Andrew Carnegie. J.P. Morgan. Cornelius Vanderbilt. John Rockefeller.
These titans of industry rank among the wealthiest and most influential men in American history, and the mere mention of their names conjures up images of power and grandeur. Not coincidentally, these business barons are also all tied to enterprises that were at one time considered to be monopolies.
Rockefeller, for example, founded Standard Oil in 1870, and quickly began building an empire. In one six-week stretch, he acquired 22 of his 26 closest rivals in the refinery-heavy Cleveland region -- absorbing their operations into his own highly efficient network. By the turn of the century, the company controlled a dominant 90% share of the market for refined petroleum products.
Thanks to this monopoly, Rockefeller would eventually stockpile a colossal fortune of $1.4 billion, equivalent to more than $300 billion in today's dollars.
Of course, the odds are decidedly against any of us amassing that type of wealth. However, there is certainly a lesson to be learned here, and investors who take note will have taken a big first step -- as they say, the first million is the hardest.
What is a Monopoly?
An economics textbook might describe a monopoly as a situation where one company exerts dominant control over a specific good or service -- meaning the firm is essentially the lone supplier and can dictate availability and pricing as it sees fit.
Today, the term is broadly used to refer to any case where a company has stifled the competition and somehow restricted fair trade. But interpretations for what constitutes a monopoly can differ greatly from person to person and from jurisdiction to jurisdiction.
Spotting a Monopoly in the Making
The list of firms that enjoy monopoly-like control over their market is thin. Over the years, the federal government has broken up a number of existing monopolies and blocked mergers that might have created new ones. And those that do exist, such as regional utility operators, are watched closely by regulatory agencies. However, that's not to say that all companies are either closely regulated or have to grapple with dozens upon dozens of rivals for market share. Others enjoy a tight hold over their market and aren't really threatened by new competitors -- either because a potential player is prevented from entering the game or simply has little reason to.
These "barriers to entry" can take many forms, and below I'll examine five of the most common that can help create monopoly-like conditions for specific firms.
Emerging Industries: It's easy to assume that almost everything worth having has already been invented, but innovative companies can and do develop new products and/or disruptive technologies all the time. In effect, these firms have created a brand new market, and until someone comes along with a better mousetrap, they have it all to themselves.
For example, Monsanto (NYSE: MON) virtually created the market for genetically engineered seeds and is now sowing the rewards. For some companies this type of edge can be fleeting, but others might gain a valuable first-mover advantage and never look back.
Strict Regulatory Oversight: Typically, the government goes to great lengths to avoid a monopoly environment, but in some rare cases it all but promotes one. For example, not just any company can set up shop as a credit ratings agency. The SEC has made it extremely tough for new companies to attain the "Nationally Recognized Statistical Ratings Organization" (NRSRO) designation that would allow them to compete.
As a result, barriers to entry in this low-capital, high-margin business are nearly insurmountable. In fact, throughout the last several decades, Moody's (NYSE: MCO) and McGraw-Hill's (NYSE: MHP) Standard & Poor's brand enjoy a government-sanctioned duopoly, controlling most of the global market. And while government legislation could bring about some changes, it could take a long time for any newcomers to crack into this close-knit market.
Massive Capital Requirements: It doesn't take a whole lot of start-up money to open a neighborhood pizzeria. By contrast, it requires hundreds of millions to buy a single ocean liner, let alone an entire fleet that would be needed to run a cruise line and ferry passengers around the globe.
As you might imagine, that immense up-front cost is a powerful barrier to entry. Because few firms are willing or able to shell out that type of cash and battle the entrenched leaders head-to-head, industry-leader Carnival Cruise Lines (NYSE: CCL) faces very few large-scale rival.
Technical Expertise/Patents: Many people are capable of running a successful retail chain, but developing a treatment for B-cell non-Hodgkin's Lymphoma, that's a whole other ballgame.
Pharmaceutical and biotech firms that have patent-protected drugs can often rake in billions in sales with little or no competition, at least until a close substitute or generic alternative is introduced. But on a larger scale, think of what it takes to enter this industry in the first place -- a multi-billion dollar research & development (R&D) budget and an army of Ph.D.-carrying scientists.
Talented software engineers, biochemists, molecular physicists and other highly trained specialists don't exactly grow on trees, so industries that require their services are often controlled by a small group of companies.
Brute Force: Anti-trust statutes warn against coercive or manipulative business practices, but they don't say anything about simply steamrolling the competition and exploiting economies of scale and supply chain efficiencies to undercut rivals and muscle out smaller companies in their path.
Adroit serial acquirers that expand their own reach by swallowing competitors and assimilating their assets can also occasionally climb to the top. These companies are essentially buying market share, as opposed to fighting for it. However, avoid firms that have little organic growth of their own, particularly if they are expanding too far away from core competencies and overly diluting their shares by habitually using stock as currency to buy other companies.
Your Turn to Spin
Pure monopolies are rare, but investors can always seek out the next best thing: powerful market share leaders in highly concentrated industries with daunting barriers to entry. Such firms might not fit the classical textbook definition of a monopoly, but their size, brand names and dominance alone are more than enough to scare away most would-be rivals.
- Create a retirement savings goal
- Design an investment plan to reach it.
- Get a professional money manager to continually monitor and rebalance your portfolio
Sound complicated? Don't stress. Vanguard's new robo advisor service can help you put all of this (and more!) on autopilot, all for an annual gross advisory fee of just 0.20%.