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July 7, 2008
Evolving theory of network effects

Should antitrust enforcers be concerned about entry barriers in the search ad market? Some believe the market exhibits "network effects," according to the New York Times.

Although traditionally applied to Industrial Age industries with high fixed costs like railroads and telephone exchanges, anything now exhibits a network effect if its value increases because more people use it. Network effects are "everywhere," according to a top former antitrust official. Coke and Pepsi drinkers, for example, "benefit from the network of their fellow consumers because Coke and Pepsi are widely available in restaurants and in vending machines," claims Timothy J. Muris.

A preexisting network of vending machines is admittedly tough for soft drink imitators to replicate. But a barrier to imitation can also be viewed as a spur to innovation because it acts as a reward which inspires creators and investors. Not an incentive to create a barely distinguishable alternative, to be sure, but to create something transformative.

The alleged network effects in search advertising are more subtle than in the case of railroads, telephone exchanges or soft drinks (in fact, they even bear a striking resemblance to what one might term legitimate and hard-won competitive advantages).

[E]conomists and analysts point out that Google does indeed have network advantages that present formidable obstacles to rivals. The "experience effects," they say, of users and advertisers familiar with Google's services make them less likely to switch. There is, for example, a sizable cottage industry of experts who tailor Web sites to get higher rankings on search engines, which drive user traffic and thus ad revenues. These experts understandably focus their efforts on the market leader, Google -- another network effect, analysts say.
This sounds remarkably like how the European Union sees the market for streaming media players. The EU prohibits Microsoft from including a free player with its PC operating system because its competitors couldn't give away enough copies of their own media players.

Network effect theory overlooks whether, perhaps, there are no other objective differences in the value propositions of the competing products. If consumers have a choice between a superior product versus an inferior product which most of their neighbors are using, the theory assumes most consumers will choose the latter. Thus, there is no incentive for anyone to design a superior streaming media player for a desktop PC.

But that may not be a bad enough thing to warrant letting politicians and bureaucrats rearrange the market. It is inherently destructive to innovation to allow them to do that, because they principally serve constituencies who are more interested in preserving the status quo.

June 16, 2008
Trade war

Picking up on Braden Cox's recent post over at Technology Liberation Front, "Abuse of Power? Competition Commissioner that Pushes 'Smart Business Decisions,'" it's no secret that Europe's software industry is years behind Microsoft, and not surprising the industry is seeking help from politicians in Brussels. When Kroes, a politician, talks about open standards one must assume she is referring to the European software industry, not to the open source movement generally. Of course, for the moment "the enemy of my enemy [may be] my friend," as they say.

In her remarks last week Kroes said,

"I know a smart business decision when I see one -- choosing open standards is a very smart business decision indeed," Ms. Kroes told a conference in Brussels. "No citizen or company should be forced or encouraged to choose a closed technology over an open one."
This statement could be read either as an innocent statement of personal opinion, or more like an informal, unofficial statement of official policy with plausible deniability. I suspect it is the latter, and that if you are a European bureaucrat or business leader you now understand what is expected of you as far as your future software procurement is concerned.

Why would Kroes need to be opaque? Because there are both structural (e.g., excessive tariffs, unreasonable licensing terms, etc.) and nonstructural trade violations (e.g., certain winks and nods) which are actionable. And because two or more can play this game.

A good reason for governments to not encourage boycotts of foreign goods is because foreign governments can do the same thing.

That can lead to trade war, in which your efforts to protect one of your small, insignificant struggling industries may result in foreign retaliation against your most successful exporters.

Trade wars don't always have serious repercussions, but they have sparked global recessions and many think a trade war sparked the Great Depression.

That's another good reason why maybe politicians on both sides of the Atlantic ought to leave software procurement decisions up to the marketplace.

May 25, 2007
EU investigating Google privacy policy
Pietro Petrucci

The European Union's Article 29 Working Party has asked Google to justify its policy of keeping information on individuals' internet searches for up to two years, according to EU Spokesman Pietro Petrucci.

Google's new policy is to anonymize its server logs after 18--24 months so searches can't be identified with individual users.

The EU itself requires that customer data must be retained "for periods of not less than six months and not more than two years from the date of the communication." Only "traffic and location data," not the "content of electronic communications, including information consulted using an electronic communications network" is required to be retained.

Google is attempting to position itself on the right side of legislation pending in Congress which would allow the Attorney General to issue regulations governing the retention of records by ISPs, as discussed here and here.

See: "EU probes Google grip on data," Financial Times, May 24, 2007

See: "EU probes Google over privacy concerns," USA TODAY, May 24, 2007.

See: "DIRECTIVE 2006/24/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 15 March 2006 on the retention of data generated or processed in connection with the provision of publicly available electronic communications services or of public communications networks and amending Directive 2002/58/EC.

April 3, 2007
EU targets Apple

European Union regulators think Apple should charge the same price across Europe for users to download content from iTunes. As it now stands, consumers in countries like Great Britain and Denmark pay a few cents more than their neighbors to download songs. Apple has been served with a Statement of Objections (basically an indictment). According to an EU press release,

The Statement of Objections alleges that distribution agreements between Apple and major record companies contain territorial sales restrictions which violate Article 81 of the EC Treaty. iTunes verifies consumers' country of residence through their credit card details. For example, in order to buy a music download from the iTunes' Belgian on-line store a consumer must use a credit card issued by a bank with an address in Belgium.

The EU's best efforts to the contrary, taxation and regulation are not completely uniform throughout the EU -- so the cost of doing business may actually differ from one country to another. For example, there are still differences in copyright protection notwithstanding recent efforts to harmonize each country's copyright law.

The EU says it is not alleging that Apple is in a "dominant market position," nor is it examining Apple's use of Digital Rights Management (DRM) to control usage of the songs it sells. My guess is someone in the EU senses political risk. The EU came down hard on Microsoft at the behest of rival software developers (some of whom are European); European cellphone makers are hoping the EU will help reduce the royalty payments they currently pay to Qualcomm; and European semiconductor manufacturers need help, too (click here). Though the complaint against Intel was brought by an American rival, European rivals would also benefit from sanctions against Intel. How many successful American companies can the EU afford to target at once?

The EU may think it can have it both ways. Apple now has separate iTunes stores throughout Europe. When the French Senate and the National Assembly approved a copyright law in June that could force Apple to make its iTunes compatible with rival music players and reducing the fine for illegal downloading of music to "little more than a parking fine," some noted Apple could just stop doing business in France (see, e.g., this and this. If the EU can pressure Apple to create a single EU-wide store, it would be harder for the company to retaliate against a single country who wants to pursue what Apple called, in the case of the French legislation, "state-sponsored piracy." The impetus for interoperability in France appears to be driven by consumer advocates, not any notion that interoperable music files will deliver what Europe needs most -- jobs and economic growth.

March 6, 2007
Growth and Jobs for Europe?

EUROCHAMBRES, the association of European chambers of commerce, has a new report out measuring the EU's progress achieving its ambitious plan of becoming "the most dynamic and competitive knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion, and respect for the environment." Unfortunately, the report concludes that the EU is still losing ground.

In two years' time, the gap EU-US (sic) has widened for all economic indicators:
  • Income (GDP per capita). The current EU level for income was achieved by the US in 1985. Since the first edition of the study, the time gap has increased by 3 years;

  • Employment and R&D. Both the current EU levels for employment and R&D investment per capita were reached by the US in 1978. (+3 years and +5 years respectively);

  • Productivity (GDP per employed). The current EU productivity level was achieved by the US in 1989 (+3 years).

  • The current EU level of Internet users per capita was reached by the US in 2002. The gap for this indicator was assessed for the first time in this edition of the study.

  • European leaders are attempting to overtake the U.S. without cutting taxes or reducing regulation. That's what they mean when they talk about sustainable economic growth, social cohesion and respect for the environment. I hope they're successful, but I fear they've set unrealistic goals and will continue to punish innovative American companies as a result. After accusing Microsoft of market dominance for commanding a mere 34% of the server market in the aggregate, European Union regulators have turned their attention to other successful American companies. Qualcomm, which offers discounts on bundled products, and Intel, which offers volume discounts, are both under investigation as a result of complaints the EU has received from American and European competitors. This is because the current generation of European leaders, like their mercantilist forbears, possess a vision of finite possibilities in which one country's success comes at the expense of another's. At least that's how I interpret the following passage from a high-level report prepared by the EU in 2004:
    Europe has to develop its own area of specialisms, excellence and comparative advantage which inevitably must lie in a commitment to the knowledge economy in its widest sense -- but here it is confronted by the dominance of the US. The US threatens to consolidate its leadership. The US accounts for 74 % of top 300 IT companies and 46 % of top 300 firms ranked by R & D spending. The EU's world share of exports of high-tech products is lower than that of the US; the share of high-tech manufacturing in total value added and numbers employed in high-tech manufacturing are also lower. In a global economy, Europe has no option but radically to improve its knowledge economy and underlying economic performance if it is to respond to the challenges of Asia and the US.

    In fact, "economic integration runs deep," as the EU commissioner for the internal market and services, Charlie McCreevy, noted this week in a Wall Street Journal column comparing Sarbanes-Oxley to the Europe's more cautious approach in regulating financial markets. The EU resisted the temptation to impose Sarbanes-Oxley regulation and this is a key reason their capital markets are thriving and outperforming ours as a result. Some Europeans are celebrating, but McCreevy pointed out "anything that hurts U.S. capital markets also hurts European companies and our economy." That's how the U.S. and the EU need to view antitrust and competition policy. Since we're economically integrated, anything that harms innovation on one side of the Atlantic hurts companies and the economy on the other side. And obviously the reverse also must be true.

    January 18, 2007
    EU vs. Intel

    Staff at the European Union's Competition Directorate are recommending formal charges against Intel, according to the Wall Street Journal.

    At the heart of the EU case are AMD's allegations that Intel withholds rebates from computer makers when they buy too many AMD chips. "It is simply a coercive tactic," Tom McCoy, AMD executive vice president for legal affairs, said this month.
    Forbes is reporting that AMD's complaints include the offering of rebates to computer manufacturers for shutting out AMD and allegations that Intel has engaged in predatory pricing aimed at keeping AMD's competing CPUs (central processing units) out of the market. Intel denies these charges.

    This could just be negative spin for volume discounts. Intel, or any other firm, offers volume discounts to induce further sales. The discounts are justified because higher sales volumes lower unit production costs. Predatory pricing occurs if the discounts reduce the sale price below the cost of production. Predatory pricing is inefficient. Assuming, that is, that we're talking about Intel's cost of production and not AMD's. Sometimes what the complainant is really saying is it can't make a profit, so it assumes the defendant's price is below-cost. Besides, if it can't make a profit then it will go out of business and the defendant could raise its prices with impunity. Sounds scary. Problem is, the remedy would be awful. If we required the most efficient firm in a market to set its prices high enough to allow the least efficient firm to make a profit, we would wind up with a cartel where prices constantly rise, quality falls, innovation suffers and everyone except the consumer is fat and happy. Since Intel can't possibly know what AMD's cost of production is, we either have to accept collusion or accept that Intel will attempt to avoid further legal trouble by setting its prices in a safe zone, which is likely to be well above its costs. These are some of the reasons antitrust law doesn't protect less efficient firms, since to do so would saddle consumers with higher prices.
    Competition law as practiced by the EU provides far more scope than our own antitrust jurisprudence for enforcers to intervene in the market in search of perfection. Yet Competition Commissioner Neelie Kroes'ds summation of her own philosophy is consistent with our approach,

    My own philosophy on this is fairly simple. First, it is competition, and not competitors, that is to be protected. Second, ultimately the aim is to avoid consumers harm.

    Trouble is, the EU is trying to make Europe more competitive without making it more efficient.

    January 9, 2007
    New policy for the EU?

    Speaking of the Streamlined Sales Tax Project, the European Union is embarking on the same type of tax harmonization project. It's designed to protect member states who levy the heaviest taxes, and is being criticized by countries who fear they'll be forced to raise their taxes to the detriment of their economies -- Great Britain, Ireland, Estonia and Slovakia.

    A 2002 study conducted by the EU found,

    ... neither Europe's knowledge society in general nor its [information and communication technologies] sector in particular are as strong as they need to be ... Whether in patent applications, numbers of scientific researchers, universities' standing in international rankings, numbers of Nobel Prize winners or references in scientific papers, Europe trails the US ....

    Europe needs to dramatically improve its attractiveness to researchers, as too many young scientists continue to leave Europe on graduating, notably for the US. Too few of the brightest and best from elsewhere in the world choose to live and work in Europe.

    Continue reading "New policy for the EU?" »

    September 11, 2006
    The games bureaucrats play

    Bureaucrats aren't clueless, so when one makes a comment the defies logic, like the following, it may mean something's up:

    It is misleading to imply that the commission could be the cause of delays," said Jonathan Todd, the spokesman for the antitrust division of the commission. "It is not up to us to tell Microsoft what it has to do to Vista. The onus is on Microsoft to design its product in conformity with European competition laws.

    Jonathan Todd, EU spokesman

    The spokesman is referring to a comment from someone at Microsoft to the effect that uncertainty over how the EU will act is making it hard for the company to make some critical decisions on how to design its new operating system, Windows Vista. Microsoft asked for guidance from the EU and the EU has declined to respond, so it's probably anything but misleading to say the commission could be the cause of delays.

    Continue reading "The games bureaucrats play" »

    August 10, 2006
    Article 82 Review yielding no results

    EU Commissioner Neelie Kroes

    The EU Commissioner in charge of competition, Neelie Kroes, noted at the Korean Competition Forum earlier this summer that a Discussion Paper issued by the EU's competition directorate on December 19th regarding the application of Article 82 EC Treaty to exclusionary practices has "met with wide interest" in the antitrust community and has generated more than 120 formal responses.

    Unfortunately, none have had any impact; Kroes repeated many of the same substantive policy observations she made prior to the Paper's release -- in September. For example:

    Basing antitrust on economics


    As an economist, I want an economically sound framework. But as an enforcer, I need a workable and operational tool for making enforcement decisions.


    As an economist, I want an economically sound framework. As an enforcer, I need a workable tool for making enforcement decisions...So any conclusions we reach on use of economics must also ensure the rules can be enforced effectively.


    Kroes is saying even though competition authorities shouldn't intervene unless harm to competition can be shown, they will do so anyway when it is convenient.

    Facts versus Conjecture


    We need to take into account not only short term harm, but also medium and long term harm arising from the exclusion of competitors,. I am well aware of the difficulty associated with predicting medium or long term harm. But I believe that we should focus not only on, for instance, the short-term price effects of a certain form of conduct, but also take into account the medium to long-term effects should residual competitors be foreclosed. Consumer prices may fall in the short-run but end up being higher in the medium to long-term because of the likely foreclosure effects. We cannot just wash our hands of responsibility and say that competition law cannot or should not protect the consumer against negative medium to long term effects, just because it is difficult to assess.


    Exclusionary abuses often lead to customer exploitation later. The Discussion Paper focuses on this as a clear enforcement priority. Looking at exclusionary abuses, we need to prevent medium and long term harm arising from the exclusion of competitors. Predicting medium or long term harm can be difficult. But we can't just look at the short term price effects of a certain form of conduct.


    Kroes is saying competition authorities are smart enough to predict the future and that we should trust their superior intelligence and foresight. It's great when you can base decisions on facts, but the political process can't stand still in the absence of clear facts. In politics, things like intuition, speculation and even paranoia matter.

    Advantages not available to smaller or newer competitors


    "Competition on the merits" takes place when an efficient competitor that does not have the benefits of a dominant position, is able to compete against the pricing conduct of the dominant company.


    "Competition on merit" takes place when an efficient competitor who does not have the benefits of a dominant position is able to compete against the pricing conduct of the dominant company.


    Kroes is saying things like hard-earned reputation and scale and scope economies are illegitimate.

    Kroes also commended the Korean Fair Trade Commission for its actions agains their joint target, Microsoft. "The KFTC's determined action in the Microsoft case...demonstrates that there will be fewer safe havens for companies engaging in abusive activities affecting competition." It's interesting, one searches in vain for evidence of any benefits to competition or innovation at all since the EU began investigating Microsoft in the late 1990s and the KFTC subsequently piled on. Not even Kroes alleges any.

    See:"Preliminary Thoughts on Policy Review of Article 82," Speech at the Fordham Corporate Law Institute New York, 23rd September 2005, by Neelie Kroes, Member of the European Commission in charge of Competition Policy

    See: "The Commission's Review of Exclusionary Abuses of Dominant Position -- Speech before the Korean Competition Forum organised on the occasion of the Fourth Annual Bilateral Meeting on 26/27 June 2006 in Seoul," by Commissioner Neelie Kroes

    EU looks for exclusivity in high-definition DVD competition

    Officials from the European Union's competition directorate have been investigating whether the backers of competing standards for high-definition DVDs, including Sony and Toshiba, are stifling competition through exclusive contracts, reports the New York Times. The EU wants to know if studios are being pressured to favor a single format.

    The two formats have similar storage capacity, at the moment, and analysts report that the image quality is comparable. Yet the Blu-ray coalition, led by Sony, has persuaded more studios to adopt the Blu-ray standard even though the cost of a Blu-ray player -- currently almost $1,000 -- is twice that of an HD-DVD player. An analyst who was interviewed for the New York Times story speculated that Sony will be looked at most closely.

    blu ray.bmp

    Nothing about the Blu-ray versus HD-DVD brawl suggests that consumers won't ultimately get a chance to vote with their feet. Both of the standards have distinct advantages and powerful backers. An investigation by the EU would just be a waste of time for everyone but the bureaucrats and the lawyers if it weren't for the fact it will lead to uncertainty for investors and consumers.

    The reason the European Commission would be concerned about Sony's aggressive competition is it's been fooled by the "network effects" theory of antitrust. As the Commission observed in the Microsoft decision, "once the network effects work in favour of a company which has gained a decisive momentum, they will amount to entry barriers for potential competitors." This cynical theory postulates that consumers will value a product not so much according to their own opinion of the product's value, but according to what they think the majority of consumers think. Therefore, it is possible that consumers will collectively opt for an inferior product just because they think their fellow consumers will do so (it's easy to see this theory's appeal to unsuccessful rivals who can't bring themselves to confront the possibility something is wrong with their product, isn't it?).


    Sure, the fact that a product is used by many of one's friends and neighbors is a positive selling point, but it's a huge leap to say consumers will buy an inferior product on this basis alone. Of course, the Betamax proves the leap too far. Betmax was another $1,000 Sony product that had a huge lead in the marketplace but ultimately failed -- notwithstanding its superior image quality -- because VHS was much cheaper and had higher storage capacity. There are other examples that contradict "network effects" theory, but competition authorities in Europe accept the theory as gospel anyway.

    See: "European Panel Investigates DVD-Standards Rivalry," by James Kanter and Ken Belson, New York Times, Aug. 9, 2006

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