All Commentary
Tuesday, June 1, 1999

Market-Share Sophisms

Market Dominance Is a Sign of Hard-Won Success and Ingenuity

Christopher Mayer is a loan officer at a bank in Maryland and an MBA student at the University of Maryland.

There are few more widely held fallacies than equating market share to power over consumers and competitors. That great companies maintain dominant positions in their markets is a red flag for regulators and anti-capitalist moralists, rather than a sign of hard-won success and ingenuity worthy of admiration and study. Weaker competitors use the market share of others as an excuse for their own failures when they turn to the government for assistance. Witness the pursuit of such great companies as Microsoft and Intel.

Market share is a reward for serving consumers better than competitors do. It does not confer special privileges or powers to a producer, which is subject to the same economic laws and will of the consumer as any other company. Market share can be easily lost by poor decisions and inefficiency.

These conditions hold true on a free market. But there are many influences in the real world that are not consistent with a free market. Minimum-wage laws, the plethora of entitlements, union privileges, government grants, state-managed money, regulations, and a host of interventions change the pattern of production in unknowable ways from what might have been in the absence of these things. We can only imagine where some of the capital deployed in the steel industry would have gone had the U.S. government not protected it from foreign competition.

What’s the Market?

Another complication is how a given market is defined. Do manufacturers of corn flakes compete only against one another? Or do they also compete against makers of other ready-to-eat cereals? What about hot cereals? What about bacon and eggs? The answers to those questions make a big difference for the market shares of companies. Regulators base their claims on arbitrary assumptions. What counts is how consumers see things.

One final element that’s often neglected in the analysis of market-share data: time. Market positions are snapshots. They change. The market leaders of ten years ago are different from today’s. They’ll be different years from now. In a free market, the continued long-term dominance of a firm reflects its superior ability to satisfy consumers.

Size doesn’t determine a firm’s degree of control over prices and production. Large and small companies may produce in whatever quantity they wish and attempt to charge whatever price they wish. Ludwig von Mises got to the heart of the matter when he wrote that “What those who blame the economies of big-scale production for the spread of monopoly prices are trying to say is that the higher efficiency of big-scale production makes it difficult or even impossible for small-scale plants to compete effectively.”

That inefficient firms are kept from the market is no vice. In fact, this is one of the market’s virtues. But that doesn’t mean small companies have no chance. Large firms are not always best at providing value to customers. There may be diseconomies of scale that make it increasingly difficult to compete effectively beyond a certain size.

This is not to deny certain advantages that large dominant firms enjoy. Large firms with deep pockets have the financial wherewithal to respond to opportunities and weather storms better than smaller, less well-capitalized rivals. A bountiful corporate treasury provides a margin for error that smaller firms may not have. This is not a market failure, but the reward for past successes.

Calculation Problem

There is something that limits the size of firms in the free market: the need for economic calculation. The application of the calculation problem to private firms, an extension of Mises’s refutation of socialism, was an important insight of Murray Rothbard in Man, Economy and State. Ronald Coase’s analysis of the firm concluded that the free market would establish a size that tended to optimize transaction costs. (See Max More, “Small is Awesome,” in the February 1999 issue of The Freeman.) But the problem of economic calculation is more fundamental.

While the economist can say little about the optimal size of a specific firm, he can say the market will tend to establish the best possible arrangement thanks to the calculation that market prices make possible. Imagine a firm that grew so big that it swallowed up the external markets for its inputs. In the absence of market prices for those inputs, the firm could not engage in economic calculation and thus could not know if it was deploying its capital in the most efficient manner. As Rothbard wrote, “When any of these external markets [for inputs] disappears, because all are absorbed in the province of a single firm, calculability disappears, there is no way for the firm rationally to allocate factors to that specific area. The more these limits are encroached upon, the greater and greater will be the sphere of irrationality, and the more difficult it will be to avoid losses”(p. 585).

The upshot is we can let the free market take its course. Let us not worry about the alleged power of dominant firms and instead focus on creating an environment in which the free market is free to function.

  • Paul Milstein Professor of Real Estate at Columbia Business School, where he is also the Research Director of the Paul Milstein Center for Real Estate. In addition, he has also been a Visiting Scholar at the Federal Reserve Bank of New York, and Research Associate at the National Bureau of Economic Research.