Quick Thoughts: Breaking Up GAFA

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June 8, 2020

Quick Thoughts: Breaking Up GAFA

  • The market’s most valuable companies are in the crosshairs, as voices from many directions are advocating for heavier regulation or even the break-up of GOOGL, AMZN, FB and (sometimes) AAPL.
  • Antitrust challenges, which in the US require proof of consumer harm, are likely to be very narrow with redress almost certainly far short of meaningful divestiture. Rather, remedies would more likely be financial penalties and negotiated changes to specific business practices deemed anticompetitive.
  • New legislation could raise the threat level, but the disparate political motives around regulating big tech, the likely negative byproducts of government intervention, and the popularity of the services that they provide could make it difficult to draft consequential bills with sufficient appeal to pass.
  • Moves to limit Section 230, which protects public forums (such as social media platforms) from litigation over content posted by 3rd parties, could have a chilling effect on free expression. Comments sections would become largely untenable and services that depend on user generated content, such as Twitter or YouTube, could face prohibitive costs.
  • Calls to “break up big tech” are largely performative rhetoric. We have seen no realistic proposals where divestitures could remedy alleged antitrust behavior without destroying the utility of popular franchise services. Ruining Google Search or the Amazon Marketplace on antitrust grounds would not be well received by the electorate.
  • Tech is a fast-moving target. In the many months that it might take to enact legislation, resolve legal challenges, and enforce the law, the nature of competition for these businesses may have fundamentally changed. The biggest long-term threats remain technological rather than legal.

Amidst the pandemic and civil unrest, new calls by disparate parties to stem the influence of the biggest tech companies – specifically, Google, Facebook, Amazon and, less frequently, Apple – are rising in frequency. The DoJ, joined by several state Attorneys General, has launched an antitrust investigation into the ways that Alphabet leverages its dominance in Search to squelch competition in other businesses. A class action lawsuit brought by applications developers asserting that Apple’s iron-fisted control over its App Store amounts to anticompetitive behavior remains unresolved amidst rumors that the DoJ would take up the banner. While she was still a candidate, Senator Elizabeth Warren explicitly called for breaking up the biggest tech firms, echoing sentiments from President Trump’s DoJ (Quick Thoughts: Breaking Up the Tech Giants? Don’t Bet On It!) with an even more expansive objective of forcing firms to unwind previous M&A and effectively banning future acquisitions. Before the pandemic, the House Judiciary Committee hosted panels of smaller companies (e.g. Sonos, Tile and others) with axes to grind against the powerful tech platforms.

Facebook (and Twitter and Google’s YouTube and Snap …) caught the ire of President Trump who joined with a sizeable contingent from the political left in calling for social networks to be held responsible for the content of everything posted to their sites, reversing doctrine established in Section 230 of 1996’s Communications Decency Act and opening them to lawsuits over the veracity of any post. AI filters are nowhere capable of playing this role and Facebook has already incurred substantial new expenses from hiring moderators to flag questionable content.

The EU – fueled by protective industrial policy, a muscular stance on data privacy, and antitrust law that protects businesses from larger competitors – has been aggressive in its approach to big tech. Alphabet has already been assessed 9.5B Euros in fines and forced to make changes to its shopping service and open Android to alternative default apps. It is appealing those rulings in European courts. Facebook is now under scrutiny for its adherence to the EU’s strict GDPR data privacy regulations and has been mandated by a German court to strictly separate data use across Facebook, Instagram, and WhatsApp. It is also appealing. Regulators in Germany, Italy, and Austria are investigating Amazon’s e-commerce business on complaints that it abuses its power over smaller merchants. The EU competition commission has said that its own investigation of Amazon is “in an advanced stage”. The EU is also investigating Apple in response to a complaint by Spotify alleging that the App Store and its 30% fee structure is an abuse of market power.

While the calls to “break up” big tech have gotten louder, we do not think that business divestitures as a remedy are any more likely. The EU might want to breakup big tech, but it lacks agency and has, thus far, avoided the transatlantic trade confrontation that would be an inevitable result of trying to unilaterally force American companies to split into parts. For US authorities – primarily the DoJ and FTC – breaking up any of these companies is easier to say than do for several reasons (Exhibit 1).

Exh 1: Challenges in breaking up Big tech vs. other corporations in the US

First, US antitrust law is different than EU antitrust law. The US agencies would need to prove consumer harm in court, not just diminished competition. Since Google and Facebook services are mostly free and Amazon is widely acknowledged to foster attractive prices, same-day/next-day delivery convenience, and matchless product selection, it’s not clear how end users are suffering. Congress could pass new laws to broaden the criteria for antitrust and make it easier to prosecute companies, but it is not at all clear that there is sufficient support to enact such legislation – even if the Democrats sweep in November. Any negative consequences to the usefulness of these flagship services could have real political implications for an administration that drove divestiture.

Second, the fault lines for splitting the tech leaders into parts are not as obvious as they were for Standard Oil or AT&T – vertical integration is not really the problem and geographic breakups would be nonsensical. Moreover, Google Search, Amazon’s Marketplace, and the eponymous Facebook app generate utility BECAUSE they are big and ubiquitous. Breaking them up would destroy things that consumers value. While it would be possible to split off businesses that are not tightly integrated to the core franchises, it is not clear how that would resolve market power. Without YouTube, Google Search would still be dominant, as would Amazon’s Marketplace without AWS. Perhaps Instagram and WhatsApp could be cleaved from Facebook, but the core franchise would still have more than 2 billion global users.

Third, the competition that these companies face come from each other. Breaking up Google Search would not enable a bounty of Search startups to thrive, rather Amazon and Microsoft would almost certainly step into the breach. Similarly, atomizing the Amazon Marketplace would be a windfall for Google and Facebook’s shopping ambitions. Apple would add to its own dominance if Android were diminished by a messy forced split from Alphabet, and Alphabet would be similarly boosted by a fragmentation of the monolithic iOS ecosystem. It would seem that an effective dissolution of market power would require the simultaneous disintegration of all of the top tech players.

Finally, tech moves fast, and courts move slowly. By the time the government acts, its concerns might be moot as aggressive competition changes the nature of the market. An example: The FTC began its inquiry into Microsoft’s business practices around its Windows OS in 1992. Eventually, a suit was filed in 1998 alleging anti-competitive bundling of the Internet Explorer with Windows, resulting in Judge Thomas Penfield Jackson’s 2000 ruling requiring a breakup of the company. This was immediately appealed, and in 2001, the DC Circuit Court of Appeals overturned Judge Jackson’s verdict, causing the DoJ to withdraw its move to split up Microsoft and begin negotiating a less drastic remedy. On November 1, 2002, Judge Kollar-Kotelly approved a preliminary consent decree, but 9 states demurred, asserting that the sanctions in the agreement were inadequate to curb Microsoft’s anti-competitive behavior (Exhibit 2). On June 30, 2004, 12 years after the initial inquiry, the US Appeals Court unanimously approved the DoJ settlement, ending the case. While Microsoft did separate its browser from the OS and provide PC makers more flexibility in installing alternatives to Microsoft default applications, the case did little to quell the dominance of Windows for personal computers. Of course, two years later, the introduction of the iPhone radically changed the nature of competition, setting Microsoft on its heels for nearly a decade. ‘Twas Apple that killed the Beast, not the DoJ.

Presuming that forced divestitures are off the table, the US government has other means to thwart the ambitions of big tech. Section 230 of the Communications Decency Act of 1996 has drawn new scrutiny as

Exh 2: Brief timeline of the US vs. MSFT anti-trust case

President Trump leads Republican criticism of a perceived liberal bias in social media and as progressives fret about foreign disinformation campaigns as a threat to elections. Section 230 protects social media platforms from direct responsibility for content posted by users. Neutering the statue would force Facebook, Google, Twitter, Reddit, and every other site that allows user comments to police every post for objectionable content. AI filters, already in place, won’t cut it, so platforms would be forced to rely on human review for all posts adding major costs and posting delays for these services.

Exh 3: SSR TMT Summary of Regulatory Risk faced by Big Tech

While both sides have chosen Facebook, Google, and Twitter as bugbears, expecting cooperation across the aisles in this environment seems farfetched. Certainly, agreement over what sort of content ought to be blocked would be highly contentious, with considerable 1st amendment implications. Without Section 230 most sites would likely eliminate user comments sections entirely and platforms that explicitly rely on user generated content would be forced to radically change their services and take on huge costs, possibly forcing smaller companies out of the market entirely. We suspect that the fervor for this sort of regulation will be tempered as the implications become better understood.

In the end, we don’t think that investors should change their valuation of big tech based on the perceived threat of government intervention. Of the existing challenges, we believe the threat to Apple’s App Store hegemony may be the most pressing – services growth could slow considerably if its 30% revenue share terms are softened or if it is forced to provide equal access to competitive alternatives to its own core apps – but we see the likelihood of a negative outcome as low. The EU could also issue billions of Euros in fines to Amazon, Facebook, and Apple, or double up on its punishment of Alphabet, while requiring incremental

changes to business practices (Exhibit 3). Given history, it would seem that these actions would be little more than a speed bump. Finally, we believe that the DoJ and FTC investigations of “GAFA” are unlikely to result in substantive charges to threaten the firms business trajectories and that any such charges will take many years to come to resolution, during which time it is probable that they would be rendered moot.

And now back to our normal pandemic-related programming …

 

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