CHAPTER 3 - « THE RISE IN MARKET POWER » PHILIPPON, TH.

(2019)

How do you interpret Figure 3.1?

8 nonmanufacturing firms own 8% of the sales on the market while manufacturing firms own ±5%. Their share
has increased since 1980.
 We can observe that during the 90’s the market power went up, and it’s still growing now. Why ? Because of
mergers, we have increasingly more big companies that have big market power.

Concentration using top eight firm Census shares, cumulative change in CR8. Annual data.
The concentration ratio is defined as the market share (by sales) of the eight largest firms in each industry.
What do we observe?  This share has increased over time.

Can we say that the increase in concentration observed by Grullon et al. (forthcoming) is similar to the
increase in concentration in the Walmart case (chapter 2)? What is(are) the main difference(s)?
No. The increase of concentration with Walmart came along with reduced profit margins, which enabled them
to gain new market shares. However, the increase in concentration observed by Grulon was linked to higher
profit margins and dividends paid to the investors. These profit margins have even substantially increased over
the past 2 decades.

What are the various explanations (causes) for the increase in market concentration?
Contrast the analysis of Furman and the analysis of Autor et al.
In Chapter 2 we discussed some caveats (reserve, opposition, avertissement) when using industry concentration
as an indicator of competition
Concentration might signal changes in industry dynamics that are not directly related to market power, such as
an increasing efficiency gap between industry leaders and laggards (Walmart in the 1990s) or consolidation in
declining industries.
 Jason Furman, when he was chair of the council of economic advisers, argued that the rise in concentration
suggested “economic rents and barriers to competition”. Autor agrees that as barriers to entry have increased,
this has given incumbents more market power, thereby decreasing domestic competition.
• Furman : economic rents and barriers to entry
• Autor : « Winner take most feature »  Higher price-elasticity of demand  Why more concentration?  Go
to page 49-50.
• Consolidation due to foreign competition

Can you rephrase the 6 hypotheses underpinning the interpretation of data?

1. Hypothesis of Much Ado about Nothing
Industry concentration measures are meaningless because industry codes are too coarse (grossier,
approximative) and because markets are local (an argument of antitrust specialists).
 No reason to find a link bc no clear measures
Philippon and co-authors show that even though HHI or CRn indices are not perfect, by using other
indicators, it is still possible to show that concentration has increase

2. Hypothesis of Decreasing Domestic Competition

Competition has declined in many US industries (the argument of this book).
 Increased concentration (more market power to the incumbents) causes decreased domestic
competition
Argument related to the increase in barriers to entry and economic rents

3. Hypothesis of the Rise of Superstar Firms

Concentration reflects the increasing productivity of industry leaders.
This is the main hypothesis supported in the book (// GAFAM market power)
 4. Hypothesis of Lower Search Costs
The internet makes price comparisons easier, and this leads to winner-take-all outcomes.
Argument of Autor et al. : internet  increase in competition (due to easier price comparison)

5. Hypothesis of Globalization
Foreign competition leads to domestic consolidation.  people buy more from their own country (?)
 Impact of globalization: domestic industries try to get together to face the foreign industries.
Domestic firms can expend to other countries and become more powerful in the international
competition.
Philippon states that this assumption hold for the manufacturing sector

6. Hypothesis of Intangible Assets

The growth of intangible assets explains the evolution of concentration, profits, and investment.
 Too much intangible assets creates entry barriers and it increases productivity.
This, arccording to Philippon, is at the origin of the GAFAM increase in market power.

According to Philippon, why has domestic competition decreased?

Barriers to entry have increased and that this has given incumbents more market power, thereby decreasing
domestic competition.

Barriers to entry related to intagible goods, data mastery have increased and that this has given incumbents
more market power, thereby decreasing domestic competition.

What do Philippon and Gutiérrez propose to overcome the caveats of the HHI? What do
you see as an advantage to these measures compared to the HHI?

Instead of looking at the concentration of market shares at a point in time, we look at the persistence of
market shares over time.

Our intuition is that in a competitive industry, the leaders should be challenged. To make the point, imagine an
industry with five firms. In any given year, one firm dominates and has a market share of 60 percent, while the
other four firms have only 10 percent each. This looks like a concentrated industry. It has an HHI of 4,000,
clearly above the “highly concentrated” threshold of 2,500. But now imagine that every two years or so, the
leader is replaced by one of the followers. This might
be because these five firms are constantly trying to innovate and out- smart each other, and one succeeds on
average every two years. This dynamic turnover would radically change the picture. We would say that this
industry is in fact quite competitive, because the dominance of the leader is temporary. Its large market share
is transient. There is turn- over at the top.

You can more easily predict who will be on top five years from now. The answer is: the same firms as today.

HHI = point of time

Phillipons' suggestion is to work on a period of time (2 years, 5
years,...)
→ Better because a marcket where concentration is hight doesn't mean that the market is not competitive.
Indeed, if the market leader change every 2 years, you can say that the merket is competitive because this
market tend to force competitor to innovate all the time.
In order to grasp the persistence of market power, they computed two measures :
• One that captures turnover at the top
• The other that compute reshuffling of market shares Make sure that you are able to interpret these
measures.

With you own words, how do you interpret Figure 3.2?

The likelihood of being replaced is more important for services industries (±23%) than for manufacturing
industries (±29%). We can clearly see that those figures were higher in the 90’ which means that leaders have
less to worry to lose their position today than before.  The probability to be exited is lower.

This line chart shows us the evolution of the probability of losing our today’s position on the market within 3
years.
We can observe that in the 70’s, this probability was low and it was constantly growing up until reaching a peak
in the middle of the 90’s. Since then she started to drop.
So now it’s less likely to see a company who is on the top, not being on the top within 3 years.
 Persistence of market power as increased.

Make sure you can define and distinguish the concepts explained in Box 3.1 (make a
glossary for yourself)
 Gross profit margin = income/revenues
 Net profit margin = (income-depreciation) / revenues
 Net profit rate = (income-depreciation) / assets (stock of capital at the beginning of the year)
 The payout rate = dividend / assets (stock of capital)
 Divident =  an amount that a company pays to the shareholders based on the net income of
the year. this is an amount of cash
 Sharebuypacks = instead of paying dividend, the company will buy its shares to the
shareholders. Better option because less taxed.

 After paying taxes and replacing the depreciated asset, the firm must decide what to do with the leftover
money. It can either invest it to grow its capital stock, or it can pay it out to its owners, the shareholders.
Instead of sending 100 checks for 5 cents each, the firm could spend $5 to buy back its own shares. The value of
the shares would rise and shareholders would get exactly the same payouts. In this example, there is no ≠ btw
dividends and share buybacks.

How do Philippon and his colleague rule out the “Much Ado about Nothing” hypothesis?
The increase in profits is systematically linked to the increase in concentration so there is a consistent link
between the increase in profits and the increase in concentration, which proves that concentration measures
are capturing something real. What rules out the Much Ado about Nothing hypothesis

Firms in concentrating industries experience rising profit margins while firms in stable industries do not.

• Because there is a consistent link between the increase in profits and the increase in concentration, which
proves that concentration measures are capturing something real.
• The two persistence measures support their argument.

What is the “China shock” and what are its consequences?

China became a member of the World Trade Organization which marked the end of lengthy negotiations as
well as a significant step toward the integration of China into the world economy.  China Shock = imported
penetration from China
- They estimate that import competition from China was one of the cause of the reduction of US
manufacturing employment during the 2000’.
- Before 2000, China was not considered to be a market economy. Under the Smoot-Hawley Tariff Act
of 1930, nonmarket economies are subject to a relatively high tariff, known as a nonnormal trade
 relations (non-NTR) tariff. From 1980 onward, US presidents began granting NTR tariff rates to China,
but these waivers had to be reapproved each year by Congress. If Congress failed to renew the waiver,
the tariffs would jump back up to levels set in the 1930s. This introduced substantial un- certainty
around future tariff rates that limited investment by both US and Chinese firms
- In 2000, permanent normal trade relations (PNTR) were granted to China. The granting of PNTR re-
moved uncertainty around tariffs, which was particularly beneficial for industries with large NTR gaps.
- In manufacturing industries with high exposure to China, it is 40 percent lowe

« A more interesting critique is that domestic HHIs are too narrow in a globalized world. When foreign
competitors wipe out domestic firms, competition clearly increases, but domestic measures of concentration,
computed with surviving firms, may very well increase. »
When China became a member of the WTO, import competition from China was a major force behind
reductions in US manufacturing employment during the 2000.