Breaking up Big Tech: Cui Bono?
? ? In a court filing on October 9, 2024, the US Department of Justice (DOJ) let it be known that it was considering a break-up of Alphabet, with the addendum that it would also be pushing for the company to share the data it collects across its multiple platforms with competitors. There is many a slip between the cup and the lip, and it is entirely possible that these are threats designed to extract more concessions from the company, but the break-up talk is a continuation of a debate about the power accumulated by big tech companies, in general, and ?with Microsoft, Amazon, Apple, Alphabet and Meta, in particular, and what should be done about that power. With politicians, economists and lawyers all in the mix, offering widely divergent solutions, I look at the evolution of anti-trust law in the United States
The Law in Spirit and Letter
? ??In the latter part of the nineteenth century, as the United States was transitioning from an emerging market to a global economic power, its growth was powered by three industries - steel, railroads and oil - all requiring large investments in infrastructure. In each one of these businesses, powerful men earned their "robber baron" standing by squashing competition and building dominant companies that aspired for pricing power. In oil, it was John D. Rockefeller, who started Standard Oil and built a sprawling empire across the nation, acquiring other players in the still nascent oil business. With Carnegie Steel as his vehicle, Andrew Carnegie took control of the growing steel market, before selling his business to J.P. Morgan, who took it public as US Steel. In railroads, a network of tycoons controlled swathes of the country, with Cornelius Vanderbilt, Jay Gold and Leland Stanford all playing starring roles, as heroes and villains. Along the way, they created the trust structure, organizations of companies which controlled production and prices, effectively monopolizing the businesses .?
? ? As these companies laid waste to competition, exploited labor and overcharged customers, a political and economic backlash
? ??In 1914, Congress passed the Clayton Act to clarify and augment the Sherman Act, and expanded its reach to cover a whole host of activities that it classified as anti-competitive, including some mergers, predatory pricing and sales ties. It also barred individuals from sitting on boards of competing companies and created the Federal Trade Commission (FTC) as an institution to provide the specifics on what constitutes unfair competition and to work with the Department of Justice, to enforce these rules. In subsequent years, Congress returned to add provisions and modify the act, including the Robinson-Patman Act in 1936, which reinforced the laws against price discrimination, the Celler-Kefauver Act of 1950, which filled in gaps on the merger provisions, and the Hart-Scott-Rodino Act of 1976, which introduced the need for any company planning an acquisition that exceeded a transaction value threshold (reset at regular intervals) to file a pre-merger notification with the Justice Department and to wait at least thirty days before consummating the acquisition.
Enforcement Ebbs and Flows
? ??The effectiveness of laws at dealing with the problems that they purport to solve depends in large part on how they are enforced. In fact, one reason that the Clayton Act created the Federal Trade Commission in 1914 was to enforce the anti-trust laws, and the FTC states its mission as protecting?"the public from deceptive or unfair business practices and from unfair methods of competition through law enforcement, advocacy, research and education." ??In carrying out this mission, the FTC often relies on the Department of Justice (DOJ), where an?antitrust division?was created specifically for this purpose, in 1919.?
? ? Through the history of anti-trust laws in the United States, the enforcement has ebbed and flowed, partly as a result of changing administrations bringing in very different idealogical perspectives on its need, partly in response to Court judgments in its favor or against it, but mostly because of questions about whether the central objective of the laws is to enhance competition or to protect consumers. The divide between enhanced competition and consumers played out in competing viewpoints, with one school, led by?Robert Bork, arguing that the original intent of the law is consumer protection, and the other pushing back that the end game of the law is to stop cartels and monopolies, i.e., enhancing competition. That tension continues to underlie much of the debate of the law today, in both political and economic circles, and will come into play if the DOJ pushes ahead trying for a big tech breakup.
? ? It is undeniable that for most of the last few decades, the consumer protection argument
That graph, though, does obscure the fact that the government has been more aggressive about challenging high profile mergers, and publicly proclaiming its intent to do so, in others. The results have been mixed, with wins in a few cases coming with losses in several others, with the failure to stop Microsoft's acquisition of Activision representing one of it s highest profile losses. In short, while Ms. Khan's argument for use of antitrust laws to restrain platforms may have found a receptive audience among some legal thinkers and politicians, it has not won over the courts (at least as of now).?
The Remedies: Sticks and Stones!
? ? No matter where you fall on the consumer versus competitor protection debate, the remedies available to the government fall into three groups, ranging from its power to stop (require) activity that it believes will stymie (advance) competition to breaking up companies, with the possibility, albeit rarely used, of allowing a company to establish monopoly power, but with pricing power restraints.?
1. Operating restraints and changes
? ??The anti-trust laws give the government the power to affect how a company operates by stopping it from acting (by acquiring another company, introducing a new product or entering a new market) or changing its behavior (in terms of pricing it products and operating its business), in the interests of increased competitiveness. In doing so, though, the courts require the government to make the case that the actions that it is stopping or the behavior it is altering are unreasonable and that it meets the "rule-of-reason" threshold, i.e., that there are anticompetitive effects that exceed any pro-competitive effects.?
a. Merger Challenges
? ? Corporate mergers in the United States, where the transaction value exceeded $111.3 million in 2023, required the acquiring company to file a pre-merger notification with the Justice department, with consummation of the merger happening only after approval. In its most recent update to requirements on pre-merger notifications, the DOJ expanded its information disclosure requirements to include transaction-related documents from deal teams and more complete information about both the products and services offered by the companies, as well as about corporate governance. As we noted in the last section, the degree to which the government uses it power to challenge mergers has waxed and waned over time, and even if challenged, the last word rests with the courts. In a?report?that it is required to file under the Hart-Scott-Rodino Act for the 2023 fiscal year, the DOJ listed out the number of merger challenges for the year (16), breaking them down into wins (1), consent agreements (4), ongoing litigation (1) and abandonments/restructured complaints (10). ?The report also lists out the industries that were targeted the most, in terms of merger challenges:
Hart-Scott-Rodino Annual Report for 2023 (DOJ)
Again, note that notwithstanding Ms. Khan's high profile thesis on the need for antitrust enforcement against technology companies, the bulk of the challenges have been directed at more traditional businesses.?
b. Operating Changes
? ? In some settlements, the government extracts concessions from a targeted company that it believes will improve the competitive standing of the business. These can range the spectrum, and I will use some of the 2023 settlements to illustrate:
In most of these cases, the government used the threat of more extreme punishment to extract concessions from the targeted companies.
c. Pricing Oversight
? ? If it is price fixing by a company that has drawn the attention of the antitrust enforcers, it is possible that the remedies sought will reflect changes in the way a company prices its products and services. In 1996, Archer Daniels Midland (ADM) pleaded guilty to fixing prices for Lysine, an animal feed, in collaboration with Japanese and Korean companies. The company, in addition to paying a large fine and having top executives face jail time, ?was also required to change its pricing processes. In 2024, the FTC published a warning that the use of algorithms by multiple competitors in the same business, to set prices, can violate antitrust laws, and sued RealPage, a property management software, for allegedly allowing landlords to use its algorithms to drive up rental prices. As AI makes algorithmic pricing more of a norm in other businesses, the FTC will undoubtedly be challenging more businesses on pricing practices.
2. Break ups
? ??The most extreme action that the DOJ can take against a company in response to what it views as anti-competitive behavior is to break up the company. Since their effects on the company in question are so wrenching, they are rarely pursued and even more rarely court-approved, but when they do occur, they are memorable. Here are three that stand out:
While each of these breakup (including the potential Microsoft one), got significant attention at the time that they happened, the net effects on competition, consumers and the companies themselves are still being debated, and we will return to examine the trade offs in the next section.
3. Regulated Monopolies
? ? The phone business was still in its nascency, when the Willis Graham Act was passed in 1921, arguing that "(t)here are monopolies which ought to exist in the interest of economy and good service in the public welfare, monopolies which must be promoted instead of being forbidden. The telephone business is one of these. Legitimate consolidation will promote economy. It will promote service. It is foolish to talk about competition in the transmission of intelligence by telephone. It is silly to believe that there can be real competition either in service or in charges… The thing that the American Congress ought to do is to.. regulate those monopolies so as to get reasonable prices and good service for the people…" That act allowed AT&T, then the leading phone company in the United States, to acquire its mostly troubled competitors to create a monopoly, with a catch. That catch was that the company's pricing power would be regulated to deliver a reasonable rate of return for its investors, thus creating the basis for regulated monopolies.
? ? The notion of a natural?monopoly was not restricted to just telecommunications, and was used for other utilities, such as water and power, with the only difference being that most of the companies offering those utilities obtained local monopolies rather than national ones. Arguably, the decision delivered benefits for customers, as the services were extended to almost every part o the country, albeit at the cost of innovation. As a side benefit, these regulated monopolies, protected from competition, had the capacity use their surplus funds to support activities that sometimes generated societal benefits, that they would not have in a competitive marketplace. With AT&T, that was the case with with Bell Labs, AT&T's in-house research laboratories, where some of the greatest inventions of the twentieth century were made.
The End Game
? ? I mentioned at the start of this post that I am not a lawyer, and I understand that antitrust is full of shades of gray, where absolutism can lead to poor outcomes. Thus, I do get Robert Bork's point that the ultimate endgame in antitrust law is not promoting competition, for the sake of competition, but only if delivers net benefits to consumers. ?At the same time, I don't think we can dismiss Lina Khan's arguments that large tech companies, using the networking benefits
? ? At the risk of adding to an already complex trade off, I believe that three?other factors have to come into play in assessing the right action forward:
If you bring these all into the mix, you will be making the work of antitrust enforcers even more difficult, but you will be considering the effects of your actions more fully:
? ?
? ??If your job as an antitrust enforcer is to balance competing interests, and do what is right only if there is a net plus to your action, you should be considering the effects of antitrust activity on all four dimensions. That said, if you have blinders on, and view only one of these dimensions (consumers, competition, company or the economy) as critical, it is entirely possible that the actions you take can have net negative consequences, in sum. Using this framework to assess the AT&T break up in 1981, the break up into seven regional phone companies and a long distance one was initially praised as an action that would promote innovation and new thinking, but history suggests otherwise. The regional phone companies continued to behave like the old Ma Bell, investing little in new technologies, and continuing with the high debt and high dividend policies of the original. Much of the innovation in telecommunications came from outsiders entering the business, and the business itself has reconsolidated suggesting that the economics cannot support a dozen or more players. And just as a bonus, Bell Labs was renamed Lucent Technologies, and after an initial burst of enthusiasm about promise and potential, sank under its contradictions. ?
The Big Tech Dilemma
? ? This post was precipitated by the Justice department’s targeting of Alphabet, with threats of a break up and requiring the company to share its data. While neither threat has been made explicit, it is worthwhile thinking about how the big tech companies measure on the competitiveness scale, and whether antitrust law can or should be used to cut them down to size. The challenge, as we will see, is that we all agree that big tech has become perhaps too big, but the question of how it got that big has to be answered before we respond to the bigness.
The Rise of Big Tech
? ? Looking at the DOJ's arguments for breaking up Alphabet, it is clear that the same arguments can be used against some of the other big tech companies. In this section, we will look at Alphabet, Amazon, Apple, Microsoft and Meta (bundled together as the Fearsome Five), all of which have been rumored, at times, to be in the crosshairs of antitrust enforcers, and the reason for their targeting, which is that they are all big, perhaps even "too big", and that can be backed up with multiple metrics:
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a. Market Capitalization:?If the companies that we have listed look like they belong together, it is because they were bundled as the FANGAM stocks in the last decade and as part of the Mag Seven in this one. In each case, that bundling was used to?illustrate how dependent the US equity markets have become on just a few stocks, to deliver overall equity returns. In the graph below, we look at the rise of these companies, in terms of market capitalization, since 2010, and how much of the aggregated market cap at all US stocks has come from just these companies:
As you can see, these five companies, in the aggregate, increased their dollar market capitalization from $716 billion at the end of 2009 billion to $12.1 trillion on October 16, 2024, accounting for 23.16% of the increase in market capitalization across all US equities over that period. On October 16, 2024, these five companies accounted for 20.22% of the market capitalization of all 6132 US equities, and in sum, they had a market capitalization that was greater than that of any other equity market in the world.?? ?
b. Revenues and Earnings: The rise in market capitalization did not just come from vibe or momentum shifts and was backed up increases in revenues and income over that period that were truly extraordinary, given the scale of these companies:
These companies increased revenues 18.8% a year between 2009 and 2024, while preserving enviable profit margins - gross, operating and net margins stayed relatively stable.?In sum, these companies have delivered a combination of revenue growth and operating profitability that is unmatched, given the size of these companies, in history.
?c. Day-to-day life: There is a final component on which you can measure how big these companies have become, and that is to look at how much of our time and lives is spent on one or more of their platforms. In a New York Times article from 2020, the writer talked about trying to live without big tech for six weeks, and how difficult she found the consequences to be. During the same year, I chronicled in a post how much time I spent each day on the platforms on one or more of the big tech companies, essentially concluding that I was in their grip for all but fifteen minutes of the day. As a thought experiment, consider what your day at work or at home will look like today, if all five of the Fearsome Five decided to make you persona non grata. Mine would be a grind, with this post not being written (it is on a Google Blog), the graphs not showing up (they are in Microsoft Excel) and my computer not responding (it is a Mac).
? ? In short, I don't there is any debate that the big tech companies have become big on every dimension, and become central players not just in the economy and markets, but in our personal lives. It is therefore no surprise that when Lina Khan and others argue that these companies have become too big, and need to be?restrained, they find a receptive audience.?
Pathways to Bigness
? ? While, for some, bigness alone is a sin that needs to be punished, ?the pathways that these companies took to get to where they are now needs to be examined for a simple reason.?If those pathways were cleared by legitimate business actions and choices, it would not only be unfair to punish them for their success in foiling competitors and establishing dominance, but it would also make the legal challenge of using antitrust laws to restrain them much more daunting. In this section, we will look at what these companies did (and are doing) that explains their success.
The question then becomes whether any of this is "unfair", and the answer is debatable. Listening to those most critical of these companies, there are five arguments that I have heard to back up the "uneven playing field" argument:
I am sure that all of these issues will be litigated, but I do think that governments (and antitrust enforcers) are on far stronger ground, on the last two, than on the first three. More generally, if you were to look big tech sins, there are two general conclusions:
Ultimately, anti-trust actions are as much about politics as they are about economics, and they work only if they carry public approval. On economic grounds, that is why pushing strong anti-trust actions against big tech will be a much more difficult sell than against other dominant businesses in the past. After all, how do you convince customers that they paying more for Amazon Prime and being charged for Google Maps will make them better off, because there may be more innovation and choice in the futures with more competition?
The Choices
?? ?The DOJ court filing suggests that the die has been cast, and that Alphabet will be the target of the anti-trust enforcers in the near future, with success or failure in that endeavor perhaps resulting in expanded action against the other big tech companies. Using the framework from the last section in assessing the costs and benefits to consumers, competitors, investors and the economy, we can evaluate the choices.
1. Break up
? ? Can the government break up Alphabet, just like it did AT&T and Standard Oil, in the last century??It can push for it, but to understand why it will be difficult, and even if plausible, unwise, here are some considerations:
Summarizing, breaking up any of the big tech companies risks the worst of all outcomes.?It will make the companies (and their investors) worse off, but not by as much as critics think, but it will also have ?negative effects that ripple across the economy and markets, while making the businesses that they operate in less efficient.?Competitors will derive short term benefits from the breakup, but those benefits are unlikely to last, if the business economics still point towards consolidation. Finally, consumers will be left off worse off, in the short term, with only promises of a better tomorrow filling the void.
2. Regulated Monopoly
? ??The second pathway that has been suggested is that the government big tech companies as regulated utilities, just as they did phone, power and other utility companies in the last century. While that would give the government power over how these companies price products and services, and make them less profitable, the flaws in the argument are large and potentially fatal:
In short, there is no pathway that works to make any of the big tech companies look like Ma Bell, and even if that pathway existed, how would that benefit consumers, markets or the economy?
3. Targeted changes
? ? Given how much of a reach it would be to break up the big tech companies or bring them under the regulated monopoly umbrella, the pathway, if the government is intent on sending a signal will take the form of constraints on and changes to operating practices. I will start with a list of changes, where I think that the government has a better chance of prevailing, because the laws and public opinion will be on their side:
There are three other changes, where the government is less likely to succeed, and deservedly so:
4. Do nothing
? ? There is a final option, and it will not be appealing to many anti-trust enforcer who came into their professions wanting to push for change. That is to do nothing! That sounds defeatist, but at least in technology, it may be the best choice, given the following:
You may have guessed already, but I do believe that doing nothing is, in fact, the most sensible option, with big tech companies. Are there risks in adopting this path? Absolutely! The big tech companies may have found ways to extend life cycles and they may buy out disruptive innovation, just to squash it, and we may all be worse off, as a consequence. I have seen no evidence of any of that behavior so far, but that fear remains, and I will remain vigilant.
Conclusion
? ?I do not see eye to eye with Lina Khan, but I will start with the presumption that she has good intentions and that her argument is deeply thought through. My concerns with her big tech views are two fold. The first is that she is a lawyer, and law schools around the world do an awful job on teaching their graduates about business, which is one reason that laws tend to be one-size-fits-all. Just to illustrate, competition is good in some businesses, but consolidation works in others, and a law or lawyer that does not discriminate between the two will do more damage than good. The second is that she is a true believer, and if you start with the view that big tech companies are evil, you will undoubtedly find good reasons to cut them down to size.
?? ?I do recognize that there are non-economic considerations at play, and that you may fear the effect that big tech platforms are having on our politics and social discourse. I share that concern, but I am not sure that there is an economic solution to that problem. If you think that breaking up Google and Meta will lead to more polite discourse on social media and a return to the cultural norms of yesteryear, you are being naive, since the problem lies not in Twitter, Facebook or Reddit, but in ourselves insofar as participating on social media seem to bring out the worst in us. I am afraid that we have opened Pandora's box, and there is no shutting it now!
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Sr. Associate, Portfolio Valuations & Analytics at Andreessen Horowitz
4 个月Thanks for sharing
Senior Portfolio Manager - Global & Non-US Equities at American Century Investment Management
4 个月From a former student, thank you for continuing to share interesting and valuable content.
SIC Capital | Growth & Progress ????
4 个月Dr Aswath You feel breaking big companies to small is a good idea and benifits society & shareholders? Regards @equityin
Head of Treasury, Banking & Corporate Finance at DBL || Winner 40Under40 || Ex - RIL, HCLTech, Axis Treasury leader || CFA, CMA (US), MBA(IIFT) || Finance & Growth Leader || AI/ML, Fund Management & Fund Raising
4 个月really great insights.. very interesting to look at the US AntiTrust laws through non-legal lense. ??