It Pays to Be Smart

Our economy is increasingly ruled by a few dominant firms. We see them everywhere, from established giants Amazon, Facebook, Google, Apple, and Walmart to fast-growing newcomers like Airbnb, Tesla, and Uber. There have always been large companies and outright monopolies, but there’s something distinctive about this new generation of what some economists call superstar companies. They appear across a broad range of business sectors and have gained their power at least in part by adeptly anticipating and using digital technologies that foster conditions where a few winners essentially take all.

Our annual list of the 50 Smartest Companies includes many of these firms, but it’s not merely a list of today’s biggest or most profitable players. It highlights technologically innovative companies whose business models allow them to exploit these advances. The list is our best guess as to which firms will be the dominant companies of the future. Amazon and Facebook and Google are on it, but so are plenty of newcomers. Though they might be unfamiliar to you today, we believe they have an inside track to take advantage of the technologies, such as artificial intelligence, that will define business in the coming years. Being smart about innovation won’t guarantee that these firms become superstars. But it does, at least, give them the potential to create and dominate new markets in an increasingly competitive business environment.

The emergence of superstar companies has, in many ways, helped to define our era. Digital giants, in particular, have cleverly leveraged the Internet, so-called network effects, and big data to become hugely profitable while providing indispensable services—like free Web search and easy online shopping—and devices that have changed our lives (see “Why Tesla Is Worth More Than GM”).

But Internet companies aren’t the only ones to become superstars. According to recent research by economists at Harvard and MIT, the share of sales by superstar companies—which the authors define as the four largest firms in a given industry—has gone up sharply in all the sectors they looked at, from transportation to services to finance. The trend toward  superstar firms is accelerating, says Lawrence Katz, a Harvard economist and coauthor of the study. It has become more uniform across industries and developed economies during the past decade or so. These companies’ dominance is particularly strong in markets undergoing rapid technological change. Katz says that’s probably because of the wide disparity in how well companies take advantage of new advances. In other words, you have to be the smartest company in your field or you might as well not bother.

In itself, that might not be bad. But the authors identified a deeply troubling result of an economy where just a few top-tier companies dominate. One of the economic truths of much of the 20th century was that the portion of the country’s overall income that went to labor was constant; as the economy grew, workers got a proportionate share of that growing pie. But labor’s share of the national income has been shrinking over the past few decades. This is true in many countries, and the decline speeded up in the United States in the 2000s.

The trend puzzles economists. Some suggest it reflects the rise of cheap robots that can do the jobs of human workers, but the data isn’t convincing. Instead, Katz and his coauthors blame the emergence of the superstar companies. As these companies grow and become more efficient and more adept at using digital technologies, they need fewer workers relative to their soaring revenues. The fact that these labor-frugal firms have so much of the market share in their sectors means labor gets a smaller portion of the nation’s overall income.

Compounding the problem is that superstar companies, which desire the best possible talent, tend to pay much better than anyone else. This dynamic is deepening the divide between the country’s economic winners and losers. Nicholas Bloom, an economist at Stanford, and his colleagues have shown that about one-third of the growth in U.S. income inequality since 1980 can be explained by the disparity between the pay premiums of a few elite companies and the salaries most workers earn. Fewer and fewer people—mostly a select group of highly trained professionals—are enjoying the vast profits generated by these top companies. It is “certainly a big part of the [economic] anxiety” that is plaguing the country, Katz believes.

The rise of the superstar companies also might help explain another disturbing economic trend. Despite the proliferation of impressive new advances in software, digital devices, and artificial intelligence over the last decade and the great profits generated by Silicon Valley, economic growth in the United States and other developed countries has been sluggish (see “Dear Silicon Valley: Forget Flying Cars, Give Us Economic Growth”). In particular, an economic measure called total factor productivity, which is meant to reflect innovation, has been dismal (see “Tech Slowdown Threatens the American Dream”). How can overall growth be so lackluster while the high-tech sector is booming?

Economists with the Organization for Economic Cooperation and Development think they have found the answer. It turns out that productivity at the top companies in various sectors—what the OECD economists call the frontier firms—is growing robustly. These are the companies making the best use of the Internet, software, and other technologies to streamline their operations and create new market opportunities. But most companies aren’t actually harnessing new technologies very effectively. And the relatively poor productivity of these laggards, says OECD economist Dan Andrews, is dragging down the overall economy. “Technologies are increasingly complex, and many firms may lack the competencies to adapt,” suggests Andrews, coauthor of the OECD study, which looked at the United States and 23 other developed countries.

In some ways the OECD findings are encouraging, because they demonstrate that recent innovations do—in the hands of top companies—have the potential to strongly improve productivity. But surprisingly, says Andrews, the laggards seem to be making little progress toward catching up; new ideas and business practices aren’t trickling down as rapidly as they should. The reason isn’t entirely clear, he says. But it seems that the economy is less dynamic and efficient at “dispersing” new technologies than we might think.

Such findings help drive home the importance of the 50 Smartest Companies list. Be assured, there are no laggards on it. But the research by Andrews and others also shows why we need a better business climate—one that allows more startups and fresh ideas to thrive. Today’s giant companies are pulling ahead, and a dwindling number of individuals are reaping the financial rewards. There is nothing inevitable about that trend. The advent of complex technologies such as artificial intelligence, which will be critical to future business success and are tricky to understand and master, could widen the gap further. They could also provide ample opportunities for new companies to create markets that don’t even exist today. We do need companies to aggressively push the frontiers of innovation. Still, as we celebrate our 50 Smartest Companies, it is worth keeping in mind the importance of distributing know-how, and the wealth it produces, more broadly.