Benedict Evans take on: What if we broke up big tech?

Published on
August 10, 2020
by
Benedict Evans
No items found.
Benedict Evans take on: What if we broke up big tech?

We’re clearly going to be arguing about the size, power and market share of large technology companies a great deal in the next couple of years. Many of the underlying concerns we have around technology are complicated, and involve deep-seated trade-offs where we actually have to make choices, and not everything is a competition problem anyway ( I wrote about this here). But if we presume that something is a competition problem, what do we do about it? The discussion here tends to jump straight to ‘break them up’, which also means presuming that break-ups would actually work. I’m not sure about that.

The folk memory here, of course, is Standard Oil. John Rockefeller built a network of production, processing and distribution companies that he bundled, tied and cross-leveraged in all sorts of ruthless and devious ways to squeeze out competition. Then in 1911, when Standard Oil was forcibly split up into over 30 different companies, that market power was broken and the oil industry became competitive again, or so the story goes.

This is a great story, but I’d suggest it’s more useful to look at, and contrast, the breakup of AT&T and the proposed breakup of Microsoft, which give a rather more mixed picture.

In 1982 AT&T settled an anti-trust case by splitting off its local access telephone network into seven regional companies (the Regional Bell Operating Companies or ‘Baby Bells’), keeping long-distance and the telecoms equipment business (which was also later split off and is now part of Nokia). This is another of the stories that anti-trust lawyers tell their young around the campfire, but its real effect was limited in important ways. Splitting local from long-distance opened up a new market for competitive long-distance carriers, and the market for telecoms equipment was liberated by breaking one customer into eight. It also led to the emergence of companies building fibre networks in city centres to connect corporate customers. However, if you were a normal consumer, and lived in the suburbs of New York or Miami, and wanted a telephone, there was still a monopoly. There was competition for long-distance, but not for your phone line; a national (near) monopoly was replaced by local monopolies.

There’s a pretty good law-of-physics reason for this: fixed-line local access telephone networks are a natural monopoly, in much the same way as water, gas or electricity networks. Building a network of copper wires to every home in a neighbourhood is not quite as expensive as laying water pipes, but it’s expensive enough, with a long payback period, and it’s very hard to cover the cost of building two parallel networks. It’s not impossible - cable TV companies did it by selling a separate and much more expensive product, but then we don’t have multiple, parallel CATV networks either. And, of course, you can’t split the wire going into your home into two and give each half to a different company.

If local access telephone networks are mostly a natural monopoly that cannot be made competitive by break-ups, what about network effects? Two decades after AT&T was broken up, the US proposed that Microsoft should be broken up - that it be split into Office and Windows. As we know, this didn’t happen, but what it it had? What would that have changed?

Going back to 1911, splitting up Standard Oil did three things. First, it replaced a company that was often the only buyer or the only seller with many competing companies. Second, it addressed the cross-leveraging, bundling and tying whereby the oil fields, refineries, pipelines, rail cars and retailers all worked together to squeeze out competition, by breaking those into separate competing companies. And third, more abstractly, it replaced a huge company with huge financial and market power with many smaller companies with less individual mass.

Now suppose that Windows and Office had become separate companies. So what? Well, the third point would be addressed; the overall mass of the company would be reduced. So, arguably, would the second; to the extent that you believe Microsoft was cross-leveraging Windows and Office, that would be ended. There would be no more Office/Windows bundles.

However, it’s not clear that this would have resulted in more actual competition for Office or for Windows. There would not have been a wave of new companies making new PC operating systems, nor new PC productivity suites, any more than there was a wave of companies building new phone networks in American suburbs in the 1980s. Microsoft might have been doing all sorts of mean and sneaky things, but people used Windows and Office because of network effects, and those network effects were and are internal to each product. People used Windows because it had the software and people wrote software for Windows because it had the users, and that had very little to do with Office. If Office had been in a different company, that wouldn’t have prompted Adobe to port Photoshop to BeOS, nor id Software to write Quake for Mac before Windows.

The strength of Windows was not that it was bundled or tied or leveraged, but that it had a network effect. The same for Office - everyone used Office because everyone used it, not because it was part of the same company as Windows. Breaking them up wouldn’t have changed this.

Indeed, these network effects would have limited the companies emerging from a broken-up Microsoft (the ‘Baby Bills’) in just the same way that they limited everyone else. The Office company could not have made a new PC operating system to compete with Windows - no-one would have written software for it. The Windows company could not have made a new productivity suite to compete with Office - no-one would have used it, any more than anyone used Open Office. These are hypotheticals, but Microsoft really was caught by exactly this mechanic in mobile a decade later - no-one made apps for Window Phone because it had no users, and it had no users because no-one wrote apps for it, and all the power Microsoft had in Office and Windows meant nothing.

In other words, one should think of network effects as comparable to a natural monopoly. In a network effect product as for a natural monopoly, once you have market dominance, that dominance persists not because of any anti-competitive behaviour by the company that owns it (even if there appears to be plenty) but because of the mechanics and economics of the product.

Network effects do not dictate that there can be only one network - it depends on the market, just as you can have both cable TV and telephones on one street but only one water pipe. Hence, in early 1990s the PC market, with only 50-100m users globally, was too small to sustain more than one network - Microsoft won, Apple clung on in a niche and almost disappeared and the other contenders did disappear. The global smartphone market, with now over 4bn global users, is big enough for two networks - iOS and Android. In the early days of social networks many people thought there would be a winner in each region - Bebo was strong in the UK, Orkut in Brazil and so on - and this had happened with instant messaging in the first internet boom, but in the end Facebook turned out to have mostly global network effects. A few years later we had the same discussion about on-demand car services - many people thought thought that the network effects would be city-by-city, but in fact we had national and regional winners. However, in some countries the market did turn out to be big enough to sustain more than one network - in the USA both Lyft and Uber.

Now, a generation after Microsoft’s antitrust case and two generations after AT&T’s breakup, we come to talking about Google, Apple, Facebook or Amazon. There is little serious talk of breaking up Apple, perhaps because it’s so obviously a single unit. There is some argument for splitting AWS apart from Amazon -  I find this unconvincing (and I’ll return to this in a future essay) but regardless, that would still leave the Amazon retail business itself as a single hugely powerful company that’s generating a torrent of cash. But there’s a lot of talk of breaking apart Google and Facebook, and here I think comparisons with Standard Oil, AT&T and Microsoft are most  interesting. On one hand, there are clearly divisible component parts (Youtube, Instagram etc) in a way that’s much less true for Apple and Amazon. But on the other hand, I’d suggest that, as for Office and Windows, the competitive strength of these component parts doesn’t come from the combined ownership, but from networks effects. Hence, breaking them apart might achieve very little.

As a first observation, Google and Facebook have two-sided business models: they address advertisers and they address consumers. There’s no question that they have market dominance in online advertising (especially if you define the relevant market for Google as search advertising and for Facebook as social advertising). Equally, there isn’t much question that they bundle and cross-leverage all of their different properties when doing business with advertisers. Break them up, and advertisers would have more leverage and the successor companies to Google and Facebook would have less leverage and less market power.

Ironically, more leverage for advertisers over search or social networking companies would, all things being equal, mean less privacy for consumers. That isn’t typically what anti-trust advocates argue for, but it points to the fact that privacy isn’t necessarily a straightforward competition problem. Real policy is about trade-offs.

However, though advertisers could now play Facebook off against Instagram and Google against Youtube, consumers would have the same choices that they had before. Just as breaking up AT&T liberalised the telecoms equipment market but not the natural monopoly local access market, changing who owns Instagram doesn’t alter the network effects that make Instagram strong, nor YouTube, nor WhatsApp, because, as for Office or Windows, the network effects are internal to the product. You don’t use WhatsApp because Facebook owns it. Google Search isn’t far ahead of Bing because it also owns Youtube. And yes, just as Microsoft was accused of doing all sorts of things to cross-leverage its businesses, so are these companies, but that’s ultimately peripheral - the market dominance comes from the products themselves.

At this point it’s sometimes suggested that if Google and YouTube became separate companies, Google would build a new video sharing product and Youtube would make an major new search engine. This is hard to take seriously - all the reasons why ‘Office Inc’ and ‘Windows Inc’ could not have competed with each other apply here in the same ways. ‘Youtube Inc’ would have none of the ongoing network effects that make Google a leader in search - it would start not just far behind Google but far behind Bing. Equally, there’s no reason for Google’s new video site to do any better than its last one - it would be on the wrong side of network effects. Indeed, the weakness of this idea becomes clearer if one asks, rhetorically, why it is that Facebook does not already compete with Google in search, or why Google has failed so many times at creating social products itself? Why would Youtube Inc’s search engine do any better than Bing - what special advantage would it have? This is all just magical thinking.

🤔

If network effects are equivalent to natural monopolies, and the market position of some of the companies that you worry about are based on network effects, what do you do? Well, when faced by a natural monopoly with problems, we don’t just shrug and give up - we regulate it.

Going back to AT&T, the local access network is a natural monopoly, but you can unbundle competitive access to that ‘last mile’ of copper at the local exchange, with wholesale access to the data streams or direct physical access to the actual copper wire itself as it comes into the building. The trigger for this was DSL. In the USA, unbundling this access this was called ‘UNE-P’ and lasted a short while before being shut down, returning the copper monopoly to the Baby Bells. Outside the USA, regulators persevered (calling it ‘unbundling the local loop’) and created an entire new competitive layer in local access. The chart below shows the result: in pretty much every large country in Europe the former monopoly (‘the ‘incumbent’) now has less than 50% share of DSL. It still owns the copper, but it rents it out for other people to provide services on top, under a legally controlled wholesale model. The result is that in these countries most consumers have a choice of a dozen or more broadband providers. You can, in fact, combine a natural monopoly with competition.

A little later, something similar happened to roaming prices in Europe. Phone calls and data had become cheap, but roaming prices had not, and stories were widespread of hapless tourists getting huge bills for trivial amounts of use when they turned their phone on abroad. The EU responded with a set of rules that removed the consumer harm, and today roaming in Europe is effectively free.

The EU went about this by constructing an argument that this was a competition problem: the roaming price you were charged was a function of the wholesale rate agreed between the host operator and your operator, and you had no say in this. You could probably debate whether this really is a competition problem, but it doesn’t matter - the regulator found a legal mechanism to address a real consumer harm. (Ironically, a decade earlier Vodafone, which had networks in most European markets, had tried to sell a discounted roaming deal across those networks and was blocked by the EU on the grounds that since other operators could not match this it was anti-competitive. Yes, really.)

Something rather similar has happened over the last five years in European credit card interchange rates. When you swipe your card the retailer is charged a fee by Visa, MasterCard or Amex: the retailer can’t negotiate this and can’t chose not to support those card providers, so this really is a competitive question. Starting from 2015, the EU has capped these prices, pushing down interchange rates. (These rates are where loyalty points come from, so this has also reduced the value of such schemes to Europeans.)

What all of these have in common is that regulators inserted competition, cut prices, or both, by digging deep inside a monopoly or oligopoly and addressing mechanics, infrastructure and internal pricing schemes that consumers never see. They didn’t ‘break them up’ - they mandated wholesale access or price changes to things that you would never see on the P&L.  Local loop unbundling came with very specific rules and pricing about every aspect of connecting to the local access network. As we look at the regulation of parts of the technology industry today, we can see some pretty similar things coming.

Hence, the UK’s competition authority, the CMA, analyses Google and Facebook’s dominant positions, and doesn’t focus on breaking them up. Instead, it proposes a long list of highly specific internal, mechanical interventions. For example:

  • “The power to require Google to provide click and query data to third-party search engines to allow them to improve their search algorithms”
  • “The power to restrict Google’s ability to secure default positions, to restrict the monetisation of default positions on devices [i.e. Apple selling the default search engine slot to Google] and to introduce choice screens”
  • “Facebook should offer a defined find contacts service to users of a third-party platform, but rival platforms should not be required to reciprocate”

There’s lots to argue about in specific proposals like this (including how much of it will be enacted), but that’s not really the point - rather, one should ask which problems you can resolve by splitting the company apart, or by fining people, and which by getting right inside the operations and writing rules. As I pointed out here, we didn’t make cars safer by breaking up GM or Ford, but by writing rules about how you can make a car.

However, while the US does regulates cars (and many other things), most of my examples come from Europe, and this points to two distinct problems.

First, what happens when monolithic global software systems are regulated by different authorities in different places? What if those authorities mandate things that are mutually contradictory? Worse, what if those contradictions reflect fundamental differences in philosophy? Adtech is relatively apolitical, but attitudes to free speech vary in important ways even between different liberal democracies.

Second,  different jurisdictions can have rather different operating models for regulation itself. The US tends to have a rules-based, lawyer-led system that moves forward one court case at a time, whereas Europe tends to have a principle-based, outcome-based, practitioner-led system. You can see that very clearly in the CMA report above. The US discussion tends to circle back to the Sherman Antitrust act of 1890 and what is or is not a violation, whereas the CMA argues for a new regulator that can write new rules about the operations of Google’s data centre whenever it thinks necessary.

Finally - markets change, and in technology they change very fast. Detailed, line-by-line regulation of the internal operations of a company is straight-forward when the market is set in place for 50 years, but IBM’s mainframes dominated the tech industry for only 15 years, and Windows/Intel for only another 15, and as I wrote here, neither one lost their dominance because of anti-trust, but because the whole basis of of their dominance became irrelevant. There are people applying to YC now who weren’t born the last time anyone started a company to write Windows software.

This of course takes us back to the shift in regulatory models. Competition regulators are very conscious that they have moved too slowly. In tech, if you take five or ten years to resolve a complaint, then the company being harmed might have disappeared, the people who did the harm have moved to other jobs and forgotten all about it, and more fundamentally the whole market structure might have changed again - you can fine people, but it’s far too late. Hence, a big part of the shift in regulator attitudes is a shift to ex ante regulation - to thinking about what might happen instead of what did happen. (In the same vein, US regulators are also starting to think about whether moving away from their historic narrow focus on low prices for consumer might be a good idea, when looking at companies whose entire model is to be cheap or free.)

Of course, predictions are hard. The main reason that Americans do now have a (moderately) competitive market for telephones is that a completely different set of physics came along, in the form of cellular, where you actually can justify building three or four competing networks. Ironically, the legendary McKinsey study that said mobile would be a tiny market, and that there would only be 900,000 mobile subscribers in the USA by 2000, was commissioned by AT&T as part of this - when AT&T was broken up, no-one expected mobile to provide mass-market competition for telephone service. Equally, the anti-trust process that Microsoft went through 20 year ago was utterly ineffective - but then a few years later smartphones turned Windows PCs into accessories and Microsoft from a monopolist into just another big tech company. That’s not an argument against regulation, but it may be an argument for humility.

Benedict Evans is a Venture Partner at Mosaic Ventures and previously a partner at A16Z. You can read more from Benedict here, or subscribe to his newsletter.