Antitrust and Economic Dynamics in the New Economy

Chapter 9 Antitrust in the New Economy

Economic Fundamentals of the New Economy The key properties of New Economy industries pertinent to antitrust analysis are 1) High fixed cost and low marginal cost of developing and selling intellectual property 2) Network effects 3) Rapid and disruptive innovation Though not a New Economy industry, the pharmaceutical industry also involves intellectual property and is characterized by high fixed cost low marginal cost and a high rate of disruptive innovation

Antitrust Issues in the New Economy The focus of antitrust actions for New Economy industries . . . is less about how firm behavior and antitrust intervention affect static efficiency through their impact on prices, products, services, and cost, and more about their effect on dynamic efficiency in creating novel products and service and producing major technological improvements that drastically lower cost David Evans and Richard Schmalensee: stated three implications for antitrust economic analysis In many New Economy industries, the primary force is competition for a market rather than competition in a market

With many New Economy industries, price below marginal cost may be a very weak standard for assessing attempted monopolization, because marginal cost is so low The nature of markets in the New Economy often results in equilibrium prices being largely unrelated to cost There is no shortage of horizontal and vertical mergers and acquisitions in the New Economy What are the two manifestations of challenges associated with the implementation of effective antitrust law and policy in the New Economy regarding the high rate of innovation?

Markets with Network Effects Economics of Markets with Network Effects Consider an example that illuminates the role of economic force (network effects) in the antitrust cases against Microsoft in the 1990s Vocabulary Positive feedback Sustained dominance Penetration pricing Discuss the optimal pricing decision of a firm in order to better understand the dynamic competition in a market with network effects

Network Externalities

Examine the tendency for market dominance to emerge The antitrust problem resides not in the dominance that prevails but rather in the potential abuse of that dominance Consider the example of exclusionary contracts involving two upstream firms

Microsoft Microsoft I: when the DOJ prohibited Microsoft from tying the sale of products to its OS and the DOJ and Microsoft created a consent decree that put restrictions on the types of contracts Microsoft could use Microsoft II: when the DOJ filed a second suit claiming that Microsoft had violated the provision of the settlement that prohibited tying, the circuit court concluded that technological bundling did not violate the consent decree Also consider the suit that accused Microsoft of violating the Sherman Act

Microsoft Microsoft I: Exclusionary contracts in the operating systems market Consider how the contractual terms in which an OEM was required to pay a fee to Microsoft for each computer that it shipped can be a violation of Section 2 of the Sherman Act (as well as the FTC Act) Microsoft II: Tying and monopolization of the browser market Consider the monopolization and tying charges against Microsoft in which Microsoft was accused of a per se violation of Section 1, and the government claimed that Microsoft had tried to leverage its monopoly in the OS market so as to monopolize the browser market and accused Microsoft of pricing predatorily by distributing IE free

Microsoft Microsoft III: Maintenance of monopoly in the operating systems market The most serious charge was that Microsoft engaged in anticompetitive practices to maintain its near-monopoly with Windows in the OS market To establish a monopolization claim, the plaintiffs must argue that 1) The accused firm has monopoly power in a relevant market 2) It has sought to maintain that monopoly through anticompetitive behavior The government reached a settlement in 2001 that restricted the conduct of Microsoft and also sought to make it more difficult for Microsoft to hamper the development of middleware and more generally to promote interoperability

Big Data Big data: the collection an analysis of data such as what we search, what we watch, what we read, and what we buy In the context of markets, big data has been used to identify trends in demand, measure consumer preferences, and assess the performance of business practices Collaborative filtering: a class of algorithms that uses a database reflecting other users preferences (based on their past activity) along with information on the current user to then make recommendations Big data can be the basis for market dominance. Consider the 2008 Facebook v. Power Ventures case

Two-Sided Platforms A two-sided platform brings together two different types of agents for the purpose of engaging in a transaction Platforms connect two user groups, and the platforms can be rather diverse A two-sided platform performs an intermediation role by reducing the transaction costs that agents might incur to find each other and consummate an exchange. Some important features of two-sided platforms are network effects, congestion, and the manner in which services are priced (the price structure)

Prices at a Two-Sided Platform Equilibrium quantity of users A two-sided platform can collect revenue by charging a fee to users to access the platform or by deciding how to price the different sides of the market The three step analysis 1) Determine which prospective users participate at the platform 2) Solve for the prices that maximize profits when there is a monopoly platform 3) Discuss what additional forces come into play when there are competing platforms Consider a two-sided platform that is an auction or retailing site, such as eBay or Amazon

Prices at a Two-Sided Platform Monopoly prices Examine monopoly prices with a generic group 1 and 2 example Many platforms have starkly different prices for different user groups In some cases, a user group s price is zero or even negative, while the other user group is charged a nontrivial positive price, e.g., eBay and Google Optimal two-sided platform prices do not only depend on the cost of serving a user or the value that a user attaches to the platform but also how much a user s participation adds to the platform s value to the other types of users

Prices at a Two-Sided Platform Prices for competing two-sided platforms Suppose there are competing two-sided platforms, such as Uber and Lyft for local transportation or Google and Bing for search engines There are factors to take into account, such as differentiation across platforms Multihoming is when a user participates in two or more platforms for the same service

Challenges in Antitrust Analysis Key Things to Know 1) A zero or even negative price is common in two-sided markets 2) A high price-cost margin need not reflect high market power 3) Prices can often be unrelated to costs Antitrust analysis must be conducted differently when it involves two-sided platforms

Challenges in Antitrust Analysis Google Google operates a general purpose (or horizontal ) search engine that is dominant in many countries By comparison, vertical search engines focus on narrowly defined content categories Discuss the EC and FTC s conclusion on Google s use of organic links that appear when a user enters a keyword Consider the FTC s stance on Google Shopping

Industries with Rapid and Disruptive Innovation Consumers benefit from competition for the market rather than competition in the market Three rationales for antitrust authority 1) Antitrust intervention can stifle innovation 2) By the time that the antitrust process runs its course . . . the market may have changed so much that any remedy is inappropriate or irrelevant 3) Any abuse of market dominance is likely soon to be rectified by the arrival of a new firm with a better technology that displaces the dominant firm A more active antitrust policy has two counteracting effects on the returns to innovation. It reduces the profits earned when a firm is a monopolist . . . but it also raises the profits earned by an entrant when it competes with the currently dominant firm

Segal-Whinston Model Suppose that at any moment in time, the market is occupied by a monopolist earning monopoly profit by virtue of having the most advanced technology Look at the problem faced by a potential entrant investing in R&D The equilibrium innovation rate Consider exclusive dealing

Summary This chapter examined common sources of dominance in and features of the New Economy such as The existence of scale economies associated with the creation and application of knowledge Big data Network effects (also present in two-sided platforms) Rapid and drastic innovation