UPDATED: The Technology Wars and the Double-Edged Sword of Regulation

The scale, scope and nature of the Amazon v. Apple v. Facebook v. Google contest seems great for consumers - but it may have hidden costs that regulators will struggle to overcome

In 2009, I wrote an IBR article hypothesizing that Google’s business model might have a deleterious effect on long term innovation. At the time, the company had been releasing a torrent of free products and services – even when they were extremely expensive to develop and operate.  While this seemed great for consumers, it often destroyed the economic viability of selling those products or services. For a company like Google, that wasn’t a problem – they entered the market to collect more user data, not to make money (directly). However, it’s obviously a problem for companies whose business models are rooted in that market. After all, how do you compete with a massive, highly-skilled and cash rich company willing to give away its hard work for free – irrespective of the costs? Again, this should seem like a consumer victory, but in the long-term, it will likely reduce competition. And that’s not good for innovation.

Last week, Matthew Yglesias wrote the following about Amazon:

I like Dropbox. I like it so much that on Monday I upgraded from the 2GB free version to the one where you get 100GB of storage. It costs $99 a year. Then today I looked at the pricing for Amazon’s competing service. They’ll sell you 100GB for $50 a year. Plus they’ll give you 5GB for free. And unlike Dropbox, Amazon offers intermediate options. You could get a 50GB account for $25 a year. As I say, I like Dropbox. And I’m already paid up for a year, so I won’t be switching any time soon. But it’s hard to see how the company can compete with Amazon rushing in, offering a superior free product, and cutting Dropbox’s prices in half. Apple tried and failed in an effort to purchase Dropbox several years ago, but I think in the long term the founders will end up wishing they’d sold.

How can Amazon afford to offer such crazy prices? Well, storage is getting cheaper and cheaper and Amazon has achieved great scale and efficiency with operating large servers. But even better, Amazon doesn’t earn meaningful profit margins on any of its lines of business so there’s no need for Cloud Drive to be any different. It’s all about growth for them, which makes Amazon every possible competitor’s worst nightmare.

This presents an interesting challenge for regulators. Though predatory pricing (where a company sets prices low and/or below cost in order to drive out or away competitors) is illegal, many of the products and services offered by the global tech giants are essentially “investments” intended to drive the rest of their business – not eliminate competition. Furthermore, the fear of predatory pricing is that after eliminating competition, the remaining monopolist will raise prices. While Amazon would no doubt like to raise prices (assuming volume remained unchanged), they don’t need to – their goal was adoption, not the ability to control market pricing. Unlike many predatory monopolists, they are likely not losing money at current prices either. But again, it would be hard to view Dropbox (or any others) being squeezed out of the industry as a good thing, even if it was due to their higher internal cost structure.

Historically, Amazon’s cloud business would likely have been regulated. Yglesias’s description of Amazon’s “great scale and efficiency” being “every possible competitor’s worst nightmare” sounds like a natural monopoly. After all, the service, in which a central “asset” is distributed across a geographic network, is remarkably similar to that of fixed-line telephony and electrical power. Furthermore, it would costs tens of billions to replicate its server and content delivery network infrastructure. And yet, it’s not only possible to imagine a competitor coming after them, it’s likely.

Over the past few years, the scale and scope of the Big Four tech companies (Amazon, Apple, Facebook and Google) has expanded tremendously. Despite having largely different business models and pursuing different dollars, they are converging on the same set of same products, services and solutions. Here, Amazon is actually a perfect example. The company has invested over $100 billion to create its hyper-efficient warehouse and fulfillment operations around the world. This, not to mention their razor-thin margins, would suggest impossibly high barriers to entry. However, in March, Google announced that it would be piloting a partnership with companies such as Target, Walgreens, Stables, American Eagle, Toys “R” Us and number of small local businesses to provide “low cost” “same day” delivery in San Francisco. Not only is Google invading Amazon’s business, the reverse is also true. In 2011, Amazon forked Google’s Android operating system to offer its own line of (be)low-cost tablets. Not only is the Kindle operating system designed by Amazon, it cuts Google out of the entire user experience. All apps, content and browser-based activities are provided and managed exclusively by Amazon.

Today’s ecosystem wars are being fought on a scale that’s not only unprecedented, it largely flies in face of corporate strategy and regulatory theories. In many ways, this is great. Rapid innovation, intense competition and subsidized-to-free products and services are all great for the consumer. What’s more, no technology giant can successfully insulate itself from the threat of disruption or enslave it’s users. Just look at Microsoft. Despite widespread fears that it was unstoppably large at the start of the millennium, it now finds itself marginalized in everything from mobile to social. However, these same market forces paint a frightening picture for successful, mid-sized software/XaaS companies. Those that aren’t acquired by a tech giants or don’t operate in a particularly specialized vertical are in real jeopardy of having their business models disrupted, if not destroyed. This isn’t in anyone’s interest. But, as I wrote four years ago, “you can’t punish a company for being innovative, nor for giving its products away for free.” What is a regulator to do?

Update: Two days after this article was published, Fairsearch Europe (a group backed by Microsoft, Nokia and Oracle, among others) filed a complaint against Google with European antitrust officials. In the filling, Fairsearch argues “Google’s predatory distribution of Android at below-cost makes it difficult for other providers of operating systems to recoup investments in competing with Google’s dominant mobile platform.” Thomas Vinje, the legal lead for the groups claim, argues Android is “a deceptive way to build advantages for key Google apps in 70 percent of the smartphones shipped today.”