As part of the European Digital Strategy, the European Commission proposed two legislative initiatives to end the regulatory fragmentation in the EU and to upgrade the rules governing the supply of digital services and the competition in digital markets in the EU: the Digital Services Act (DSA) and the Digital Markets Act (DMA).
More precisely, according to the Commission, the DSA and DMA will have two main goals :
- To create a safer digital space in which the fundamental rights of all users of digital services are protected
- To establish a level playing field to foster innovation, growth, and competitiveness, both in the European Single Market and globally
The Zero marginal cost economy
Data, and especially Big Data, is the new oil of the XXIst century. This cliché has been made popular by an article published in The Economist in 2017. This was already the case for the software industry of the 1980S-1990s and the argument was used to justify the hyper inflated valuations of the New Economy Internet stocks of the late 1990s – the likes of Yahoo (Ya…who???), AOL (idem) and the list goes on. The implosion of the first Tech Bubble was also a consequence of these economics.
The economics of the digital economy are based on high development costs combined with “zero marginal costs” – actually very low marginal costs – hence leading to massive economies of scale and profits. Indeed, to become profitable companies must kill their competitors in order to achieve economies of scale meaning that only a few large companies can ultimately survive and naturally come to dominate the market.
A case in point was the quasi monopoly achieved by Microsoft through its Windows operating system and Microsoft Office suite. In the case against Microsoft initiated by the US Department of Justice – – following years of enquiries, the court ordered on June 7, 2000, the court ordered a breakup of Microsoft as its remedy. According to that judgment, Microsoft would have to be broken into two separate units, one to produce the operating system, and one to produce other software components. However, the the D.C. Circuit Court of Appeals overturned Judge Jackson’s rulings against Microsoft (cf. United States v. Microsoft Corporation, 253 F.3d 34 (D.C. Cir. 2001). The Appeal Court recognised the substantial harm inflicted by Microsoft to its competitors and customers as stated in the prior judgement but fell short from recommending that the company should be broken up. Eventually, the DOJ announced on September 6, 2001 that it was no longer seeking to break up Microsoft and would instead seek a lesser antitrust penalty. Microsoft decided to draft a settlement proposal allowing PC manufacturers to adopt non-Microsoft software
Network effects and proprietary ecosystems
Beside the boost provided by economies of scale and economies of scope stemming from the supply-side, another well-known feature that enables Tech companies to achieve comfortable profit margins are the demand-side related “network effects” – which encompass a number of positive externalities that arise when the value of a product/service is an increasing function of the number of its users. Network effects can be same-sided – the classical example being “social networks” like Facebook or Linkedin . or cross-sided as in the matchmaking platforms between purchasers and providers of different products and services (e.g. Airbnb, Uber, eBay, …).
In its proposed Digital Markets Act, the EC states that: “Large platforms have emerged benefitting from characteristics of the sector such as strong network effects.”
Taking in consideration Search Engine for examples, Google has been claiming that there are no network effects associated with its search engine. In a way, Google is right to claim that as the classical economies of scale associated with rising numbers of users of its search engine should not be confused with network effects. For example, if I am looking on Google Search for webpages related to “antitrust laws”, the fact that there are other people searching on the Internet the same pages does not bring any direct benefit to me.
It is different from the unfair advantage gained by locking-in proprietary ecosystems. For example in the case against Google initiated by the EC in 2015, very much like in the United States vs. Microsoft case – in which Microsoft accused of unfairly bundling together Internet Explorer into its Windows Operating system -, following a formal complaint addressed in 2013 by the European branch of FairSearch – a lobbying group representing major tech companies which was turned into a Google watchdog – the EC investigated Google’s practices with Android (Case number 40099 Google Android). The complaint identified that Google required any original equipment manufacturer (OEM) wanting to install Google’s suite of Android apps, including access to the Google Play Store, had to license the entire suite and feature them predominately on the mobile device. During the investigation, Google formed Alphabet Inc., a holding company for Google’s various subsidiaries, with Google becoming one of Alphabet’s subsidiaries. On 19 July 2018, EU has fined Google €4.3 billion (about US$5 billion). In March 2019 Google announced that it will give European users of Android phones an option of which browser and search engine they want on their phone at the time of purchase to further comply with the EU’s decision
From economies of scope to gatekeeper status
Economies of scale are related to single products or very similar products, however many companies sell multiple products. In this case, alongside economies of scale achieved in the production of one specific product, the question to ask is whether there are economies of scope which could stem from the fact that the company produces product A alongside product B. Indeed, providers of on online intermediation services can and do cross-sell different lines of products and services by leveraging their access to customers data, online experiences and inferred preferences. In this case, what matters is the cross-product or portfolio/bundle marginal cost. Economies of scope are not always obvious however and cannot be easily proven. In any case, they are legitimate and rational.
However, the EC states in the Digital Markets Acts state that: “A few large platforms enjoy entrenched and durable positions as a result of the creation of conglomerate ecosystems around their core platform services, which reinforces existing entry barriers.” In its presentation of these new legislative initiatives the European Commission reaffirmed its opinion that “the accelerating digitalisation of society and the economy has created a situation where a few large platforms control important ecosystems in the digital economy. They have emerged as gatekeepers in digital markets, with the power to act as private rule-makers. These rules, however, sometimes result in unfair conditions for businesses using these platforms and less choice for consumers.”
Accordingly, the new antitrust rules and policies will specifically target the largest Online platforms by castigating their role as “gatekeepers in digital markets”. There are therefore two complementary dimensions involved in these new regulations:
- A horizontal “market competition” dimension related to competition among different platforms. It is known that more than 10 000 platforms operate in Europe but a bucketful controls the majority of all online business transactions and reaps the related value added. This is mostly related to classical competition/antitrust law.
- A vertical “fairness / market discipline” dimension related to the conditions offered for businesses and consumers operating on these platforms. This is related to consumer protection law but also to competition laws when platforms promote and sell their own products alongside hosting third party suppliers.
The originality of the new regulations stems from their “ex ante” character which comes after years of “ex post” antitrust proceedings conducted by the EC’s DG Competition against the dominant Internet players.
On the vertical “fairness / market discipline” dimension for instance, ten years ago, on 10 November 2010, the European Commission opened a formal investigation into Google’s search algorithm, following a number of complaints issued by smaller web companies that Google was downgrading their placement in results returned in Google’s search results, and that Google was preferentially favouring their own products over competitors (cf. Wikipedia). The EC’s investigation also considered if there were issues with Google’s terms of use for Google AdSense that prevented those using AdSense to not use advertising from Google’s competitors. On 27 June 2017, Google was found guilty and was fined €2.4 billion (about US$2.7 billion). In order to comply, Google separated its comparison shopping service into its own company after the fine.
Who are the gatekeepers
The Digital Markets Act (DMA) establishes a set of criteria for qualifying a large online platform as a so-called “gatekeeper” with a particular focus on large, systemic online platforms.
These criteria will be met if a company has:
- a strong economic position with significant impact on the internal market and activity in multiple EU countries
- a strong intermediation position, meaning that it links a large user base to a large number of businesses
- an actual (or potential) entrenched and durable position in the market
More specifically: A provider of core platform services shall be presumed to satisfy:
- An annual EEA turnover equal to or above EUR 6.5 billion in the last three financial years, or an average market capitalisation or the equivalent fair market value of the undertaking to which it belongs amounted to at least EUR 65 billion in the last financial year, and a core platform service in at least three Member States;
- A core platform service that has more than 45 million monthly active end users established located in the Union and more than 10 000 yearly active business users established in the Union in the last financial year;
To ensure that the new gatekeeper rules keep up with the fast pace of digital markets, the Commission will carry out market investigations. These will allow the Commission to:
- qualify companies as gatekeepers
- update dynamically the obligations for gatekeepers when necessary
- design remedies to tackle systematic infringements of the Digital Markets Act rules
Indeed as mentioned in the legislative proposal, the preferred option to achieve the objective of the legislation is constituted by
- (a) a closed list of core platform services;
- (b) a combination of quantitative and qualitative criteria to designate providers of core platform services as gatekeepers;
- (c) directly applicable obligations, including certain obligations where a regulatory dialogue may facilitate their effective implementation; and
- (d) a possibility for the Commission to update the instrument, following a market investigation, as regards the obligations for gatekeepers, by way of delegated acts insofar as new practices are identified that are equally unfair and likely to impair contestability and through amending proposals in the other cases. Market investigations may also point to the need for an amendment of the list of core platform services.“
What are the new obligations for the platforms?
The obligations are listed in Chapter III Article 6 of the Digital Markets Act proposal. These include, for example, prohibitions to discriminate in favour of own services, obligations to ensure interoperability with its platform, and obligations to share, in compliance with privacy rules, data that is provided or generated through business users’ and their customers’ interactions on the gatekeepers’ platform.
To be ore precise, in respect of each of its core platform services, a gatekeeper shall:
- (a) refrain from using, in competition with business users, any data not publicly available, which is generated through activities by those business users, including by the end users of these business users, of its core platform services or provided by those business users of its core platform services or by the end users of these business users;
- (b) allow end users to un-install any pre-installed software applications on its core platform service without prejudice to the possibility for a gatekeeper to restrict such un-installation in relation to software applications that are essential for the functioning of the operating system or of the device and which cannot technically be offered on a standalone basis by third-parties;
- (c) allow the installation and effective use of third party software applications or software application stores using, or interoperating with, operating systems of that gatekeeper and allow these software applications or software application stores to be accessed by means other than the core platform services of that gatekeeper. The gatekeeper shall not be prevented from taking proportionate measures to ensure that third party software applications or software application stores do not endanger the integrity of the hardware or operating system provided by the gatekeeper;
- (d) refrain from treating more favourably in ranking services and products offered by the gatekeeper itself or by any third party belonging to the same undertaking compared to similar services or products of third party and apply fair and non- discriminatory conditions to such ranking;
- (e) refrain from technically restricting the ability of end users to switch between and subscribe to different software applications and services to be accessed using the operating system of the gatekeeper, including as regards the choice of Internet access provider for end users;
- (f) allow business users and providers of ancillary services access to and interoperability with the same operating system, hardware or software features that are available or used in the provision by the gatekeeper of any ancillary services;
- (g) provide advertisers and publishers, upon their request and free of charge, with access to the performance measuring tools of the gatekeeper and the information necessary for advertisers and publishers to carry out their own independent verification of the ad inventory;
- (h) provide effective portability of data generated through the activity of a business user or end user and shall, in particular, provide tools for end users to facilitate the exercise of data portability, in line with Regulation EU 2016/679, including by the provision of continuous and real-time access ;
- (i) provide business users, or third parties authorised by a business user, free of charge, with effective, high-quality, continuous and real-time access and use of aggregated or non-aggregated data, that is provided for or generated in the context of the use of the relevant core platform services by those business users and the end users engaging with the products or services provided by those business users; for personal data, provide access and use only where directly connected with the use effectuated by the end user in respect of the products or services offered by the relevant business user through the relevant core platform service, and when the end user opts in to such sharing with a consent in the sense of the Regulation (EU) 2016/679; ;
- (j) provide to any third party providers of online search engines, upon their request, with access on fair, reasonable and non-discriminatory terms to ranking, query, click and view data in relation to free and paid search generated by end users on online search engines of the gatekeeper, subject to anonymisation for the query, click and view data that constitutes personal data;
- (k) apply fair and non-discriminatory general conditions of access for business users to its software application store designated pursuant to Article 3 of this Regulation.
What will happen if the platforms don’t apply the new rules?
In case of non compliance, the new rules would give the European Commission the power to impose Fines of up to 10% of the company’s total worldwide annual turnover, alongside Periodic penalty payments of up to 5% of the average daily turnover.
In case of systematic infringements of the DMA obligations by gatekeepers, additional remedies could be imposed after a market investigation. If necessary and as a last resort option, non-financial remedies can be imposed. These can include the divestiture of (parts of) a business.
Is there a chance the new rules could be used to break one or more dominant Internet player?
This is really the trillion dollars question haunting every single asset manager and individual investor that has invested in the FAANGS stocks. The threat is real as shown by the EC’s more aggressive interpretation and application of antitrust laws to Internet players than the more lenient – some would say “toothless” – approach that has been applied in the United States until now (Although the latter is also changing rapidly with an intensification of scrutiny on Big Tech and a multiplication of antitrust cases waged against the FAANGs alongside new legislative proposals that could be pushed forward in the years to come, in what law professionals dub a “post-Chicago” turnaround – referring to a departure from the Chicago School neoliberal approach that prevailed in US antitrust policies over the last forty years).
However, one should remember that despite the theatrical announcements and the related political messages, this new rules remain much in line with a “market contestability approach” that puts the onus of antitrust policies on insuring fair market access and preventing/repressing abusive market practices by dominant players, not on the absolute size of market players or on the micro-structure of the market. In this regard, the unbundling of different business lines which are used to achieve economies of scope and scale is a solution of last resort.
As stated in the Digital Markets Act proposal, “the preferred option will increase the contestability of core platform services and the broader digital sector, and it will help businesses overcome the barriers stemming from market failures or from gatekeepers’ unfair business practices. This will help to foster the emergence of alternative platforms, which could deliver high-quality, innovative products and services at affordable prices. Fairer and more equitable conditions for all players in the digital sector would allow them to take greater advantage of the growth potential of the platform economy.”
Investors should also keep in mind that the competition policy zealots and the staunch antitrust advocates are not the “only policy kids in town” in Brussels. There are competing and contradictory interests, especially now that there are more and more voices inside the EU calling for a move away from what is perceived as an excessive focus on consumer-centric or “consumerist” policies toward more producer-centric or “industrialist” policies.
In other words, there is an appeal from certain business interest groups and from traditionally more State-interventionist countries like France and Italy for more industrial policy related measures to support the development of “European champions” in the digital economy. In the incumbent Commission, Thierry Breton, the French Commissioner for the internal market embodies this approach which moves away from antitrust orthodoxy. But the message of the industrialists is blurred by their insistence for the EU to be more aggressive when it comes to containing the market power of non-EU players while at the same appealing for a laxer application of the same rules when it comes to EU players.
A new governance for supervising Big Tech
As part of the new legislation, one consensual proposed measure that is likely to gain broad-based approval is the call for an oversight structure to address the complexity of the online space. In the Commission’s new proposal, EU countries will still have the primary role in internal competition matters, but they will be supported by a new European Board for Digital Services. For very large platforms, enhanced supervision and enforcement would be exercised directly by the Commission – this would mirror the prevailing banking supervision system which has now moved to the EU level for large banks and is directly exercised by the ECB.
Next steps
The European Parliament and Member States will discuss the Commission’s proposal according the ordinary legislative procedure – meaning that it will take at least two years before it finally translates into law. Once adopted, the new rules will be directly applicable across the EU. All online intermediaries offering their services in the single market, whether they are established in the EU or outside, will have to comply with the new rules.
In practice, before new digital rules are endorsed this might involves years of political infighting and legislative shuttle diplomacy between the European Commission, the European Council (i.e. the EU’s Member States) and the European Parliament. On paper, the political will is there to regulate and rein-in Big Tech – especially the largest Internet platforms which are almost all non-European (mostly US and Chinese). But the reality on the ground, in Brussels policy trenches, amid multiple lobbying groups and often diverging national interests – especially on such sensitive issues with important economic repercussions (think Ireland for example which hosts many if not all of US Big Tech’s European headquarters) – is more complicated.