Cost Economies: A Driving Force for Consolidation and Concentration?

Abstract

Expanding concentration in many industries has generated concern about the determinants of these market structure patterns. Understanding such trends requires information on technological characteristics underlying cost efficiency. However, market structure and power analyses are typically based on restrictive models that limit the representation of cost drivers. In this paper, I model and estimate a comprehensive cost specification allowing for utilization, scale, scope, and multiplant economies using U.S. beef packing plant data. My evidence of substantive cost economies implies economic motivations for observed concentration, consolidation, and diversification and facilitates the interpretation and use of market structure measures for policy guidance. concentration and consolidation in the past few decades, stimulating concerns about market power and questions about the factors underlying such trends. Evaluation of market power often takes the form of measuring perceived output demand relationships and imputing the implied price-marginal cost deviations. However, understanding market structure patterns in more depth requires obtaining comprehensive information about the cost (supply) structure, which is precluded by the restrictive cost assumptions of most market power models. Since cost economies imply greater efficiency of larger scale or more diversified operations, this may seriously limit the insights obtainable from such models. Cost economies-including short-run (utilization), long-run (scale), scope (jointness), and multiplant (information- or risk-sharing) economies-may provide economic incentives for expanding throughput, size, diversification, and plant numbers. Thus, information on the existence and extent of a variety of potential cost economies is key to the relevant construction, interpretation, and use of market structure and power measures. It provides insights about why concentration might have increased, whether these trends could be welfare enhancing rather than harmful, and what trends to expect in the future that are crucial for guiding policy measures to monitor and control market power. The importance of the cost structure as a potential driver of market structure patterns and thus of a comprehensive empirical representation for its evaluation has been recognized at least since the advent of the New Empirical Industrial Organization (NEIO) literature.' The literature on regulation and natural monopoly, targeting primarily public utilities, has also focused on the extent and form of cost economies and how they affect appropriate policy formulation.2 But for most industries, the cost