Competition Bureau call-out to market participants for information on potentially anti-competitive conduct in the digital economy

Competition issues in the digital economy

The Bureau is examining concerns that certain core digital markets, like online search, social media, display advertising and online marketplaces, have become increasingly concentrated, to the detriment of consumers and businesses.

The Bureau is seeking information from the market to understand whether, and if so why, this is the case. This paper explores two potential, and possibly complementary, explanations:

• Digital markets may ‘tip’ to a dominant firm: characteristics of certain digital markets may favour the emergence of a single winner or a small group of winners; and
• Anti-competitive conduct rather than competition on the merits: leading firms may not have achieved success by outperforming their competitors, but rather by executing anti-competitive strategies that target existing or potential rivals.

The following sections provide an overview of these issues and identify specific points of interest for the Bureau.

Characteristics of digital markets may lead to ‘tipping’

The Bureau’s 2017 discussion paper “Big data and Innovation: Implications for competition policy in Canada” stated that features of certain digital markets may ultimately favour the emergence of a single winner or small group of winners. Recent reports published by international authorities have supported this view.^{Footnote 1}

The tendency for a single firm, or a small group of firms, to take control of certain digital markets is referred to as ‘tipping’. Tipping is most likely to occur where firms benefit from:

1. strong network effects;
2. economies of scale and scope; and
3. access to large volumes of data.

I. Network effects may result in established products beating out new, higher-quality options

Network effects exist when the value or benefit to a particular user of a product or service depends on the number of other users. There are two broad types of network effects:

• Direct network effects occur when the value to a user of a product or service increases as more people use it for a similar purpose. For instance, consider a social media platform. It is more valuable to you if your friends and (maybe) family also use it. A search engine is also likely to be more valuable to you when more people use it. More users means more data, which can be used to improve the quality of search results.
• Indirect network effects may be present when a product or service brings together two or more distinct types of users – think, for instance, of an online marketplace that allows buyers to interact with third-party sellers. Indirect network effects occur when the value of a product or service to one user group increases with the number of users in another user group. In some cases, indirect network effects may be strong for users on one side of the market, but weak for users on the other side of the market. This is likely true of social media platforms and search engines: while advertisers benefit more when there are many users, users may not experience much, if any, additional benefit as the number of advertisers increases. In other cases, like with ride-hailing apps (riders and drivers), online marketplaces (buyers and sellers) and app stores (app purchasers and app developers), indirect network effects are likely strong for both types of users.

Where network effects are strong, markets may tend towards concentration, as both current and prospective users are likely to experience greater value with the more widely used product or service, perhaps even if it is inferior in quality. This presents a unique challenge for new entrants, known as the ‘chicken-and-egg’ problem: in order to attract users to a product or service it must be perceived as valuable, yet a product or service will not be perceived as valuable unless it has many users.

II. Economies of scale and scope favour the biggest firms

Firms that wish to compete in certain digital markets must often incur significant upfront costs in order to develop a high-quality product or service. After making these investments, however, firms are generally able to offer their product or service to the masses without having to incur any significant additional costs. These two characteristics define economies of scale: the average cost of supplying a product or service decreases sharply as the number of users grows.

While economies of scale tend to benefit customers through lower prices, they can also deter firms from attempting to compete in a market. As explained in the University of Chicago Booth School of Business’ report:

“[I] ncreasing returns to scale create barriers to entry: New firms cannot offer the quality of the incumbent without the same large-scale operation to pay for the fixed costs. But the firm can only achieve a large scale if quality is high. Thus, a potential entrant, foreseeing that it will not be profitable at the smaller scale, will not enter the market to challenge the incumbent”.^{Footnote 2}

Larger firms can also benefit from economies of scope. A firm that already provides a variety of products or services can be more efficient at entering another product or service market than new entrants. For example, it may be less costly for a firm that controls a leading search engine to capture other markets because it can take advantage of its existing resources. This may include using data it has already accumulated, leveraging its existing user base, or redeploying technologies to help ease expansion.

III. Access to large volumes of data can help keep competitors at bay

In many digital markets, data is a key input needed to develop high quality products and services. We expect search engines, for instance, to produce better results when they receive a high volume of search queries on a wide variety of topics. This potential benefit of data, known as a user feedback loop, is one of two ways that a data-rich incumbent can use its bounty to beat rivals. User feedback loops occur when firms are able to use data collected from their users to improve the quality of their product or service, in turn attracting more users.

Incumbent firms can also separate themselves from rivals by using their data to improve the quality of targeted advertising on their platform. As incumbent firms take advantage of their data to improve the quality of targeted advertising on their platform, advertisers will be willing to pay more for advertisements. This provides incumbents with additional money to reinvest in improving the quality of its product or service. Known as a monetization feedback loop, this is another way for incumbent firms to attract more users by taking advantage of data.

As incumbents take advantage of user and monetization feedback loops, it becomes harder for rival firms with less, or no, data to keep up. This is nicely explained by the Law Society of Scotland in its submission to the UK’s Digital Competition Expert Panel:

“[A]s data is power, those already large, often global, businesses which are able to utilise existing data effectively, have advantages in terms of maintaining their existing position and further increasing their market share. This will inevitably pose a barrier to new entrants (without any such data) or even smaller competitors”.^{Footnote 3}

Collectively, these market characteristics may lead to less competition

While each of the three factors identified above may individually ‘nudge’ a market towards a single winner or a small group of winners, it is their collective presence that is most likely to push a market towards concentration. Not only that, but once a market has tipped, these same factors increase the odds the market will stay that way by making it more costly for new, upstart firms to capture part – or all – of the market.

Given that these factors are often present in digital markets – making these markets prone to tipping and harder to contest – it becomes all the more important for the Bureau to be able to identify and take action against any anti-competitive strategies that may be adopted by incumbent firms to shield themselves from competition. If not addressed in a timely fashion, such strategies – which effectively prevent competition on the merits – are likely to make it that much more difficult for new firms to successfully compete in the market, as discussed below.

Anti-competitive strategies may be effective – and particularly profitable – in digital markets

Since certain digital markets tend towards a ‘winner takes all’ outcome, firms in these markets have a strong incentive to adopt strategies that increase the likelihood the market tips in their favour, and stays that way.

In this race to the finish line, firms are likely to focus their efforts on trying to ‘outcompete’ their rivals by developing better products and services, to the benefit of their users. Some firms, however, may conclude that competing on the merits will be too costly, or insufficient on its own, to claim – and keep – the market. For these firms, anti-competitive strategies that target existing or potential rivals may appear particularly attractive.

In the digital world, the Bureau anticipates that anti-competitive strategies will likely aim to achieve one or both of the following objectives:

• Protecting a ‘core’ market: certain anti-competitive strategies may attempt to prevent rivals from capturing a firm’s core market. This would include, for instance, efforts to prevent or impede the emergence of a rival search engine, online marketplace or social media platform.
• Capturing adjacent markets: firms may also adopt anti-competitive strategies in order to capture markets related to a core market under their control. This would include, for instance, efforts by a firm that controls a leading search engine to systematically push its search users towards its own navigation or restaurant review products, rather than those offered by rivals.

Some of the potential strategies firms may adopt to achieve these objectives include:

• Refusal to deal: this occurs when a firm that controls an important input or channel refuses to provide access to actual or potential competitors. Possible examples include:
  1. a social media platform providing a subset of its data to firms so that they can offer complementary products on the platform, but cutting off access once it starts offering its own similar products; or
  2. a dominant online marketplace removing popular products and services from the platform in favour of selling its own offerings.
• Self-preferencing: this occurs when a firm that controls a platform props up its own products and services over those of its rivals. Possible examples include:
  1. an online marketplace manipulating its rankings so that its own products and services appear above those offered by rivals; or
  2. as described above, biasing search results to favour products and services owned by the online search company.
• Margin squeezing: this occurs when a firm that controls an important input or channel is only willing to provide it to actual or potential rivals at a price that makes it difficult, if not impossible, for them to compete in an adjacent market. This could occur, for instance, where a firm that controls an app store, but that also develops apps itself, charges customers $5 for its own apps while charging rival app producers a commission of $5 each time they sell an app.
• Most favoured nation requirements: this occurs when a firm explicitly or implicitly prohibits its suppliers from providing rivals with better prices or other trade terms. This could occur, for instance, where a hotel-booking website prohibits hotels from offering better rates to rival hotel-booking websites.
• Creeping acquisitions: this occurs when a firm buys out actual or potential rivals, resulting in less head-to-head rivalry in the market. Unlike the other strategies described above, which tend to harm rivals, this strategy may, in some circumstances, actually benefit both the incumbent and its rivals, through reduced competition and large payouts, respectively.

The Bureau recognizes that, in many cases, the types of conduct identified above will not raise competition concerns and may, in fact, promote competition in the short and/or long run. For instance, such conduct may result in lower prices or ensure that firms’ incentives to innovate remain strong. As such, when reviewing these types of conduct, the Bureau’s focus will be on the unique facts of each case, with a view to determining whether the conduct is more likely to harm or enhance competition in the short and/or long run.

In making this determination, the Bureau is likely to place significant weight on three key factors:

1. whether the firm engaging in the conduct appears to have durable market power, in the sense that it has, and is likely to maintain, significant control over a market;
2. whether there is compelling evidence that the firm was actually engaging in the conduct for a pro-competitive or efficiency enhancing purpose, and whether these benefits were realized; and
3. whether prohibiting the conduct at issue is likely to dampen incentives for firms to invest in innovation.

Sharing information with the Competition Bureau

The Bureau encourages all market participants in the digital economy to share their experiences and perspectives on the issues raised in this paper.

Information provided to the Bureau may be used for the following purposes:

• to support the commencement or further development of an investigation into alleged anti-competitive conduct;
• to inform how the Bureau analyzes anti-competitive strategies in the digital economy; and
• to inform potential guidance to market participants on competition law enforcement issues relevant to digital markets (for instance, in a form similar to the Bureau’s various enforcement guidelines).

There are three main ways for sharing information with the Bureau:

1. Interested parties are invited to provide written submissions by November 30, 2019, through the online form on the Bureau’s website, or by sending an email to CBDigitalEconomy-BCEconomieNumerique@cb-bc.gc.ca. The Bureau will treat all submissions as confidential. Parties are encouraged to focus their submissions on the following topics:
   • Potential explanations for why certain digital markets have become (and appear to remain) highly concentrated, which will help the Bureau in its efforts to distinguish anti-competitive conduct from conduct that may be pro-competitive or competitively neutral.
   • Identification of past or ongoing conduct in the digital economy that may raise competition concerns, including but not limited to the types of conduct identified in this paper.
   • A description of how this conduct has impacted, or is likely to impact, the ability of rivals to effectively challenge the incumbent firm(s).
2. The Bureau expects to schedule meetings with market participants in the fall in a number of Canada’s innovation hubs. Parties interested in such meetings are encouraged to contact the Bureau. During these meetings, the Bureau will explain its role as the enforcer of Canada’s competition laws, and provide market participants with an opportunity to identify conduct of concern in the digital economy.
3. Interested parties can also contact the Bureau at any time by submitting a complaint or a request for information on the Bureau’s website.