Even Megacorporations Aren't Bulletproof --- Embraer's potential venture into 737-sized commercial planes highlights how even companies in a global duopoly must innovate

"Size matters in today's stock market: Investors seem to have an insatiable appetite for big companies that dominate global markets. 

In the corporate world, however, no moat is as deep as it looks.

Brazil's Embraer is exploring the development of a next-generation narrow-body aircraft, which would target the same customers that currently buy Boeing's 737 MAX and Airbus's A320neo, The Wall Street Journal reported Wednesday.

This is happening as Boeing is reshuffling its leadership, losing market share to Airbus and grappling to correct flaws in quality control that have led to several accidents.

The fallout might have toppled the U.S. plane maker, were it not for the global duopoly enjoyed by the commercial-jet industry. Barriers to entry are higher than almost anywhere else. Designing a big aircraft takes a decade or more and costs tens of billions of dollars. Airlines get huge advantages from fleet commonality, making it hard to switch suppliers.

In oligopolistic markets like this, firms can be tempted to retrench and live off rents. Both Boeing and Airbus -- which is feeling less heat because of its rival's crisis -- have delayed the rollout of more fuel-efficient narrow-body jets until the middle of the next decade, despite rising environmentalist concerns.

This dynamic is worth watching because market concentration has been increasing everywhere in corporate America. Digital technology has unlocked unprecedented "network effects" that reward scale, making Silicon Valley companies the new kings.

The trend is mirrored on Wall Street as the stock market gets increasingly top-heavy. The aggregate value of the 10% of companies with the highest revenue in the S&P Composite 1500 has risen 6.5% this year, whereas the bottom 10% is down 6.3%. The result is similar even excluding tech.

Regulators are worried, with a focus since 2021 on opposing mergers. Just last week, the Federal Trade Commission moved to block Tapestry's purchase of Michael Kors owner Capri.

Yet true competition isn't measured by the number of companies in a market, but by how much they invest to increase their productivity.

The jet duopoly, for example, was cutthroat until Boeing's crisis.

 As for tech giants, they have plowed vast amounts of money into research and development. In 2023, the largest 10% of firms accounted for 58% of all capital expenditures in the S&P 1500, FactSet data suggests. As a percentage of their massive operating cash flows, their spending was only slightly below the average.

Some investors see this as a problem, especially as big firms increase spending on artificial intelligence. They would prefer them to distribute more cash instead. U.S. chip maker Intel has become the worst-performing member of the S&P 500 this year as markets balk at the price tag of its move to compete with Taiwan's TSMC as a chip foundry. Meta Platforms shareholders are keeping a close eye on how much money Chief Executive Mark Zuckerberg spends on his AI and metaverse projects.

But Embraer's tentative plans underscore the vulnerability of companies that stop innovating, even in an extremely concentrated industry.

To be sure, oligopoly power can buy time to avoid the worst outcomes, just as it has protected Boeing. 

Those who bought the "Nifty Fifty" blue-chip stocks at outrageous valuations in the 1970s, when investors also flocked to the largest companies, still did relatively well.

But there were casualties. Kodak, a key "Nifty Fifty" member that had cornered the U.S. photography market, infamously went under when digital cameras appeared. Finnish cellphone powerhouse Nokia and British retailer Tesco are other past objects of unwarranted antitrust attention. In software, search engine Netscape and Apple's iTunes music store had moats that turned out to be easily breached.

Embraer's potential expansion from its regional-jet niche into big aircraft brings up another important point: As economists P.W.S. Andrews and Elizabeth Brunner emphasized in the 1960s, even apparent monopolies can face implicit competition from large players in adjacent markets.

The battle between big-box retailer Walmart and e-commerce giant Amazon.com is a recent case. Moves by Chinese phone makers Xiaomi and Huawei into electric cars are another.

The Brazilian plane maker may decide not to take the plunge, or do so and fail.

Bombardier already tried this strategy in the 2000s, almost bankrupting the company and prompting Airbus to take over its newly developed commercial jet.

Likewise, Intel's foundry plans may not work out. But the reason the chip maker needs a new approach is that it didn't invest enough in cutting-edge technology when it mattered. The lesson for Boeing is that getting its house in order isn't enough; it needs to reclaim a culture of innovation by bringing forward a clean-sheet plane.

More broadly, investors who are wondering whether big tech stocks have become too expensive should remember that oligopolies retain their value not despite heavy spending, but thanks to it." [1]

There is one big elephant in the room: Brazil, China, Russia and other players are coming to compete with the West. Combined market power of the Rest is huge even for the golden West.

1. Even Megacorporations Aren't Bulletproof --- Embraer's potential venture into 737-sized commercial planes highlights how even companies in a global duopoly must innovate. Sindreu, Jon.  Wall Street Journal, Eastern edition; New York, N.Y.. 03 May 2024: B.12.