The Rising Risk of Platform Regulation

Unless platform companies act now, regulation could erode the powerful network effects that drive their growth and benefit their users.

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On Oct. 6, 2020, the U.S. House Judiciary Committee’s antitrust subcommittee released a 450-page report following a 16-month inquiry into the digital economy. It recommended fundamental changes to antitrust laws generally and targeted the Amazon, Apple, Facebook, and Google technology platforms specifically.1 Several weeks later, the U.S. Department of Justice filed suit against Google, accusing it of using “anticompetitive tactics to maintain and extend its monopolies in the markets for general search services, search advertising and general search text advertising.”2 Similar regulatory initiatives aimed at platforms are underway around the world, including in the European Union, United Kingdom, Japan, Korea, and India.3

The blizzard of regulatory action swirling around platforms is producing new rules and laws, expanded powers for existing regulatory authorities, and the establishment of new regulatory authorities. These outcomes will not only affect Big Tech but also many other companies, in industries such as construction, health care, finance, energy, and industrial manufacturing, that have adopted or are considering adopting platform business models.

Few platform operators and owners have fully considered how the growing regulatory risk — which includes breakups, line-of-business restrictions, acquisition limits, and interoperability and data portability mandates — could derail their businesses. As a result, they could be caught off guard, just like many companies were caught off guard when the Sarbanes-Oxley Act of 2002 mandated board restructurings and expanded executive financial accountability in the aftermath of accounting scandals.4

The regulatory outcomes being proposed and adopted today could have varying degrees of impact on platform businesses. The most severe proposal in the House Judiciary Committee report would dictate a structural breakup, requiring “divestiture and separate ownership of each business.” This could unravel the network effects that drive platform growth and produce value. U.S. regulators have rarely pursued solutions this extreme, but there are notable exceptions, including the breakups of Standard Oil in 1911 and AT&T in 1984, and the attempted breakup of Microsoft, which settled with the DOJ in 2004. (It’s too early to say whether Google will join this list, but the DOJ complaint leaves open the possibility.)

A more likely outcome is the separation of platforms from the products and services sold on them, which some policymakers advocate to combat self-preferencing, a catchall term for actions that favor a platform owner’s offerings over those of its competitors. In its limited form, such a rule might restrict potential bias in search listings. In its extreme form, it could forbid vertical integration — a significant source of value in many platform models — by precluding a company from selling its own offerings on its platform, even when they offer superior value to users. In 2019, for example, India imposed a flat rule forbidding companies from owning more than 25% equity in any product sold on their platforms.5

Another outcome proposed in the House Judiciary Committee report is the forced sharing of commercial data with competitors, which is aimed at creating an even playing field by providing equal access to data. But giving competitors access to user data also entails privacy and security risks, including secondary misuse of data and ambiguities in accountability for data breaches.6

The report also recommends strict limits on the merger and acquisition activity of platform companies to prevent what the committee believes are anti-competitive activities, such as dictating prices and the rules of commerce in their markets. However, these limits can also hamper the ability of platforms to reach scale, to acquire new functionality that they can share with large pools of users, and to obtain the talent and capabilities needed if they are to innovate.

More generally, the House Judiciary Committee report proposes changing presumptions about how antitrust works in ways that would benefit plaintiffs — for example, by reducing the need to show causal harm (aka antitrust injury) to bring a claim. These presumptions, along with the extension of antitrust by adopting vague, noneconomic factors (such as “fairness”), could make many of the value-creating everyday business decisions currently made by platform operators (such as exclusive dealing, bundled offerings, and price cuts) more prone to antitrust litigation, fines, and other restrictions.

How should companies with platform businesses respond to the rising prospect of regulation? We suggest taking the following actions.

Internal Responses

Companies that own and operate platforms can forestall regulatory action and perhaps avoid the most draconian interventions by embracing self-regulation and shared governance. In doing so, they may be able to allay the fears of regulators without destroying the value-creating network effects on which they and their partners and users depend.

Toward this end, companies can erect firewalls between their platforms and their products by compartmentalizing employees and information into separate business units. Then they can offer third-party sellers the same competitive terms accorded to the walled-off product units. Google did this when, in response to a European Commission decision, it created equal access for its competitors by auctioning off positions in the shopping box adjacent to its search engine results.7

Companies also can offer their partners a role and a voice in the governance of platforms. The German software company SAP, for example, offers three tiers of platform access.8 The lowest tier provides access for apps that are vetted for security and compatibility. The middle tier represents products that SAP’s sales teams promote alongside SAP’s own products. The top tier of platform partners, who must be approved by SAP’s board, get a voice in determining platform strategy.

External Responses

Given that regulation can have such a powerful effect on markets and business results, platform companies should prepare to engage in the regulatory process as a more fundamental and integral element of business strategy. Toward this end, they should identify theories of value creation (platform effects that make society better off through more efficient outcomes) as distinct from theories of harm (platform effects that are detrimental to social welfare or competition) to better frame regulatory risks and their responses to regulatory initiatives.

To avoid regulations that could confer advantage on some platforms over others, companies should seek commercially neutral regulatory outcomes that allow them to compete on their merits. For example, the Glass-Steagall Act, which was repealed in 1999, forced banks to separate retail from investment banking. This reduced the advantage that integrated banks had in terms of access to funds, but it also reduced investment banks’ bets with depositor funds. Studies have shown that there was more banking competition and that bank customers were better off both before Glass-Steagall was enacted and after it was repealed.9

Moreover, lobbying efforts should seek to promote regulation that’s narrowly targeted. Focused regulation can improve markets. In the EU, for example, a revised Payment Services Directive enables open banking by giving consumers more control over who can access their accounts. But overly broad regulation can distort markets. For example, the General Data Protection Regulation has made it harder for small advertisers to compete with larger ones and reduced investment funds available to technology startups.10

New regulations do not always work as intended. Nor do existing regulations, especially when they misapprehend new business models. The taxi industry, with its monopoly on medallions, clearly suffered from regulatory capture that drove up prices for drivers and riders until ride-sharing platforms arrived with expanded services and lower prices.11 Platform businesses and companies that want to build platforms can avoid these problems by using internal firewalls and shared governance to reduce bias and the need for regulation, and by identifying new external sources of value and highlighting specific market distortions to shape the ways and means of regulation.

Topics

References

1. U.S. House Committee on the Judiciary, “Investigation of Competition in Digital Markets” (Washington, D.C.: Government Printing Office, 2020).

2. C. Kang, D. McCabe, and D. Wakabayashi, “U.S. Accuses Google of Illegally Protecting Monopoly,” The New York Times, Oct. 20, 2020, www.nytimes.com.

3. J. Espinoza, “EU Targets Big Tech With ‘Hit List’ Facing Tougher Rules,” Financial Times, Oct. 11, 2020, www.ft.com; and “Andrea Coscelli Calls for New Digital Markets Regulatory Regime,” Gov.uk, Oct. 9, 2020; “Japan to Introduce Bill to Ensure Fair Online Business Competition,” Kyodo News, Nov. 12, 2019, https://english.kyodonews.net; S. Ji-hye, “Competition Laws Should Be More Flexible in Digital Era,” The Korea Herald, May 23, 2019, http://www.koreaherald.com; and M. Nandy and G.C. Prasad, “New Regulatory Regime for  E-commerce  Kicks In,” Mint, July 24, 2020, www.livemint.com.

4. P. Lanois, “The Legacy of the Sarbanes-Oxley Act, 15 Years On,” The CLS Blue Sky Blog, Feb. 9, 2017, http://clsbluesky.law.columbia.edu.

5.The Dark Side of India’s New Ecommerce Rules,” PYMNTS.com, Jan. 28, 2019, www.pymnts.com.

6. M.W. Van Alstyne and A. Lenart, “Using Data and Respecting Users,” Communications of the ACM 63, no. 11 (October 2020): 28-30.

7.Summary of Commission Decision of 27 June 2017 Relating to a Proceeding Under Article 102 of the Treaty on the Functioning of the European Union and Article 54 of the EEA Agreement,” Official Journal of the European Union, Jan. 12, 2018, https://eur-lex.europa.eu.

8. M. Iansiti and K.R. Lakhani, “SAP AG: Orchestrating the Ecosystem,” Harvard Business School case no. 609-069 (Boston: Harvard Business School Publishing, 2009).

9. R.S. Kroszner and R.G. Rajan, “Is the Glass-Steagall Act Justified? A Study of the U.S. Experience with Universal Banking Before 1933,” The American Economic Review 84, no. 4 (September 1994): 810-832; and D. Neuhann and F. Saidi, “Do Universal Banks Finance Riskier but More Productive Firms?” Journal of Financial Economics 128, no. 1 (April 2018): 66-85.

10. J. Davies, “The Impact of GDPR, in 5 Charts,” Digiday, Aug. 24, 2018, https://digiday.com; and J. Jia, G.Z. Jin, and L. Wagman, “The Short-Run Effects of GDPR on Technology Venture Investment,” SSRN, March 5, 2019, https://papers.ssrn.com.

11. R. Collier, V. Dubal, and C. Carter, “Disrupting Regulation, Regulating Disruption: The Politics of Uber in the United States,” Perspectives on Politics 16, no. 4 (December 2018): 919-937.

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