Archives For Internet Monopolies

Policymakers’ recent focus on how Big Tech should be treated under antitrust law has been accompanied by claims that companies like Facebook and Google hold dominant positions in various “markets.” Notwithstanding the tendency to conflate whether a firm is large with whether it hold a dominant position, we must first answer the question most of these claims tend to ignore: “dominant over what?”

For example, as set out in this earlier Truth on the Market post, a recent lawsuit filed by various states and the U.S. Justice Department outlined five areas related to online display advertising over which Google is alleged by the plaintiffs to hold a dominant position. But crucially, none appear to have been arrived at via the application of economic reasoning.

As that post explained, other forms of advertising (such as online search and offline advertising) might form part of a “relevant market” (i.e., the market in which a product actually competes) over which Google’s alleged dominance should be assessed. The post makes a strong case for the actual relevant market being much broader than that claimed in the lawsuit. Of course, some might disagree with that assessment, so it is useful to step back and examine the principles that underlie and motivate how a relevant market is defined.

In any antitrust case, defining the relevant market should be regarded as a means to an end, not an end in itself. While such definitions provide the basis to calculate market shares, the process of thinking about relevant markets also should provide a framework to consider and highlight important aspects of the case. The process enables one to think about how a particular firm and market operates, the constraints that it and rival firms face, and whether entry by other firms is feasible or likely.

Many naïve attempts to define the relevant market will limit their analysis to a particular industry. But an industry could include too few competitors, or it might even include too many—for example, if some firms in the industry generate products that do not constitute strong competitive constraints. If one were to define all cars as the “relevant” market, that would imply that a Dacia Sandero (a supermini model produced Renault’s Romanian subsidiary Dacia) constrains the price of Maserati’s Quattroporte luxury sports sedan as much as the Ferrari Portofino grand touring sports car does. This is very unlikely to hold in reality.[1]

The relevant market should be the smallest possible group of products and services that contains all such products and services that could provide a reasonable competitive constraint. But that, of course, merely raises the question of what is meant by a “reasonable competitive constraint.” Thankfully, by applying economic reasoning, we can answer that question.

More specifically, we have the “hypothetical monopolist test.” This test operates by considering whether a hypothetical monopolist (i.e., a single firm that controlled all the products considered part of the relevant market) could profitably undertake “a small but significant, non-transitory, increase in price” (typically shortened as the SSNIP test).[2]

If the hypothetical monopolist could profitably implement this increase in price, then the group of products under consideration is said to constitute a relevant market. On the other hand, if the hypothetical monopolist could not profitably increase the price of that group of products (due to demand-side or supply-side constraints on their ability to increase prices), then that group of products is not a relevant market, and more products need to be included in the candidate relevant market. The process of widening the group of products continues until the hypothetical monopolist could profitably increase prices over that group.

So how does this test work in practice? Let’s use an example to make things concrete. In particular, let’s focus on Google’s display advertising, as that has been a significant focus of attention. Starting from the narrowest possible market, Google’s own display advertising, the HM test would ask whether a hypothetical monopolist controlling these services (and just these services) could profitably increase prices of these services permanently by 5% to 10%.

At this initial stage, it is important to avoid the “cellophane fallacy,” in which a monopolist firm could not profitably increase its prices by 5% to 10% because it is already charging the monopoly price. This fallacy usually arises in situations where the product under consideration has very few (if any) substitutes. But as has been shown here, there are already plenty of alternatives to Google’s display-advertising services, so we can be reasonably confident that the fallacy does not apply here.

We would then consider what is likely to happen if Google were to increase the prices of its online display advertising services by 5% to 10%. Given the plethora of other options (such as Microsoft, Facebook, and customers have for obtaining online display ads, a sufficiently high number of Google’s customers are likely to switch away, such that the price increase would not be profitable. It is therefore necessary to expand the candidate relevant market to include those closest alternatives to which Google’s customers would switch.

We repeat the exercise, but now with the hypothetical monopolist also increasing the prices of those newly included products. It might be the case that alternatives such as online search ads (as opposed to display ads), print advertising, TV advertising and/or other forms of advertising would sufficiently constrain the hypothetical monopolist in this case that those other alternatives form part of the relevant market.

In determining whether an alternative sufficiently constrains our hypothetical monopolist, it is important to consider actual consumer/firm behavior, rather than relying on products having “similar” characteristics. Although constraints can come from either the demand side (i.e., customers switching to another provider) or the supply side (entry/switching by other providers to start producing the products offered by the HM), for market-definition purposes, it is almost always demand-side switching that matters most. Switching by consumers tends to happen much more quickly than does switching by providers, such that it can be a more effective constraint. (Note that supply-side switching is still important when assessing overall competitive constraints, but because such switching can take one or more years, it is usually considered in the overall competitive assessment, rather than at the market-definition stage.)

Identifying which alternatives consumers do and would switch to therefore highlights the rival products and services that constrain the candidate hypothetical monopolist. It is only once the hypothetical monopolist test has been completed and the relevant market has been found that market shares can be calculated.[3]

It is at that point than an assessment of a firm’s alleged market power (or of a proposed merger) can proceed. This is why claims that “Facebook is a monopolist” or that “Google has market power” often fail at the first hurdle (indeed, in the case of Facebook, they recently have.)

Indeed, I would go so far as to argue that any antitrust claim that does not first undertake a market-definition exercise with sound economic reasoning akin to that described above should be discounted and ignored.

[1] Some might argue that there is a “chain of substitution” from the Maserati to, for example, an Audi A4, to a Ford Focus, to a Mini, to a Dacia Sandero, such that the latter does, indeed, provide some constraint on the former. However, the size of that constraint is likely to be de minimis, given how many “links” there are in that chain.

[2] The “small but significant” price increase is usually taken to be between 5% and 10%.

[3] Even if a product or group of products ends up excluded from the definition of the relevant market, these products can still form a competitive constraint in the overall assessment and are still considered at that point.

There are some who view a host of claimed negative social ills allegedly related to the large size of firms like Amazon as an occasion to call for the company’s break up. And, unfortunately, these critics find an unlikely ally in President Trump, whose tweet storms claim that tech platforms are too big and extract unfair rents at the expense of small businesses. But these critics are wrong: Amazon is not a dangerous monopoly, and it certainly should not be broken up.  

Of course, no one really spells out what it means for these companies to be “too big.” Even Barry Lynn, a champion of the neo-Brandeisian antitrust movement, has shied away from specifics. The best that emerges when probing his writings is that he favors something like a return to Joe Bain’s “Structure-Conduct-Performance” paradigm (but even here, the details are fuzzy).

The reality of Amazon’s impact on the market is quite different than that asserted by its critics. Amazon has had decades to fulfill a nefarious scheme to suddenly raise prices and reap the benefits of anticompetive behavior. Yet it keeps putting downward pressure on prices in a way that seems to be commoditizing goods instead of building anticompetitive moats.

Amazon Does Not Anticompetitively Exercise Market Power

Twitter rants aside, more serious attempts to attack Amazon on antitrust grounds argue that it is engaging in pricing that is “predatory.” But “predatory pricing” requires a specific demonstration of factors — which, to date, have not been demonstrated — in order to justify legal action. Absent a showing of these factors, it has long been understood that seemingly “predatory” conduct is unlikely to harm consumers and often actually benefits consumers.

One important requirement that has gone unsatisfied is that a firm engaging in predatory pricing must have market power. Contrary to common characterizations of Amazon as a retail monopolist, its market power is less than it seems. By no means does it control retail in general. Rather, less than half of all online commerce (44%) takes place on its platform (and that number represents only 4% of total US retail commerce). Of that 44 percent, a significant portion is attributable to the merchants who use Amazon as a platform for their own online retail sales. Rather than abusing a monopoly market position to predatorily harm its retail competitors, at worst Amazon has created a retail business model that puts pressure on other firms to offer more convenience and lower prices to their customers. This is what we want and expect of competitive markets.

The claims leveled at Amazon are the intellectual kin of the ones made against Walmart during its ascendancy that it was destroying main street throughout the nation. In 1993, it was feared that Walmart’s quest to vertically integrate its offerings through Sam’s Club warehouse operations meant that “[r]etailers could simply bypass their distributors in favor of Sam’s — and Sam’s could take revenues from local merchants on two levels: as a supplier at the wholesale level, and as a competitor at retail.” This is a strikingly similar accusation to those leveled against Amazon’s use of its Seller Marketplace to aggregate smaller retailers on its platform.

But, just as in 1993 with Walmart, and now with Amazon, the basic fact remains that consumer preferences shift. Firms need to alter their behavior to satisfy their customers, not pretend they can change consumer preferences to suit their own needs. Preferring small, local retailers to Amazon or Walmart is a decision for individual consumers interacting in their communities, not for federal officials figuring out how best to pattern the economy.

All of this is not to say that Amazon is not large, or important, or that, as a consequence of its success it does not exert influence over the markets it operates in. But having influence through success is not the same as anticompetitively asserting market power.

Other criticisms of Amazon focus on its conduct in specific vertical markets in which it does have more significant market share. For instance, a UK Liberal Democratic leader recently claimed that “[j]ust as Standard Oil once cornered 85% of the refined oil market, today… Amazon accounts for 75% of ebook sales … .”

The problem with this concern is that Amazon’s conduct in the ebook market has had, on net, pro-competitive, not anti-competitive, effects. Amazon’s behavior in the ebook market has actually increased demand for books overall (and expanded output), increased the amount that consumers read, and decreased the price of theses books. Amazon is now even opening physical bookstores. Lina Khan made much hay in her widely cited article last year that this was all part of a grand strategy to predatorily push competitors out of the market:

The fact that Amazon has been willing to forego profits for growth undercuts a central premise of contemporary predatory pricing doctrine, which assumes that predation is irrational precisely because firms prioritize profits over growth. In this way, Amazon’s strategy has enabled it to use predatory pricing tactics without triggering the scrutiny of predatory pricing laws.

But it’s hard to allege predation in a market when over the past twenty years Amazon has consistently expanded output and lowered overall prices in the book market. Courts and lawmakers have sought to craft laws that encourage firms to provide consumers with more choices at lower prices — a feat that Amazon repeatedly accomplishes. To describe this conduct as anticompetitive is asking for a legal requirement that is at odds with the goal of benefiting consumers. It is to claim that Amazon has a contradictory duty to both benefit consumers and its shareholders, while also making sure that all of its less successful competitors also stay in business.

But far from creating a monopoly, the empirical reality appears to be that Amazon is driving categories of goods, like books, closer to the textbook model of commodities in a perfectly competitive market. Hardly an antitrust violation.

Amazon Should Not Be Broken Up

“Big is bad” may roll off the tongue, but, as a guiding ethic, it makes for terrible public policy. Amazon’s size and success are a direct result of its ability to enter relevant markets and to innovate. To break up Amazon, or any other large firm, is to punish it for serving the needs of its consumers.

None of this is to say that large firms are incapable of causing harm or acting anticompetitively. But we should accept calls for dramatic regulatory intervention  — especially from those in a position to influence regulatory or market reactions to such calls — to be supported by substantial factual evidence and legal and economic theory.

This tendency to go after large players is nothing new. As noted above, Walmart triggered many similar concerns thirty years ago. Thinking about Walmart then, pundits feared that direct competition with Walmart was fruitless:

In the spring of 1992 Ken Stone came to Maine to address merchant groups from towns in the path of the Wal-Mart advance. His advice was simple and direct: don’t compete directly with Wal-Mart; specialize and carry harder-to-get and better-quality products; emphasize customer service; extend your hours; advertise more — not just your products but your business — and perhaps most pertinent of all to this group of Yankee individualists, work together.

And today, some think it would be similarly pointless to compete with Amazon:

Concentration means it is much harder for someone to start a new business that might, for example, try to take advantage of the cheap housing in Minneapolis. Why bother when you know that if you challenge Amazon, they will simply dump your product below cost and drive you out of business?

The interesting thing to note, of course, is that Walmart is now desperately trying to compete with Amazon. But despite being very successful in its own right, and having strong revenues, Walmart doesn’t seem able to keep up.

Some small businesses will close as new business models emerge and consumer preferences shift. This is to be expected in a market driven by creative destruction. Once upon a time Walmart changed retail and improved the lives of many Americans. If our lawmakers can resist the urge to intervene without real evidence of harm, Amazon just might do the same.

[Cross posted at Technology Liberation Front]

We’ve been reading with interest a bit of an blog squabble between Tim Wu and Adam Thierer ( see here and here) set off by Professor Wu’s WSJ column: “In the Grip of the New Monopolists.”  Wu’s column makes some remarkable claims, and, like Adam, we find it extremely troubling.

Wu starts off with some serious teeth-gnashing concern over “The Internet Economy”:

The Internet has long been held up as a model for what the free market is supposed to look like—competition in its purest form. So why does it look increasingly like a Monopoly board? Most of the major sectors today are controlled by one dominant company or an oligopoly. Google “owns” search; Facebook, social networking; eBay rules auctions; Apple dominates online content delivery; Amazon, retail; and so on.

There are digital Kashmirs, disputed territories that remain anyone’s game, like digital publishing. But the dominions of major firms have enjoyed surprisingly secure borders over the last five years, their core markets secure. Microsoft’s Bing, launched last year by a giant with $40 billion in cash on hand, has captured a mere 3.25% of query volume (Google retains 83%). Still, no one expects Google Buzz to seriously encroach on Facebook’s market, or, for that matter, Skype to take over from Twitter. Though the border incursions do keep dominant firms on their toes, they have largely foundered as business ventures.

What struck us about Wu’s column was that there was not even a thin veil over the “big is bad” theme of the essay.  Holding aside complicated market definition questions about the markets in which Google, Twitter, Facebook, Apple, Amazon and others upon whom Wu focuses operate — that is, the question of whether these firms are actually “monopolists”  or even “near monopolists”–a question that Adam deals with masterfully in his response (in essence: There is a serious defect in an analysis of online markets in which Amazon and eBay are asserted to be non-competitors, monopolizing distinct sectors of commerce) — the most striking feature of Wu’s essay was the presumption that market concentration of this type leads to harm. Continue Reading…