Platform regulation: What policymakers can and cannot learn from utility industries

Tobias Kretschmer, Sven Werner 28 August 2021

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Recent discussions on how to regulate dominant online platforms revolve around the extent to which existing regulatory frameworks – for example, for utilities – can and should be applied to modern-day platforms.

At the heart of platform business models is their function as intermediaries who enable valuable connections and/or transactions between one or several groups of agents (Goldfarb and Tucker 2019). Many of today’s most valuable firms operate a platform business model – for example, the Google search engine brings together users, webpages and advertisers. Amazon and Alibaba operate marketplaces that match sellers to consumers. Apple sells devices to users, who interact with app developers. The main success factor of a platform business is the creation of network effects – a platform ecosystem provides more value to its users the more connections to other users it potentially can enable. This amplifying effect (more users create more network value which in turn attracts more users) has led to a fairly concentrated market structure in several markets, raising questions of the most efficient market structure as network effects would call for more concentration letting users benefit from a larger-sized network. Nevertheless, there are ongoing discussions about the market power of some of the big technology firms and whether they should be regulated ex ante, supplementing current ex-post competition law. For example, Caffarra and Scott Morton (2021) discuss the European attempt to regulate online platforms.            

Many commentators (e.g. Bostoen 2019) point to utilities industries for guidance on how to shape efficient regulation for platforms because they seemingly have undergone a comparable trajectory. Until the 1990s, utility markets were dominated by few firms, and it was presumed that significant economies of scale in infrastructure provision and network effects rendered these markets natural monopolies in which multiple firms might inefficiently duplicate infrastructure or might fragment the market which would reduce network effects for consumers. Since then, several procompetitive ex-ante regulatory measures have been introduced to these markets with the aim “to deliver real choice for all consumers […], new business opportunities and more cross-border trade, so as to achieve efficiency gains, competitive prices, and higher standards of service” (EU Directive 2009/72/EC).1 Several such measures for utilities are mentioned as giving helpful guidance for platform regulation in the current debate, for example on interoperability and data portability (OECD 2021), or self-preferencing (Padilla et al. 2020).

Comparing and contrasting economic and strategic features of platforms with utilities from a business model perspective is insightful to analyse the applicability of utility-like regulation for platforms (Kretschmer and Werner 2021). Superficially, utilities and large platforms both typically occupy dominant market positions and can act as gatekeepers for users and completers. However, looking at four dimensions – value creation, monetisation, competition/entry, and innovation – reveals that several differences exist which make broad applicability of utility like regulation for platforms inappropriate.

Dimension 1: Value creation

The value that a platform provides stems from two sources: on the one hand, from the platform’s facilitation of connections and transactions between the third parties using the platform such as users, businesses, and advertisers (e.g. through high quality search results, trusted review systems or secure payments); on the other hand, the platform provides access to the network value resulting from the quantity of third parties on the platform and their qualitative engagement, which are often called network effects or demand-side economies of scale (e.g. many vendors offering in-demand products, friends frequently sharing pictures with each other or app developers creating innovative phone applications). Hence, value creation on the platform crucially depends on the operation and governance of an ecosystem of interconnected third parties and on its success to foster value creation by third parties. 

By contrast, utilities industries feature strong supply-side economies of scale in the provision of transmission infrastructure. The products and services delivered through these infrastructures, such as electricity, water, and phone calls, are mature products and services with somewhat standardised features and quality.2

For platform regulation, this implies that the assessment of potential remedies is much more complex for platforms as it should account for potential adverse and self-reinforcing side-effects on overall value creation within the entire platform ecosystem.

Dimension 2: Monetisation

The fact that a platforms’ value creation crucially depends on the entire ecosystem’s value creation also resurfaces in the monetisation strategy. Platforms use two-sided pricing to balance user and complementor participation, value creation and rent extraction. This means that platforms may charge different mark-ups for different market sides, depending on the extent of cross-side network effects and the respective demand elasticities for the different market sides to increase value creation within its ecosystem, for example advertisers pay a fee while consumers search for free (Armstrong 2006).

While at first glance, utilities use similar pricing instruments such as monthly subscription models and per-use charges, utility pricing does not follow a two-sided logic and price mark-ups typically reflect market power.

For platform regulation, this means that prices above marginal cost cannot automatically be associated with platform market power, and nor are negative prices necessarily a sign of predatory practices (Wright 2004). 

Dimension 3: Competition and entry

A platform requires sufficient traction on both market sides to compete or to enter a market. Platforms can differentiate through hosting different sets of users/complementors, thus creating benefits of multihoming (think of Netflix offering access to different films than Disney+). Importantly, small-scale entry is also possible when strong network effects between a focused group of consumers exist (for example, in the early beginning TikTok had focused content on self-made dance videos which attracted its early adopters and from there on achieved mass adoption with a larger variety of content). 

By contrast, utilities entrants require access to infrastructure or high fixed cost to build an own transmission network. Further, there is little differentiation between competitors, giving existing consumers reduced incentives to change operators or to multihome. 

For regulation, this implies that the forces driving competition and entry in platform markets are more dynamic than in utilities due to evolving user preferences. Therefore, not all platforms should be considered dominant per se, and remedies should consequently be carefully targeted and frequently reassessed. 

Dimension 4: Innovation

Digital platforms evolve continuously in short innovation cycles and, additionally, innovation takes place at all levels of the platform ecosystem. First, a platform can improve its core intermediation service, for example an improved recommendation system which allows for more and better matching of market participants. Second, the platform can introduce an innovative increase in functionality which stipulates subsequent innovation by complementors such as increased security mechanisms for banking apps following the introduction of fingerprint sensors in smartphones. Third, complementors may develop and invest in increasing quality or provide more variety in the market, called ‘horizontal innovation’ (Panico and Cennamo 2020), even absent a change in the underlying platform technology. Summarising, an innovative platform does not simply focus on its own innovation efforts, but rather steers and governs the activities of an interdependent ecosystem of independent innovating economic actors.

In most utilities,3 innovation cycles are very long and disruptive innovation is rare (Montero and Finger 2019) – for example, water pipes in the UK are on average 70 years old (Speight 2015). Hence, investment is mainly to maintain and improve existing physical transmission infrastructure which constitutes the competitive bottleneck in utilities. In addition, final product offerings are relatively mature and consumers often view them as homogeneous, resulting in low incentives to design innovative products (Rutter et al. 2018).

For regulation, this means that while a focus on static competition and efficiency seems appropriate for most utilities (for example, through mandating access to the incumbent’s infrastructure), considering the impact on innovation incentives and dynamic efficiency is crucial for successful platform regulation in fast-changing digital environment.

Regulation needs to account for platform ecosystem dynamics

This high-level comparison of utilities and platform business models and economic features along four dimensions (as summarised in Table 1) is an attempt at starting and guiding a constructive debate about the importance to consider the specifics of platform markets and their actors in the design of possible remedies. Overall, the design of effective remedies for dominant digital platforms must take into account ecosystem dynamics and innovation activities, which are less pronounced in utility markets.

Table 1 Business model comparison of utilities and platforms

References

Armstrong, M (2006), “Competition in two-sided markets”, RAND Journal of Economics 37(3): 668–691.

Bostoen, F (2019), “Regulating Online Platforms: Lessons from 100 Years of Telecommunications Regulation”, Mimeo.

Caffara, C and F Scott Morton (2021), “The European Commission Digital Markets Act: A translation”, VoxEU.org, 5 January.  

Directive 2009/72/EC of the European Parliament and of the Council. (2009). Concerning common rules for the internal market in electricity and repealing Directive 2003/54/EC.

Goldfarb, A and C Tucker (2019), “Digital economics”, Journal of Economic Literature 57(1): 3–43.

OECD (2021), “Data portability, interoperability and digital platform competition”, OECD Competition Committee Discussion Paper.

Kretschmer, T and S Werner (2021), “ Regulating Platforms as Utilities? A Business Model Perspective”, Working Paper.

Montero, J J and M Finger (2019), “Digital Platforms as the New Network Industries”, Network Industries Quarterly 21.

Rutter, R, K J Chalvatzis, S Roper and F Lettice (2018), “Branding Instead of Product Innovation: A Study on the Brand Personalities of the UK’s Electricity Market”, European Management Review 15(2): 255–272.

Padilla J, J Perkins and S Piccolo (2020), “Self-preferencing by gatekeeper platforms: Implications for digital regulation”, VoxEU.org, 22 October. 

Panico, C and C Cennamo (2020), “User preferences and strategic interactions in platform ecosystems”, Strategic Management Journal.

Speight, V L (2015), “Innovation in the water industry: barriers and opportunities for US and UK utilities”, Wiley Interdisciplinary Reviews: Water 2(4): 301–313.

Wright, J (2004), “One-sided Logic in Two-sided Markets”, Review of Network Economics 3(1).

Endnotes

1 The quote is taken from the EU directive providing interoperability to telcos in 2009 and illustrates the underlying rational of introducing procompetitive measures, exemplary also for other utility markets

2 Telecoms, arguably the most closely related utility, features some more caveats, as discussed in Kretschmer and Werner (2021).

3 There are notable exemptions for telecoms industry discussed in Kretschmer and Werner (2021)

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Topics:  Competition policy Industrial organisation

Tags:  regulation, Digital technology, online platforms, utilities, Big Tech

Professor of Strategy, Technology and Organization, LMU Munich School of Management

Economist, Institute for Strategy, Technology and Organization, LMU Munich School of Management

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