The University Of Chicago Worries About A Lack Of Competition: Its Economists Used To Champion Big Firms, But The Mood Has Shifted

|
Includes: AAPL, AMZN, FB, GOOG, GOOGL, MSFT
by: Dr. Jacques Saint-Pierre

Summary

Data do not support that the economics of competition has changed.

Don’t burn the books of the old Chicago school too quickly!

Basic economic principles that could be use to see the competition at work.

From The Economist (Crony Capitalism, April 15th 2017):

"There is an emerging consensus among economists that competition in the economy has weakened significantly. That is bad news: it means that incumbent firms may not need to innovate as much, and that inequality may increase if companies can hoard profits and spend less on investment and wages. It may yet be premature to talk about a new Chicago school, but investors and bosses should pay attention to the intellectual shift, which may change American business."

The Economist adds:

"The technology industry's expansion could exacerbate the problem. An analysis by The Economist in 2016 suggested that about half the pool of abnormally high profits is being earned by tech firms. The big five platform companies-Alphabet, Amazon, Apple, Facebook and Microsoft-earned $93bn last year and have high market shares, for instance in search and advertising."

However, our data do not support that the economics of competition has changed. If we look at the "competitive spreads" of the big five platform companies - Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB) and Microsoft (NASDAQ:MSFT) that are mentioned in the article, the teachings of the "old" Chicago school in general, and of Merton Miller (a Nobel laureate in economics from Chicago) in particular are robust.

Below, we present for the five companies, the trend in their "competitive spread" over the years 2012-2016. We define "competitive spread" as the difference between the return on capital and the cost of capital (a difference correctly measured that is after transforming GAAP numbers into a rigorous computation of economic profit, after deducting the full cost of capital, and eliminating the accounting distortions).

We also show, in the seventh column, the percentage distribution of the market value of total capital between the value of the current operations (VA) and the value of the future growth opportunities (VG). As shown by Merton Miller more than fifty years ago, the value of a business is equal to the value of its assets in place, plus the value of its growth options. Today, we add a third term (ignores here) that corresponds to the value of the flexibility that the company has in exercising its growth options.

The last column gives the market price of the stock of the company at the time of writing (MV) and the estimated intrinsic value (IV).

As an example, for Alphabet, its competitive spreads are positive; revealing some competitive advantages, but the competition is bringing them down to equilibrium. The market value of its total capital (100%) consists of 32% of its current operating value and 68% of its future growth value. Finally, in the last column, we can observe why a great discrepancy exists between the market price of its share (MV) and its estimated intrinsic value (IV): The major part of its value come from its future growth opportunities where much uncertainty resides. For the other companies, the same basic economic principles could be use to see the competition at work.

Conclusion: Don't burn the books of the old Chicago school too quickly!

2012

2013

2014

2015

2016

Va, Vg

MV, IV

Alphabet

7.8%

5.5%

2.3%

3.3%

2.2%

32%, 68%

840$,311$

Amazon

0.4%

2.6%

-1.8%

-2.2%

-0.8%

10%, 90%

885$,55$

Apple

21.9%

15.3%

19.2%

17.4%

9.1%

54%, 46%

141$, 134$

Facebook

-8.2%

-2.0%

7.7%

1.7%

12.1%

32%, 68%

139$, 61$

Microsoft

7.5%

8.2%

5.5%

2.4%

1.7%

38%, 62%

65$, 24$

Disclosure: I am/we are long GOOG, AMZN, AAPL, FB, MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here