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Preserving Dynamic Competition with the Digital Markets Act

· December 8, 2020

The EU Digital Markets Act, due to be released later this month, has the potential to fundamentally alter how competition works in digitally enabled markets. It could be an opportunity for the European Commission to put innovation first with a new framework for enforcement that properly accounts for the nuances of digitally enabled markets and dynamic competition. But there is also a risk that the process will favour the chorus of voices that urge for a more structural approach that would punish size as such, regardless of actual anticompetitive harm, the existence of market failures, or even proof of dominance. But every new regulation carries a risk of under enforcement and over enforcement, and it will be difficult to find the right balance. Where competition is concerned, as cautioned by one former Director-General for Competition and current member of the European Court, “the balance between over- and under-enforcement does not lead us away from a thorough effects analysis.” A structural approach, with rigid and inflexible ex-ante rules divorced from an assessment of actual effects and justifications, would likely do more harm than good, particularly in digitally enabled markets where dynamic competition dominates.

1. What is the problem?

Even critics of the status quo generally acknowledge that digital intermediaries generate tremendous consumer surplus and more efficient markets. As recently explained by the OECD, digital intermediaries “enhance productivity by helping economies to allocate resources faster and more efficiently”, and also result in “enhanced competitive pressure … by making it possible for more buyers and sellers to participate”. Consumers benefit from an abundance of choice on digital shelves. Prices are driven down by vigorous competition between suppliers on digital intermediaries that make it easier than ever for consumers to learn about the products, services, and sellers they choose to deal with. Digital intermediaries pass on the benefits of their scale, network and learning effects, and dramatically lower transaction costs. Growing and evolving demand combined with the versatility and diversity of software makes it ever easier for new entrants to successfully target a niche audience with innovative and differentiated offers, disrupting bigger players, and maintaining a dynamically competitive environment. Competition focused concerns tend to presume that even though markets are working well now, they would be working even better if markets were less concentrated.

Such views are often based on a static model of competition, whereby size itself is seen as an indication of a competitive bottleneck or anticompetitive harm, the thinking being that if markets were truly competitive, there would be a large number of players each on relatively equal footing. But this ignores the nature of network effects, economies of scale, which incentivise growth and confer first mover advantages. Some more insightful critics will say that these features of digitally enabled markets mean there is a “tipping effect” and a “winner-takes-most” dynamic that justifies ex-ante intervention to ensure that markets are “won” on the merits. But even this view ignores the very real competitive constraints facing digital intermediaries regardless of size. 

2. Dynamic competition and the “winner-takes-most” fallacy

In the digital era, size alone is no moat. Acquiring a leading position in an industry used to be a slow process spanning over decades. Nowadays growth can be much quicker.  Zoom gained hundreds of millions of users in the span of a few months, TikTok has grown nearly as fast. By the same token, however, the fall of leading market players can be just as rapid. As noted by the UK Department of Business and Innovation, the loss of network effects “may turn a small decline into a rapid collapse”. The OECD’s recent hearing on disruptive innovation revealed that “Google and Facebook disrupted their markets despite the fact that those markets already had strong network effects that had been insulating the incumbents. These two disruptors succeeded with a jiu jitsu style strategy that dislodged incumbents with the same network effects that had been working in the incumbents’ favour”. Growing and evolving demand combined with the versatility and diversity of software makes it ever easier for new entrants to successfully target a niche audience with innovative and differentiated offers, disrupting bigger players, and maintaining a dynamically competitive environment

One of the most common and successful strategies to dislodge a leading company is to target a niche of the market. Microsoft entered a niche of the computing ecosystem, disrupting the then-industry-defining IBM. As the personal computer market grew, much smaller Apple and Google competed dynamically with Microsoft, through mobile devices, browsers and mobile operating systems. Amazon entered a niche of the retail market; Netflix, a niche of film distribution; Facebook, a niche of digital media and advertising. The same is true of Spotify with streaming, Shopify with retail, Zoom with communications, TikTok and Snap with social media, DeliveryHero with logistics, and Zalando with fashion. Their success is not in copying what has been done before, but meeting previously underserved customer demand where incumbents were slow or unwilling to react. This threat of disruptive competition keeps even the largest players on their toes and responsive to evolving consumer demand. This forces digital intermediaries to pass on the benefits of their scale, network and learning effects, and vigorously compete regardless of market size.

3. Preserving what works

There are over 10,000 European digital platforms, and currently 112 billion-dollar European tech companies combining for a $416 billion market valuation; this number has almost quadrupled since 2014, with 32 new companies joining the European unicorn club in the last year alone. These companies, spanning across industries, all rely on robust technological ecosystems. Some are complementors, adding value to existing ecosystems. Others use the tools and infrastructure of existing incumbents to serve a particular niche, aspiring to grow their own ecosystems. They will succeed by attracting investment capital, acquiring the best human talent, minimising costs, and dynamically adapting in the evolving global environment. 

The next generation of innovative disruptors will benefit from thriving ecosystems they can trust. Complementary innovators need confidence to invest in intermediary-specific ecosystems. Digital intermediaries have market incentives to keep that trust, because of network effects. But, digital intermediaries can also become so large and indispensable that their incentives shift. Anticompetitive conduct should be prohibited, particularly where there is a relation of dependence. For example, an indispensable platform that attracts developers with the promise of continued software interface access should not be allowed to unduly remove that access.

But what may be “undue” in the eyes of an upset customer may not be undue from the ecosystem perspective. Changes that harm the interests of some subset of users may benefit the wider interest; balancing these multidimensional concerns is difficult in practice and requires repeated readjustment. As recognised by one recent global survey of platform enterprises, “[a] more integrated understanding of technology and business will be fundamental to the success of platform firms, or the success of platform business units within traditional firms. Where and how to design technological interfaces, how open or closed should they be, how to price them, who will the complementors be, how to govern the ecosystems, will become as fundamental and as routine to business strategy and management as the well-honed traditional questions of product segmentation, pricing of products, management of the supply chain, and how to design distribution channels.” Platform operators have the greatest ability and incentive to meet evolving preferences and grow overall demand for the benefit of all platform users, and must do so while balancing the sometimes diverging interests of particular platform users. This is what led to their success, and their continued ability to make necessary adjustments that preserves continued dynamic competition. It is unlikely that legislators can find that future-proof balance, ex-ante, and divorced from market circumstances. To prohibit or oblige, ex-ante and inflexibly, a wide range of practices, in a wide range of industries, without even the possibility of refinement or readjustment, risks eroding the value-generating ecosystems upon which future innovations depend. EU Law grants even the most anticompetitive of agreements the possibility of pro-competitive justification. Dynamic digital markets deserve a case-by-case assessment of potential justifications as well.

  • Ex-ante prohibitions on large players are likely to reduce competitive constraints between them. Even where entry is uncertain, the threat keeps incumbents responsive to demand. But regulatory suspicion of pro-competitive product design choices will chill future demand driven technological development and adaptability. Unrebuttable ex-ante prohibitions would thereby create new regulatory barriers to dynamic competition that would otherwise benefit all users.
  • Ex-ante obligations to supply previously uncommercialised services (such as data access or interoperability) also risk reinforcing existing dependencies by turning large intermediaries into legislatively created infrastructure suppliers divorced from evolving consumer demands. Meanwhile, potential rivals will choose the “easy” option of a remedy-taker business model. Unappealable ex-ante obligations would hence distort and dampen competitive incentives. 

Even those who advocate for competition reform recognise that “innovation is best promoted when market leaders are allowed to exploit their competitive advantages while also facing pressure to perform coming from both conventional rivals and from disruptive entrants” (pg. 2). Particularly in dynamic digital markets, the risk of rigid and inflexible ex-ante rules is a loss of innovation. If the Digital Markets Act is to preserve dynamic innovation-based competition, a case-by-case assessment allowing for tailored remedies is needed.

There are legitimate concerns about the growing size and influence of leading technology companies. But as noted by Nobel prize winner Jean Tirole, “we should err on the side of competition, while recognizing that we will make mistakes in the process. …The possibility of error must be accepted, and so the regulatory innovations must evolve as the authorities learn by doing and slowly incorporate them into guidelines. ” The history of competition enforcement shows that the most pro-competitive remedies are adapted to market circumstances, with the insight and participation of industry, and an eye towards future innovation and market growth. A case-by-case assessment is needed to ensure the best outcomes can be achieved here as well.

European Union

DisCo is dedicated to examining technology and policy at a global scale.  Developments in the European Union play a considerable role in shaping both European and global technology markets.  EU regulations related to copyright, competition, privacy, innovation, and trade all affect the international development of technology and tech markets.