The next great driver of growth is shaping up to be centred on the technology industry. We see this in political rhetoric across the developed world, from Malcolm Turnbull’s ‘Ideas Boom’, to Barack Obama’s long-term focus on S.T.E.M. education, to that vague recurring notion of a Fourth Industrial Revolution of the Internet of Things. It’s not just words either. Concrete policy like ‘La French Tech’, a targeted funding initiative for tech start-ups in, you guessed it, France, helped French tech firms dominate the most recent Consumer Electronics Show in Las Vegas.
Even the private sector is getting in on the act. Canary Wharf Group, landlord to London’s banks, created Level 39 – a start-up incubator they call a ‘financial technologies accelerator space’ – in an effort to create the tenants of tomorrow. But a look at the giants of Silicon Valley shows why this may not be the broad based growth that politicians hope for.
The growth driver that created the last generation of corporate giants – the General Electrics and Fords of the world – was both labour and capital intensive. The creation of consumer durable goods, such as washing machines and cars, required a large amount of machinery and created strong demand for semi-skilled and secure factory jobs. In contrast, large technology companies are ‘asset light’ without the need for large networks of factories. They have relatively small, highly skilled workforces, and thus increase demand in a small section of the labour market. The result is upward wage pressure for those with the necessary skills, while the broader labour market is largely unaffected. Even today, General Electric maintains a workforce over 30 times the size of Facebook and controls over 16 times the assets. Yet the company’s market capitalisation is only around 10% higher than Facebook. As of March 31 2015, it employed over 300,000 people. Facebook employs 9,199.
Competitive pressures also function better in durable goods markets compared with those for technology products. When consumers are making a purchasing decision about a washing machine, for instance, they are concerned primarily with price and quality. Whilst some product differentiation due to brand value may exist, it is relatively easy for a new firm to enter the market by making a similar product more cheaply, or by charging less of a mark-up. This encourages consumers to purchase their products instead. Accordingly, substantial profits are competed away. Competitive markets work most effectively when products have little differentiation.
The value of many technology products, however, is in the ecosystems and networks they provide. A new smartphone operating system cannot just compete on price or quality, but needs a critical mass of support from developers before it can be taken seriously in the market. As a result, Apple and Google benefit from monopolistic competition between iOS and Android, which is monetised through Google Play Services. Even Microsoft, an established firm with deep pockets, invaluable expertise, brand loyalty and awareness from their Windows PC operating system, has so far failed to make an impact in the smartphone market. Unfortunately, Windows Phone accounted for only 2.6% of global market share in 2015.
Similarly, the success of network dependent products such as Facebook or LinkedIn gain value as they scale, giving them monopolistic power due to the increased difficulty for others to enter the market. This market power allows these tech-based firms to make outsized profits that cannot be easily competed away. It creates an all or nothing dynamic where a new entrant, instead of carving out some relatively stable market share from their competitor, will either gain enough traction to take over the market completely, or fester in obscurity. When Facebook created a product much more compelling than the incumbent Myspace, it was able to dominate. Myspace was forced to effectively exit the market completely, trying to establish a niche as a music platform. Market entry becomes harder and harder as the incumbent player becomes more established. When Myspace was the incumbent, the market was immature. But with Facebook now a well-established incumbent in a more mature market, even Google, with its Google Plus offering, struggles to make an impact on the social media platform.
Evidently, successful tech companies naturally dominate the industries that they’re in. That success, rather than encouraging new and genuine competition, feeds on itself. It is thus important to be realistic about the potential of continued innovation in technology. It will continue to make our daily lives easier and pull more and more of science fiction into reality. It will create new companies and products, and invent and reinvent industries. The nature of the markets in which they compete, however, suggests that the benefits of the economic growth this provides will be directed at only a small subsection of society. Despite the hype surrounding the technology industry, it should not be expected to employ the next generation of the middle class.
This doesn’t have to mean that new wealth cannot spread throughout the community, but the current industry trend of insular corporate campuses doesn’t help either. So what is this trend and why does it suppress the market? Stay tuned to find out.
Image source: flickr.com