The total number of firms has dropped far less than the number of publicly traded firms, so in part this is probably due to laws affecting publicly traded firms in particular such as Sarbanes-Oxley. But there has also been a drop in the total number of firms. As a result, concentration ratios have increased which suggests that competition might have fallen.
Some possible stories.
1. The number of manufacturing firms declines as manufacturing declines as a share of GDP. Meanwhile, in the growing sectors of health care and education, government creates huge barriers to entry. It seems to actively encourage consolidation in health care.
2. The Internet and globalization create winners-take-most markets in several categories. Think of how many department stores were killed off by Wal-mart.
3. Lots of consolidation in finance. Remember that as recently as the 1970s banks were not allowed to cross state lines, so we probably had more banks than was efficient well into the 1990s.
I am not ready to buy the story that competition has fallen across the board. One of the big stories of the past couple decades is the big rise in prices in education and health care and the much slower rise in prices for manufactured goods. To me, that goes along more with a story of government policies to subsidize demand and restrict supply in the former sectors.
I’ll add a couple speculative factors:
4. The global savings glut has made financing M&A activity cheaper.
5. The Great Stagnation has made increasing market share (via M&A activity) for existing products/services the only reliable path to growing revenues and profits for many firms.
6. Decreasing transaction costs in capital markets have shortened investors’ time horizons (ie, more speculation, less long-term investing), making acquisitions more attractive to the acquiree’s shareholders when there is even a modest premium being paid over the FMV of the shares they own.
Also under 2. Current account imbalances have suppressed both job and company creation.
4 Demographics. With population growth largely among retirees, buybacks and dividends now make more sense than increasing capacity.
Maybe we just don’t need as many firms as we used to. Maybe big corporations are getting more nimble, able to serve niches and act quickly in the ways that only lots of smaller firms used to before. And maybe big firms are able to earn and then monetize superior customer loyalty that they would have been too big and slow to keep in the past.
(But maybe this a product of Cowen-esque secular stagnation, where genuine innovation is tapped out and firms are just gilding lillies, not facing imminent technological disruption…)
For example: depending on who does the counting, there are over 100 different brands of smart phone worldwide, but Apple still makes monster profits on iPhones (for now).
These add-in to the other answers given, but:
1). My subjective observation is that almost every firm, be it public or private, profit or non-profit has become much more lean and competitive in its operations. The belt buckle’s been tightened everywhere I look.
Instinctively I don’t sense that firms are becoming less competitive.
2). Regional patterns of trade have mostly been replaced with global patterns of trade, eroding the comparative advantage of many firms and causing optimal firm size to increase, allowing for consolidation at the top.
3). Large companies have gotten much better at in-house experimentation, creating a larger ecosystem of intrapreneurs who effectively do start their own businesses, just within existing ones.
4). Overall rates of business startups have gone down, but the number of “game changing” startups has increased. So we have less mom-and-pop ice cream shops but more sophisticated, venture backed C-Corps making big plays at important markets.
Overall, I’m confident that business dynamics have changed, but am very uncertain they’ve decreased.
Maybe fewer bucket shops selling crappy stocks. It used to be that stock brokers would sell these shares ala Wolf of Wall Street. With regulation and decimalization and internet brokers and lots of individual investors getting better educated and moving to ETFs, there just isnt the broker support out there for penny stocks.
Increased compliance costs of a public vs private corp?
More regulation always favors larger firms – lower cost of compliance as a % of revenue.
” we probably had more banks than was efficient well into the 1990s.” << assuming no systemic risk. Had the banks remained constrained to states, I'm certain that Finance would not be getting some 40% of US profits in any year, and the housing 2001-2006 bubble & 2007-2008 crash, would have been different, and much less costly.
It wasn't that long ago when there was a Big-8 for accounting firms. I'm pretty sure there was less psuedo-cartelization of banking & accounting when there were more presidents of more big companies rather than fewer presidents of fewer but larger companies.
Comparing bank mergers with tech mergers (like HP – Compaq), the efficiency increase in the tech mergers seems clear. Yet, even there, Acer & Asus growth shows that Compaq, with internal cost-cutting, could have continued independently, making a more-commodity like product.
In banks, maybe the pure financial profit efficiency went up (externalizing the increased systemic risk), but with a reduction in consumer choice and a higher price per service than what would have been offered without the mergers; and thus fewer, much richer financiers captured more of the "deal surplus" value.
Had the Big Banks been allowed to go bankrupt in 2008, as their bad decisions made them deserve, would you still think it the efficiency had increased?
Only corporations can be publicly traded. If a business can get access to capital without using the corporate form, by using a disregarded entity such as an LLC, it can avoid a layer of taxation. Add all of the other disadvantages of being publicly traded, and there is a significant incentive for a firm to remain private if it can get the necessary financing. There are some quite large LLCs.
Several related theories:
– cost of compliance is probably the ur-cause of all. I am somewhat making this number up, but I believe the costs of regulatory compliance start at $2m/yr (and in many cases are much, much higher) if you want to be public. If that number is treated as a cost-of-capital, it does not become smaller than a 2% fund management fee until a company has a valuation over $100m. That’s not a particularly goo way to think of it though, because a $100m company with a 12x P/E valuation would have earnings of only ~$8m/yr. For a company of that size, the $2m/yr compliance cost is the difference between an 8% ROE and a 10% ROE. Compound that over several years and it’s simply not justifiable. If one thinks the ROE reduction doesn’t become tolerable until it’s down to 50pbs, then you need a $400m valuation to justify being public. Once you start getting to numbers that big, the number of companies that are even big enough to consider public markets starts shrinking very rapidly.
– the existence of large and well-developed PE firms, especially those that specialize in particular industries, coordinates investment into companies needing growth capital more efficiently than does the ‘hire an investment-bank to pitch your company to public markets’ model. The PE funding / development model in some industries (tech most famously) has gotten sufficiently sophisticated and standardized that everyone knows what the difference between “seed”, “series A”, “series B”, etc is, and investment firms can specialize not only in industry but in maturity-level of the companies in which they invest.
– the efficiency of private- over public- equity markets can be measured several ways: 1) If one considers the standard 2% annual management fee of PE to be the intermediation cost, the relevant comp is an investment bank’s one-time, 7%-ish underwriting fee. It takes fairly long time horizons for the public-market route to become more efficient. 2) In the PE situation, the investor rather than the investee pays the intermediator, which creates much better alignment of interests. PE firms are scrutinized on how well they allocate capital in a way investment banks are not.
– There are really only three reasons for a company to want to be public 1) Liquidity. Liquidity gives a valuation premium, and allows mgmt and earlier investors to cash in their returns 2) accessing large amounts of capital without ceding management control. TSLA a great example. TSLA raised about $225m in their IPO, relative to an overall $1.3b market cap. Any single-source investor putting that much money into a company would have (rightfully) demanded board seats commensurate with the size of their stake, no matter how starry-eyed they were over Elon Musk. With a public offering though, no such concession need be made. 3) The ability (related to 1) to use your stock as a currency for acquisitions. If you are a company whose valuation reflects big growth expectations, acquisition-by-stock issuance is a very cheap source of financing that growth.