A FEW BIG FIRMS
SIR WALTER MURDOCH SCHOOL POLICY SEMINAR
WEDNESDAY, 7 JUNE 2017
I acknowledge the traditional owners of the land, the Whadjuk people, and thank Benjamin Reilly and the Sir Walter Murdoch School of Public Policy and International Affairs for inviting me to speak here today.
It’s great to be here on the left coast of Australia – particularly now that your state’s politics and geography are once again in alignment.
And it’s terrific to be in Perth, the city that the New York Times recently called ‘Hipster Heaven’.
It’s fitting that I’m giving this speech in Hipster Heaven because, although they may not realise it, hipsters play an important but often underappreciated role in competition policy.
The reason for this is simple. Hipsters don’t like the mainstream. They’re not happy unless their clothes are vintage, their bikes are fixies, and their flat whites are served in avocados. If it is mass-produced by a multinational, they won’t touch it.
Indeed, hipsters are the reason we have so many choices when it comes to which alleyway speakeasy to drink in. Across our inner cities, hipsters are the reason why mechanics and car dealers are giving way to cocktail bars and edgy restaurants.
Those from Perth know the power of the hipster more than anyone. Whether it’s Uncle Joe’s Mess Hall, urban orchards in Northbridge or the fact you now seem to have more bars and cafes than people, hipsters’ desire for innovation, difference and choice has seen a boost in competition.
But alas, despite their best efforts, the hipsters have not managed to save the day.
Take craft beer as an example.
Thirty years ago, Phil Sexton was a local Western Australian brewer who found himself increasingly disheartened by the beer industry. To Phil, conventional beer brewing was blokey, sexist and parochial. He felt the industry treated brewing like a bland exercise in engineering rather than a craft to be mastered.
Fed up with the status quo, Phil and his friends pooled their resources and started their own brewery. The going was tough. The big players used their market muscle to shut them out of virtually every local pub. But Phil and his friends persisted. They started their own pub, sold their own beers and created what is now a household name for craft beer drinkers in Australia: Matilda Bay.
Matilda Bay did what every brewer, hipster and economist would hope: it took market share away from the major keg-rollers and introduced a middy of healthy competition. Sadly, however, the competitive threat of Matilda Bay and many other craft beers have since been neutralised. After spending years fighting the big players, Matilda Bay was eventually bought by multinational mega-brewer, SABMiller. Last year, SABMiller was itself bought by Anheuser-Busch InBev, a $100 billion deal that was one of the largest corporate takeovers in history. The little beer that Phil once brewed is now produced by the world’s biggest beer manufacturer.
Matilda Bay is not alone. White Rabbit, Little Creatures, Kosciusko, Knappstein and a host of other well-known craft beers have all been bought-up by the big guys. This makes one of Australia’s most concentrated markets even more concentrated. The four big players – Anheuser-Busch, Lion, Coopers and Coca-Cola – control more than 90 per cent of the market. Australia might once have had a West Australian educated Prime Minister who held the world record for beer sculling. These days our only gold medal is in just how few firms make our beer.
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This increase in market concentration is not unique to beer. Grattan Institute head John Daley once asked me how many industries I could name in Australia that weren’t dominated by just a few big firms. Struggling to name more than a handful, I realised John was on to something.
Working with Australian National University researcher Adam Triggs, we collected market share data on Australia’s 481 industries. Our findings, published in the Australian Economic Review last December, struck us as pretty alarming.
To take a few examples, in department stores, newspapers, banking, health insurance, supermarkets, domestic airlines, internet service providers, baby food and soft drinks, the biggest four firms control more than four-fifths of the market. In petrol retailing, telecommunications, credit unions, cinemas, liquor retailing, bottled water and fruit juice, the largest four companies control more than two-thirds of the market. In pharmacies, pharmaceuticals, hardware, gyms, snack foods, magazines, newsagents and international airlines, the big four account for more than half the market.
The data also gives a few answers to John Daley’s tricky question. Car dealers, hairdressers, dentists and law firms are all industries where the top four firms account for less than one-tenth of the market. Construction also appears to have a low concentration ratio, though this may be because this rather broad category combines a number of more concentrated sub-markets.
Although there is no set rule, a sector with a four-firm share of more than one-third is often considered to be concentrated. On this measure, over half of Australia’s industries are concentrated.
Concentration is getting worse, too. Since 1990 the number of mergers and acquisitions in Australia has more than quadrupled from 346 (with a combined value of $28 billion) to 1595 in 2016 (with a value of $140 billion). This has led to a substantial increase in market concentration in supermarkets, banking, airlines, meat processing, bottled drinks, telecommunications and a range of other important industries. And despite all the rhetoric that mergers improve economies of scale and boost efficiency, recent research from the United States suggests that productivity improvements from mergers has been low.
And while the megacorps are amalgamating, fewer start-ups are starting. The rate at which new businesses are being created in Australia has slowed over time. Back in the 2000s we would typically see a new business creation rate of 17% per year. Since 2010 this has fallen to 13%. For all the talk of incubators, accelerators and innovation, our nation isn’t starting as many businesses as it used to.
So market concentration is high in Australia, it is high by international standards and it is increasing. But is it necessarily a problem?
Defenders of the status quo sometimes point out that increased concentration doesn’t necessarily mean reduced competition. This is true. But the fact is that competition problems rarely emerge in markets that are not concentrated. For example, merger guidelines from the Australian Competition and Consumer Commission say that the competition watchdog is unlikely to identify concerns in a market in which concentration is low. Its overseas counterparts take a similar approach. After all, bullies aren’t usually the scrawniest kids in the playground.
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To see how market concentration can lead to competition problems you need to look no further than this city.
For those of you who drove here today, you’ll be familiar with the price cycles in Perth’s petrol retailers. Somewhere in the middle of the week, prices suddenly spike – often by as much as 15 to 20 cents per litre. Over the next six days, they fall by a few cents each day. The next week, the cycle begins again. If you time it carefully, you can save some money. But if you wait too long, you’ll lose out.
Although we have become used to these price cycles, have you ever thought they are a little strange? After all, it’s not as though there’s a cheap day to buy groceries, whitegoods, cars of home appliances – so why is there a cheap day to buy petrol?
After decades of researchers trying to understand bowsernomics, a new study may have cracked the nut. Economists David Byrne from the University of Melbourne and Nicolas de Roos from the University of Sydney analyse nearly 2 million daily petrol prices across the Perth metropolitan area. Alarmingly, they find that petrol retailers have been engaged in ‘tacit collusion’, resulting in coordinated prices, less competition and higher margins for retailers.
Sifting through the data, the researchers produce the economic equivalent of an Agatha Christie novel. They find that the dominant firm, BP, performed the role of the price leader. BP’s prices acted as a focal point for the broader market to converge on. Through a long process of trial and error, by 2010 all of Perth’s petrol stations had adopted the same pricing strategy.
This strategy will be familiar to many of you. On Thursday, prices go up by 15-20 cents per litre. Then, for the next six days, the price falls by 2 cents each day. Like clockwork, the cycle repeats itself week after week. The only change was in 2015, when all petrol stations switched from Thursday price jumps to Tuesday price jumps. (I mention this since today is Wednesday: so you might want to wait a few days to fill your tank.)
Byrne and de Roos warned that the reason this tacit collusion was possible was because the Perth’s petrol market is highly concentrated. After all, it’s easier to collude with just a couple of companies that dozens of companies. The result for Perth’s motorists is that you pay 10 cents more per litre – that’s an extra $360 a year to fill up a Holden Commodore once a week. But because the process involved number crunching rather than clandestine deals, it didn’t break the law.
Perth’s petrol market highlights an important point: not only are we seeing Australia’s markets becoming more concentrated, we are also seeing anti-competitive conduct becoming much more widespread.
Another area where this is evident is in payment terms. In 2016, Rio Tinto told many of its small suppliers that, with no compensation, it would pay its bills after 90 days instead of 45 days (in 2014 it was 30 days). While Rio Tinto backed down following intense public pressure, the attempt followed BHP’s decision to pay its suppliers after 60 days instead of 30 days. In recent years, Procter & Gamble, Mars, Kellogg, Heinz and Woolworths are among the major firms that have told their suppliers that they will have to wait longer before getting paid.
If you think that longer payment terms have nothing to do with market power, try going to the supermarket and telling the checkout operator that you’ll pay for your groceries after 60 days. The reason firms can get away with longer payment terms and you can’t is straightforward: they have market power.
On average, large companies are almost 20% slower in paying their bills than small companies. The industries that are the laziest in paying their bills are telecommunications, mining, utilities and the industry for finance, insurance and real estate. These industries also tend to be the ones that are highly concentrated. Australian companies are also tardier than those in New Zealand, where bills are paid 22% faster.
Just last week, the Business Council of Australia launched a Supplier Payment Code which, among other things, seeks to address this problem. The jury is still out on whether this will see big companies exercising constraint in their use of market power (the major supermarkets are yet to sign on to the Code). But the whole episode shows that when given to power to profit at the expense of their smaller suppliers, big firms find it hard to resist.
Take agriculture as another example. There are few people in Australia who had a tougher 2016 than our dairy farmers. Fiona and Lynden Plant are one example of many. They and their three children have 900 dairy cows in Gippsland. Their struggles began in May 2016 when their milk brokering company, National Dairy Products, followed Murray Goulburn and announced cuts to the price of milk. To their horror, the Plant family learned that these price cuts would be applied retrospectively.
For Fiona and Lynden Plant, this meant a $240,000 loss overnight. In the months that followed, they were forced to cull 200 cows from their herd. While the price of their produce fell, the price of many inputs continued to rise. ‘There's a lot of people out there hurting at the moment’ they said. ‘At the end of the day, we still have families to feed and employees to pay.’
The farming industry is not a concentrated market. But despite this low-level of concentration, farmers are being caught between highly concentrated buyers and highly concentrated sellers, all of which have substantial market power.
When farmers are selling their produce, they face firms with enormous market power. These include supermarkets and meat processes as well as the manufacturers of milk, cream, butter, flour, sugar, cheese, cereal, pasta, cooking oil, margarine, leather - the list goes on. All of them are highly concentrated.
When they are buying inputs, whether they are purchasing pesticides, fertiliser, animal feed or veterinary pharmaceuticals, more often than not they are dealing with major companies with substantial market power. The four firm market share for pesticides, for example, is 100 per cent.
This ‘concentration sandwich’ is making life impossible for many of our farmers.
If you want to see the cost of excessive market concentration, just watch the news. Dairy farmers being pushed to bankruptcy by retrospective price changes. Suppliers being squeezed out of business by the big supermarkets. Reports of bid-rigging, physical intimidation and intense social pressure on rural families in cattle auctions.
But when it comes to market power, the agricultural sector are amateurs compared to our banking sector. Just ask yourself: what do the Storm Financial, Timbercorp, Comminsure and bank bill swap rate scandals have in common? The answer: they all involved one of the big four banks in some way. As the Reserve Bank recently warned, ‘banks that allow or encourage a culture of excessive risk-taking can pose significant harm to financial stability’.
The big four have increased their share of market assets from 65% to 77% over the past decade. In a competitive environment, we would expect to see profits squeezed down by intense competition. But over the past decade, Australia’s major banks have enjoyed an annual return on equity around 15%, making them among the most profitable financial institutions in the world. Over the same period, banks in Europe, Japan and the US have seen returns on equity below 10%.
But market power is not just bad for motorists, farmers and customers. It’s bad for workers too. Take the example of Michael Devine, a former computer scientist at Adobe in Seattle, Washington. After working for Adobe for four years, Michael was curious why he never seemed to receive job offers from any of the other tech companies in Silicon Valley.
It took Michael another four years to find out why. It turned out that Adobe had entered into a secret agreement with five other tech giants – Apple, Google, Intel, Intuit and Pixar – not to hire each other’s workers.
Unfortunately, Michael’s story is not uniquely American. Australia’s competition laws allow what are called ‘non-compete clauses’ in employment contracts. These clauses prevent employees from working for a competitor, starting a competing firm or poaching their customers. A recent study in Australia found that large firms are using non-compete clauses more frequently than in the past. In the United States, which collects better data on such clauses, a recent study found that 38% of employees have signed a non-compete clause at some point in their lives, while 18% are currently covered by one. These days, it’s not just technology workers and lawyers who are being asked to sign non-compete clauses, it’s also cleaners, landscapers and personal care aides.
Market power in employment means less competition for workers. This means lower wages, poorer conditions and reduced mobility. Non-compete clauses make it harder for employees to switch to a better job and stifle start-ups. Since many new companies are created by employees who leave to start a competing company, non-compete clauses reduce innovation. Using three decades of patent data, a US study found a ‘brain drain’ of inventors from states that enforce non-compete clauses to states that do not.
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Competition is not just about preventing tacit collusion, breaking up cartels or stopping the accumulation and abuse of market power. It’s also about ensuring companies tell the truth.
Competition and consumer protection are inherently linked. When companies can get away with fibbing, they stop competing. Why compete on price if you can get away with hidden shipping charges? Why work to make a nourishing product if you can falsely label it as being ‘fresh and healthy’? Why bother creating innovative products if you can make any unsubstantiated claims you like?
Alas, misleading and deceptive conduct in Australia is on the rise. This is evidenced by the fact that the word ‘fatberg’ has become part of the English language. If you don’t already know what a ‘fatberg’ is, I apologise for what you’re about to learn.
Last December, Perth’s Water Corporation put out a warning on so-called ‘flushable’ wipes. The warning was basically that these wipes are about as flushable as a bathmat. According to Perth’s Mid West regional manager Steve Greeve, there had been a significant spike in blockages through Perth’s 589km of mains, with Mid West waste management crews clearing the wipes from 70 wastewater pump stations and 19 wastewater treatment plants in the region.
‘If you mix these wipes with fat’ Steve warned ‘they sort of congeal together in what are called ‘fatbergs’ and you end up with blockages that overflow sewage into people’s houses, or backyards, or streets’.
‘No one likes sewage overflow anywhere’ Steve said ‘let alone inside your house.’
By the way, thanks to Ben for putting on lunch for us today. I hope everyone’s enjoying their sandwiches.
False claims aren’t just a casual annoyance, they damage our economy. By my calculations, the companies that were identified by the Australian Competition and Consumer Commission to have misled and deceived consumers in 2016 operate in industries with over $200 billion of revenues annually. This is a sizeable chunk of the Australian economy. Last year, losses to scammers averaged nearly more than ten dollars for every person in Australia. Customers with less education and poorer social networks are particularly vulnerable to scams.
The problem is getting worse. Complaints to the competition watchdog of misleading and deceptive conduct are up one third over the last three years. The list of companies that have been reprimanded by the competition watchdog or the Federal Court reads like the ‘who’s who’ of the top end of town, including Jetstar, Virgin, Arnott’s, Optus, Harvey Norman franchisees, Kogan and Unilever.
You couldn’t make up some of these claims. For four years, starting in 2011, Nurofen, a big shot in the painkiller business, began selling a series of products that aimed to ‘target’ specific kinds of pain. But while they had different names – Nurofen Back Pain, Nurofen Period Pain, Nurofen Migraine Pain and Nurofen Tension Headache – they all had the same active ingredient, 342 milligrams of ibuprofen lysine. No doubt, customers trusted Nurofen’s claims more than they would have done with an unknown firm.
In 2016 the Federal Court found Woolworths to be liable for selling a faulty drain cleaner that burned multiple customers, including a baby that required surgery, and deep fryers with handles that could easily fall off. Woolworths reportedly refrained to withdraw these items from sale even after it learned of the injuries.
Similarly, when Uncle Toby’s said that its oats were a ‘natural source of protein’, few would have paused to look at the fine print ‘when prepared with skim milk’. In the end, all these big firms were fined for misleading consumers – but the reason they could profit in the meantime was that they had considerable market share.
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To sum up the problem: more than half of Australia’s markets are concentrated, some of our biggest industries are very concentrated and the problem is getting worse because fewer new businesses are being created and more existing businesses are merging. We are seeing a rise in firms using their market power for anti-competitive purposes to the detriment of small businesses, workers and consumers. And we are seeing too much anti-consumer conduct which is reducing the incentive of firms to compete on the price, quality and effectiveness of their goods and services.
So what can be done about Australia’s growing competition problem?
First, we need to make it easier for more competitors to enter the market. It’s perfectly reasonable for firms to prevent ex-employees stealing confidential information. But ‘non-compete clauses’ are a sledgehammer to crack a nut. Studies show that making these clauses unenforceable – as California has done – leads to an upsurge in innovation.
New companies can also be nurtured through accelerators and incubators and by removing unnecessary impediments to angel investment. When we make it easier for entrepreneurs to get a visa to Australia, we put welcome pressure on the incumbent firms. Whenever policymakers are thinking about planning and zoning laws, they should ensure that the rules aren’t unwittingly helping the establishment over the up-and-comers. In the banking sector, credit unions and building societies will be able to compete more effectively if they have fairer access to capital.
In transport, accommodation and logistics, the biggest competitive challenge will come from new online platforms using business models that would have been unthinkable a generation ago. Uber owns no cars. AirBNB owns no hotels. Netflix has no stores. And yet they represent a major threat to the taxi, accommodation and video rental industries.
In the US, Amazon accounts for about half of online sales, and 5% of all retail spending. Amazon’s impending arrival in Australia is an existential threat to shopping centres, supermarkets and department stores. Chat with the large banks and you notice how worried they are about Apple’s potential to expand into the finance sector.
The risk here is that technology might simply replace an old-fashioned oligopoly with a Silicon Valley monopoly. While anyone can start a firm in their garage, the story of platforms such as Facebook and Google is one of rapid market dominance. Some people now think that the best hope for more competition in sectors like internet search and social media will come when these players start intruding into each other’s domains.
Ensuring we get the most out of technical disruption will require stronger skills and better infrastructure. Charles Darwin famously said it’s not the strongest of the species that survive, it’s the ones that adapt successfully to change. Workers are more likely to find new jobs if they have broad-based skills and a love of learning. Start-ups will be more successful with access to high-speed broadband.
Just as police forces must evolve to fight new types of crime, the competition watchdog needs the right powers and resources to tackle monopolies. Last month, the Economist said that ‘antitrust authorities need to move from the industrial age into the 21st century’. Using Facebook’s acquisition of WhatsApp as an example, the magazine argued that merger authorities should take account of firms’ data assets, not just their market size, when deciding whether to approve a deal.
It’s also worth considering whether the Australian Competition and Consumer Commission should have new powers. Its British counterpart has a market studies function, which allows the regulator to investigate concentrated sectors and propose solutions before the problems emerge into public view. For example, a market studies power would have allowed Australia’s competition watchdog to initiate its own inquiry into the energy sector without waiting for a specific reference from the federal government. Ian Harper’s 2015 competition review recommended a strong market studies power and the Australian Competition and Consumer Commission has repeatedly requested such a power.
When it comes to deterring bad behaviour, our laws are only as powerful as the penalties courts can impose. When Nurofen was taken to court for their ‘specific pain’ range, they ended up being fined just $6 million – a tiny fraction of total sales. Similarly, the fines imposed on Woolworths for selling faulty drain cleaner and dodgy deep fryers amounted to just 0.006% of its annual sales, despite the fact that these products caused serious burns and injuries.
Michelle Gordon, who was also recently appointed to the High Court, has warned that these penalties do little to deter illegal conduct. As Australian Competition and Consumer Commission chair Rod Sims puts it, the risk is that companies see these penalties as a mere ‘cost of doing business’.
At the 2016 election, Labor proposed that the fines for consumer rip-offs be raised to $10 million. We’re pleased that in the May 2017 budget, the Coalition government adopted this approach. Raising the maximum fine for consumer scams is good for consumers and good for the federal budget.
But while they’re adopting our policies, I’d be delighted if the government would take a few more as well. To clearly signal that corporate wrongdoing doesn’t pay, we’ve advocated linking the penalty for anti-competitive conduct to total sales. Such a move would bring Australian penalties into line with jurisdictions such as the European Union.
Some of the revenue from these higher fines could be directed back into the competition watchdog’s litigation budget, which would give it more firepower to go after companies that flout the law. And given that anti-competitive and anti-consumer conduct especially harms the most vulnerable in the community, the competition watchdog ought to explicitly prioritise investigations into wrongdoing that targets disadvantaged Australians. When rip-off merchants go door-to-door selling unnecessary funeral insurance in Indigenous communities, the law should come down on them like a ton of bricks.
In a competitive market, our big banks shouldn’t be among the most profitable in the world. Farmers shouldn’t find themselves having only a couple of choices when they buy their seeds and fertiliser; and then having to sell to a monopoly agribusiness. And there shouldn’t be a ‘cheap day’ to buy petrol.
Getting competition right isn’t just about creating a stronger economy, it’s also fundamental to forging a fairer society. For hipsters – and everyone else too.
* My thanks to Adam Triggs for assistance drafting this speech, which partially draws on our co-authored article ‘A Few Big Firms’, published in The Monthly on 17 May 2017.
WEDNESDAY, 7 JUNE 2017