Putting prof­its in per­spec­tive

Financial Mirror (Cyprus) - - FRONT PAGE -

High prof­its are usu­ally viewed as a sign of a com­pany’s eco­nomic prow­ess, the re­sult of in­no­va­tion and ef­fi­ciency forged by healthy com­pe­ti­tion. But, as a re­cent re­port by the US Coun­cil of Eco­nomic Ad­vis­ers shows, high prof­its can have an­other cause: mar­ket con­cen­tra­tion.

The re­port lists sev­eral in­di­ca­tors of de­creas­ing com­pe­ti­tion in the US econ­omy, in­clud­ing a long-term de­cline in new busi­ness for­ma­tion and the ac­crual of enor­mous prof­its to a small num­ber of firms. Act­ing on its rec­om­men­da­tions, Pres­i­dent Barack Obama re­cently is­sued an ex­ec­u­tive or­der call­ing on all US govern­ment agen­cies to use their au­thor­ity to pro­mote com­pe­ti­tion.

It is an i mpor­tant mo­ment to as­sess the state of com­pe­ti­tion in var­i­ous sec­tors. Many US in­dus­tries, in­clud­ing some of the most in­no­va­tive, are dom­i­nated by a hand­ful of large com­pa­nies, some of which en­joy very large mar­ket shares and gen­er­ate re­turns that greatly ex­ceed his­tor­i­cal av­er­ages. And some com­pa­nies are stock­pil­ing cash or ac­quir­ing com­peti­tors rather than us­ing their re­turns to build pro­duc­tive ca­pac­ity.

Nonethe­less, it would be a mis­take to con­clude that weak­en­ing com­pe­ti­tion is driv­ing these un­usual eco­nomic trends. They are tak­ing place in a con­text of swiftly chang­ing sec­toral dy­nam­ics and rapid digi­ti­sa­tion.

Cor­po­rate prof­its may be near all-time highs, but their vari­ance among firms and in­dus­tries has also in­creased sig­nif­i­cantly. The most prof­itable firms in the US are no longer in heavy in­dus­try; they are in sec­tors that cap­i­talise on re­search and de­vel­op­ment, brands, soft­ware, and al­go­rithms. Com­pa­nies in sec­tors like phar­ma­ceu­ti­cals, me­dia, fi­nance, in­for­ma­tion tech­nol­ogy, and busi­ness ser­vices have the high­est profit mar­gins. Even ex­clud­ing fi­nance, these sec­tors’ share of US cor­po­rate prof­its has in­creased sig­nif­i­cantly, from 25% in 1999 to 35% in 2013.

Cor­po­rate prof­itabil­ity is in­creas­ingly driven by dig­i­tal ca­pa­bil­i­ties. In the most dig­i­tally ad­vanced sec­tors of the econ­omy, mar­gins have grown 2-3 times faster than av­er­age. And even within these sec­tors, there are enor­mous spreads be­tween the top-per­form­ing com­pa­nies and the rest of the pack. The “win­ner-take-most” dy­namic of the dig­i­tal econ­omy is not only pro­duc­ing record prof­its for lead­ing firms; it may be ac­cel­er­at­ing the pace of in­no­va­tion and broad­en­ing the ar­eas in which com­pa­nies can quickly es­tab­lish mar­ket power.

There are also many rea­sons why some firms ap­pear to have de­cided to stock­pile their re­turns. For starters, while gross busi­ness in­vest­ment as a share of GDP has yet to re­cover from the 2008 fi­nan­cial cri­sis, growth in in­vest­ment has been in line with its his­tor­i­cal re­la­tion­ship to out­put growth. At the macroe­co­nomic level, in­vest­ment growth has been weak, be­cause eco­nomic growth has been anaemic. At the same time, in­vest­ment growth has been strong in sec­tors like tech­nol­ogy and – un­til re­cently – en­ergy, where de­mand has been ex­pected to rise. And while await­ing stronger de­mand at home, some US com­pa­nies have been in­vest­ing in for­eign mar­kets, at­tracted by their size and pro­jected growth.

Sec­ond, mea­sure­ment is­sues may be cloud­ing in­vest­ment fig­ures. The price of cap­i­tal equip­ment, par­tic­u­larly ICT equip­ment and soft­ware, has de­clined sharply since the 1980s, even as qual­ity has im­proved. Thus, real price- and qual­ity-ad­justed in­vest­ment may be con­sid­er­ably stronger than of­fi­cial statis­tics im­ply.

Third, as­set-light, heav­ily digi­tised firms have a much larger pres­ence in the US than they did even a decade ago. By their na­ture, these firms do not need much in the way of fac­to­ries, equip­ment, and fleets of ve­hi­cles. Fo­cus­ing on their in­vest­ment in phys­i­cal cap­i­tal ig­nores their abil­ity to gen­er­ate re­turns from in­tel­lec­tual prop­erty and other in­tan­gi­ble as­sets. And it over­looks their in­vest­ment in R&D and in­tel­lec­tual prop­erty as­sets. In fact, R&D in­vest­ment has hit a record high, driven by ideas-in­ten­sive com­pa­nies that com­pete through in­no­va­tion.

Mean­while, many lead­ing firms in ideas-in­ten­sive sec­tors are us­ing their sub­stan­tial cash hold­ings to grow through merg­ers and ac­qui­si­tions. The big­ger and more prof­itable these firms be­come, the more they tend to use M&A as one of the few avail­able av­enues for con­tin­ued growth.

To be sure, this could ac­cel­er­ate mar­ket con­cen­tra­tion. But it is im­por­tant to note that the ef­fects of mar­ket con­cen­tra­tion are chang­ing. In­deed, in a grow­ing num­ber of dig­i­tal mar­kets where a few gi­ant firms hold com­mand­ing shares, there is lit­tle ev­i­dence that mar­ket power is lead­ing to higher prices. On the con­trary, con­sumers have gained an ar­ray of free ser­vices and con­ve­niences.

More rel­e­vant con­cerns about mar­ket con­cen­tra­tion may turn out to be pri­vacy and data own­er­ship, not pric­ing power. In­deed, some have be­gun to ask whether the col­lec­tion and con­trol of large amounts of data by a few huge firms with com­mand­ing mar­ket shares can be an an­ti­com­pet­i­tive force, cre­at­ing in­sur­mount­able en­try bar­ri­ers for would-be in­no­va­tors.

en­ter and

At the same time, how­ever, some of the largest dig­i­tal plat­forms, by their very na­ture, may pro­mote com­pe­ti­tion, as they im­prove trans­parency in mar­kets and en­able mil­lions of small en­ter­prises to reach cus­tomers and sup­pli­ers around the world. A re­cent study found that dig­i­tal plat­forms can help small busi­nesses in­crease their ex­port rates dra­mat­i­cally.

It is pos­si­ble that the era of “peak prof­its” that has sparked con­cerns about mar­ket power is com­ing to a close. US cor­po­ra­tions have had a re­mark­able three-decade run, but prof­its have al­ready slipped from 11.5% of na­tional in­come in 2012 to 9.5% last year. To­day, wages are ris­ing, bor­row­ing costs have nowhere to go but up, and cor­po­rate tax poli­cies are un­der scru­tiny.

On top of those shifts, the digi­ti­sa­tion of Amer­i­can busi­ness is still in its early stages. Re­cent re­search has es­ti­mated that the US econ­omy has re­al­ized only about 18% of its dig­i­tal po­ten­tial. As the eco­nomic trans­for­ma­tion con­tin­ues to play out, the cor­po­rate world may be­come even more Dar­winian. In­deed, many dig­i­tal be­he­moths did not ex­ist a decade ago, and it is pos­si­ble that they will no longer ex­ist a decade from now. To­day’s mar­ket lead­ers may look in­vin­ci­ble. But they can al­ways be top­pled by the next new thing.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.