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naraburns  nihil supernum  1yr ago (text post)   4031 thread views

Friday Fun Thread for February 10, 2023

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Can someone who has a good understanding of economics or businesses or something explain/clarify the theory that businesses can maintain monopolies by buying out smaller competitors whenever they pop up? Because I keep hearing this as an explanation why, for instance, insulin costs so much, or some other thing, but it feels to me like it should be game-theoretically unstable. Any industry where large companies reliably buy smaller competitors should incentivize lots of startups seeking to exploit this and investors eager to earn a small but reliable sum of money.

Maybe my understanding economics is too mathematically naive, so let me put forth the argument:

Let A is the point where you create a brand new company costing $X in startup costs, B is the point where you're big enough that a monopoly will offer to buy you out for $Y, and C is the point where you become a large competitor splitting the near-monopolistic profits for $Z. Let p be the probability of getting from A to B, and q be the probability of getting from B to C conditional on not accepting a buyout offer.

Case 1: suppose X > pqZ. That is, the average payoff from forming a company and growing it to size is lower than the cost of trying, so nobody will try in the first place. This should be the case in an oversaturated (or perfectly saturated) market, not one which has a near monopoly charging exorbitant prices way higher than their production costs like for insulin. And if this were the case, then this would be the appropriate explanation for why the product costs too much, not blaming the larger company for buying out smaller competitors (which they wouldn't need to do in the first place, since nobody would try to compete with them in the first place)

Case 2: suppose X < pqZ < pY. X < pqZ means that if a monopolistic offer does not exist a new company would be profitable, so people make startups. But pqZ < pY means that, once p has been rolled sucessfully and you have a small company, the offer (Y) is greater than the expected value of continuing the company to completion (qZ), so the startup sells. But this is a profit. pY > X means that new startups will on average earn a profit from selling out, and in fact will do so with less variance than having to roll both p and q, and in a shorter turnaround time. Investors should be repeatedly funding startup after startup to arbitrage this (unless the buyout offer has some sort of non-complete clause that extends to the investors or something). Which should continue until negative feedback loops force the large companies to lower Y, sending us to case 3.

Case 3: suppose X < pY < pqZ. Then new companies will start up hoping to become large, and when they receive an offer, they will decline it because the expected value of continuing, qZ, is larger than the offer Y. And then you have competition and the monopoly weakens, lowering the cost of the produced good. Continue until a fair market equilibrium is reached.

QED.

And yet we see near-monopolies and exhorbitant prices in real life, and we don't see literal thousands of eager startups constantly getting bought in the same industry with little effort, so clearly reality has disproven my counterargument and at least one of my premises must be flawed. What am I missing? Is the explanation of buyouts being to blame just wrong and near-monopolies are always caused by patents or unfair regulations or something else? Is there a shortage of competent entrepreneurs such that most potential company founders would hit case 1, and the few who hit case 2 can be bought out and non-competed away without bankrupting the large company? Does this transition from Case 2 to 3 actually happen all the time but slowly and near-monopolies are simply temporary blips during the time it takes for this to play out? I'd love to hear if someone actually understands this.

Monopolies or oligopolies exist where moats prevent new competitors. It’s easy to find capital, labor, and regulatory approval for a new restaurant, so we see tons of competition and low margins. Hollywood sees big margins because blockbusters require huge capital outlays other film markets can’t compete with. A hospital might have huge margins because competitors are barred by law from entering the marketplace. High-end microchip manufacturing is so difficult that nearly all skilled engineers in the field are concentrated in a few firms, so no one else can make products of a similar quality no matter the capital outlay.

Drug manufacturing is a combo of all three. You need a ton of capital, regulatory approval from the FDA, and some skilled industrial chemists. It’s somehow legal to ‘pay for delay’, where company A pays company B to not make their drug, but this only works when B is the only competitor with sufficient industrial capacity to compete. Ibuprophen is old, easy to make, with huge demand; weak moat, so the price is great. But long-acting insulin analogues like glargine or degludec are new, complex biologics targeting the small DMI market; it’s too expensive to compete so great margins, high price. The problem is similar to adverse selection; a small number will buy at any price, so either sick people get extorted, it’s subsidized by the public pocketbook, or new drugs are underprovisioned. Pick your poison.

A hospital might have huge margins because competitors are barred by law from entering the marketplace.

It's even called a CON.

This seems like a topic for the culture-war thread, but the standard libertarian claim* is that big companies lobby the government to increase startup costs (your variable X), causing your case 1 to be more common than it would be in a truly free market.

*For example:

The recent era of antitrust reassessment has resulted in general agreement among economists that the most successful instances of cartelization and monopoly pricing have involved companies that enjoy the protection of government regulation of prices and government control of entry by new competitors. Occupational licensing and trucking regulation, for example, have allowed competitors to alter terms of competition and legally prevent entry into the market. Unfortunately, monopolies created by the federal government are almost always exempt from antitrust laws, and those created by state governments frequently are exempt as well. Municipal monopolies (e.g., taxicabs, utilities) may be subject to antitrust action but often are protected by statute.

I recall reading somewhere that regardless of size, every drug (or just insulin?) company has to contribute the same flat amount of cash to the FDA, which gives a huge competitive disadvantage to new/small companies.

The FDA charges fees for processing applications for drugs and medical devices. That is per application, not per company. Given the high cost of development they don't seem to be particularly high. And note that for some applications, smaller companies are indeed charged less.

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