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What SMEs Stand to Lose from Overregulation

· August 3, 2021

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The unintended consequences of the bundle of new technology regulations approved by the House Judiciary Committee earlier this summer are still being explored, but thus far have not considered an important group: small and medium-sized enterprises (SMEs).

As noted platform economists Andrei Hagiu and Julian Wright point out, the House bills would prohibit leading American digital services like Amazon and Apple from offering a marketplace or ecosystem for small businesses, while also selling products within that ecosystem 一 an end to so-called one-stop shopping. What the authors of these bills, which even House Majority Leader Rep. Steny Hoyer has indicated were hastily drafted, seem not to appreciate is that the net effect will harm small businesses by damaging the business model that has enabled independent app developers and small retail sellers to thrive. 

In a New York Times interview, sponsor Rep. David Cicilline made clear that companies providing a marketplace would have to “authentically separate” the marketplace from their own retail stores (i.e., divest, sell off, or cease to operate the marketplace). In the case of Amazon, for example, third party sellers would no longer be allowed to sell alongside Amazon’s own retail offerings 一 a setup that allowed independent small sellers on Amazon to grow from less than 3% of Amazon’s sales to over half of its sales in less than 20 years.

The common assumption of policymakers championing this 20th-century industrial policy appears to be that regulated companies would spin off operations involved in selling into their own marketplaces, and simply “be a marketplace.” Indeed, this is the goal, according to some policymakers: smashing one-stop shop hybrid services, which unite first-party and third-party business in one location.

However, policymakers misapprehend the likely consequences of forcibly separating selling functions from marketplace functions, first-party from third-party. The assumption that companies will cease offering products in their own marketplace and yet continue to operate that marketplace 一 subject to onerous regulation 一 needs reexamination.  

Some companies may simply stop providing a marketplace. This would no doubt impair the company’s business, but that’s unavoidable in an onerous regulatory environment. When all options are bad, the question is which does the least damage.  And when regulations are designed to penalize marketplaces relative to traditional retailers who don’t allow independent sellers to sell alongside their own retail operation, companies may choose to revert to more traditional models that don’t have room for independent small businesses.   

Consider Amazon: faced with the option of becoming either eBay or Walmart, the company has a strong incentive to focus on first-party retail instead of third-party sellers. Amazon already attempted operating a third-party marketplace twice. Both attempts, it acknowledges, were failures. Why assume the third time is the charm? 

The safer strategy would be to abandon the marketplace model entirely, avoiding that model’s attendant regulatory burdens that would disadvantage it relative to its big-box competitors, and focus entirely on direct online retailing. Like most retailers, Amazon purchases wholesale from brands, and sells directly to consumers. The loss of this line of business, even more so than Amazon’s house brands like Amazon Basics, would have a significant impact. If faced with a choice between relying entirely on third parties to meet consumers’ needs, or reverting to its original business model of being a first-party retailer where it has direct control of its inventory, pricing and fulfilment network, no one should be surprised if Amazon chooses to restructure its store to look more like Walmart rather than eBay.  

This would greatly disadvantage Amazon’s third-party sellers, over 90% of whom had up to 50 employees in 2018, and 73% of whom had one to five employees. When Amazon’s Marketplace provided new opportunities to small and medium-sized businesses routed by the big box stores in the 1990s, small and medium-sized businesses began a transition toward online retail that continues today. Brand identities and customer relations have been built. For Congress to now shutter some marketplaces to third parties, forcing them to move to other venues not similarly targeted, could have serious implications for a portion of America’s digital Main Street.

More broadly, this is not necessarily an Amazon-specific phenomenon. Other marketplace operators may similarly eliminate marketplace functions and embrace first-party sales. App store operators, for example, could close down third-party stores, acquire the rights to successful apps, and retail those apps directly.  

Hagiu and Wright point out that the benefits of hybrid or “dual mode” operation are being discovered “by an increasing number of companies who open up marketplaces where they sell their own products alongside third-parties.” These benefits, they conclude, “are clear and obvious, while the harms that can arise from it are not.” Policymakers may sacrifice those consumer benefits by imposing onerous structural regulations, thus discouraging companies across the economy from adopting hybrid or dual mode strategies. If dual mode marketplaces offering first-party and third-party products are regarded with regulatory suspicion, why be one?   For example, why would Target continue to build out its third-party marketplace, if only to be forced to divest or discontinue it when it became successful?  

Until now, the potential unintended consequences of over-regulating digital marketplaces have focused largely on the consumers of those marketplaces. While those potential injuries are considerable, they are not unique. Policymakers must also consider the risk that misfiring has for SMEs who are selling via these marketplaces, and the jobs that those SMEs create.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.