And those investments paid off. Since the 1980s, four leading firms in each industry have increased their market share by 4-5% in most sectors. My research shows that investment in proprietary software has caused much of this increase.
This greater dominance of leading companies in the industry is accompanied by a corresponding reduction in the risk that they will be thwarted, a prospect that has fascinated corporate managers since the time of Clayton Christensen. The dilemma of the innovator released in 1997. At the time Christensen was writing his book, the breakdown was on the rise. But around 2000, when leading firms began investing in patented systems, this trend has declined sharply. In this industry, the probability that a firm with a high rating (measured by sales) will fall out of one of the top four places in four years has decreased from more than 20% to about 10%. Here, too, the investments of dominant firms in their internal systems are largely driven by change. While some new technologies are destroying entire industries – think of what the Internet has done with newspapers or DVDs – others are now suppressing the destruction of dominant firms.
How does this happen, and why does it seem to affect the economy so much? This is because these business systems eliminate the major shortcoming of modern capitalism. Beginning in the late 19th century, innovative firms found that they could often achieve significant cost savings by producing on a large scale. The shift has sharply reduced consumer prices, but there has been a trade-off: for companies to achieve such large volumes, products and services need to be standardized. Henry Ford has stated perfectly that car buyers can have “any color as long as it’s black”. Retail chains have achieved their efficiency by providing a limited set of products to their thousands of stores. Financial companies offered standard mortgages and loans. As a result, the products had limited feature sets; stores had limited choices and responded slowly to changing demand; and many consumers could not get credit or got it only on terms that were expensive and not suitable for their needs.
The software changes the equation, partially overcoming these limitations. This is because it reduces the cost of managing complexity. With the right data and the right organization, software allows businesses to tailor products and services to individual needs by offering more variety or more product features. And it allows them to win over competitors, to dominate their markets. Walmart stores offer much more choice than Sears or Kmart stores, and they are quicker to respond to changing customer needs. Sears has long been the king of retail; now Walmart and Sears bankrupt. Toyota is rapidly producing new models when it detects new consumer trends; smaller car companies cannot afford the billions of dollars needed to do so. Similarly, only Boeing and Airbus can build very sophisticated new giant aircraft. Four leading credit card companies have the data and systems to effectively target offers to individual consumers, maximizing profits and market share; they dominate the market.
These software platforms have allowed leading firms to consolidate their dominance. They have also slowed the growth of competitors, including innovative startups.
Numerous pieces of evidence support the idea that the growth of startups has slowed significantly. One sign is how long it takes for venture startups to receive funding: from 2006 to 2020, the average age of a startup at the start-up stage increased from 0.9 years to 2.5 years. The average age of a startup at a later stage increased from 6.8 years to 8.1 years over the same period. Among acquired firms, the average time from first financing to acquisition has tripled, from just over two years in 2000 to 6.1 years in 2021. A similar story was for firms that went public. But the most obvious evidence of a slowdown is what happens when firms become more productive.
Large firms use large-scale technologies that complicate the growth of startups.
A key feature of a dynamic economy, which economist Josef Schumpeter called “creative destruction,” is that more productive firms — those with better products, lower costs, or better business models — grow faster than less productive ones, ultimately displacing them. But after 2000, on average, firms with this level of productivity grew only twice as fast as firms with the same level of productivity grew in the 1980s and 1990s. In other words, performance has less of an impact on growth than before. And if productive firms grow more slowly, they are less likely to “overtake” industry leaders and displace them – a hallmark of failure. Last year, a study I conducted with my colleague Erich Denk directly linked reduced performance impacts to greater dominance of large companies in the industry and their investments in software and other intangibles.
Another view expressed by Congressional investigators at hearings and in a staff report published in 2020 links the decline in economic dynamism to another source: the weakening of government antitrust policies since the 1980s. In this regard, large firms were allowed to acquire their competitors, reducing competition. Acquisitions have made these firms more dominant, especially in large technologies, leading to a decline in both the emergence of new technology firms and venture funding for early-stage companies. But in fact, the rate at which new technology firms are entering the market has declined slightly due to an exceptional surge in the dot-com boom, and early-stage venture funding is at a record high: twice as much today as in 2006. and four times the amount invested. The problem is not that large firms are preventing startups from entering markets or obtaining funding; the problem is that large firms use large-scale technologies that complicate the growth of startups. What’s more, large firms such as Walmart and Amazon have grown largely by adopting the best business models rather than buying competitors. Indeed, since 2000, the rate of acquisition of dominant firms has declined.
Of course, such acquisitions sometimes affect the landscape of startups. Some researchers have singled out so-called “killing zones” where Big Tech makes acquisitions to stop competition, and venture capital becomes hard to find. But other researchers find that startups often respond by transferring their innovation to another application. Moreover, the prospect of acquiring a large firm often encourages people to create startups. Indeed, despite what happened to Nuance, the number of startups entering the market has quadrupled since 2005, and 55% of those startups have received venture capital.
Slowing down the growth of innovative startups is a challenge not only for several thousand firms in the technology sector; Encounters the wind that blows against companies like Nuance are responsible for issues that affect the health of the entire economy. Researchers from the U.S. Census Bureau have shown that the slower growth in aggregate productivity is driven by slower growth in productive firms, a figure that measures the amount of output the economy produces per capita and serves as an approximate index of economic well-being. being. My own work has also shown that it plays a role in increasing economic inequality, greater social division and reducing government efficiency.
What will it take to reverse the trend? Tightening antitrust control may help, but changes in economic dynamism are driven by new technologies rather than mergers and acquisitions. The more basic problem is that the most important new technologies are property available only to a small number of huge corporations. In the past, new technologies became widespread either through licensing or when firms developed their own alternatives; this has increased competition and innovation. The government sometimes assisted in this process. Bell Labs developed the transistor, but antitrust authorities were forced to license the technology extensively, creating a semiconductor industry. Similarly, IBM created the modern software industry when, in response to antitrust pressure, it began selling software separately from computer hardware.
Today we are witnessing some similar developments even without government action. For example, Amazon has opened its own IT infrastructure to create a cloud industry, which has greatly improved the prospects of many small startups. But antitrust policies can be used to encourage or force larger firms to open their own platforms. Easing the restrictions that non-compete agreements and intellectual property rights impose on employee mobility can also encourage greater proliferation of technology.
It will be difficult to come up with the right balance of policy, and it will take time – we do not want to undermine the incentives to innovate. But the starting point is the recognition that in today’s economy, technology has taken on a new role. Once it was a force that caused disruption and competition, now it is used to suppress them.
James Bessen is a professor of law at Boston University and author of the forthcoming book “New Goliaths: How Corporations Use Software to Dominate Areas, Destroy Innovation and Undermine Regulation,” with which this essay is adapted.