The Great Bluff of the American Economy

In winner-takes-all economics, mergers and acquisitions tilt the playing field.

Bloomberg

In late October, corks popped on Wall Street. Beer giant Anheuser-Busch of the Netherlands and SABMiller of Britain announced their merger, a gargantuan $104-billion deal. The two companies, which control big-brand suds like Budweiser, Miller and Stella Artois, plan to merge into the biggest alcohol company in history.

The business press applauded. Beer industry experts, investment bankers, traders and analysts were deeply moved. The acquiring company’s managers were expanding their business empire, power and prestige; the people at the company being bought might lose power and prestige but they would gain billions of dollars. The bankers’ fees frothed to new heights. If the deal doesn’t go through, the fines will come to a cool $3 billion.

But there was one piddling matter mentioned at the end of the news reports: Permission from the antitrust authorities in both countries is necessary for the deal to be sealed. Analysts suspect the authorities will force the companies to sell some of their brands.

This merger is a big one, but it’s just another in the trend of mergers and acquisitions we have been seeing in recent decades throughout the American market.

The American press generally treats these mergers as a natural, positive process, designed to strengthen the companies involved, to give them the advantages of larger firms, to make them more efficient and enable them to better hold their own in an increasingly competitive world.

But could there be another explanation for these deals? One that shines a whole new light on M&A on Wall Street and on economic developments in the United States?

The narrative is that the American economy is competitive. We have written in the past about examples showing otherwise, including in the realm of telecommunications: Prices of mobile communications, Internet and cable TV in the U.S. are much higher than elsewhere in the West. Health care is another such industry, also marked by M&A.

Or take fashion glasses and sunglasses. What do the brands Prada, Chanel, Dolce & Gabbana, Versace, Burberry, Ralph Lauren, Tiffany, Bulgari, Vogue, Personal, Donna Karan, Ray-Ban and Oakley all have in common? They are horribly expensive. A pair of glasses costs hundreds of dollars, though the cost of making the frame is a tiny fraction of their selling price at stores. And what do the chains selling glasses in malls all over America – Sunglasses Hut, LensCrafters, Oliver Peoples, Pearle Vision, Target Optical and Sears Optical – have in common? Of course: Even though they “compete” with one another and are roughly positioned as less high-end, the prices of the brands noted above are in general extremely high.

This is not coincidence. All these brands are manufactured by a single company. More surprising perhaps is that all these eyewear chains belong to a single company too. Its sales in 2014 came to $9.2 billion, and in the last decade, it was the Pacman of the eyewear industry. It ate Ray-Ban, Oakley and almost every other leading brand. It paid well for the Italian company Luxottica: Its share climbed 183% in 10 years, lifting its market cap to $33 billion and turning its founder, Leonardo del Vecchio, into one of the richest men in the world, with an estimated fortune of $20 billion. A quick Google search finds his a five-story 203-foot yacht. Anybody prepared to pay $1,000 for a piece of plastic with the Prada logo can take comfort in the thought that at the end of this capitalist value chain is a gorgeous yacht suitable for the Italian monopolist and his changing wives.

Luxottica’s control over most of the top prestige eyewear brands and most of their marketing chains raises the concern that the American slogan about choice is a smokescreen. In many industries, including food, beverages, toiletries and healthcare are giant companies with tremendous market shares that control and sometimes “manage,” almost like a central planner, prices in the markets, creating a false presentation to consumers and regulators that there is a “choice” between the different distribution channels and names.

Mobile communications, eyegear, health insurance. All merely anecdotal? No, it turns out.

Prof. Roni Michaely of Cornell University and the Herzliya Interdisciplinary Center is a prominent expert on finance. A year ago he and his colleague, Prof. Gustavo Grullon noticed something interesting: The steepest drop in 30 years in the number of companies traded on Wall Street.

At first Michaely assumed the American economy was undergoing a transition, from the merits of a public listing to the merits of being private. But when he delved into the material with Grullon and Prof. Yelena Larkin, they had a surprise.

The first finding was clear: From 1997 to 2013, the number of public companies in the U.S. had halved. The number of companies on Wall Street had returned to its figures from the 1970s, when GDP was a third of its present level.

Secondly, during that period, the number of big private companies increased. Meaning, the total number of companies simply decreased.

Next they checked the concentration in each of America’s 71 main sectors. The Herfindahl Index (which measures the size of companies in relation to the industry and is indicative of the degree of competition among them) had risen, sometimes sharply, in 85% of America’s industries.

Giant companies merging sell the thesis that these mergers are necessary for them to survive in the global contest. In some other countries, corporate giants get government backing. Michaely, Grullon and Larkin looked at that too, and found that in the last 30 years there had been no increase in the share of foreign companies in America.

The first conclusion of the study is that in contrast to the tenet that the American economy has become more competitive because of globalization, technology an so on, it has become more concentrated. Fully 90% of America’s industries are more concentrated and in half, the number of companies has fallen by 50%.

Michaely and his colleagues found that the companies leaving the game were not financially weak; they didn’t have to be bought, nor were they rendered niche companies because of technological advance.

Mounting concentration

AP

Why did the markets become so concentrated? What drove these mergers? It was the desire of the companies to achieve more market power against consumers, suppliers and competitors. In contrast to the usual claim that size serves efficiency – Michaely and his colleagues found that the mergers had not made the companies more efficient.

What grew beautifully after the mergers was, of course, the purchasing companies’ profits. Their bigger market power enabled them to raise prices for consumers or press smaller suppliers. In some places consumer prices rose; in others, companies – like Wal-Mart for instance – used their power to lower the prices they pay suppliers.

The growth in profit from the increase in concentration did well by the companies’ shareholders. Michaely and his colleagues checked the returns of a theoretical portfolio of long investments (betting that share prices will rise) in industries where concentration grew. The portfolio outperformed the market by 9%.

They found that the mounting concentration gave the buying companies another advantage: They got yet more opportunity to buy other companies and raised the entry barriers to their markets.

The U.S. Department of Justice also published charts showing mounting concentration in numerous industries.

The study therefore seems to belie a great American bluff. Could it be that the slogan that American companies “create value” for investors is twaddle? That much of the value created in all too many industries is simply wealth moving from consumers to companies and investors through increased concentration, rising market power and rising prices?

Maybe the real goal of the Anheuser-Busch-SABMiller merger isn’t to become more efficient but to increase market power and raise prices?

Is America something very different than the myth?

Michaely thinks so: Increased concentration has translated into steeply higher profits and returns on shares, which fits with increased market power and change in the structure of the branches of the American economy.

Michaely is a professor of financing, not antitrust or industrial organization. But he takes the leap of hinting that the mounting concentration in America isn’t driven by technological change, but political decisions. George Bush junion's election was a turning point, he suggests: Antitrust policy under him became more biased toward the big companies. Michaely notes the drop in antitrust investigations from that time.

Historians might argue that American antitrust powers began to weaken 50 years ago and that the political power of the giant companies has done nothing but grow in that time. They field top experts who state that the mergers won’t hurt competition in the industry, they will show that competition remains fierce, that the market is complex and that the merger is necessary for the sake of the firms’ efficiency and the interests of the workers and consumers. In practice, however, as the study by Michaely and his colleagues shows, the companies’ market power and profitability have been rising.

Could the growing inequality in the U.S. arise not only from technological advance and globalization, but the ability of the giants to jack up prices and share the loot with their shareholders and top people? Could it be that behind the PR of the companies, energies in American business are devoted to increasing concentration, to raising entry barriers, to damping competition and to accruing monopolistic rents? Is rising concentration another aspect of the “winner takes all” economics?