Network Effects and the Inevitable Monopoly

Posted by Cyberbear on December 1, 2010 in Internet, Tech News |

Posted By: Matt Kimmel

The Wall Street Journal recently published a piece by Professor Tim Wu of Columbia Law School entitled In the Grip of the Internet Monopolists. In it, he argues that we are living in an era of nascent information monopolies residing on the internet. These monopolies are currently kind and benevolent, but with time will become increasingly obstructionist, greedy, and inept.

He compares Google, Amazon, Twitter, today’s AT&T, and Verizon and others to the AT&T, Hollywood, and NBC/ABC/CBS of the mid 20th century. To be sure, some of these are strong monopolies. The chances of a new wireless carrier muscling into AT&T and Verizon’s market niche is slim to none. Several of these dominant players have network effects that brutally exclude any potential competitor. Several of them enjoy the advantages of traditional dominant market players, such as economies of scale. Without delving into the mires of the wireless phone carrier marketplace, I would say that AT&T, Verizon, and perhaps a small number of smaller players represent an oligopoly on par with some of the worst found in the last century. However, as for the rest, I am not so sure.

Let’s look at Amazon. They are not a monopoly in the sense of having sole possession of some market, or even in the colloquial sense of being the only big player in a market. They certainly do not rise to the standard of old AT&T, whose monopoly status was government enforced. They benefit from having no brick and mortar locations, but this is no different from any other online retailer. It is simply the evolution of a business model. Their advantages come primarily from economies of scale. Their size lets them negotiate more favorable terms from suppliers, and they are able to take advantage of a higher ratio of variable to fixed costs. This has been the goal of every major retailer probably since retail was started. These advantages are the reason that Borders outcompete The Tattered Cover, why Amazon outcompetes Bob’s Bargain Book Barn Online, and why Walmart outcompetes pretty much every retailer of anything in their arena. Amazon doesn’t represent a new and scary kind of monopoly, but is really just the Walmart business model taken online.

Consider Google for a minute. Their share of the search market is over 80%, and even Microsoft failed to capture a significant fraction of the market with Bing, even when they launched a program that paid users for every search they made on Bing that led to them purchasing something (by the way, Microsoft, I’ll stick with Google for my noncommercial searching, but my wallet thanked you while it lasted). Google has no serious network effects in its favor. Even Professor Wu acknowledged that Google Buzz made no real impact when compared with Facebook. Google is the dominant market player because they had the best search engine, as determined by the free market. They will benefit from this position as much as, say, Coca Cola does over RC Cola based on brand name recognition, and seeing other people use it, but such a benefit is a far cry from a monopoly. if another search engine comes along with something new, be it a much improved algorithm, a visual representation of search results, or perfected recognition of garbage and malware sites, Google could be knocked down from its perch in no time.

Finally, let’s consider those sites that do benefit from immense network effects. Twitter, Facebook, whatever the next one is. These sites get more useful the more people use them; if all your friends are using one, you are much less likely to use the other. The whole point of them is to communicate with your friends, after all. While we have already seen Myspace dethroned by Facebook, and a niche carved out of its forum empire by Twitter, let’s assume that Facebook’s network effects are so strong as to be enduring and make them a true monopoly, or at least monopolistic. The question then becomes “so what?” There are places where monopolies would have a huge negative impact on the consumer: food, housing, electricity, connectivity, and so on. There are also places where they’re detrimental, but hidden: a certain necessary car part, a PC operating system, anything where a component can raise the price of the final product. But what product is Facebook selling? They, like Google, are selling advertising. I have a hard time getting too upset if advertising is monopolized, given the nature of the product. It’s also important to define your market when discussing monopolies. Google may monopolize internet advertising with exceptions, Facebook may monopolize advertising to users of social networks, but people still watch TV, read magazines, see billboards, have fliers shoved in the cracks of their front doors, and get their mail. It’s difficult to see if an online advertising monopoly is really a monopoly on anything.

In conclusion, Professor Wu is either using an overly broad definition of monopoly, or overly pessimistic about how those monopolies will be used. A monopoly on one venue of advertising, for instance, is far less useful than a monopoly on operating systems. We have already seen Microsoft put up against the wall for anticompetitive trade practices, and we’ve also seen them get out of it with a slap on the wrist. The tech community as a whole ought to stop worrying so much about Google, and more about the monopolists we already have, who already abuse their market position with the strategy “extend, embrace, extinguish”.

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