China's digital monopolies are killing competition and need to be regulated

PUBLISHED : Wednesday, 19 August, 2015, 7:00am
UPDATED : Thursday, 20 August, 2015, 3:06pm

The government should step in and regulate digital monopolies because at the end of the day, healthy competition benefits all.

Monopoly is relatively new in the history of business—it only emerged some 100 years ago. And anti-monopoly policy makers have always been in an awkward position because the line between monopoly and free competition is oftentimes vague, and people’s attitude towards monopoly has been non-consistent.

One recent example of this inconsistency is how Google was treated differently in the US and the European Union (EU). Google enjoys 67 per cent market share in the search business and 75 per cent of search-related ad revenue in the US. The US Federal Trade Commission launched an anti-monopoly investigation against Google in 2012, but only concluded in January 2013 that there wasn’t sufficient evidence to support legal actions against the internet giant.

However, in April 2015, the EU filed an anti-trust lawsuit against Google, based on a five-year investigation. The core issue of the case lies in whether Google used its dominance to benefit its own comparison-shopping business by hampering competitors, which hurts consumers’ interests. A recent study by Michael Luca from Harvard Business School and Tim Wu from Columbia Law School found that Google’s way of displaying search results would lower the chances of consumers finding the product they need by one-third. One EU official even warned that the European economy will be at risk due to its overreliance on American internet companies such as Google. In China, the monopoly position of Baidu, Alibaba and Tencent is self-evident. After Google left in 2010, Baidu cornered 70 per cent of the revenue in the search business in China; in e-commerce, Alibaba takes up 80 per cent of the online shopping revenue; and Tencent has 500 million active WeChat users and 815 million QQ users—about 60 per cent of the country’s total population.

Internet monopolies

Compared with traditional industries, internet companies bear two traits that will magnify their chances of becoming monopolistic. The first one is externality, or demand-side economies of scale—it means that customers’ evaluation of one network largely depends on the number of users on that network. In other words, the more users one website has, the more likely new users will be attracted to it. This is why the “winner takes all” effect is particularly strong in the internet industry. The Metcalfe Law, a theory named after the founder of the Ethernet, vividly manifests externality by stating that a network’s value is proportional to the square of the number of its users.

So when companies can’t differentiate sufficiently, externality will unavoidably create monopolies. In any market segment—be it search, e-commerce or the sharing economy— the market will end up with only one winner. The mergers of Youku and Tudou (online video streaming sites), 58 Tongcheng and Ganji (Craigslist-like sites) and Didi and Kuaidi (taxi hailing apps) are all proof of this phenomenon.

The second trait is the supply-side economies of scale, which means that cost becomes lower when sales go up. Therefore, it is the most cost-efficient when only one company is there to serve the market—a scenario defined as “natural monopoly” by economists. However, a monopoly would raise prices and lead to the uneven distribution of social resources, creating a paradoxical situation for policy makers. Therefore, the government often regulates natural monopolies by setting prices and controlling market access. On one hand, the government will limit prices; and on the other hand, it will raise the bar on market entry, giving existing players bigger market shares to save costs.

Because of the two traits mentioned above, the chance of the formation of natural monopoly in the internet industry is high. And for regulators, the challenge is unprecedented—should they regulate prices and market entry the way they do in traditional industries?

Regulating internet monopolies?

In the past decade, little progress has been made in anti-trust investigations against internet giants mostly because current laws can rarely be applied to them. One example is that the ultimate manifestation of monopoly is monopoly pricing, but oftentimes the internet is free for users. However, people’s lack of understanding of digital monopoly doesn’t mean that the government should just stand by. Regulating internet monopolies should be put on the to-do list of the government.

So where shall the government begin? Regulators should see that compared with traditional industries, there are two distinctive features of the internet industry.

First, in the digital age, we need a broader definition of 'assets'. Alibaba chairman Jack Ma once said that in the future, the importance of data will be equivalent to that of energy today. A statement released in 2010 by Eric Schmidt, executive chairman of Google, showed that it only took Google as little as two days to collect 5 exabytes of data, which equals to the total amount of data produced by all of mankind till 2003. In that sense, a digital monopoly is not that different from monopoly in oil or the railway.

The other resource internet companies can monopolise is web traffic. When a few giants corner all the web traffic, they basically control the whole market. For instance, Taobao can easily influence sales of an online shop by changing its algorithm and Tencent can copy an innovative business very easily by taking advantage of its huge user base. If core resources like data and traffic are controlled by only a handful of companies, it will be too difficult to prevent them from manipulating the market.

We should also reconsider the distribution of wealth along the value chain. Many internet companies make profits by matching resources and eliminating intermediaries, both of which increase efficiency and creates value. But when monopolies form, we find out that most profits have gone into the pockets of the monopolies, leaving other suppliers in the chain high and dry. For instance, Taobao, while creating benefits for customers, is enjoying supernormal profits itself by sacrificing online retailers, many of which are reportedly in the red. Similarly, if ride-hailing companies like Uber and Didi-Kuaidi eventually become market monopolies, we can’t be sure that drivers and passengers will enjoy more benefits than they did before.

But when the society is flooded with success stories of entrepreneurs and how they revolutionise industries, people pay less attention to the issue of monopoly. Talking about monopoly can be seen as untimely, and even as a vicious attack on technological progress and entrepreneurship. But if we don’t curb the monopoly at all, the public will lose the benefits that are otherwise enjoyable under healthy competition.

Being anti-monopoly doesn’t equal being anti-technology or anti-capital. It is for the fair use of technology and capital. Regulators should realise that monopolies are already in place in most markets in the internet industry. The focus for them now is to face up to this trend and make sure that digital monopolies comply with the rules of the game so that public welfare is maximised.

There is no force comparable to that of technological progress. But revering technology doesn’t mean surrendering our rational sense. As Edward Thurlow, Lord Chancellor of Great Britain in the 19th century, said, “Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?"

Chen Xinlei is Professor of Marketing at Cheung Kong Graduate School of Business. This is a translation from an article originally written in Chinese.

This article has been reproduced with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China's leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge.