Notes on network economics, vertical integration and innovation
The first meetings today were about network economics and future vertical integration. A simple example would be access providers moving into content to leverage their infrastructure investments (för example cable companies buying baseball teams or basketball teams and rights to their matches).
A few years back the general consensus was that "content is not king" and that telecommunication companies should stay with what they know. Andrew Odlyzko's celebrated paper - with that title - even discouraged (according to informed observers) Swedish telco Telia from at all considering deals with content companies of different kinds. I asked one of the regulatory economic experts we met today if Odlyzko´s thesis is as true today as it was perceived to be back in the early 00's.
His answer was interesting: he said that in a market that is highly or fairly competitive it is reasonable to expect that content will not be king, because in such a market vertical integration may divert energies from your core industries and competencies. But in a concentrated market with low competition, vertical integration in fact becomes a sound strategy to safe-guard against new entrants and optimize gains.
Vertical integration attempts thus can be used as a diagnostic of the level of competition on a certain market. He also pointed out that vertical integration today can be driven by completely different forces, one of them actually consumer benefits.
In the past, when Standard Oil would buy refineries, for example, the vertical integration was in a sense opaque to the consumer. They had no benefits from integration. In considering for example software this no longer seems as obvious: the operating system provider who vertically integrates with word processing or media player functionality does so with a unique knowledge about the operating systems functionality, thus guaranteeing a better consumer benefit. The network effects then makes it easier for consumers to share content if a certain standard or application becomes dominant.
Sure, the natural counter-argument would be that this vertical integration stifles innovation and that it thus imposes a cost on the consumer. Well, that is an empirical question. Is there any evidence that attempts at antitrust litigation have ensured consumer benefits?
Dr Robert Crandall, at Brookings Institute, denies this. He told us that he has published findings that show that there is no empirical evidence whatsoever that antitrust cases won by the government have, in fact, increased consumer benefits. (See "Does Antitrust Policy Improve Consumer Welfare? Assessing the Evidence," with Clifford Winston, Journal of Economic Perspectives (Fall 2003)) This is a truly revolutionary - and controversial - result.
What, then, is the answer? Are we in fact moving into the golden age of the benign monopoly? Is this the end of competition? Surely not, but one possible answer to this question is that competition is truly Schumpeterian: competition about a market rather than in or on a market.
Vertical integration remains one of the trickiest issues for emerging internet business models, and it seems that it is no less tricky for regulators. One interesting take away is that the companies that are the most apt at vertical integration are the winners of the future: what do you integrate, how and what cost?
Is integration the new innovation?