When clearing out a drawer, we found an old FT cutting of the FTSE 100 as it was set up on 3rd January 1984.
It is surprising how few of the companies are still quoted today in a comparable form. We estimate that over the past 30 years, more that 50% were acquired by larger competitors.
The drinks sector comprised companies such as Allied Lyons, Bass, Distillers, Scottish & Newcastle and Whitbread, all of which experienced radical restructuring with most of their brewing and spirits businesses bought by larger overseas businesses.
Whereas the insurance sector included General Accident, Guardian Royal Exchange, Royal Insurance, Sun Alliance and Sun Life; all of which experienced corporate activity and mainly consolidated within the UK.
There is a sizeable body of research which shows that there has been a significant increase in industry concentrations as measured by the Concentration Ratio or Herfindahl Index. However, many pieces of academic research are now quite dated and tend to use national figures, which are increasingly less relevant in today’s global economy.
There are many reasons to explain the increase in concentration. Whether it has been driven by the formation of the EU, cross-border trade agreements or by the relaxation of import controls, economic theory teaches that when barriers to trade reduce, market forces drive economic activity. Corporate activity has not been far behind.
As barriers to trade decline with the consequent relaxation of protectionism, it is more likely that businesses with competitive advantages will prosper. From analysing businesses for over 30 years, we observe that in most industries, but especially in the more mature economies, industry concentration has been steadily increasing.
There are many obvious drivers underlying this trend such as the formation of global suppliers to meet global customers, economies of scale in manufacturing, rising barriers to entry from technology, and know-how or access to finance. In addition, the growth in the internet has resulted in individuals in many countries recognising and often aspiring to the same brands and products.
One of the attractions in researching investments for a global fund is aiming to identify the likely winners which are able to re-invest returns in capital expenditure, bolt-on acquisitions (and rising dividends) which will increase the long-term earnings of the business. We have been pleasantly surprised to find that many of the leaders in the mature economies have also an established presence in emerging markets for over 30 years and frequently occupy leadership positions in their sector.
We observe that many sectors in Emerging Markets are much less concentrated than in the more mature Western economies.
However, either as a result of the presence of the well-financed multinational which is able to acquire smaller competitors or through the ‘natural’ process of competitive advantage, we would expect many of these industries to increase in concentration over the next decade.
There is a large body of economic theory which relates the concentration of an industry to its profitability, with the implication that the more concentrated (monopolistic) the higher the profitability. In contrast industries with low concentrations are more likely to be more competitive and generate lower returns. The relationship between concentration and profitability is unlikely to
be a linear.
We suspect that while this is a logical theory, it is still too early to tell as many businesses are still in the investment and acquisition mode and concentration may not yet be sufficient to improve significantly the profitability of the champions.
Technology changes can be very disruptive to the status quo. Many industries in the more mature economies are already quite concentrated and the largest businesses have already built up strong positions in Emerging Markets. Some of the winners from trends in globalisation are likely to be businesses which are domiciled in Emerging markets.
These businesses will be able to exert cost advantages or apply a new business model or approach which engages with customer needs or aspirations. We believe that significant concentration in Emerging Markets is inevitable and it will be fascinating and rewarding to identify the global winners.