Diagnosing Monopoly Power in Markets with Rapid Technological Change (RTC Markets)

Richard Schmalensee
MIT Sloan School of Management
DOJ/FTC Hearings
March 8, 2007

• (Expected) SR market power is necessary ex ante for innovation; thus expect SR market power, perhaps dominance, in RTC markets
• But to find monopoly power need durability of SR power, usually assessed via analysis of barriers to me-too entry
• In RTC markets innovative/Schumpeterian entry may quickly eliminate SR power even if me-too entry is difficult
• Vigor of dynamic competition to innovate, not price competition, is key to future performance when rapid technological change is possible
• Testimony focus is problems, not solutions:
  • Ignoring the special features of RTC markets false positives,
  • But exaggerating those features false negatives

• The difficulty of predicting whether RTC market features will endure
• The fragility of market power based on network effects
• Some special problems posed by two-sided/platform/catalyst businesses

• If vigorous Schumpeterian competition endures – disruptive, market-stealing innovation – SR power not a great concern
  • Still worry about using SR power to limit LR competition
• Innovation often comes in bursts of uncertain length, timing
  • Autos: RTC until mid-1920; another burst coming?
• Direction and sources of innovation also hard to predict
  • Music: Walkman wiped out after years by MP3/iPod
  • Innovation markets miss the radical; sometimes useful
• Need to be thoughtfully skeptical to avoid two errors:
  • Ignoring disruptive innovations under serious development
  • Assuming all sexy new technologies will actually disrupt

• In some RTC markets, network effects can lead to high shares, substantial SR market power
• Snapshot is consistent with vigorous Schumpeterian competition, no expected excess profits – also consistent with its absence
• SR power from network effects is especially vulnerable to innovation: large share because everyone expects a large share
  • PCs wiped out Wang word processors quickly
• Esp. important & hard to predict the pace of disruptive change
  • After years of talk about software as (web-based) service, Google recently launched potential threat to MS Office

• Platforms make money by igniting reactions between disparate customer groups; indirect network effects, Coase theorem fails
  • Description of business models, not market fundamentals
  • Rochet-Tirole saw common features; live research area
• A wide variety of old & new businesses are two-sided: marriage brokers, media, shopping malls, exchanges, payment cards,...
• Newly important because of software platforms + internet
• Maintaining balance among groups is key to platform strategies
  • Often involves asymmetric pricing; all profit on one side
  • But must think of all groups (e.g., apps writers) as customers
  • Can have overlapping, single-sided, intersecting competition

• Need to recognize that the business is not just sales to the profitable side: game consoles worry about games, consumers
• Need to worry about competition from different models: FM v. satellite radio, Google v. magazines, CraigsList v. newspapers
• Price-cost margin useless because of asymmetric pricing
• Using the Guidelines approach is at least tricky
  • Competitors may have very different models: games v. PCs
  • Raising price to A reduces demand from A, thus B, which feeds back on A; tough to get elasticities right
• Because both groups are necessary, intense competition for either one can eliminate profits even if “dominate” the other

• Monopoly power can certainly exist in markets with rapid technological change; Section 2 should apply there
• But be careful: slowing rapid technological change is very costly
• Dangerous to assume that today’s conditions --SR power or vigor of dynamic competition – will persist; hard to predict change
• Market power based on network effects/expectations is particularly fragile if innovation is vigorous
• Platforms in RTC markets pose tough analytic problems; ignoring their special features can lead to a variety of serous errors
• Wish I could be more upbeat, but sometimes life is just hard...

D.S. Evans and R. Schmalensee, “Some Economic Aspects of Antitrust Analysis in Dynamically Competitive Industries,” in J. Lerner and S. Stern, eds., Innovation Policy and the Economy, vol. 2, Cambridge: MIT Press, 2002, pp. 1-49.

_____________, “The Industrial Organization of Markets with Two-Sided Platforms,” in W.D. Collins, ed., Issues in Competition Law and Economics, forthcoming.

_____________, Catalyst Code, Boston: Harvard Business School Press, 2007.

D.S. Evans, A. Hagiu, and R. Schmalensee, Invisible Engines, Cambridge: MIT Press, 2006.

J.-C. Rochet and J. Tirole, “Two-Sided Markets: A Progress Report,” Rand Journal of Economics, 37 (2007), forthcoming.

R. Schmalensee, “Antitrust Issues in Schumpeterian Industries,” American Economic Review, 90 (May 2000), pp. 192-196.