The leading tech giants – such as Apple, Amazon, Facebook, and Google – explicitly set out to disrupt much of the world’s industrial and social status quo. They have now succeeded (I suspect) beyond their own wildest dreams, and probably beyond what some of their founders would have wished, considering the baneful effects that social media have had on democratic elections.
Given the scale and scope of these firms’ impact on our societies, it is no surprise that they inspire both hope and fear in the public consciousness. But one thing is clear: A small cohort of technology firms now guards the door to the modern economy. That today’s information-technology markets are highly concentrated is beyond dispute. In most cases, a single company dominates a given market. There is nothing abnormal about this, as users are prone to flocking to just one or two platforms, depending on the service. But there are still legitimate grounds for concern about whether competition is functioning properly.
There are two reasons why digital markets are so concentrated. The first is a network externality: We need to be on the same network as the person with whom we want to interact. That is Facebook’s business model, and no one can doubt its success, at least insofar as the company’s interests are concerned. If our friends are on Facebook, we need to be there, too, even if we would really prefer another social network.
When the telephone was invented, competition among (non-interconnected) networks in every country with a phone system ended with a monopoly. Again, this was not abnormal. Users wanted to be able to call one another easily, so they naturally congregated on a single platform. When competition was reintroduced into the telephone industry in the 1980s and 1990s, it was necessary that the networks be interconnected, so that a user on one had access to them all. Without regulation, incumbent operators would not have granted such access to new, smaller entrants. While it is cheaper and easier to patronize several social networks (to “multihome”) than multiple phone companies, it still requires coordination.
Network externalities can be direct, as in Facebook’s case, or indirect, as in the case of platforms for which many apps or games have been created. The more users there are on the platform, the more apps there will be, and vice versa. In other cases, the volume of users may determine the quality of the service, by allowing for better crowdsourced predictions. This is how both Google’s search engine and the navigation app Waze work. While competing search engines can match Google’s results for the most common queries, they do not have access to enough data to do so for more unusual search requests. Moreover, new services often require data, which users of existing services supply.
Thus, users on the dominant digital platforms benefit from the presence of other users on the same platform, even if there is no direct interaction among them. The same is true for city dwellers. Though they are almost all strangers to one another, the presence of other city dwellers means more employment opportunities and easier job mobility – not to mention more bars, cinemas, and other amenities – than in less densely populated locations.
A PROBLEM OF SCALE
The second reason for the high level of concentration in digital markets is that the dominant firms benefit from economies of scale. Some services require large technological investments, and if that service is a search engine, then designing it will cost roughly the same regardless of whether it attracts two thousand or two trillion search requests per year. What will not be the same is the value of the user data that is generated. The search engine that receives two trillion requests can charge advertisers far more, and scale up far more quickly.
Hence, by dint of network effects and economies of scale, the digital economy almost inexorably creates “natural monopolies.” The online economy follows a winner-takes-all logic, albeit with different winners across sectors and time. The Internet browser market was dominated first by Netscape Navigator, then by Microsoft’s Internet Explorer, and now by Google Chrome.
There are exceptions, of course. Economies of scale and network externalities have not played a paramount role in the markets for digital music and movies, where there are a number of platforms, including Amazon Prime, Apple’s iTunes, Deezer, Spotify, Pandora, and Netflix. But these services are differentiated by their degree of interaction with the user.
ADAPTING POLICY TO NEW BUSINESS MODELS
Policymakers and regulators around the world must face the fact that the reasoning behind traditional competition measures is no longer valid. It is now common for a platform like Google or Facebook to set very low prices – or provide a service for free – on one side of the market and very high prices on the other side. This naturally creates suspicion among competition authorities. In traditional markets, such practices could well be regarded as a form of market predation that is meant to weaken or kill off a smaller competitor. By the same token, a very high price on the other side of the market could mean that monopoly power has been brought to bear.
Article published in Project Syndicate, January 9, 2019 - Copyright ©