Harnessing Platform Envelopment in the Digital World' by Daniele Condorelli and Jorge Padilla in (2020) 16(2)
Journal of Competition Law and Economics 143–187 comments
We revisit the economics of “platform envelopment strategies,” whereby a dominant platform (the enveloper) operating in a multi-sided market (the origin market) enters a second multi-sided market (the target market) by leveraging the data obtained from its shared user relationships. In particular, we analyze the logic and effects of “privacy policy tying,” a strategy whereby the enveloper requests consumers to grant their consent to combining their data in both origin and target markets. This may allow the enveloper to fund the services offered to all sides of the target market by monetizing data in the origin market, monopolize the target market, and entrench its dominant position in the origin market. We conclude by considering a range of possible policy interventions that may serve to limit such potential anticompetitive effects, while preserving the efficiencies generated by conglomerate platforms.
The authors state
In their seminal paper, Eisenmann et al. (2011) explained that entry in platform markets subject to network effects and high switching costs can occur in two ways: first, by offering drastically new functionality (that is, through Schumpeterian innovation) and second, through “platform envelopment.”
They noted that
Through envelopment, a provider in one platform market [the origin market] can enter another
platform market [the target market] and combine its own functionality with that of the target in
a multi-platform bundle that leverages shared user relationships. Envelopers capture market share
by foreclosing an incumbent’s access to users; in doing so, they harness the network effects that previously had protected the incumbent.
Platform envelopment thus involves the combination or bundling of the
entrant’s functionality in the origin market with that of its new platform in
the target market. The goal is to leverage shared user relationships and/or
common components. For example, Google entered into mobile operating
systems by bundling Android with Google Search, two separate platforms,
in order to, among other possible goals, leverage the data generated by users
of both platforms. Such data were effectively monetized through Google’s
online advertising platforms. This strategy allowed Google to fund its entry
in a way that could not be replicated by other competitors and contributed to its eventual dominance of the mobile operating system market.
Importantly, platform envelopment strategies are viable not only when
bundling platforms that are complements but also when they are weak substitutes or are functionally unrelated. Google entered online display advertising
by bundling DoubleClick’s online display platform and its own online search
platform, which were regarded as complements by many advertisers and weak substitutes by others. It entered into the mobile operating system market by combining two functionally unrelated platforms. And it may, like Facebook or Alibaba, successfully penetrate retail banking by combining a payment system platform with its online advertising businesses (De la Mano and Padilla, 2018).
Eisenmann et al. demonstrated that “an entrant that bundles a complementary platform is most likely to succeed when the platforms’ users overlap significantly [ . . . ] an entrant that bundles a weak substitute platform is most likely to succeed when bundling offers significant economies of scope; [ . . . ] an entrant that bundles a functionally unrelated platform is most likely to succeed when the platforms’ users overlap significantly and when economies of scope are high.”
Focusing attention on the bundling of functionally unrelated platforms, Eisenmann et al. explain that in this case the multi-platform entrant may benefit when (a) component overlap is meaningful and cost economies of scope are significant, or (b) user overlap is large and there are significant demand economies of scope (and thus users prefer to concentrate their purchases on
a single supplier), or (c) user overlap is large and the entrant can exploit
negative correlations in valuations across platforms to price discriminate more effectively.
In this article, we consider alternative conditions under which bundling unrelated platforms are likely to be profitable. In addition to the scenarios (a)–(c) identified by Eisenmann et al. and listed above, we find that enveloping of unrelated platforms can be profitable even in the absence of “direct” economies of scope in demand and/or supply and when there is no component overlap. We show that this may occur when a firm operating in multiple platform markets with a common user side engages in “privacy policy tying,” that is, when the (conglomerate) firm’s privacy policies in each of those platform markets request users to grant consent so that it can combine the data they generate when using its multiple platforms to improve its offerings in one or more of them.
In particular, we show how a platform monopolizing a multi-sided market
where user data are monetized (the origin market) can profitably envelop
another platform market with overlapping users (the target market) by tying
its privacy policies in both platform markets to (i) combine the data generated
by the common users in both markets without infringing the privacy laws and
(ii) monetize such rich and difficult-to-replicate data in its dominant origin which can be profitably exploited by the dominant enveloping platform in the origin market. The combination of data across multiple platforms allows the enveloper to fund the services offered to all sides of the target market by monetizing that data in the origin market. As a result of this and its position of dominance in a key primary market, it may be able to monopolize the target market and entrench its dominant position in the origin market.
The enveloping platform’s advantage does not lie in any “deep pockets,” because both the enveloper and its rivals may have the same profitability. Rather it flows from the enveloper’s first-mover advantage granted by itsestablished monopoly on a key origin market. In fact, in challenging a young rival in a data-ripe market, the dominant enjoys a commitment to compete toughly to monopolize the target market. This is so because leaving the data in the hands of the rival may in turn trigger its entry in the origin and more profitable market. Crucial to our argument is the competitive advantage resulting from the combination of data from unrelated markets; a combination that is facilitated by a strategy of tying privacy policies.
Platform envelopment strategies may explain why “competition in the digital sector today is heavily shaped by competition between large digital competitors (Bourreau and Streel, 2019, p. 4).” Such strategies can distort competition and cause consumer harm. In particular, we discuss how this strategy can be used to protect the origin market from potential entry by more efficient competitors that operate (or may operate) in the target market. We illustrate the use of this enveloping strategy by reference to an actual case study.
Finally, we discuss possible remedies, including ex post antitrust intervention, ex ante business-line regulation, limitations on the ability to combine user data from multiple platforms, data sharing, and so forth, seeking to constrain the potential competitive and consumer harm created by platform envelopment while allowing these strategies when they are likely to be welfare increasing.
We discuss two regulatory solutions in greater detail. The first alternative is to mandate data sharing conditional on customer consent so that dominant platforms provide consistent application program interface in an interoperable form on terms parallel to FRAND licensing. Platforms with market power in well-defined origin markets would be mandated to grant access to other platforms to access a subset of their data, including personal data, if the individual or business in question decides so. Because data are “non-rivalrous” and, therefore, can be shared without losing them, data sharing is likely to have a small disincentive effect on the incentives to collect data. Meanwhile, the benefits of mandated access or data sharing are bound to be large since those data can be used to foster competition in many related and unrelated platforms at once. It follows that, unlike it may be the case with physical assets, patents, and other intellectual property rights, the trade-off between the short-term and long-term effects on competition and innovation points in favor of mandatory sharing.
The second option is to enhance the privacy protection offered by dominant, conglomerate platforms by limiting their ability to combine user data across their platforms regardless of user consent. Of course, a potential drawback of this policy is that it may limit efficiency by preventing the creation of large and rich databases that could be mined in the interest of consumers and business users. We thus consider less stringent alternatives, which however may fell short of the objective of limiting the data superiority of dominant multi-platform conglomerates.
The remainder of the article is organized as follows. In Section II, we provide a brief overview of the economics of platforms. This is a well-known topic; yet we believe it is important to ensure that the reader understands the basic principles and terminology used in subsequent sections. In Section III, we discuss the logic of platform envelopment. In Section IV, we particularize this discussion to consider platform envelopment strategies based on the combination of data from origin and target markets. We illustrate how such a strategy may work when the monetization platform (that is, the platform where the data are monetized) is an online advertising platform in Section V. In Section VI, we summarize the potential procompetitive and anticompetitive effects of such strategies, and in Section VII, we explore alternative ways to limit their possible detrimental effects on the integrity of the competitive process and consumer welfare. Section VIII concludes.
