Barry Ritholtz, one of the most interesting business bloggers around, links to Philip H. Howard’s thoughts on consolidation in the market for soft drinks:
“Three firms control 89% of US soft drink sales. This dominance is obscured from us by the appearance of numerous choices on retailer shelves. Steve Hannaford refers to this as “pseudovariety,” or the illusion of diversity, concealing a lack of real choice. To visualize the extent of pseudovariety in this industry we developed a cluster diagram to represent the number of soft drink brands and varieties found in the refrigerator cases of 94 Michigan retailers, along with their ownership connections.”
I find this way of thinking very strange. As a friend of mine asked, isn’t there real choice if, well, the different beverages taste different, and thus cater to a wide variety of different palettes? It could be that we don’t have enough variety of tastes and flavors. But of course that presents an opportunity for entrepreneurs in the speciality food market, a subject to which I’ll return in a moment.
On a tangential note, Ritholtz wonders how many of these beverages use corn syrup rather than cane sugar. This reminded me of a fascinating piece by Tom Philpott at Grist on the economic forces behind HFCS. It is a commonplace observation that agricultural subsidies are behind heavy use of HFCS. But as Philpott argues, the truth is more complicated. Citing a study by Tufts University researchers, he writes:
The authors also note corn subsidies have saved HFCS makers significant cash over the years. Indeed, they reckon that because of the downward pressure on corn prices from subsidies, HFCS producers — including the dominant one, Archer Daniels Midland — accessed “corn priced 27% below its cost from 1997-2005.” As a result, producers booked a cool $2.2 billion in savings between 1997 and 2005 (a period of dramatically heightened subsidy payments).
That’s a lot of money, but as the authors note, meat packers and dairy processors fared even better over this period. Buying livestock fattened on cheap subsidized grain saved chicken processors $11.3 billion, pork processors $8.5 billion, and beef packers $4.5 billion in the 1997-2005 time frame.
These subsidies only affect final food prices by a penny or two. The real driver of HFCS use was the sugar quota that limited imports in the early 1980s. But Australia, which uses very little HFCS, facing a similar obesity problem. For Philpott, this represents a case against eliminating subsidies. He’d prefer redirecting them towards environmentally sound practices. I’ll withhold judgment. Yet I will say that the “culprit” here seems to be the near-universal human taste for sugary foods.
But back to Howard’s thoughts on pseudovariety. His argument bears a strong family resemblance to “Who Broke America’s Jobs Machine?,” a Washington Monthly story by Barry Lynn and Phil Longman that made the case against corporate consolidation. Lynn and Longman describe the extraordinary consolidation of the food industry, among others. I’m a great admirer of Phil Longman, but I found the article very fishy:
The Austrian economist Joseph Schumpeter famously theorized that monopolists would invest their outsized profits into new R&D to enable themselves to innovate and thus stay ahead of potential rivals—an argument that defenders of consolidation have long relied on. But numerous empirical studies in recent years have found the opposite to be true: competition is a greater spur to innovation than monopoly is.
This sounds like a straw man to me. I don’t think many people would endorse Schumpeter’s thesis, including most defenders of consolidation. The argument Lynn and Longman described was part and parcel of Schumpeter’s belief that bureaucratic socialism would thus triumph over entrepreneurial capitalism, a view that isn’t widely embraced these days. I’d say Amar Bhidé’s take in The Venturesome Economy makes more sense, as The Economist suggested a few years ago:
The most important part of innovation may be the willingness of consumers, whether individuals or firms, to try new products and services, says Mr Bhidé. In his view, it is America’s venturesome consumers that drive the country’s leadership in innovation. Particularly important has been the venturesome consumption of new innovations by American firms. Although America has a lowish overall investment rate compared with other rich countries, it has a very high rate of adoption of information technology (IT). Contrast that with Japan (the original technology bogeyman from the East) where, despite an abundance of inventive scientists and engineers, many firms remain primitive in their use of IT.
One reason why American firms are able to be so venturesome is that they have the managers capable of adapting their organisations to embrace innovation, says Mr Bhidé. Pressure to be venturesome may have come from America’s highly competitive markets. And America’s downstream firms are arguably the world’s leaders in finding ways to encourage consumers to try new things, not least through their enormous marketing arms and by ensuring that there is a lavish supply of credit. [Emphasis added.]
Lynn and Longman continue:
In one widely cited study, for instance, Philippe Aghion of Harvard University and Peter Howitt of Brown University looked at British manufacturing firms from 1968 to 1997, when the UK’s economy was integrating with Europe and hence subject to the EU’s antitrust policies. They found that on balance these firms became more innovative—as measured by patent applications and R&D spending—as they were forced to compete more directly with their continental rivals.
Bhidé would challenge the notion that patent applications and R&D spending are the best metric. How valuable is R&D spending if it is wasted? And how valuable are defensive patents that actually clog the innovation process, as Michael Heller argued in The Gridlock Economy? The innovation that matters in advanced economies, Bhidé argues, is downstream innovation rather than upstream innovation, i.e., how quickly a country’s firms and consumers embrace successful innovations. Back to Lynn and Longman:
The opposite trend took place in some of America’s biggest industrial firms in the years after 1981, when the Reagan administration all but abandoned antitrust enforcement. Many of the most successful U.S. companies adopted a winner-take-all approach to their industries that allowed them to shortchange innovation and productive expansion. Prior to 1981, for instance, General Electric invested heavily in R&D in many fields, seeking to compete in as many markets as possible; after 1981 it pulled back its resources, focusing instead on gathering sufficient power to govern the pace of technological change.
Again, this seems like a truly bizarre metric. Don’t the productivity explosions of 1995 to 2000 and 2003 to 2006 offer an instructive contrast? In both cases, economy-wide productivity increases were driven by the embrace of IT-intensive business practices. How were these firms shortchanging innovation and productive expansion? If we go by R&D investment, we’re missing the crucial importance of ground-level innovation.
Consolidation in the retail sector can also inhibit job growth. As behemoth retailers garner ever more power over the sale of some product or service, they also gain an ever greater ability to strip away the profits that once would have made their way into the hands of their suppliers. The money that the managers and workers at these smaller companies would have used to expand their business, or upgrade their machinery and skills, is instead transferred to the bottom lines of dominant retailers and traders and thence to shareholders.
Does the money vanish? Or is it then saved, invested, and spent? And isn’t this another, darker way to describe the productivity increases that transformed retail in the 1990s? Lynn and Longman go on to complain about inexpensive books and other aspects of the Wal-Mart economy.
Here is one of the more vexing passages in the article, for me at least:
Another way that monopolization can inhibit the creation of new jobs is the practice of entrenched corporations using their power to buy up, and sometimes stash away, new technologies, rather than building them themselves. Prior to the 1980s, if a company wanted to enter a new area of business, it would typically have had to open a new division, hire talent, and invest in R&D in order to compete with existing companies in that area. Now it can simply buy them. There is a whole business model based on this idea, sometimes called “innovation through acquisition.” The model is often associated with the Internet technology company Cisco, which, starting in the early ’90s and continuing apace afterward, gobbled up more than 100 smaller companies. Other tech titans, including Oracle, have in recent years adopted much the same basic approach. Even Google, many people’s notion of an enlightened, innovative corporate Goliath, has acquired many of its game-changing technologies—such as Google Earth, Google Analytics, and Google Docs—from smaller start-ups that Google bought out. As the falloff in IPOs over the last decade seems to confirm, one practical result of all this is that fewer and fewer entrepreneurs at start-up companies even attempt any longer to build their firms into ventures able to produce not merely new products but new jobs and new competition into established companies. Instead, increasingly their goal, once they have proven that a viable business can be built around a particular technology, is simply to sell out to one of the behemoths.
These talent acquisitions really are common. But it is far more common for larger firms to make talent acquisitions in order to actually use ideas from young entrepreneurial firms rather than hoard them. And if firms do hoard good ideas, one assumes that other entrepreneurs and indeed other large firms will find a way to get access to slightly-modified versions of the best, most disruptive ideas to beat the competition. This is one version of the story behind Dennis Crowley’s sale of Dodgeball and his subsequent founding of Foursquare. How is this a bad thing? It gives entrepreneurs a very happy “exit” — and the wealth they need to fund other start-ups. This is the story behind Paul Graham’s YCombinator, the so-called “PayPal Mafia,” and, to come full circle, a lot of the innovation happening in the food and beverage industry.
Consider the story of Siggi’s, a new brand of Icelandic yogurt or skyr. Jill Priluck wrote a terrific piece on Siggi’s in Slate earlier this month, and it illustrates how innovation happens in a consolidated food industry:
In late 2004, Icelandic native Siggi Hilmarsson was a miserable Deloitte consultant working in Manhattan. Craving the comforts of home during his first Christmas away, he made skyr, Iceland’s yogurt, in his Tribeca kitchen.
More than five years later, Hilmarsson’s Icelandic Milk & Skyr Corp. supplies Whole Foods, Wegman’s, and Stop & Shop and boasts nine employees plus about 350 cows from six family farms. In July, private equity firm Revelry Brands acquired a minority stake in the company.
Suffice it to say, this doesn’t happen every day. But tons of entrepreneurs, in specialty foods as well as in social gaming and media and biotech and other sectors, start companies in the hope of getting acquired. Siggi Hilmarsson might be thinking he’ll eventually go public at the helm of a vast skyr empire. But I’m guessing he’d be just as happy getting acquired by a multinational firm like Paris-based Groupe Danone. The big firm will help get this distinctive flavor into supermarkets across the U.S. and across the world. And pace Philip H. Howard, that ultimately means more real variety.
Lynn and Longman are right to worry about the broken jobs machine. But rising productivity and the consolidation of certain goods-producing industries isn’t the culprit. Rather, it is mass incarceration, wrongheaded labor market regulations, an educational system that fails to impart the noncognitive skills that workers in a modern economy need to thrive, family disruption, and a broken and bloated public sector.