Here’s How You Know Your Industry Is About To Be Disrupted
On a recent episode of Last Week Tonight, John Oliver pointed out the dangers of corporate consolidation. In a variety of industries today, ranging from airlines to healthcare to even buying a coffin for a funeral, a handful of major players dominate, which allows them to raise prices and restrict consumer choice.
Anybody who has flown on an airplane in recent years knows what he’s talking about. The once reeling industry now charges more and delivers less, but is reaping record profits, despite its horrific service. As Oliver pointed out, United posted strong results even after its notorious passenger dragging scandal.
Clearly, we have a problem with antitrust regulation and consumer protection, but corporate consolidation is more than an example of corporate greed, it is also an indication of industry weakness. Growing industries generally don’t consolidate and, by restricting competition, firms in oligopoly markets often hasten their own disruption and demise.
The Rise and Fall (And Rise Again) Of Microsoft
It’s hard to think of a business more dominant than Microsoft in the 1990s. Its control of 95% of the market for operating systems allowed it to leverage its clout into a leading position in business applications. By the turn of the century, it became embroiled in one of the largest antitrust suits in history.
Yet the next decade showed how fragile the company’s empire actually was. It whiffed on music players with Zune, completely missed the market for mobile and never really became competitive in the lucrative search engine market. Before long, the market for PC’s was in decline and Apple replaced it as the world’s most valuable company.
The Redmond giant is far from the exception. From the Detroit automakers to Kodak to big box retailers, a period of total dominance often seems to foreshadow a steep descent and that’s not a coincidence. An industry without competition innovates and the illusion of stability often leads managers to ignore the forces that would help them adapt.
As current Microsoft CEO Satya Nadella points out in his new book, Hit Refresh, part of the problem was that the company’s original mission, to put “a computer on every desk and in every home,” had long been achieved. His new mission for the company, “to empower every person and every organization on the planet to achieve more,” is inherently more collaborative.
The Lump of Market Fallacy
Market dominance is always somewhat dependent on how you define an industry. Microsoft’s power over the PC industry did little to protect it from the rise of smartphones, much like its predecessor IBM’s dominance over mainframes did little to protect it from the rise of minicomputers. The minicomputer companies were later blindsided by PC’s.
In a sense, consolidation strategies fall prey to something similar to what economists call the lump of labor fallacy, which assumes that there is always a fixed amount of work available in an economy and increased productivity will lead to fewer jobs. In public policy, that usually leads to policies that restrict productivity and reduce prosperity.
Firms that seek to diminish competition often hasten their own downfall because the strategy assumes a static market in which profit is a function of how much money you can squeeze out of a fixed pie. It is this myopic view that leads them to ignore the growing threat from new market entrants and substitute products.
By reducing competition, firms also reduce their incentive to increase productivity and open up a window for new market entrants. Would hyperloop companies be attracting so much interest and investment if people were actually happy with airline service?
Corporate Dutch Disease
While the lump of market fallacy tends to reduce firms’ incentive to pursue new opportunities, limited competition also tends to increase costs. The process is similar to the Dutch disease that plagues many resource rich countries and the results can be just as devastating as what is happening now in countries like Venezuela and Russia.
A business that can earn excess profits with low productivity will be much less likely to invest in the technology and human capital that leads to increased efficiency. Also, because increasing efficiency will have little effect on profits, capital tends to get returned to shareholders. These two forces reinforce each other and starve the industry of investment.
It’s not hard to figure out what happens next. By the time a new technology or a change in customer preferences disrupts a consolidated industry, it has long become highly inefficient. To make matters worse, because it has insulated itself from market forces for so long, it has lost its ability to seek out and identify genuinely new opportunities.
All too often, executives fall into the trap of believing that greed is good, but rent seeking behavior is not sound business practice. It may delay an inevitable decline, but market forces tend to win out in the end.
Every Business Is A Square Peg Business
None of this should be seen as excusing predatory corporate behavior, but we should also understand where it comes from. Industry consolidation is almost always an attempt to protect a dying business model in a mature industry. Yet the unfortunate reality is that business models never last and the sooner an industry faces up to that simple fact, the better off it will be.
The truth is that every square-peg business eventually meets its round-hole world and the answer to that problem isn’t to force your customers to simply pay more for square pegs, but to identify a new problem to solve. Airlines, to take John Oliver’s favorite example, offer lousy service because its customers see its product as a commodity. That’s never a good place to be.
So while it is impossible to tell what will eventually disrupt airlines — it could be the hyperloop, high speed rail, virtual reality teleconferencing or something else entirely — it should be clear that something eventually will and when it does, the industry will be practically defenseless against it.
Today, we need to manage not for stability, but disruption and creating artificial stability through consolidation is not a survival strategy. It will only hasten an inevitable demise.
An earlier version of this article first appeared in Inc.com