You know what used to be a fundamental notion of capitalism: creative destruction.
Entrepreneurs with good ideas launch companies, which grow and become more successful, until they are toppled by another wave of smaller, more dynamic firms that deliver better products and services at a lower price.
Jason Zweig has written a very interesting article from the Wall Street Journal that suggests that today, not only is this not happening, it may be operating in reverse.
According to Zweig, new research by economists Gustavo Grullon of Rice University, Yelena Larkin of York University and Roni Michaely of Cornell University suggests that large US firms are growing bigger and are creating a “winner take all” economy.
The argument is that very large firms such as Apple or Google parent Alphabet not only enjoy large economies of scale, but sufficient economic power to suppress competition and prevent erosion of market share.
The Wall Street Journal article notes that 20 years ago, the US had more than 7000 public companies and today there are fewer than 4000. And those fewer corporations are also earning a bigger proportion of corporate profits too.
Zweig reports that by the end of 1986, the 25 companies of the Standard & Poor’s 500 with the highest net profit margins enjoyed a median of just over USD$.20 for every dollar of sales. Today’s top 25 current a median of $.39 per dollar.
While all firms became more profitable, the top earners are pulling away from the pack. Last year’s highest margin firms? eBay, Altria Group, Baxter International, Gilead Sciences, Corning, Visa, MasterCard, Facebook, Amgen, and Biogen.
Three of these firms are in the pharmaceutical sector, which is no surprise and the presence of Visa and MasterCard is expected too. Interestingly, eBay and Facebook are the only software tech firms on the list.
And manufacturers? Altria Group, Baxter International and Corning and those three manufacturers are in radically different sectors.
Altria Group is the new iteration of Philip Morris and as a cigarette maker there’s no surprise that margins are healthy. After smoking those Marlboros for a lifetime, Baxter International takes care of us by making a wide range of healthcare products and hospital equipment. Corning of course, is a broad range manufacturer of technologies from life-sciences, specialty materials to optical fiber and electronic components.
Of those manufacturers, Corning is the only 20th-Century-style traditional manufacturing firm to make the list. Unlike Internet titans, globalization has made it very difficult for large mass producers of consumer goods to dominate markets. Note that neither GM or Ford is on that list.
The research strongly suggests that so-called tech firms grow in ways that maximize profitability by suppressing competition and limiting access to markets. Traditional manufacturers are the opposite, open to attack from other vendors with new ideas for better, low-cost goods and services.
Tesla is a great example, as an upstart automobile manufacturer up against industry giants.
The recent wave of tech IPOs such as Snapchat suggests that the same is true in software, but it remains to be seen how many independent upstart coding firms survive.
I suspect they’ll be gobbled up by cash-rich heavyweights like Google, Apple and Facebook. Will it slow true innovation? It has in the past. Between the enormous cash reserves of major US corporations and increasing barriers to entry for start-up firms, it doesn’t look good.
President Trump has promised to drastically reduce the regulatory burden on American corporations and he could start no better a place than small business. So far, he’s been vague about his plan to reduce regulation in American industry, but it’s early days yet. In manufacturing, we’ll all be watching.