The Latest Stage of Capitalism

Louis Proyect lnp3 at
Mon Feb 25 08:40:59 MST 2002

Wall Street Journal, Feb. 25, 2002

Oligopolies Are on the Rise
As the Urge to Merge Grows


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

• 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.

• 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. (See article.)

• 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.

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

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

Textbook Case

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

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.

Recruiting Turmoil

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 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

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.

Shifting Power

"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

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.

Louis Proyect
Marxism mailing list:

PLEASE clip all extraneous text before replying to a message.

More information about the Marxism mailing list