Reduced competition can increase risk

One of the most powerful forces driving business people is the often unacknowledged desire to build a monopoly. This is not because they like to flout the competition rules or gouge the market. It is simply because they want their firm to be the biggest and the best, and that means eliminating the competition. It is part of the DNA of a go-getting executive. It is what makes them successful, but it is also sometimes gets them into trouble.

Look at the pharmaceuticals industry. It is built on the monopoly concept: you invent a compound, patent it and then have the exclusive rights for a long time. The industry has always claimed that this is necessary for them to recoup the cost of research, and that is true. It is also true that its livelihood depends on patenting one blockbuster after another and then milking them for all they are worth. Only recently have we woken up to the fact that this doesn’t necessary produce the medicines that patients actually need and that in some cases their marketing methods have been corrupt. The sector’s business model has been challenged as a result.

Tesco’s business model, and an important source of its success, was based on being large enough to wield pricing power in an industry where, until recently, there was not a lot of competition. BA depends heavily on its lucrative transatlantic business, which was the source of a competition enquiry some years ago. Wherever competition is weak, products are complex, or pricing is obscure there is a risk of trouble. The UK utility sector may feel maligned but its approach to the pricing of household energy bills has left it with few political friends.

We should not blame business people for harbouring these thoughts. Nor do the examples above mean to suggest that individuals involved have done anything wrong in a legal sense. The reality is that the more successful firms are in their natural task of eliminating competition, the more they are risk of behaving in ways that will damage themselves, their franchise, their customers and their shareholders. The reason is quite simple – as the competition abates, there is less to stop executives helping themselves. Taking the opportunity for high reward becomes too easy to resist.

The banks are a clear example. The essential point about the Libor scandal is that you cannot rig a market interest rate without collusion, which means that competition is broken. One of the factors behind the banking crisis was that, although there are a lot of banks, competition between them was not working properly. Otherwise they would not have been in a position systematically to extract value from their customers rather than delivering value to them.

Regulators have responded by clamping down on investment banking, making it more difficult operationally and more expensive in terms of capital. That has led to a contraction, which means there is even less choice than before for those wishing to access corporate finance. Despite all our efforts at strengthening regulation, the problems in banking are thus likely to continue. It is time to pause and think what we really need.

This is not a market which is regulated in such a way as to stymie all legitimate entrepreneurialism, but one in which competition flourishes in such a way as to encourage companies to compete on the basis of the value they deliver to their customers. That would be nice, wouldn’t it? Don’t hold your breath.

Peter Montagnon is giving the keynote address on ethics in governance at ICSA's Guernsey Conference on 29th April, 2015.

Peter Montagnon is Associate Director at the Institute of Business Ethics. Prior to that he was Senior Investment Adviser at the Financial Reporting Council

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