In the 1960s, IBM dominated the computer mainframe market. It still does. In the 1980s, Microsoft and Intel dominated the PC software and processor markets. They still do. In the 1990s, with the advent of the World Wide Web, the winners were Google in search, Amazon in e-commerce and Facebook in social networking. They still dominate those markets. Since 2007, Apple and Google (Android) have dominated the market for mobile internet operating systems.
The pattern is clear. New tech markets are often intensely competitive, amplified by the volatile nature of the technologies themselves. But once a tech company achieves clear market leadership - usually as a fast follower with better execution than the pioneer - it soon attains complete dominance and is then almost impossible to displace. Instead, the threat is that a newer, bigger, adjacent market emerges, dominated by another player, as mainframes and PCs have been overshadowed by online, mobile and cloud-based technologies. In the words of industry analyst Ben Thompson of Stratechery.com, dominant tech companies can be eclipsed but not displaced.
“Competition is for losers. If you want to create and capture lasting value, look to build a monopoly”
Cofounder of PayPal and Palantir
What is behind this phenomenon? Will today’s market leaders (GAFA - Google, Apple, Facebook and Amazon – and Microsoft) be displaced or eclipsed by others? Or will the dynamic change? Nine mutually reinforcing factors drive these companies’ market dominance. The first four factors are relatively obvious; the others perhaps less so, being based more on human behaviour than on economics and technology.
At least part of the tech giants’ market dominance can be attributed to traditional economic factors. Digital products and services have high fixed costs and low-to-zero marginal costs, as well as economies of scope and learning. For instance, AI and cloud-based resources can support a wide range of diverse activities, and get better and more efficient the more they are used.
The value of a communications network increases disproportionately as it expands, bringing in more other people for each user to connect with. This effect is formally known as a “direct network externality” (“externality” because it involves third parties in addition to the individual customer and firm). There can also be both positive and negative “behavioural” direct network effects if other consumers’ adoption of a product makes it either more, or less, acceptable, fashionable or attractive. For instance, these behavioural effects are important for teenagers’ choice of social media.
Most tech companies are, at least to a degree, “platform” businesses: they create value by matching customers with complementary needs, such as software developers and users (Microsoft’s MS-DOS and Apple’s App Store), suppliers and customers (Amazon), drivers and potential passengers (Uber) or advertisers and consumers (Google and Facebook). These network effects are “indirect” because – unlike with the direct, single-market, externalities above – the value to participants in each market (e.g. diners) depends on the number of participants in the other market (e.g. restaurants), and vice versa. Once a platform dominates the relevant markets, these network effects become self-sustaining as users on each side help generate users on the other. The general term for platform markets is “multi-sided” because some platforms facilitate interaction between more than two types of user. For instance, Facebook connects six: friends as message senders, friends as message receivers, advertisers, app developers, and businesses as both message senders and receivers.
New platform businesses face the chicken-and-egg challenge of achieving critical mass in both or all the key markets simultaneously. That’s why the failure rate is high, and tech start-ups such as Twitter, LinkedIn, Uber, Pinterest and Snapchat may need to be sustained over many loss-making years - or even never achieve profitability as standalone businesses.
Digital businesses gather data relentlessly, cheaply and efficiently. To exploit it, they use analytics, increasingly automated (“machine learning”), mainly to drive continuous improvement in products and services, pricing, personalisation and advertising targeting. They often add free or subsidised services to generate more data, producing a recursive relationship between adoption and usage, product and service quality, and further adoption and usage. Amazon, for example, constantly evaluates and refines its services and communications, doubling up on what works and reinforcing its dominance. The combination of big data and machine learning amplifies network effects and returns to scale, again strengthening tech market leaders’ dominance and deterring others from entering.
In November 2017, WPP ranked Google, Apple, Amazon, Microsoft and Facebook – in that order – as the five most valuable brands in the world, worth a total of just over a trillion dollars, or nearly 30% of their $3.6 trillion combined market capitalisation. Other brand valuation companies agree that these are among the most valuable global brands (although the numbers vary). Digital products are “experience goods”: users need to try them and learn about them (from their own or trusted others’ usage experience) to judge their quality. Well-known, trusted brands are essential in online markets to encourage trial and discourage switching to a competitor. Usage becomes habitual or even addictive, reinforcing the incumbents’ dominance.
Tech companies deploy a range of strategies to lock users in by making it difficult or costly to switch to a rival. Incompatibility between providers (“walled gardens” – for example, where iOS apps do not work on Android) and the resulting loss of non-portable data, and time invested in learning a particular system (“brand-specific consumer human capital”), all discourage user mobility. Service customisation, and accruing content such as playlists that cannot be migrated, further add to switching costs.
The brand valuations mentioned above relate to consumer brand equity – the brand associations in consumers’ long-term memory that make them more likely to buy or use the brand in the future. Tech giants also have significant employee brand equity, the equivalent in the talent market. This enables them to attract the best technical, managerial and commercial staff, further reinforcing their product-market dominance.
All the tech giants have, or had, strong, capable, hard-driving, hands-on founders such as Jeff Bezos, Steve Jobs and Mark Zuckerberg. The resulting corporate culture is epitomised by Facebook’s former motto, “Move fast and break things”. At Amazon, Bezos famously still insists that every day is treated as “Day One for the internet”. This obsessive, relentlessly active, innovative corporate culture is a significant strength, further reinforcing the tech giants’ continuing market dominance. Some would argue that it also drives their hyper-aggressive tax policies, adding to their competitive advantage.
Despite the claims of some Brexit enthusiasts, geography still matters, especially for innovation. Google (Alphabet), Apple and Facebook are all located in Silicon Valley, as are Oracle, Intel and Cisco. Amazon and Microsoft are headquartered in Seattle, a two-hour plane ride to the North. These eight companies account for more than half of the 14 tech companies in the global top 100 public companies by market capitalisation. Apart from China (whose big tech companies are still largely focused on their highly protected home market), no other country has more than one. In addition, 16 of the top 50 tech “unicorns” – firms founded after 2000 with a valuation of more than $1 billion – are also based in Silicon Valley. If one of them starts to be a threat, the incumbent will soon know about it and either acquire it or attack its business model with new service features. The incumbent’s early-warning system will be especially acute if it is providing the start-up with cloud-based or other services.
Will “creative destruction” – capitalism’s ability to innovate, destroy and reinvent itself - eventually take care of the tech giants’ market dominance? This seems unlikely because the combination of winner-take-all factors is so powerful. For example, a challenger to Google in search would have to offer an incentive or a noticeably better experience to attract users, over a period long enough to break their Googling habit. This would take years and cost tens of billions, with little chance of success. Microsoft’s cumulative losses in search were estimated at $11 billion in 2013.
It is therefore hard to see the tech titans losing control of their core markets anytime soon. The partial exception is Apple. Still the most profitable company in the world, Apple now faces challenges as it is increasingly forced to include Google services in its ecosystem and its price premium over high-end Android devices is eroded. The other tech giants also face some competition at the margin of their core markets. For Google, the main direct threat is Amazon’s growing search business, as consumers looking for a product increasingly go direct to Amazon, possibly using its Echo smart speaker (and microphone!) and Alexa voice assistant. Similarly, in social media, users can “multi-home” – engage with more than one platform – enabling competitors to co-exist with Facebook. Nevertheless, following the pattern described earlier, there seems little chance of Google, Amazon, Facebook or Microsoft losing its global core market dominance in the foreseeable future.
Eclipse by a rival with a dominant share of a new and potentially bigger market is always a possibility, however. To head off this threat, the big tech firms invest heavily in emerging products and technologies, whether through their own R&D, by acquiring promising or threatening start-ups, or by replicating those that cannot be bought. Self-driving technology is a good example, with companies such as Tesla, Google and Apple jostling to capture the leading position in a high-stakes new market.
Google users pay nothing for an excellent search service, while search advertisers have a highly effective tool that did not exist 20 years ago, for which they pay a competitive, auction-based market price. This creates a new situation for regulators to deal with: extreme market concentration which nonetheless offers customers great value for money.
Responses to date differ between Europe and the US. European antitrust legislation focuses on ensuring fair competition (reflected in the Commission’s recent 2.42bn euro fine on Google for “systematically” prioritising its own shopping service over rivals in searches), whereas US legislation focuses more narrowly on whether market dominance leads to demonstrable consumer harm. Because the dominant tech platforms are all US-based, this is likely to be an area of growing transatlantic conflict in the future.
We all benefit every day from the tech giants’ services, but, as Julian Birkinshaw and Ben Laurance argued in the previous issue we need new and better antitrust regulation to address issues arising from their enormous market power. For starters, competition authorities need to look closely at the likely effects of their acquisitions. The power of big tech also comes with other important downsides: fake news and filter bubbles, fraud, cyberbullying, interference in elections, tax avoidance and the reinforcement of inequality, to name but some. In short, the challenge of the tech companies’ self-reinforcing market dominance is only set to grow.
This article is based on Patrick Barwise and Leo Watkins, “The Evolution of Digital Dominance: How and Why We Got to GAFA”, in Martin Moore and Damian Tambini, eds, Digital Dominance: The Power of Google, Amazon, Facebook and Apple, OUP 2018. After publication in July 2018, the full chapter can be downloaded at http://lbsresearch.london.edu/914/ .
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