Big Business: Why the Sudden Rise In the
Urge to Merge And Form Oligopolies? --- Higher Payoffs, a Lowering Of Antitrust
Obstacles And Some Burst Bubbles --- Consumers Can Win or Lose BAIN CAPITAL Inc., a private equity firm
founded by former Bain & Co. partners, is among the firms with stakes in
telecommunications companies. A page-one article yesterday incorrectly said that
Bain & Co., which is a consulting firm, was such an investor.
(WSJ Feb. 26, 2002)
(See related letter: "Letters to the
Editor: Too Few Buyers Hurts Farming" -- WSJ March 4, 2002)
Everywhere you look, powerful forces are
driving American industries to consolidate into oligopolies -- and the obstacles
are getting less formidable.
The rewards for getting bigger are growing,
particularly in the world of technology, media and telecommunications, where
fixed costs are especially large and the cost of serving each additional
customer is small. Some snapshots: -- Twenty years ago, cable television was
dominated by a patchwork of thousands of tiny, family-operated companies. Today,
a pending deal would leave three companies in control of nearly two-thirds of
the market.
And investors are less eager to finance
upstarts who challenge giants. In all, about $73 billion was raised for
enterprises of all sorts through venture-capital financing and initial public
offerings last year. That was robust by long-term historical standards, but it
was less than half the $164 billion raised in the peak year of 2000.
The appetite for mergers is restrained by a
sagging stock market and recession, but it probably will revive as the economy
rebounds. "Even with the economic slowdown," President Bush's Council of
Economic Advisers noted recently, "merger activity in 2001 was well above
average levels during the past three decades."
An oligopoly, a market in which a few
sellers offer similar products, isn't always avoidable or undesirable. It can
produce efficiencies that allow firms to offer consumers better products at
lower prices and lead to industry-wide standards that make life smooth for
consumers.
But an oligopoly can allow big businesses
to make big profits at the expense of consumers and economic progress. It can
destroy the competition that is vital to preventing firms from pushing prices
well above costs and to forcing companies to change or die. Rates for cable
television, for instance, have soared 36%, almost triple the amount of overall
inflation, since the industry was deregulated in 1996 and then consolidated in a
few big firms. The Organization of Petroleum Exporting Countries is a classic
oligopoly. Members manipulate their control over the supply of oil to force
consumers to pay prices well above levels at which market forces would otherwise
set them.
"A certain amount of consolidation does
generate a certain amount of efficiency and is good for customers," says
economist Carl Shapiro, who served in the Clinton Justice Department's antitrust
division and now teaches at the University of California at Berkeley. "That's
what economies of scale are about. Particularly in a lot of these
industries that have heavy fixed costs, it's natural to have some
consolidation."
"Twenty [competitors] to four is good," Mr.
Shapiro says. "It's four to two that is much more dubious."
The rise of early-21st-century oligopolies
echoes the late 19th century. "They are both periods where there was a retreat
from government oversight of the economy, a tremendous amount of entrepreneurial
activity, lots of new technology -- and it wasn't clear who would be the winners
and losers," says Naomi Lamoreaux, an economic historian at the University of
California at Los Angeles. "Firms try to put some bounds on the chaos, to
control some markets."
Many industries also face staggering costs.
A typical semiconductor-fabrication plant now costs between $2 billion and $3
billion, compared with $1 billion five years ago. A maker of basic memory chips
must sell far more chips to justify an investment of that size, which is why
makers of dynamic random access memory, or DRAM, chips are so eager to merge. If
Micron Technology Inc. succeeds in buying the chip-making assets of South
Korea's Hynix Semiconductor Inc., four firms will control 83% of the market, up
from 46% in 1995. It cost pharmaceutical companies $800 million to develop and
get approval for a new drug in the last decade, according to Joseph DiMasi of
Tufts University's Center for the Study of Drug Development, six times what it
cost in the 1970s after adjusting for inflation.
For a textbook case of the pros and cons of
oligopoly, look no further than the industry that produces texbooks. Last year,
Thomson Co., No. 2 in the $3.2 billion-a-year college-text business, bid for the
college-book line of Harcourt General Inc., No. 4. Charles James, the Justice
Department's assistant attorney general for antitrust, initially objected,
warning that competition in certain courses "will be substantially lessened,
resulting in students paying higher prices." But the government cleared the deal
after Thomson agreed to sell certain titles, from psychology to intermediate
Spanish, as well as a testing company.
Today, three big companies -- Britain's
Pearson PLC, Canada's Thomson, and New York-based McGraw-Hill -- dominate the
U.S. college-textbook business. The industry says consolidation helps
shareholders and students. In a bigger company, says Peter Jovanovich, chief
executive of Pearson Education, sales representatives are more specialized and
know more about the books they're hawking.
And because publishers must complement
their textbook offerings with Internet services, each textbook becomes a more
expensive proposition. Publishers post online simulations of chemical bonding,
practice tests and ready-to-serve Power Point presentations for professors.
But the textbook industry also shows two
big economic risks that consolidation poses for consumers.
The first is rising prices. The
best-selling introductory economics textbooks go for more than $100 now. The
Labor Department's measure of textbook prices that publishers charge bookstores
and distributors has climbed 65% over the past 10 years while overall producer
prices rose just 11.2%.
The other risk is that the textbook
oligopoly, with its profits dependent on hard-backed textbooks and its Web sites
primarily intended to help sell books rather than replace them, will stifle
innovation. "The odds that somebody will come up with a successful innovation go
up with the number of people who are trying new things," says Paul Romer, a
Stanford business-school professor. His new company -- Aplia Inc. of San Carlos,
Calif. -- offers online teaching tools that aren't tied to any particular
textbook. And the fewer the players, the lower the likelihood that a
ground-breaking innovation will be perfected and rolled out quickly.
DSL, or digital subscriber line, the
high-speech Internet pathway that relies on normal telephone lines, was
developed by a Bell engineer in 1989. It languished for almost a decade because
the Bells didn't want to cannibalize another, more lucrative high-speed Internet
service for businesses. The Bells began deploying DSL broadly only after
upstarts like Covad Communications Co., a Bell rival founded in 1996, quickly
proved there was a consumer market for it.
With money flowing in from eager investors,
upstarts rolled out new technologies and business models that the Bells had been
unwilling or unable to devise. Some newcomers used high-capacity
fiber-optic cables instead of old copper phone lines. Others allowed Internet
service providers to install equipment at telephone switching centers. But when
the capital markets all but stopped funding the Bell rivals two years ago, many
innovators disappeared.
The pressure to consolidate is evident in
the young online recruitment industry. For a while, it looked as if
HeadHunter.Net Inc. would be a rare dot-com startup: profitable and independent.
Last summer, it showed its first quarter of positive cash flow. A month later,
it agreed to be bought by CareerBuilder Inc., itself the product of a merger.
The Web sites face huge marketing costs to
attract a critical mass of job seekers and employers, says Craig Stamm, who was
chief financial officer of HeadHunter.Net and now has the same post with the
merged firm. With enough customers, the added cost of a new one is nearly nil.
With too few, he says, "You slow down sales and marketing. Customers go away.
There's even less revenue to invest. It's a downward spiral."
In online recruitment, market leader
Monster.com was spending heavily on marketing, backed by its deep-pocketed
parent, TMP Worldwide Inc. Worried about keeping up, HeadHunter.Net decided to
merge with CareerBuilder, which is backed by two newspaper chains. The Federal
Trade Commission scrutinized the deal and approved it without comment last
November. TMP Worldwide's agreement to buy another competitor, HotJobs Inc., was
scuttled, in part because of repeated requests for information from the FTC. In
the end, Yahoo Inc. bought HotJobs.
All this transformed a market that at the
height of the Internet bubble had more than 10 competitors, most routinely
offering 50% discounts to lure job postings. Today the market is dominated by
three firms, which are more committed to holding the line on prices. (Dow Jones
& Co., publisher of this newspaper, operates a recruitment Web site for
executives and professionals.)
In other industries the growing strength
and size of customers is prompting suppliers to get bigger, too. In eastern
Massachusetts, three big organizations came to control 75% of the insurance
market, which gave them substantial bargaining power with local hospitals. If a
hospital wouldn't offer one health maintenance organization deep discounts, the
HMO could easily divert patients to other hospitals that would.
Then the hospitals started to join forces
through mergers. The most significant was the December 1993 merger of two of the
most prestigious, Massachusetts General Hospital and Brigham & Women's -- a
combination that created Partners HealthCare System Inc. "In order to increase
your leverage in a competitive environment, you need to increase your size,"
says Richard Averbuch, a spokesman for the Massachusetts Hospital Association.
In 1993, metropolitan Boston had 34 separate hospital networks. Today it has 12
-- and life for patients is already changing.
In the fall of 2000, nearly 200,000 of the
900,000 members of one big HMO, Tufts Health Plan, got letters announcing that
they would no longer be able to use hospitals or physicians affiliated with
Partners. The reason: Tufts wouldn't accept the fee increases Partners wanted.
The uproar was enormous. Without Partners, says James Roosevelt Jr., Tufts
general counsel, so many HMO members and their employers "would drop us that we
wouldn't have a health network anymore." Even people who never used Partners'
doctors wanted the option of going to the top teaching hospitals in town in case
of a serious illness. "They would switch their health plan even though that
wasn't where they normally went for their medical care." Tufts went back to
Partners, and agreed to a fee increase of 30% over three years.
"The bargaining power in the system has, in
fact, shifted back to the providers, indisputably," says John E. McDonough, a
health-policy professor at Brandeis University and a former Democratic state
legislator. Last month, hospitals say, the Massachusetts attorney general opened
an investigation into allegations of anticompetitive activities by the hospitals
in connection with physician referral practices. The attorney general's office
will neither confirm nor deny the existence of an investigation.
Earlier waves of concentration provoked a
government reaction. And since Enron Corp.'s implosion, public hostility to big
business has grown. The Bush administration's top antitrust officials insist
they intend to be as aggressive as their Clinton predecessors.
Those expecting easier treatment from the
Bush FTC appointees will be "disappointed," FTC Chairman Timothy Muris told an
American Bar Association forum last summer. Mr. James, the Justice antitrust
chief, said much the same at the event.
Indeed, not every merger sails through the
Bush administration. But there's no doubt about the change in tone.
The new Economic Report of the President
declares that there is "little evidence" the mergers of the 1980s and 1990s
"harmed competition." At the FCC, Chairman Michael Powell says he is largely
unconcerned about preventing concentration in any one industry as long as cable,
old-style telephone, wireless and satellite are all competing to serve
consumers.
Such comments are sparking predictions that
the Powell FCC will approve Comcast Corp.'s proposed acquisition of AT&T
Corp.'s cable arm, which would leave three companies in control of 65% of the
cable business. There's also speculation that the FCC might allow a Bell company
to buy a long-distance giant like Worldcom Inc. or Sprint Corp., a combination
that would have been unthinkable even two years ago. Last week's appeals-court
decision struck down FCC rules barring cable-TV operators from owning broadcast
stations in the same market and forces the FCC to reconsider old rules
preventing broadcast networks from owning local affiliates that reach more than
35% of the nation.
In the Microsoft case, the most celebrated
antitrust action in decades, the Bush administration is widely regarded to be
softer than its Clinton predecessors. After a seven-judge federal appeals court
upheld the finding that Microsoft Corp. used its monopoly power to protect its
Windows product, Mr. James agreed to a settlement that has been criticized as
too soft and riddled with loopholes to restore competition.
"To say that it sets a tone for how this
administration will be perceived is an understatement," says Robert Lande, a
critic of Microsoft and an antitrust specialist at University of Baltimore law
school. Even Einer Elhauge, a Harvard law professor and supporter of the Bush
administration's antitrust approach, has criticized the settlement, now being
reviewed by a federal judge. "The proposed settlement leaves Microsoft free to
harm competition at the cost of technological progress in precisely the way it
was found to have done so in the past." Mr. Elhauge says.
For much of the 1990s, ebullient stock and
bond markets offered a vigorous countervailing force to the oligopolistic
tendencies of American business by financing scores of aggressive upstarts.
Indeed, Congress was counting on capital flowing into new ventures when it
deregulated the telecommunications industry in 1996. Lawmakers envisioned a
world in which nimble upstarts, known as "competitive local exchange carriers,"
would challenge the behemoths controlling local phone markets.
Investors poured tens of billions of
dollars into CLECs, wagering that these rivals to the Bell companies would
eventually take as much as 50% of the $112 billion market. XO Communications
Inc. raised more than $258 million in a 1997 IPO, and saw its shares rise 34%
above their offering price on the first day of trading. ICG Communications Inc.
of Denver raised more than $2.5 billion from investors like Hicks Muse and
Liberty Media Corp., AT&T's media-investment arm, and then had a hugely
successful IPO.
In just two years, 1998 and 1999, more than
$50 billion in high-yield telecom bonds were issued, according to Thomson
Financial Securities Data. Private equity investors like Hicks, Muse, Tate &
Furst, Kohlberg Kravis Roberts & Co. and Bain & Co. invested $10.3
billion in stakes in telecommunications companies.
By 2000, however, investors had begun to
sour on the upstarts, which showed few signs of turning profits anytime soon.
Companies that survived are still trying to adjust to the change. "It's really
unprecedented. We've gone from full spigot to a situation where every capital
source has shut down at the same time," says Randall Curran, chief executive of
ICG Communcations, which filed for bankruptcy protection in November of 2000. XO
now trades at five cents a share.
Consumer groups and many of the upstarts
blame the Bells for the CLECs' woes. They accuse the giants of trying to thwart
competition by charging unfairly high prices for access to their phone lines,
which they're required to share with competitors, or intentionally providing
poor service to the upstarts' customers. The Bells say the companies expanded
too fast and failed to develop a sustainable business model.
At the end of 2000, there were 330 CLECs
challenging the Bells. A year later, there were 150 left.
--- The
Oligopoly Watch
By Wall
Street Journal staff reporters Yochi J. Dreazen, Greg Ip and Nicholas
Kulish
02/25/2002
The Wall Street Journal
A1
(Copyright (c)
2002, Dow Jones & Company, Inc.)
Corrections & Amplifications
-- In 1990, three big publishers of
college textbooks accounted for 35% of industry sales. Today they have 62%.
-- In 1993, then-Defense Secretary
William Perry told executives of more than a dozen big defense contractors that
half their companies wouldn't exist in five years. He was right. Today, five
titans dominate the industry, and one of them, Northrop Grumman Corp., Friday
made a surprise $5.9 billion bid for TRW Inc., a maker of auto parts, defense
and aerospace equipment. The offer includes $5.5 billion in assumed debt.
-- In 1996, when Congress deregulated
telecommunications, there were eight Baby Bells. Today there are four, and
dozens of small rivals are dead.
-- In 1999, more than 10 significant
firms offered help-wanted Web sites. Today, three firms dominate.
Even as economic forces push these
industries toward oligopoly, some of the forces that checked this trend in the
1990s are weakening. U.S. antitrust cops, regulators and judges seem less
antagonistic toward bigness. Just last week, a federal appeals court opened the
door to another round of media mergers by striking down rules that in effect
barred cable companies from buying broadcast networks.
Industry: Defense contractors
State of
Market: After a wave of Pentagon-encouraged consolidation,
there are five industry titans: Northrop Grumman,
Lockheed Martin,
Boeing, Raytheon and General
Dynamics.
Recent Deals: Northrop last week
bid $5.9 billion for TRW, soon after
buying
Newport News Shipbuilding.
Outlook: Pentagon
likely to oppose further consolidation among the
biggest players, but giants may snap up smaller firms. Possible
targets: L3 Communications, United Defense.
Industry: Basic
DRAM semiconductor chips
State of Market: If
Micron Technology succeeds in buying the DRAM
operations of South Korea's Hynix Semiconductor, the four
largest
companies would control 83% of the
global market, compared with 46% in
1995.
Recent Deals: In December Micron
agreed to buy U.S. DRAM operations
of No. 6
Toshiba. Also, No. 7 Hitachi and No. 5 NEC last year agreed
to merge memory-chip operations.
Outlook: Consolidation fueled by excess
capacity and price slump.
Reviving
demand and mergers help prices rebound. Some small players
likely to be squeezed out as four giants
dominate.
Industry: Cable TV
State of Market: If
Comcast-AT&T broadband deal goes through, three
companies will control 65%.
Recent
Deals: Pending acquisition of AT&T's cable arm by Comcast.
Outlook: More deals likely as companies try to compete
with
Comcast-AT&T. Court decision
striking down rules limiting cable
companies'
scale makes deals easier.
Industry: College textbooks
State of Market: Three companies control 61.5%:
Pearson (26.7%),
Thomson (21.8%), McGraw-Hill
(13%)
Recent Deals: Thomson's $2.06 billion
acquisition last year of
several Harcourt
business lines, including its college titles.
Outlook: Several smaller players could get snatched up by one of
the
big three, but the biggest remaining
player, Houghton Mifflin, has
5.2%.
Industry: Job
recruitment Web sites
State of Market: Three
players control 66% of industry revenues. Two
years ago, at least 10 players were contenders
Recent Deals: Yahoo! this year bought HotJobs.com, and
CareerBuilder,
whose major shareholders are
Tribune and Knight Ridder, last year
acquired
HeadHunter.Net.
Outlook: No more
consolidation likely among three top players.
Several major employers, seeking to broaden their options,
recently
formed a cooperative site.
Industry: Local
TV
State of Market: Viacom and Fox each reach
41% of homes already. A
pending deal would
give NBC 30%.
Recent Deals: Viacom this year
agreed to buy KCAL-TV, last
independent
station in Los Angeles, for $650 million. General Electric
bought Spanish-language Telemundo network and KVEA
station in same
market last year.
Outlook: Appeals-court decision last week ordering
regulators to
rethink ownership cap will
spark more deals. Likely targets: Belo and
Scripps-Howard.
Industry: Pharmaceuticals
State of Market: Three companies have 26.2% of U.S. sales:
Pfizer
(10.2%), GlaxoSmithKline (8.8%) and
Merck (7.2%)
Recent Deals: In 2000, Glaxo
Wellcome and SmithKline Beecham agreed
to
merge and Pfizer acquired Warner-Lambert.
Outlook: Plenty of room for consolidation remains, but some companies
find bigger isn't better as sales growth
after deals remains poor.
Industry: Wireless phones
State of Market: Five companies control 71%: Verizon Wireless
(23%),
AT&T Wireless (14%), Sprint (10%),
Cingular, the joint venture of SBC
and
BellSouth (17%) and Nextel (7%)
Recent Deals:
Deutsche Telekom bought VoiceStream Wireless last year
for $26 billion.
Outlook: Deals likely as major players take advantage of FCC decision
last year increasing amount of spectrum any
company can own. Major
carriers likely to
snap up smaller ones, such as Nextel and Northcoast.
Sources: Simba Information; Legg
Mason; Ad Media Partners; IMS
Health; Gartner
Dataquest; Forrester Research; WSJ research
Copyright © 2000 Dow Jones &
Company, Inc. All Rights Reserved.