It is a difficult question to answer. Let us consider the following worldviews:
- Decline in competition. Competition has decreased because we see greater market concentration, an increase in markets, a decrease in labor force participation, and a lower rate of new firm formation at the macro level.
- Competition in actionIf a few “superstar” firms in an industry grow by offering greater value to customers based on their superior ability to adopt and use new technologies that entail higher fixed costs and lower marginal costs, we would expect both concentration and price/cost margins to increase along the same lines.
In short, the same empirical evidence could support very different worldviews.
Market concentration:Let’s consider another example where the market concentration of the top four firms (known as the C4 statistic) increased from 50% to 90% over time. If this concentration was due solely to acquisitions, there might be concerns of market concentration/market power. Conversely, if the growth in C4 was due to internal growth of several large, efficient firms, leading to better products and lower prices, this increase in C4 would be less of a problem.
Let us also consider how market definitions might lead to upward or downward biases in market concentration.
Underestimating market concentration by using overly broad categories: NAICS code 325412 is “Pharmaceutical Preparation Manufacturing.” Using this as a “market,” a drug that treats one disease would be in the same “market” as all other drugs that treat other diseases. In extreme cases, if there are many diseases of similar prevalence and severity, and each disease class had a single patented monopolist, then measuring concentration in NAICS code 325412 would misleadingly yield low concentration. In contrast, researchers studying the industrial organization of pharmaceutical markets have tended to define markets much more narrowly. For example, Cunningham, Ederer, and Ma (2021) define markets as a combination of therapeutic class and mechanism of action. This sensible procedure results in hundreds of separate pharmaceutical markets. Similarly, NAICS code 513210 is “Software Publishers.” This code groups together all software, whether desktop operating systems, enterprise databases, mobile applications, computer games, or specialized technical software. Market Overstatement Concentration through the use of overly wide regions:NAICS code 444130 is “Hardware Stores.” Consider competition among hardware stores before and after the expansion of Home Depot and Lowe’s. Suppose each city starts with its own monopoly hardware store with a different local owner. New technology then enables economies of scale across geographies, allowing the most efficient hardware stores to expand nationally. Suppose the result is that each city has two big-box hardware stores, Home Depot and Lowe’s. Concentration measured at the national level will have increased dramatically, moving from a highly fragmented industry to a duopoly. But consumers would benefit from increased local competition, having two choices instead of one.
Profit margins can tell us whether a firm exercises market power. Profit margins are prices that closely approximate marginal cost. However, even estimating marginal cost is problematic for several reasons.
First, distinguishing costs that vary with output (in the relevant range and time frame) from those that do not is extremely difficult to do at scale. Second, marginal costs often include opportunity costs that are difficult to observe, especially when firms face capacity constraints. Third, multiproduct firms typically have variable costs that are spread across different products and are difficult to apportion. Fourth, the way in which estimated price/cost margins are aggregated from the product level to the firm level, and from the firm level to summary measures for entire sectors or the entire economy is important quantitatively and for interpretation. For example, a shift toward industries in which intellectual property is more important will itself cause economy-wide average margins to rise, even without any change within the industry.
Consider, for example, the following chart. Corporate profits have been growing over time (see chart on the left), but this is largely because domestic companies have been more successful in foreign markets (see chart on the right).
There are two main approaches to estimating margins, the latter of which is the most commonly used. De Loecker, Eeckhout and Unger (2020) The (“DLEU”) method of applying the production approach has been influential in this literature.
- Demand approachA consumer demand system is estimated and assumptions are made about the firm’s behavior to infer what the marginal costs must have been to generate the observed prices, given that demand system and the assumed firm’s behavior.
- Production approachData on inputs and outputs are used to infer what the price/cost margin must have been for a cost-minimizing firm to decide to produce the observed quantity of output using the observed quantity of inputs.
Most of these arguments were set out in a document Carl Shapiro and Ali Yurukoglu (2024)The aim of this article is to examine what is going on by focusing on detailed industry-level data rather than just aggregate economy-wide data. The article does an excellent job of summarizing recent literature on trends in market concentration, pricing/margins, and retrospective analysis of recent mergers. The above content summarizes some of the challenges, but the full article does a really good review of the current literature on both sides of the argument.
Additional details:
- Documents of Sutton (1991) and Sutton (1997) He explains the argument of competition in action in his two books on competition.
- The Clayton Act prohibits mergers and acquisitions when “the effect of such acquisition would be to substantially lessen competition or tend to create a monopoly.”
- Currently, transactions valued at more than $119.5 million must be reported under the Hart-Scott-Rodino Act (“HSR”).
