The New Oligopoly Boom
Last month, General Electric Co. won a coveted 20-year contract as exclusive supplier of engines for Boeing Co.’s new 777X long-range jet, a deal that could generate sales of $15 billion.
The global aircraft-engine industry is a classic oligopoly, consisting of just three players of any size, with GE claiming market share exceeding 50%.
Yet GE’s reward for such dominance is unending cutthroat competition from its two rivals, United Technologies Corp.’s Pratt & Whitney unit and Britain’s Rolls-Royce.
Indeed, GE cut its Boeing bid so close to the bone that analysts say it may never earn a dime on the engines themselves; its real hope for profit lies in servicing the equipment.
What’s more, GE may not have won the contract had its GE Capital unit not stood ready to provide Boeing with attractive financing to develop the jet.
As the century ends, the harsh competitive realities of the aircraft-engine oligopoly are the rule rather than the exception in countless other major industries, experts say.
Despite the unprecedented wave of business consolidation worldwide in the 1990s, the growing concentration of corporate power has so far failed to produce the result usually associated with such oligopolies: the ability to raise prices at will.
Nor do many economists expect the new oligopolies to assume that ability soon. On the contrary: The disinflation trend of the 1990s could last well into the new decade, led by the oligopolies themselves, some analysts say.
For consumers, the end result may be relatively stable prices for better and better goods.
“If you have an income, it’s a paradise,” argues Joseph L. Bower, an economist at Harvard Business School.
Others aren’t quite as sanguine. As Asia’s economy rebounds and Europe’s shows increasing signs of strength, some experts worry that the new oligopolies will make their pricing power apparent should the global economy begin to boom.
“In the final analysis, if you shrink capacity and put the market in the hands of one or two global companies, at some point you will get pricing power,” said David M. Jones, chief economist at Aubrey G. Lanston & Co.
*
So far, however, this era of corporate gigantism is a far cry from the days of John D. Rockefeller and the industrial trusts of the late 1800s, when fear of oligopolies spurred the government to attack and dismantle them.
Yet the merger wave that is sweeping the United States and the world--with the value of corporate deals this year expected to approach $3 trillion--is producing a level of concentration within industries that might easily have frightened even Wall Street 10 years ago.
“In automobiles, tobacco, accounting firms, advertising agencies, soft drinks, music, wireless phones and many others, fewer than five companies essentially ‘own’ their domestic market and are moving toward global domination,” Susan L. Decker, director of global research at brokerage Donaldson, Lufkin & Jenrette, wrote in a massive new report the firm produced on the rise of oligopolies.
In North America, for example, the five largest railroads now control 76% of the market as measured by total sales, DLJ analysts estimate. Ten years ago, the top five firms had 59% of the market.
In the department store business, the market is 75%-controlled by the five biggest players, including Federated Department Stores and J.C. Penney. The five biggest players had 46% of the market in 1988.
Banking, oil field services, cable TV, grocery stores and airlines all have seen significant concentration in the hands of a small group of players.
Certainly, in some industries consumers may argue that they feel increasingly at companies’ mercy in terms of prices--in banking, for example, and cable TV. But overall, growing concentration of corporate power in the 1990s has been accompanied by intense downward pressure on consumer prices in the U.S. and most of the world.
It isn’t mere coincidence, experts say. A central goal of many or perhaps even most companies in the merger boom has been improving investment returns through cost cutting, productivity gains and economies of scale.
That has in large part been a reaction to heavy business investment in much of the world well into the 1990s, producing global overcapacity in many industries.
A. Marshall Acuff, equity strategist at Salomon Smith Barney, says consolidation clearly became a defensive strategy in many businesses, the only way to address capacity problems that depressed all players’ financial results.
The paper industry in the 1990s, for example, has suffered through its worst period of financial performance in five decades. Yet mergers have only recently begun to accelerate in the industry, including this year’s marriages of International Paper and Union Camp and of Georgia-Pacific and Unisource.
Dominant paper companies, Acuff notes, can opt to temporarily idle less efficient mills, removing capacity when demand slows--then reopen them when demand returns. A smaller firm would be reluctant to cut production lest similarly sized competitors take the opportunity to grab market share.
Acuff believes that consolidation finally is helping to push prices upward in some cyclical industries such as paper, energy and metals.
Even so, “excessive” capital investment here and abroad in the 1990s created such general overcapacity that it is unlikely firms in many industries will regain pricing power any time soon, he said.
Just as important, the idea of boosting profits by gaining market share, cutting costs and raising efficiency--not by automatically raising prices--has become the mantra of companies worldwide, experts note.
Bower said that GE, for one, has delivered the equivalent of 5% to 10% annual price cuts for years by adding more value to its products without raising prices.
But such cost-conscious management is not necessarily compatible with lifetime employment.
*
So workers, in turn, must adapt to technology and improve their own productivity to keep pace with companies’ devotion to efficiency.
Technology itself, which is allowing companies to do more at lower cost, also abets the consolidation wave by increasing the reach of the biggest companies.
“Technology is allowing larger firms to be more agile and flexible,” said DLJ’s chief equity strategist, Thomas M. Galvin. “This has turned their mammoth cost structures into competitive weapons instead of the enormous handicaps they were previously.”
To sell computers to the world, for example, IBM needs both local expertise on six continents and a consistent marketing message, Harvard’s Bower noted.
That’s why WPP Group, the British advertising giant that represents Big Blue, has grown by acquisition to cover 90 countries.
WPP, a consolidator extraordinaire, bought Madison Avenue stalwarts J. Walter Thompson and Ogilvy Group in the late 1980s, and in the last two years has bought stakes in market research firms in Latin America, Italy and Canada and ad agencies in Japan and elsewhere in Asia.
(Incidentally, the letters “WPP” hint at the company’s own evolution. They stand for Wire & Plastic Products, the firm’s name when it was founded as a manufacturer of grocery baskets.)
According to DLJ, the top five ad agencies worldwide control 45% of the market, up from 30% in 1988.
But could such oligopolies begin to exercise far more pricing power should the global economy boom in the next few years?
The Asian economic crisis of the last two years unquestionably helped restrain prices worldwide, as Asian demand plunged and the overcapacity problem worsened. But Asia is now recovering. Could strong growth worldwide give oligarchs an easy road to abusive pricing?
Jones, the Aubrey Lanston economist, thinks actual price gouging is a remote threat, but he can easily envision companies in concentrated industries starting to assert some pricing power. He, like Acuff, sees it already happening in the paper and aluminum sectors. Aluminum futures prices have risen 13% this year--even before U.S. giants Alcoa and Reynolds Metals agreed Thursday to merge.
And in the oil business, major exporting countries this year have stuck to promised production cuts, driving crude oil prices up 81% since Dec. 31. But analysts also note that those rebounds in commodity prices have come off extraordinarily depressed levels.
Elsewhere, the trend in prices is more subtle. Consider the six-pack.
Domestically, the aggregate market share of the top five brewing companies actually slipped from 89% in 1988 to 87% last year, according to DLJ. But that disguises the continued consolidation of what was already a tight little oligopoly.
Anheuser-Busch Cos. increased its leading share of the market to 46% from 41% over the decade, en route to a stated corporate goal of a 60% share. Hoping to steal back some market share from the Budweiser juggernaut, No. 2 Miller Brewing Co., a unit of Philip Morris Cos., embarked on a costly price war in 1997. The battle didn’t jostle Anheuser much, but it forced out Stroh Brewing Co., which sold its lines to rivals Miller and Pabst Brewing Co.
Brewers now seem to realize that it is next to impossible to buy market share from Anheuser through a price war, so the climate of the industry has grown more “rational,” said Philip Olesen, a beverage industry analyst with Warburg Dillon Read.
“You never want to use the word ‘collusion,’ but it’s more likely now that a price increase will stick, that your competitors will meet your increase,” he said.
Price increases on beer generally are imposed regionally rather than nationally, making it difficult to spot a broad trend, but Olesen said brewers are now succeeding in getting low single-digit increases where a year ago price cuts were the norm.
Something similar is happening within the airline oligopoly.
Air fares leaped 6.5% in July, the biggest monthly increase in six years, according to the consumer price index report released last week by the Labor Department.
Nobody expects such spikes to become commonplace, but airlines do at least appear to have the power to pass along the big increases in fuel prices that have hit them lately.
Some travel agents say that although they have not seen big year-over-year fare increases, there has been a marked weakening in the airlines’ tendency toward price wars.
Still, experts say, powerful forces stand in the way of long-term pricing power for many oligopolies.
*
One is the Internet. It allows businesses and consumers to seek out the most competitive prices for goods and services, and can give anyone with a better idea a potentially global forum in which to challenge entrenched rivals.
Antitrust regulators also could flex their own muscles if market control became a hot button. Already, U.S. regulators have blocked planned mergers involving the two biggest office supplies firms--Staples Inc. and Office Depot Inc.--and the four biggest wholesale drug producers.
Ironically, perhaps the biggest impediment to pricing power is the continued globalization of markets. As competitors in oligopolies like aircraft engines increase their scale and market reach, their customers know they can be served by any one of them. What’s more, the determination of lesser-developed countries to industrialize means new competition in many industries is almost certainly on the horizon.
“All the new Japans are pouring into markets that are already crowded,” economist Bower said, citing Taiwan in petrochemicals and Thailand in cement.
In Bower’s view, the new oligopolies will not gain pricing power until the biggest Third World players--China and India--are fully integrated into the industrial world, which could be years away.
In the meantime, the recent struggles of one of the world’s biggest oligarchs speaks volumes about the ephemeral nature of market power, some say.
Coca-Cola Co., which controls a full 50% of the global soft drink market, has been using its financial muscle to make direct investments in bottling companies around the world, modernizing and consolidating them and gradually squeezing out the independent local bottle rs.
Nonetheless, Coke has found itself struggling with weak demand for much of the last year. Its operating earnings dropped 9% in the first half of this year.
Though it may be “the ultimate global brand,” as DLJ analyst Skip Carpenter describes it, Coke has seen its stock price make no net gain in two years.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
The Global Merger Wave ...
Number of merger deals and dollar value of deals, worldwide, annually through 1998 and year to date through Aug. 12:
... Concentrates Corporate Power ...
Market share of top five companies in each industry, 1988 and 1998:
... Yet Inflation Remains Tame
U.S. consumer price index, annual percentage changes:
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Consolidation: Where the Action Is
Here are the U.S. industries in which the dollar value of announced merger deals this year has been largest (data through Aug. 12):
*--*
Industry Dollar value of 1999 deals, in billions Telecommunications $172 Radio/TV 126 Business services 63 Utilities 59 Banks 59 Oil/gas refining 46 Insurance 31 Communications equip. 31 Software 29 Machinery 26 Chemicals 26 Drugs 24 Instrumentation 23 Electronic equipment 18 Brokerages 18
*--*
Source: Thomson Financial Securiites Data
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Where Concentration Isn’t Surging
The market share of major companies has stayed fairly flat or even declined in some key U.S. industries over the last 10 years. A sampling:
Source: Donaldson, Lufkin & Jenrette
*
Times staff writer Thomas S. Mulligan can be reached by e-mail at
