can afford it… They even use a strategy called ‘predatory real estate’. They pay more than market rate rents to keep competitors out of a location.
Even in some of the sectors you list—like automotive manufacturing—we haven’t seen much net consolidation. We haven’t seen a lot of new entrants, but’s it’s not like the number of car manufacturers is rapidly decreasing either. It’s at an equilibrium, and that equilibrium has a lot more than just one company—which is not something you’d see if economic forces generally favored consolidation.
The American automotive market consolidated from more than 250 manufacturers in 1909 to fewer than 50 by 1930. How many companies are there now?
One more example:
At the end of 1985 there were 18,000 banks in the United States. By 2007, this had been reduced to just 8,534, and since then has dropped further. Today, the ten largest U.S. financial institutions own more than 50% of total financial assets.
Of course there have been particular cases where an industry consolidated during a particular period. You made a much stronger claim: that industries in general tend toward consolidation. Pointing to two or three examples where industries consolidated does not provide much evidence for such a claim. On the other hand, pointing to examples where industries did not consolidate provides significant evidence against such a claim.
Of course there have been particular cases where an industry consolidated during a particular period.
That period being… any moment in time.
You made a much stronger claim: that industries in general tend toward consolidation. Pointing to two or three examples where industries consolidated does not provide much evidence for such a claim.
I didn’t point to “two or three examples”, but eleven business sectors dominated by huge conglomerates.
On the other hand, pointing to examples where industries did not consolidate provides significant evidence against such a claim.
You responded with a single sector: services.
Even then, I gave a counter-example showing how big companies can drive small companies away.
And you see that happening all the time: Starbucks, McDonalds, etc.
The consolidation is a process, it didn’t finish yet.
Services are not “one sector”, they’re generally considered a category of sectors, and they comprise a majority of all first-world economic activity. If something is true of the service sectors, then it’s true of the majority of the economy.
Your eleven business sectors are not all dominated by huge conglomerates. Automotive production is, but automotive sales aren’t. Construction isn’t. Electronics isn’t. Finance is mixed bag, depending on the sub-sector. Healthcare isn’t. Insurance has big conglomerates on the backend, but lots of small independent salespeople on the frontend. Internet infrastructure is dominated by large companies, but the volume of small e-companies operating on that infrastructure is massive. Oil and gas is more concentrated than most of these sectors, but I’d still guess that you’ve never looked at the numbers enough to notice the long tail of medium-to-small oil producers (I have seen some of those numbers). Pharma is also relatively concentrated, and there the pressure toward aggregation is real. Retail has a long tail. Telecoms is concentrated, though it’s become less concentrated in recent decades.
Note that, in each of these sectors there do exist large conglomerates. That does not mean that the industry is dominated by conglomerates. The big conglomerates are highly visible and salient; the small companies are not.
So out of these, you’re right on maybe half of them if I’m generous. Overall, it sounds like you’re making a really strong claim without ever having looked at the data, and the data does not back the claim.
Retail is a prime example of consolidation—think of Walmart,
Sales by the 20 largest food retailers totaled $515.3 billion in 2016, accounting for 66.6 percent of U.S. grocery store sales, up from 42.2 percent in 1996. Amazon acquired Whole Foods in the summer of 2017. (Source)
Fast forward to 2020, “Amazon and Walmart are like two elephants wrestling, and all the other retailers in the U.S. are the grass” (Source).
Telecoms is concentrated, though it’s become less concentrated in recent decades.
Telecom is another classic example of consolidation.
A long antitrust case completed in 1984 led to the old AT&T being broken into seven regional Bell operating companies and the much smaller new AT&T.
Less than 30 years later, in 2009 the Department of Justice started to look into whether AT&T and Verizon were abusing the market power they had amassed in recent years.
Now… you don’t have to take my word for it. Google for “consolidation in _____ industry” and you are going to see the phenomenon being repeated everywhere.
You still seem to be missing the key point: if you want to claim that industries tend toward concentration in general, citing particular concentrated industries isn’t going to cut it. You need to argue that industries which don’t concentrate don’t exist (or are at least rare), not merely that industries which do concentrate do exist. That requires a more comprehensive view. You cannot get there just by picking particular industries and arguing that they’re concentrated.
You still seem to be missing the key point: if you want to claim that industries tend toward concentration in general, citing particular concentrated industries isn’t going to cut it.
Well… I gave you some examples in trillion-dollar industries and asked for counter-examples.
Many of your counter-examples—car dealerships, spas, hair salons, etc—are niche markets.
Few of them were multi-billion industries, and they provide more examples of consolidation.
Just google for “consolidation in restaurant industry” and you will find articles like “6 reasons for restaurants’ massive consolidation wave”, “Deals and consolidation dominate restaurant industry”.
“With the rise in demand for their service, combined with the dire situation COVID-19 has created for most of the population, platforms such as Uber Eats and GrubHub are facing increased scrutiny over restaurant fees that can range from 10% to 40% of gross transactions, according to restaurant owners. (...)
In the future, retailers and customers can expect to pay even more in delivery fees, as the few delivery conglomerates monopolize the market and limit retailers’ ability to sustain a profitable business.”
One important thing I’d include: while adding more people (i.e. more than two) creates the possibility of individuals becoming worse off, it also very quickly removes most of the incentives for strategic negotiation behavior (i.e. hiding information, faking skill, threatening to blow up islands, etc). Even with just a dozen people/islands, multiple people have to form a cartel in order to achieve high price for a particular good, and it only takes one defector to break a cartel.
In general, yes, but there can be other factors that reduce the possibility to interact with many possible partners.
Geographical local monopolies—there are thousands of islands in the ocean, but most of them are too far from your home. You could replace your nearest trade partner with someone further away, at an extra cost; and if your nearest trade partner pushes you too far, you will do it. But within that interval, the negotiation is important.
Upfront transaction costs—even if the trade partners are equivalent, but it is costly to start interacting with another one (you have to do a complicated background check, you need to adapt to their specifics), this again creates an extra cost of switching, and an interval within which it is about negotiation.
Both can apply at the same time.
There is also a gray line between “cartel” and “people doing the same thing, acting selfishly, but updating on their competitors’ past actions”. To make it simple, imagine that that a fair price for a ton of bananas is $100. (Fair price = what would be the market balance if anyone could trade with anyone, in a world with zero transaction costs.) But there is a $8 cost for trading with someone who is not your geographically nearest trade partner. In this situation, the banana buyers can individually precommit to buy at e.g. $95, because they know that you will prefer to sell them for $95 rather than sell someone else for $100, pay $8 for transit, and only keep $92.
Now imagine the banana buyers have a website, where they publicly share their experience. (This is perfectly legal, right?) And there is this highly upvoted article called: “Don’t buy bananas for $100, you can get them for $95 using game theory”. It becomes common knowledge that the banana sellers suck at negotiation (they don’t have an analogical website), and that most banana buyers only pay $95. -- Armed with this knowledge, you can now precommit to only pay $90 for a ton of bananas next year, because now it is known that the best price your neighbor can get from anyone else is $95.
How many iterations can happen, depends on the exact shape of diminishing returns. For example, even if I was willing to pay $100 for my first ton of bananas, but using my power of precommitment I already got them from my neighbor for $85, I am probably not willing to pay $100 for the second ton of bananas. Suppose the second ton of bananas is only worth $90 to me. But to obtain it, from someone who is not my neighbor, I would have to pay $85 + $8, which is more. So I will not defect against the new equilibrium. -- Here I act almost like a cartel member (my first ton of bananas is worth $100 to me, and at the end I only buy one ton, and yet I precommitted to not pay more than $85), but I am still only following my selfish incentives, and at no point I am sacrificing a potential extra profit in favor of keeping the balance.
I feel like I am reinventing here the Marxist class conflict, in a more general form, with emphasis on sharing negotiation tactics. The essence is that one side shares their negotiation tricks, which work individually even if no one else is using them (this is what makes it not a cartel), but quickly become a new standard if shared; and the new standard—and the common knowledge thereof—becomes a more powerful leverage (this is what makes it cartel-like in effect) in the following iteration of negotiation. The power to say: “Yes, you noticed that I am using this dirty trick against you, but we both know that all my competitors use exactly the same trick, so you cannot punish me by switching to another. And it is perfectly legal, because we coordinated this publicly. Your side as a whole sucks at negotiation, my side successfully turned it into a global leverage, and you as an individual face an uphill battle here.”
What we see in reality is that companies tend to consolidate into bigger and bigger conglomerates.
It’s easy to see why.
As small companies compete, you naturally get market leaders. As these companies get larger they become more efficient at producing goods and services. They invest in mass production techniques in order to produce goods more cheaply than their competitors. They buy raw materials at cheaper prices because they buy in bulk. They expand specialization amongst their workforce. The bigger they get, the easier it is to make money.
When two market leaders merge they achieve massive economies of scale. This forces others to merge in order to compete, leading to ever greater concentration. Monopolies often buy their rivals.
It’s not a matter of being “evil”, it’s just a natural outcome of capitalism. If they don’t, a competitors will.
I recently finished reading a book on theory of the firm, a branch of economics which studies where the boundaries of companies end up and why they end up there. For instance, why do companies in-house some functions and outsource others? What’s the equilibrium number of companies in an industry? Why don’t companies end up larger or smaller than observed?
Based on that background knowledge… your empirical claim here is true only in a relatively narrow subset of industries, and the “easy to see why” part is just wrong.
There are many industries where companies do not tend to consolidate, and even in industries where companies do consolidate there’s usually an equilibrium with new companies constantly entering the industry. Larger companies are not always more efficient at producing goods and services—size introduces inefficiencies of its own, and industries vary in the extent to production costs decrease at scale (sometimes production is cheaper at smaller scale!).
On the “why” side of things, there’s no inherent reason why large-scale production has to take place within a single company—many of the benefits of scale can be achieved via multiple independent companies pooling resources (as is commonly the case in e.g. the finance industry). This was the first and primary insight which really kickstarted the theory of the firm—why do some industries see a few giant companies, rather than many smaller companies with resource-pooling agreements? Presumably there are trade-offs between the overhead of contracts and the overhead of company management, and those trade-offs are exactly what the theory of the firm studies.
Can you give me a few examples? I’ll list a few important industries:
Automotive
Construction
Electronics
Financials
Healthcare
Insurance
Internet
Oil and gas
Pharmaceutical
Retail
Telecommunications
In each one of these, you’ll find a bunch of big players.
For example:
Automotive
Volkswagen (Germany)
Toyota (Japan)
Daimler (Germany)
Ford (US)
Honda (Japan)
General Motors (US)
Internet
Google
Facebook
Retail
Walmart
Amazon
Costco
Even if you consider new entrants (such as Tesla) we are still talking about a few companies that dominate the industry.
Can you list any important sector where we don’t see consolidation?
Restaurants, car dealerships, spas and hair salons, construction, plumbers and electricians, doctors and lawyers. Every industry dominated by small businesses.
Even in some of the sectors you list—like automotive manufacturing—we haven’t seen much net consolidation. We haven’t seen a lot of new entrants, but’s it’s not like the number of car manufacturers is rapidly decreasing either. It’s at an equilibrium, and that equilibrium has a lot more than just one company—which is not something you’d see if economic forces generally favored consolidation.
What you are saying is that services can be provided by small companies.
Fair enough.
But we still can see consolidation there.
Starbucks uses a tactic known as ‘clustering’. They’ll build several cafes right in the same area to obliterate competition. This costs a lot of money, but they can afford it… They even use a strategy called ‘predatory real estate’. They pay more than market rate rents to keep competitors out of a location.
The American automotive market consolidated from more than 250 manufacturers in 1909 to fewer than 50 by 1930. How many companies are there now?
One more example:
At the end of 1985 there were 18,000 banks in the United States. By 2007, this had been reduced to just 8,534, and since then has dropped further. Today, the ten largest U.S. financial institutions own more than 50% of total financial assets.
Of course there have been particular cases where an industry consolidated during a particular period. You made a much stronger claim: that industries in general tend toward consolidation. Pointing to two or three examples where industries consolidated does not provide much evidence for such a claim. On the other hand, pointing to examples where industries did not consolidate provides significant evidence against such a claim.
That period being… any moment in time.
I didn’t point to “two or three examples”, but eleven business sectors dominated by huge conglomerates.
You responded with a single sector: services.
Even then, I gave a counter-example showing how big companies can drive small companies away.
And you see that happening all the time: Starbucks, McDonalds, etc.
The consolidation is a process, it didn’t finish yet.
Services are not “one sector”, they’re generally considered a category of sectors, and they comprise a majority of all first-world economic activity. If something is true of the service sectors, then it’s true of the majority of the economy.
Your eleven business sectors are not all dominated by huge conglomerates. Automotive production is, but automotive sales aren’t. Construction isn’t. Electronics isn’t. Finance is mixed bag, depending on the sub-sector. Healthcare isn’t. Insurance has big conglomerates on the backend, but lots of small independent salespeople on the frontend. Internet infrastructure is dominated by large companies, but the volume of small e-companies operating on that infrastructure is massive. Oil and gas is more concentrated than most of these sectors, but I’d still guess that you’ve never looked at the numbers enough to notice the long tail of medium-to-small oil producers (I have seen some of those numbers). Pharma is also relatively concentrated, and there the pressure toward aggregation is real. Retail has a long tail. Telecoms is concentrated, though it’s become less concentrated in recent decades.
Note that, in each of these sectors there do exist large conglomerates. That does not mean that the industry is dominated by conglomerates. The big conglomerates are highly visible and salient; the small companies are not.
So out of these, you’re right on maybe half of them if I’m generous. Overall, it sounds like you’re making a really strong claim without ever having looked at the data, and the data does not back the claim.
Isn’t it? Think of a subcategory.
Lenovo, HP, Dell and Apple dominate 3⁄4 of the computer market.
Samsung, Apple, Huawey and Xiaomi dominate 3⁄4 of the smartphone market.
I could go on and on.
Retail is a prime example of consolidation—think of Walmart,
Sales by the 20 largest food retailers totaled $515.3 billion in 2016, accounting for 66.6 percent of U.S. grocery store sales, up from 42.2 percent in 1996. Amazon acquired Whole Foods in the summer of 2017. (Source)
Fast forward to 2020, “Amazon and Walmart are like two elephants wrestling, and all the other retailers in the U.S. are the grass” (Source).
Telecom is another classic example of consolidation.
A long antitrust case completed in 1984 led to the old AT&T being broken into seven regional Bell operating companies and the much smaller new AT&T.
Less than 30 years later, in 2009 the Department of Justice started to look into whether AT&T and Verizon were abusing the market power they had amassed in recent years.
Now… you don’t have to take my word for it. Google for “consolidation in _____ industry” and you are going to see the phenomenon being repeated everywhere.
Or read “America’s monopoly problem, explained by your internet bill”.
You still seem to be missing the key point: if you want to claim that industries tend toward concentration in general, citing particular concentrated industries isn’t going to cut it. You need to argue that industries which don’t concentrate don’t exist (or are at least rare), not merely that industries which do concentrate do exist. That requires a more comprehensive view. You cannot get there just by picking particular industries and arguing that they’re concentrated.
Well… I gave you some examples in trillion-dollar industries and asked for counter-examples.
Many of your counter-examples—car dealerships, spas, hair salons, etc—are niche markets.
Few of them were multi-billion industries, and they provide more examples of consolidation.
Just google for “consolidation in restaurant industry” and you will find articles like “6 reasons for restaurants’ massive consolidation wave”, “Deals and consolidation dominate restaurant industry”.
How about the small restaurants? According to “Food Delivery Consolidation: Good For Now, But Not For Long”, platforms such as Uber Eats and GrubHub are taking 10% to 40% of gross transactions:
“With the rise in demand for their service, combined with the dire situation COVID-19 has created for most of the population, platforms such as Uber Eats and GrubHub are facing increased scrutiny over restaurant fees that can range from 10% to 40% of gross transactions, according to restaurant owners. (...)
In the future, retailers and customers can expect to pay even more in delivery fees, as the few delivery conglomerates monopolize the market and limit retailers’ ability to sustain a profitable business.”