Self-preferencing by gatekeeper platforms: Implications for digital regulation
Alleged market abuse by so-called ‘gatekeeper platforms’ – firms with large bases of loyal customers that can determine how and whether third parties can access these customers – has become a pressing concern in regulatory and competition debates in recent months.
Several jurisdictions are considering the role of gatekeepers in moves towards digital regulation. The European Commission is consulting on creating an ex-ante regulatory framework for gatekeeper platforms and establishing a new competition tool to make it easier to intervene where there are structural market problems. The UK is developing its plans for a Digital Markets Unit that would, among other things, set a code of competitive conduct for strategically important firms.
These proposals draw on high-profile reports on digital markets, such as those led by Jacques Crémer in the EU (Crémer et al. 2019) and Jason Furman in the UK (HM Treasury 2019). Most recently, a US Congressional Subcommittee has recommended a wide range of actions to strengthen competition in digital markets and antitrust enforcement (Subcommittee on Antitrust, Commercial and Administrative Law of the Committee on the Judiciary 2020).
But there is little agreement on the precise nature of the problems caused by gatekeepers, or about potential solutions. Drawing on recent research, we aim here to clarify some of the questions around market abuse by gatekeepers, and in doing so, to suggest possible ways forward for competition authorities and regulators.
In particular, we argue that significant consumer harm can result from gatekeeper platforms’ attempts to gain revenue from their installed bases of platform users (e.g. users of a smartphone platform) at the expense of third-party firms offering complementary services (e.g. developers of apps for that smartphone platform). Such harm is more likely to arise as the platform business (e.g. the sale of smartphones) slows.
The changing shape of many platform markets
Though their names have largely stayed the same, the nature of large consumer-facing technology firms has changed in recent years. In smartphone markets, for instance, revenues and attention have increasingly moved away from the devices that people use to the ecosystems of services that surround them. The Apple App Store and Google Play had combined gross revenues of around €70 billion in 2019, of which almost €10 billion was in Europe.
Smartphone operating systems systematically restrict access to their consumers by third parties. On Apple’s iOS, apps are only available via the App Store or pre-loaded. The Android ecosystem of services is somewhat more liberal but nonetheless makes it difficult to access apps outside Google Play or device manufacturers’ pre-installed app stores.
Access to the customers of smartphone platforms is not free. These platforms benefit from their gatekeeper position, charging substantial fees to third parties for access. On both Apple’s App Store and Google Play, app developers typically pay 30% of subscription revenues in the first year, and 15% of revenues from subscriptions lasting more than one year; in-app purchases face a flat fee of 30% of the price. This is a notable reversal from typical practice in the early stages of the mobile OS market, when Microsoft, for instance, paid app providers to develop services for its platform.
Third parties may also find themselves competing with products owned by the gatekeeper platform. Thus, for example, the music streaming service Spotify competes with Apple Music and the video company Netflix competes with Apple TV. In such instances, the platform acts both as umpire and player in the relevant market.
Why this matters: Potential abuses of market power
Popular platforms can be beneficial for both sides of the market. Consumers may benefit when they can use a single trusted platform, on which many different services compete for their business. Service providers also benefit when they have a straightforward route to market and a large potential customer base. Ecosystems of third-party suppliers continue to grow. Amazon’s Marketplace now incorporates over two million active sellers. There are over 2.5 million apps available on Google Play, and 1.8 million on the App Store.
But when a popular platform acquires a gatekeeper status the possibility of market abuse cannot be ignored. Gatekeeper platforms have been accused of privileging their products and services over competitors or directly excluding competitors’ services. In 2017, the European Commission found that Google had abused its dominant position by favouring its own shopping comparison service and required Google to devise remedies that would prevent this from happening in the future.
The continuing complaints about Apple’s behaviour as a gatekeeper relate to foreclosure of third parties and excessive pricing or unfair contract terms. Spotify argues that Apple has given Apple Music an unfair advantage in streaming music, for example by restricting Spotify’s ability to use alternative in-app payment providers, instead requiring it exclusively to use Apple’s In-App Purchase (IAP) and pay the IAP fees to which Apple Music is not subject, and by restricting Spotify’s ability to inform users of alternative ways of paying.
Epic Games, which owns the Fortnite video game, argues that the exclusivity of Apple’s App Store in the iOS ecosystem enables it to extract excessive profits relative to a more open structure. The complaints argue that such behaviour results in harm to consumers since it leads third-party service providers to increase prices.
Arguments have been made recently that such allegations make no economic sense since they will not benefit a firm like Apple, whose revenues principally come from selling smartphone devices (Caffara et al. 2020). The claim is that charging excessive commissions or excluding competing but popular apps will reduce the appeal of, and therefore the demand for, the highly profitable gatekeeper platform’s devices. The ensuing profit sacrifice is claimed to be so large as to offset any gains that could be achieved by charging disproportionate fees or monopolising any app market. There may therefore be more innocent explanations for the gatekeeper firm’s behaviour, it is then said.
This is, in principle, plausible and may be true in markets where devices are currently, and are always likely to remain, much more profitable than the complementary services. But it need not hold true when changing market dynamics alter devices’ and services’ relative profitability.
Our recent paper (Padilla et al. 2020) analyses a simple model in which a firm that sells devices controls third-party firms’ access to a linked services or app market. We find that in a one-period setting, the device seller would have no reason to exclude third parties; it can charge higher prices for the device because of the value that consumers place on third-party services.
But this simple logic collapses once we examine a dynamic two-period setting. Then, the gatekeeper device seller may wish to exclude third-party service providers in favour of a lower-quality service it can sell itself. Alternatively, it may be willing to degrade the quality of third parties’ services to try to bargain for a greater share of the revenues from services. This is because it has an incentive to increase the revenues from its installed customer base, who are unlikely to buy another device soon but who could be persuaded to spend money on the device-seller’s additional services if third parties were excluded. Consumers are likely to lose out as a result of lower-quality products.
The device seller is more likely to try to exclude third parties when demand growth for its devices is slow. Alongside reduced competition in smartphones, this may help to explain observed changes in business strategies over time, including Apple’s focus on developing apps such as Apple Music and Apple TV. This change in strategy coincides with falling growth in demand for smartphones, as the double-digit growth seen a decade ago has been replaced by declining shipments in recent years.
Conversely, Apple’s revenues from services have increased by 286% since 2012, and now account for 18% of its total revenues. In recent annual reports, Apple cites increased services sales as a way of offsetting declines in device sales; this contrasts with its statements when the App Store was first developed, such as Steve Jobs’s 2008 claim that “[w]e don’t intend to make any money off the App Store” (see Subcommittee on Antitrust, Commercial and Administrative Law of the Committee on the Judiciary 2020).
The drive to increase revenues from an installed customer base dovetails with other potential motivations for exclusionary behaviour, such as raising the barriers to entry for rivals in the device market, diversifying the business model to reduce risks, and enhancing brand image to reinforce the position in devices.
Thoughts for future regulation
Our work, along with wider developments in digital markets, tentatively implies some broad principles that competition authorities and regulators should consider as they develop new approaches.
Be wary where a device-funded gatekeeper competes directly with third parties
While there should not be a blanket presumption against device-funded gatekeepers providing their own products on their platforms (any more than one should block supermarkets from offering their own labels), the potential for abuse is there.
In our model, consumer welfare would be increased by preventing the device-seller from selling its own apps and associated services in competition with third-party apps. Regulators may therefore wish to place a special responsibility on gatekeeper firms to ensure that consumers are not harmed through activities such as self-preferencing or raising rivals’ costs.
Be alive to the specifics of a market
Most basically, our analysis shows that it would be a mistake to assume that any broad-brush rules can be applied whereby, for instance, device-funded platforms are less likely to lead to consumer harm than those funded by advertising. Indeed, research in progress by economists at Compass Lexecon suggests that the opposite might be more nearly true, because device-funded platforms are less likely to take full account of the network externalities between consumers and third-party suppliers.
Detailed assessment of incentives and behaviour in particular markets is crucial for effective regulation.
Aim to reduce consumer lock-in at an early stage
Our work shows that market abuse by device-funded gatekeepers is more likely in mature device markets. This suggests that reducing consumer lock-in, and the potential for consumer lock-in, at an early stage may nip many possible abuses in the bud.
In her recent assessment of the case for a new competition tool in the EU, Amelia Fletcher outlines possible interventions that could help to promote interoperability in digital markets, including enabling cross-posting on social media sites and increasing coordination on industry standards and protocols as in telecoms markets (Fletcher 2020).
More radically, authorities could consider the case for opening up ‘closed’ ecosystems. While the closed business model may bring potential benefits (e.g. guaranteeing the products’ stability and safety), it is not obvious that these benefits outweigh the costs relative to a more open system.
Authors’ note: The research paper on self-preferencing by gatekeeper platforms (Padilla et al. 2020) was partly funded by the music streaming service Spotify. The views expressed in this column and the paper are the sole responsibility of the authors and cannot be attributed to Compass Lexecon or any other parties.
Caffara, C, F Etro, O Latham and F Scott Morton (2020), “Designing regulation for digital platforms: Why economists need to work on business models”, VoxEU.org, 4 June.
Crémer, J, Y-A de Montjoye and H Schweitzer (2019), Competition policy for the digital era, European Commission.
Fletcher, A (2020), “Market Investigations for Digital Platforms: Panacea or Complement?”, Centre for Competition Policy Working Paper, 6 August.
HM Treasury (2019), Unlocking digital competition, Report of the Digital Competition Expert Panel.
Padilla, J, J Perkins and S Piccolo (2020), “Self-Preferencing and Consumer Harm in Markets with Gatekeeper Platforms”, SSRN Working Paper.
Subcommittee on Antitrust, Commercial and Administrative Law of the Committee on the Judiciary (2020), Investigation of Competition in Digital Markets.