Question:
When speaking of a dominant market position in economics, people usually only think about the abuse of a dominant market position. I decided to look for some answers to see if a dominant market position is acceptable, but I couldn't find anything. My question is: Can you give an example of when a dominant market position is acceptable?Answer:
My short answer from ten years ago: When consumers are made better off in the short and long run.
My short answer today: That’s a toughie.
My long answer: You have actually hit on a question that is today a giant debate in the economic field of industrial organization. It is also a giant debate in the field of antitrust law. At the end of this answer, I will link you to a 2018 Yale Law Journal special issue titled “Unlocking Antitrust Enforcement” that has contributed papers from both lawyers and economists about the history of the law and economics surrounding the issue of what we in industrial organization simply refer to as “bigness.”
Don’t look for “bigness” in scholarly journals, it’s really something we use among ourselves (at a recent conference I attended, “bigness” became a stand-in for any discussion of not well-defined dominance).
We are certain about particular industry structures. Monopoly (a single firm in an industry), duopoly (two firms), oligopoly (a handful of large firms) and even a “dominant firm facing a competitive fringe” are well defined and have very well-understood and theoretically measurable economic harm from market power (those “deadweight triangles” you might recall from an econ class). Once you start talking about dominance in reference to simply “bigness” where one or two firms are very large or very present across several markets but there still may be an assortment of other small firms around, or where one or two firms are very large in various segments of the marketing chain, those theoretical harms get a little murkier. It becomes murkier still when one or two firms are very large and have a lot of reach into many industries though perhaps only dominate a single market where prices remain low.
Economists have traditionally worried about market power: the ability of a seller to price above its marginal cost of production and marketing (or in the case of a buyer, the ability of a firm to set a price below its marginal cost of acquiring a product). An unregulated, profit-maximizing monopoly in a single market has the most market power and causes the biggest negative impact on consumers. Perfectly competitive firms where there is no dominance, cause the biggest positive impact on consumers. When considering the impact of dominance, for a long time economists made the argument that you should try to find ways of comparing prices that might exist in these two extremes (explaining how we do that would take another entry, but we do try). If you find that there isn’t (much) market power from a dominant firm, then there really isn’t (much) consumer harm regardless how big that firm is. Many (not all) economists argued in that case that the size of the firm didn’t matter. Further, in numerous court cases because of economies of scale (where costs drop as a firm gets larger) consumers can be made better off by larger firms. A lot of lawyers (especially a Reagan-era legal scholar and judge named Robert Bork) thought this argument made sense and over the years it began to carry a lot of weight in antitrust cases.
What I have just described generally is probably the broadly accepted view that answers your question, but things are starting to cause us to re-think these ideas.
Microsoft was nearly broken up in the early 2000s because it was deemed a monopoly for tying its web browser to its operating system and making other browsers incompatible. Microsoft agreed to a consent decree that kept it from being broken up. That case makes the textbooks but it turns out that in easily hundreds of court cases, judges have made the determination that dominance is acceptable and the Microsoft case is recalled today probably more for its being the exception rather than the rule. My guess is the classic example of a dominant firm can be seen no farther than your own city limits. How many electric power or cable providers do you have? In many places there is only one of each. The efficiency of having just one company that operates at scale makes consumers better off and in that case economists refer to that type of dominance as a “natural monopoly” but always call for regulation to make sure the company really is transferring the efficiency on to the customers. (If you are complaining about your monopoly cable provider, you are not alone: just because there should be efficiency sometimes doesn’t make it out of the textbooks.)
In the 1980s, more and more legal scholars and more and more courts made decisions about mergers and acquisitions based upon efficiency arguments. The rule courts followed when approving mergers had two main provisions (and, again see the readings at the end of this for more details): When approving a merger that would create a dominant firm or when approving a dominant firm moving into a new market, the dominant firm could not charge consumers lower prices in order to run other firms out of business, and then raise prices afterward. If the dominant firm’s prices stayed low after other firms left the market, then that was just the normal churn of a competitive market and courts felt they should not be in the business of keeping inefficient firms around since consumers would be better off with lower prices. When Wal-Mart began filling prescriptions, they might have been responsible for a pharmacy closing, but the lower drug prices that existed afterward because of Wal-Mart’s scale and bargaining power were deemed beneficial to consumers. If you were the pharmacist that went out of business, however, this was little consolation. The courts ruled a firm’s dominance was beneficial in cases like these (usually).
Today, with the horizontal and vertical relationships among firms along supply chains that are impacted in online ventures, some economists and lawyers are calling into question efficiency arguments about bigness. Online dominance can be in the eye of the beholder when you cannot clearly see where the dominance manifests itself. Economists are used to looking at prices and products, but what if the dominance is a platform or a cloud or artificial intelligence or advertising on one platform things you are selling on another or a digital marketplace that another business needs access to in order to compete? What if dominance is having so much personal data about customers in a movie streaming market that a subsidiary has a better idea of those customers’ desires in a food market? Can a sprawling, dominant company make larger political contributions across more areas of Congressional oversight? Suppose a dominant firm’s platform is a necessary condition for political messaging simply because more people use its platform than any other. Does that make the firm more like a utility that should be regulated like we regulate airwaves, or electricity, or water (or sewage)? Many legal scholars today argue that the Sherman Antitrust Act of 1890 was never supposed to be about efficiency and market power, which is how it is used today. They argue that economists and lawyers in the 1980s corrupted its purpose. The Sherman Act, they argue, was always about “bigness” and reach and power, and was actually intended to answer not too dissimilar questions way back in the Gilded Age when oil companies owned other oil companies, owned the gasoline refineries, owned the filling stations, and the restaurants across the street, and were beginning to get interested in manufacturing vehicles and investing in newspapers.
Why isn’t the problem of dominance obvious?
To take a well-known example of a dominant firm in multiple industries, you would have to have been asleep for the last decade to not know that Amazon is a dominant player in, well, pretty much everything, such as online shopping, trucking, delivery, grocery retailing, music, video streaming, film production, book publishing and cloud services. Amazon is also making inroads into things you might not know about like lending and manufacturing. All the while, Amazon is spending a lot of money on research and development into everything from logistics to face and voice recognition to drones to artificial intelligence--things that are basic research that Amazon hopes will allow it to be ready for “the next big thing,” whatever that is. And when Amazon finds somebody doing something better than they do, they often buy them. Or more important, their patents. Amazon is not a monopoly in any of the markets it serves and while a few of those markets might be seen as consisting only of large dominant firms, if you look more closely you do find smaller businesses trying to compete and the prices are all similar. Amazon has dominance, but does its dominance, its “bigness,” mean it has market power? When trying to describe Amazon’s dominance, sometimes I just say “it’s big,” which is nebulous but somewhat descriptive. The question I’d like to answer is, “Does Amazon’s dominance in so many things cause any harm?”
Well, based on the typical things economists have used to measure harm, it’s hard to see. A funny thing that most people don’t know about Amazon: its dominance may be big, but its profits are not.
Yes, its market capitalization (the price of its stock multiplied by the number of shares outstanding) is astonishing (currently about $1.6 trillion) making its primary shareholder, Jeff Bezos, incredibly wealthy. But, Amazon’s net income (profit) never cracked $1 billion until 2016 and for many years prior to that was actually negative (it was negative in 2015, in fact)! Currently, Amazon’s net income is about $25 billion or about as much as Bank of America’s, or about half of Alphabet’s (Google’s) net income. Until 2019, Home Depot had higher annual profits than Amazon based on some simple searches I did of these companies on Yahoo Finance. So, clearly we all think of Amazon as dominant, but its profits so far don’t seem to show a big current benefit to that dominance. If you pay for Amazon Prime, you have enjoyed savings on deliveries and Amazon has been selling you Prime at a loss for all of Prime’s existence. Customers do not seem to be complaining. If Amazon were being faced with calls for its breakup, it might respond, “How can we be dominant in so many industries and yet make a total profit about the same as a single player in the banking industry or a single player in the home improvement industry?”
However, that market capitalization is telling. Are investors thinking Amazon could be a lot more profitable than it is? Amazon’s share price may be indicative of potential market power, but the potential for market power is not the same thing as actually exerting market power.
Is Amazon a dominant firm in many markets? Looks like it. Does it have a loyal customer base? Looks like it. Are other firms being harmed? There’s the rub, and if they go out of business, will Amazon raise its prices? So far, it hasn’t appeared to have done that even when it has bought out its competitors.
But the bigger question that you (and economists and lawyers) are grappling with today is are we measuring dominance in the right way, and that is what makes your question so hard to answer.
Learn More about Modern Theories of Dominance:
Yale Law Journal Special Issue on Antitrust Enforcement from 2018: https://www.yalelawjournal.org/collection/unlocking-antitrust-enforcement
