Anti trust in capital intensive commodity businesses?

[Hielko]

For example, I've always been amazed. Everywhere I travel in Europe, North America, Asia the price per litre of gas for your car is approximately the same. Plus-minus but about the same..Regardless if the country is poor or rich and if the cost is more onerous in the poorer ones. Yet you take something like cable broadband and there I see price differences far greater than oil! For example, in Ukraine or Romania I can get 4g lte unlimited for under $10 USD, sometimes $5 USD. In Canada or USA, the same thing would cost say $30 to $40 usd. There has to be something going on. Is oil a better business because everywhere you sell it you get the same price? Or is cable just a horrible subsidized non profitable business in some places vs others? And why the difference in outcomes for various lines of businesses? Is government the reason or something else?

I don't think you paid attention if you think a litre of gas is roughly equally priced everywhere in the world, see for example here for a nice comparison: https://www.bloomberg.com/graphics/gas-prices/#20193:United-States:USD:g In general, some oil producing countries have subsidies and as a result have extremely cheap gasoline. The US isn't that cheap, but has basically no taxes compared to most european countries where gasoline prices are easily 2x those of the US.

 

About mobile internet, in most countries 4G-provides have to pay to use spectrum. In richer countries they correctly figure that most people are willing and capable of paying more, so they can also offer more money for spectrum. So it's some kind of (indirect) tax. Besides that, there can be large differences in population density, terrain, and many other factors that can have a large impact on the price.

[SharperDingaan]

If you are big enough to be subject to trust busting, you ARE a 'state' entity; under different economic models, it is merely more/less transparent. In the US it's just done via the use of professional lobbyists. Bribe as the carrot, threaten to walk as the stick, and remind that it takes money to get re-elected. Smart.

 

Oil vs telecom/broadband are just different models.

 

Telecom/broadband is a local utility to the ares within its reach, and often viewed as a basic human 'right' in many places. As with all utilities, it's better if there is only one monopoly provider, public/private ownership depends on the nation.

 

Refined fuel is a global, process driven commodity. Price is the same for everyone at the refiners gate, and depends primarily on global/regional demand. In-country price depends primary on transport/local infrastructure, plus whatever tax a local authority chooses to impose. Don't take the fuel and it just goes somewhere else, and lowers the price for everyone else (more supply, same demand).

 

Investment wise, there are lots of opportunities ....

But you must be clear on the business models driving the sector, how/why it makes money, and where it is vulnerable to change.

Thereafter, it becomes purely a tactical application.

 

SD

 

[scorpioncapital]

Agree. Like Canadian banks, an investor is happy the state provides monopoly profits. If the state were ever to take it away or require a bail-in or out, it's another story. It's funny because a free for all, capitalist, unregulated market may have pricing so low that investors actually make poor profits. So are we in an upside down world were pure capitalism leads to lower profits and only by the grace of socialism-government intervention do we actually get fat profits in some industries? )

[LC]

pure capitalism leads to lower profits

What do you mean by pure capitalism? This is like the one true scotsman.

 

If you mean a complete laissez-faire approach, as you saw with the Standard Oil example, sometimes pure capitalism leads to monopolies.

 

But, sometimes it leads to an optimal case: low pricing that is great for the consumer, and great profits for the business. Think Walmart for example.

 

A handful of large players competing is a decent outcome, in the generic case:

(1) They have large enough size to take advantage of economies of scale, and therefore drive costs down for the consumer.

(2) But, there are still enough independent competitors to prevent price fixing. E.g. if Walmart jacks up their prices, others competition still exists.

 

How large is optimal? I'd argue it depends on nature of the demand (market factors) and supply (characteristics of the product/service being offered):

-Economies of scale are global in nature for Walmart - this allows incredible benefits and justifies a global company.

-In contrast, these same economies of scale are regional for concrete/rock aggregates - this is why you see regional companies rather than global.

[SharperDingaan]

'How large is optimal?'

 

Ultimately, the purpose of all this economic activity is to benefit 'us, the people'; expressed as our standard of living.

A standard that is largely controlled by a 'governance' approach that ranges from purely communist to purely capitalist. Russia and China evidence every day, that you can have oligarchs within a 'communist' framework. Canada's banking system evidences every day that you can have oligarchs within a purely capitalist activity. Co-existence is the norm, NOT the exception.

 

Global trade (multi-nationals) optimizes mutual benefit, based solely on price; we assume lower price = higher standard of living. But sadly, not true, per the evidence. Ask any low-skilled NA minimum wage factory worker, who lost his/her job to an offshore sweatshop.

 

Hence optimal really means that which provides the highest standard of living.

If you have a large workforce, 'optimal' means that which generates the most employment (China, India, South Africa, etc)

If you have a small/shrinking workforce, 'optimal' means that which most allows you to leverage your workforce  (Japan, Germany, Canada, etc.)

..... And the ability to freely walk away to someplace else, if you don't like it.

 

SD

 

 

[Cigarbutt]

Agree. Like Canadian banks, an investor is happy the state provides monopoly profits. If the state were ever to take it away or require a bail-in or out, it's another story. It's funny because a free for all, capitalist, unregulated market may have pricing so low that investors actually make poor profits. So are we in an upside down world were pure capitalism leads to lower profits and only by the grace of socialism-government intervention do we actually get fat profits in some industries? )

BTW, thanks for the thread. I've been thinking about the above for a while and sometimes wonder how it may affect specific investment decisions.

 

Market concentration has increased across many industries and an argument could be made that this is one of the factors behind higher profit margins and stock returns (so who's complaining?). Some figure that tolerating (or somehow allowing) an environment with less competition will permit the "super-firms" to produce better overall results. I don't necessarily buy it. Higher market concentration with pseudo oligopolistic monopolies explains IMO to a significant degree what has happened to wages in general and how low the rise of wages has been despite the incredibly low unemployment numbers now. Some people call this new phenomenon a monopsony. It seems that higher concentration allowed companies to earn 'abnormal' (whenever one hears abnormal, one has to check sustainable) profits and to fund share buyback activity. What is disturbing is that firms in the developed world, despite higher profitability, have not often increased re-investments in their businesses and this new normal has not resulted, at least so far, in promising productivity measures. And I wonder if this increasing concentration is simply linked to the loose application of regulatory control in horizontal mergers or if regulation is the answer.

 

The dilemma resolves around the two definitions of the word maturity.

Maturity:a very advanced or developed form or state

Maturity:having attained a final or desired state before decay

 

As usual, the 'truth' may lie between the two meanings but I would submit that there is an unusual proximity and collaboration between business and government that needs to be improved.

 

I thought the following to be helpful (balanced):

https://rooseveltinstitute.org/wp-content/uploads/2018/09/The-United-States-has-a-market-concentration-problem-brief-final.pdf

 

Rockefeller's story is fascinating. He greatly helped to reduce costs by taking advantage of economies of scale. But I think he went too far to achieve that status and the end result represented a challenge to constructive competition. It is ironic that the anti-trust legislation resulted in the liberation of value embedded in the trust instead of destroying it.

[LC]

Interesting ft article

 

https://www.ft.com/content/97be3f2c-00b1-11ea-b7bc-f3fa4e77dd47

[Cigarbutt]

Interesting ft article

 

https://www.ft.com/content/97be3f2c-00b1-11ea-b7bc-f3fa4e77dd47

In the 5% of time allocated to macro, Mr. Philippon's work occupies a small place.

The tribal argument would imply that he has nothing to teach, given his 'origin', but, perhaps, one could listen to a 'reformist' who supports some of the ideas brought forward by the Iron Lady. He has produced solid work on intermediation cost, especially convincing in healthcare and finance.

I like his idea of raising tax as a default option because somehow promoting competition would likely be a more effective and 'natural' tool for redistribution, even if associated with transition costs.

 

[rukawa]

Market concentration has increased across many industries and an argument could be made that this is one of the factors behind higher profit margins and stock returns (so who's complaining?)

 

Why are profit margins important? It seems like profit margin is more a reflection of business strategy or industry structure and as those change profit margins change. Returns on equity should be the important. They are at 14% which is on the upper end of the historical range of about 10-15% but definitely not unusual.

 

http://investorfieldguide.com/wp-content/uploads/2014/05/img4.png

[LC]

Why are profit margins important? It seems like profit margin is more a reflection of business strategy or industry structure and as those change profit margins change.

When looking at an overall economy, profit margins are important exactly for the reasons you mention: a signification change in profit margins indicate a structural change in the overall economy.

 

Returns on equity should be the important. They are at 14% which is on the upper end of the historical range of about 10-15% but definitely not unusual.

Again if we are looking at an overall economy, is ROE a flawed metric because is ignores the cost of debt? There must be a cost paid by economies which deflate the value of debt capital. Therefore, I would think ROC would be more informative of the nature of an economy.

[Cigarbutt]

^From a personal business experience point of view, profit margins and return on equity are joined at the hip, both when trying to expand the business prospectively and when assessing the historical record retrospectively.

 

The two charts, on the surface, suggest an absence of a strong correlation which, conceptually, is hard to reconcile. Let's try. For a very long time, the corporate profits per gdp as expressed remained in a 'band' between 5 and 7%. During that long period, ROE, as measured in the second chart hovered around 12% (that was one of the premises that Mr. Buffett used in his The Inflation Swindles the Investor article). More recently, profit margins have increased significantly and now deviate from that historical band. See below for a more recent update. I just looked at S&P 500 numbers as a proxy for market ROE and compared earnings to book value in the aggregate and note that, in the last few years, ROE has also settled to around 15 to 16% which, I submit, also appears to be a clear break from the historical band. While the increase in profit margins, as measured, appears to have outpaced the increase ROE, as measured, I suggest that there are confounding variables including the fact that the book value growth of the S&P 500 has outpaced the growth in GDP (both values nominal) by about 15 to 20%, in the last 20 years, which suggests that a higher denominator vs the right chart may contribute in partly "hiding" the paradigm shift that has also occurred at the ROE level.

https://fred.stlouisfed.org/graph/?g=1Pik

 

Another consideration is that the aggregate numbers "hide" another factor which is the increasing concentration of highly profitable firms. If you look at the last few years, the number of companies forming the S&P500 responsible for 50% of net income has been decreasing, which adds another level to the concentration problem and the competitive landscape.

 

In 1999, Mr. Buffett said the following:

{For an investor to achieve juicy profits}, "Corporate profitability in relation to GDP must rise. You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems--and in my view a major reslicing of the pie just isn't going to happen."

 

The above suggests that competition is no longer that alive or that well and some other group has been looking at that growing pie, with envy.

 

Staying away from politics and going back to the personal record, I hope that the highly correlated and high margins and returns were due to talented resistance to competition but I have to admit that some of it (perhaps a lot of it) was due to opportunistic capture of features not related to competition (artificial barriers to entry, excessive regulatory protection etc). I took my market segment as it was and benefitted from the steep inelasticity of demand for my 'products' but somehow wish that people with governance responsibility did better, for the benefit of the aggregate, because I really enjoy tough (even extreme) but fair competition.