Montero, Juan and Matthias Finger (2021). The Rise of the New Network Industries: Regulating Digital Platforms. New York & London: Routledge, 292 pages.
By Melanie Kolbe-Guyot
“The Rise of the New Network Industries – Regulating Digital Platforms” (2021), by Juan Montero and Matthias Finger, is an excellent resource on the rise and inner workings of digital platforms and the particular regulatory challenges they pose. Digital platforms, such as Facebook, Google, Amazon, eBay, Uber, and Airbnb have become highly influential market players that significantly shape the very markets they created. Although the success of online platforms has generated a number of customer benefits and increased economic value, dominant market players have abused their market position in multiple ways: denial of access, discrimination, excessive charges, and self-preferencing (i.e., placing their own products at a competitive advantage on their platform). Yet, digital platforms have also eroded the vital infrastructure industries that they are built on and benefit from. Increasingly, these developments have come to pose significant challenges to regulatory authorities.
In “The Rise of the New Network Industries”, Montero and Finger trace how digital platforms have become dominant market players and how they have disrupted traditional markets, and they explain which potential avenues for regulating their negative fallout could be advanced. They do so through the particular lens of the history and politics of the industrial organizational model of traditional network industries (communications, transport, and energy). These particular industries are characterized by a physical network of assets, integrated by a company into a single entity in order to generate network effects. Drawing on their deep knowledge of infrastructure industries, they advance several important points in this book: First, they contend that digital platforms constitute a new form of network industry that operates at the virtual level, rather than the physical. Second, they demonstrate that these new network industries weaken conventional infrastructure players who provide essential services to society. And third, the authors argue that sensible solutions to the negative of effects of the digital platforms’ market dominance can be derived from the regulatory experience of traditional network industries.
The book is divided into five parts. In part one, the authors introduce the principle digitalization dilemma that traditional network industries face, and they discuss how digital platforms have created multi-sided markets that disrupt these traditional industries. In parts two, three, and four, the authors trace the rise, impact, and regulatory challenges of the digital platforms of the three main traditional network industries: communications, transport, and energy. In part five, they discuss the potential and proposed regulations of digital platforms, specifically the regulation of their market dominance, focusing on the platforms’ roles as intermediaries and super-intermediaries, as well as the platform ecosystem as a whole.
The Power of Network Effects
To understand why and how digital platforms have become so powerful, the authors begin by taking a step back to discuss the characteristics of traditional network industries, such as communication (postal networks, telecom carriers, and media), transport (railways and public mobility) and energy (electricity generation and management). Notably, these industries are defined by network effects, a phenomenon by which a product or service gains additional value or utility according to the number of connected users it has. Similarly, digital platforms, which allow the online interaction of users for commercial and non-commercial reasons, are also characterized by such network effects: The more users are connected to Facebook or eBay, for example, the greater the value is for newcomers to join such a network.
However, digital platforms do not rely solely on these so-called “direct” network effects, they also rely crucially on “indirect” network effects. Indirect network effects arise when the value of goods or services increases for one type of user, when new users of a wholly different type join the network. For example, the more regular users Facebook or Instagram acquire, the more interesting the networks become for advertisers. The more commercial sellers offer their products via the Amazon marketplace, the more interesting the platform becomes for potential buyers. And the more drivers offer their service via Uber, the more attractive the platform becomes for ride seekers, and vice-versa.
These indirect network effects, Montero and Finger argue, set new network industries apart from traditional network industries: Digital platforms, more so than traditional network industries, can take full advantage of digitalization; and this drastically reduces the transaction costs (such as search, information, monitoring, communication and bargaining costs) between third parties, hence makes transactions more efficient, safer and less expensive. In bringing together different types of users, digital platforms have enabled the development of multi-sided markets, in which the intermediating firm (the platform) acts as a highly sophisticated match-maker between different groups of clients. However, these multi-sided markets, as the authors later outline, fundamentally alter the relationship between sellers and buyers.
A precondition for and reinforcement of both these network effects are a third type of network effect: algorithmic network effects. Enabled by digitalization, big data, and by the rise of machine learning, algorithmic network effects describe the phenomenon where a matching service improves as it obtains more and more data from service users, thus using it to identify the most efficient complementarities between different groups of users. Algorithmic network effects continuously increase the efficiency of the platforms’ intermediating service by enabling even highly personalized product recommendations and advertisement.
The Digitalization Dilemma and the Disruptive Power of Digital Platforms
Montero and Finger demonstrate that, by creating digital networks on top of traditional physical-network industries, digital platforms operate in the data sphere, intermediating the supply and demand of previously little coordinated physical assets and services. Furthermore, they coordinate transactions that take place in the newly created multi-sided markets by setting standards and rules and by determining the distribution of benefits created by network effects to the different parties involved. In this sense, online platforms not only take on a role as intermediaries but also as system coordinators (super-intermediaries), similarly to firms operating in traditional network industries.
This renaissance of the classic middleman in the form of digital platforms, however, threatens traditional market players, Montero and Finger explain: because it removes the direct link between the transacting parties (i.e., producers and consumers) and relegates product and service suppliers to being just one side of the multi-sided market. This change in roles commoditizes traditional market players; this is a development that is particularly acute in traditional network industries, as demonstrated throughout Chapters two, three, and four.
Simply minimizing the extent to which services are delivered or accessible on the data layer where platforms operate is, however, not a feasible solution. As this would mean to simultaneously forego the valuable efficiency gains that digitalization brings. Therefore, the authors state that traditional network industries (as well as almost every other industry) face a fundamental digitalization dilemma: Whereas, for traditional market players digitalization reduces transaction costs and data-based algorithms improve firm coordination, it also enables the creation of digital platforms that constitute a particularly disruptive new type of industrial player. According to Montero and Finger, this disruptive potential unfolds in two ways: substitution and “platformization”.
First, digital platforms can substitute traditional market players, i.e., digital platforms now provide goods and services that were previously provided by traditional companies. This can take on different forms. On the one hand, new digital products can replace existing physical ones (for example, e-mails instead of letters, internet telephony instead of cellphone and landline telephony, and digital music files instead of physical records and CDs). On the other hand, platforms can also empower market newcomers that substitute the goods and services of traditional players (such as in the case of private drivers substituting taxi services through Uber, and private accommodations substituting hotels via AirBnB). The consequences can range from a severely diminished revenue basis to being largely pushed out of the market.
Second, digital platforms can “platformize” traditional players, i.e., platforms take over the direct relationship with the customer and the intermediated companies. Traditional providers become just one side of a multi-sided market, which significantly changes their position in the market: The conditions for the provision of the intermediated services, including the pricing, distribution of benefits and product standards, are determined by the platforms instead of by providers themselves. Through the power of algorithms, platforms also shape the demand side of this market, as they actively nudge demand to a specific service provided by a specific supplier. Companies also lose direct access to valuable customer data hence are weakened in their ability to accurately analyze market dynamics. Lastly, they also lose potential revenue, because platforms extract the largest portion of value out of the market. In particular – for traditional network industries such as telecoms, transportation, and electricity – this means that digital platforms increasingly replace them as system coordinators.
Throughout the book, the authors illustrate how platforms have successfully created networks on top of traditional network industries while disrupting them by either substituting or platforming traditional infrastructure players. However, the authors uncover important differences. For example, substitution is not as common and occurs mostly in the industries in which online platforms can successfully identify idle assets that could be coordinated in new and creative ways. Substitution is therefore most evident in, but not limited to, communication industries, such as postal networks (e-mails substitute letters), telecom carriers (Skype and WhatsApp substitute traditional phone networks), and media (YouTube and Facebook substitute newspapers with user-generated content). In contrast, substitution effects are limited in those types of infrastructure industries where the provision and management of the physical network elements (railways and trains, broadband cables and networks, powerplants and electricity grids) are still necessary.
Conversely, platformization is a more common phenomenon affecting almost all market industries, including network industries such as the communication and transport industries. In particular, the latter shows both substitution (Uber, Blabla Car) and platformization (mobility and ticketing platforms) tendencies. Platformization is the weakest in the energy industry. Although there is a clear potential for the intermediation of an increasingly fragmented energy market with the rise of new forms of electricity generation and the entry of prosumers (e.g., private solar-energy generation), the tight regulation of these industries, as well as the high level of technical system coordination required to keep electricity grids stable, has significantly decelerated the emergence of digital platforms.
THE DARK SIDE OF DIGITAL PLATFORMS
Across several thematic chapters, Montero and Finger demonstrate that the rise of digital platforms has led to distinct patterns of market concentration, driven both by legitimate (scale and network effects) and illegitimate (systematic strategies to monopolize markets) reasons. Propelled by the inherent winner-takes-all dynamics of multi-sided markets, digital platforms have reached market positions akin to oligopolies and, in some cases, even monopolies (think Amazon Marketplace or Google Search). This enables them to dictate the conditions for the provision of services they intermediate. Consequently, this constitutes a dangerous power asymmetry and dependency among digital platforms – acting as gate-keepers to vital markets – and other market participants. Furthermore, in most industries, digital platforms do not have the ambition to produce their own assets. Whereas in some cases, mature digital platforms, such as Amazon, will also seek to integrate vertically and begin to produce their own services and products that are in direct competition with the suppliers they intermediate.
In the absence of serious regulation that creates transparency and accountability, these developments have led to a series of anti-competitive behavior and to the power abuse of digital platforms, such as self-preferencing, discrimination, excessive charges, and access denial. For example, Amazon and Google have been found guilty of self-preferencing, i.e., placing their own products at a competitive advantage – both in terms of search ranking and pricing. Most recently, hence not mentioned in the book, Google (as well as Apple) has been charged with exploiting their control of their iOS and app stores in order to collect sensitive information from third-party apps that support their own competing offerings.
The power of digital platforms also adversely affects traditional network industries by creating multiple pressures. Infrastructure players suffer a loss in revenue through platformization and substitution effects, while infrastructure managers have to continuously invest in the maintenance and expansion of the very physical assets that digital platforms operate on, but are not compensated for. For example, although telecom providers have lost revenue from cellphone and landline telephony to over-the-top (OTT) services such as WhatsApp, Skype etc., they also have to finance the maintenance and the upgrade of the internet infrastructure.
Lastly, Montero and Finger touch on the fact that the rise of private platforms also challenges the public interest. As leading platforms become gatekeepers and coordinators of the media ecosystem, they nonetheless continue to operate largely on economic incentives. A lack of economic or legal obligations to uphold public values means that it becomes increasingly difficult to ensure values such as news reliability, diversity, or pluralism in the public debate. This then also has direct consequences for the working of democratic political systems.
REGULATING DIGITAL PLATFORMS
The authors conclude with an in-depth discussion of potential regulatory approaches. Here, in order to weaken the market-stifling dominance of digital platforms, they particularly favor a market competition-based approach that promotes platform neutrality and the creation of a level playing field. Hence, Montero and Finger focus principally on addressing how to fight market concentration in the form of digital monopolies while making clear that regulation should be advanced in a fashion that does not undermine the value-generating activity of digital platforms per se. The authors argue that although regulation is needed, the over-regulation, in particular of start-up companies, would threaten the development and sustainability of network effects that are necessary to create the desired efficiency and value gains.
Taking a page from the playbook of deregulation and liberalization of previously similarly monopolistic network industries, the authors suggest that “unbundling” (i.e., separating the infrastructure owners from the service providers operating on said infrastructure), as well as reducing the barriers to market entry and enabling the sharing of network effects would constitute promising avenues of action for the new network industries. The authors also argue that a lack of understanding of both the business model and the precise market roles that digital platforms assume complicates regulatory action. Therefore, by clarifying both issues, Montero and Finger discuss three ways in which the platform economy needs to be regulated.
First, digital platforms need to be regulated in their role as intermediaries. Similarly, to the way other traditional intermediating service industries, such as real estate agents, insurance agents, stock exchange, or marriage brokers, digital platforms need to be held accountable in their role as match makers, and not as goods and service providers themselves. This means that, for example, liability laws, which digital platforms are currently mostly exempt from, should not attribute full liability to digital platforms but only for adverse factors occurring in their function as intermediators. Ample examples for this exist in traditional intermediating service industries and can be extended to the digital services provided by platforms. Furthermore, in their role as intermediaries, online platforms also need to be held accountable for the protection and promotion of the interest of their clients, in the form of platform neutrality, i.e., by providing neutral and objective, transparent and non-discriminatory services at reasonable conditions.
Second, Montero and Finger also recognize that, beyond the role as intermediaries, some particularly dominant digital platforms also have the power to dictate the conditions for the provision of services, including pricing, and the function of the market as a whole. Therefore, these companies need to also be regulated in their role as super-intermediaries. Yet, the authors argue that a singular focus on antitrust laws is not the best approach for accomplishing this, as antitrust laws are limited in scope and application. Instead, they suggest to emulate the liberalizing regulatory interventions undertaken in traditional network industries. This includes pro-competition obligations (e.g., data portability, prohibition of exclusivity, interoperability, data openness), the prohibition of exploitative behavior, as well as vertical divestiture, i.e., the “unbundling” of only the largest digital platforms that not only intermediate but also compete with their own goods and services.
Lastly, the authors also suggest regulating the platform ecosystem as a whole. This includes shifting general interest obligations onto digital platforms, requiring greater transparency in algorithms to ensure accountability, and demanding a fair distribution of the captured value back to the underlying infrastructure managers to enable the sustainability of the needed physical ecosystem. It is also imperative that public authorities protect and promote the creation of network effects while ensuring easy market entry for smaller market players.
With their detailed and highly informative chapters, Montero and Finger offer a tour de force through the history, politics, and operations of both traditional and new network industries. The information-dense chapters double as a great general reference for each specific infrastructure sector; they repeat and illustrate the core tenets of the book, thus making them easy to read as stand-alones. In particular, the conceptual contributions on the power of network effects, the digitalization dilemma, and the disruptive mechanisms at work (i.e., substitution or platformization effects) make the book relevant to the study of digital platforms, well beyond the infrastructure industry context. As such, the book’s theoretical chapters seamlessly explain the demise of US bookstore giant, Borders, with the arrival of Amazon, and of the movie-lending monopolist, Blockbuster, a consequence of the rise of Netflix. It also helps us understand the significant changes the music distribution industry has undergone due to digital platforms such as Spotify, Apple music, and YouTube. The authors also enable us to better understand the rationale behind contemporary telecom companies’ attempts to levy service charges on platforms that extensively use their internet infrastructure to generate profits, such as Netflix.
Both authors come from the field of economic regulation and draw on their extensive experience in and research of infrastructure network industries, which clearly informs the book’s strong and informative point of view. This perspective, however, also limits their treatment of digital platforms. Montero and Finger conceive digital platforms and their regulation, predominantly, as a problem of market competition. This could leave some readers dissatisfied, as it necessarily precludes a more detailed treatment of other important area of concerns, including most notably consumer data and privacy protection, but also mounting labor (in the case of Uber), urban housing (in the case of Airbnb) and social media content and manipulation (in the case of YouTube, Facebook, etc.) issues.
Nonetheless, their book constitutes a valuable contribution to the questions of why and how digital platforms and their dependent economies should be governed. In particular, the in-depth discussion of regulatory avenues is both enlightening and constructive. It makes clear that the theoretical departure from network infrastructure industries is not just a hobby horse of the authors but that it also informs convincingly concrete regulatory actions for reigning in digital platforms’ problematic market dominance.
This edition of the Digital Governance Book Review was authored by: Melanie Kolbe-Guyot, C4DT
Image credit: Cover of The Rise of the New Network Industries: Regulating Digital Platforms by Juan Montero and Matthias Finger, published by Routledge.