An elucidative look at what it means for market competitors to be like markets in themselves.
An old and enduring premise at economics is the value placed in the concept of competition and much of the prescriptive content of economics (the things that economic principles approve as appropriate action, policy or behavior) is aimed at telling the government, “Back off, buddy! We’ll manage this just fine without your intervention! Have you seen how awesome and shiny our market looks when you’re not around?” This is appropriate because governments famously want pieces from pies they weren’t really involved in baking and their many Leviathan teeth have to be slapped away from the pie before they can find a way to grab a bite (votes/money/favours) from it. Since people generally have a better idea than governments about what would make them happy, private enterprise and free market economies are more likely to keep them happy than centrally planned regulations. They end up getting what they want and not what the government thinks they want or should have.
This isn’t always the case though. Economists can be thick but they glorify rationality too much to not change their views in the face of evidence. While there have been terrible rows over the matter and close friendships have been broken forever, it is well-accepted today that unregulated markets do see the concentration of economic power in the hands of a few market players. Some still contend that this isn’t such a bad thing and it all gets better eventually because markets have the inherent tendency to correct themselves. Others are certain that when markets have fewer players it necessarily raises the possibility of harm being caused to the consumers because of the reduction in the number and quality of choices available and the prevalence of higher prices by monopolies. The latter group is regulated today in many countries by what is called competition or antitrust law. Competition agencies around the world work to ensure that, in each market within their respective jurisdictions, market power and unfair practices are not used to exclude competitors or entrants with potentially better products and services. Emphasis should be attributed to the point about the exclusion of better products because it will be important for what is to follow.
Here, we want to look at a particular case of competitive markets that has been fascinating economists for years: network industries. Trust me when I say that you already know what these creatures are. Economies today abound in network industries. Yes, social networks are the obvious guess but the list is pretty long: taxi cab aggregators, banks, share markets and other financial exchanges, technologies like VCR, software products like Skype, search engines, railway networks, electricity supply, internet service provision etc. What differentiates network industries from other industries is the occurrence of what is called “network effects”. Normally, when a product is purchased and used, the benefit or utility from the product is only experienced by one person: the very same consumer who consumed the product. What happens when the nature of a product is such that its usage results in benefits not just for the direct consumer but also for other consumers of that kind of product? This is exactly what happens when products are consumed in “networks”. The value of the product for each user is dependent on how many other users are using it at the same time. The value of Skype rises when more people use Skype. The value of Uber for cab drivers rises when more commuters use Uber to book their cabs. VCRs became more advantageous when media businesses started releasing more of their videos in cassettes. The more the people on social networks, the more advertisers will find them valuable as spaces for advertising. Catch the differences in these examples? Sometimes the value of the network rises for consumers when there are more consumers just like them (Skype). Sometimes it rises because of the production of more complementary products (video cassettes complementing VCRs). Sometimes it rises because a different kind of consumer is also participating in the network. This second kind of consumer may actually be a producer who wants to use the network to get easier access to his customers (Uber).
Sometimes a network’s value can suffer when there are more users: a negative network effect. For example, when too many users of a website reduce loading speeds because the servers become congested. For the initiated, it would be apparent that these phenomena are linked with the concepts of economies of scale and externalities.
The intrigue really ratchets up for networks when you realize that they could be turning the idea of competition on its head. Remember, a competitor in a network industry is making his product much more useful when he ensures that more and more users participate in the market. Would the enforcement of better competition strategies in the market lead to the network product to not be adopted by more and more users and would not become as useful as it could potentially be? Would the competition agency really cut the network competitor down to size even though the fundamental objective of competition law is ensuring the availability of more useful products? As experts have been saying since way back in 1999, network industries don’t really have to be treated differently when potentially better rival products are being eliminated right in front of you. Perhaps tech behemoths like Google and Facebook would have been replaced by now if they weren’t so voracious with their corporate acquisitions and intellectual property purchases. On the other hand, would we really enjoy an internet where everyone’s favourite search engine or social network is changing every month? Changing products takes effort and it might be a good thing that the vendor is locked-in as a result of our unanimous endorsement. It creates stability.
What do you want me to do? Make up my mind as to whether I’m on Google’s side or on the competition agencies’ side? My sincere apologies. I just wanted to throw questions at you, not answers. Questions about network economics are popping up at a bewildering pace. Even the whole of the net neutrality debate is only a fraction of the larger debate surrounding network competition. Think about it: ISPs are like Uber. The website designers are like the cab drivers looking for passengers. Internet users are like commuters. If Uber is allowed to discriminate between which cab drivers it will field on the app, why aren’t ISPs allowed to discriminate between which websites it wants to field for users? Perhaps the value of information, expression and speech is just more quality-sensitive and competition-sensitive than cab transport which is price-sensitive. Two-sided networks are like markets in themselves, simulating their own flavor of competition. And this means that a market in which networks are competing with each other is a market for markets. That’s right. No answers. Questions all the way.