Winner-takes-all companies are grabbing the lion’s share of profits
How much companies can charge for products – and how that affects their profitability – is the very heart of investment. Pricing power generates the profit streams upon which equity investors lay claim. Profits are the first line of defence against defaults for credit investors. Pricing power is inextricably linked with inflation and monetary policy, and the expected path of the short-term risk-free rates that drive fixed-income markets. When a company becomes all powerful and can drive down the level of wages in a region there are societal implications. Yet until recently there has been little research into how pricing power has evolved.
The downward trend in the labour share over several decades and across many countries has meant, unsurprisingly, that the profit share of national income has increased. However, profit share is an average across the entire corporate sector and says little about individual companies. The mark-up between price and marginal production costs cannot be directly observed either in the national accounts of an entire economy or the accounts of individual companies. But mark-up estimates derived from published data tell us that the rise in global market power is being driven by a small number of high-performing, highly profitable superstar companies
In their paper “The Rise of Market Power and the Macroeconomic Implications” Jan de Loecker, Jan Eeckhout and Gabriel Unger document the evolution of mark-ups using firm-level data for the US economy since 1955. They find that:
- At the start of the period mark-ups were stable, even slightly decreasing. From 1980 average mark-ups started to rise from 21% above marginal cost to 61% now. The rise in mark-ups is evidence of a rise in market power.
- The increase is being driven by the upper tail of the mark-up distribution and there is a reallocation of market share from low to high mark-up firms. This rise occurs mostly within industry for all industries.
- There was an average increase in the profit rate from 1% to 8%.
- The rise in mark-ups provides “compelling justification for the secular decline in the labour share that the aggregate US economy has experienced.”
- Macroeconomic implications of the increase in market power can account for some other of the secular trends apparent over the last four decades including:
- the decline in capital market share;
- the decrease in wages for the low skilled, the fall in labour force participation and rise in inequality;
- the decrease in the dynamism of the labour market and migration rates.
- Mark-ups of some firms are reaching levels that are multiples of the previous highs since the Second World War. There are no signs that mark-ups will decrease any time soon.
This large secular change in the relative performance of companies has potentially massive societal implications.
To watch a video of Jan de Loecker, speaking about market power at BNP Paribas Asset Management’s 2018 Investment Forum, click here >
For a reading list on market power, superstar firms and inequality, click here >
To read “Superstar firms and the concentration of corporate power – getting out of hand” referring to research on the subject by McKinsey, click here >