Deloitte points out several more very interesting explanations for the surge in share buybacks, and the accompanying stagnation of business investment. Let’s take a look at a few more fo them:
“Another theory [for the increase in share buybacks] is that increased industry concentration and reduced business dynamism have encouraged methods of boosting short-term shareholder value while reducing the incentive to invest for long-term growth. Therefore, practices such as buying back shares has gradually increased while the proportion of profit spent on business investment has declined…”
Industry concentration is just a phrase for the word, monopolization. Monopolization is when an industry goes from competitive, to dominated by one or two companies. Monopolies kill business dynamism. We can find a great definition of business dynamism at the Brookings Institute:
“Business dynamism is the process by which firms continually are born, fail, expand, and contract, as some jobs are created, others are destroyed, and others still are turned over. Research has firmly established that this dynamic process is vital to productivity and sustained economic growth.”
Business dynamism is a critical component of a dynamic, vibrant economy. The process of business creation, expansion, contraction, destruction, and construction, is part of a healthy market economy. The Sherman and Clayton Acts were Anti-Trust laws passed early in the history of the United States because of the real threat monopolies pose to business dynamism. Monopolies affect the ability for companies to be born, and expand. Monopolies price out, undercut, and manipulate industries so as to prevent competition from rooting. As a last resort, monopolies will buy out their competition, which means companies cannot expand to their full potential, even if they managed to make it past the early stages of business development. When monopolies successfully eliminate competition, and make entry barriers too high for start-ups, they become lazy. They have less incentive to invest in their businesses. Competition pushes businesses to keep investing and innovating; when competition is gone, companies get lazy, and do things like share buybacks. The following quote, also from Deloitte, is more evidence of reduced competition in several industries; more of an industries revenue, and more of its return on invested capital, is flowing to fewer companies:
“Data across several industries indicates that the share of revenue flowing to the top 50 companies in each industry has increased over time (1997 to 2012). Furthermore, returns on capital invested by public nonfinancial corporations in the United States has also become more concentrated. Returns flowing to the 90th percentile company was five times the median in 2014, up from just twice the median in 1990.”
The final quote below from Deloitte addresses the point we made earlier, which is that large companies that dominate an industry simply buy out their competition, if they couldn’t kill their competition:
“Increased merger and acquisition deal volume has also contributed to industry concentration and erosion of competition.10 Data also shows that the firm start-up rate has been declining since 1980, while the firm exit rate has remained flat, indicating reduced business dynamism.”
The last part of the above excerpt should be cause for alarm. It says that the rate of formation of start-up companies by entrepreneurs is declining, while the rate of firms exiting (either by acquisition, merger, or bankruptcy) is staying flat. This means business “birth” at the start-up level is not replenishing business “death”. This represents a very large threat to capitalism, in my opinion, as entrepreneurship is what keeps economies innovating. This piece by Brookings mentions that,
“…this decline has been documented across a broad range of sectors in the US economy, even in high-tech”.
This decline indicates that the US economy is suffering from a lack of “animals spirits”. The industry concentration [fewer companies doing more of the business], and the wealth disparity [a consequence of the former] are certainly significant reasons. Wealth is entrenched amongst an elite few, and that club sees little to no turnover. The burden of debt, at the federal, corporate, and personal level, has stifled risk taking. The Federal Reserve knows that the fiscal situation is dire, and the only response it has is low interest rates. As we said, industry concentration is just a phrase that describes monopolization. The government, with or without realizing, has encouraged monopolies, all in the name of stability. It is socialism, the opposite of “animal spirits”. The erosion of competition is a clear symptom of the US economy today. For all the benefits the FAANG companies (Facebook, Amazon, Apple, Netflix, and Google) have given us, they are each a modern day Standard Oil in their respective industries. For a great read on how these companies have impacted American culture, economics, and politics, check out Jonathan Taplin’s Move Fast and Break Things: How Facebook, Google, and Amazon Cornered Culture and Undermined Democracy. Recently in the news is Amazon. Amazon either sells, or brokers sales, in 49% of e-commerce transactions. One company does half the e-commerce in the United States. Amazon is not stopping there; they may be getting involved in consumer pharma, are involved in distribution of media and news (Washington Post acquisition), are involved in consumer staples (Whole Foods acquisition), and technologically, are the best in web services and cloud computing (AWS). Amazon is stifling competition, not just in terms of supplying goods and services, but also in terms of its monopoly on the best talent for high tech jobs. In this recent piece, CNBC points out Amazon’s work with the federal government, and specifically tier one agencies such as CIA, have yielded only more monopolization for Amazon in cloud business:
“AWS won a key CIA contract in 2013, and the agency’s chief information officer boasted last year that the adoption has had a “material impact.” Following that deal, several private-sector companies, like GoDaddy and Shutterfly, have opted to move their computing infrastructure to AWS.”
The fact is that government has been, and still is, complicit in the monopolization of American business. The precedence set by New Deal cartelization haunts us to this day. Facebook and Google control nearly 60% of the digital advertising market. Google’s market share in online search is 90%. Unfortunately, the Federal Reserve and the US government preach constantly on the importance of small business and entrepreneurship to the US economy, but in practice, throw all their weight behind big business. At 90% or 60% sector market share, big business effectively closes the door on entrepreneurship in their industries. As Justice Douglas once put it, “We have here the problem of bigness.”
There is a question that gets asked from time to time, and that is if capital expenditure requirements just aren’t what they used to be. To start a business today, just doesn’t cost what it used to cost. This was certainly true at one point in software, before it got commoditized. I’m writing this article in Google Docs, which is free. The Deloitte piece points to the possibility that not having to spend on capital expenditure means more cash left over for buy-backs, pointing to technology companies as evidence, since they do the most buybacks out of all the sector categories. From Deloitte,
“Another reason [for share buybacks] is lower capital expenditure requirements, because of the rise of high-value technology companies that require lower spending on equipment and structure as well as due to reduced capital expenditure requirements in traditionally capital-intensive sectors such as the energy sector. This hypothesis is supported, in part, by the fact that business investment in intellectual property products (software, R&D, entertainment) has grown quicker on average since 2000, than investment in equipment or structures…Reduced capital intensity in key industries helps explain why a lower share of overall profits is being spent on physical investment, therefore allowing firms to use profits, cash reserves, or cheap debt to boost stock values while also returning profits to shareholders. Large share buybacks have been a constant feature in the technology sector since 2000. In oil and gas, buybacks have varied along with the price of crude oil, spiking between 2006 and 2008 and again between 2011 and 2014 before declining in 2015.”
There’s a possibility that technologically, the world is reaching peak hardware performance. The theory that the number of transistors in a dense integrated circuit doubles about every two years is called Moore’s Law. A detailed explanation of it can be found here. Performance, specifically CPU performance, is directly related to how many transistors fit on a chip, or IC (integrated circuit). The following plot, from the Moore’s Law wikipedia page, shows that recent chip architecture releases are bunching up around what appears to be an upper limit on transistor count. They appear to be not doubling bi-annually any longer
This has led leading scientists at DARPA (Defense Advanced Research Project Agency) to make public statements that they expect Moore’s law to be dead by the year 2022. DARPA and the other research organizations are making plans to advance computing speed and performance by other means than shrinking the size of a transistor. The costs associated with building factories and making capital investments in equipment to produce these IC chips are becoming prohibitory. Not to mention the cost of employing the researchers, engineers, scientists, and physicists that design them; those labor costs are very high. Government organizations like DARPA have long subsidized research that was far too expensive for the private sector to undertake. In a 1997 New York Times article, Dr. Albert Yu of Intel gave an optimistic outlook on innovation, but with one caveat: the market must keep up.
”Innovation is accelerating,” said Dr. Albert Yu, head of microprocessor products at Intel. ”I’m very optimistic. I don’t think things are going to slow down as long as the market keeps going.”
The market is not keeping up. One reason is because productivity has not kept up with the advancement of technology. Technology has actually outpaced productivity; we are not using the full capability of current hardware technology, and therefore, the cost of hardware has plummeted, making further advancement cost ineffective for companies like Intel. Intel invested heavily in constantly upping the speed game in it’s CPU’s. For quite sometime, in the 90’s and 00’s, it paid off. It dominated the competition, in every way, in the CPU space. But as the following excerpt from May 2013 issue of The Atlantic states, many predicted Intel’s underperformance going into the explosion of the cloud, smartphone and tablets, and distributed computing world. Paul Otellini was the CEO who resisted taking Intel in that direction. Under him, Intel stayed committed to the shrinking PC and laptop chip business. From The Atlantic:
“They’ll say Otellini did not get Intel’s chips into smartphones and tablets, leaving the company locked out of computing’s fastest growing market. They’ll say Intel’s risky, capital-intensive, vertically integrated business model doesn’t belong in the new semiconductor industry, and that the loose coalition built around ARM’s phone-friendly chip architecture have bypassed the once-invincible Intel along with its old WinTel friends, Microsoft, Dell, and HP.”
Intel nearly put AMD out of business in the 2000s; today, AMD is a surging company in the GPU industry, while Intel is a laggard in every chip sector, outside of PC’s and laptops. Intel took the risky, capital intensive route, of investing in faster and smaller, and it did not pay off. Today, it is stuck selling older chip architectures at discount, to legacy PC makers like Dell and HP. Today, businesses that provide software as a service, like Amazon Web Services, Google, Workday, OpenText, Apple, and Microsoft, are consolidating data centers. This means that where normally, companies would have to invest in hardware to run their businesses, they are now outsourcing it to the cloud and simply paying a fee, a fee much cheaper than building out and maintaining their own data centers. This is leading to deflation and commoditization of physical machinery and equipment. This, in turn, leads to less and less capital investment by businesses, and leads to the cloud companies (AWS, Microsoft, Google, etc…), with their wealth of intellectual capital (very smart people) finding better and better ways to do more with less (software that can run faster even on legacy hardware). Because for them, the more money they can do with less, the better their productivity, and the more money they make. This delays the upgrade cycle, further depressing capital expenditure, making life even tougher for companies that produce the hardware.