The Adam Smith doctrine posits that the natural end point of laissez-faire capitalism is perfect competition. Yet, when left to their own device, markets can lead to oligopolies, or quasi-monopolies, and their tacit corollaries: collusion and higher prices.
In the late 19th century, several sectors of the American economy experienced extreme consolidation, eventually compelling the government to step in and enact anti-trust legislation. Standard Oil’s John D. Rockefeller, US Steel’s Andrew Carnegie and railroad barons Leland Stanford and Cornelius Vanderbilt, among others, became so rich from establishing industry cartels that they could generously finance the creation and expansion of public libraries, universities and business schools across the country.
Alternative fund managers and tech conglomerates are today’s embodiments of market consolidators. And since the global financial crisis (GFC), the largest participants have increased their competitive power.
The leading quatuor of alternative investment firms - namely Apollo Global Management, The Blackstone Group, The Carlyle Group, and KKR & Co. - represent about 22% of the industry’s $5.8 trillion assets under management (AUM). Industry concentration is intensifying: Their market share has doubled in the past decade.
Private Capital Firms And The Privatization of Markets
As a consequence of new legislation introduced to tame the financial markets after the dotcom bubble, then again post-GFC, since the turn of the millennium many deal-doers have migrated to the lightly-regulated arenas of private markets.
Today, there are over 5,000 private equity (PE) firms worldwide and about 1,000 venture capital (VC) firms in the US alone. The private capital industry’s asset base has risen sevenfold since 2002. As explained, the leading investment groups recorded much more dramatic growth: Apollo has expanded its AUMs sevenfold to $300 billion in the last decade alone.
Not content with assets in excess of $500 billion, Blackstone has started using one of its investment platforms to sponsor other fund managers. It recently took a minority stake in BC Partners, a firm with $22 billion under management focused on Blackstone’s bread and butter: deal sizes above $1 billion in Europe and the US. What could possibly go wrong?
Imagine the following scenario: After some research, BC Partners finds an interesting business to acquire. Unbeknown to the prowler, Blackstone has also identified the prey as a compelling target. What could happen next is that the two bidding parties submit a joint offer, or one of them agrees to step aside. Either way, free markets lose one of their most praised characteristics - open competition.
Earlier this year, Goldman Sachs Asset Management, a division which includes the PE arm of the namesake investment bank, raised a dedicated vehicle to invest in up to 15 private capital firms. The latter could be strongly encouraged to use Goldman’s lending facilities or its co-investment capabilities. One decade after the industry was accused of collusion, financial regulators seem to have been caught unawares by this latest trend.
A Marked Trend In Private Markets
This is important for several reasons. First, in America PE-backed businesses account for a quarter of all midsized enterprises and over 10% of large companies. According to McKinsey, in 2018 about 8,000 US companies were reported to be PE-owned while the number of publicly-listed companies had almost halved in the previous 20 years. Private capital firms have enlarged their market share so dramatically that, via their portfolio holdings, they can affect job markets. As a case in point, KKR’s portfolio companies employ over 750,000 people worldwide.
Second, in the aftermath of the GFC the largest PE groups have extended their presence across the whole spectrum of the capital structure: real estate, private debt, hedge funds, infrastructure, and even venture capital. This gives them a chance to set the corporate agenda not just as shareholders and employers, but also as landlords, lenders, government advisers and activist investors.
These trends - increased concentration, a growing market share and a broader remit - should be of concern. In a way similar to the Gang of Four encompassing Google, Apple, Facebook and Amazon (GAFA) in the tech world - sometimes expanded to incorporate Microsoft - private capital has seen the emergence of the aforementioned quatuor. The consequences for other economic participants, from clients and workers to fellow lenders and investors, could be devastating.
Cornering the Decacorn Market
At the other end of the unquoted investment sector, the start-up world is also witnessing developments that could lead to market manipulation. The GAFAM have been singled out by governments and regulators - Facebook’s digital currency venture Libra shows that some of these groups’ proposals pose a threat to national sovereignty. But the risk of abuse also exists in the privately-owned technology sector.
Here is a case in point: After investing in many high-profile decacorns - start-ups valued in excess of $10 billion - Japanese group SoftBank is busy encouraging its investees to collaborate or merge with each other.
While publicly described as an ‘operating’ initiative to help businesses leverage each other’s capabilities - for instance, by inviting portfolio companies to rent office space from WeWork, one of SoftBank’s troubled investments - a more perverse outcome is likely to occur.
Instead of competing, these well-funded companies will likely work jointly or stay out of each other’s way. A clear example was Uber’s sale of its Chinese operations in 2016 in exchange for a stake in the combined entity Didi Chuxing. Although the move took place before SoftBank’s investment in Uber, this ‘cooperation’ strategy is catching on and should do wonders to these start-ups’ economics. Yet the likely impact on consumers and competitors is all too predictable.
What would prevent SoftBank-sponsored Indian online hotel chain Oyo from gently prompting its guests to order rides through Uber and Ola (both SoftBank investments) rather than with local cab companies across India? Why shouldn’t Uber customers be coaxed into booking Didi Chuxing’s services when in China or Grab’s when visiting South East Asia, these two companies counting SoftBank’s $100 billion Vision Fund as investor?
Close collaboration between Oyo - already one of the ten largest hotel groups in the world, with operations in India, China, the US and the UK - and WeWork could grant these companies unfair influence in corporate offices and lodging across key geographies.
Rivals of SoftBank-funded companies already sense the danger. In Britain, for instance, to keep up with Uber Eats, earlier this year Deliveroo attracted funding from Amazon after the latter chose to discontinue its food-delivery activities. Understandably, UK regulators are flagging the risk of oligopolization in the sector. Grubhub’s recent one-day 43% share price drop following a profit warning proves that US competitors to Uber Eats - whose parent sits on more than $5 billion in cash - are also feeling the pressure.
In India, TaxiForSure was unable to raise sufficient capital after SoftBank backed its competitor Ola in a $210 million round in October 2014. No investor was willing or able to match SoftBank’s firepower to back a rival. TaxiForSure’s only alternative was to sell itself to Ola, which it duly did in March 2015. Its legacy operations were shut down 18 months later.
Yet, this approach to market consolidation creates tension among SoftBank’s portfolio assets. On at least two occasions (2016 and 2018), SoftBank demanded a merger between Ola and its only remaining, but much weaker, ride-hailing peer in India: Uber. So far, Ola has resisted such proposals.
Private Capital Firms: A Job for Regulators
This modus operandi is not just a threat to healthy competition in national markets. Start-ups funded with billions of dollars aim for global leadership and (ultimately) monopoly profits. In a winner-takes-all environment, they seek sponsors with deep pockets. Some have received the backing of major retirement-plan managers like BlackRock and Fidelity, and of more traditional PE groups, including Blackstone and KKR. Consequently, they can outspend and outpace any competitor.
To properly monitor these fast-growing businesses, regulators must cooperate in a coordinated manner. Otherwise, we risk seeing the likes of Uber, WeWork and Oyo - irrespective of their dubious valuations and the long-term viability of their business models - create dominant positions that will fundamentally and enduringly distort market structures in a way similar to what Google and Facebook did in the online advertising and social media segments. Anyone prepared to readily dismiss this concentration of power should consider what the GAFAM have done to our privacy and pathological addiction to the latest fad.
Worrying about the possible repercussions of corporate dealings among private capital firms’ portfolio assets might seem excessive. Still, few people would today dispute that, in view of the market power they subsequently granted, Google’s purchases of YouTube and DoubleClick, and Facebook’s Instagram and WhatsApp transactions, should have been probed more carefully, perhaps even blocked. With that in mind, it is worth considering the long-term effects of SoftBank’s holdings in multiple ride-hailing platforms.
A Warning Call
The migration of our economies into private hands gives unprecedented influence to a small number of under-regulated fund managers. Now that many of them are publicly listed and manage a disproportionate amount of capital, the situation needs proper oversight.
As Blackstone’s Stephen Schwarzman multiplies generous contributions toward causes similar to those of 19th century industrialists, including a $100 million donation in 2008 to the New York Public Library - an institution that benefitted from robber baron Andrew Carnegie’s generosity back in 1901 - governments must take heed and upgrade anti-trust legislation to quash the supremacy of global private capital firms.
The most damaging drawback of capitalism is that, when unrestrained, it facilitates the emergence of industry consolidators, thereby hindering an orderly market economy.
- SoftBank creating operating group, FT article: https://www.ft.com/content/b956f236-bd14-11e9-b350-db00d509634e
- PE industry structure, including proportion of US mid-size and large companies under PE ownership: https://www.economist.com/briefing/2016/10/22/the-barbarian-establishment
- McKinsey report on growth in assets under management since 2002 and on the number of PE-backed companies and publicly-listed companies: https://www.mckinsey.com/~/media/McKinsey/Industries/Private%20Equity%20and%20Principal%20Investors/Our%20Insights/Private%20markets%20come%20of%20age/Private-markets-come-of-age-McKinsey-Global-Private-Markets-Review-2019-vF.ashx
- Blackstone investment in BC: https://www.ft.com/content/e9a4a8cc-b853-11e9-96bd-8e884d3ea203
- GSAM’s Petershill fund: https://www.bloomberg.com/news/articles/2019-05-01/goldman-s-petershill-is-said-to-seek-up-to-4-billion-for-fund
- SEC case on PE collusion:
- Softank invests in Ola: https://techcrunch.com/2014/10/27/olacabs-SoftBank-india/?renderMode=ie11
- Ola buying Taxyforsure after SoftBank invested: https://www.forbes.com/sites/saritharai/2015/03/02/indias-largest-cab-hiring-startup-ola-acquires-biggest-rival-taxiforsure-leaving-uber-far-behind/#46d811792519
- Uber-Ola merger asked by SoftBank: https://www.business-standard.com/article/companies/ola-uber-in-talks-to-merge-in-india-deal-said-to-be-brokered-by-SoftBank-118032800774_1.html
- Ola rejecting further funding from SoftBank: https://economictimes.indiatimes.com/small-biz/startups/features/why-bhavish-aggarwal-turned-down-a-1-1-billion-SoftBank-deal/articleshow/68788526.cms
- UK regulator investigates Amazon investment in Deliveroo:
- Grubhub’s stock price drop and profit warning: https://www.wsj.com/articles/grubhub-shares-fall-after-downbeat-outlook-11572367468