There are many occasions where the finance professional in me is in a tussle with the economist in me. And today’s topic is an example of such an internal conflict. Is there an inherent difference in the way finance professionals and economists think about competition?

Let me wear my economist hat first. Economics textbooks have always supported competition. The more the better. It speeds up the price discovery mechanism and increases the consumer surplus. That is the Economics 101.

Now let us turn to finance. The management textbooks teach us to find companies having a moat or competitive advantage. Oligopolies, duopolies, and monopolies are stock market darlings. If you are encountering such a sentence for the first time then take a moment to digest this fact. I would like to draw your attention to the first chapter of the book The Myth of Capitalism by Jonathan Tepper.

He writes that right from Warren Buffet, an investment guru to Joseph Schumpeter, an economist and from Peter Thiel, the PayPal founder to Michael Porter, the creator of Porter’s five forces, everyone in some or the other form has promoted a less competitive world.

Buffet and Munger, his partner, have always invested in the sectors where the competition is lower. Take the case of Coca-Cola – a duopoly market, or Moody’s Credit Rating – again a sector with only three companies.

Peter Thiel believes competition and capitalism are opposite and has said that competition is for the losers.

Schumpeter has coined the word ‘creative destruction’ which in a way promotes competition. Creative destruction means that the old processes or businesses will be disrupted by the new ones. For example, once an industry turns non-profitable, then the resources can be diverted to more productive activities or industries through innovation. This process is intensified due to competition. Competition keeps you on the toes and therefore instigates you to innovate. Now, you would think that how can the man who coined this term be anti-competitive! But Schumpeter, himself, lost faith in the sustainability of this process and became a champion for monopoly.

Now coming to Porter. Every MBA student has learnt those five forces. One force is the ‘threat of established rivals’ and the other the ‘threat of new entrants’. So, the sector where incumbent competition is high, and the entry barriers are low is a no-go zone. Therefore, those students after becoming the CEOs or founders of any company want to eliminate the competition and keep the entry barriers high.

I have felt that any policy that increases competition is good. In my last article on ONDC, I mentioned more than a couple of times that since this technology will increase competition everyone will benefit. However, ONDC will hamper the monopoly power of the incumbent. If the new technology gathers steam, then we might see the earnings of incumbents which have been enjoying the monopoly power go south, in the initial stage. So, as a consumer, you might benefit, but you might lose as an investor, at least in theory. That is how the nature of the stock market is. Or has become.

From a stock market point of view, low competition means having a price power which translates into steady earnings. In a competitive world, company A can surpass company B and sometimes a new company K can overtake all others. There is more uncertainty. Therefore, investors look for a stock where they don’t have to track this rigmarole and are more confident in its earnings and therefore, prices.

Then, here comes another factor. Is this parameter useful in the secondary market or just in the primary markets? We have seen how the valuations of tech companies in the generative AI space have topped recently. One can understand higher valuations during VC or PE funding rounds. Or even during the filing of an IPO. The lead manager of the IPO will see to it that the monopolistic power premium is included in the bid price. But will that factor still play a role after the company is listed? Many people will say – Yes.

Such a mechanism has made monopolies even stronger and invincible unless there is a disruption. We believe that we have more choices today. However, if we analyse what we consume through a microscope, we will see that in every sector, the market share is concentrated in the hands of a few players only. It is startling yet unstoppable. With every passing crisis, the number of players in a sector diminishes. In the developed markets, especially in the US, this is a more pronounced crisis. However, we can see it happening in India as well, at least in a few sectors.

Can we stop it? Probably yes. But will someone stop it? Probably not. I guess, it requires social agitation. Relax, this is not a call for any protest. It is more of a mental exercise or food for thought (at best) or rant (at worst).

Now coming back to the original problem. What do I look for when buying a stock these days? I am afraid that the answer is the same old ‘moat’! I know you will call me crazy. But I told you at the beginning – these two parts of my mind have not settled this fight yet. Let me know what you think about all this.

Sources and Further References

The Myth of Capitalism by Jonathan Tepper

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