Deep Dives

Identifying Market Power In Digital Ecosystems

On April 21 the U.S. Senate Judiciary Subcommittee on Competition Policy, Antitrust and Consumer Rights met to discuss the dominance of Google and Apple’s mobile app stores and whether the companies abuse their power at the expense of smaller competitors. What follows is the Testimony I submitted in writing, in advance, for this meeting.

Their scale and variety can suggest the apps on our smartphones are a boundless market with tremendous choice. This is especially so given that as consumers we tend to merge in our minds the digital products we access on different electronic devices—mobile, tablet, PC, and others—even when, in fact, our experiences with each tend to be far less interchangeable.

This image can obscure the powers that constrain and harm the businesses making these digital goods and the users consuming them. These constraints set in the moment we purchase a smartphone and tighten the more apps we use and purchase, and, in turn, the more locked-in we become. These constraints are not simply a matter of product design, nor are they necessary outcomes of digital ecosystems and their underlying technologies. Rather, they result from an ecosystem strategically engineered to bind otherwise separate choices by consumers and businesses and make them hard to change. I will explain.

Apple and Google may wish to argue that we are free agents when we purchase a smartphone, and that we are not bound to their app stores for accessing digital applications. However, this ignores the reality of the market and consumer behavior.

Smartphones are durable goods, costly and typically lasting 2-3 years for consumers, and most of us already own one, making our next purchase an upgrade. The reality is that very few consumers switch between a phone running iOS and a phone running Android, and for good reason. We do not want to face the learning curve of gaining familiarity with a new operating system—try to operate a smartphone that uses a different operating system; you may struggle to rely on your muscle memory to navigate it. We also do not want to “start over” with our existing applications; in many cases, past purchases and data cannot migrate to the other mobile operating system.

So, our initial choice of smartphone operating system proves to be a particularly enduring investment. Apple technologically and contractually ties this sticky durable good (iOS) to the massive market for the distribution of applications for iOS by mandating that only the Apple App Store can be used to distribute apps to iOS devices.

Google locks consumers into its app store, the Play Store, through a less direct means, by leveraging known consumer behavior and preferences. Google permits alternative app stores on its operating system, Android. But, under the terms for licensing Android, Google ties the Play Store to other popular Google apps. Specifically, Google requires that any preinstallation by OEMs of the Play Store or popular Google apps (e.g., Chrome, Gmail, YouTube, and others) be done as an all-or-none bundle. As OEMs must ship out smartphones with popular apps preinstalled in order to sell a commercially viable product, Google effectively requires the Play Store be preinstalled on Android devices. (This is true outside of China, where the Play Store is not supported). As consumers tend to use default settings, the Play Store has risen to be the dominant app store on Android. “Network effects”—which attract buyers to a platform with lots of sellers and vice versa—reinforce the Play Store’s incumbency and serve as a barrier to the use of other, emergent pre-installed app stores, such as the Galaxy Store (Samsung). Google further ties its own app store to its apps and the app market by making Google Search apps exclusive to the Play Store. 

Other electronic devices are not viable alternatives to smart phones when accessing mobile-first (“native”) applications. Smartphones are designed to, and generally do, come with us everywhere we go. They are hand-held and have touch screens and other features and functionalities that support this “mobile” experience. A consumer is unlikely to pull out their laptop at a bar to check if they have any new matches on a dating app—in this context, it is cumbersome to use a laptop, potentially challenging to connect to the internet, and presumably not a great move.

The mobile phone browser is also not a close substitute for mobile-first applications. Take, for example, that slow loading or clunky webpage redirection you might have experienced when using the browser on your phone to navigate an app. Generally, the user experience on a mobile phone browser is inferior, with fewer features, less functionality, and lower performance than apps that are native (i.e., built directly on top of the mobile operating system rather than built for use in a web browser).

Apple and Google, therefore, benefit from massive bases of users who are largely locked-in to a mobile operating system and receive the best performance from apps that necessarily are sold through the App Store on iOS and are very likely to be sold through the Play Store on Android. History and path-dependency has endowed them with significant power in the core markets in the US, the EU, and elsewhere. This is worth contrasting with China, a market with its own pathologies and strong government involvement, which, on the other hand, has supported a more balanced set of app stores, some sponsored by the key platforms such as Tencent/WeChat, some by retail giants like Alibaba, and some by device manufacturers such as Xiaomi and Huawei.

In the U.S., though, there is a clear dominance of two app stores. Digital businesses selling to these consumers must engage with Apple and Google on these platforms’ terms. They cannot effectively access their consumers through alternative means, for the reasons described. They also cannot forgo serving them given their size (and spending power) and because, for many apps, Android users demand being connected to iPhone users and vice versa. With the network effects that characterize such apps, users get more value from the service with each additional user of that service.

As a result, Apple and Google have market power over both developers and the major bodies of consumers that already have iOS or Android smartphones. The question becomes what they do with this power.

Apple and Google’s market power over developers allows these platforms to take further steps to disempower developers. In the sale of digital goods, Apple and (with some exceptions) Google give themselves exclusive control over payments processing, which is a key part of the consumer relationship—and, as discussed later, the mechanism through which these platforms impose their supracompetitive commissions. Apple also uses its power to control valuable consumer data from app and in-app digital sales without sharing it back with the developer. This, in turn, helps make any individual developer more replaceable from the vantage point of the platform, especially given the depth of apps available in any given category in the App Store and Play Store.

If regulators are waiting for competition to iOS or Android to disrupt the market power of these platforms, that day is not imminent. In over a decade, there has not been a successful new entrant. And not for lack of funding or innovation capacity—Microsoft, among others, tried and failed. That is because the existing base of users and developers on each platform is a barrier to entry. Users want to use a mobile operating system with existing applications, and developers want to build applications for a mobile operating system with existing users. Again, network effects play a role in consolidating the market towards the incumbents.

The power exercised by Apple and Google over consumers and developers is not the norm. In healthy markets, platforms compete not by locking consumers in and closing off alternatives, but on price and quality. In fact, this distinction can be made through practical criteria, which I created for my research, to identify the existence and strength of market power. They include:

  1. Does the platform have exclusive access to a large body of consumers?
  2. Is it difficult for users to multi-home or switch platforms?
  3. Can sellers be replaced without harm to the platform?
  4. Do users benefit from network effects, requiring sellers to multi-home across platforms?
  5. Does the platform have an establish network that creates barriers to entry for competitor platforms?

Affirmative answers to these questions indicate market power. By these standards, Apple and Google possess considerable market power, and platforms in other markets do not. In the market for PC gaming, for example, no platform has exclusive access over consumers. Because PC operating systems do not restrict installation of gaming platforms or distribution of games, the same user can be accessed by multiple PC gaming platforms. And because consumers have choice, the platforms tend towards practices that favor consumers, such as enabling switching or multi-homing by making game purchases transferable. Competition over consumers also pressures the platforms to treat sellers more fairly and compete for them. Top game developers are courted by the platforms because, due to the market’s power structure, they are not easily replaced without the risk of the platform losing users.  

The market power Apple and Google have over consumers and developers leads to real harms. Without competition, Apple and Google can charge a 30% commission on their app store sales and in-app digital purchases. For many developers—with their own brand name to attract consumers and their own payment processing systems or easy access to third-party alternatives—the 30% commission is an outsized take. In other digital markets, significant competition among payment providers has driven down transaction fees to 1-5% of the transaction value, plus a small, fixed fee. These services are provided by firms, such as PayPal and Stripe, that specialize in payments processing and have a track record of providing payment services at large scales across industries and technologies. Exposure to competition in payments would not only pressure Apple to reduce prices, but also to provide developers with improved quality and innovation and share data (e.g., credit card information) from payments with developers.

But today, developers must accept this commission in order to distribute through the App Store and Play Store irrespective of the value developers receive in return. And the harm flows to consumers. The 30% commission directly results in higher prices, as some developers pass through a portion or all of the 30% commission to consumers. For example, YouTube, Amazon Music, Candy Crush, Pandora, Twitch, Facebook, and Tinder are among the top-grossing apps that increase their iOS app prices relative to their web prices to cover the cost. These competitively unconstrained commissions also result in less innovative products, as developers are left with less revenue for R&D. The 30% commission reduces developers’ gross margins because developers may not pass on all of it to consumers, and any price increases that are passed on result in fewer purchases, as higher prices reduce volume of sales. The resulting reduction in revenue diminishes the amount that developers can invest in innovation, research and development, and other quality enhancing investments. 

Digital ecosystems orchestrated by platforms are becoming a more prominent feature of our economy, but existing regulatory tools are not well suited to addressing market power in them. Regulation must fully reckon with the forces behind market power in ecosystems orchestrated by platforms. To do so, regulation must move beyond a generic conception of markets, looking at individual markets in isolation, when many dominant platforms harness their power across markets (e.g., Apple and Google’s tie-ins from their operating systems to their app stores and then to payment processing). Understanding the ecosystem architecture and the specific rules, and roles, and relationships through which platforms gain market power is necessary to make the regulation of gatekeepers more effective.

One of the greatest challenges of the platform economy is that the complexity of its economics and underlying technology may lead to confusion and regulatory inaction, for fear of interfering with innovation or what powerful platforms often frame as rightful product design choices. Yet, there are important tradeoffs between giving platforms leeway and allowing them to pursue and entrench their power with a heavy price for the businesses and consumers they control. We can start with some simple, collectively agreed upon guidelines for identifying market power in platforms and the resulting harms. I have endeavored to provide such a framework.

This guest essay, which was written  by Michael G. Jacobides, was submitted to the U.S. Senate hearings. Jacobides holds the Sir Donald Gordon Chair of Entrepreneurship & Innovation at London Business School, where he is Professor of Strategy. He is an Academic Advisor to Boston Consulting Group, the Lead Advisor of Evolution Ltd, a boutique consultancy on digital strategy and ecosystems and the Chief Digital Economy Advisor at the Hellenic Competition Commission. A frequent keynote speaker, he works with companies as they adjust to a shifting environment. He studies industry evolution, new business models, value migration and structural change in firms and sectors, and looks at how digital ecosystems transform the business context. He teaches strategy, innovation, transformation and turnarounds, and works on thought leadership with consultants such as McKinsey, IDEO, Accenture, PwC and Deloitte, and on strategy with corporates such as EnelX, MasMovil, SwissRe, Haier, Santander, Gartner, DeBeers, Burberry and MerckSerono.

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Michael G. Jacobides