Digital Platforms Primer: Digital platforms and Competition (Part 3)

In analyzing the competitiveness of a market, it is important to look at who competes in a market. Several groups to consider are:

• Incumbent firms: Incumbent firms refers to firms that are well-established in a market. For example, GM, Ford, and Toyota are incumbent firms in the automotive industry. In competitive markets with multiple incumbents, incumbent firms compete with each other for market share and profits.
• Startup challengers: Startups are new firms that have entered a market to challenge incumbent firms. For instance, in the late 1990s, Netflix was a startup challenging Blockbuster in the video rental industry. In competitive markets, an innovative startup can pose a significant challenge to incumbent firms, forcing them to improve their business, better cater to consumers, or risk bankruptcy.
• Non-startup challengers: A firm from a different industry can enter a market to challenge incumbents in that industry. For instance, in 2007, Apple entered the phone market to challenge incumbents like Nokia and BlackBerry.
• Potential challengers: Potential challengers are firms that do not yet exist in a market but can emerge to challenge an incumbent. In a competitive market with low barriers to entry, the threat of a potential challenger can pressure incumbent firms to maintain or improve their quality and price for consumers. However, in industries with high barriers to entry, incumbents might not feel much pressure from the potential threat of these firms.

The identification of these competitors and potential competitors is important for evaluating the competitiveness of a market, but other factors, such as consumer behavior and government policy, affect market dynamics as well. For example, government regulations and policies that create barriers to entry can reduce a market’s competitiveness, while those that prevent anticompetitive actions, like policies that prevents price fixing, can increase it. Therefore, a market should be looked at holistically to determine its level of competitiveness.

Digital platforms have changed the competitive landscape in several ways mentioned earlier in this blog series. First, network effects (see part 1) are common in many platform businesses and can encourage “winner-take-all” and “winner-take-most” markets, barring other countervailing forces. Second, digitization (see part 2) makes it easier for platforms to scale rapidly and at a low cost. The combination of network effects and digitization can result in firms that become very large. Finally, digital platforms can collect very large amounts of data and make use of tools that digitization enables, such as recommendation systems and interoperability.

These trends’ impact the market in complicated ways, and readers should consider several questions when evaluating the competitiveness of a market a digital platform competes in:

1. What processes and metrics should be used to evaluate market competitiveness? How should factors such as the number of new entrants, productivity growth, market concentration, business investment, market turnover, profit margins, innovation, barriers to entry, and switching costs be used when evaluating the competitiveness of these markets?
2. What barriers to entry exist for non-incumbents (such as startups) to enter a market and compete with an incumbent digital platform?
3. How much incentive is there for incumbents and non-incumbents to innovate in a market?
4. How hard is it for users and other external parties on a digital platform to switch between platforms?
5. How much leverage does a digital platform have over external parties on the platform?
6. What are the competitive effects of the data an incumbent firm has? How is the incumbent firm using this data?
7. How are a digital platform’s merger and acquisition activities affecting the competitive landscape of a market? Is a particular acquisition or acquisition strategy by a digital platform promoting or stifling innovation?
8. How are practices and tools digitization has enabled, such as interoperability and recommendation systems, affecting competition?
9. How hard is it to detect and distinguish between procompetitive and anticompetitive behavior by a digital platform? Are any firms engaging in anticompetitive behavior? If so, what can be done to prevent it?

The next few sections will look at who these digital platforms compete with, but it will not directly evaluate the competitiveness of these markets.

Digital platforms often compete directly with other digital platforms in the same business. For instance, Uber and Lyft compete directly in the ridesharing space. Digital platforms can also enter new markets to compete directly with other digital platforms. For instance, Uber is a ridesharing service, but, given its driver network and expertise in transportation, it entered the food delivery business to compete directly with digital platforms like Grubhub and DoorDash. Factors that affect direct competition include how easy is it for users to switch between platforms and what barriers to entry exist for startups and other firms trying to challenge incumbents.

Digital platforms often compete indirectly with digital platforms that are in different businesses. For instance, YouTube and Twitter are video sharing and microblogging services respectively, but they compete to attract peoples’ attention to show them ads and get their data. Indirect competition between digital platforms can involve:

• Competition for external parties that create content, make applications, and provide other goods and services to users on a platform. A large part of a digital platform’s value is dependent on the external parties that interact on these platforms. Therefore, it is necessary for platforms to retain and attract external parties that create value for them.
• Competition for user data. Data is of great value to many digital platforms, since it can be monetized in a variety of ways, such as selling it to advertisers. For instance, Facebook and Google rely heavily on monetizing user data for revenue.
• Competition for user attention. A user’s attention is of great value to many digital platforms. The time a user spends on a digital platform is time the platform can use to show them ads or collect data from them.

The effects of indirect competition on the market can be complicated and less obvious than those of direct competition. However, properly evaluating the competitive effects of indirect competition on mergers, acquisitions, and other practices in digital markets is important.

Digital platforms and their products often compete with other external parties on their platform. For instance, Apple Music competes with Spotify on the iPhone. When an external party on a platform competes with the platform itself, the external party is usually competing for a share of the revenue generated on the platform, but it can sometimes go beyond that. For instance, a best-selling vendor on an ecommerce site can decide to leave the ecommerce platform and bring along other vendors with it to create their own digital platform and compete with the incumbent. Factors to consider when evaluating the interactions between digital platforms and external parties include what gatekeeping powers a digital platform has over the external parties, whether they are using these powers in an anticompetitive manner, and how much leverage each side has given the overall competitive landscape. Further, questions about what data a digital platform collects on external vendors that might be competing directly with their in-house products and what rules govern their use of this data are also important.

Digital platforms also compete with firms that don’t fit into the previous three categories. For instance, digital platforms like Lyft and Uber compete with taxis for passengers. An online marketplace might compete with a local brick and mortar retailer. Analyzing the competition digital platforms face from these other businesses requires considering factors such as how substitutable their services are and how they compete with each other.

Competition plays a critical role in fostering dynamism in a market economy and being reshaped by the rise of digital platforms. Policymakers and competition authorities should continue to study the various characteristics of digital platforms and market competition in the digital economy. Certain questions must be answered to help evaluate the competitiveness of these markets and whether antitrust laws are adequate for the digital era. The final blog in this series will focus on antitrust laws and ideas being considered for reform.