Tag Archives: competition

Burdened by Bigness

Suppose your company invested billions of dollars in new equipment. And suppose now, very shortly after taking delivery, you’ve discovered that your investment was misguided. The machines you’ve bought are threatening to destroy your business. What would you do?

That, in essence, was the subject of a conference I spoke at in October at the Copenhagen Business School. Shipping is a very, very big business in Denmark, and of course Maersk Line, the world’s largest container shipping company, is headquartered on the Copenhagen waterfront. Maersk itself built the first of the megaships — ships that carry as much cargo as 8,000 or 10,000 trucks — back in 2006, when it launched what it called its E class (hence such clever ship names as Emma Maersk and Evelyn Maersk). There are now roughly 150 vessels this big or larger on the seas. More are on the way: the South Korean government just agreed to finance ships the size of 12,000 trucks. This is not something the world needs.

I’ve been spending some time of late studying how the megaships came to be, and I’m convinced that they are a colossal error. The ship lines that commissioned them, by and large, were transfixed by the idea of economies of scale: if you can actually fill one of these giant vessels, they can carry a single container for about 30 percent less than a ship half the size. But filling them has been a persistent challenge. Moreover, the people obsessed with achieving economies of scale at sea largely ignored the fact that these behemoths would create diseconomies of scale on land. With fewer ships calling but each ship discharging and loading many more boxes, ships spend more time in port, the ports are half-buried beneath mountains of containers, and service for the manufacturers and retailers who ship goods in containers has become much less reliable. These days, when a containership arrives in port, it’s behind schedule nearly half the time, and when the goods will reach their final destinations is anyone’s guess.

The ship lines have been praying that international trade will grow faster, as it did before 2009, and fill up all those half-empty ships. Some thoughtful people, including the experts who monitor shipping for the United Nations Conference on Trade and Development (UNCTAD), think this will happen. My own view is that it’s highly unlikely. The world economy itself is likely to grow more slowly than it has in recent decades; China’s years of 10% annual growth are over. Adding to that, the gradual shift of manufacturing closer to end markets and the desire of manufacturers and retailers to minimize risks from malfunctioning supply chains will suppress demand for container shipping. Managers of ship lines, in my view, need to think very hard about where they’re going to make money, because they are probably not going to make much from operating ships.

Many of the people I met in Copenhagen, including the authors of a new McKinsey study envisioning the shipping industry of 2043, seemed to agree with my analysis. There was much discussion about the digital future. What that seems to mean is that ship lines might figure out how to use information technology to provide higher-value services to their customers. In other words, they might become logistics managers, coordinating the efficient flow of goods around the world for individual customers, rather than simply selling cheap transportation. It’s an alluring vision. Many start-up companies are now pursuing similar strategies, without the burden of owning all those money-losing ships. Ocean carriers have to figure out how to turn their underutilized floating assets into a competitive advantage even as they transform themselves into technology companies — and given the fairly bleak profit outlook for the shipping industry, some of them may not have much time to get it right.

Some Wisdom from Henry Kaufman

Sometimes, when you write history, you can end up feeling old. I had that feeling a couple of weekends ago, when Henry Kaufman ventured to Baltimore to talk to the Business History Conference, an organization of historians.

I’ve known Kaufman for many years, and when my neighbor in the audience said, “I don’t know who this person is,” it was hard to explain how important he was on Wall Street in the second half of the twentieth century — how he, then head of research at Salomon Brothers, and Albert Wojnilower, the chief economist at First Boston, presciently warned in 1981 that Ronald Reagan’s economic policies would drive interest rates and the dollar sky-high, or how Kaufman’s pronouncement in August 1982 that interest rates had entered a long-term downward trend awoke the stock market from years of slumber. Since then, Kaufman has come in for a good bit of criticism: he was insufficiently bullish on the stock market in the 1990s, it is said, and as a board member bears responsibility for the collapse of Lehman Brothers, a venerable investment bank, in September 2008. He remains bitter about his experience with Lehman, and he blames the Treasury and the Securities and Exchange Commission for telling the directors Lehman should declare bankruptcy. “I think it was partly a political decision to allow Lehman to fail,” he says, recalling the pressure on the Fed and the Bush Administration to force someone on Wall Street to lose big.

Kaufman is 90 now, and he continues to cast a skeptical eye on the markets. He has always been a bond guy, and bond guys, by nature, worry about risks more than opportunities. His greatest worry is the financial system itself. He thinks that regulators missed the boat in the 1990s when they phased out the rules that separated commercial banking from investment banking; they expected deregulation would lead to greater competition among banks, he recalls, but instead it brought large-scale consolidation. The Dodd-Frank law and the other reforms that followed the 2008-2009 crisis, he thinks, have reinforced that trend. “It preserved the enormous financial concentration that had taken place and even accelerated concentration. That was a mistake,” Kaufman says. The result, in his view, is a system that is even riskier, with rules that are too complicated for bank supervisors to enforce.

His recommendation is to force financial institutions to specialize. The advantage in having companies that deal only in insurance, or consumer banking, or money management, he says, is that managers and regulators could better understand their finances. “I dare anyone to tell me they can go into a large financial institution [today] and tell me the details,” Kaufman insists. “You can’t,” he says, because the companies are too complicated to comprehend. The idea that “living wills” will enable them to disentangle their affairs in the event of crisis, as Dodd-Frank commands, is fatuous, Kaufman adds. Even with a living will, the markets will devalue a troubled institution’s assets, spreading pain widely.

Kaufman knows the world has moved on, and he is not optimistic about bringing the old times back. But he distinctly remembers how, back when Wall Street firms were partnerships for which partners bore personal responsibility, they behaved differently than they do today. When he was hired at Salomon in 1962, he recalls, he was told, “Go home and tell your wife you’re going to be liable for $2 billion.” Answering to shareholders isn’t the same thing at all.

Information and Competition

It seems that competition regulators at the European Union are looking into whether “Big Data” is a potential threat to competition. The concern, apparently, is that a company may be able to use a trove of proprietary data about consumers in ways that foreclose competition — and that the assets changing hands in a merger could include enough data to give the merged firm an insurmountable advantage over would-be competitors.

There’s no doubt that control over data can affect competition. But it’s not so obvious how to ensure that consumers benefit.

Consider the logistics business. Every containership line publishes a schedule with the rate for moving one container from, say, Shanghai to Los Angeles. In practice, though, almost all ocean freight moves under confidential contracts between shippers and carriers. These contracts may be filled with contingencies providing for bonuses and penalties if the parties exceed or fail to meet their respective commitments. A large retailer, manufacturer, or freight forwarder has many such contracts in force at any one time, and it is always negotiating new ones. This means that big shippers have lots of up-to-date information about current shipping rates.

Now, imagine a small shipper, a modest retail chain rather than a Walmart or a Carrefour. Because of its size, this firm has only a handful of contracts with ship lines, and it may go months without negotiating a new one. It therefore lacks the current rate information its bigger competitors possess, so it will have a tougher time bargaining for the best rates. It may use a freight forwarder to get better rates, but then must pay the forwarder for its trouble. Either way, the smaller company’s information deficit will force it to pay more to move its goods than its larger competitors do.

This information disadvantage is one reason smaller retailers and manufacturers have been having such a difficult time. Their supply chains are comparatively costly to operate, on a per-container basis, and their higher costs make it hard for them to match their competitors’ prices. I suspect this is one reason we’ve been seeing increased concentration in so many industries. The big benefit from their control of big data about shipping costs; the small are harmed by their lack of information.

Is there a solution to this problem? Of course there is: it could be made mandatory to publicly disclose information about shipping costs. We actually tried such a policy in the United States in the early days of railroad deregulation. What happened? Railroads were reluctant to offer discounts to individual shippers when they knew that publicity would lead other shippers to demand similar discounts. Little freight moved under contract and rates remained relatively high. Only after confidential agreements were permitted did railroads’ freight rates fall and their service improve.

I think there’s a lesson here. Control of information can be anti-competitive, no question. But public disclosure of information can be anti-competitive as well, potentially raising costs for consumers. The EU will face a challenge getting the balance right.

 

Amazon, Whole Foods, and The Great A&P

A lot of people are concerned that if Amazon.com’s purchase of Whole Foods Market goes through, Amazon will be able to use its might and technological savvy to monopolize the grocery business. I’m not concerned about that myself, because I think the grocery business is pretty difficult to monopolize. Even the Great A&P, the subject of one of my books, never managed to amass enough power to force up the price of food; indeed, when a federal court found it guilty of violating antitrust law in 1946, the charge was that it was using its size to sell food too cheaply, not to raise prices unfairly.

So when the New York Times asked me to write about Amazon and Whole Foods in mid-June, I used my space to wonder why Amazon, which reports precious little profit from all the goods it sells, wants to go into the low-profit grocery business.  Perhaps, I suggested, Amazon should take a portion of the space in Whole Foods’ stores, most of which are in affluent neighborhoods, and turn it into an exciting retail concept that sells exclusive merchandise at a high mark-up. I was thinking of something similar to the Apple Store, which is a far more profitable retail venture than Amazon.com.

Amazon.com hasn’t yet offered me a consulting contract, so it apparently didn’t think much of my idea. Jeff Bezos seems to be a pretty smart guy, so if he thinks his company can make billions shaking up the stodgy grocery industry, perhaps he’s right.  But the list of others who have thought the same thing is very long indeed.

End of the Road for an American Icon

The July 20 bankruptcy filing by the Great Atlantic & Pacific Tea Company marks the end of the road for one of the icons of American business. The filing was in no sense a surprise: A&P has spent more than half a century driving itself out of business, shrinking over the years from a nationwide retailer to a small regional grocery chain. Few people, aside from its remaining employees, will grieve. Indeed, most people who think of A&P at all today remember it mainly as the dim and dowdy place where their Grandma used to shop.

But in its day, A&P transformed American retailing several times over. The company, then known as the Great American Tea Company, introduced mail-order shopping in the 1860s. In the 1890s, it developed the concept of handing out reward coupons with each purchase, an idea that soon had millions of housewives collecting trading stamps to exchange for lamps and crockery. Discount shopping as we know it today originated with A&P in 1912, despite the objections of Boston attorney Louis D. Brandeis, not yet on the Supreme Court, who thought consumers would be confused if a product did not sell at the same price everywhere. “The evil results of price-cutting are far-reaching,” Brandeis warned.

For more than four decades, from 1920 into the 1960s, A&P was the largest retailer in the world. It may also have been the most controversial. With stores in 3,800 towns, supplied by its own state-of-the-art bakeries and macaroni plants, dairies and salmon canneries, it squeezed costs out of the food distribution system and consistently undercut mom-and-pop grocers. A&P put fear into the hearts of small-town merchants. The earliest radio talk show hosts built their audiences by inveighing against it. State legislatures tried to tax it out of business. When that did not stop it from cutting prices, many states limited discounting by requiring minimum mark-ups on every single item in the store.

Washington got into the act, too. The literature lionizing Franklin Roosevelt as the first pro-consumer president ignores his support for a 1936 law intended to prohibit manufacturers from granting volume discounts, as well as the fact that his Justice Department sued A&P for selling food too cheaply—and won in court. As late as the 1950s, the federal government was still trying to break A&P into pieces, claiming that it was “impervious to competition.”

Washington needn’t have bothered. Competition carried the day. More aggressive grocers pushed A&P to the sidelines, but now they, too, are being pushed aside. The supermarket, a format A&P pioneered in the 1930s, is old hat. A host of innovators, from deep discounters to organic food chains to drug stores touting packaged foods to glitzy gourmet emporia, has the food retail industry in turmoil. If you shop for groceries, this is a wonderful development. If you’re trying to sell them, life won’t get any easier.

The Limits of Co-ops

I recently gave a talk to some retailers with a problem. For many years, these mom-and-pop shopkeepers have belonged to a cooperative. The co-op functions as their distributor: it supplies them with merchandise cheaply enough to make them competitive with chain stores, it controls brand names that consumers know, it advises them how to display their merchandise and plan special events, it represents them when new government regulations pose a threat.

So what’s the problem? The co-op hasn’t been doing terrifically of late, as competition in the retail market is changing. The shop owners want to keep it, because they value its services. But they also are the co-op’s shareholders, and they know that their personal wealth will take a hit if the co-op goes into decline. The question is what to do.

This is actually an old question. Retail co-ops have been around since the industrial revolution; Britain’s Co-operative Group dates its birth to 1844. In the United States, they began around World War I, when chain stores began taking a significant share of the grocery market. Chain grocers, back in those days, could underprice mom and pop largely because they could buy directly from manufacturers, obtaining volume discounts and avoiding payment of commissions to wholesalers. Some of them, such as A&P, a company I’ve written about, also developed powerful brands. Co-ops provided these same benefits to small stores. By banding together, small retailers could buy in quantity, and the co-ops could build brands just as chains did.

The co-op movement was highly successful in some areas of retailing, notably groceries, drugs, and hardware. IGA–the Independent Grocers Alliance–was a household name in the town where I grew up. I suspect that few of the people in New Jersey and Connecticut who buy their food at ShopRite realize that it really isn’t a chain, but a group of separately owned stores that all receive their goods from, and use the brands of, Wakefern Foods, which in turn is owned cooperatively by the store owners.

Co-ops thrived for decades, and they arguably helped mom-and-pop stores survive the chain store onslaught. But many of them have gone by the boards, largely for reasons beyond their control. Their retailer-members, largely small merchants, often lacked the cash to build big, modern stores like the chains owned. If a retailer-member failed to keep its store looking good, the co-op could usually do little about it. With the arrival of television advertising in the 1950s, consumers were persuaded that nationally advertised products were better than the goods in their local store. As a result, co-ops’ brands became associated with outdated, down-market stores and low-quality products.Some retailer-owned co-ops have managed to overcome these obstacles, but many have not.

Today, the incredible rate of change in retailing poses a daunting challenge for co-ops. Almost by definition, co-ops move slowly. Management cannot make major changes without the approval of a board comprised of retailer-members, many of whom may not see the need. Repositioning the brand requires convincing the members of the urgency of drastic change, a process that can take years.

So while I’d like to be optimistic about the future of retailer co-ops, that’s not easy. Co-ops have played an important role in retailing, and in helping independent retailers stay in business. There are a handful of exceptionally well-run operations, which I very much admire. But for the most part, the retailer co-ops’ day has passed. I think it’s better to recognize that, and to look for alternatives, rather than to wait for the good old days to come back.

The Case for Giving It Away

Elon Musk, the head of Tesla Motors, announced today that his company will not sue others who use Tesla’s technology. Rather than continuing to protect its inventions, Tesla is giving them away.

This isn’t as daft as it sounds. In fact, I wrote about a similar situation in my book on containerization, The Box. One of the factors that limited the growth of container shipping, in the 1950s and early 1960s, is that there was no standard way to move containers. Some had slots at the bottom, so they could be lifted by forklifts. Others had eyes on the top, to be picked up by hooks dangling from a crane. Most had steel fittings at the corners, so that a crane could lower a steel frame, called a spreader, that could grab the container at all four corners and lift it. But the corner fittings and spreaders were patented, and no two companies’ designs were alike. What this meant was that a crane capable of handling a Grace Line container couldn’t lift a container belonging to Sea-Land Service or United States Lines.

Everyone connected with the container shipping recognized that a standard design was essential if the industry was to grow. But each company thought its design should become the standard. Finally, in 1963, Malcom McLean, who had started the modern container shipping industry in 1956 with the ship line that became Sea-Land, agreed that his company would allow anyone to use its patents for the corner fitting and the twist-lock, a nifty little device that connects the corner fittings of two containers with the turn of a handle. The Sea-Land corner fitting became the basis for a worldwide standard. Once any crane in any port could lift any container, the container shipping industry burgeoned. Sea-Land became far bigger and more profitable by giving away its technology than it would have been had it kept its innovations to itself.

This seems to be what Mr. Musk has in mind. Tesla, its stratospheric market capitalization notwithstanding, is a small manufacturer of what is very much a niche product. The company’s long-run prospects are limited unless electric cars go mainstream, but this won’t happen unless they become far cheaper than they are today.  Cost saving is likely to require standardization of many components in electric vehicles. By giving away Tesla’s technology, Mr. Musk may be encouraging suppliers to develop components that can be sold to many electric vehicle assemblers, creating economies of scale. If that happens, costs and prices should fall, boosting sales of electric cars and accelerating the installation of charging stations. Down the road, Tesla could have an important role in a far larger industry, with profits to match.

 

Cooperation at Sea

Capitalists, in my experience, are often less than enthusiastic about competition. To be sure, they (and their speechwriters) know to praise the virtues of market forces. But the reality is that competition can be bad for business: all other things equal, it erodes profits, costs jobs, and drives firms to failure. It is always tempting to cooperate with the enemy.

How much cooperation to tolerate was one of the subjects of an unusual event today in Washington. The discussions at the first-ever joint meeting of shipping regulators from the United States, the European Union, and China were private, but it’s a good bet that a proposed collaboration among the world’s three largest container shipping lines was the major topic of conversation.

Between them, Maersk Line of Denmark, Swiss-based Mediterranean Shipping Company, and the French line CMA CGM control close to 40% of the world’s container shipping capacity. These companies have battled for market share for many years, to the benefit of freight shippers and consumers. But now, if the various governments agree, they would like to work together. They propose to create something called the P3 Network, through which the three companies would share space on up to 180 containerships sailing between East Asia and Europe, Europe and North America, and North America and East Asia. The companies would not share price information, and each would strike its own agreements with customers. But by working together, they could squeeze capacity out of the market, which might help prop up shipping rates.

The container shipping industry is awash in excess capacity, which is great for shippers but terrible for ship owners. A number of major carriers have been bringing very large vessels on line at a time when demand is growing slowly; the largest of these can carry more than 9,000 standard 40-foot containers. All this capacity has depressed rates and driven most ship lines into the red.

Given the economic importance of container shipping, cooperation among the three largest sip lines would be no small deal. Shippers could obviously face higher rates, but ports, stevedoring companies, railroads, and trucking companies might be even more severely affected. As part of their proposed agreement, Maersk, MSC, and CMA CGM would be able to consolidate the land side of their operations. This could mean that their vessels would stop serving some ports and expand at others. They would be able to bargain jointly with stevedores and land transportation companies, using their very large combined market share – the three companies jointly carry about 41% of container traffic between Europe and North America, for example – to demand lower prices. On the plus side, shippers might benefit from more frequent service between certain ports. Also, the three carriers may try to establish joint barge or feeder-ship services to move containers among U.S. ports, something none of them alone has enough traffic to do profitably.

As they weigh the P3 proposal, competition authorities and shipping regulators will be very much aware that it is not the only collaboration in the works. The six carriers in a competing group, the G6 Alliance, have shared vessels between Asia and the East Coast of North America since last May, and now they are seeking permission to cooperate on services between Asia and U.S. Pacific coast ports.  Meanwhile, several container lines are rumored to be seeking merger partners.

All of this is very much in line with the history of the container shipping industry. Since its earliest days, it’s been a treacherous business; each time rates rise, shipping lines order new vessels, overcapacity returns, and the most troubled companies exit. That’s the way capitalism is meant to work, but it’s a tough way to make a profit.