Size Matters in Business

New firms are discouraged from entering markets where rival companies are backed by wealthy corporate groups, raising concerns over a possible lack of competition in some sectors, a study has found.

Cash-rich corporate groups, which actively switch capital between member firms, frighten off stand-alone competitors who fear they will be unable to compete with the groups’ financial muscle.

The study, carried out by Cass Business School, which is part of City University London, together with other European institutions, examined 70,000 French firms running from 1995 to 2004. It found that companies with the largest market share were in most cases affiliated with corporate groups, particularly in the industrial sector.

Examples of corporate groups include Vivendi and Danone in France, Virgin in the UK, Adidas in Germany, Pirelli in Italy and Tata in India.

Co-author of the study, Dr Giacinta Cestone, a senior lecturer at Cass Business School, said: “Many corporate groups operate an internal capital market, actively redistributing funds among their member firms. This is more likely at times when raising external capital is expensive, or when companies are faced with new competition,” she said.

“Our research indicates this gives group-affiliated firms a clear competitive edge over other companies. We found the rate of new firms entering the market dropped when cash-rich corporate groups were present. This suggests that stand-alone businesses are discouraged from entering potential markets by the deep-pockets of their rivals.”

The decline in competition was found to be greater in markets where it is harder to raise external capital. In particular, companies backed by corporate groups enjoyed a tighter grip on R&D intensive sectors and in industries where firms had fewer tangible assets.

Dr Cestone said: “Companies are more likely to see their market-power boosted when they belong to a corporate group. This is particularly true in sectors where limited access to external capital shapes the competitive arena. Having the ability to call on large cash-holdings enhances both the company’s actual and perceived strength.”

According to the study, the rate of entry of new firms dropped more significantly when corporate groups operated more active internal capital markets. Dr Cestone added: “Firms are only likely to benefit from belonging to a corporate group if cash is actively reallocated between members. In line with this, we found that the entry of rival companies dropped in markets where groups aggressively switched funds between subsidiaries.

“Active internal capital markets may give companies a significant competitive advantage, especially at times when external capital is more costly. Having access to a group’s deep pockets enables them to take action in ways their stand-alone competitors cannot.”