What really is a monopoly, anyway?

Our most recent previous post discusses the common view of monopolies, and we argued that companies are not really "monopolies" just because they dominate an industry (the way Google currently dominates search).*

This statement may have raised some objections in some readers, who have been taught over and over that the above statement is pretty much a definition of a monopoly (and not just in school -- the CFA coursework material defines a monopoly as a single firm taking over an industry, and even uses Microsoft as an example).*

We would argue, however, that a monopoly does not exist unless physical force is used to prevent competition -- and in countries in which the government maintains a monopoly on physical force, this means that monopoly cannot exist without government restriction of competition.

Monopoly does not exist just because one company is able to provide far and away the best service for the best price, because competitors could beat them, if they were able (nobody is stopping anyone from making better search than Google, for example -- it's just that nobody has been able to do it, thus far).

In the previous post, we referenced economist and professor George Reisman, who says, "Rationally understood, monopoly is external to the normal operation of the economic system and is, as I say, imposed by the government or the government's sanction. It is, as it was originally understood, an exclusive grant of government privilege, such as was extended by English monarchs in earlier centuries to the British East India Company and to various guilds of producers or merchants" (377).

He points out a historical example of a situation that many would call a monopoly but was not: "Under the freedom of competition, Alcoa was for many years practically the only seller of aluminum ingot in the United States. Nevertheless, it was not a monopoly [. . .] because its position did not rest on the initiation of physical force, but on its ability and willingness to produce and sell its aluminum at prices that were profitable to it, but yet too low for any potential competitor to be profitable" (378).*

In such a case, the customers are getting the best prices possible. If a company with a "monopoly" dominance on an industry tries to charge too much, then they are just inviting competition to put them out of business -- and competition will arise, as long as the government does not prevent competition. Hence, the assertion that monopoly always includes the government's restriction of competition.

Interestingly enough, the day after we posted our piece on Google, monopolies, and the misguided views of the European Union's anti-trust commission, economist and professor Mark Perry posted the above YouTube video on his excellent Carpe Diem blog.

It is a trailer for an upcoming documentary entitled The Cartel, about a real-life monopoly in the United States: the public education system. Twenty-eight seconds into the trailer, one of the speakers in the film accurately declares, "Education is a business that has a monopoly; when you have a monopoly, you can do whatever you want."

This important distinction about what is and what is not a monopoly is one that all investors (and indeed all voting citizens) should understand.

* The principals of Taylor Frigon Capital Management do not own securities issued by Google (GOOG), Microsoft (MSFT) or Alcoa (AA).

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How ironic -- Microsoft asks the EU to bring antitrust investigation against Google

Search giant Google is in the news today for two different stories*.

One story has to do with the Italian government trying to hold the company responsible for a video posted on Google's YouTube website, but the more significant story from a business standpoint is the indication by the European Union that it is launching an anti-trust investigation based on allegations that the company is violating an "abuse of dominant position" clause.

The anti-trust investigation stems from a complaint filed by competitors of Google (including one owned by competitor Microsoft*) alleging that Google ranks search results unfairly and charges unfairly for advertising.

Regardless of whether this allegation is true or false, we would argue that consumers are capable of making such decisions without government assistance.

As we noted almost two years ago in response to the ironic news that the European Union was supporting a monopoly on the use of the term "champagne" by seizing and smashing the bottles of non-French champagne competitors using the term, "the use of EU government force against Microsoft and the use of EU government force against makers of non-French champagne are consistent in that both are restrictions of free markets."

In a free enterprise system, no matter how big a company becomes, if they attempt to charge too much for an inferior product competitors can arise to offer customers a better product or a better price. There should not be a rule that companies need to help their competitors beat them, however.

Conventional wisdom may hold a view that is similar to that depicted in the cartoon above in which big monopolies (or trusts) threaten freedom and democracy to such an extent that only the government can rein them in. However, it is our view that this idea is false and is countered by the ideas of economists such as Schumpeter, whom we have discussed before.

Further elaboration of the alternative to the conventional ideas about monopoly is given by economist George Reisman, who explains it in terms of human freedom: individuals, and the corporations that are composed of individuals, should be allowed to do whatever they are capable of doing, short of the initiation of violence (he includes fraud as a form of violence). To read further, visit his online text Capitalism, particularly chapter 10.

The idea that Microsoft was so big and powerful that the EU (and the US Department of Justice) needed to restrict them with government power twelve years ago seems laughable today, when Microsoft's software-based business model is under serious and potentially mortal threats from the arrival of a new cloud-based paradigm (and cloud-based competitors such as Google). How ironic that the EU does not recognize that Microsoft (the target of their previous anti-trust fears) is now trying to claim that they are helpless in the face of a new monopoly.

We have previously noted research suggesting that the "topple rate" at which dominant companies fall out of their dominant positions in various industries appears to be increasing. This is really the important point for investors to understand, since they cannot realistically hope to change the thinking of the European Union's anti-trust commissioners, or those of the US DOJ either for that matter.

A few of the many important points we feel come out of this topic include the importance of having a solid sell discipline and of staying apprised of potential paradigm shifts that may unseat the dominant players in the industries of companies to which you commit capital.

* The principals of Taylor Frigon Capital Management do not own securities issued by Google (GOOG) or Microsoft (MSFT).

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Banker calls for a "new capitalism"

Today there is an interview on National Public Radio with British banker Stephen Green, chairman of giant international money center bank HSBC.

In it, Mr. Green puts forth numerous assertions with which we would disagree as proponents of free-enterprise, including the idea that "markets are not reliably self-policing and you do need a government-supported regulatory environment which is constructive and effective in watching out for the weaknesses that are sometimes endemic to the system" and that the recent crisis grew out of global savings and trade imbalances.

We've addressed these topics before (see here and here for instance), but the assertion we want to focus in on is the assertion that corporations have responsibilities to "the community" beyond a responsibility to make a profit -- often called a "social responsibility."

The great Milt Friedman decisively demonstrated the fallacy of this innocuous-sounding idea in his famous 1970 essay "The social responsibility of business is to increase its profits," as we discuss in this previous post.

Some might argue, however, that banking as a business is different -- perhaps banks have social responsibilities beyond other corporations, because society has an interest in more people getting loans for homes or businesses or education, and because banking meltdowns have an impact on all other businesses.

However, we would argue that trying to force "social responsibilities" onto banks contributed greatly to the meltdown. Legislation such as the Community Reinvestment Act dictated that banks lend money based on criteria other than the ability of borrowers to repay. An even bigger example, of course, was the existence of the quasi-government entities Fannie Mae and Freddie Mac, which were also created as a way to further socially desirable goals for home lending.

In this noteworthy video interview between businessman Steve Forbes and economist Brian Wesbury, Mr. Forbes brings up the important insight that the existence of these socialized institutions (Fannie and Freddie, which had the implicit backing of the U.S. government and hence could borrow money at lower rates than a strictly private institution could) drove the private banks into the subprime markets.

As Mr. Wesbury says in agreement with Mr. Forbes' question, "The bigger Fannie and Freddie got, the banks could not compete. Because Fannie and Freddie have the implicit guarantee of the government, which means they can borrow cheaper than banks could in the open market. Therefore they could offer products at lower yields and still make a spread that was wider than banks. The banks had to go into the subprime arena to compete. That was the only place left for them, in a sense. Because Fannie and Freddie had taken out the profit margins in the conventional mortgage market. It just didn't exist."

In other words, contrary to the assertions of Mr. Green (which fit into the misguided economic ideas that NPR frequently promotes), the financial panic's lesson is not that we need a "new capitalism" in which corporations make decisions based on a "wider public interest," but that such ideas (as Milt Friedman told us forty years ago) end up hurting everybody, including the wider public.

* The principals of Taylor Frigon Capital Management do not own securities issued by HSBC (HBC).

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Will "friend-casting" be as big as search for discovering information?

Here is a link to an interesting article that appeared recently in the San Francisco Chronicle.

Entitled "Facebook directs more online users than Google," the article cites data illustrating that Facebook sends almost as much traffic to certain websites (and more in some cases) than search engines such as Google.*

As with any research for investment purposes, the quality of the source must be considered, and it is obvious that many of those quoted in the article make their living trying to convince companies to hire their services for "social network optimization," which they believe will be as important or more important than "search engine optimization."

Even accounting for some bias, however, these issues are important ones to be aware of. In fact, we wrote about them on this blog over two years ago, in "A paradigm shift in the way you get information." This topic has enormous consequences for advertising, as George Gilder predicted over ten years ago (see the discussion in that blog post) -- in fact, it has huge consequences that stretch far beyond that area, and which may overturn many social and cultural realities that are based around the familiar advertising model that was created by the advent of radio and especially the advent of television in the 1950s.

All investors should pay close attention to this subject.

* The principals of Taylor Frigon Capital Management do not own securities issued by Google (GOOG).
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Have you heard of this company? TSCO

In the past, we've explained some of the fundamental tenets of the classic growth investment philosophy that we follow at Taylor Frigon Capital Management. To revisit those, see "The Classic Growth Stock Investment Philosophy" or the series entitled "Beautiful Growth Companies" (this is a link to part I, and below that post are links to parts II and III).

Recently, we described some aspects of our investment thesis for a company that is a classic Taylor Frigon growth company, in order to provide some idea of how that theory translates into actual investment holdings, as well as to encourage investors to focus on the kind of good businesses which can be found in almost any economic environment -- a focus that is very easy to lose amidst the noise of the financial media and the geopolitical events that crowd the news each day.

We also selected a growth company that is outside of the "tech sector," to illustrate that (although we believe there are excellent growth opportunities related to technology right now) there are growth companies in many sectors that investors might not think about when they hear the phrase "growth stock."

Here is another one, which we have owned for clients in our portfolios since 2004, a company called Tractor Supply*. Tractor Supply Stores are located in rural communities in the continental United States, and their stores serve a niche that other retailers do not address. The company started out serving the needs of farmers and ranchers, but their merchandise includes a wide variety of goods difficult to find under a single roof anywhere else, and includes pet supplies, well pumps, generators, other power tools, tack and feed, welding equipment, lawn and garden products, and men's and women's workwear. Each Tractor Supply Store has on staff a welder, a horse owner, and a farmer.

The company has over 800 stores in 40 states, which may sound as though they have the nation pretty well covered, but the map below illustrates that there are still plenty of markets where Tractor Supply can continue to grow, and where customers would likely be very happy to see them (to see a more detailed list of their store locations, click here for a link to the company's store list by state).

The stock performance since we began investing in the company (in September 2004, at the very left end of the chart below) has been a bit erratic, and reflect fears in 2008 and 2009 that the US consumer was going to fall off a cliff, never to return (at least not for the foreseeable future). However, the company's growth has been strong and the holding is illustrative of the point we have made about investing through cycles when the growth story of a business remains intact.

In its most recent quarterly earnings, the company beat analysts' expectations in both revenues and earnings, growing its earnings by 55% over the year-ago quarter.

* The principals of Taylor Frigon Capital Management own securities issued by Tractor Supply Company (TSCO).

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Why can't we all just get along (on economic policy)?

The latest video (above) from Dan Mitchell of the Cato Institute reiterates the points made in a video that we posted and discussed back on January 15 of last year, when President Obama was still President-elect Obama and the market had yet to make its March lows, let alone recover.

As Dan Mitchell says in this video, and as he explained in the previous video from January 2009, government stimulus does not work. He takes pains to point out that this fact about the uselessness (and actual harmfulness) of government stimulus holds true whether the so-called stimulus is enacted by Republicans or Democrats (for that matter, it holds true for Greens, Libertarians, bipartisan coalitions, or any other party or un-party, in any country and in any decade).

What actually works to stimulate economic development (and this has been proven over and over in actual historical experience throughout the past century) are lower tax rates on marginal income, and lower levels of growth in government spending (at least keep it below the growth in the economy). While real reductions in government spending are desirable, we are trying to be pragmatic here: we simply ask for lower levels of growth in that spending, which goes up every year and probably always will!

It is important to emphasize lower tax rates, because (as we explained in this previous post) lower tax rates lead to greater economic activity and growth and ultimately then to higher tax receipts (charging a lower percentage but on a larger amount of profits).

This truth should not be a partisan dispute, any more than the law of gravity should be considered the exclusive province of Republicans or Democrats.

What social policies to pursue with the expanded revenues can be a partisan issue -- let the parties argue over that all they want. They can argue over how much of the increased revenue should go to defense spending, or whether taxpayer dollars should be funneled to something called the National Endowment for the Arts. With all the time that they save by not having to argue over stimulus packages, politicians could argue about these other issues all day long.

What mystifies us is that members of both parties continue to act as though government stimulus somehow helps the economy. Everyone should simply agree that it never has and it never will, and move on to discussing and debating other issues.

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Have you heard of this company? RMD

There are always plenty of events for investors to focus on that can easily distract them from the start of the day until its end -- big issues of politics, global events, market reversals, and fears about the next crisis (whatever that will be).

However, a constant theme of our blog has and always will be that investing is really about matching up capital with solid businesses, and we believe that investors should be focused on finding good companies even in the midst of uncertain environments (as we have noted before, the 1970s serve as an excellent historical example of the importance of this concept).

To illustrate this, and to point out that even in the midst of general angst about the economy and about potential political events good companies are continuing to grow their business and make money for their shareholders, we'd like to call attention to a business we've owned for our clients since 2003, a specialized medical device company called ResMed.*

We believe that ResMed is an ideal example of a Taylor Frigon growth company. The company provides continuous positive airway pressure (CPAP) devices such as masks and respirators, which are used in the treatment of obstructive sleep apnea and other sleep breathing disorders.

Awareness of sleep breathing disorders is on the rise among both patients and physicians, as well as understanding of the other health problems that can be related to these issues -- including extremely serious health problems such as heart disease, diabetes, and strokes. Because they take place during sleep, when we are unconscious, awareness of sleep problems has been very limited in the past. In fact, research shows that up to 80% of those with sleep problems are unaware of the fact.

In many ways, the incredible importance of sleep in health is only now becoming widely appreciated. Harvard Medical School has created a website dealing with the subject of healthy sleep here, which gives some indication of the depth of this issue.

Because this issue is so important but so underappreciated, it represents a potential paradigm shift. As awareness has grown among physicians and the general public, the perceived value of products that can promote healthy sleep has grown. ResMed, which was founded by a pioneer in CPAP research, has been an important provider of sleep treatments during this time.

Not only is the market expanding due to the increasing awareness of the issue itself, but ResMed as a business is taking market share. There has been an increased understanding of the importance of using high-quality CPAP devices -- patients tend to stop using lower-quality devices, which doesn't do them any good and in fact does them harm (in addition to wasting their money). ResMed is a maker of high-end masks and devices.

Recently, ResMed announced quarterly revenue growth of 23% over the year-ago quarter, and earnings growth of 36% over the year-ago quarter, beating analysts' estimates in both numbers. The company is one of the only publicly-traded businesses focused solely on their particular market.

We believe that focusing on the fundamentals of well-run businesses in front of fertile fields of growth is important for investors, all the more important during periods in which worry and distractions are widespread. Doing so may also help them to sleep better at night.

* The principals of Taylor Frigon Capital Management own securities issued by ResMed (RMD).

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How your view of the crisis of 2008-2009 impacts your understanding of today's big issues

Here is a link to a very interesting interview of former Treasury Secretary Hank Paulson by economist Larry Kudlow.

It is worth paying attention to, because it highlights the difference between major "belief systems" regarding what caused the 2008-2009 financial crisis, belief systems that play a crucial role today in shaping the different views on where the economy is right now and what measures should be taken to prevent a similar crisis in the future.

Former Secretary Paulson repudiates the arguments outlined recently by Steve Forbes in this column (in the February 8 edition of Forbes), in which Mr. Forbes argues that Fannie Mae and Freddie Mac, government interference in housing lending, and above all the disastrous role played by the introduction of new mark-to-market accounting standards in 2007 played in the 2008 meltdown. Interviewer Larry Kudlow mentioned that column in the first part of the above video.

Mr. Paulson's arguments against this view of the crisis are not very convincing. We ourselves have put forth arguments similar to those made by Mr. Forbes in numerous previous blog posts during 2008 and 2009 (see for instance:
"Big news on mark-to-market accounting" March 13, 2009
"It's a panic, not a Great Depression" January 21, 2009
"Taking stock of 2008" December 31, 2008
and "The wages of socializing," about Fannie Mae, Freddie Mac, and the Community Reinvestment Act, from July 16, 2008).

If, as we have argued, the crisis of 2008-2009 was a financial panic which then spread to the rest of the economy, then the sharp recovery (which began when Congress pressured FASB into removing the mark-to-market accounting rule at the heart of the panic) is not a surprise. It is also plain that the recovery has not been the result of government "stimulus" (for more on that subject, see our post from January 15 of last year). If this view is correct, then further stimulus is not necessary to keep the economy from collapsing again, and in fact (as we argued in that January 15 post), it will retard real growth.

These issues are very important for investors to understand, and are worthy of careful consideration.

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