Who said monopoly is a bad thing?
Just about everybody has a good thing to say about competition. However, in practice, the very same people always prefer monopoly -- for themselves, of course, and not for others, who are deemed to be better off fighting it out among themselves. The tune changes dramatically if they are the underdogs, having to face monopolistic control that benefits others rather than themselves. Then, they are fervently in favour of greater competition. It is a fair assessment that in modern economic history, people and organisations have always striven for as much of a monopoly position as they can get. The astute economist, Adam Smith, recognised this fact, back in eighteenth century England. Striving to control the market and make big profits are natural motives of economic entities, and the same tendencies are present today as in the past.
Rent-seeking has always been the aim of both individuals and companies. The term refers to the extra profit or income that you can command because of a measure of exclusivity that you possess. If you don’t have it, then the iron law of competition will drive down your returns to a normal market average. So there is obviously an intense interest in erecting any feasible barrier to entry. In fact, the goal of attaining monopoly profits is the crucial factor in the process of creative-destruction that has brought us high income-levels, productivity and innovations and has transformed the economic landscape in the past two centuries. This process produces a lot of benefits, despite some nasty collateral damage, which we properly refer to as "destruction". It is not surprising that, given the high stakes, people play this monopoly game by any means possible: fair or foul. The latter approach has little merit and can be counter-productive in terms of long-run growth and efficient resource allocation but is, nevertheless, part of how the real world works.
Entry barriers can be profitably exploited
Putting up barriers by foul means has a long history, and includes closing off markets to competition by government policies or giving singular privileges to particular groups or companies by passing special laws. It can also be created by a combination of businessmen deliberately restricting competition or sabotaging competitors. Many a great fortune during the robber-baron period in the United States was built on just such tactics. The record amply demonstrates that Rockefeller, Morgan and others were very successful at it. Modern-day laws are rather more restrictive and do not allow capitalists to act with quite the same panache. But in some emerging markets the legislation is less refined and the opportunities greater. In both developed and emerging markets the central thing that investors should grasp is this: whenever inefficiencies are being increased or reduced there are profits to be made by selling the disadvantaged firms and buying the advantaged. Changes in laws and regulations are good signals on where money is likely to be made and lost.
Creativity has good returns too
Let’s now look at the fair means of cornering markets. When we make long-term investments in stocks we are often searching for companies that have a degree of monopoly power that generates extra-normal profits -- it being understood that just having efficient operations isn’t going to produce high profits. Efficiency is a necessary but not a sufficient condition for high profitability. What is needed is an edge in proprietary products, processes or technology. Alternatively, it could be in the novelty of organisation or management, or the perceptive recognition of unsatisfied consumer needs. The key things to shoot for are market power and pricing power. Warren Buffett, among others, has shown a good nose for this in the past, selecting companies that had capability and clout in the markets they served.
One problem with this strategy is that branded products and entrenched market positions do not last forever. Indeed, there are indications that in recent years dominant standings are being eroded faster than in the past. In other words, companies with great brand names cannot rest on their laurels and hope that their traditional hefty margins can continue to be just as high in the future. There is a great deal of innovation taking place, which means that competitors are bringing out newer and possibly better products all the time. In some areas, consumers are willing to experiment and try out cheaper generics. In other areas, what was cool and fashionable can quickly become un-cool and distinctly unfashionable.
If a quasi-monopoly is being threatened then there is little reason to pay high multiples for a stock whose forward earnings-growth rate may be a lot slower than in the past. We have seen this sort of re-evaluation happen in the pharmaceutical and retail sectors. For long-term investors, holding-periods for many stocks may be lower than was the case previously. Even Buffett, who used to aim for very long holding-periods, appears to have shortened his horizon -- at any rate, for some stocks in his portfolio. For an investor, the important things to focus on are these: Does the firm have an edge that is not easily blunted, that gives it sustainable pricing power and market power? How sustainable is it? Who is losing ground and who is gaining it?
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