With Big Tech Bracing for Antitrust Legislation, Here’s What You Need to Know about the Economics of Digital Platforms
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Efforts to break up the world’s tech giants are mounting and won’t slow down anytime soon
This year will mark a turning point for large tech platforms and how they do business, with numerous bills moving through Congress, a new FTC chair and DOJ antitrust head on record for challenging Big Tech practices, ongoing cases against Facebook and Google, and aggressive actions by the EU and other countries.
Born out of heightened scrutiny of Big Tech and a 16-month investigation by a House subcommittee into the competitive practices of prevailing tech giants—which concluded that several hold monopoly power—new regulatory pressures take aim at stifling anticompetitive mergers, preventing conflicts of interest, and stopping perceived discriminatory behaviors that may hamper competitors to the platforms. The American Innovation and Choice Online Act, for instance, would set new restrictions on how large digital platforms can “unfairly promote themselves and disadvantage rivals.” The bill has gained considerable momentum and, if passed, would represent a significant change to antitrust law.
Even if the bill doesn’t pass, the spotlight on Big Tech won’t dissipate anytime soon. Current legislation is surprisingly bipartisan in its efforts to address the unique challenges Congress and regulatory agencies believe many prominent digital platforms pose to fair competition in digital markets. One report found that a majority of Americans believe these companies don’t act responsibly and should be regulated.
Given the potential for such drastic shifts on the horizon, it’s crucial that policymakers, market participants, and industry observers understand how digital platforms have been defined historically, the benefits they provide, and, consequently, the implications of efforts to redefine them.
Defining platforms
The basis of much of the current antitrust legislation and investigation stems from a perspective that certain types of digital platforms have become too dominant—and thereby undermine competition, hamper innovation, and harm consumers. But what do we mean when we say “platforms”?
The Supreme Court provides one answer. In a 2018 decision, Ohio et al. v. American Express Co. et al., the court’s recognition of platform markets was essential to its holding that American Express’s anti-steering provisions, which prevented merchants from attempting to dissuade consumers from using Amex cards at point of sale, were not anticompetitive. The court stated that “a two-sided platform offers different products or services to two different groups who both depend on the platform to intermediate between them.”
Substantial economics literature supports this notion of a two- or multi-sided platform. David Evans and Richard Schmalensee define platforms as:
(a) two or more groups of customers; (b) who need each other in some way; (c) but who cannot capture the value from their mutual attraction on their own; and (d) rely on the catalyst to facilitate value-creating interactions between them.
It follows that platforms emerge when economic frictions exist between potential partners in an economic exchange (i.e., between two or more “sides” of a market). These frictions create transaction costs that, without the platform, make the economic exchange cost-prohibitive.
Several tech giants neatly fit into this definition. But this understanding of platform competition extends beyond the names we immediately associate with Big Tech. For example, a shopping mall is a platform that historically has connected—and provided value to—both customers and shops.
Platforms versus single-sided markets*
Several key differences exist between multi-sided platforms and firms in single-sided markets.
In this diagram of a firm in a single-sided market, a supplier sells goods or services to a retailer, which resells these goods or services to the ultimate customer:
Another type of firm in a single-sided market, such as a local bakery, is vertically integrated. The diagram below depicts how such firms control or “own” the supply of an input; e.g., a local baker makes cakes from raw materials and sells cakes directly to the ultimate customer:
In contrast, the diagram below depicts a platform in a multi-sided market. Platforms like Amazon, eBay, or Google take in and distribute information to different groups to facilitate those groups’ direct interaction:
The benefits of platforms
Platforms offer significant benefits to consumers and, in some cases, small and individual market entrants. Along with the overarching value of connecting two or more groups noted above, key benefits identified by the economic literature include:
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Usage externalities (e.g., reduced transaction costs). A usage externality exists when two users must act together to create value. Platforms generate usage externalities by reducing transaction costs and facilitating value-creating interactions among platform users. Platforms also increase value by improving the quality of the matches between users.
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Easier market entry. As a report based on an FTC workshop studying platforms put it, reduced transaction costs encountered by small or individual entities “mak[e] it possible for them to enter a market and provide a service” (think: someone starting a jewelry business via an online marketplace). Additionally, platforms “facilitate entry by assembling and providing information needed to begin service, supplying necessary inputs (e.g., insurance), and taking steps to reduce other challenges facing small entities.”
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Network effects. Oxford economist Mark Armstrong’s definition of a platform emphasizes that it is an intermediary, facilitating interactions of two groups of agents where the benefit to one group from joining the platform depends on the size of the other group on that platform. Indirect network effects exist when the benefit to users of one side (e.g., side A) depends on the number of users on the other side of the platform (e.g., side B), whose benefit in turn depends on the number of users on side A.
Large tech firms aren’t the only ones who often exhibit indirect network effects; shopping malls are platforms that provide these effects as well. The more retail stores there are in a shopping mall, the more likely a consumer is to visit such a mall, and retailers are more likely to locate in a mall visited by a greater number of consumers.
The road ahead
In general, the concerns around platforms revolve around Big Tech firms self-preferencing their products on their platforms at the expense of competitors and creating barriers to entry for new and potential competitors. As momentum for tech antitrust legislation and challenges to specific practices continue, regulators likely will posit that Big Tech’s digital platforms are stifling consumer choice and competition; Big Tech will counter that new laws and challenges will raise prices and stifle innovation.
Understanding how platforms are defined and what benefits they provide offers important context to these conversations, particularly as each side assesses the potential trade-offs that inevitably will come with new regulations and challenges to current practices.
* Figures adapted from Andrei Hagiu and Julian Wright, “Multi-sided platforms” International Journal of Industrial Organization 43:1 (2015): 162–174.
