WSJ: Oligopolies Are on the Rise As the Urge to Merge Grows

_marco _ cuito61 at hotmail.com
Wed Feb 27 08:00:16 MST 2002


http://online.wsj.com/article_email/0,,SB1014589181477203560,00.html
Oligopolies Are on the Rise As the Urge to Merge Grows
By YOCHI J. DREAZEN, GREG IP and NICHOLAS KULISH
Staff Reporters of THE WALL STREET JOURNAL

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.

• 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 
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.

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 
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.

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 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.

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 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.



---*---*---
+Marc ("marco") Rodrigues: cuito61 at hotmail.com
+cell: 914-661-9783
+Queens College Radical Activist: qc_activist at hotmail.com
http://groups.yahoo.com/group/QCactivist

"We declare our right on this earth ... to be a human being, to be respected 
as a human being, to be given the rights of a human being in this society, 
on this earth, in this day, which we intend to bring into existence by any 
means necessary. -Malcolm X

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