“The more we compete, the less we gain” – Peter Thiel (Zero to one)
Within Microeconomics, a very important concept is that of market structure. It refers to the number of firms in a market and their conduct with one another and their ultimate customers. Accordingly, every market falls somewhere on a spectrum from perfect competition to a perfect monopoly.
If there is only one firm in a market, it is a monopoly. This position allows it superior power: it can charge higher prices, since customers cannot go to a competitor. Since it is the only supplier of a specific product, it can also decrease the quality, potentially producing for less cost. It might also enjoy a higher degree of bargaining power with suppliers if it is the only buyer of their products. All that means is that this company will be able to extract more profits for itself, in what is known as monopoly profits. The dangers of this I discussed last week and can be found here.
On the other end of the spectrum is perfect competition. This is the case when there are a lot of companies selling identical products, eager to compete with one another. If this is the market situation, no company could charge higher prices than the others since consumers would simply buy from the competitors instead. Eager to gain more customers, those companies would also constantly underbid their prices, until selling their products for exactly what it costs to produce.
Most markets fall somewhere in between these two extremes, resembling neither a monopoly nor a perfect competition. But why?
There is no market with perfectly identical products, even the most standardized products have different attributes from different suppliers. Think of apples for example, they still taste very different. Or different water brands. Companies usually also resort to brand values and marketing to differentiate their products, prohibiting any perfect competition marketplace to materialize. Perfect competition would be the most desirable result for consumers in the market. At this point, they would pay the least to get the most amount of value. However, for companies, this is of course the least desirable situation, a point where they would not be able to earn a profit. As such, companies are incentivized to ensure such situation does not arise and they have a number of methods to do so.
A monopoly situation would be best for companies, since it allows for greater profits and a lot less risk, due to lack of competition. But exactly those profits and lack of risks are an incentive for new companies to enter the market, to compete against the incumbent and to shift the structure further to the right of the spectrum, eroding the monopoly profits and enriching the consumers.
In both of these cases, no intervention in the market was necessary. In both cases, the “invisible hand of the market”, as Adam Smith predicted, allowed for a market structure that is somewhere in the middle of the spectrum, allowing companies to earn some profit, but not monopoly level profit. But there are other forces playing a role in the market structure, equally strong to that of the market: government and the public.
The government dislikes monopolies, as does the public, for obvious reasons. The public cannot do as much to fight a monopoly, by definition being forced to buy its products. But if it has a very negative perception of a particular company, that company will not survive for long. People can quit working for the company, they can campaign against It and buy competing products as soon as they pop up. Perhaps even more importantly, they can influence the governmental force.
The government usually has a strong mission to keep marketplaces competitive. This is the case in most major developed economies of today, to varying levels and interpretations of course. Usually, it can fulfill this mission by challenging a firms conduct, or in the most extreme cases, breaking it up to create competition where before there was none. It can sue to block acquisitions, it can levy fines for anticompetitive behavior, in short, it has a lot of levers to punish monopolies.
But what if, due to chance, you find yourself leading a company that could arguably be classified as a monopoly right now. Is there a way to maintain this position for a longer period of time, to delay the forces of the market which erode your profits?
To answer this question, one can look at the underlying mechanism that destroys the monopolies. The incentives for newcomers on the market, which undermines the current position, are the profits the monopoly currently earns. They want to get a piece of the pie. Of course, the monopoly could give up those profits by charging people a low price and thus kill the incentive for new companies to join the market. But what’s the point of a monopoly without the profits?
Instead, what it can do is try and hide its profits. If nobody knows how big the pie actually is, they might not fight for a piece of it. For a private company, this is easy enough. Simply limiting who is able to look into your finances should keep unwarranted attention from outsiders at bay.
As a public company, this is much harder. Every 3 months you upload a statement detailing your financial performance to a regulatory agency, over which financial professionals then obsess over and discuss in great detail. Hiding your profits in this case is near impossible, if not strictly illegal.
The only possible way is to divert some of them. Instead of it being profits, it is now costs. Invest them into researching a new promising technology, spend billions doing so and you effectively hide the profits. If competitors’ glance over your financials, they see meager profits, not big enough to compel them to jump into your markets. The public and the government may be suspicious, but upon seeing those average profit margins, they will shift their focus elsewhere.
Now of course this also lowers your current profits. But putting that money to work now could ensure that in the future, in a new market, you can still keep being a monopoly, earning a good amount of money, but never too much.
There also exists another way to maintain your status as a monopoly. In the first method, you try to kill the incentives for newcomers. In this method, you simply kill the newcomers. Of course, crushing your competitors is the pinnacle of monopoly and the best way to make everybody aware of your status. Obviously, such behavior in business has a very limited lifetime.
But instead of killing your competition, you could use your monopoly profits to buy them. It will reduce your profits, but also ensures that you keep most of them for yourself, while not acting outright as a monopoly. When asked for reasons as to why you would buy these small companies, you do not mention their threat to your monopoly status, you simply mention the synergies and potential for complementary innovation.
In this way, you share a bit of your profits with those upstarts, but more importantly, you still get to be in control of both the profits and the market. If you pick the most credible competition and acquire them, you eliminate the threat while still keeping most of the pie. If you do so in a clever way, without showing too much of your true position, you may be able to hide yourself from the scrutiny of the public and the government, further ensuring your position.
While a monopoly is the theoretically perfect position for any business to be in; market, government and social forces almost always ensure that this position is short lived. To achieve it, and then exploit it for a meaningful amount of time, is a constant struggle. Only a few companies could ever hope to achieve it. One of them is Meta, formerly known as Facebook, Inc.
Meta is almost as controversial a company as one can think of. Embroiled in scandal after scandal (Cambridge Analytica, Election Misinformation, Data Breaches …), one has to admire its size and market power. Before having its stock fall of a cliff in 2022, it previously reached a market capitalization of $1 trillion in June 2021. During 2021 it amassed $118 billion in Revenue and almost $40 billion in profit.
Almost accepted as a monopoly in social media among society, the FTC ultimately tried to challenge this status. It sued on grounds of anticompetitive behavior, arguing Facebook had a market share in social media of more than 60%. The judge dismissed the argument, saying it had no legal basis and the FTC did not even try to specify the market or the share.
But the argument laid out by the FTC paints a picture of acquisitions by Facebook meant to solidify its position in the market. Having risen to be the social media platforms during the 2000s, in the early 2010s Facebook recognized its status and the risk of increasing competition that comes with it. Not wanting to follow the path to irrelevance like former competitors Friendster or Myspace, Facebook realized it was no longer the disruptor, but the to-be-disrupted and needed to act accordingly. In an email from Zuckerberg to his CFO in February 2012, this realization and its implications become apparent:
https://twitter.com/TechEmails/status/1400812133580001281
(Email provided by Twitter Account Internal Tech Emails)
In those emails, Zuckerberg highlights the potential of upstarts to disrupt Facebook, their growth and unwillingness to sell for small prices. This presumably is how the process of acquiring Instagram started, which got acquired for $1 Billion by Facebook approximately 6 weeks later. Also in these emails, he outlines his reasoning for the acquisitions – a combination of neutralizing a competitor and integrating their products into Facebook. More tellingly, he writes that effectively they are buying time, the integration of their social dynamics would happen soon anyways, but in the future no competition using those mechanics could be built, since Facebook already has them. They could copy Instagram, but its user base would allow it to sustain itself, perhaps even grow. From Zuckerberg’s perspective, eliminating the risk of any disruption from Instagram was easily worth a billion. This would also eliminate any possible competition using this social dynamic in the future.
Zuckerberg’s reasoning in the email reads like corporate attorneys’ nightmare, explaining that these acquisitions will eliminate any future competition saying that: “Even if some new competitors spring up, … those new products won’t get much traction since we´ll already have their mechanics deployed at scale.”
Approximately an hour after sending this email, and presumably a chat with some panicked legal counsel, he sent another email stating that this is in no way to stop competition, just to combine the products and build what they had invented into more people’s experience.
A similar story led to the Acquisition of WhatsApp. Sensing the popularity of the messaging app, Facebook feared it could enter the social media game by developing new features or a new associated platform. It certainly had enough users: 450 million at the time of its acquisition. The only revenue came from a $1 annual subscription fee. Purchasing WhatsApp at $19 Billion, Zuckerberg essentially paid 40x sales. He did not pay that much for the business, but rather to eliminate what it could become. A legitimate competitor.
These acquisitions, and the dozens of others over the years, allowed Facebook to stay further monopoly side of the market spectrum. Of course, it still faced competition, upcomers in social media which it couldn’t buy. Snapchat turned Facebook down twice, the first time only shortly after the Instagram acquisition. Musical.ly turned down Facebook and after its acquisition by ByteDance evolved into a real competitive threat under TikTok. Those are the competitors that Zuckerberg described in his early email, who had social dynamics which Facebook would later mimic (Snapchat Stories, TikTok Videos), kneecapping them, but not fully eliminating them.
In hindsight, his vision was perfectly right: Had he not bought these competitors early on for large sums of money, they would have cost him much more in the future. But one is left to wonder how different the social media landscape could look if those acquisitions would not have happened. Would there be more innovation? Would there be legitimate competition? Would Facebook still exist? Would consumers be better off?
But Facebook is not alone in this strategy. Big Tech companies have been acquiring all kind of emerging companies throughout the entire last decade without much pushback. Recently they have begun facing the heat for their monopoly status. A rare instance of agreement between democrats and republicans, their market structure and conduct are now closely scrutinized. How Zuckerberg and Meta face this challenge is the topic for another issue.