Part one of two - markets reward winners with the ability to win more, reducing competition
For unto every one that hath shall be given, and he shall have abundance: but from him, that hath not shall be taken away even that which he hath. And cast ye the unprofitable servant into outer darkness: there shall be weeping and gnashing of teeth
In the Parable of Talents (Matthew 25:14–30), a master entrusts an amount of money to each of his three servants. Two of the servants used the master’s wealth productively, increasing the value of what they had received. The third, buried it underground, thereby failing to make use of it, and so was punished by the master.
From this parable we can begin to understand the Matthew effect of accumulated advantage, a phrase coined by Robert Merton, prominent American sociologist and father of Nobel prize-winning economist (also Robert Merton). The Matthew effect essentially holds that success begets success, i.e. given a certain advantage, the owner of that advantage will be able to compound and leverage that advantage, making their lead that much more unassailable.
The Matthew effect can be seen in many aspects of society, from sport to education. For example, children who succeed at an early age tend to gain acknowledgment and support for their success – boosting their confidence and the likelihood they will succeed in the future. Keith Stanovich, Emeritus Professor at the University of Toronto, was an early researcher on the Matthews effect in education, highlighting that students who show early success in reading tend to have greater success in reading over time, while those students who fall behind may also fail in other areas of their development.
But this is an economics blog… so let’s think of this from the perspective of industry and the economy, the Matthew effect holds that the rich get richer, and the poor get left behind. The Matthew effect can be used to explain why many industries become concentrated, with only a few companies gaining a significant share of the economic pie.
Wide moats, high walls and deep pockets
In the United States stock market, only a handful of companies have been shown to truly matter. Between 1926 and 2016, of nearly 26,000 companies, 90 were responsible for approximately half of the 35trn in wealth creation. Most companies, or 57.9% to be precise, actually destroyed wealth - equivalent to the third servant in our parable. Through the lens of the Matthews effect, we might suggest that the 90 companies were able to leverage their advantages to outcompete their peers and become dominant in their industries. Good luck picking winners. As long as those industries remain undisrupted, what is stopping this from continuing indefinitely? More on that later.
One of those top 90 companies, is Amazon, the third-largest listed company in the world with USD 1.5trn in market cap. Having started as an online bookstore, the company has disrupted bricks & mortar retail, delivery services and streaming, among other industries. The company’s level of success, at least in part, is attributable to the significant network effects of its e-commerce platform, where due to the number of 'eyeballs' (Amazon.com gets over 2bn visits per month) it may be difficult for e-commerce retailers to think of not listing their products on the site.
These eyeballs give Amazon incredible market power and make it exceedingly difficult for anyone to assail their advantage. It also means the company has a ready audience for additional services. Amazon Prime, for example, started its life in 2005 as a two-day delivery service, a logical next step one could argue for the burgeoning e-commerce platform. Since then, Prime has grown to encompass music, video, reading and even Amazon Pantry, a specialised delivery service for groceries.
None of this is inherently wrong, but it was not that long ago that the notion of video and groceries being delivered via one platform was difficult to conceive of, let alone implement – highlighting the role of technology in breaking down market barriers. Amazon’s market power has been hard-won, but at the same time, now that it has it, it's challenging for other companies to compete against its incumbent power. The “moat” around Amazon is too deep. To illustrate – how would a new online platform start today? Even if its offering and concept were somehow superior to Amazons, the investment required to win over retailers and customer 'eyeballs' would be prohibitive.
Byte-Size Story is another good example, despite superior writing and insight (haha) we still only get circa 300-400 viewers a month compared to over 35 million for the NZ Herald! So where does it end? What is to prevent a single company from dominating its chosen industries forever?
The usual answers have been either regulation or disruption
The landmark case for scaling back a dominant company in its industry was Standard Oil, which in 1911 was ruled an illegal monopoly and broken into 34 different companies. ExxonMobil and Chevron are descendants of these. Disruption is also a possibility, with the disruptive effect of e-commerce on bricks and mortar retailers (e.g. Walmart) being a good example of how disruption can shake the business models of even the strongest companies.
But we worry this time might be different. Although there are, and have been, antitrust investigations and probes for companies such as Amazon in both the EU and US, strong links between the private sector and government, can make regulation to even the playing field more difficult. Meanwhile, the “Winners” today (which means Big Tech) have shown the ability to operate across multiple industries and different product lines. They buy-out other companies, removing the potential for competition. Facebook's purchase of Whatsapp in 2014 is a good example. The implication is that this makes it more difficult for an external force or competitor to challenge the incumbent's business model.
It may… therefore… be the case that these companies grow so big they sow the seeds of their own destruction. Either by growing so big that administrative costs and difficulty in establishing accountability make the company too difficult to run. Or through cultural change, as subsequent generations of executives who lack the same drive and vision as the founders come through. There may be a long time to wait.
Stay tuned for part two of 'Winner takes it all' later on.
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