september 17th 2016 - the economist...2016/09/17 · gdp in america and a smuc h a s4 7% in j ap...

September 17th 2016

S P E C I A L R E P O R T

C O M PA N I E S

The rise of the superstars

20160917_SRcompanies.indd 1 06/09/2016 13:30

The Economist September 17th 2016 1

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A list of sources is atEconomist.com/specialreports

CONTENT S

2 A history lessonWhat goes around

3 Driving forcesWhy giants thrive

5 MisconceptionsThe new Methuselahs

8 Key attributesThe alphabet of success

9 Joining the ranksDo you blitzscale?

10 DownsidesThe dark arts

12 Future policyA delicate balance

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ON AUGUST 31ST 1910 Theodore Roosevelt delivered a fiery speech inOsawatomie, Kansas. The formerpresidentcelebrated America’sextraor-dinary new commercial power but also gave warning that America’s in-dustrial economy had been taken over by a handful of corporate giantsthat were generating unparalleled wealth for a small number of peopleand exercising growing control over American politics. Roosevelt cau-tioned that a country founded on the principle of equality of opportuni-ty was in danger of becoming a land of corporate privilege, and pledgedto do whatever he could to bring the new giants under control.

Roosevelt’s speech soundsas fresh todayason the dayhe made it. Asmall number of giant companies are once again on the march, tighten-ing their grip on global markets, merging with each other to get even big-ger, and enjoying vast profits. As a proportion of GDP, American cor-porate profits are higher than they have been at any time since 1929.Apple, Google, Amazon and their peers dominate today’s economy justas surely as US Steel, Standard Oil and Sears, Roebuck and Companydominated the economy of Roosevelt’s day. Some of these moderngiants are long-established stars that have reinvented themselves manytimes over. Some are brash newcomers from the emerging world. Someare high-tech wizards that are conjuring business empires out ofnoughtsand ones. Butall ofthem have learned howto combine the advantages ofsize with the virtues of entrepreneurialism. They are pulling ahead oftheir rivals in one area after another and building up powerful defencesagainst competition, including enormous cash piles equivalent to 10% ofGDP in America and as much as 47% in Japan.

In the 1980sand 1990smanagementguruspointed to the “demise ofsize” as bigcompanies seemed to be givingway to a much more entrepre-neurial economy. Giants such as AT&T were broken up and state-ownedfirms were privatised. High-tech companies emerged from nowhere. Pe-ter Drucker, a veteran management thinker, announced that “the Fortune500 [list of the biggest American companies] is over.” That chimed withthe ideas of Ronald Coase, an academic who had argued in “The Natureof the Firm” (1937) that companies make sense only when they can pro-

The rise of the superstars

A small group of giant companies—some old, some new—are onceagain dominating the global economy, says Adrian Wooldridge. Isthat a good or a bad thing?

ACKNOWLEDGMENT S

In addition to those mentioned inthe text, particular thanks for theirhelp in preparing this report are dueto: Chris Anderson, StephenBainbridge, Michael Chui, CharlieCraig, Marty Curran, Jeff Evenson,Anis Fadul, Philip Howard, EricKutcher, Barratt Jaruzelski, DavidMorse, Paul Oyer, Susan Peters, KaraSprague, Janice Semper, ChristopherZook and James Zhan.

2 The Economist September 17th 2016

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vide the services concerned more cheaply than the market can. But now size seems to matter again. The McKinsey Global

Institute, the consultancy’s research arm, calculates that 10% ofthe world’s public companies generate 80% of all profits. Firmswith more than $1 billion in annual revenue account for nearly60% of total global revenues and 65% ofmarket capitalisation.

The quest for size is producing a global bull market in merg-ers and acquisitions. In 1990 there were 11,500 M&A deals with acombined value equivalent to 2% of global GDP. In the yearssince 2008 the number has risen to 30,000 a year, worth about3% of global GDP. America’s antitrust authorities have recentlygiven Anheuser-Busch InBev, one of the world’s biggest drinkscompanies, the all-clear to buy SABMiller, another global drinksfirm, for $107 billion.

The superstar effect is most visible in America, the world’smost advanced economy. The share of nominal GDP generatedby the Fortune 100 biggest American companies rose from about33% of GDP in 1994 to 46% in 2013, and the Fortune 100’s share ofthe revenues generated by the Fortune 500 went up from 57% to63% over the same period. The number of listed companies inAmerica nearly halved between 1997 and 2013, from 6,797 to3,485, according to Gustavo Grullon of Rice University and twocolleagues, reflecting the trend towards consolidation and grow-ing size. Sales by the median listed public company are almostthree times as big as they were 20 years ago. Profit margins haveincreased in direct proportion to the concentration ofthe market.

Startups, meanwhile, have found it harder to get off theground. Robert Litan, of the Council on Foreign Relations, and

ALFRED CHANDLER, AMERICA’S leadingbusiness historian, once summed up thehistory of American business after the civilwar as “ten years of competition and 90 yearsof oligopoly”. American business history hasbeen defined by periods of intense competi-tion followed by long periods of consolida-tion. The digital revolution is likely to repeatthat pattern, but on a global scale.

The decades after the civil war sawbursts of intense competition in America’stwo leading industries, oil refining andsteelmaking, in which the robber baronsquickly built up giant companies. Economiesof scale and technological innovation causedproductivity to rise and prices to fall, allow-ing the robber barons to present consolida-tion as the friend of the common man.

The same thing happened in retailingand consumer products as a handful of com-panies established a lead over less agilecompetitors. Sears, Roebuck and Companyset up a giant mail-order operation in Chica-go that crushed smaller rivals, as did Procter& Gamble, Heinz, Philip Morris, Ford andGeneral Motors as they worked to becomenational brands. The first Dow Jones Indus-trial Average index in 1896 included 12 lead-ers of the emerging industrial economy. Tenyears later two-thirds of the names hadchanged. Another 20 years on, the list hadbegun to settle down and the same namesappeared again and again.

J.P. Morgan, America’s most powerfulbanker, increased the pace of consolidationby buying Carnegie Steel from Andrew Car-negie, combining it with dozens of smallersteel firms he already owned and selling theresulting company to the public at a valua-tion of $1.4 billion, a vast sum at the time.Naomi Lamoreaux, of Yale University, studied93 such consolidations between 1895 and

1904 in detail and found that 72 of themcreated companies that controlled at least40% of their industries, with 42 controllingat least 70%. These 42 included GeneralElectric and American Tobacco, each of whichdominated 90% of its respective market. Thepeople who controlled these giant companiesaccumulated money and power on an unpre-cedented scale. The Senate was so full ofthem and their placemen that it was knownas “the millionaires’ club”.

Americans grew uneasy as their faith inbusiness clashed with their faith in equalityof opportunity. The Sherman Act of 1890tried to tackle monopolies. The 16th amend-ment to the American constitution intro-duced an income tax and the 17th decreedthat US senators should be elected by popularvote, not by local legislatures.

But the backlash remained relativelymild. Periods of anti-corporate sentimentsuch as the 1910s and 1930s were invariablyfollowed by periods of pro-corporate policiessuch as the 1920s and 1950s. And whichever

What goes around

America’s corporate world alternates between competition and consolidation

way the wind blew, big companies showed agenius for turning federal regulations intobarriers to entry. By 1930 most big compa-nies were run by professional managers andowned by small shareholders. In the 1950sthe giant corporations formed half a centuryearlier consolidated their position. Everyindustry was dominated by a small group ofcompanies, such as Ford, General Motors andChrysler in cars and General Electric andWestinghouse in electrical goods, all ofwhich had a close relationship with govern-ment. In the 1980s deregulation and global-isation helped unpick corporate America. Butthe digital revolution seems likely to bringanother about-turn.

Like the robber barons, the captains ofnew technology are replacing a freewheelingculture with the rule of a handful of corpo-rations. They dominate a growing share oftheir respective industries. Google controls69% of the world’s search activity; Googleand Apple between them provide the operat-ing systems of 90% of smartphones. Theyboth grab market share by cutting prices andeliminating competitors, often buying them.

Tech titans such as Mark Zuckerberg,Sergey Brin and Larry Page are expandinginto more and more industries as technologytransforms everything that it touches. Justas General Electric diversified into everythingelectrical, so Google is diversifying intoeverything to do with information.

Yet there are also striking differencesbetween the big companies of yesterday andtoday. Today’s giants have fewer assets andfewer roots in local society. They are alsomuch more global. In the second IndustrialRevolution politicians used the power ofnational governments to tame their corpo-rations. Taming highly agile global corpo-rations is much more difficult.


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Ian Hathaway, of the Brookings Institution, note that the numberof startups is lower than at any time since the late 1970s, and thatmore companies die than are born, pushing up their average age.American workers are also changing jobs and moving acrossstate borders less often than at any time since the 1970s.

Competition is for losersThe superstar effect is particularly marked in the knowl-

edge economy. In Silic��

alley a handful of giants are enjoyingmarket shares and profit margins not seen since the robber bar-ons in the late 19th century. “Competition is for losers,” says PeterThiel, a co-founder of PayPal, a payments system, and the firstoutside investor in Facebook. On Wall Street the five largestbanks have increased their share of America’s banking assetsfrom 25% in 2000 to 45% today.

The picture in other rich countries is more varied. Whereasin Britain and South Korea the scale of consolidation has beensimilar to that in America, in continental Europe it has beenmuch less pronounced. In a list of the world’s top 100 companiesby market capitalisation compiled by PwC, an accountancy firm,the number of continental European firms has declined from 19in 2009 to 17 now. Still, in most of the world some consolidationis the rule. The OECD, a club of mostly rich countries, notes thatfirms with more than 250 employees account for the biggestshare ofvalue added in every country it monitors.

There are good reasons for thinking that the superstar effectwill gather strength. Big and powerful companies force their ri-vals to bulk up in order to compete with them. They also obligelarge numbers of lawyers, consultancies and other professional-services firms to become global to supply their needs. Digitisa-tion reinforces the trend because digital companies can exploitnetworkeffects and operate across borders.

James Manyika, of the McKinsey Global Institute, pointsout that today’s superstar companies are big in different waysfrom their predecessors. In the old days companies with largerevenues and global footprints almost always had lots of assetsand employees. Some superstar companies, such as Walmartand Exxon, still do. But digital companies with huge market valu-ations and market shares typically have few assets. In 1990 thetop three carmakers in Detroit between them had nominal rev-enues of $250 billion, a market capitalisation of $36 billion and1.2m employees. In 2014 the top three companies in Silic

��alley

had revenues of $247 billion and a market capitalisation of over$1 trillion but just137,000 employees.

Yet even “old” big companies employ far fewerpeople thanthey used to. Exxon, the world’s most successful oil company,has cut back its workforce from 150,000 in the 1960s to less thanhalf that today, despite having merged with a giant rival, Mobil.At the same time “new” big companies are becoming more likethe corporations of yore. High-tech companies often give seniorjobs to formerWashington insidersand employarmiesof lobby-ists. Many modern superstar companies park their money in off-shore hideaways and devote considerable efforts to keepingdown their tax bills. Superstar companies tend to excel at every-thing they do—including squeezing as much as they can out ofgovernment while paying the lowest possible taxes.

This special report will explain why the age of entrepre-neurialism, ushered in by Britain’s Margaret Thatcher and Amer-ica’s Ronald Reagan, is giving way to an age of corporate consoli-dation even as most companies are becoming more virtual. Itwill examine the forces behind the rise of the superstars and re-veal their managerial secrets. And it will attempt to answer thequestion that Roosevelt raised in Osawatomie: are such cor-porate giants a cause for concern or for celebration? 7

ACROSS NORTHERN CALIFORNIA the world’s best-known tech companies are engaged in a construction con-

test. Facebook got off to an early start with a building of 430,000square feet (40,000 square metres) that looks like a giant ware-house. It is said to be the largest open-plan office building in theworld. Google is hard at work on a new headquarters to replaceits Googleplex: a collection of movable glass buildings that canexpand or contract as business requires. Samsung and Uber, too,are in construction mode. But the most ambitious builder is Ap-ple, which is spending $5 billion on something that looks like agiant spaceship.

Silicon Valley is a very different place from what it was inthe 1990s. Back then it was seen as the breeding ground of a newkind of capitalism—open-ended and freewheeling—and a newkind of business organisation—small, nimble and fluid. Compa-niespopped up to solve specificproblemsand then disappeared.Nomadic professionals hopped from one company to another,knowing that their value lay in their skills rather than their will-ingness to wear the company collar. Today the valley has beenthoroughly corporatised: a handful of winner-takes-most com-panies have taken over the world’s most vibrant innovation cen-tre, while the region’s (admittedly numerous) startups competeto provide the big league with services or, if they are lucky, withtheir next acquisition.

Tech aristocracyThe most successful tech companies have achieved mas-

sive scale in just a couple of decades. Google processes 4 billionsearchesa day. The numberofpeople who go on Facebookeverymonth is much larger than the population of China. These com-panies have translated vast scale into market dominance andsoaring revenues. The infrastructure of the information econ-omy is increasingly controlled by a handful of companies: Ama-

Driving forces

Why giants thrive

The power of technology, globalisation and regulation

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zon has almost one-third of the market for cloud computing, andits cloud-services division has grown by more than half over thepast year. The world’s three most valuable companies at presentare all tech companies, and Amazon and Facebook come in atnumber six and seven (see chart, previous page).

In the industrial era companies used economies of scale tobecome giants: the more a steel company could produce, themore it could cut its unit costs, driving its smaller competitors tothe wall, and the more money ithad to invest in research, market-ingand distribution. The same applied to any otherphysical pro-duct. Tech companies have reinvented this principle for the vir-tual age by shifting their attention from the supply side(production efficiencies) to the demand side (network effects).Justas the old industrial giantsused technological innovations toreduce their costs, the new tech giants use technological innova-tions to expand their networks.

Powerful connectionsNetwork effects have always been powerful engines of

growth: not only is success self-reinforcing but it follows the lawofincreasingreturns. Some networkcompanieseven paypeopleto become customers in order to achieve scale. And those effectsbecome even more powerful ifnetworks connect with each oth-er to produce multi-sided versions. Most of the new tech firmsare “platforms” that connect different groups of people and al-low them to engage in mutually beneficial exchanges. Older techcompanies too are putting increasing emphasis on the platformside of their business. Everyone wants to sit at the heart ofa webof connected users and devices that are constantly opening upfurther opportunities for growth.

In some ways these tech giants look not so much like over-grown startups but more like traditional corporations. The open-plan offices and informal dress codes are still there, but their spir-it is changing. They are investing more in traditional corporatefunctions such as sales and branding. This corporatisation is onereason for the companies’ success. Startups are increasingly will-ing to sell themselves to established companies, which can pro-vide everything from legal services to quality control. Whereasmost startups are happy to get things right 90% of the time, cus-tomers demand perfect products.

The mostpowerful force behind the rise ofthe newgiants istechnology. But two other forces are pushing in the same direc-tion: globalisation and regulation.

The biggest beneficiaries from the liberalisation of the glo-bal economy from 1980 onwards have been large multinationalcompanies. An annual list of the world’s top multinationals pro-duced by the United Nations Conference on Trade and Develop-ment (UNCTAD) shows that, judged by measures such as salesand employment, such companies have all become substantial-ly bigger since the mid-1990s. They have also become more andmore complex. UNCTAD points out that the top 100 multination-als have an average of 20 holding companies each, often domi-ciled in low-tax jurisdictions, and more than 500 affiliates, oper-ating in more than 50 countries.

Big companies have reaped enormous efficiencies by creat-ingsupply chains that stretch around the world and involve hun-dreds of partners, ranging from wholly owned subsidiaries tooutside contractors. Companies are chopping their businessesinto ever smaller chunks and placing those chunks in the mostcost-effective locations. They are also forming ever more compli-cated alliances. Pankaj Ghemawat, of the Stern School of Busi-ness at New York University and the IESE Business School at Na-varra, Spain, calculates that America’s top 1,000 publiccompaniesnowderive 40% oftheir revenue from alliances, com-pared with just1% in 1980.

Multinationals are increasingly focusing on building upknowledge networks as well as production networks. Strategy&,the consulting arm of PwC, an accountancy giant, produces anannual survey of the world’s 1,000 most innovative companies.It found that last year those that deployed 60% or more of theirR&D spending abroad enjoyed significantly higher operatingmargins and return on assets, as well as faster growth in operat-ing income, than their more domestically oriented competitors.Global companies can buy more innovation for their money bydoing theirR&D in cheaperplaces. Theycan also tap into local in-novation resources. General Electric develops more than a quar-ter of its new health-care products in India to take advantage ofthe country’s frugal innovation. Its revenues outside Americahave risen from $4.8 billion in 1980 to $65 billion in 2015.

Such companies are starting to be challenged by non-West-ern competitors. Fortune magazine’s annual list of the world’s500 biggest companies now features 156 emerging-market firms,compared with 18 in 1995. McKinsey predicts that by 2025 some45% of the Fortune Global 500 will be based in emerging econo-mies, which are now producing world-class companies withhuge domestic markets and a determination to invest in innova-

tion. China’s Tencent rolled out its mobiletext and messaging service, WeChat, to700m customers in just a few years. AtChina’s Huawei, which makes network-ing and telecommunications equipment,half the staff of 150,000 works in the re-search department. IfWestern companiesare to survive against such competition,they have to become even bigger andmore innovative.

The growth in regulation has alsoplayed into the hands ofpowerful incum-bents. The collapse of Enron in 2001 argu-ably marked the end of the age of deregu-lation, which began in the late 1970s, andthe beginning of re-regulation. The finan-cial crisis of 2008 served to reinforce thattrend. The 2002 Sarbanes-Oxley legisla-tion that followed Enron’s demise the pre-vious year reshaped general corporate go-vernance; the 2010 Affordable Care actre-engineered the health-care industry,

Most of thenew techfirms are“plat-forms” thatconnectdifferentgroups ofpeople


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which accounts for nearly a fifth of the American economy; andin the same year the Dodd-Frank act rejigged the financial-ser-vices industry.

Regulatory bodies have got bigger. Between 1995 and 2016the budget of America’s Securities and Exchange Commissionincreased from $300m to $1.6 billion. They have also becomemuch more active. America’s Department of Justice has used theForeign Corrupt Practices act of1977 to challenge companies thathave engaged in questionable behaviour abroad. The averagecost of a resolution under this act rose from $7.2m in 2005 to$157m in 2014.

Regulation inevitably imposes a disproportionate burdenon smaller companies because compliance has a high fixed cost.Nicole and Mark Crain, of Lafayette College, calculate that thecost per employee of federal regulatory compliance is $10,585 forbusinesseswith 19 orfeweremployeesbutonly$7,755 forcompa-nies with 500 ormore. Youngercompanies also suffermore fromregulation because they have less experience of dealing with it.Sarbanes-Oxley imposed a particularly heavy burden on small-erpublic companies. The share ofnon-executive directors’ pay atsmaller firms increased from $5.91out ofevery $1,000 in sales be-fore the legislation to $9.76 afterwards. The JOBS act of 2012 ex-empted small businesses from some of the more onerous re-quirements of the legislation, but the number of startups andIPOs in America remains at disappointingly low levels.

Too much to readThe complexity of the American system also serves to pe-

nalise small firms. The country’s taxcode runs to more than 3.4mwords. The Dodd-Frank bill was 2,319 pages long. Big organisa-tions can afford to employ experts who can work their waythrough these mountainsoflegislation; indeed, Dodd-Frank wasquickly dubbed the “Lawyers’ and Consultants’ Full-Employ-ment act”. General Electric has 900 people working in its tax di-vision. In 2010 it paid hardly any tax. Smaller companies have tospend money on outside lawyers and constantly worry aboutfalling foul of one of the Inland Revenue Service’s often contra-dictory rules.

Both Sarbanes-Oxley and Dodd-Frankset the tone for legis-lation in Britain and mainland Europe. China has also becomemore zealous about regulation, partly in order to pursuenationalist and political goals and partly because of worriesabout conflicts of interest. But different regions have adopted dif-ferent approaches to regulation, exacerbating the problem ofcomplexity. As a result, in many markets all but the most sophis-ticated companies can find it impossible to do business.

An additional problem thatcompanieshave to face today is

disappointing economic growth, particularly in the West, at atime of widespread technological disruption. This paradox iseasier for big companies to deal with. Martin Reeves, of BCG, aconsultancy, argues that such companies are good at “buffering”.They have enough spare resources to absorb external shocks orride out temporary downturns, and they can move operationsfrom one part of the world to another if the political climateturns against them. Mr Reeves points out that the mortality ratefor all American listed companies over a five-year period is ashigh as 36%, but for companies worth more than $1 billion it isonly half that.

Slow growth also plays into the hands of incumbents. Jo-seph Gruber and Steven Kamin, two economists at the FederalReserve, find that big companies are increasingly saving morethan they spend. Apple, for instance, holds about a quarter of itsmarket capitalisation in cash. These huge cash piles allow lead-ing companies to consolidate their position by buying startupsand hoovering up the most talented employees.

The superstar companies, then, seem to have all the advan-tages. But two argumentsare beingadvanced to suggest that theirsuccess may not last. One is that the forces speeding up creation,which currently work in their favour, could also speed up de-struction. The other, more fundamental one is that these compa-nies are merely holdouts against a general trend towards a morefluid economy. The next article will consider these objections. 7

IN SEPTEMBER 2009 Fast Company magazine published along article entitled “Nokia rocks the world”. The Finnish

company was the world’s biggest mobile-phone maker, account-ingfor40% ofthe global marketand serving1.1billion users in 150countries, the article pointed out. It had big plans to expand intoother areas such as digital transactions, music and entertain-ment. “We will quickly become the world’s biggest entertain-ment media network,” a Nokia vice-president told the magazine.

It did not quite workout that way. Apple was already begin-ning to eat into Nokia’s market with its smartphones. Nokia’sdigital dreams came to nothing. The company has become ashadowofits formerself. Havingsold itsmobile-phone businessto Microsoft, it now makes telecoms networkequipment.

There are plenty of examples of corporate heroes becom-ing zeros: think of BlackBerry, Blockbuster, Borders and Barings,to name just four that begin with a “b”. McKinsey notes that theaverage company’s tenure on the S&P 500 list has fallen from 61years in the 1958 to just 18 in 2011, and predicts that 75% of currentS&P 500 companies will have disappeared by 2027. Ram Charan,a consultant, argues that the balance of power has shifted fromdefenders to attackers.

Incumbents have always had a tendency to grow fat andcomplacent. In an era of technological disruption, that can be le-thal. New technology allows companies to come from nowhere(as Nokia once did) and turn entire markets upside down. Chal-lengers can achieve scale faster than ever before. According toBain, a consultancy, successful new companies reach Fortune500 scale more than twice as fast as they did two decades ago.

Misconceptions

The new Methuselahs

Superstar companies are far more resilient thancritics give them credit for

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They can also take on incumbents in completely new ways:Airbnb is competing with the big hotel chains without buying asingle hotel.

Next in line for disruption, some say, are financial servicesand the car industry. Anthony Jenkins, a former chief executiveof Barclays, a bank, worries that banking is about to experiencean “Ubermoment”. Elon Musk, a founderofTesla Motors, hopesto dismember the car industry (as well as colonise Mars).

It is perfectly possible that the consolidation described sofar in this special report will prove temporary. But two things ar-gue against it. First, a high degree of churn is compatible withwinner-takes-most markets. Nokia and Motorola have been re-placed by even bigger companies, not dozens ofsmall ones. Ven-ture capitalists are betting on continued consolidation, increas-ingly focusing on a handful ofbig companies such as Tesla. SandHill Road, the home ofSilicon Valley’s venture capitalists, echoeswith talkof“decacorns” and “hyperscaling”.

Second, today’s tech giants have a good chance ofmaking itinto old age. They have built a formidable array of defencesagainst their rivals. Most obviously, they are making productsthat complement each other. Apple’s customers usually buy anentire suite of its gadgets because they are designed to work to-gether. The tech giants are also continuously buying up smallercompanies. In 2012 Facebook acquired Instagram for $1 billion,which worksoutat$30 foreach ofthe service’s 33m users. In 2014Facebookbought WhatsApp for $22 billion, or $49 for each of the450m users. This year Microsoft spent $26.2 billion on LinkedIn,or $60.5 for each of the 433m users. Companies that a decade agomight have gone public, such as Nest, a company that makes re-mote-control gadgets for the home, and Waze, a mappingservice,are now being gobbled up by established giants.

Buying up smaller companies is usually part of a widerstrategy: investing in their proprietary technologies. The techgiants climbed to the top of the pile because they were signifi-cantly better than their rivals at what they did. Amazon, for ex-ample, offered a choice ofmillionsofbookswhen local booksell-ers had just thousands. Their success provided them with pilesof cash that they could invest in improving their own ideas andprotecting them with armies of lawyers, and buying other peo-ple’s ideas in the market. Google purchased Motorola Mobilityfor$12.5 billion in order to acquire the company’sportfolio ofpat-ents. These tech giants relentlessly extend their businesses intoadjacent areas: thus Amazon expanded from books and retailinggenerally into internet servers, and Google is expanding intoeverything to do with information.

In praise of asymmetriesDerek Kennedy, of BCG, a consultancy, says that one of the

tech companies’ most powerful defences in the long term will betheir ability to combine “asymmetries of information” with“asymmetries of execution”. These companies have unmatchedstores of information, as well as an unmatched ability to use thatinformation to reshape their existing businesses or create newones. Not only do they know what you want before you knowyourself but they can also deliver it to you. Companies can usethese combined asymmetries to shift into new areas.

The rise of the internet of things (IoT) will give a powerfulpush to consolidation. Gartner, a research firm, predicts that thenumber of products connected to the internet will increase from6.4 billion today to 21 billion by 2020 as companies discover thepower of software. The process has already begun. Coca-Colauses microchips to track the whereabouts of its bottles. Tesla im-proved its cars’ uphill starts by transmitting a software update.General Electric thinks that the IoT will be the biggest revolutionof the coming decades.

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The increasing convergence of hardware and software letscompanies establish much closer relations with their customers.They can gather up-to-the-minute information on the responseto their products and use it to make improvements. They can tai-lor products to the needs of individual customers. Sonos, a mak-er ofmusic systems, produces speakers that can tune themselvesto the acoustic qualities of the room they are placed in. They cansort out problems before they arise. Diebold monitors its cashmachines for signs of trouble, eitherfixingproblems remotely bymeans ofa software patch or sendinga technician. They can alsobranch out into delivering services. John Deere, a maker ofheavy machinery, is building sensors for tractors that can receivedata on weather and soil conditions, enabling farmers to makemore informed decisions on the use of their land.

Oldercompanies such as GE and Caterpillarmay well havea fight on their hands with born-digital companies such as Goo-gle and Amazon that try to extend their empires into the physicalworld. But the overall effect will be consolidation. Only compa-nies that can afford to make substantial investments in both thephysical and virtual worlds will prosper. And once companieshave established strong relationships with their customers, theywill have a good chance of keeping them regardless of price. Themore that things are connected to each other and to the compa-nies in charge of the networks that control them, the harder itwill be for insurgents to get a foothold in the market.

A symbiotic relationshipMost management gurus have a Manichean view of the re-

lationship between big companies and startups: the more youhave ofone, the less you have of the other. They also add an evo-lutionary twist: the more advanced a society becomes, the bettersmall organisations will do in relation to big ones. Gerald Davis,of the University of Michigan’s Ross School of Business, has justpublished a new book, “T��

anishing American Corporation”,in which he points out that the classic argument for the existenceof corporations—that the cost of doing things through them islower than through the market—has lost its force because ad-vances in technology (of the sort that Silic��alley has pioneer-ed) have slashed the cost ofdoing things through the market.

Likewise, he says, limited-liability companies replaced oth-er corporate forms because firms in capital-intensive industriessuch as steel needed to raise a lot of capital, but software compa-nies typically do not need to raise much money. Mr Davis arguesthat in future companies are likely to become much more fluid:entrepreneurs can raise money from Kickstarter, rent employeesfrom Upwork, computer power from Amazon cloud and toolsfrom TechShop, register their companies in Liberia and still reach

a global audience thanks to cloud computing. There are also evermore ways of organising co-operation; Wikipedia has alreadyproduced the world’sbiggestencyclopaedia byusingvolunteers.“The Web and the smartphone allow pervasive markets andspontaneous collaborations at minimal cost. They make institu-tions like the modern corporation increasingly unsustainable,”he explains.

RocketSpace, which makes its living by looking after start-ups, at first sight looks like an example of what Mr Davis had inmind. Its basic business is to sell space in its nine floors of officesin the heart of San Francisco, though it does a lot more than that.Starting a company can be lonely as well as gruelling, and work-ing in RocketSpace provides you with an instant network and ac-cess to good advice. The company has been so successful that itturns away 90% ofcompanies that apply foraccommodation. Asa result, being admitted provides instant cachet (former occu-pants include Uber and Spotify).

But look again, and a more complicated picture emerges.RocketSpace is increasingly acting as a middleman betweenstartups and big companies. The IPO market has shrunk into in-significance; about 90% of today’s successful startups “exit” byselling themselves to an established company. RocketSpacemakes that easier by introducing them to the right partners. Bigcompanies outside the tech industry, in turn, benefit fromRocketSpace helping them understand the tech world.

The storyofRocketSpace suggests thatbigand small organi-sations have a symbiotic relationship. Duncan Logan, Rocket-Space’s founder, argues that corporations are, in effect, out-sourcing some of their tech R&D to the startup world. This is truenot only of non-tech companies that do not understand the techworld but also of big tech companies that do some of their R&D

in-house but leave some of it to the market to get the best ofbothworlds. Big companies have much to gain from contracting outtheir R&D to startups. They can make lots of different bets with-out involving their corporate bureaucracies. But startups alsohave a lot to gain by selling themselves to an established com-pany that can provide stability, reliability and predictability, allof which can be hard to come by in the tech world. Big compa-nies have phalanxes of lawyers to protect intellectual property,bureaucrats to make sure that the t’s are crossed and the i’s dot-ted, and slickmarketing machines.

Mr Davis is right that it is getting easier to put together acompany from a variety of components, but he is wrong to con-clude that big companies are in retreat. The “virtualisation” ofsome sectors of the economy and the “corporatisation” ofothersare going hand in hand. Superstar companies try to keep theircosts under control by contracting out any functions they regardas non-core. Startups try to reach global markets with the help ofplatforms such as eBay and Alibaba. The upshot is the develop-ment ofa multi-tiered economy. The commanding heights of theglobal economy may be dominated by familiar companies: apremier league of superstars that constantly jostle to avoid rele-gation, and a first division of less stellar performers that struggleto be promoted. But the lower rungs are studded with large num-bers ofMr Davis’s pop-up companies.

If corporatisation and virtualisation can coexist, two of thebasic tenets of modern management theory need to be re-thought. The first is that corporate man (and woman) is a thingofthe past, and that the only way to succeed in business is to turnyourself into an entrepreneur. The reality is more nuanced. Bigcompanies are certainly cutting back on long-term employees.Dan Kaminsky, chief scientist and a co-founder of White Ops,one of RocketSpace’s startups, recalls that, in a previous cor-porate job, he filled out a form in which a “mid-career worker”was defined as someone who had been in the same post for two

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or three years. And employment patterns are becoming muchmore varied. Lawrence Katz, of Harvard, and Alan Krueger, ofPrinceton, calculate that the proportion ofAmerican workers en-gaged in “alternative work arrangements” (working as freelan-cers, temporary contractors and the like) increased from 10.1% in2005 to 15.8% in late 2015.

But big companies nevertheless preserve a core of employ-ees who help maintain a long-term institutional memory and adistinctive culture. Strategy& has been collecting data on thechief executives of the world’s top 2,500 public companies formore than 15 years. The consultancy’s Per-Ola Karlsson notesthat more than 80% of these companies’ CEOs are internal ap-pointments. Almost two-thirds of them have spent 12 years ormore climbing up the corporate hierarchy. They are drawn froma large cadre of long-term employees who dominate the upperranks of the organisation and usually outperform external re-cruits because they have far more company-specific knowledge.

Conversely, entrepreneurship is not necessarily a road tosuccess. Reid Hoffman, the co-founder of LinkedIn, a social-net-working company, and author of “The Start-Up of You”, mayhave made $2.8 billion by selling his own startup to Microsoft,but the coffee shops of San Francisco are full of middle-agedhopefuls scratching a living without a pension.

The second idea that needs overhauling is the transaction-cost theory ofthe firm formulated by Ronald Coase 80 years ago:that firms are worth having only if they can do things morecheaply than the market can. Since firms continue to occupy acentral place in the modern economy despite the enormous ad-vances of the market in recent years, there must be other factorsat work. Companies are not just a way of keeping transactioncosts to a minimum. They are proof that when people are tryingto solve common problems, they are wiser collectively than theyare individually. Such collective wisdom can accumulate overtime and be embodied in corporate traditions that cannot bebought in the market. 7

GENERAL ELECTRIC, THE product of an alliance betweenThomas Edison, America’s greatest inventor, and J.P. Mor-

gan, its greatest banker, was the technology superstarof the early20th century. Edison’s patents have long since expired and elec-tricity has become a commodity, but GE remains a commercialempire, the only intact survivor of the companies that made upthe original Dow Jones index. GE employs 330,000 people in 180countries, owns $493 billion-worth of assets and earned $117 bil-lion in 2015. It has survived where other technology stocks havefaded because it has fully mastered the art of management. Itsslogan, “Imagination at work”, could just as easily be “Manage-ment at work”.

Every superstar company is a superstar in its own way.Great companies have distinctive cultures and traditions that areall their own and inhabit well-defined market niches. But theyalso share a set of common characteristics. The first is an obses-sion with talent. The only way to remain on top for any length oftime is to hire the right people and turn them into loyal corporate

warriors. GE spends a billion dollars a year on training. Its suc-cess has been such that between 2003 and 2011about 40 GE vice-presidents have become CEOs of other major companies. Goo-gle, which is doing for information what GE once did for electric-ity, is similarly obsessed with training.

Superstar companies tend to be unashamedly elitist. GE

fast-tracks its most promising employees. Hindustan Unilevercompiles a list of people who show innate leadership qualities(and refers to them throughout their careers as “listers”). LaszloBock, Google’s head ofhuman resources, argues that a top-notchengineer “is worth 300 times more than an average engineer”.

Such companies keep a watchful eye on their high-flyersthroughout their careers. Jeff Immelt, GE’s boss, prides himselfon his detailed knowledge of the 600 people at the top of hiscompany, including their family circumstances and personalambitions. Hindustan Unilever’s managers constantly test po-tential leadersbymovingthem from one division to another andsubjecting them to “stretch assignments”. Procter& Gamble talksabout “accelerator experiences” and “crucible roles”.

The second obsession superstar firms share is with invest-ing in their core skills. Corning, the company that made the glassfor Edison’s first light bulb, started life producing the raw materi-al for bottles and windows. It now manufactures the glass usedin the majority of the world’s electronic devices. Its fibre opticscarry information around the world. Its “Gorilla” glass helps pre-vent your iPhone from shattering when you drop it, and is start-ing to be used in cars. Next will be huge glass screens that coverentire walls, flexible ones that can be rolled up like scrolls andwindows that operate like giant sunglasses for the office. Thecompany’s R&D centre in upstate New�ork resembles a univer-sity campus. Its best scientists have the equivalent of academictenure (some stay around into their 90s), publishing academicpapers and notching up scientific breakthroughs.

The same obsession can be found in all successful techcompanies. Amazon sacrificed dividends for years in order to es-tablish its mastery of online shopping. Today it is taking anequally long-term view of the computer cloud by pouring mon-ey into servers. Google is putting the riches generated by itssearch engines into more adventurous technologies. BMW is in-vesting in newmaterials such as carbon fibre and enhancementssuch as parking assistance.

Remaining focused on the long term is difficult in a world

Key attributes

The alphabet of success

Superstars need a dazzling range of qualities


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where public companies are answerable to the stockmarket ev-ery quarter, and it turns out that a remarkable number of super-star companies have dominant owners who can resist the pres-sure for short-term results. According to one study, more thanone in ten of tech companies that went to the market betweenJanuary 2010 and March 2012 had dual voting structures givingtheir founders extra rights. Both Facebook and Google explicitlyjustify such structures by the need to pursue long-term projects.

Familycompanies frequentlypunch above theirweight be-cause their dominant owners are free to think about the longterm. Companies in emerging countries typically put more em-phasis on long-term growth than on short-term results. The bestwidely held companies have developed formidable skills atmanaging the financial markets and making the case for long-term goals.

But investors cannot be expected to be patient forever; theyneed a mechanism to tell them when they are pouring money

down the drain. Striking the right balance between the long andthe short term is the first on a long list of balancing acts that su-perstar companies have to perform in order to earn their laurels.

All of them set themselves extravagant goals. Coca-Coladoes not just want to sell a lot offizzy drinks, it wants to put a canof Coke within easy reach of everyone on the planet. And whentheyhave achieved those goals, theymove the goalposts. Googlehas expanded its vision from “just” wanting to organise theworld’s information to wanting to use that information to rein-vent transport, beside a host ofother things. Amazon, having be-come the world’s biggest bookstore, now wants to be the world’sbiggest everything store.

At the same time they all pay endless attention to detail.When Steve Jobs was in charge ofApple, he agonised over everytiny detail, down to the exact shade of grey to be used for thesigns in its stores’ lavatories. Ingvar Kamprad, the founder ofIKEA, a homeware giant, continually toured his stores until well

SUPERSTAR COMPANIES CAN create powerfulbarriers to entry. Their success allows themto generate huge piles of cash, and that cashallows them to attract talent and buy upcompetitors. So how do aspiring companiesbreak into the magic circle? The answerdepends very much on the industry.

High-tech companies rely on discov-ering niche markets and scaling up as fast aspossible. Peter Thiel, the co-founder ofPayPal, points out that almost all successfulstartups begin by dominating a niche mar-ket. Facebook dominated social networkingat Harvard University before branching out toother universities and then to social net-working in general. Reid Hoffman, who atone time was PayPal’s COO, has coined thephrase “blitzscaling” to describe the road tosuccess. The term refers to the Blitzkrieg(lightning war) that Germany pioneered inthe second world war. Software allows com-panies to advance rapidly because the mar-ginal costs of adding new customers is moreor less zero. Globalisation has a similar effectbecause it lowers the barriers to entry acrosscountries. Facebook’s old motto, “Move fastand break things”, captures the spirit of theBlitzkrieg perfectly.

Blitzscaling is necessary for bothoffensive and defensive reasons. Offensively,software businesses become valuable onlyonce they have acquired lots of customers.Markets like eBay are not useful until theyhave both buyers and sellers. Defensively,businesses have to scale faster than theircustomers because the first to reach thosecustomers often end up owning them.

Blitzscaling initially burns through alot of cash quickly without producing much

revenue. To attract people to a firm with anuncertain future, you have to generate a buzzin the tech world and offer your staff gener-ous stock options. You also have to sub-ordinate everything to immediate problem-solving. Mr Hoffman says that every blitz-scaling organisation he has worked inseemed close to collapsing in chaos. “Thething that keeps these companies together—whether it’s PayPal, Google, eBay, Facebook,LinkedIn or Twitter—is the sense of excite-ment about what’s happening and the visionof a great future.”

The dangers of blitzscaling will becomemuch clearer as technology transforms widerareas of the economy. Theranos, a companythat claimed to have invented a new way oftesting blood, expanded at breakneck speedbefore the Wall Street Journal revealed thatits tests were unreliable.

There are some echoes of this strategyin the emerging world. Emerging-marketcompanies establish a fortress in their do-mestic markets before invading foreignmarkets. Grupo Bimbo, which started out asMexico’s biggest baked-goods company, hassince become the biggest baker in the UnitedStates as well, through a combination ofexporting its goods and buying bits of fam-ous American brands such as Weston Foodsand Sara Lee. Such emerging-market cham-pions frequently advance at great speed,often buying in more sophisticated skills likebranding and R&Dby acquiring Westerncompanies. For example, Lenovo, a Chinesecomputer company, bought Microsoft’sThinkPad division in order to break intoforeign markets.

Some of the brightest rising stars are

Do you blitzscale?

How superstars are made

emerging-market tech companies. China’sAlibaba, an e-commerce firm, raised $25billion when it went public on the New YorkStock Exchange in 2014, the largest IPO inhistory. Didi Chuxing, a Chinese taxi service,this summer merged with Uber, which took a20% stake in the combined company, valuedat $35 billion, after a prolonged battle.

Outside the tech industry and awayfrom emerging markets, rising stars oftensparkle by consolidating existing marketsand squeezing out costs. A prime example is3G Capital, a Brazilian-rooted company thatspecialises in taking over mature companiesand bringing in its own managers to stream-line them. It forces firms in its portfolio tojustify their spending afresh every year,consolidate their product lines and trimexcess brands. 3G is exceptionally stingy withits managers, making them share rooms onbusiness trips, but also motivates them bygiving them stock options. Having started offsmall in Brazil, it has taken over a successionof beer giants, including Anheuser Busch andSABMiller. Its acquisitions have given itcontrol of a third of the world’s beer marketand several large food companies, includingHeinz, Burger King and Kraft.

Some of the world’s most successfulfamily companies practise a gentler versionof consolidation, buying up smaller familycompanies to add scale but allowing them tokeep their names and identities. The luxuryand drinks sectors excel at this. LVMH, aFrench luxury-goods company, has acquireda succession of other family companies suchas Bulgari, Dior, Krug and Dom Perignon, ashas Estée Lauder with Tommy Hilfiger, Bum-ble and Bumble and Jo Malone.

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into his 80s (he is now 90). Superstar companies are particularlygood at establishing a link between their strategic vision andtheireverydayoperations. Disney, for instance, isutterly commit-ted to projecting wholesomeness.

Great companies combine a strong sense of identity with afierce hostility to groupthink. Andy Grove, a CEO of Intel, ad-vised CEOs to balance the sycophants they inevitably attract bycultivating“Cassandras” who are “quickto recognise impendingchange and cry out an early warning”. These Cassandras are of-ten middle managers who “usually know more about upcomingchange than the senior management because they spend somuch time ‘outdoors’ where the winds of the real world blow intheir faces”. GE insists that its high-flying executives, most ofwhom are engineersby training, take courses in painting in orderto “loosen them up” a little.

Such companies also regularly reassess their investmentdecisions in the light of changing markets. McKinsey measuredthe agility of more than 1,600 companies by looking at howmuch of their capital they reallocated every year, and found astrong positive correlation between the companies’ willingnessto move their capital around and the total return to shareholders.

How to stay litheSuperstars do everything they can to remain agile despite

their size. They fight a constant war against bureaucratic bloat,unnecessary complexity and overlong meetings. They often lo-cate themselves in the latest tech hotspot in order to absorb itsideas and energy. In 2014 Pfizer opened an R&D facility with1,000 employees near MIT in Cambridge, Massachusetts. Appleand Intel have set up R&D labs in Carnegie Mellon’s Collabora-tive Innovation Centre in Pittsburgh. Every car company worthits salthasopened an office in Silicon Valley. Theyalso form closerelationships with startups. In 2012 GE launched GE Garages, alab incubator, to provide startupswith access to its experts and toequipment such as 3D printers and laser cutters.

Successful big companies strike a balance between globalscale and local roots to become “rooted cosmopolitans”. LG, aSouth Korean conglomerate, can tailor its products for specificmarkets: microwave ovens destined for east India, for example,have an autocook option for Bengali fish curry. Kraft has re-engi-neered the Oreo biscuit for Chinese taste buds, using less sugarand more familiar flavours such as green tea.

Such companiesalso understand that theyneed to keep un-dergoing radical changes in order to survive, as companies suchas Google and Facebook have done on several occasions. Theyare even willing to disrupt their own core businesses beforesomeone else does. Netflix disrupted its video-delivery businessby embracing streaming. China’s Tencent disrupted its own so-cial-media business by introducing WeChat, a platform that al-lows users to book taxis, order food and so on. Again, GE was atrailblazer. In the 1980s and 1990s its then boss, Jack Welch, de-creed that it should be amongthe world’s top three in all the busi-nesses itwas involved in, orgetout. NowMrImmelt is restructur-ing the company for the digital age, selling off GE appliances,buying France’s Alstom, investing heavily in the internet ofthings and moving the company’s headquarters to Boston to becloser to the heart ofhigh-tech.

Thanks to all these changes, even the classic companies arebecoming more asset- and employment-light. In 1962 Exxon, oneof the world’s most durable and financially successful corpora-tions, had 150,000 employees; today it has half as many. As forthe new breed of tech firms, they typically employ as few peopleas they possibly can.

But for all their virtues, superstar companies, both old andnew, have their darksides. 7

COMPANIES ARE BY nature competitive. That is mostly tobe welcomed, but sometimes their competitive instincts

play out in less welcome ways as they engage in some of thedarker arts of management. The two most obvious ones are topay as little tax as is legally possible, and to lobby governmentsand a variety ofother bodies to gain an advantage over rivals. Toa greater or lesser extent all companies do this. The big differenceis that the superstar companies, being good at everything theydo, are also much better than the rest at practising these darkartsand taking them mainstream.

This raises three worries. The first is that they will keep get-ting better at them, applying the same creative excellence to rule-bending as they do to running their business in general. Second,superstars might use the combination of these and other skills tobuild up impregnable advantages, giving them growing monop-oly power. Third, as their businesses become more mature, theymay come to rely increasingly on those darkarts.

Multinationals routinely use foreign direct investment(FDI) in order to reduce the amount of tax they have to pay. Theycreate holding companies to keep their corporate assets in low-tax jurisdictions. These holding companies in turn put their sub-sidiaries in the most tax- and regulation-efficient jurisdictions,creating a constant cascade of ownership and control. The vol-ume of money moving through such havens on the way to theirfinal destination has risen sharply since 2000 and currentlymakes up about 30% of all FDI. In 2012 the British Virgin Islandswere the world’s fifth-largest recipient of FDI, with an inflow of

Downsides

The dark arts

Superstar companies are good at everything,including pushing the boundaries


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$72 billion. Britain, with an economy 3,000 times larger, had aninflow of only $46 billion. The Netherlands and Luxembourgalso attracted big inflows, and there are many more such hubs.

Superstar companies are naturally better at tax and regula-tion shopping than the rest, partly because of their size andpartly because they can afford to employ the best managers andprofessional advisers. According to UNCTAD, the world’s 100most globalised companies each have an average of 20 holdingcompanies that in turn sit on top of a complicated chain of own-ership, part-ownership and co-ownership. More than 40% offor-eign affiliates have several national identities because they areco-owned by companies from different countries. The owner-ship structure of new high-tech multinationals is often particu-larly convoluted, often more so than that of low-tech companiesthat have been around for a century.

Such companies have pioneered two highly successfultechniques for exploiting differences in tax codes. One is transferpricing, or charging one affiliate for using intangible assets (suchas brands, intellectual property or business services) said to orig-inate in another part of the company. The more that companiesrely on knowledge rather than physical assets to make theirmoney, the greater their opportunities for shifting profits fromone jurisdiction to another. Apple established a cosy deal withIreland that allowed it to channel most of its non-American salesand profits through special corporate entities, saving itself €13billion in taxes over ten years, the European Commission has re-cently claimed. Google achieved an effective tax rate of 2.4% onits non-American profits in 2007-09 by routing profits to Bermu-da, via Ireland and the Netherlands (known as a double Irish).

Another technique is “inversion”, orbuyingforeign compa-nies and shifting nominal headquarters to the junior partner inthe acquisition. Pfizer, one of America’s leading pharmaceuticalcompanies, contemplated engaging in a giant inversion by buy-ing Allergan for $160 billion and moving its headquarters to Ire-land, but retreated in the face ofstrong political pressure.

Superstars are also devoting increasing resources to lobby-ing, an industry that is at its most advanced in America. Compa-

nies and theirassociations are easily America’s biggest lobbyists,accounting for over 70% of all expenditure on lobbying. And thebiggest companies are pulling ever farther ahead of their smallerrivals in getting their voices heard. Lee Drutman, of New Ameri-ca, a think-tank, points to a paradox. The past 20 years have seenan enormous increase in lobbying, with more than 37,700 inter-est groups now saying they are active in the field, but a handfulof organisations seem to dominate the conversation. They arehaving to spend ever more to retain their position. Back in 1998,the minimum an organisation had to shell out in order to be in-cluded among the top 100 spenders was $2.4m. By 2012 that sumhad nearly doubled, to $4.4m.

Friends in WashingtonSuperstar firms will generally keep a dozen or more full-

time registered lobbyists of their own on Capitol Hill, but alsouse a couple of dozen lobbying firms to be called upon as andwhen needed. This allows them to keep constant pressure onlawmakers to advance their cause, as well as to flood Congresswith extra hired hands in the event ofa crisis.

Tech giants have been particularly successful in gettingtheir voices heard. They were originally reluctant to play the lob-bying game, but soon realised that was a mistake: Microsoft’sprolonged legal battle with the Department of Justice overwhether its was abusing its dominant position in the softwaremarket, which was finally settled in 2001, persuaded the wholeindustry that it pays to have friends in Washington. Since thentech companies have turned into some of America’s most assi-duous lobbyists and most enthusiastic employers of Washing-ton insiders. Barack Obama’s former press secretary, Jay Carney,now works for Amazon and his former campaign manager, Da-vid Plouffe, has joined Uber.

Investment in lobbying is paying bigger dividends than inthe past as the federal government extends its power over eco-nomically sensitive areas such as health care and financial ser-vices. Lobbyists can earn their keep by influencing the directionof the debate. For example, back in 2003 the pharmaceutical in-dustry pushed successfully for a revision of America’s Medicarehealth-insurance programme for older people. This included anew prescription-drug benefit but no measures to control thecosts of that benefit through means-testing or bulk-buying. JohnFriedman, an economist at Brown University, estimated the re-sulting benefits to drugmakers at $242 billion over ten years, ahealthy return on the $130m the industry spent on lobbying inthe year the law was passed.

The American government has also got into the habit ofproducing open-ended pieces of legislation such as the Dodd-

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2 Frank financial-reform bill, which ran to2,319 pages. Again, lobbyists can earn theirkeep by writing bits of the legislation, asthey clearly did with Dodd Frank, or bylobbying Congress over its interpretation.

Companies are also becoming moreambitious in what they are trying toachieve. In the past they put most of theireffort into heading offtax increases or reg-ulatory changes that might damage them;today they are trying to boost their profitsand shape future markets. In his book,“The Business of America is Lobbying”,New America’s Mr Drutman shows thatcompanies are increasingly using lobby-ists to set the terms of the debate by fund-ing Washington’s innumerable talking-shops, then puttingpressure on politiciansand officials to ensure that the legislationworks to their advantage.

The same pattern is being repeatedin the European Union. The Corporate Eu-rope Observatory, an NGO, calculates thatBrussels is home to at least 30,000 lobby-ists, almost the same number as the staffemployed by the European Commission.These official lobbyists are part of a largearmy of people who try to influence legislation and regulationfor more than 500m European citizens.

The revolving doorSuperstar companies are hiring the best lobbyists and em-

ploying the most prominent politicians. In July this year José Ma-nuel Barroso, until recently president of the European Commis-sion, joined Goldman Sachs, a bank, as the non-executivechairman of its international arm, replacing Peter Sutherland, aformer EU trade commissioner. Mr Barroso’s appointment hascaused widespread protests. Such high-profile recruits not onlygive big companies access to information about past policy-making, they allow them to influence serving politicians whowould like to join the board ofa big company when they retire.

Superstar companies are also particularly good at gettinginside their customers’ skin and shaping their habits. Great com-panies have excelled at doing this since the birth of mass adver-tising in the 1890s, but today’s superstars are using modern sci-ence to push advertising into areas that have not been triedbefore, raising difficult ethical questions about what “freechoice” means in a capitalist economy.

Manyofthe newtech giantsare atheartadvertising compa-nies: they persuade customers to give away personal details (forinstance, by allowing them to Google something or Facebook afriend without charge) and then selling that information, dulyanonymised, to their clients. These internet services are not real-ly free. Users are paying for them indirectly by allowing the com-panies that provide them to gather information about their on-line behaviour through cookies (small pieces of code) lodged intheir computers.

Professional data-miners use this information to build updetailed pictures of what people have bought in the past (“his-tory-sniffing”), and how they have gone about it (“behaviour-sniffing”). They can use this information to draw people’s atten-tion to products they might want to buy in the future or to bar-gains thatare on offer. Theyare getting increasinglysophisticatedabout predicting users’ behaviour, working from hidden signals.For example, when people are depressed, they tend to post

darker pictures online than when they are feeling cheerful.Tech companies take advantage of the fact that a large num-

ber of tech products are habit-forming. A typical user reportedlychecks his smartphone at least150 times a day. This is mainly be-cause many tech products are interactive. In his book, “Hooked:How to Build a Habit-Forming Product”, Nir Eyal points out thatservices such as Facebook and Twitter are constantly being ad-justed according to what users put into them and commentsfrom their friends. Internet entrepreneurs devote a lot of thoughtto getting users hooked on their products, providing them withendless feedback(such as beeps and pings) in order to keep themcoming back. Habit-forming products help companies weavetheir devices into their customers’ daily routines and squeezeeven more money and information out of them.

That pervasive influence is now being extended into newparts of the economy. Google is using its mastery of informationto work on interactive “smart homes” that can be controlledfrom afar. It may not be long before the company starts suggest-ing what people need to put in their fridge and where they canget the best deal on their groceries. Amazon, meanwhile, is re-lentlessly extending its retail empire, drawing on its command ofinformation and logistics. Apple and other companies are tryingto anticipate whatconsumersmightwantbefore theyknow theywant it, and then co-ordinate networks of app-makers to ensurethat their devices arrive fully loaded with those apps.

This has produced an extraordinary situation. Tech compa-nies have persuaded their customers to carry devices in theirpockets that can constantly nudge them in some direction oroth-er. Seventy years agance Packard wrote a bestseller called“The Hidden Persuaders” which revealed some of the sophisti-cated psychological techniques advertisers then used to per-suade consumers to buy their stuff. Today billions of people vo-luntarily carry around their own private “hidden persuaders”that allow global behemoths to monitor their behaviour and in-fluence their choices. “We know where you are,” says EricSchmidt, the chairman of Alphabet, Google’s holding company.“We know where you’ve been. We can more or less know whatyou’re thinking about.”

But increasingnumbers ofconsumers are becomingdisillu-sioned with big and powerful companies. That is generating agrowing backlash. 7

Habit-formingproductshelpcompaniessqueezeeven moremoney outof theircustomers

ARTHUR SCHLESINGER, A historian, claimed that Ameri-can history moves in 30-year cycles, with each period re-

sponding to the excesses of the previous one. The laissez-faireGilded Age that ended around 1900 led to the progressive era,when government stepped in to regulate business and create asocial safety net. That was followed by the laissez-faire roaring20s, which in turn led to the New Deal and then the pro-businessEisenhower era, followed by the progressive 1960s and the lais-sez-faire Reagan era. Schlesinger’s theory of 30-year cyclesdoesn’t quite work: the roaring 20s, when President Calvin Coo-lidge pronounced that “the business of America is business”, in-terrupted a long cycle of pro-government progressivism. But his

Future policy

A delicate balance

How to keep the superstars on their toes withoutmaking them fall over

1

point about each era reacting to the excesses of the previous oneis surely right. The long pro-business era that began under Ron-ald Reagan in the 1980s and continued under Bill Clinton in the1990s is giving way to a much more anti-business mood.

The Republican Party, the traditional party of business,now has a presidential candidate who fiercely rejects corporateAmerica’s two most cherished policies, free trade and liberal im-migration. “I am not going to let companies move to other coun-tries, firing their employees along the way, without conse-quences,” Donald Trump warned in his acceptance speech forthe presidential nomination in July.

His Democratic opponent, Hillary Clinton, bruised by apowerful challenge from Bernie Sanders, has chastised big com-panies for“using theirpower to raise prices, limit choices forcon-sumers, lower wages for workers and hold back competitionfrom startups and small businesses”. The share of Americanswho hold “very” or “mostly” favourable opinions of corpora-tions has fallen from 73% in 1999 to 40% today, according to thePew Research Centre. Surveys by Gallup of views on big busi-ness show less extreme swings, but point in the same direction(see chart). Over 70% of America’s population believes that theeconomy is rigged in favour ofvested interests.

Such growing hostility to business is in evidence across therich world. Britain’s decision in June to leave the European Un-ion was driven in part by popular discontent with big business,which had lobbied heavily to remain. Many continental Euro-peans are becoming ever more vocal in expressing their long-standing doubts about “Anglo-Saxon capitalism”.

This backlash against big business is already having an im-pact on policymakers. The antitrust division of America’s De-partment of Justice says that under President Obama it has won39 victories in merger cases—deals blocked by courts or aban-doned in the face of government opposition—compared with 16underGeorge W. Bush. Those victories included a string ofblock-buster deals such as Comcast’s proposed bid for Time Warner

Cable and Halliburton’s planned takeover of Baker Hughes. TheEuropean Union has launched a succession of tough measuresagainstSilicon Valley’s tech giants, such asaskingApple to stumpup billions of euros in allegedly underpaid taxes in Europe, andallowing European news publishers to charge international plat-forms such as Google that show snippets of their stories. Brit-ain’snewprime minister, Theresa May, has said that she maycapCEO pay and put workers on boards. Governments worldwidehave started co-operating to curb the use of tax havens.

This special report has shown that there are good reasonsto worry about corporate consolidation. The age of entrepre-neurialism that started in the early 1980s is giving way to a newage ofcorporatism. This has been particularly true in the world’smost advanced economy, America, and in the world’s mostknowledge-intensive industries. Big companies have been get-ting bigger and putting down deeper roots. In the technology in-dustry a handful of companies have grown into giants in a cou-ple of decades and are now making sure they stay on top,hooveringup talent, buyingup patentsand investing in research.At the same time the rate of small-business creation is at its low-est level since the 1970s.

The perils of consolidationSuch consolidation is worrying for lots of reasons. Over-

mighty companies exacerbate inequality because they reap ab-normally high profits and allow senior managers to pocket anunseemlyshare ofthem. The proportion ofcorporate income go-ing on the pay of the top five executives of large American publiccompanies increased from an average of 5% in 1993 to more than15% in 2013, even though research has shown that there is a nega-tive relationship between CEO pay and performance (see charton the next page).

Such companies also create political problems by concen-trating power in the hands of fewer people. The more en-trenched companies get, the more unhealthy their relations withgovernment are likely to become as they employ large numbersof lobbyists and put former politicians on their boards. The techcompanies have added a new concern by amassing unprece-dented volumes of information on ordinary people.

But a great deal ofanti-business sentiment is also being dri-ven by xenophobia, protectionism and resentment. Utopian so-cialists such as the leader of Britain’s Labour Party, Jeremy Cor-byn, dislike business in any shape or form. Right-wingnationalists such as Donald Trump and France’s Marine Le Pendislike foreign business giants rather than business giants assuch. The European Union’s crusade against America’s techgiants is partly based on protectionism.


COMPANIES

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SPECIAL REPOR T

regulation has quietly becomemore obtrusive. The share ofjobs that require licences has in-creased from 5% of the total inthe 1950s to more than 25% to-day, including occupations suchas hair-braiding and interior de-sign. Doctors who want to be re-imbursed by medical insurershave to fill in a form with140,000 coding categories, in-cluding 23 different codes forspacecraft-related injuries. Fir-ing a worker who is not pullinghis weight is an invitation to filea lawsuit.

The great policy challengeof the coming years is to dealwith legitimate worries aboutbusiness concentration withoutsuccumbing to anti-businesssentiment that will punish suc-cess and reduce overall prosper-ity. Policymakers will need tobecome more vigilant aboutpreventing business concentra-tions from developing in the firstplace. In the 1980s and 1990s,when manymarketswere open-ing up, antitrust authoritieswere probably right to give thebenefit of the doubt to business,butnowtheywill need to thinkagain in the face ofso much moreconcentration.

Above all, policymakers need to revamp antitrust policyfor a world based on information and networks rather than onselling lumps of stuff. Up to now companies such as Uber havefocused on running ahead of regulators, quickly building up abody of loyal customers and then daring the regulators to chal-lenge them. Antitrust authorities need to start setting the agendaby examining the ways that digital companies are using networkeffects to crowd out potential competitors, or inventing newways of extracting rents by repackaging other people’s content.But the regulators must also beware of trying to load too muchonto the rules: the point of antitrust policy is to promote compe-tition and hence economic efficiency, not to solve problems suchas inequality.

Policymakers also need to get much tougher on the darkarts of management such as tax-dodging. Superstar companiesare already making impressive returns; there should be no needfor fancy tax-avoidance schemes that undermine the legitimacyof the system in the eyes of the public. But any moves to disci-pline companies need to be made multilaterally in order to pre-vent potential trade wars. And excessive government is as pro-blematic as excessive corporate power.

This special report started by quoting Theodore Rooseveltthundering about the evils of giant corporations before a crowdin Kansas. Once again, the world needs some thunder about theexcesses of giant companies, which are beginning to produce apopular backlash that threatens the success of the global econ-omy. But there is a need for subtlety too, so that consolidation ischallenged without discouraging innovation, and excesses arecurbed without overregulation. Policymakers must aim to pro-mote vigorous competition so that the world keeps existing su-perstars on their toes but also continues to create new ones. 7

As the backlash against big business mounts, three thingsneed to be kept in mind. First, the superstar companies at theheart of the current consolidation of capitalism are for the mostpart forces for progress. Apple’s iPhones and iPads have becomepeople’s constant companions because they are portable mir-acles. In disrupting many industries, tech giants are changingthem for the better. Uberprovides a service superior to that ofes-tablished taxi companies, and is forcingthem to improve. Airbnboffers a cheap and convenient alternative to hotels. Some high-tech companies, such as Amazon and Uber, exert downwardpressure on prices. Others, such as Google and Twitter, provideservices without charge. McKinsey calculates that consumers inAmerica and Europe alone get about $280 billion-worth of“free”services—such as search or directions—from the web that wouldonce have cost theirusers a significant amount ofmoney or time. �

ijay Govindarajan, of the Tuck School of Business at Dart-mouth College, points out that big companies can solve eco-nomic and social problems that are too big for small companiesand too complicated for governments. They have the financialmuscle to make long-term investments, the global scale to mobil-ise resources across borders and the management skills to deliv-eron theirpromises. Theycan use theirexpertise in supply-chainmanagement to get resources to the poor or teach governmentsand NGOs how to do it. They can use their scale and manage-ment expertise to co-ordinate many different resources, spreadbest practice across the world and scale up clever ideas.

Don’t overdo itThe second point is that government intervention can easi-

ly backfire. The European Union’s hard line on American techcompanies such as Apple or Google threatens to provoke a tradewar between the world’s two biggest trading blocks, partly be-cause the EU’s rhetoric is so fierce and partly because its meth-ods, such as trying to force Apple to pay taxes retrospectively, areso questionable. Regulation that is supposed to promote compe-tition can often have the opposite effect, killing off small compa-nies and protecting big ones by raising barriers to entry. Regula-tion meant to prevent companies from getting too rich cansometimes discourage them from making long-term invest-ments in research. Policymakers need to balance consumers’preference for lots of competition against businesses’ legitimatedesire to reap appropriate rewards from their investments.

In his book, “Capitalism, Socialism and Democracy” (1942),Joseph Schumpeter argued that concentration is both a causeand a consequence of success. Successful companies race aheadof their rivals in order to enjoy the advantages of temporary mo-nopolies. They invest the super-profits that they gain from those

temporary monopolies inmore R&D in order to stayahead in the race. Greatfirms “largely create whatthey exploit”, as he put it.Rob them of the chance ofexploiting what they create,and they will stop investing.

The third point is thatthe decline in entrepreneur-ialism is more often the faultof bad government than ofbig business. In the Euro-pean Union the proposedsingle market in services isbeing strangled by nationalregulation. Even in suppos-edly freewheeling America,



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