Do Tech Firms Have Too Much Market Power?
Do Tech Firms Have Too Much Market Power?
In Brief Over the past two decades, tech giants such as Amazon and Apple have been phenomenally successful, and economists are now studying the impact of their considerable market power on the rest of the economy.
Why This Matters There is a danger that the explosive growth of these tech firms could lead to a host of social ills including low wages for the average worker and underinvestment.
The Takeaway Research suggests that to date, tech firms have not harmed the economy as a whole by engaging in monopolistic behavior. But economists remain worried that these superstar firms will soon begin using their market power to stifle competition by gobbling up start-ups using new technologies.
In Depth Over the past several years, many economists have suggested that tech giants such as the FANG stocks—Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Alphabet (GOOGL)—have too much market power. Exhibit A in this widely held hypothesis is the fact that the rate of return on invested capital (ROIC) for these superstar companies is typically two or three times higher than that for firms in other industries. This sharp difference in profitability has been blamed for a host of economic and social ills, including rising inequality, a reduction in economic dynamism and declining pay for the average worker. For example, in a 2017 working paper for the National Bureau of Economic Research, German Gutierrez and Thomas Philippon connect the stratospheric success of tech giants to a reduction in competition, which, in turn, has led to underinvestment throughout the economy as a whole. However, based on the extensive research that he has conducted on these same macroeconomic variables, Vojislav Maksimovic, Ed Snider Center affiliated researcher and the William A. Longbrake Chair in Finance at the Smith School, sees little evidence of this underinvestment. “The data do not support the conclusion that tech firms are responsible for all these negative macroeconomic effects,” he says.
In a recent working paper, “Rise in Market Power and Corporate Inequality? Role of Measurement Error,” co-written with Meghana Ayyagari, Associate Professor of International Business and International Affairs at George Washington University’s Elliott School of International Affairs, and Asli Demirguc-Kunt, Director of Research at the World Bank, Maksimovic makes the case that the tech giants are not actually pulling away from the rest of the economy. “Most studies do not include the cost of ‘intangible capital,’ which refers to intellectual property and other non-physical assets of the tech firms,” he says. “When you factor ‘intangible capital’ into the equation, the huge gap in the rates of return between the superstar firms and the next rung of successful companies largely disappears.” According to Maksimovic, most economists are thus guilty of a significant measurement error, which by reducing the amount of money spent on invested capital, inflates the ROIC numbers.
If we correct for this measurement error, argues Maksimovic, we are forced to conclude that to date, tech firms have not been relying on monopolistic practices, which typically involve flexing market power to engage in price-gouging. And his insight certainly makes sense to all those consumers who are addicted to clicking on Amazon prime to save money on everything from acetaminophen to zucchini. “From its inception as a bookseller in the mid-90s, Amazon has always put growth before profits. Its pricing has always been consumer-friendly,” he says.
Maksimovic is convinced that the stratospheric success of tech firms over the last two decades has been a win-win situation for both shareholders and for consumers. But while he stresses that superstar firms have not historically been acting like monopolies, he fears that this is now starting to change. He is particularly concerned about the degree to which the superstar firms like Amazon have begun to take over the infrastructure of the whole economy. After all, Amazon is now an Everything store; it is not only selling just about every type of product under the sun, it is also renting out its servers via Amazon web services. The worry is that today’s tech giants, which are in the habit of gobbling up established companies—consider for example Amazon’s recent purchase of Whole Foods—will also begin to buy up start-ups relying on new technologies. And these mergers could stifle competition. “We are entering a new age where traditional views of anti-trust law may no longer be applicable,” says Maksimovic. “Policy makers may soon need to roll out new regulations ensuring that the superstar firms are not able to trample over entrants with new technologies that could challenge their dominance.”
Joshua Kendall has written on business and healthcare for numerous publications including BusinessWeek, Fortune.com, The New York Times, The Boston Globe and The Washington Post. For more about his work visit JoshuaCKendall.com.