Philippa Kaur

LAST YEAR was a terrible one for travel of any sort. You would not know it from the way some American chief executives trousered pay. Annual filings show that Larry Culp, boss of GE, whose jet-engine business stalled as aviation nosedived, earned $73m, almost triple his total pay in 2019. Christopher Nassetta, CEO of Hilton, a hotel chain, enjoyed a 161% pay boost, receiving $55.9m. Norwegian Cruise Line, which described 2020 as the hardest year in its history, more than doubled the compensation of its CEO, Frank Del Rio, to $36.4m. All three were among the corporate titans who grandly took cuts in their basic pay and/or bonuses during the pandemic. They pocketed far more than they gave up.Listen to this storyYour browser does not support the element.Enjoy more audio and podcasts on More

ONE OF THE first rules of American politics is not to pick a fight with Big Pharma. Its army of lobbyists in Washington, DC, has ensured that presidents from both parties, from Ronald Reagan to Barack Obama, have upheld the industry’s stout defence of intellectual-property (IP) rights, including in international treaties. Donald Trump threatened to impose drug price controls, which won bipartisan support in Congress, but intense lobbying ensured that his initiative flopped. That effort to rein in Big Pharma chimed with the industry’s global image as arrogant and greedy.President Joe Biden is throwing his weight behind a proposal at the World Trade Organisation to waive patent protections for covid-19 vaccines. If Mr Biden is willing to rethink IP rights for covid vaccines abroad, he might also have the audacity to take on patent protection for new drugs at home. To judge whether America’s industry deserves such treatment, it is worth asking three questions. First, how much innovation is happening? Second, is rent-seeking behaviour—ranging from price gouging to patent manipulation—declining? Third, what might happen if patent rules were watered down?Start with innovation. In the 2000s pharma investment fell out of fashion. But since 2010 America’s industry has raised spending on research and development (R&D) sharply as a share of revenues, to over 25% (see chart). Venture funding into life sciences in America is booming, hitting a record high of $36bn in 2020, double the level in 2017. The number of new drugs approved by America’s Food and Drug Administration has more than doubled in the past decade. None of these measures is an ideal proxy for future innovation, but they suggest the mood has changed.On rent-seeking, too, the picture is less dire that it was. Drug prices in America are still the world’s highest on average, but the rate of increase has slowed. According to IQVIA, a data firm, once secret rebates offered to big customers are discounted, net drug prices rose more slowly than inflation in 2018 and 2019. Political pressure is only one reason. Consolidation among health insurers and pharmacy-benefit managers (big middlemen) who pay for drugs gave them more power to negotiate price cuts. It has got harder to mint cash from blockbuster drugs. Deloitte, a consultancy, reckons that the internal rate of return on in-house R&D at a dozen big drugs firms fell from 10% a decade ago to 2% in 2019—below their weighted-average cost of capital of 7%. The average cost to bring a drug to market has increased by two-thirds since 2010, to some $2bn. And the forecast for peak sales for each new drug has also fallen by half over that period. Often big firms prefer to buy smaller innovative rivals. According to EY, a consultancy, American drugs firms spent $185bn in the past five years on biotech acquisitions. Roughly a third of revenues at big drugs firms are the result of IP arising from acquisitions.What would happen if patent rules were weakened? Rent-seeking would fall, but innovation might, too. One way of getting a sense of this is to look at how much innovation happens outside America, where IP rights are often weaker or less well enforced. In most industries innovation is now happening globally, not just in America, but in pharma it still has a powerful American skew. Two-thirds of worldwide biotech venture-capital investment takes place there. Despite China’s advances on other fronts, in life sciences it still accounts for only about 15% of the global total of venture-capital funding. Similarly, even as American multinational pharma firms have become more global (earning roughly half their revenues abroad), their preference for domestic R&D has risen, with 88% of it done in America.This suggests that America’s government will eschew wholesale changes that damage innovation. But it still might loosen the patent regime to reduce rent-seeking from old drugs. In 2019 the Federal Trade Commission, a regulator, found that the industry is relying less than it used to on egregious “pay for delay” agreements, through which it paid generics firms to hold off on launching low-cost rivals to pricey drugs coming off patent. However, Big Pharma is still using other wheezes, such as “evergreening” IP protection beyond the initial 20-year period by filing a thicket of patents on minor modifications. More can be done to rein in such abuses.The S&P index of big drugs firms has risen by roughly 20% over the past five years while the broader equity market has doubled. Despite miraculous covid-19 treatments, this year the pharma index has declined by nearly a tenth. It is clear that even as spending on innovation rises, presumably reflecting confidence that important IP rights in America will remain intact, investors think the opportunity to print easy money is not as good as it was. That seems about right.■This article appeared in the Business section of the print edition under the headline “Less buck for the bang” More

Source: Business – economist.com More

BABY BOOMERS, aged 57-75, are as the name implies, plentiful. Healthier and more adventurous than similarly aged cohorts in the past, since 2018 over-65s have outnumbered the under-fives. They are also wealthier. America’s boomer-led households spend $64,000 a year, almost twice as much as those headed by youngsters born from 1997 onwards. Together with the earlier “silent” generation, they account for two-fifths of American consumer spending. Yet brands and retailers have long given older shoppers short shrift, focusing most of their attention on the wrinkle-free. As with many things, the pandemic is demanding a rethink.Listen to this storyYour browser does not support the element.Enjoy more audio and podcasts on More

IN “THE REPAIR SHOP”, a British television series, carpenters, textile workers and mechanics mend family heirlooms that viewers have brought to their workshop. The fascination comes from watching them apply their craft to restore these keepsakes and the emotional appeal from the tears that follow when the owner is presented with the beautifully rendered result.Listen to this storyYour browser does not support the element.Enjoy more audio and podcasts on More

AMERICA HAS long been the global protector-in-chief of intellectual property. But on May 5th it sought to tear up the rule book. “The extraordinary circumstances of the covid-19 pandemic call for extraordinary measures,” said Katherine Tai, the United States Trade Representative. To help battle the pandemic, the administration of President Joe Biden said it supported waiving some intellectual-property protections for vaccines. Jaws dropped—along with the share prices of vaccinemakers.Investors shuddered at the idea that other manufacturers might pounce on unprotected intellectual property. Only a day earlier, Pfizer forecast vaccine revenues of $26bn in 2021, with profits around $7bn. Splitting such spoils could blunt the incentive to invest and undermine innovation. And if firms fear that their know-how can be pilfered with impunity, it could undermine collaborative efforts. Just as bad, botched imitations by generic manufacturers could fuel vaccine hesitancy.The waiver’s advocates argue that a pandemic is not the time to be thinking about profits. Moreover, existing commercial agreements should be unaffected. Beyond that, it is unclear how much extra supply of vaccines a waiver could unlock. The complexity of some production processes means that copycats will need co-operation from originators. James Love of Knowledge Ecology International, an advocacy group, hopes that the threat of weaker protections could encourage more voluntary-licensing agreements, in which companies transfer their know-how. There are untapped suppliers such as Teva, an Israeli generics firm, which recently said that it would give up looking for a production partner. But even these sort of voluntary agreements are likely to take around six months to set up.American support for a waiver is the first step in what could be a lengthy process. Several countries, including members of the European Union, Britain and Switzerland, which opposed such a move at the WTO last year, must be persuaded to change their minds. They will struggle to hold the line against America, so may agree to a narrow exception to trade rules. A broader waiving of the rules, as proposed by India and South Africa, to include the removal of patent and trade-secret protections for all covid-related products, including therapeutics and diagnostics, is not on the table. In her comments Ms Tai mentioned waiving intellectual-property protections, but only for vaccines.Consensus at the WTO could take months to secure, and after that countries will still have to change domestic laws. Meanwhile, the pandemic will be raging, while other constraints on vaccine supply continue to bite, including the availability of special inputs from plastic tubing, filters and even specialist bags. Investors may worry about a fall in profits. If negotiations at the WTO suck energy away from other initiatives to transfer technology and increase vaccine supplies, that would really be something to fear. ■This article appeared in the Business section of the print edition under the headline “A shot in the arm” More

IS APPLE’S ONLINE store for smartphone apps akin to a private club, where the firm can set the rules no matter what, even if this means it can exclude people it does not like and overcharge the rest? Or is the app store more like a town market square, meaning among other things that any firm is allowed to do business there?The devilish details of antitrust law aside, this is the main question before a judge in California in a trial that started on May 3rd. It will be a battle royal between Epic Games, the maker of Fortnite, a popular online video game, and Apple, the world’s most valuable tech firm. Epic accuses Apple of having abused its dominance when it kicked Fortnite off the app store last year after Epic tried to offer a separate payment system. Apple counters that Epic is just trying to avoid paying its commission rate of up to 30% and free ride on the tech giant’s inventions.An Epic win would up-end the economics of smartphone apps. Epic, and others, would probably be allowed to use their own payment systems in iPhone apps and perhaps even offer alternative app stores. Both would put pressure on the profitability of Apple’s services business, of which the app store is a large part—estimates put its margins at well above 70%.Yet legal experts expect Apple to prevail: antitrust precedent is stacked against Epic and the judge has voiced scepticism about the firm’s position. Even if she indeed sides with Apple, however, the victory may well turn out to be a setback. It would add further fuel to a debate among regulators around the world: how durably to rein in the biggest tech firms, which are increasingly seen not just as powerful platforms, but as gatekeepers for growing parts of the economy.Gatekeepers are as old as the economy itself. Toll bridges qualify, as do railways and even nationwide supermarket chains such as Walmart. Nor are they necessarily bad. Without Apple’s largely effective policing of its platform, the app business would be much smaller: users would have to worry much more about scams and system crashes. And allowing rival app stores, which Epic wants, may increase competition, but risks causing security problems.Digital gatekeepers come with drawbacks, too, says Tommaso Valletti of Imperial College in London. For starters, they never seem to stop growing, as last week’s round of blockbuster financial results again shows, although pandemic-induced digital demand also played a big role (see chart). Gatekeepers benefit from strong network effects which mean that size begets size. As the economy becomes more digitised, they can also move more easily into adjacent markets than their analogue brethren.The bigger problem is, however, that digital gatekeepers are not the benevolent dictators they pretend to be. To protect its commission (or “take rate”) of up to 30%, Apple forces app developers to use its payment system and prohibits any links to their websites, where they might offer a better deal. This is the core complaint in another case against the iPhone-maker, brought by Spotify, an audio-streaming service, and taken up by the European Commission on April 30th. Apple’s rule book is also getting hellishly complex and seems arbitrarily enforced. “Every developer can tell a horror story,” says Benedict Evans, who publishes a widely read tech newsletter.In its defence, Apple argues that it is well within its rights: it built the app store and, crucially, is not a monopoly. If developers do not like the rules, they can go to Android’s Play Store or create an app that runs in a browser. Not so, counter the firm’s critics. Any developer that wants to make good money needs to be in the App Store. As for consumers, switching from an iPhone to an Android device is in most cases tricky. And in America the iPhone is now dominant, boasting a market share of nearly two-thirds.Such back and forth about the “relevant market” and other wonkish concepts is at the centre of most antitrust cases. In Epic’s suit against Apple, predicts William Kovacic of George Washington University, this will be enlightening: arguments have to be made in public over a few weeks. But most other cases drag on for ever. And once a verdict is finally reached and a remedy is found, it is often too late, as the European Commission in particular has found in recent years. It has convicted Alphabet, Google’s parent company, three times, imposed fines of more than €8bn ($10bn) and demanded far-reaching remedies—only to see that not much has changed. Although European Android users are now asked to pick their default search engine on a “choice screen”, Google’s market share has hardly budged.Understandably, the commission is now trying to go down another path. Proposed in December, its Digital Markets Act (DMA) avoids lengthy debates about such things as the “relevant market” by explicitly defining a gatekeeper: firms that have annual revenues in the EU of at least €6.5bn in the past three financial years and have at least 45m users in at least three member states. Any company that meets these criteria will have to follow a set of strict rules. Among many other things, barring app developers from linking to their own website would be prohibited, as would be efforts by gatekeepers to give their own offerings a leg up (which Apple stands accused of doing with its music-streaming service).Although they think along similar lines, regulators in other countries are not as convinced a thick rule book will do the trick. Britain, for instance, is likely to go for more flexibility, paired with a strong regulatory agency, called the Digital Markets Unit (DMU). In America the Federal Trade Commission could become a DMU, although Congress may yet turn growing bipartisan tech hostility into action and pass a DMA-like law.It will still take several years before this is settled, but it would come as a surprise if digital gatekeepers, like many of their analogue predecessors, do not end up regulated in some way. Even if it wins its fight with Epic, Apple may want to start changing some of its policies. This may be good business anyway, Bill Gurley, a noted venture capitalist in Silicon Valley, has long argued. Maximising the take rate may backfire because it tends to weaken a platform, he wrote a few years back in a blog post. “There is a big difference between what you can extract versus what you should extract.” More

THE ANNUAL shareholders’ meeting of Berkshire Hathaway has been dubbed “Woodstock for capitalists”, so large is the throng it usually attracts. For the second year running, though, thanks to covid-19, the groupies have been denied their close-up love-in with Warren Buffett. The event on May 1st was online only, with Mr Buffett joined on screen by his longtime sidekick and fellow nonagenarian, Charlie Munger—a headline act that makes the Rolling Stones look like striplings. Nevertheless, Warren and Charlie outdid Mick and Keith for stamina, taking more than three hours of questions, covering everything from Berkshire’s first-quarter results, announced earlier that day, to the ways in which its subsidiaries do and don’t resemble children.Mr Buffett has long held the stage as the world’s most celebrated investor, having turned a troubled textile firm purchased in the mid-1960s into a $630bn conglomerate spanning everything from railways and real estate to insurance and ice-cream parlours. Berkshire, which is essentially made up of two halves—a collection of owned or controlled businesses employing 360,000 people, and a $300bn portfolio of minority stakes in blue chips—has done long-term investors proud. Over the 56 years of Mr Buffett’s stewardship its stock has enjoyed a compounded annual gain of 20%, double that of the S&P 500 index (including dividends).Berkshire’s more recent record looks less stellar, however—leaving some wondering if the company, like the Rolling Stones, is trading on its back catalogue, its greatest hits a thing of the distant past. That prompts another concern. At 90, Mr Buffett is still sharp and seemingly in good health. But no one lives forever. A change of front man, when it comes, will be a test of the endurance of Berkshire’s unique culture and its quirky (some would say anachronistic) governance.It will also test whether the sprawling group can remain in one piece at a time when conglomerates are out of fashion. Berkshire has long enjoyed a sort of corporate exceptionalism, thanks to the halo over Mr Buffett. With disquiet growing over so-so returns, poor disclosure and more, that benefit of the doubt looks threatened.You got the silverStart with the financial performance. Operating profit—the number Mr Buffett urges shareholders to focus on—fell by 9% in 2020, to $22bn, after a flat 2019 (though it rebounded in the latest quarter, up 20% year on year). Berkshire’s shares badly underperformed the S&P 500 index in both years. Over the past ten years, its per-share market value has handily beaten the index just twice, while lagging far behind it four times. In truth, Berkshire’s performance relative to the S&P has been slipping for decades (see chart 1).This loss of oomph is partly explained by the law of large numbers; the bigger Berkshire grows, the harder it is for any single successful investment to move the needle. Another factor is the dwindling of a past advantage. Berkshire has long used the float (premiums not paid out as claims) from its giant insurer, Geico, to funnel low-cost capital to its other operations. But these days capital is cheap for everyone.Some wounds have been self-inflicted, however. Big bets on Occidental Petroleum and Kraft Heinz soured quickly. The consumer-goods giant, of which Berkshire owns 26.6%, is weighed down by $28bn of debt and bloated goodwill after a mispriced merger in 2015. Mr Buffett has admitted to overpaying for Precision Castparts, an industrial-parts maker that Berkshire bought in 2016, which subsequently triggered an $11bn write-down. Some of his timing has looks awry, too. Having built a big position in American airline stocks, Berkshire bulked up on more at the start of 2020, but lost its nerve as the pandemic spread, quickly dumping its holdings and crystallising a loss of perhaps $3bn-4bn. Within months the sector’s share prices had rebounded. Indeed, the past year has given the lie to the received wisdom that Mr Buffett thrives in adversity. That was certainly true during the financial crisis of 2007-09, when Berkshire acted as an investor of last resort, striking highly lucrative deals to bail out GE and Goldman Sachs; the GE investment yielded a 50% return, most of it within three years. This time, though, with market liquidity less constrained, Berkshire has had less opportunity to pounce. Nor has it been able to find an acquisition that is both good value and big enough to move that needle. Identifying “elephants” on which it could spend a sizeable part of its $145bn cash pile has become a parlour game in investment circles. When covid-19 first struck, many thought Mr Buffett would be spoilt for choice. But buoyant stockmarkets mean fewer bargains for value investors like him to snaffle up. And Mr Buffett eschews corporate auctions because they often involve paying big premiums.Another turn-off is increased competition from private equity and SPACs. Berkshire’s biggest deal of 2020 was more bolt-on than blockbuster: the $10bn purchase of a gas-pipeline operator by its utility, Berkshire Hathaway Energy (BHE). That was less than half of what Berkshire spent over the year on buying back its own shares. (It has sharply increased buybacks over the past two years in response to calls for it to deploy more unspent capital, though the non-payment of a dividend remains a sacred cow.)Perhaps the clearest sign that Berkshire may have lost its touch when it comes to finding attractive targets was the rapid in-and-out of Bill Ackman. The star hedge-fund manager, a lifelong Buffett fan, built a $1bn position in Berkshire in 2019 but had fully sold out by mid-2020, apparently after concluding he could find overlooked gems more effectively himself.Berkshire has also taken flak for largely missing out on the tech boom of the past decade owing to Mr Buffett’s preference for mature businesses. There is one glaring exception, though: its 5.4% stake in Apple, which has produced a whopping $90bn gain over five years. Moreover, the economic pendulum may be swinging back towards the sort of industrial firms he favours: they should benefit from trillions of federal dollars earmarked for infrastructure upgrades as the economy recovers from the pandemic. BNSF, Berkshire’s railway network, can expect to profit as more heavy stuff needs shifting around for all these projects.Some investors have grown increasingly vocal in pressing Berkshire to eke out more from its main divisions. Mr Buffett has described BNSF as one of the conglomerate’s four “jewels”, along with Geico, BHE and the Apple stake. But when Mr Ackman crunched the numbers in 2019, he found the railway’s operating margins to be five percentage points below the average of its peers. Geico has many virtues, including making a profit on its underwriting most years (unlike many rivals, which rely on investment gains to offset underwriting losses). But its margins, and its use of analytics, lag behind those of an arch-rival, Progressive.Shine a lightThe answer, says one large investor, is for Mr Buffett to be more hands-on with subsidiaries. That, though, would go against the grain of the idiosyncratic management structure and governance long in place. Division bosses are given almost total autonomy; it is not unheard of for them to go months without speaking to Mr Buffett. Berkshire’s head office is tiny, with just 26 people; subsidiaries have their own legal, accounting and human-resources departments. They report to head office, but it reports little to the outside world. Berkshire does not hold analyst calls or investor days. It gives out scant financial information beyond mandatory filings, says Meyer Shields, an analyst with KBW (who has long been shut out of Berkshire’s annual conclave because of his sceptical views).Mr Buffett is proud of being different. Whereas other big companies have moved to a command-and-control approach, Berkshire’s remains rooted in trust: he trusts the divisions to get on with it, and shareholders are expected to trust that he will make more right calls than wrong ones. This approach is increasingly at odds with corporate trends. At this year’s AGM, Berkshire faced shareholder proposals on its skimpy climate-risk disclosure and diversity policies (though both were defeated). It is also under fire over executive pay, which at Berkshire is heavily weighted to base salary, owing to Mr Buffett’s long-held suspicion that stock incentives encourage managers to manipulate the share price. Big proxy-advisory firms like ISS have backed some of these criticisms. Some have also taken aim at the board for being too old (four of its 14 members are 90 or over), too entrenched and too close to the boss. Berkshire has become a “very attractive lightning rod”, says Lawrence Cunningham of George Washington University, who has written several books about Mr Buffett.Mr Buffett has little time for ESG metrics, diversity targets and the like. He has said he doesn’t want his managers to have to spend their time “responding to questionnaires or trying to score better with somebody that is working on that”. A lot of what is considered good governance today doesn’t fit with Berkshire’s heavily decentralised approach.Even if so, pressure for change is growing, and is likely to intensify further once Mr Buffett no longer calls the shots. Berkshire has not disclosed its succession plan, but no one doubts the next CEO will come from within. The favourite is Greg Abel, 58, who oversees the non-insurance operations; his odds shortened on Saturday when Mr Munger, in an apparent slip, said “Greg will keep the culture”. Mr Buffett’s role as chairman is set to go to his son, Howard. His third role, as investment chief, will probably go to one of the group’s two top equity-portfolio managers, Todd Combs and Ted Weschler.Though it will be more diffuse, the post-Buffett leadership is unlikely to be any less dedicated to his way of doing things. All of the contenders are steeped in Buffett-think. “They’ve done all they reasonably can to ensure things stay the same,” says Mr Cunningham.The most forceful efforts to impose change may come from those seeking to break up Berkshire. When he is gone, Mr Buffett conceded last year, “everybody in the world will come around and propose something, and say it’s wonderful for shareholders, and by the way it involves huge fees.” Some on Wall Street would see it as a coup to “release value” by, for instance, splitting the conglomerate into three bits, focused on insurance, industrial assets and consumer businesses.Few doubt that Berkshire trades at less than the sum of its parts. But even the sceptical Mr Shields thinks the discount is only around 5% Others think it may rise above 10% once its leader departs. Mr Buffett insists that a well-run conglomerate has enduring advantages. One is not being associated with a given industry, meaning it feels less pressure to maintain the status quo—“if horses had controlled investment decisions, there would have been no auto industry,” as he once put it.A crunchier benefit relates to tax: Berkshire can move capital between businesses or into new ventures without incurring any. And taxable income at one subsidiary can help generate tax credits at another. Mr Buffett has claimed this gives BHE a “major advantage” over rivals in developing wind and solar projects.On with the showHow vulnerable to centrifugal forces Berkshire proves to be will depend more than anything else on the composition of its shareholder base. Currently, it affords protection. The typical large American listed company is mostly owned by institutional investors. Berkshire is different. Mr Buffett has around 30% of the voting share; another 40% is held by an estimated 1m other individuals, many of them long-term loyalists (with whom he has spoken of having a “special kinship”); the rest is owned by institutions. If a vote were held today, it would overwhelmingly reject a break-up or wrenching strategic shift. Mr Buffett and his retail kinsmen may not form such a powerful block for much longer, however. Many of the loyalists are getting on in years. The children who inherit their shares may show less zeal. Even some of the faithful may sell once the Oracle of Omaha has gone. Moreover, Mr Buffett’s stake will be sold into the market after his death, albeit over more than a decade: he has bequeathed it to various foundations on condition that they sell the shares and spend the proceeds on good causes. Posthumous shifts in the shareholder base are Berkshire’s “Achilles heel”, reckons Mr Cunningham.As a keen student of corporate history, Mr Buffett will doubtless know that James J. Hill, a 19th-century railroad baron who led an operator that would later become part of BNSF, once declared that a company only has “permanent value” when it no longer depends on “the life or labour of any single individual”. Berkshire’s greatest challenges will come only after its grizzled rock star has left the stage.■ More