Competitive Edge: Remedying monopoly violation by social networks—the role of interoperability and rulemaking

Antitrust and competition issues are receiving renewed interest, and for good reason. So far, the discussion has occurred at a high level of generality. To address important specific antitrust enforcement and competition issues, the Washington Center for Equitable Growth has launched this blog, which we call “Competitive Edge.” This series features leading experts in antitrust enforcement on a broad range of topics: potential areas for antitrust enforcement, concerns about existing doctrine, practical realities enforcers face, proposals for reform, and broader policies to promote competition. Michael Kades and Fiona Scott Morton have authored this contribution.

The octopus image, above, updates an iconic editorial cartoon first published in 1904 in the magazine Puck to portray the Standard Oil monopoly. Please note the harpoon. Our goal for Competitive Edge is to promote the development of sharp and effective tools to increase competition in the United States economy.

All eyes are laser-focused on competition in digital technology platforms such as Amazon.com Inc.’s Marketplace, Apple Inc.’s App store, Facebook Inc.’s eponymous social network, and the search engine operated by Alphabet Inc.’s Google unit. Congress, the Federal Trade Commission, the U.S. Department of Justice, and various state attorneys general are investigating their conduct, and, if press reports are to be believed, both Google and Facebook could soon find themselves as defendants in major monopolization cases. By way of comparison, the previous major monopolization case, United States v. Microsoft, was filed in 1998, when “You’ve got mail,” and that static noise of a dial-up connection were common.

It is, however, past time to think only about whether these technology giants are violating the antitrust laws and ask how to address such antitrust violations if they have occurred. Even in the most successful monopoly prosecutions, such as the antitrust cases against AT&T Inc. in the 1980s and against Microsoft Corp. in the 1990s, the courts struggled to develop and implement effective remedies with various degrees of success. Discussing remedy before there is a case may seem like putting the cart before the horse—but think of it as designing the cart before deciding what horses to use.

Today, we have posted a working paper that proposes a remedy for one type of digital platform: a social network such as Facebook. Our remedy proposal relies on five principles, summarized here and discussed in more detail below:

Social networks, like most digital platforms, have large “network effects.” We discuss this concept in detail below, but the basic idea is that like the telephone system and email, the more people on the same network, the more useful it is to its users. Those network effects create entry barriers, which make it easier for anticompetitive conduct to successfully create and protect monopoly power.
Unless a remedy addresses the entry barriers created by these network effects, it will likely fail to fully restore competition or prevent future violations.
Interoperability refers to the way phones from Verizon Communications Inc., AT&T, and other companies can connect with each other, or users of Gmail and Hotmail can write to each other. In the case of a social network, interoperability would enable social network users on different social networks to seamlessly connect with each other, meaning that interoperability is likely to be critical, although not sufficient, to address harms caused by an antitrust violation.
Implementing interoperability poses challenges for the litigation process. It requires the creation of a technical committee to address the technical details. The committee can’t be manipulated by the dominant players. Policing compliance with the remedy must be efficient. And substantial penalties are needed to deter incentives to violate the remedy order.
The Federal Trade Commission could use its rulemaking authority, outside of any particular litigation, to develop a default interoperability order that could increase the workability and effectiveness of any future interoperability requirement.

Digital platforms are under scrutiny

On Capitol Hill, the Senate Judiciary Committee just held a hearing on Google and online advertising. The House Judiciary Committee will release its report on digital platforms shortly. Jason Furman, a professor of the practice of economic policy at the Harvard Kennedy School and a member of Equitable Growth’s Steering Committee, outlined the role of networks on competition in digital markets in testimony before Congress (available as a Competitive Edge), and Equitable Growth has also summarized research more broadly.

A network effect means a digital platform’s value to users increases as the number of users increases. Take Facebook as an example. As the number of users on Facebook increases overall, any individual will need to be on Facebook to communicate with her friends or family; conversely, no one wants to be on a social network if none of their friends or family use it. Similarly, advertising on Facebook becomes more valuable the bigger Facebook’s user base grows, the longer users are on Facebook, and the more Facebook can help target the ads to those who will most likely respond to them, which is a function of the first two benefits of size.

In turn, this network effect can lead to a winner-take-all (or most) dynamic, also known as tipping. When one social network creates an edge in number of users, either legitimately or through exclusionary conduct, that advantage attracts even more users. The social network may become dominant and earn monopoly returns. Ultimately, the network effect creates an entry barrier. Few will join a new social network until their friends, families, and neighbors do.

Neither entry barriers nor tipping present insurmountable barriers for a new competitor, but they do make it easier to monopolize a market. In a market subject to tipping (even if it is not permanent), the value of excluding a competitor is greater because the prize is bigger. If entry barriers are high, any potential competitor’s chance of success is low. As a result, a social network may be able to inexpensively acquire nascent or potential competitors before they pose a threat to the network’s dominance.

A successful remedy will reduce entry barriers created by network effects

If this type of digital platform has violated antitrust laws, it has engaged in anticompetitive conduct that relies on and exploits the network effect and the entry barriers it creates. Absent intervention, the dominant platform will continue to benefit from its conduct; entry is unlikely and difficult. A divested network can compete with its existing installed base of users, and this will create choice for users—provided their friends move with them. So long as the network effect remains, however, the dominant firm continues to have the same incentives to adopt different and new exclusionary conduct to protect its monopoly. For a remedy to be fully effective, it needs to reduce the network effect and the entry barriers it creates.

Network effects manifest themselves across different types of digital platforms: social networks, online marketplaces, app stores, and online advertising. But they can operate differently in each setting. Network effects can be direct or indirect; platforms can have multiple sides. The effects may be asymmetric, and some may be strong and others weak. A remedy that addresses network effects present in a social network market may be meaningless in addressing network effects in an online marketplace. We use Facebook to explore addressing network effects as a remedy for a monopolization violation involving a social network.

Based on allegations currently being made, assume that Facebook has allegedly acquired a series of nascent or potential competitors to eliminate companies; that it cut off access to Facebook when a company could pose a competitive threat; and that those actions violate the antitrust laws as illegal monopolization. How would one remedy the violation? (Our working paper and this column do not comment on the merits of these allegations.)

Certainly, a court could forbid Facebook from repeating the illegal act and similar acts. Facebook could face fines or have to give up its profits from violating the law. But we are doubtful that those remedies alone would recreate the lost competition and thereby give consumers the competition they were earlier denied. Conduct prohibitions are likely to create an expensive whack-a-mole game, with the government and the dominant firm arguing over both the impact of every new strategy and whether it counts as “similar” to what violated the law.

A more substantial remedy would break up a social network into separate parts and provide real benefits by setting the stage for robust competition. A remedy, for example, could require Facebook to divest its Instagram photo- and video-sharing unit and its messaging unit, WhatsApp. Divestiture would significantly benefit users post-break-up as the divested components would compete with each other to attract users. Each network would innovate and provide better service to win an advantage in the number of users. The competition would likely be fierce. But without additional remedies, the market would likely tip again to one of the competitors, creating another monopoly. Then, the winning social network has both the incentive and ability to engage in exclusionary acts to prevent future threats to its newly established or re-established market dominance.

Interoperability has the potential to lower entry barriers

Requiring interoperability can neutralize or significantly reduce the network effect that the incumbent employed to create and protect its monopoly. By interoperability, we mean that users on other or new social networks should be able to friend Facebook users and vice versa. Posts should flow from a Facebook user to her friend on a new network in much the same way email can be sent and received regardless of whether both parties use Gmail, or phone calls connect people regardless of their carriers.

Interoperability reduces the barriers to entry created by network effects. Let’s say, for example, that one of the divested Facebook companies begins to lose users. It radically changes its business model from advertising-supported to a subscription-based business model and promotes the resulting high-quality user interface. It hopes to attract users because it has no advertising and strong privacy protections. Without interoperability, a user who prefers the subscription model and leaves Facebook to join it will lose contact with all her friends on Facebook and perhaps institutions there, such as her child’s school. Such costs might deter her from joining her preferred network. With interoperability, by contrast, she receives school forms and news of family vacations and college reunions that are sent to her through her new network. In short, with interoperability, each person can choose the network they prefer while staying in touch with their social circles. The network effect ceases to be an entry barrier.

In this world, entering social networks could compete on features outside the standard, such as their user interface, policies concerning news or offensive content, and privacy policies. Consumers could change social networks like they change wireless carriers, without losing the ability to stay in touch with their contacts. The need to compete for consumers on the basis of service quality, such as the amount of advertising and how it is targeted, rather than relying on network effects to keep users, would intensify competition among social networks to the benefit of consumers.

Interoperability could be ordered in addition to other relief, such as a divestiture, and could be complementary to it or stand on its own. It could be an appropriate remedy in any situation in which the dominant social networking firm has exploited network effects by violating antitrust laws. In today’s internet-based network markets, interoperability carries no incremental costs such as the dedicated wires and machines that were required for telecom interoperability in past decades. It requires the establishment of an open standard to exchange commonly used functionalities, such as text, calendars, and images between and among competing social networks.

The challenges of implementing interoperability as a remedy

Although interoperability as a concept is straightforward, effectively implementing it raises challenges. In our working paper, we look back at both the AT&T break-up order, where interoperability was effective, and the remedial order in United States v. Microsoft, where those provisions had little impact. From those cases, we suggest several operational principles.

Substantively, the remedy must establish the technical capability for users to communicate across platforms, balance the needs of multiple actors, promote entry, and enhance the user experience, including protecting privacy. Importantly, the remedy order must prevent the offending, dominant social network (or its divested parts) from manipulating the process. This requires that the remedy include provisions that will deter the defendant from violating the order, require standards that many entrants can meet, and not favor large incumbents.

The remedy also must establish a process for determining whether the defendant has violated the order. That process must be fast enough to provide relief to a harmed competitor before that firm fails, and the penalties must be significant enough that the dominant social network will be worse-off for having violated the remedy order.

From a process perspective, creating a technical committee overseen by an antitrust enforcer is the most promising option to solve these implementation challenges. Judge Harold Green used a similar procedure in the AT&T break-up, and Judge Colleen Kollar-Kotelly relied on a technical committee in Microsoft. Such a committee would include representatives of all relevant industry segments, but the antitrust enforcer engaged in policing the remedy would control the decision-making process to prevent capture by the dominant social network (or its divested parts).

FTC rulemaking can improve the remedy process

The final element of our proposal is that the Federal Trade Commission should use its rulemaking authority to develop a default order for interoperability. Rulemaking provides a number of advantages for developing the groundwork for a successful remedy. A default order derived through rulemaking can identify basic principles to apply in monopolization cases involving strong network effects or issue separate rules on remedies for different types of digital platforms.

In an administrative adjudication, where the Federal Trade Commissioners are the judges, the default order would be a mandatory starting point for a remedy. In cases brought in federal court by the Justice Department’s Antitrust Division, the states, or the Federal Trade Commission (the FTC can either bring cases internally, where it acts as a decisionmaker, or in federal court, where it is the plaintiff), courts would not be required to rely on the default order but would be free to do so.

In any individual case, the decision-maker could adjust the terms as necessary to fit the particular situation, but the default order would save time and effort. The default order would also help focus on the issues in dispute. Parties could appeal any of the decisions we describe to the courts. Given the existence of a carefully crafted, robust order, however, those appeals would likely be less frequent and burdensome than if a court had to resolve every issue from scratch.

Conclusion

The debate over whether any digital platform violates antitrust laws will continue in the press, in the halls of Congress, and, probably, in courtrooms across the country. Antitrust policymakers need not—and should not—wait for a liability determination before considering remedies they can apply today, using current law and existing institutions. Our working paper provides a contribution to the remedy discussion and on the need to address entry barriers as a necessary, but not necessarily a sufficient, goal of a successful remedy.

—Fiona M. Scott Morton is the Theodore Nierenberg Professor of Economics at the Yale University School of Management. She consults on antitrust issues for a range of corporations, including Apple Inc. and Amazon.com Inc. Michael Kades is the director for markets and competition policy at the Washington Center for Equitable Growth. He does no outside consulting.