‘For whosoever hath, to him shall be given… but whosoever hath not, from him shall be taken away even that he hath.’ Not exactly what a young soul expected to hear at Sunday school, but a verse that comes to mind when thoughts turn to monopolies.
Understanding monopoly is vital for equity investing. Large companies that abuse their powers can stir the regulator to action. Regulation can dramatically affect returns – that is its intention. And lowered returns mean sharply lower share prices.
The US Congress’ antitrust hearing in July, where the heads of Amazon, Apple, Alphabet (Google) and Facebook were quizzed, should be sufficient warning of the relevance of this issue today.
Companies generate higher margins and higher returns on capital when they have built barriers to entry and so avoid cut-throat competition. Those barriers (or moats) mark out the ‘quality stocks’ that Warren Buffett, among others, identifies as the best long-term investments. But barriers to entry can come by fair means or foul.
Monopoly at play
Foul means of building barriers and making high profits have long been recognised and prohibited. Edward the Confessor would sanction those guilty of ‘foresteel’ – buying up large quantities of corn and other goods before they reached the marketplace to inflate prices.
Adam Smith lamented the abuses from companies with royal patents, warning that ‘people of the same trade seldom meet together… but the conversation ends in a conspiracy against the public’. Again, his concern was to promote fair competition and fair pricing.
The European tradition of identifying monopolies assumes that companies with high market shares of any defined industry are likely to act against the public interest. Monopolies are identified using the Herfindahl-Hirschman index. If the sum of the squares of the market shares of all the participants is below 1,500 there is a competitive market. A score of 1,500 to 2,500 is considered moderately concentrated. A score of 10,000 is clearly a monopoly.
In the US, monopolies are more likely to be deemed innocent until proven guilty. Republican president Theodore Roosevelt said that government should not attack business unless it could show that business used ‘unfair practice’. Unfortunately, in his day that left quite a few to attack. And, surprisingly, he did. The US railways had freight rates regulated in 1906, and in 1911 Rockefeller’s Standard Oil (which owned 64% of US oil production at the time) was split into 34 companies over claims of predatory pricing.
Companies with a large market share do not always raise prices to the public. They can also distort competition by keeping prices low to deter new entrants. The breakup of AT&T’s Bell System Laboratories in 1982 was simply to encourage competition. There were few claims of monopoly pricing.
Nor are monopolies always about scheming to control supply – this can happen naturally. In the cases of networks such as railways, electricity grids and water companies it makes no sense for more than one network to be laid. Some thought telephone wires would be similar until there was enough money in pay TV for Nynex and others to take a digger to our streets, laying cables under scars of tarmac.
The digital challenge
The digital era opens up a new set of problems for monopoly regulators. At the end of the session in Congress, the chair of the sub-committee, Democrat David Cicilline, declared: “These companies as they exist today have monopoly power. Some need to be broken up; all need to be properly regulated and held accountable. We need to ensure the antitrust laws, first written more than a century ago, work in the digital age.”
When a politician makes a statement like that you have to factor in showboating and party political agendas. Are many of the stocks that have dominated recent bull markets actually monopolies?
It is clear that the world leaders in online shopping, internet searches, cloud services and social media all benefit from the network effect that attracts users to the place where users already congregate – an instance of whosever hath being given more.
A case could be made for some of these companies adopting ‘predatory pricing’ – keeping prices down to deter competitors entering the market. But it is hard to see how their services have not benefited the public at low cost. These businesses have built their own intellectual property and invested heavily to get where they are, and that property merits some protection in law.
It is argued some have bought up would-be rivals to reduce competition or bundled products to bind users into using their applications even when these are not competitive (though most avoid these practices since 2004, when Microsoft was fined £381 million by the EU for including its media-player within Windows). Perhaps some have frustrated competition. More pertinently, in the realm of realpolitik, most do not pay much tax.
That combination of high market power and low tax may be less secure than some think in an era when governments have big spending plans. We still hold a number of the digital giant stocks – they have performed well for us. But as investors, we need to be alert to regulatory risk and factor it into our decision-making.
Nobody expected Teddy Roosevelt to become a trust buster. It seems far more likely that Joe Biden will fit that role. Those that hath may actually find some of it taken away.
Simon Edelsten co-manages the Artemis Global Select Fund and the Mid Wynd International Investment Trust. Visit the fund and trust pages for further information about its performance and current positioning.
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