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Superstar companies are good at everything, including pushing the boundaries

Posted by hkarner - 18. September 2016

Date: 15-09-2016
Source: The Economist
Subject: Downsides: The dark arts

COMPANIES ARE BY nature competitive. That is mostly to be welcomed, but sometimes their competitive instincts play out in less welcome ways as they engage in some of the darker arts of management. The two most obvious ones are to pay as little tax as is legally possible, and to lobby governments and a variety of other bodies to gain an advantage over rivals. To a greater or lesser extent all companies do this. The big difference is that the superstar companies, being good at everything they do, are also much better than the rest at practising these dark arts and taking them mainstream.

This raises three worries. The first is that they will keep getting better at them, applying the same creative excellence to rule-bending as they do to running their business in general. Second, superstars might use the combination of these and other skills to build up impregnable advantages, giving them growing monopoly power. Third, as their businesses become more mature, they may come to rely increasingly on those dark arts.

Multinationals routinely use foreign direct investment (FDI) in order to reduce the amount of tax they have to pay. They create holding companies to keep their corporate assets in low-tax jurisdictions. These holding companies in turn put their subsidiaries in the most tax- and regulation-efficient jurisdictions, creating a constant cascade of ownership and control. The volume of money moving through such havens on the way to their final destination has risen sharply since 2000 and currently makes up about 30% of all FDI. In 2012 the British Virgin Islands were the world’s fifth-largest recipient of FDI, with an inflow of $72 billion. Britain, with an economy 3,000 times larger, had an inflow of only $46 billion. The Netherlands and Luxembourg also attracted big inflows, and there are many more such hubs.

superstars-assetsSuperstar companies are naturally better at tax and regulation shopping than the rest, partly because of their size and partly because they can afford to employ the best managers and professional advisers. According to UNCTAD, the world’s 100 most globalised companies each have an average of 20 holding companies that in turn sit on top of a complicated chain of ownership, part-ownership and co-ownership. More than 40% of foreign affiliates have several national identities because they are co-owned by companies from different countries. The ownership structure of new high-tech multinationals is often particularly convoluted, often more so than that of low-tech companies that have been around for a century.

Such companies have pioneered two highly successful techniques for exploiting differences in tax codes. One is transfer pricing, or charging one affiliate for using intangible assets (such as brands, intellectual property or business services) said to originate in another part of the company. The more that companies rely on knowledge rather than physical assets to make their money, the greater their opportunities for shifting profits from one jurisdiction to another. Apple established a cosy deal with Ireland that allowed it to channel most of its non-American sales and profits through special corporate entities, saving itself €13 billion in taxes over ten years, the European Commission has recently claimed. Google achieved an effective tax rate of 2.4% on its non-American profits in 2007-09 by routing profits to Bermuda, via Ireland and the Netherlands (known as a double Irish).

Habit-forming products help companies squeeze even more money out of their customers

Another technique is “inversion”, or buying foreign companies and shifting nominal headquarters to the junior partner in the acquisition. Pfizer, one of America’s leading pharmaceutical companies, contemplated engaging in a giant inversion by buying Allergan for $160 billion and moving its headquarters to Ireland, but retreated in the face of strong political pressure.

Superstars are also devoting increasing resources to lobbying, an industry that is at its most advanced in America. Companies and their associations are easily America’s biggest lobbyists, accounting for over 70% of all expenditure on lobbying. And the biggest companies are pulling ever farther ahead of their smaller rivals in getting their voices heard. Lee Drutman, of New America, a think-tank, points to a paradox. The past 20 years have seen an enormous increase in lobbying, with more than 37,700 interest groups now saying they are active in the field, but a handful of organisations seem to dominate the conversation. They are having to spend ever more to retain their position. Back in 1998, the minimum an organisation had to shell out in order to be included among the top 100 spenders was $2.4m. By 2012 that sum had nearly doubled, to $4.4m.

Friends in Washington
Superstar firms will generally keep a dozen or more full-time registered lobbyists of their own on Capitol Hill, but also use a couple of dozen lobbying firms to be called upon as and when needed. This allows them to keep constant pressure on lawmakers to advance their cause, as well as to flood Congress with extra hired hands in the event of a crisis.

Tech giants have been particularly successful in getting their voices heard. They were originally reluctant to play the lobbying game, but soon realised that was a mistake: Microsoft’s prolonged legal battle with the Department of Justice over whether its was abusing its dominant position in the software market, which was finally settled in 2001, persuaded the whole industry that it pays to have friends in Washington. Since then tech companies have turned into some of America’s most assiduous lobbyists and most enthusiastic employers of Washington insiders. Barack Obama’s former press secretary, Jay Carney, now works for Amazon and his former campaign manager, David Plouffe, has joined Uber.

Investment in lobbying is paying bigger dividends than in the past as the federal government extends its power over economically sensitive areas such as health care and financial services. Lobbyists can earn their keep by influencing the direction of the debate. For example, back in 2003 the pharmaceutical industry pushed successfully for a revision of America’s Medicare health-insurance programme for older people. This included a new prescription-drug benefit but no measures to control the costs of that benefit through means-testing or bulk-buying. John Friedman, an economist at Brown University, estimated the resulting benefits to drugmakers at $242 billion over ten years, a healthy return on the $130m the industry spent on lobbying in the year the law was passed.

The American government has also got into the habit of producing open-ended pieces of legislation such as the Dodd-Frank financial-reform bill, which ran to 2,319 pages. Again, lobbyists can earn their keep by writing bits of the legislation, as they clearly did with Dodd Frank, or by lobbying Congress over its interpretation.

Companies are also becoming more ambitious in what they are trying to achieve. In the past they put most of their effort into heading off tax increases or regulatory changes that might damage them; today they are trying to boost their profits and shape future markets. In his book, “The Business of America is Lobbying”, New America’s Mr Drutman shows that companies are increasingly using lobbyists to set the terms of the debate by funding Washington’s innumerable talking-shops, then putting pressure on politicians and officials to ensure that the legislation works to their advantage.

The same pattern is being repeated in the European Union. The Corporate Europe Observatory, an NGO, calculates that Brussels is home to at least 30,000 lobbyists, almost the same number as the staff employed by the European Commission. These official lobbyists are part of a large army of people who try to influence legislation and regulation for more than 500m European citizens.

The revolving door
Superstar companies are hiring the best lobbyists and employing the most prominent politicians. In July this year José Manuel Barroso, until recently president of the European Commission, joined Goldman Sachs, a bank, as the non-executive chairman of its international arm, replacing Peter Sutherland, a former EU trade commissioner. Mr Barroso’s appointment has caused widespread protests. Such high-profile recruits not only give big companies access to information about past policymaking, they allow them to influence serving politicians who would like to join the board of a big company when they retire.

Superstar companies are also particularly good at getting inside their customers’ skin and shaping their habits. Great companies have excelled at doing this since the birth of mass advertising in the 1890s, but today’s superstars are using modern science to push advertising into areas that have not been tried before, raising difficult ethical questions about what “free choice” means in a capitalist economy.

Many of the new tech giants are at heart advertising companies: they persuade customers to give away personal details (for instance, by allowing them to Google something or Facebook a friend without charge) and then selling that information, duly anonymised, to their clients. These internet services are not really free. Users are paying for them indirectly by allowing the companies that provide them to gather information about their online behaviour through cookies (small pieces of code) lodged in their computers.

Professional data-miners use this information to build up detailed pictures of what people have bought in the past (“history-sniffing”), and how they have gone about it (“behaviour-sniffing”). They can use this information to draw people’s attention to products they might want to buy in the future or to bargains that are on offer. They are getting increasingly sophisticated about predicting users’ behaviour, working from hidden signals. For example, when people are depressed, they tend to post darker pictures online than when they are feeling cheerful.

Tech companies take advantage of the fact that a large number of tech products are habit-forming. A typical user reportedly checks his smartphone at least 150 times a day. This is mainly because many tech products are interactive. In his book, “Hooked: How to Build a Habit-Forming Product”, Nir Eyal points out that services such as Facebook and Twitter are constantly being adjusted according to what users put into them and comments from their friends. Internet entrepreneurs devote a lot of thought to getting users hooked on their products, providing them with endless feedback (such as beeps and pings) in order to keep them coming back. Habit-forming products help companies weave their devices into their customers’ daily routines and squeeze even more money and information out of them.

That pervasive influence is now being extended into new parts of the economy. Google is using its mastery of information to work on interactive “smart homes” that can be controlled from afar. It may not be long before the company starts suggesting what people need to put in their fridge and where they can get the best deal on their groceries. Amazon, meanwhile, is relentlessly extending its retail empire, drawing on its command of information and logistics. Apple and other companies are trying to anticipate what consumers might want before they know they want it, and then co-ordinate networks of app-makers to ensure that their devices arrive fully loaded with those apps.

This has produced an extraordinary situation. Tech companies have persuaded their customers to carry devices in their pockets that can constantly nudge them in some direction or other. Seventy years ago Vance Packard wrote a bestseller called “The Hidden Persuaders” which revealed some of the sophisticated psychological techniques advertisers then used to persuade consumers to buy their stuff. Today billions of people voluntarily carry around their own private “hidden persuaders” that allow global behemoths to monitor their behaviour and influence their choices. “We know where you are,” says Eric Schmidt, the chairman of Alphabet, Google’s holding company. “We know where you’ve been. We can more or less know what you’re thinking about.”

But increasing numbers of consumers are becoming disillusioned with big and powerful companies. That is generating a growing backlash.

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