Monopoly Economy
The other side of network effects
Late last week I stumbled upon this story by Timothy Lee on Vox: Why America needs more Teslas and fewer Ubers. It encompasses many of the anxieties that have emerged from our growing internet economy. The basis of this collective anxiety seems to be that the power in previously quite fragmented and siloed industries seems to be converging on a small number of mega-firms with outsize market control. Of course this power convergence can be seen as a threat to employment opportunities, to the widening of economic inequalities, and can even be considered as threats to civic freedoms. These concerns are legitimate.
None of this is particularly unexpected. Of course, any introductory economics course will leave its student with one take away: economics is the study of choice within the constraints of scarcity, and economic value is always generated through the provision of goods and services that are inherently scarce. But what is scarce in this age of abundance? In a world where we have no shortage of choices for entertainment, news, and hotels, the only thing that is legitimately scarce is a filter that allows us to make good choices.
As this blog has discussed in the past, journalism is the perfect manifestation of this phenomenon. With the geographical barriers that propped up news journalism for decades knocked down, the value in news has moved to platforms such as Facebook, which organise news by using our friends and algorithms to present us with news we might like. Facebook converges hundreds, thousands, of news instances from over the world onto one global front page: your news feed.
In Q4 2016, Facebook netted $8.81 billion in revenue. With a staff of roughly 17,000, Facebook’s revenue per employee equates to almost $2 million annualised. The world’s most reputable newspaper – the New York Times – earned revenues per employee of merely $433,000 in 2016. The most telling point is that Facebook’s 17,000 employees influence news distribution for over 1 billion people around the world. The way that the internet has propelled such an encompassing global monopoly of news deployment is truly astounding.
We’ve reached a tipping point in the life-cycle of the World Wide Web which has created the perfect environment for enormous, network-effects based industries and firms. The internet’s best use case, sharing, has been discovered, and enabled by increasingly low barriers to entry. In developed economies, satisfactorily generous mobile data plans are commonplace enabling users to access the internet for a multitude of mobile use cases. Globally, the rise of the smartphone has empowered many people to access the internet at significantly lower upfront costs than traditional computers. Importantly, the conditions of familiarity have also been satisfied. People aren’t afraid of sharing: non-privacy is the new norm.
The most successful internet companies leverage all of these conditions to thrive. In the case of Facebook, it has grown its user base phenomenally as access to internet has exploded globally, and as a result has created an entire platform based on the sharing of content and personal data. Facebook has grasped the mobile revolution, with the majority of its ad revenue now being generated through mobile. Of course, Facebook has also been a primary driver in the erosion of privacy concerns amongst internet users.
Uber, like Facebook is a poster child of Silicon Valley ‘unicorns’ in this age of sharing, and likewise leverages the conditions of the contemporary web. Mobile devices with location awareness enable myriad new interactions, and privacy concerns are no longer a hindrance — users are exceedingly comfortable perpetually sharing their credit card details and location with Uber for the benefit of convenience. The most important and exceedingly obvious thing however is that Uber’s business model is primarily based on network effects, and just like any sort of ‘network’, Uber’s most important feature is that other people are on it.
In his story, Timothy Lee draws the comparison between Tesla and Uber, asserting that Tesla uses the capital it raises to build factories and vehicles that provide jobs to the economy and create genuinely tangible end-products. Uber on the other hand, spends its capital to buy customers and thwart its competitors. Essentially, Uber’s outlays are purely ‘wasted’ on zero-sum battles for market share.
This is all true, but the criticisms here are the exact same criticisms we can apply to almost every facet of our market economy. The concept of market share is by nature zero-sum. Advertising in particular which has consistently accounted for roughly 20% of annual GDP is nothing more than an exercise employed by firms to yell over the top of one another.
Competitive waste is one of the many unfortunate by-products of our market economy. In fact, I’ve long considered the fact that competitive markets, which by design, generally avoid the confluence of monopolising firms is in fact, one of the most inefficient market designs that can exist. Perhaps the greatest contradiction of modern capitalism is that monopolies are in fact, materially speaking, one of the most efficient outcomes.
Monopoly firms with 100% market share generate all of the industry’s profits and can invest this money into consolidated R&D efforts, avoiding duplication. Monopoly firms enjoy economies of scale and greater fixed cost spread. Of course, very little, if any money is wasted on tit-for-tat advertising campaigns. Having said that, monopolies are only materially or theoretically efficient because monopoly markets have historically proven otherwise. All the incentives are in the wrong place. With no competition, firms don’t innovate and they hike up their prices, nullifying the cost savings from economies of scale. Because of this, we accept the inefficiencies of competitive markets simply because firms can’t behave themselves.
One of the other noted detriments of monopolies is the lack of choice for consumers. Choice is ostensibly, a good thing. But in this age of network effects, there are many industries in which choice is bad: social networks, ride sharing, online shopping, and hotel booking are among them. These are all industries that benefit from a singular, dominant player. Like I said earlier, Uber’s most important feature is the fact that other people use it, and it’s remarkably difficult to realise those scaled benefits if we have myriad competing firms with similar market share. Imagine going to five different apps just to get a ride. The same is true of social networking, life is much easier when everyone is just on Facebook.
This desire for a limitation or control of choice has been validated by the market. In this age of abundance, aggregators have emerged in most markets which converge and organise offerings onto a singular front. Hotels.com is one place to book any hotel, eBay and Amazon are aggregators of online shopping, Google is an aggregator of web content. Evidently, consumers want the benefits of choice — price competitiveness and variety — without the chore of actually having to sift through the choices. It goes without saying, aggregators are amongst today’s most valuable firms because they provide the only thing that is genuinely scarce: time and organisation.
The internet is truly an enabler of these sorts of businesses and criticising them for ‘buying customers’ is very much the same as criticising any other firm for trying to build out their product feature set. It just so turns out that having customers is one of Uber’s most important features. The way we measure value in platforms is very different to the way we measure value in products. Whilst the market will naturally enable these firms to leverage network effects to gain outsize market share and deliver valuable services to consumers, the real question is how does the market resolve the incentive issues associated with monopolies and near-monopolies? Do we have safeguards to actually ensure that our Ubers and Facebooks don’t abuse the market power we’re happily giving them? This is our newest challenge.
