62.In setting out its concerns about online platforms the European Commission focused on their market power and the implications of this for businesses and consumers: “The market power of some online platforms potentially raises concerns, particularly in relation to the most powerful platforms whose importance for other market participants is becoming increasingly critical”. It noted that as a result of their market power “some platforms can control access to online markets and can exercise significant influence over how various players in the market are remunerated.” The Commission suggested that its specific concerns—about data use, transparency, terms and conditions, and switching—were all different aspects of the largest platforms’ market power. This chapter considers whether the nature of online platforms, and the markets they operate in, is likely to lead to them acquiring substantial market power.
63.Market power is measured by competition authorities in order to determine whether a firm has a dominant position in a particular market, in which case it could potentially abuse that dominant position. Mr Chisholm, Chief Executive of the Competition and Markets Authority, described dominance as: “one’s ability to act without reference to one’s competitors or customers; to be able to dictate terms.”
64.Competition authorities assess market power through a complex process that involves considering a firm’s share of the relevant market, the costs consumers and businesses incur when trying to switch to alternative firms in the market, and the challenges new firms face when attempting to the enter the market. Guillaume Loriot, of DG Competition, told us: “The assessment of whether this platform—or company, indeed—has market power, whether it can be considered dominant, is an analysis that is performed on a case-by-case basis in light of the legal, economic and technical evidence that we have to gather … That depends on specific market features.”
65.Many witnesses suggested that ‘network effects’ were key to understanding how firms could become dominant in these markets. Mr French, Legal Director at the Digital Catapult, noted that platforms were “by their very nature … networked businesses” and that, as such, they displayed ‘network effects’. Professors Alain Strowel and Wouter Vergote, from the universities of Louvain and Saint-Louis, noted that, according to economic theory, strong network or external effects were essential “to explain the rapid expansion and dominance of some digital platforms.” Professor Ezrachi said that “network effects illustrate the way in which online platforms may acquire market power” and potentially “become truly dominant”.
In economics, a network effect refers to the effect that one user of a good or service has on the value of that product to other users. Positive network effects occur when increasing the number of users increases the value or utility of the network to other users. Negative network effects occur when an increase in the number of users decreases the value of the network to its users (for instance through network congestion). In multi-sided markets, in which there are always at least two distinct user groups, two basic types of network effect can be discerned:
66.Professor Gawer said that network effects were the “accelerating mechanism” that fuelled online platforms’ rapid growth. She explained that as successful platforms became larger they attracted more users, resulting in a “self-sustaining momentum of growth”. Describing this dynamic, Professor Eric Clemons explained that these effects did not arise in non-networked industries (“I do not get greater value out of a Big Mac because other people are eating them”), whereas with online platforms, “customers flock to the most successful car platforms and apartment rental platforms, which brings them more drivers and more apartments to rent, which brings them more customers.” Professors Ezrachi and Stucke described this as a “positive feedback loop”.
67.Direct network effects were most clearly associated with social networks. Professor Annabelle Gawer said: “We can see that with Facebook: every new member of Facebook brings in 200 friends on average.” Professors Stucke and Ezrachi explained that: “As more people join Facebook, the utility of the platform to users increases as it becomes easier to connect with others. The value of the network increases with its growth.” Indirect network effects, according to e-Conomics, were observable in multi-sided e-commerce platforms: “eBay becomes interesting for retailers if more consumers shop on the platform, and it becomes more interesting for consumers to shop on the platform if more retailers offer their products on eBay.”
68.We heard that the use of data-driven algorithms resulted in new types of network effect specific to online platforms. Professors Ezrachi and Stucke said that search engines’ use of data allowed them to harness new types of direct network effect: “the more consumers who use the search engine and the more searches they run, the more trials the search engine has in predicting consumer preferences, the more feedback the search engine receives of any errors, and the quicker the search engine can respond with recalibrating its offerings. Naturally, the quality improvement attracts additional consumers to that search engine compared to competitor sites.” They also suggested that the “scope of data” collected about individual users’ preferences through the variety of “e-mail, geo-location data, social network and browser history” allowed them to better harness indirect network effects through the “targeting of users with specific sponsored ads”.
69.Professors Ezrachi and Stucke described how these different positive feedback loops often ‘spilled over’ from one side of the platform to the other and had a cumulative effect: “As more users are drawn to the platform, and as the company amasses a greater variety of data to effectively target consumers with relevant online ads … the more advertisers will use the platform, the more relevant and targeted the advertisements, the likelier that users will click the ads, and the more profits the search engine has”.
70.Various features of the Internet and the digital economy mean that network effects are particularly pronounced for online platforms. Professor Gawer noted that the “7 billion mobile phones in the hands of users” had resulted in “pervasive connectivity” to the Internet, which had “accelerated the network effects.” In the case of online platforms, she said, such network effects could lead to “exponential growth.”
71.We heard that a number of features of the digital economy facilitated the rapid growth of these networks of users. Professor Zimmer observed that, once a platform had invested in developing a service, the subsequent cost of “rolling out this service to more and more consumers” was low, because it drew on existing Internet infrastructure. Economists referred to this as “zero marginal cost”. The Digital Policy Alliance explained that cloud services “offer the great advantage of being quickly scalable to deal with demand peaks and troughs, enabling new entrants to grow sustainable businesses very quickly.”
72.Mr French agreed that the reliance on the pre-existing infrastructure of the Internet, and on users to provide content, meant that the growth of platforms was “unconstrained by what might be called the usual barriers”, including access to capital, access to new markets, geographical borders, trade tariffs and quotas. Mr French said this dynamic “explains why some online platforms have emerged very quickly and grown to dominate the digital economy.” Mr Chisholm cited the rapid growth of the WhatsApp communications platform as an example: “In the space of only a few months it has been able to acquire 200 employees, and build a business valued at €17 billion. It is quite unlike the physical world that came before it.”
73.Network effects can also lead to markets becoming highly concentrated, with firms acquiring large market shares. Mr Chisholm explained that network effects could lead to ‘tipping’, “whereby more and more people use [a platform] until it seems almost pointless to use any other platform … If, for example, your ability as a seller to be able to reach very large numbers of potential purchasers is so great on one platform … why would you consider other platforms?” He continued: “There is that risk of the markets concentrating excessively in that way”.
74.There are many examples of high market shares. Tim Godfray, Chief Executive of the Booksellers Association said that Amazon was responsible for “90 per cent of all e-book sales in the UK and an estimated 80 per cent of online physical book sales.” EU VAT Action said: “Audible (owned by Amazon) has an effective 90% of the digital audiobook market”, while 92% of small businesses used PayPal’s transaction platform. A hotel chain, that wished to remain anonymous, said that Booking.com’s market share of the online travel agents sector was “believed to be between 60 and 70 per cent”, with Expedia holding much of the rest, and that the combined market share of these two platforms was forecast to rise to 94%.
75.Search engines and social networks were cited as examples of the most concentrated markets. Professor Rodden said that it was “now common for a single provider to dominate a service sector (Facebook for social networks, Google for search)”. Professors Dutton and Jeitschko highlighted “evidence of concentration in such areas as search and social networking.” Kostas Rossoglou, from Yelp drew attention to the fact that Google had “over 90% market share in Search alone in Europe,” while the Bed and Breakfast Association put the figure for the UK at 89%. From a global perspective, Professor Zimmer noted that a similar degree of market concentration existed in other regions of the world “where Google is not present, in China and Russia, where you also have one main search engine”.
76.Mr French said that some online platforms’ market shares across multiple markets meant that they represented a high share of all online activity: “When some Google services went offline in August 2013 for between 1 and 5 minutes, global Internet traffic shrunk by 40%.”
77.‘Switching costs’ are the barriers that platforms’ users may face when seeking to switch to another platform. Baroness Neville-Rolfe DBE CMG, Parliamentary Under Secretary of State and Minister for Intellectual Property, referred the Committee to an OECD report, The Digital Economy, which “found that consumer switching has a low cost” in these markets; the report also noted, though, that network effects could increase switching costs and “result in lock-in to a particular platform” and have “detrimental effects on competition”.
78.Consumers face particularly high switching costs with social networks, because they display strong direct network effects. Professor Zimmer said: “With a social network you have huge switching costs, particularly if you cannot take your friends with you—you are locked in.” He said that the switching cost of leaving Facebook was “that you may not have any more friends in the digital sphere.” Dr Ansgar Koene, Senior Research Fellow at the Horizon Digital Economy Research Institute, described the same phenomenon: “Anecdotally, many people who would like to quit Facebook and move to a different platform ultimately continue to use Facebook because that is where their peers are.”
79.Mr Chisholm said that switching costs were lower for the users of search engines: “if you decide, even for a moment, that you have had enough and want to use another one, it is very easy to do that with just one click”. However, Professors Ezrachi and Stucke said research found that: “most users, when asked how they react if the search results are not exactly what they expected, say that they will then try to change the search query—not the search engine” which meant that “most users actually perceive the switching costs to be much higher than we perceive them to be”.
80.Professor Gawer emphasised that “it is not the network effect per se that may harm consumers”, but that consumers were harmed when switching costs were very high and they became “stuck with one provider and a lack of choice”.
81.Traders can also experience difficulties switching platform, particularly when network effects lead to one platform becoming favoured by consumers. IMPALA, the Independent Music Companies Association, said that traders were likely to become reliant on a platform “when the number of visitors accessing the platform greatly surpasses that of its competitors”, adding that in such cases “the online platforms’ business model places them in a position of indispensable trading partner, ‘essential facility’ or ‘gatekeeper’.”
82.Many large businesses said that they were reliant on Google Search in precisely this way. Getty Images said: “We agree with the EU Commission assessment that Google is dominant in general search and in online advertising services. We believe that Google is an unavoidable trading partner as a result.” Carolyn Jameson, Chief Legal Officer at Skyscanner, agreed:
“We are certainly dependent upon Google in the same way as any other company operating on the Internet is. Google is so dominant in general search now that inevitably any company operating online is dependent on visitors finding their site through Google.”
83.Smaller firms are similarly reliant on platforms. The British Hospitality Association said that, if its members did not trade with the two main online travel agents, they would become “pretty invisible” online. Mr Godfray said that if booksellers wished “to reach a large number of consumers, many booksellers find that they have little option other than to use Amazon’s Marketplace.” Amazon’s position in this market “pivots upon control of access to customers, something which is unique.” First Tutors told us that switching costs varied and depended on the degree of market concentration: “In markets such as [tutoring] the supplier can always go and sign up on another platform (so actually our power is effectively checked by competition), but for example, I’m not sure an eBay trader would have such an easy time making a living elsewhere”.
84.We also heard that online platforms could deliberately increase switching costs. David Viros, Head of International and European affairs at the French Competition Authority, said that an EU Commission investigation had found that Google’s strength in the online advertising market was, in part, “a by-product of the fact that most market players are unable to switch to an alternative online search advertising provider”. Google had consolidated its position in this market “by imposing certain contractual restrictions that further increase barriers to switching.”
85.While platforms undoubtedly lower entry barriers for start-ups and SMEs seeking to access global markets, we also heard that network effects could create entry barriers for potential rival platforms. Dr Evans told us that a key challenge for emerging online platforms was getting a critical mass of users on both sides, so that ‘ignition’ could occur. Professors Ezrachi and Stucke said that network effects meant that “there are economies of scale that make you much stronger and may create a barrier to entry for newcomers”, by making it more difficult for new entrants “to obtain the necessary scale to meaningfully compete”. e-Conomics said that switching costs “may strengthen the market power of the platform by raising entry barriers for competitors “.
86.A number of witnesses suggested that the manner in which network effects facilitated rapid growth and increased entry barriers created a ‘first mover advantage’. Professor Clemons said: “there is a strong first mover advantage in network industries, and it will be difficult for a new company to compete with an existing firm.” Dr Anna Plodowski agreed that online platforms transformed “first-mover advantage into network-effect business models that lock-out the entrance of later competitors.” Mr French said that the Internet “amplifies hugely the advantage of the first mover”.
87.The Association of Authors’ Agents suggested that these tendencies could result in the most successful online platforms’ market power becoming entrenched: “the rapid development and business models of early entrants into the market has led to monopolistic situations, creating an inherent danger whereby an individual marketplace becomes the main market stall, jeopardising healthy competition and controlling access to the consumer.” Getty Images agreed: “the adoption of one platform or technology may make switching to another more difficult … increasing barriers to entry for later players … This may mean that one player captures a market and then entrenches itself, with customers being denied the benefits of innovation over time.” Professors Ezrachi and Stucke concluded that “network effects, absence of outside options, high switching costs and locked-in customers, may all give rise to market power at lower levels than in traditional markets.”
88.However, Dr Christopher Pleatsikas, Lecturer at the University of California, reminded us that “there is significant variation in the strength of scale and network effects across different dynamically competitive markets”, and emphasised the need for individual analysis. The OECD report, The Digital Economy, also concluded that “network effects have to be assessed on a case-by-case basis to determine their competitive implications.”
89.The various factors we have outlined can give rise to monopolistic outcomes. Dr Richard Hill, of the Association for Proper Internet Governance, told us that “because of the economies of scale and network effects … online platforms have a tendency to be natural monopolies”. Clare Moody MEP agreed: “Currently, we are seeing a tendency to monopolies in this area. I do not think any of us would think that is necessarily a healthy outcome.” Dr Koene and Professor Rodden called them: “virtual monopolies”. Professor Zimmer called them “quasi-monopolists”.
90.This gives rise to the possibility that online platforms should be regulated as if they were public utilities. Professor Richard N. Langlois, from the University of Connecticut, said that “Platform services have many of the characteristics of old-fashioned public utilities”, adding that some people found it “tempting to regulate platforms as if they were public utilities, controlling rates and terms of access”. Dr Jerry Ellig, Senior Research Fellow at George Mason University, noted that “Various commentators have argued that some type of sharing or openness regulation is appropriate for Facebook, Google, eBay, Twitter, and Amazon because network externalities make them natural monopolies or close to it.”
91. Mr Chisholm, on the other hand, argued that online platforms were different from other networked industries commonly thought of as natural monopolies:
“Many of us think about natural monopolies based on typical analogue-type situations. Take, for example, a gas distribution network, for which the idea of a rival set of pipes being built over the same ground would be inherently implausible, or similarly a port, providing access to a small island. I think that when one speaks about online platforms, a natural monopoly is not quite as complete as that.”
92.Professor Zimmer said that the German Monopolies Commission’s report on the subject of online platforms had likewise “expressed a reluctance to say that there is a natural monopoly”. Dr Weck said that instead they considered online platforms to have “a monopoly arising out of innovation.”
93.Professor Zimmer told us that, for this reason, regulators should ask themselves whether “it makes sense to intervene in the sense of break-up or divestiture”. He said they should take into account “whether there will be a benefit for consumers or, on the contrary, whether there may be disadvantage for consumers.” He urged caution, noting that there was a risk that intervention might “give the people stones instead of bread … If you imagine the hypothetical situation of having three different [social] networks, the users would have to look for their friends on three different platforms, which would be less efficient and attractive.”
94.The pace of innovation in these markets means that market power can be transient. The CMA said this was because online platforms were still subject to disruptive cycles of innovation “where last year’s ‘winner’ can quickly become this year’s ‘nobody’.” Dr Evans reminded us that:
“Sitting here in 2015, it looks a lot different from the way it did in 2010. In 2010, Apple was kind of getting off the ground with the iPhone, it was two years before Facebook’s IPO, and only two years before that MySpace was the dominant social network; it was not Facebook at all.”
95.While the tendency for one online platform to become the main player could reduce competition within a particular market, such monopolistic outcomes can also incentivise rival firms to replace incumbent businesses by changing the market structure in innovative ways. Professor Langlois explained that firms did not compete “just, or even primarily, within existing market structures but also to change markets’ structures”. This meant “completely redefining products and relationships with customers: in short … innovation.” Daniel Gordon, Senior Director of Markets at the CMA argued that it was “the competition to replace that is the dynamic incentive.” He referred to this as the “competition for the market” as opposed to “competition within the market”.
96.Professors Ezrachi and Stucke highlighted the risk that “new technology and innovation … could undermine the growth of the large players”. This could “generate sufficient competitive pressure which would ‘police’ the activities of the large players”, even if it did not lead to a new firm entering the market. e-Conomics agreed:
“The threat of innovators disrupting existing markets is greater in digital markets … This threat drives all digital companies, small and large, to prepare for the unexpected through constant innovation … By doing so, digital companies embrace former Intel CEO Andrew Grove’s management motto ‘Only the paranoid survive’.”
97.Witnesses acknowledged, though, that competitive pressures varied in intensity and that, as the threat of being disrupted by an innovative competitor receded, the likelihood of a dominant firm being able to abuse its position increased. Dr Weck said: “The problem arises only if that concentration becomes permanent because the market tilts, for example, and the dominant company finds out, ‘Okay, I can protect my dominant position. I do not need to innovate any more’.” Dr Pleatsikas observed that the perceived pressure from the threat of innovation by a competitor was “generally not sufficient to constrain the exercise of market power by a dominant firm as incumbents have a poor record of anticipating paradigm shifts (they also generally have a poor record of adapting to them).”
98.Despite their reservations about the need for general regulation of platforms, TechUK, the CMA, and Dr Evans all emphasised the need for competition authorities to be vigilant regarding the activities of the most powerful online platforms. Mr Chisholm said competition authorities should be alert to whether firms were gaining and maintaining market power through “innovation”, or by “putting in place artificial restrictions” on businesses and consumers. Professor Zimmer told us that competition authorities should seek to ensure that market positions were kept “as vulnerable as possible, in order to have a risk of competition and potential competition.”
99.Dr Weck said that the concentrating tendencies in these markets meant that, alongside effective competition enforcement, “you also have to look at the other side and to strengthen the users of platforms, because if the market concentrates towards a platform, protecting consumers and so on gets more and more important … you have to make sure that consumer rights, content rights and data protection rights are respected.”
100.The markets in which online platforms operate are characterised by accelerated network effects. These may fuel exponential growth, increase switching costs, increase entry barriers for potential competitors and lead to monopolistic outcomes. Firms that succeed in harnessing these network effects may become the main platform in a sector, gateways through which markets and information are accessed. This can reduce choice for users and mean that they become an almost unavoidable trading partner for businesses. Such platforms are likely to possess a significant degree of market power.
101.However, in contrast to some networked industries, the market power of the most successful online platforms is secured through innovation that has succeeded in harnessing network effects. The risk of disruptive innovation is also greater in these markets because the up- front investment in infrastructure required for market entry is often lower. Therefore, ‘competition for the market’ may create competitive pressure even when one firm has a high market share.
102.Furthermore, we note that competitive pressures vary in type and intensity from sector to sector, and many online platforms are unlikely to possess significant market power. Case by case analysis is therefore necessary.
103.On this basis, while competition authorities reserve the power to break up firms and limit their market shares, we do not believe that ex ante regulation of platforms that sought to substantially restrict their activities on the basis of their market share alone, is necessary. Nonetheless, the potential for dominant positions to emerge means that competition authorities must be vigilant in these markets, to ensure that market power is not abused. Protecting users in these markets also requires that consumer rights and data protection rights are effectively enforced.
92 Communication from the Commission, A Digital Single Market Strategy for Europe, , p 11
93 (Alex Chisholm)
94 (Guilame Loriot)
95 (Richard French)
96 Written evidence from Professor Alain Strowel and Professor Wouter Vergote ()
97 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke (), (Professor Ariel Ezrachi)
98 (Professor Annabelle Gawer)
99 Written evidence from Professor Eric Clemons ()
100 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke ()
101 (Professor Annabelle Gawer)
102 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke ()
103 Written evidence from e-Conomics (). e-Conomics is an independent consultancy and research network that focusses on digital and telecom related policy studies. Olga Batura, Nicolai van Gorp and Prof. Pierre Larouche co-produced their submission, with guidance from Lapo Filistrucchi. Hereafter they will collectively be referred to as e-Conomics.
104 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke ()
105 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke ()
106 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke ()
107 (Professor Annabelle Gawer)
108 (Professor Daniel Zimmer)
109 Written evidence from the Digital Policy Alliance Eurim ()
110 Written evidence from Richard French ()
111 (Alex Chisholm)
112 (Alex Chisholm)
113 (Tim Godfray)
114 Written evidence from EU VAT Action Campaign ()
115 Written evidence from anonymous witness ()
116 Written evidence from Professor Rodden ()
117 Written evidence from Professor Dutton and Professor Jeitschko ()
118 (Kostas Rossoglou) and written evidence from the Bed and Breakfast Association ()
119 (Professor Daniel Zimmer)
120 OECD, The Digital Economy (2012): [Accessed 23 March 2016]
121 (Baroness Neville-Rolfe)
122 (Professor Daniel Zimmer)
123 Written evidence from Dr Ansgar Koene ()
124 (Alex Chisholm)
125 (Professor Ariel Ezrachi)
126 Supplementary written evidence from Professor Annabelle Gawer ()
127 Written evidence from IMPALA the Independent Music Companies Association ()
128 Written evidence from Getty Images ()
129 (Carolyn Jameson)
130 (Ufi Ibrahim)
131 Written evidence from The Booksellers Association ()
132 Written evidence from First Tutors EduNation Ltd ()
133 (David Viros)
134 (David Evans)
135 Written evidence from Professor Maurice Stucke and Professor Ariel Ezrachi ()
136 Written evidence from e-Conomics ()
137 Written evidence from Professor Eric Clemons ()
138 Written evidence from Dr Plodowski ()
139 Written evidence from Richard French ()
140 Written evidence from the Association of Authors’ Agents ()
141 Written evidence from Getty Images ()
142 Written evidence from Professor Ezrachi and Professor Stucke ()
143 Written evidence from Dr Christopher Pleatsikas ()
144 OECD, The Digital Economy (2012): [accessed 23 March 2016]
145 Written evidence from Dr Richard Hill ()
146 (Clare Moody MEP)
147 Written evidence from Dr Ansgar Koene () and from Professor Tom Rodden ()
148 (Professor Daniel Zimmer)
149 Written evidence from Professor Richard Langlois ()
150 Written evidence from Dr Jerry Ellig ()
151 (Alex Chisholm)
152 (Professor Daniel Zimmer)
153 (Dr Thomas Weck)
154 (Professor Daniel Zimmer)
155 Written evidence from the Competition and Markets Authority ()
156 (Professor David Evans)
157 Written evidence from Professor Richard Langlois ()
158 (Daniel Gordon)
159 Written evidence from Professor Ariel Ezrachi and Professor Maurice Stucke ()
160 Written evidence from e-Conomics ()
161 (Dr Thomas Weck)
162 Written evidence from Dr Christopher Pleatsikas ()
163 (Alex Chisholm)
164 (Professor Daniel Zimmer)
165 (Dr Thomas Weck)