ALL HAPPY COMPANIES ARE DIFFERENT

ALL HAPPY COMPANIES ARE DIFFERENT

THE BUSINESS VERSION of our contrarian question is: what valuable company is nobody building?

This question is more challenging than it looks because your company could create much value without becoming very valuable itself. Creating value is not enough—you also need to capture some of the value you create.

This means that even massive businesses can be bad businesses. For example, U.S. airline companies serve millions of passengers and create hundreds of billions of dollars of value each year. But in 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to Google, which creates less value but captures far more. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry’s profit margin that year. Google makes so much money that it’s now worth three times more than every U.S. airline combined.

MASSIVE BUSINESS

The airlines compete with each other, but Google stands alone. Economists use two simplified models to explain the difference: perfect competition and monopoly.

“Perfect competition” is considered both the ideal and the default state in Economics 101. So-called perfectly competitive markets achieve equilibrium when producer supply meets consumer demand. Every firm in a competitive market is undifferentiated and sells the same homogeneous products. Since no firm has any market power, they must all sell at whatever price the market determines. If there is money to be made, new firms will enter the market, increase supply, drive prices down, and thereby eliminate the profits that attracted them in the first place. If too many firms enter the market, they’ll suffer losses, some will fold, and prices will rise back to sustainable levels. Under perfect competition, in the long run, no company makes an economic profit.

The opposite of perfect competition is a monopoly. Whereas a competitive firm must sell at the market price, a trust owns its market to set its prices. Since it has no competition, it produces at the quantity and price combination that maximizes its profits.

To an economist, every monopoly looks the same, whether it deviously eliminates rivals, secures a license from the state, or innovates its way to the top. In this article, we’re not interested in illegal bullies or government favorites: by “monopoly,” we mean the kind ‘of the company that’s so good at what it does that no other firm can offer a close substitute. Google is an excellent example of a company that went from 0 to 1: it hadn’t competed in search since the early 2000s when it definitively distanced itself from Microsoft and Yahoo!

ECONOMIST

Americans mythologize competition and credit it with saving us from socialist bread lines. Capitalism and competition are opposites. Capitalism is premised on capital accumulation, but under perfect match, all profits get competed away. The lesson for entrepreneurs is clear: if you want to create and capture lasting value, don’t build an undifferentiated commodity business.

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