The Challenges of Using Return on Capital as an Indicator of Monopoly Power
White paper, December 9, 2020
The success of many large technology companies has sparked concerns that these companies are exercising monopoly power. These concerns are reflected in antitrust suits filed in the US against both Google and Facebook. More broadly, competition authorities across the globe have reassessed the tools at their disposal to detect the exercise of market power in the digital economy. One metric that many antitrust regulators monitor is a company’s return on capital, the amount by which its profits exceed its cost of investment. The thinking behind this approach is that persistently high profits suggest a lack of competitors in the market, and hence indicate the existence of market power and barriers to entry.
In a paper presented at a meeting of the Competition Conference of India, four Analysis Group consultants – Managing Principals Laurits Christensen and Aaron Yeater, Vice President Divya Mathur, and Manager Laszlo Jakab – offer notes of caution on the use of return on capital as a proxy for monopoly power in the digital economy. The authors analyze the question from both a theoretical and an empirical point of view. Their review of the academic literature finds a number of theoretical obstacles to identifying return on capital with monopoly power. Empirically, they survey a large number of public companies and find numerous examples of high excess returns in industries generally considered to be highly competitive.
The paper, The Challenges of Using Return on Capital as an Indicator of Monopoly Power, was presented at the National Conference on Economics of Competition Law in March 2021.