Key Elements and Functions of a New Digital Regulatory Agency

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February 12, 2020, 5:03 pm
Gene Kimmelman, Senior Fellow, Digital Platforms and Democracy Project

This Policy Paper is part of the Digital Platforms & Democracy Project’s efforts to explain and disseminate ideas about regulation of major technology and digital platform companies. Click here to read more of their research and commentary.

This paper is an evolution on the ideas first laid out in Gene Kimmelman’s September 2019 Policy Paper, The Right Way to Regulate Digital Platforms. They can be read in sequence or independently.

The views expressed in Shorenstein Center Policy Papers are those of the author(s) and do not necessarily reflect those of Harvard Kennedy School or of Harvard University.

Policy Papers have not undergone formal review and approval. Such papers are included in this series to elicit feedback and to encourage debate on important issues and challenges in media, politics and public policy. Copyright belongs to the author(s). Papers may be downloaded and shared for personal use under the Shorenstein Center’s Open Access Policy. Please contact the Shorenstein Center with any republication requests.

A report issued by the United Kingdom’s competition authority (CMA)  provides interim findings that both Google and Facebook have a virtual lock on key elements of and inputs to the digital advertising market. As a result the U.K. proposes an extensive set of policy interventions through an anticipated new regulatory body that many expect the U.K. to establish in the near future.

Although the U.K. findings are interim and the U.S. market may have somewhat different attributes, it is almost certainly the case that the U.S. market is likely subject to similar forces that tend to constrain competition. It is time for U.S. policy makers to at least plan for this likelihood and therefore begin working on the development of a similar oversight body to ensure accountability and fair competition in the digital marketplace. What follows is one approach to such an oversight body.

Congress should create a new regulatory authority that is focused on digital markets. The most important institutional change needed to address monopolistic tendencies arising in digital markets is competition-expanding regulation that addresses the problems antitrust cannot solve – even with strong enforcement. A new expert regulator equipped by Congress with the tools to promote entry and expansion in these markets could actually expand competition to benefit consumers, entrepreneurship, and innovation.

The new regulator should also be responsible for consumer protection regulations relating to digital platforms, such as privacy protections for users (except for existing privacy protections established by Congress and overseen by other agencies). These rules may also have pro-competitive benefits. For example, if the incredibly detailed data streams that the large platforms are continuously collecting on their users are significantly curtailed by data protection legislation that limits collection and use of personal data, it may be easier for smaller or new companies which don’t have access to those data streams to compete. But these rules are also crucially important to protect users’ rights and people’s freedom from the type of control that detailed data collection can provide to companies.

One primary goal of the regulator, however, should be promoting competition. This is an important distinction: actively promoting competition, not simply maintaining existing competition, as most antitrust generally does. As a result of the economic constraints described in the Stigler Report on Digital Platforms and Market Structure,1The Stigler Report identified network effects, economies of scope and scale, and bounded rationality behavior by users as key economic factors that lead to a strong incumbency advantage for digital platforms. Available at https://research.chicagobooth.edu/-/media/research/stigler/pdfs/market-structure-report.pdf?la=en&hash=E08C7C9AA7367F2D612DE24F814074BA43CAED8C. digital platforms require an additional jolt from a regulator to promote new competition. There is not enough competition here for us to merely “maintain” it. Here are three key tools with which Congress must equip the regulator to work towards this goal: interoperability, non-discrimination, and merger review.

Interoperability

First, the agency should be authorized to require dominant platforms (defined below) to be interoperable with other services, so competitors can offer their customers access to the dominant network. For example, if Facebook, with its dominant position in social networking and ownership of Instagram and WhatsApp, were required to allow Snapchat users and new alternative platforms to communicate with their Facebook friends easily using these other services, Facebook’s network effect advantages would be reduced and competition could more easily expand. 

In many of the services that we use the most, we’ve come to take interoperability for granted, and often don’t even realize how essential it is. For telephone networks, the 1996 Telecom Act included interoperability requirements, which it referred to as “interconnection,” between competing carriers. The Act built upon Federal Communications Commission (FCC) regulations, setting forth a regulatory regime of duties to connect, and of parity in quality between connections, offered to the incumbent’s own affiliates and competitors. This duty to deal created the possibility of more competition, and allowed for there to be just one national (indeed, global) telephone network, made up of thousands of independent carriers, including multiple competitors in many geographic markets. Allowing interconnection to the dominant network was also a crucial component of the breakup of AT&T. Many early internet services, as well, such as email and the world wide web, were designed in such a way as to permit many different entities to interoperate. Today, online platforms that benefit from network effects and control an important market bottleneck are also appropriate targets for an interoperability rule.

Of course, a rule requiring the transfer of user data depends on strong privacy protections either as part of the rule or guaranteed by another statute such as comprehensive privacy law. However, it’s also important that privacy improvement efforts don’t inadvertently make interoperability harder or impossible, for example by banning any transfer of data from one company to another. The data protection and data empowerment tools that must be joined with interoperability should be the responsibility of the same regulator or carefully coordinated across two agencies. Basic protections like affirmative consent, access, correction, and deletion rights, a private right of action to supplement agency enforcement, and explicit protections for states that want to require stronger privacy rules are all important components of any comprehensive data protection law.2Senator Cantwell’s COPRA legislation is perhaps the best example so far. Available at, https://www.cantwell.senate.gov/imo/media/doc/COPRA%20Bill%20Text.pdf.

Creating open interoperability regimes for the digital economy is a complex task that should be undertaken by an expert regulator, not generalist law enforcers. A regulator is especially useful for a tool like this because it will require technical detail, frequent updates, and speedy dispute resolution to make sure the interoperability requirement actually promotes competition effectively. Antitrust enforcers, focused on competition, are not well positioned to effectuate user intent and protect users’ personal data on an ongoing basis.

There’s also the question of how far interoperability should extend. In the telephone networks example, the essential nature of the network and the Telecom Act’s mandate to promote affordable access to all Americans drove the need for network equipment and infrastructure to work seamlessly. In order to simply promote competition and consumer choice in the diverse digital platform market, that exacting level of interoperability may not be necessary. For example, the old “Find My Friends” feature that Facebook used to offer when a Facebook user joined another social network provides a certain level of interoperability, making it easier for users to link up with friends who are already using the new network. But the users of the new network would still be isolated from friends who did not switch. A further level of interoperability would allow communication from Facebook onto the new network. However, sometimes competing social networks will offer vastly different features, and this diversity is great for competition. A key component of Twitter, for example, is short messages. It may dampen innovation if every new feature must be perfectly mirrored across networks. Some types of data may be particularly sensitive from a privacy perspective, for example, Facebook tracks users’ browsing history across the web. While privacy protections must be in place at the receiving platform for any data that a user chooses to transfer, some data may not provide significant competitive benefits and does not need to be shared. Policymakers should take on this question, and decide, with the help of experts and relevant stakeholders, what level of interoperability should be required. This would include which types of data should be part of an interoperability mandate, and under which conditions.

Non-Discrimination

Competing against an incumbent digital platform is hard. But it can happen in two ways: head-to-head platform entry and/or expansion from one vertical to many. Recently we have experienced very little market entry into areas where one platform has gained enormous market share, like Google in search and Facebook in social networking. Therefore, it is important to assess other ways in which competition may grow.

Online platforms know that companies which use their platform can “disintermediate” them by connecting directly with the consumer, effectively cutting out the platform middleman. Online platforms know that a company which competes with them in one vertical can expand to compete in other verticals, becoming stronger as it takes advantage of synergies from the multiple verticals. This means that for platforms, the companies that use the platform are also potential competitors. As a result of this competitive dynamic, some platforms have the incentive and ability to discriminate in ways that may harm competition. The platform has a variety of mechanisms it can use to disadvantage companies that pose a competitive threat, including its access to transaction data, its prioritization of search results, its allocation of space on the page, etc. In the most extreme versions of this behavior, antitrust can prevent abuse, but it is less useful to prevent many subtle discriminatory practices.

Congress should authorize the new regulator to monitor and ban discrimination by digital platforms with bottleneck power (defined below) in favor of their own services and against their competitors who rely on their platform to reach customers. This is another tool that particularly requires speedy adjudication and an expert regulator. There is a difficult line drawing problem in identifying which aspects of business are features of a platform, and which are products competing on the platform. For example, an app store may be an essential part of a smartphone operating system, so preferencing the operating system’s own app store by having it pre-loaded on the phone may not be appropriately understood as “discrimination.” On the other hand, a grocery store is probably not an part of an e-commerce platform, so preferencing Whole Foods over a competing grocery retailer on the Amazon Marketplace might be a good example of the type of discrimination that would be subject to the rule. The slow pace and complexity of antitrust litigation does not lend itself to fast-paced digital markets where discrimination can quickly make or break a competitive outcome.

Similarly, the agency should be authorized to ban certain “take it or leave it” contract terms that require companies doing business with a dominant digital platform to turn over customer data for the dominant platform to use however it pleases. This effectively bundles the service the companies need with data sharing that could undermine their competitive market position. By prohibiting these practices, we can give potential competitors a fighting chance.

Enforcement Handoffs from Antitrust Agencies

Neither the Department of Justice (DOJ) nor the Federal Trade Commission (FTC) have extensive ongoing oversight personnel who monitor companies or industry sectors on a day to day basis. For this reason and other enforcement goals, antitrust officials are often not comfortable with behavioral and other regulatory tools when fashioning consent decrees. Therefore tools like data portability, interoperability, non-discrimination and transparency— even when recognized as effective ways to open markets to competition — are often treated as sub-optimal or short-term fixes by antitrust officials.

However, if the digital regulatory authority is empowered by Congress to use these regulatory tools when requested by antitrust officials through an enforcement process, we could expand the current toolkit available to remedy competitive harms in highly concentrated markets. It therefore makes sense to create this opportunity to synchronize antitrust and regulatory engagement as part of either merger review, monopolization or other antitrust enforcement activity.

We believe Congress should promote such interagency collaboration. However given the case by case nature of antitrust enforcement, it makes sense to give the agencies flexibility to develop the most effective and efficient way to operationalize this process.

Merger Review

Another major concern with digital platforms is their acquisition of potential competitors. Acquisitions of potential or nascent competitors are often small, even falling below the value threshold for pre-merger notification of the competition authorities under the Hart Scott Rodino (HSR) Act. It is very difficult to effectively assess how likely such companies in adjacent markets are to truly be potential competitors to the acquiring digital platform. The small size or lack of pre-existing direct competition of these types of mergers can make it much harder for antitrust enforcement agencies to block them, even if there are indications the merger may be anticompetitive. Markets move quickly and a competitor’s window of opportunity to gain traction against the incumbent is short, making mergers an even more effective tactic at preventing competition, and making effective merger enforcement even more important.

Thus, the regulator should also have the power to review and block mergers, concurrently with the existing antitrust agencies. For particularly important industries, like communications, energy, and national security, we have an expert agency merger review process in addition to antitrust. Similarly, the most powerful digital platforms occupy a special role in our economy and society and face inadequate competition require merger review under a new and different standard, in addition to traditional antitrust review.

The new regulator would have a different standard than the antitrust agencies. This standard should place a higher burden on dominant platforms to demonstrate overall benefits to society that antitrust enforcers do not have the tools to thoroughly measure. It should only review mergers involving platforms with bottleneck power. It should only allow those mergers that actually expand competition and do not impede market entry by new potential competitors. And, there should be no size limit for mergers to warrant pre-merger review by the agency. Any acquisition by a platform with bottleneck power should be reviewed for its competitive impact. This would prevent increased concentration of power when the company being purchased is too small or the competitive consequences are too uncertain. Mergers that provide no clear competitive benefit would be blocked. The standard also must take account of the particular ways that competition happens in digital platforms. For example, non-horizontal mergers may be particularly harmful here due to the economies of scope in data-driven platforms, as well as the importance of interoperability between complementary products.

Jurisdiction

To which types of companies should these regulations apply? Some of the regulations, such as limits on data collection and use, are not related to levels of competition and therefore must apply broadly to be effective. Some others, like the requirement of non-discrimination, need only apply to especially powerful companies that have the incentive and opportunity to disadvantage competitors. Identifying which companies are powerful enough to be subject to those rules will require some additional work by the agency. Using the definitions of market power from the jurisprudence of antitrust is likely not sufficient. Instead, the regulator would need to make a determination of which companies hold important “bottlenecks” in the marketplace. This might be because they hold the buying power of many customers, so that anyone who wants to sell must be on their platform to reach those customers. Or it might be because they have a monopoly on a key product that is complementary to many others, creating lock-in for a suite of related products as well. The Stigler Report describes “bottleneck power” as a situation where buyers or sellers primarily rely upon a single-service provider, a“single-home,” which makes obtaining access to those buyers or sellers for the relevant activity prohibitively costly without them. It might be more efficient for the regulator to assess companies for their bottleneck status at regular intervals. Or the regulator may prefer to assess them at the point of investigation, but have that assessment remain “sticky” for a period of time. Either way, it will be important for companies to know in advance if they are deemed to be bottlenecks, so that they will know which rules apply to them. This will improve predictability for the companies, and more importantly it will improve compliance with the law, since companies will know they risk an enforcement action by engaging in certain proscribed behavior.

In addition, it is important for this new regulatory authority not to duplicate or interfere with any other agency Congress has already authorized to review mergers or otherwise establish policy goals governing such companies. The purpose of a new agency is simply to fill in gaps and supplement antitrust enforcement, not to displace existing public oversight functions.

Key Features of the Agency

To accomplish the goals described above, Congress must establish a nimble, 21st century entity empowered to develop rules, adjudicate complaints, review mergers and establish general protocols for information gathering, auditing and similar functions necessary to carry out its duties. To avoid regulatory creep, agency capture and similar well-known weaknesses of existing agencies, Congress should limit the Digital Agency’s power and purview precisely. For example, the Agency must only use tools known to expand competitive opportunities (interoperability, data portability, interconnection, prohibit contracts that impede market entry or expansion,  and prevent self-preferencing or similar discrimination through rules or separation of functions) for companies it finds to be dominant or have bottleneck power. Congress could prohibit utility regulation, price regulation and ownership regulation, leaving such deeper interventions to antitrust or future reassessment of market conditions, and still achieve enormous opportunities for digital platform innovation and competition. Congress should also limit the Agency’s role to prevent duplication with the work of other sector specific regulators, including when such other agencies review sectoral mergers. The only merger overlap should be with the antitrust agencies, ensuring full enforcement of antitrust law and augmenting such enforcement with Digital Agency pro-competitive determinations. The only general powers over the digital marketplace should be limited to consumer protections like privacy, with broad authority to promulgate rules, adjudicate complaints, gather data, require transparent presentation of market practices and comply with targeted audits necessary for the Agency to function.

The Agency must, through rulemaking, determine what companies have dominance or bottleneck power over key elements of the digital market. Following traditional Administrative Procedure Act (APA) rulemaking processes, the Agency should determine whether network effects, economies of scale, economies of scope, power over data and similar factors have created excessive barriers to market entry which gives certain companies a dominant position or bottleneck control over a key aspect of the digital market.

Once the Agency makes this finding, it must devise, through rulemaking, a process for adjudicating complaints alleging harms to actual or potential competitors. For companies found to be dominant or have bottleneck power, the Agency is empowered to require data portability, interoperability, prohibit contractual provisions that impede market entry or expansion, create excessive friction and prevent unreasonable discrimination that favors the dominant/bottleneck company’s affiliates through rules or an expedited complaint adjudication process. If such efforts fail to adequately address the harms to competition, the Agency should be empowered to require functional separation to the extent necessary to prevent unreasonable discrimination.

Bottleneck Power

Some rules should apply only to firms with a particular market position, referred to sometimes as “bottleneck” or “gatekeeper” power. The Stigler Report defines bottleneck power this way:

“Bottleneck power” describes a situation where consumers primarily single-home and rely upon a single service provider (a “bottleneck”), which makes obtaining access to those consumers for the relevant activity by other service providers prohibitively costly.3Stigler Competition Report, at 84.

Similarly, the Furman Report defines gatekeeper power:

[O]ne, or in some cases two firms in certain digital markets have a high degree of control and influence over the relationship between buyers and sellers, or over access by advertisers to potential buyers. As these markets are frequently important routes to market, or gateways for other firms, such bottlenecks are then able to act as a gatekeeper between businesses and their prospective customers.4U.K. Competition Report, at 41. Found at https://www.gov.uk/government/publications/unlocking-digital-competition-report-of-the-digital-competition-expert-panel

Firms may benefit from bottleneck or gatekeeper power due to economic forces that impede entry and foreclose large swaths of the market from competition. The two reports note the significant impact that high switching costs can have in these markets. For example, users may lose access to communications or photos they value if they switch. Reputational concerns may play a significant role, such as when highly personal data will be collected without much real assurance of data security. There are often technological barriers to switching. There may be technically-necessary tying between two products. Economists have studied the inertia of default choices, which can also push users towards single-homing. Digital businesses that have this incentive and ability to develop and preserve a single-homing environment should be considered entities with bottleneck or gatekeeper power.

The definition of this power and the determination of which firms are subject to the rules should be determined by the new authority, with guidance from the statute. The definition will likely need to be updated over time by the authority.

Anticompetitive Contract Provisions

Factors that encourage single-homing may be inherent to the technology, as described above, or they may be policy decisions made by the incumbents. For example, choosing not to provide interoperability between the old service and the new service is usually a policy choice on the part of the firm. Competitors may find their own way to provide interoperability without permission, sometimes called “adversarial interoperability,” and incumbents may affirmatively choose to block this when they discover it. Firms may impose a product tie or product bundle by contract where it is not technically necessary. Other contract terms may deter switching. The following two examples illustrate what the Agency needs to devise rules or a complaint process to establish a competitive playing field.

A gatekeeper firm may have a contract with business customers (app developers on an app store, or retailers on an ecommerce platform) that bundles together access to their transaction data along with the regular services they provide. The Stigler Report examines how this type of bundle could have harmful anticompetitive effects.5Stigler Competition Report at 94. If the gatekeeper also competes against those business customers on its own platform, for example, if it sells apps on its own app store, or if it is a retailer on its own e-commerce marketplace, there’s likely an incentive to use the retailers’ data to benefit the platform’s own plans. “That data advantage over rivals can enable a company to achieve and/or maintain critical economies of scale, better predict consumer behavior, and form a powerful barrier to entry for potential competitors.”6Stigler Competition Report at 95. The platform could use that data to learn which products are selling well and enter the market niche of the business customer, either through acquisition or its own new product development. It could use data to learn about the customer’s strategies and how effective they are, either copying them or avoiding them as the data indicates. It could use that data to identify customers and market its competing product directly to them, leaving the costs of identifying potential customers to the independent competitor.

Or a platform company may require installation of a bundle of products on the platform chosen to block the growth of rivals rather than to best serve the user. For example, an operating system company might select a bundle of apps for the user because those are the apps where the operating system company faces real or potential competition. This type of problem could have significant impacts throughout the economy in the context of e-commerce or the Internet of Things. Consumers must be able to change their defaults, make choices, and connect to unaffiliated products and services in a practical way. When a gatekeeper firm is setting up these bundles, an antitrust case may be ineffective in protecting competition due to the complexity of the problem and the slow pace of litigation. This is another reason the specialized Agency is needed. It could promulgate rules prohibiting anticompetitive bundling by digital gatekeepers. It could require unbundling of products and enforce this on an ongoing basis.

Conclusion

Even with the most aggressive antitrust enforcement, there is a clear need for pro-competitive regulations to counteract network effects, economies of scale, data advantages and economies of scope that are tipping many digital markets toward monopoly. By establishing an Agency designed to promote market entry and expansion, Congress could expand competition that will spur innovation and benefit consumers.