03 July 2007

Competition and Homologization

"Homologization" is a term I have coined to refer to a fairly common trend in technological change. The term is derived from "homology," a term in logic in which a person argues that two things are not merely analogous—i.e., sharing similar patterns—but share a common identity or root. So, for example, someone might draw an analogy between the Internet and the system of roads; but everyone understands the two things are so dissimilar that the analogy only illustrates a peculiar pattern common to both. On the other hand, the same person might go much further in comparing the Industrial Revolution and the Internet Revolution, arguing that the two were essentially the same phenomenon occurring twice (that someone would not be me).

The homologization of two or more businesses consists of them becoming essentially the same business, albeit through somewhat different media.

Finance, Insurance, & Real Estate (FIRE)
The most famous example is the Usonian financial services sector, which had been split into several separate businesses after the financial crash of 1929. Even before the Crash, the banking sector had been partitioned geographically, which of course divided capital markets from local savings banks. Between 1933 and 1999, commercial banking, stock brokerage, investment banking, insurance, and real estate were barred from mixing into each other. A commercial bank like Citibank was barred from selling insurance or underwriting issues of new equities, nor could it offer brokerage services to customers. In the years between 1996 and 2003 there was a frenzy of M&A activity as the entire financial sector effectively merged into a few financial supermarkets.

Homologization of the US FIRE sector posed an interesting paradox: each company within that sector was now free to enter other businesses heretofore closed off to it. Commercial banks could now sell insurance; investment bankers could offer underwriting services to a wholly different clientèle. Looking at this from another angle, this reflected increased competition: in theory, each bank was now facing competition from all insurance companies, all brokerages, and vice versa. This posed a rather interesting paradox: virtually all firms in the FIRE sector were in favor of changing the regulations to allow homologization. It was the brass ring of pro-business legislation. All of the financial press praised the repeal of the Glass-Steagall Act as if it were the sine qua non of happiness. Yet the same businesses and the same business press argued, at the exact same time, that the new competition created by homologization imposed extraordinary new burdens on that same victorious FIRE sector. That meant that still more regulatory tweaking was required.

Financial services in the USA and other industrial nations tend to share certain state-like powers and benefits that make them utterly different from non-bank firms. For one thing, commercial banks have the power to create money. Investment banks have the unique power to underwrite capital issues under limited liability laws. Brokerages have exclusive access to capital markets, which are—in turn—made possible by limited liability laws. Financial services, perhaps most importantly of all, are governed by accounting laws that are the rest of us; they are allowed to bear far greater leverage against capitalization than non-financial firms. The last feature, common to the whole sector, reflects its role as a premier state surrogate: it can borrow so much money because it guarantees the greater part of the nation's sovereign debt.

I point this out because I want to make the point that the financial sector already is a part of the national polity; with the events of 1999, it was absolved from two layers of social responsibility. It was liberated from prudential restrictions on what businesses it could undertake, and it was absolved of [most] community banking regulations.

The increased-competition side of financial homologization has been, in my view, an obvious bust. The banks tended to merge with each other, and bought insurance companies, brokers, and investment banks. They did not "invade" each others' business with enhanced services. Mostly, they did increase convenience through internet automation or ATM's. However, savings/commercial banks withdrew from the auto loan markets in favor of home equity loans. In other words, the actual bundle of services offered to customers was shuffled about between banks and 3rd parties (like auto dealers). A branch bank does offer services unavailable in the early 1990's; mostly they are not services a consumer ought to use. It has abandoned useful services as well, creating new monopolies.

Telephony, PCS, ISP, Cable, & Network Broadcasting
The Internet Revolution has led inevitably to the homologization of media. Like the banking sector under the McFadden Act, the old media was regionally segmented; modern media is internationally homogeneous. However, another curious development was the short history of the ISP. In the early 1990's, the number of genuinely autonomous internet service providers (ISP's) was immense, because running an ISP required particular capital and skills that could be delivered anywhere. Telephone companies still regarded their business as telephony, and were concerned mainly with the booming personal cellular service (PCS) industry. By 2000 or so, telephony and PCS were mostly united in odd international cartels, with occasionally-overlapping service areas. The vast majority of people used their telephone company as their ISP, although a few specialized firms like Earthlink continued to survive as autonomous ISP's.

Cable television remained divided from the telephony/PCS/ISP part of communications, as did network broadcasting from both. This changed somewhat as cable companies were snapped up by computer companies like Microsoft, and as laws on cross-holdings or market consolidation in media were abolished. Fox News has enjoyed favorable treatment by Congress, and Clear Channel Communications has transformed the media delivery system in this country. Today these two companies have merged cable, radio, and television "content" production, while MSN* has merged software, ISP, and other media categories.

The same paradox has arisen here: all of the media firms involved insist they are experiencing greater competition. Telephony faces competition from VoIP; DSL faces competition from cable; cable faces competition from YouTube, network television faces competition from content-producing cable conglomerates; and so on. Yet market concentration by single firms has exploded in all markets concurrently. All participants insist, and the FTC insists on their behalf, that competition is much greater and there is no longer any reason for public interest regulation.

In the case of the media industry, it's fair to point out that the process of homologization was driven by technology. It's harder to make this claim in the FIRE businesses, where no technological breakthrough comparable to the Internet has occurred. In FIRE, there has been far less acrimony among the industry members; rather, the abolition of Glass-Steagall has permitted polyamory in the sector. In the new media industry, there is clearly a struggle between rival commercial interests, with each purporting to defend the public interest.

A final note: homologization is occurring in other industries and has in still others. It leads to an interesting aftermath, where the entire mix of products available is changed. Initially, the customer suffers through deception: even very well-informed customers are vulnerable deception by gigantic institutions interested in getting them to make sucker bets. Whether the situation improves depends in large measure on if the customer remembers that she is also a citizen.
*MSN is now known as Windows Live.

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