In business, ‘big’ doesn’t always mean ‘bad’

Monopolies, companies utterly dominate the sale of a good or service, have a bad name in the United States, and the country rightly maintains laws against the anti-competitive things that many do. On the other hand, their perfectly legal cousins, monopsonies — entities that likewise dominate the purchase of good or service — are one of the modern era’s greatest boons to consumer welfare.  As many questions arise about the size and scope of companies involved in businesses ranging from retail to social media, it’s important to realize that while some types of “bigness” can be bad for consumers, others are very good.

Monopolies, of course, can do a lot of harm. The late 19th and early 20th century trusts that dominated everything from oil to sugar were nearly all corrupt, cronyistic institutions that relied on underhanded tactics to maintain market position. Even less rapacious monopolies like the old New Jersey-based AT&T — which once owned nearly every telephone in the country — proved themselves to be staid and inefficient. Although some later-day critics find “monopolies” in markets that appear highly competitive by commonsense measures, there’s a near universal consensus amongst economists that monopolies on sales gained through unfair means are almost always bad for consumers.

{mosads}Allowing a single company to dominate the purchase of a product, on the other hand, often makes thing better for consumers. The reasoning is simple: no individual consumer and only a small handful of businesses will ever buy more than a very small percentage of anyone’s goods. Although other companies can generally enter and underprice companies that are charging “too much,” this doesn’t typically help consumers much in the short run. If they want a product, they have to take the prices offered.

But big purchasers of goods have both the incentive and the power to negotiate on behalf of consumers. And it works. Harvard University economist Jason Furman, a senior economic advisor to president Obama, estimates that Walmart’s enormous bargaining power with the sellers of everything from food to clothing produces over $2,500 in yearly current-dollar benefits to American households. In many cases, this monopsony pricing power has literally created new markets: $5 DVDs are largely the creation of Walmart.

And similar stories exist in nearly every other line of business. Massive insurance brokers like Marsh and Willis make it possible for businesses to negotiate favorable rates with insurance companies while health insurers (for all their faults) manage to get far better prices from doctors and hospitals than consumers ever could on their own. And sometimes monopsony power is a whole a business model. Warehouse club chains make large purchases of a reasonably small number of items and then sell them, more-or-less, at cost. Their profits come largely from credit card and membership fees.

Monopsony isn’t always good everywhere. In markets for labor, the economist Joan Robinson famously showed that monopsony power possessed by employers can do a good deal of harm by driving wages below their optimal level. This sort of “imperfect competition,” as Robinson termed it, provides the widely accepted economic case for institutions like minimum wage laws and the legal protections for unionization. Likewise, products for which literally only one buyer exists — certain weapons systems for the military and highly customized computer software developed for businesses — can often end up being almost impossible to price in a way that’s fair to the buyer and produces profits for the seller.

Nonetheless, companies that can reach a scale sufficient to exert monopsony power are among the strongest allies available to American consumers. While some companies may have ideological commitments to low prices and consumer welfare, furthermore, their motivations don’t need to be public spirited in any way. Exerting monopsony power on behalf of consumers provides a competitive advantage that very often leads to greater market share and higher profits. And, in certain cases, for many consumers, this type of big businesses can be very, very good.

Eli Lehrer (@EliLehrerDC) is the president of the R Street Institute, a nonprofit group dedicated to promoting limited government.