The Paradox of Trust: Anti-Competitive Behaviour in the Tech Industry

Photo from metamorworks

How much trust do you put in tech companies that have repeatedly demonstrated a willingness to engage in anti-competitive behaviour that violates antitrust laws? For most digital citizens, the answer to this question is a resounding “more than I should”.

From password management and location services to private messaging and document storage, modern consumers seem disinclined to ‘vote with their feet’ when it comes to being wary of tech giants. Convenience, herd mentality and a sense that there are no better alternatives leads us to place undue levels of confidence in both tech companies themselves and the institutions designed to police them. Under this lack of accountability, many firms in the tech industry are able to engage in anti-competitive behaviour with impunity. So, what do we classify as anti-competitive behaviour?

The United States Federal Trade Commission (FTC), the governing body responsible for regulating unfair business practices in the US, defines anti-competitive practices as “activities like price fixing, group boycotts, and exclusionary exclusive dealing contracts or trade association rules”. More broadly, the term encompasses any action that a firm takes to intentionally stifle competition in their given market, typically to the detriment of consumers in that market. The FTC categorizes anti-competitive behaviour into two distinct groupings; horizontal conduct (agreements between competitors) and single firm conduct (monopolization).

While the precise legal definitions of antitrust violations differ from country to country, I will continue to use the FTC definition since the tech industry is dominated by US companies. For instance, Google, a subsidiary of the ‘Big Five’ parent company Alphabet, accounts for 93% of global internet traffic. Not only are the rest of the ‘Big Five’ companies (Amazon, Meta, Apple, and Microsoft) also based in the US, but it is important to remember that every international tech company that competes with these US tech giants will be affected by the strength of the FTC’s antitrust regulations.

Thankfully, the role and impact of the FTC is one of the few facets of anti-competitive analysis in the tech sector that inspires optimism. Between suing Amazon for monopolistic behaviour, filing a suit against Meta to block a proposed merger that would stifle competition in the VR market, and filing an administrative complaint against the merger between Microsoft and Activision Blizzart, Lina Kahn has played an instrumental role in cracking down on US tech giants’ attempts to skirt antitrust laws ever since she assumed the position of FTC chairwoman in 2021.

What are Competitive Restraints?

In many markets, there is an economic incentive to employ competitive ‘restraints’. Due to the tendency for competing firms to undercut each other to capture market share, economic profits in excess of production costs will be dissipated to zero through competition in the long run— a race to the bottom, if you will. Consequently, competitive firms acting solely in their own self-interest will produce an outcome with lower payoffs than if they colluded— this is where restraints enter the equation. Firms will often conspire in clever ways to imitate monopolistic profits through cartel behaviour, including price fixing, boycotting and market allocation.

Competitive restraints can be categorized as two separate phenomena; vertical restraints and horizontal restraints. The important distinction between these two types of restraints is that vertical restraints occur across different levels of the supply chain. For instance, a distributor signing an exclusivity deal with a supplier. These types of restraints are not always harmful or anti-competitive, and are therefore not always illegal.

Conversely, horizontal restraints occur laterally between competitors at the same level of production, and involve an agreement to artificially suppress any competitive behaviour that would damage both firms’ profits. These restraints are far more likely to be illegal per se due to their tendency to harm consumers and circumvent existing antitrust laws.

The Downsides of Monopolization

The Sherman Antitrust Act passed by US congress in 1890 codified a blanket ban on conspiratorial trust behaviour that was “in restraint of trade or commerce”. This broad definition has allowed the US government Department of Justice to pursue several tech giants over the past decades, such as their 2020 lawsuit against Google for digital advertising monopolization, their 1974 lawsuit against AT&T demanding divestiture of their telecommunications services and their 1998 complaint against Microsoft’s monopoly on computer operating systems (Windows). In all three of these lawsuits (and many others), the Sherman Act was specifically cited to prove antitrust violations.

Whereas section 1 of the Sherman Act allows the government to investigate conspiratorial trust behaviour that may not be obvious to consumers, section 2 of the Sherman Act focuses on direct monopoly behaviour— generally classified as securing a market share in excess of 70%. Section 2 of the Sherman Act states that forming, attempting to form, or conspiring to form a monopoly is de jure illegal. While this definition is relatively easy to quantify using sales data, the tech industry is especially prone to monopolies.

For instance, many tech products are what economists would call network goods, meaning that they become increasingly useful when more people begin to use them. For example, the first consumer to ever buy a telephone received near zero utility from the purchase because nobody else had a telephone, and so they could not call anyone. Today, buying a phone allows you to tap into the existing network of phones, making it a valuable communication tool. As a more modern example, Facetime is a popular service solely because Apple has such a large market share in the North American cell phone industry— if only 10% of consumers had iPhones, Facetime would be a far less useful product. Similarly, social media sites, online video games, and messaging services become more useful to each consumer when market share for that particular product is dominated by one firm. This can pose a difficult problem for courts, who sometimes have to mandate divestiture despite the monopolistic outcome being a result of legitimate, rational consumer behaviour.

credit: Rob Dobi

Another aspect of the technology goods and services that makes the tech sector so vulnerable to monopolies is the increasing returns to scale. As Morgan Stanley’s head of consilient research and adjunct professor of finance at Columbia Business School Michael Mauboussin points out, tech companies benefit from increasing returns to scale in multiple ways. Whereas other industries suffer from overcrowding inefficiencies, marginal labour productivity in tech jobs often scales with company size, such as Google programmers being able to draw upon the largest codebase in the world. Furthermore, many tech products have an essentially infinite profit margin due to their nonexistent marginal cost and complete lack of transaction costs. Microsoft, for instance, has massive fixed costs used for R&D and capital investment, but can sell an additional Windows license without incurring any additional cost.

With all of these legitimate reasons for large firms to dominate in the tech sector, the distinction between anti-competitive behaviour and organic market function is often a gray area left up to the discretion of courts. The line between collusion and collaboration is a blurry one, and retroactively proving conspiracy can feel like an impossible task.

So what now?

Many of the reasons why regulating antitrust behaviour in the tech industry can be so difficult are symptomatic of the nature of the sector itself. As former FTC chairman Robert Pitofsky points out, “many high-tech industries involve questions that are challenging for lawyers and judges who typically lack a technical background.” This was a concern for Pitofsky in 1999 when he wrote it, and it has only become a bigger issue since. For some context on the extent to which current congresspeople seem not to understand the tech industry despite being responsible for regulating it (and for a little laugh) here is a list of real questions posed to Mark Zuckerberg during his 2018 congressional hearing.

Additionally, Pitofsky highlighted other idiosyncrasies that render the tech sector uniquely difficult to legislate, including instantaneous market transactions, frequency of (legitimate) collaborative activities, significant barriers to entry and network efficiencies between tech goods. In his conclusion, Pitofsky clarifies that these challenges should be an incentive for a “cautious approach” to the ever changing industry, rather than an abandoning of antitrust principles. 25 years later, this conclusion still rings true.

Given how difficult anti-competitive behaviour can be to regulate in the courts, the burden of minimizing damage may fall on us as consumers. Like all profit seeking firms, tech companies respond to consumer driven demand with enthusiasm, which can be an even stronger motivator than legal arm-twisting.