This post is part one of a series that explores the current Big Tech antitrust cases.
The case against Google filed by the Department of Justice (DOJ) finds its roots in a common theory about platforms. As the complaint summarizes,
Most general search engines do not charge a cash price to consumers. At least one, Bing, even offers to pay consumers rewards for using its general search engine. That does not mean, however, that these general search engines are free. When a consumer uses Google, the consumer provides personal information and attention in exchange for search results. Google then monetizes the consumer’s information and attention by selling ads.
The term free is deceptive. In one context, free means that a good or service has no explicit price. In this sense, free means that there is zero price at the point of use, such that consumption does not depend on the ability to pay. On the other hand, free also suggests that a thing or service has no cost. But every choice comes with a cost, or more precisely, an opportunity cost. In the classic definition offered by economist James Buchanan, opportunity cost is the anticipated value of “that which might be” if the choice were made differently.
While both zero price and opportunity cost are critical for understanding platforms like Google, pricing is key to properly apply antitrust principles. Public policy that ignores the role for pricing here will ultimately make consumers worse-off.
For some time, economists have recognized the unique nature of multisided platforms. Malls, credit cards, gaming consoles, social media sites, and search engines all fall into this special category because they can bring together two or more distinct user groups for mutual exchange. However, integrating these groups in a mutually advantageous way requires pricing and investment strategies that just don’t make sense in normal one-sided markets. The prices for each side are a function of the total value that the group gets from being a part of the platform.
Both restaurants and their diners save time and effort with reservation platforms like OpenTable. But each group values the exchange in a different way. Users tend to care about the total number of restaurants that are a part of the platform. In contrast, restaurants care about which networks consumers actually use. They want to know, do patrons go to OpenTable or Resy for a night out? This two-way relationship means that demand on one side of the platform is impacted by demand on another. What distinguishes platforms from other kinds of business are these relationships, often called demand interdependencies.
Similarly, the value created by Google hinges on the demand interdependencies between advertisers and users. As I explained in a filing before the Federal Trade Commission,
If users experience an increase in price or a reduction in quality, then they are likely to exit or use the platform less. Yet, advertisers are on the other side because they can reach users. So in response to the decline in user quality, advertiser demand will drop even if the ad prices stay constant. The result echoes back. When advertisers drop out, the total amount of content also recedes and user demand falls because the platform is less valuable to them. Demand is tightly integrated between the two sides of the platform. Changes in user and advertiser preferences have far outsized effects on the platforms because each side responds to the other. In other words, small changes in price or quality tends to be far more impactful in chasing off both groups from the platforms as compared to one-sided goods.
Normal businesses will price their good or service based on their marginal cost and how a consumer responds to price increases. Formally, this is a classic example of what is known as demand elasticity. But platform businesses have to price at least two goods with two different cost structures and two different consumer responses that are themselves interconnected. Most of the economic research into platforms in the past 30 years concerns these difficult pricing problems.
The Xbox gaming console, which was launched in 2001, serves as a great example of the pricing problem. By and large, the first Xbox was a failure. Research, design, manufacturing, support, and gaming development were costly for Microsoft and the losses totaled nearly $7 billion. Yet, consumers buying a console never paid the full price. Instead, the company hoped to jumpstart a platform that would spur users to buy more games, since Microsoft retains a portion of game revenue. Had consumers paid the full price of the console, there would have been fewer console sales and, in turn, fewer sales of games. The company built off the lessons learned in making the next iteration, the Xbox 360, a financial success. But if you look only at the sales of the first Xbox, it’s a failure. Microsoft lost money on each console sold. Yet looking at the entire legacy of Microsoft’s Xbox shows why the system is a money maker today.
Even for businesses taking risk, pricing is tough to get right. Economists David Evans and Richard Schmalensee explained why this insight is so critical, “The key point is that it is wrong as a matter of economics to ignore significant demand interdependencies among the multiple platform sides.” If ignored, the typical analytical tools used in antitrust will yield incorrect assessments. As it stands, the DOJ is poised to make this very mistake in their case against Google.
To take just one example, competition authorities might be concerned with market power when conducting an investigation or bringing a case. Typically market power is defined as a firm’s ability to raise prices significantly above the competitive level. Yet, platforms come into existence because they shift prices among two or more groups of users. If only one side of the platform is considered, it might be inappropriately concluded that a firm is raising prices above a competitive level. In the case of search engines and social media sites, users face zero price while advertisers pay. Whether or not advertisers are paying too high of a price is a concern that the courts will have to parse in the Google case.
Economists and antitrust scholars have been actively working on merging insights from the nascent platform literature into traditional antitrust analysis. A legitimate assessment of Google’s pending case will necessitate that the entire platform is considered.
The next edition of this series will analyze why zero price products, like social media sites and search engines, are unique and require special attention for antitrust.