Source: Farnam Street
Markets tend to favor unequal distributions of market share and profits, with a few leaders emerging in any industry. Winner-take-all markets are hard to disrupt and suppress the entry of new players by locking in market share for leading players.
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In almost any market, crowds of competitors fight for business.
But over time, with few exceptions, a small number of companies come to dominate the industry.These are the names we all know. The logos we see every day. The brands which shape the world with every decision they make. Even those which are not household names have a great influence on our lives. Operating behind the scenes, they quietly grow more powerful each year, often sowing the seeds of their own destruction in the process.
A winner-take-all market doesn’t mean there is only one company in the market. Rather, when we say a winner takes all, what we mean is that a single company is able to control the market. In most cases, they receive the majority of available profits or dictate the nature of competition. The other companies are left with a modest share of the profits and little to no influence. The winner doesn’t want these companies to disappear, because they provide the illusion of competition. In reality, however, they don’t pose a credible threat.
In a winner-take-all market, the winners have tremendous power to dictate outcomes. Winner-take-all markets occur in many different areas. We can apply the concept to all situations which involve unequal distributions.
Unequal Distribution
As a general rule, resources are never distributed evenly among people. In almost every situation, a small number of people or organizations are the winners.
Most of the books sold each year are written by a handful of authors. Most internet traffic is to a few websites. The top 100 websites get more traffic than ranks 100-999 combined (welcome to power laws). Most citations in any field refer to the same few papers and researchers. Most clicks on Google searches are on the first result. Each of these is an instance of a winner-take-all market.
Wealth is a prime example of this type of market. The Pareto Principle states that in a given nation, 20% of the people own 80% of the wealth (the actual figures are 15% and 85%.) However, the Pareto Principle goes deeper than that. We can look at the richest 20%, then calculate the wealth of the richest 20% of that group. Once again, the Pareto principle applies. So roughly 4% own 64% of the wealth. Keep repeating that calculation and we end up with about 9 people. By some estimates, this tiny group has as much as wealth as the poorest half of the world.
“With limited time or opportunity to experiment, we intentionally narrow our choices to those at the top.”
The Perks of Being the Best
There are tremendous benefits to being the best in any particular area. Top performers might be only slightly more skilled than the people one level below them, yet they receive an exponential payoff. A small difference in relative performance—an athlete who can run 100 meters a few microseconds faster, a leader who can make better decisions, an opera singer who can go a little higher—can mean the difference between a lucrative career and relative obscurity. The people at the tops of their fields get it all. They are the winners in that particular market. And once someone is regarded as the best, they tend to retain that status. It takes a monumental effort for a newcomer to rise to such a position. Every day new people do make it to the top, but in a lot of cases, it’s a lot easier to stay there than to get there.
Top performers don’t just earn the most. They also tend to receive the majority of media coverage and win most awards. They have the most leverage when it comes to choosing their work. These benefits are exponential, following a power law distribution. A silver medalist might get 10 times the benefits the bronze medalist does. But the gold medalist will receive 10 times the benefits of the silver. If a company is risking millions over a lawsuit, they will want the best possible lawyer no matter the cost. And a surgeon who is 10% better than average can charge more than 10% higher fees. When someone or something is the best, we hear about it. The winners take all the attention. It’s one reason why the careers of Nobel Prize winners tend to go downhill after receiving the award. It becomes too lucrative for them to devote their time to the media, giving talks or writing books. Producing more original research falls by the wayside.
Leverage
One reason the best are rewarded more now than ever is leverage. Up until recently, if you were a nanosecond faster than someone else, there was no real advantage. Now there is. Small differences in performance translate into large differences in real-world benefits. A gold medallist in the Olympics, even one that wins by a nanosecond, is disproportionately rewarded for a very small edge. No one wants to watch the second best person.
Now we all live in a world of leverage, through capital, technology, and productivity. Leveraged workers can outperform unleveraged ones by orders of magnitude. When you’re leveraged, judgment becomes far more important. That small difference in ability can be put to better use. Software engineers can create billions of dollars of value through code. Ten coders working 10 times harder but slightly less effective in their thinking will have nothing to show for it. Just as with winner-take-all markets, the inputs don’t match the outputs.
Feedback Loops
Economist Sherwin Rosen looked at unequal distribution in The Economics of Superstars. Rosen found that the demand for classical music and live comedy is high and continues to grow. Yet each area only employees about two hundred full-time performers. These top-performing comedians and musicians take most of the market. Meanwhile, thousands of others struggle for any recognition. Performers regarded as second best within a field earn considerably less than the top performers, even though the average person cannot discern any difference.
In Success and Luck, Robert H. Frank explains the self-perpetuating nature of winner take all markets:
Is the Mona Lisa special? Is Kim Kardashian? They’re both famous, but sometimes things are famous just for being famous. Although we often try to explain their success by scrutinising their objective qualities, they are in fact often no more special than many of their less renowned counterparts…Success often results from positive feedback loops that amplify tiny initial variations into enormous differences in final outcomes.
Winner-take-all markets are increasingly dictated by feedback loops. Feedback loops develop when the output becomes the input. Consider books. More people will buy a best-selling book because it’s a best-selling book. More people will listen to a song that tops charts. More people will go to see an Oscar-winning film. These feedback loops serve to magnify initial luck or manipulation. Some writers will purchase thousands of copies of their own book to push it onto bestseller lists. Once it makes it onto the list, the feedback loop will begin and possibly keep it there longer than it merits.1
It’s hard to establish what sets off these feedback loops. In many cases, the answer is simple: luck. Although many people and organizations create narratives to explain their achievements, luck plays a large role. This is a combination of hindsight bias and the narrative fallacy. In retrospect, becoming the winner in the market seems inevitable. In truth, luck plays a substantial role in the creation of winner-takes-all markets. A combination of timing, location, and connections serves to create winners. Their status is never inevitable, no matter what they might tell those who ask.
In some cases, governments deliberately strive to create positive feedback loops. Drug patents are one example. These create a powerful incentive for companies to invest in research and development. Releasing a new, copyrighted drug is a lucrative enterprise. As the only company in that particular market, a company can set the price to whatever it wishes. Until the patent runs out, that company is the winner. This is exactly how the market plays out. In 2016, the highest grossing drug company earned $71 billion. The three runners-up each earned around $50…
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