Why consolidation?

In my latest essay, More or Less Competitive?, I discuss the very important question of what accounts for the apparent consolidation within industries, with a few winners taking large market shares. I think that the role that software plays in the competitive environment is a big factor.

The strategic utilization of software becomes crucial when software is eating the world, as Marc Andreessen put it. Firms led by executives who quickly grasp the business implications of software and the Internet will win, and other firms will lose.

Read the whole thing (so far, not many people have).

13 thoughts on “Why consolidation?

  1. So basically the whole economy is becoming like Hollywood economics so a few winning firms, few big winners income and a very large payroll on the bottom. Every once in awhile there is a large disruption (say the New Wave, 1970s filmmakers, etc.) but global consolidation continues. (Note on Hollywood just check out the global earnings on American diversity right center movies like Star Wars and Marvel. Also note how many immigrants work in Hollywood.)

    1) Is it any wonder with this situation labor supply signals too much? Again slowing down college needs to convince the labor demand side not supply side IMO.
    2) I suspect this is the reason why global family formation is decreasing. I bet the next generation will have the Baby Bust Crisis if African continues to declining. (I will love the Davos crowd coming up with solutions.)

  2. Doesn’t this dovetail with Tyler Cowens “The complacent class@?

    Anyway, great read. Please keep posting on medium.

  3. I think you are overlooking one key factor: access to capital. Part of the reason so much tech has consolidated around Northern California is that’s where the money is. There are smart people everywhere. There aren’t rich people everywhere.

    • I thought Tech consolidate in Northern California originally because of its proximity to Southern California defense industry location from 1960 – 1990. It seems reasonable that a group in Utah (or anywhere in the US) could access capital necessary for a tech company. (Although it is very risky capital.)

  4. All the examples are examples of public corporations as opposed to other forms of business. These corporations trade against the treasury yield curve and are subject to the ebb and flow of huge federal spending patterns. They tend to be formally or informally part of the TBTF banking system we use. Theu have to be big, they help insure guv against default.

  5. I think the concentration has to be viewed more case by case.

    re#1 from the essay: Amazon, Facebook, Apple, Microsoft, Google, Intel, to my knowlege Walmart and Oracle – were not created by mergers, but are all fundamentally “organic” – so if firms are growing large by such organic processes, rather than GM or GE style roll-up mergers, anti-merger law won’t have much effect on concentration. This argument would not apply to beer, pesticide, or drug, companies.

    From the essay:
    “My hunch is that companies that achieve alignment between business processes and computer systems have powerful advantages over competitors who are less successful at creating such alignment.”

    Surely so – BUT – does that really explain concentration in insurance markets? All insurance companies are actuary software + management software + a bank. All of them. Unless you show that the SAME firm has huge market share in many states, it’s hard to see “better at software and business integration” explains huge market shares in various states (but not in all…)

    How does this explain consolidation in beer, pesticides, drugs, or beef?

    Also – automobile manufacture became heavily consolidated well before digital computing was extent – surely the forces that drove that are still extent?

    • Facebook is well known for buying up related companies, e.g., WhatsApp. Google, too, e.g. YouTube. Friends who are dog owners tell me their mail order pet supply company now seems to be part of Amazon.

  6. I think that software is a major factor. Custom software development is very expensive, and the benefits are hardly immediate.

    One factor you didn’t consider is an analysis of the differences in available business opportunities today vs. in the past. As the economy becomes more complex and specialized, success is often less and less about a singular innovation. Often the biggest returns are only available to companies that can chain together multiple technologies and operations to produce a significant efficiency gain. Automating a task is great, but automating a complex workflow is far more powerful.

    The iPhone is a perfect example. Apple had to reach thresholds of technical gain in dozens of technologies to make their phones “smart”. The resulting profits have been epic.

  7. This is a profoundly important topic and I hope you explore it in multiple themed posts. In my view, as I’ve tried to outline here in other comments, it is one of the key topics the understanding of which, and the underlying mechanisms driving it, are the keys to unlock insightful analysis of the various economic mysteries of our time. The regulatory complaince / overhead costs hint at economies of scale, but in my opinion it would have been better to mention it explicitly.

  8. Here are two potential test of the “scarce supply of the best software-savvy managers” theory of consolidation, since it’s hard to observe or manage “good software development management” directly.

    1. Are measures of company health in the sector correlated with company size or market share? Relatedly, how dynamic are sectors, with maybe upstarts who have discovered some software management “special sauce” quickly dislodging established giant incumbents?

    2. Are there any hints of consolidation plateauing or even reversing as “software savvy best practices management” skill-set becomes more essential or widespread?

    My hunch is that when looking at sectors which have seen a lot of consolidation in the past few decades, when looking at the time-series chart of market share for competitors in the sector, there won’t often be obvious “software savvy” stories to tell to explain why the trails of the giant companies expanded when they did.

  9. One way of assessing the “elite management skill” story of consolidation is to consider big winner cities instead of big winner companies. Cities, at least in zones of open and easy human mobility, are, after all, theoretically in open competition with each other, and one might guess that good local government which was skilled at establishing pleasant, secure, and affordable conditions conducive to the flourishing of productive and decent people would have an edge over the rest.

    But what we actually see – in major U.S. hubs like DC, NYC, and the Bay Area at least – is almost precisely the opposite: the most successful the winner city’s economy, the worse and more and predatory the local government, the more dysfunctional its management, and in terms of the condition under potential government control, the harder it is for ordinary folks to thrive. The management of these cities is awful, not excellent, precisely because the captured prosperity means it can be awful.

    And the local prosperity is captive – that is, the city is insulated from competition and locals have no effective option of exit – because of an impossible-to-solve coordination problem which would require everyone to agree to move away to some other new hub at the same time, a challenge on the order of everyone in a city decided to start speaking a different language starting next month, and which, ironically, would probably just result in the problem moving with them.

    So, it’s entirely possible that some of the big winners we see not only didn’t get their because of elite-level management, but for some other reason that allows them to retain their positions despite mediocre management and lousy, overpriced products.

  10. The “cost of regulatory compliance” story has at least two features that the essay is missing:
    1. The litigation environment — There is a fairly steady progression in the ability of plaintiff’s lawyers to impose cost on businesses that scales with regulatory complexity. Key mechanisms are: class and collective actions, recovery of attorney’s fees only by plaintiff’s as a part of damages, readier availability of punitive damages, the spread of statutory damages that do not require proof of a quantity of damages, and the rising cost of defense as the hourly rates of defense counsel outstrip inflation every year.
    2. Flow-down — Large organizations have, in the past ten years or so, more broadly embraced the idea of flowing its compliance obligations down to both its clients and its suppliers. Where, historically, small companies could succeed doing what they uniquely know how to do and then find a few large customers, they now have to wade through 100-page contracts specifying a bunch of stuff that small companies don’t have, from data security to harassment training to risk management systems.

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