Foresight

The rise of US superstar firms and its implications for investors


Over the past two decades, over 75% of US industries have become more concentrated, with a small number of large firms controlling greater shares of their markets. These “superstar” firms – including Microsoft, Apple, Amazon, Facebook and Alphabet (Google’s parent) – increasingly dominate their respective industries in terms of sales, profits and equity returns. Although this winner-takesall market has been great for investors, there is a growing concern that it is indirectly harming consumers and worsening income inequality. The regulatory backlash against these superstars could curb their abnormal profits, with potential consequences for stock market returns.

Competition is the bedrock of the market economy. It incentivises firms to keep prices low, produce better quality products and offer attractive wages. So when firms compete for market share, prices fall, economic output increases, productivity rises and standards of living improve. This not only benefits consumers and workers, but also the economy in general as resources are allocated more efficiently.

However, over the past two decades, there have been signs that competition has weakened across numerous US industries, as a handful of “superstar” firms exert more market power than before. In 2000, for example, the top two telecom service providers controlled around 30% of industry sales. Today they control 70%1. In the US airline industry, the top four airlines have increased their share of domestic air travel from 48% in 1997 to 68% today2.

Economy-wide indicators all point in the same direction. Between 1997 and 2012, over 75% of US industries have become more concentrated, with the four biggest firms accounting for a greater share of revenues than in the past. Specifically, the weighted average share of revenues of the top four firms in a given industry rose from 24% to 33%, with the largest increases occurring in the information technology (IT), telecoms, media and retail sectors (Figure 1).

A similar trend can be observed using the Herfindahl-Hirschman Index (HHI) – a commonly accepted measure of market competitiveness that takes the sum of squared market shares of all firms3. Research has found that, between 1995 and 2013, the weighted-average HHI of all industries in the US equity market has risen by 54% and is now approaching its previous peak reached in the early 1980s (Figure 2). This has coincided with the large-scale disappearance of publicly traded firms, as the number of listed companies has nearly halved4. Meanwhile, the average and median size of publicly traded firms has tripled in real terms5. As a result of this increased market control, firms have been able to charge higher prices, or keep them unusually high. Average mark-ups (prices over marginal costs) for publicly traded firms have increased from around 3% in 1980 to 20% in 20156.

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1 Goldman Sachs Global Investment Research, June 2019.
2 Bureau of Transportation Statistics. Data from 1997 to 2018. Measured using domestic revenue passenger miles.
3 If a firm has a 100% market share, the HHI would equal 10,000, indicating a monopoly. The US Department of Justice considers an HHI of 1,500 and 2,500 to be a moderately concentrated marketplace, and an HHI of 2,500 or greater to be a highly concentrated marketplace.
4 See our paper: “What is the point of the equity market.” Schroders, April 2018.
5 “Are US Industries Becoming More Concentrated”. Grullon, G. et al. Review of Finance, Volume 23, Issue 4, pages 697-743, July 2019.
6 “Who are America’s Star Firms?” Ayyagari, M. et al. World Bank Group. July, 2018.

 

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