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Matthew Gordon, CFA
Hardly a day goes by without some news outlet publishing a story that highlights the concentration of market power in the hands of a few large technology companies. As investors living and working in the Bay Area, we are particularly attuned to these stories, since we all know friends, family, and clients working at these companies. We experience the innovation produced by the Bay Area ecosystem every day, as we cruise past Waymo self-driving cars, hail an Uber or Lyft with a tap on the phone, and marvel at the explosion of new companies and high-paying software engineering jobs. But other regions and competing companies have not been so blessed by the growth of these large technology platforms.
For many, the standard story goes something like this: massive technology companies like Google, Amazon, and Facebook are abusing their positions to harvest consumer data and stifle competition, which limits innovation and customer choice. As result, privacy activists and competitors are loudly calling for policy makers and regulators to step in.
Lawmakers and regulators have heard these calls. Last year, the Federal Trade Commission (FTC) fined Facebook $5 billion over consumer privacy violations. Currently, the Department of Justice (DOJ) and FTC are conducting anti-trust investigations into Amazon, Apple, Facebook, and Google. The specifics of each investigation have not been confirmed, but regardless of their merits, there is clearly political pressure on both sides of the aisle for these investigations to produce action.
So why do we still own stocks like Facebook and Alphabet, Google’s parent company, for our clients? Aren’t we worried about the impact of increased regulation and anti-trust action on these companies?
In many cases, increased regulation actually benefits these businesses. Because neither Facebook nor Google sell user information, regulations that restrict data sharing between companies have little impact on their walled gardens. For example, since the European Union enacted the General Data Protection Regulation (GDPR) in May of 2018, Google and Facebook have easily extended their track record of double-digit advertising revenue growth. We expect the California Consumer Privacy Act (CCPA) that went into effect on January 1st of this year will likely produce the same result.
As for the ongoing anti-trust investigations, Microsoft’s experience at the turn of the century is telling. The DOJ sued Microsoft in 1998 over the company’s practice of forcing computer makers to install the company’s Internet Explorer web browser by default, if they wanted to offer Microsoft’s Windows operating system. Effectively, this meant that OEMs were forced to install the browser, since Windows held a monopoly on computer operating systems at the time. The DOJ and Microsoft eventually agreed to a settlement in 2002, which prevented Microsoft from excluding competing software from Windows and required the company to make Windows interoperable with non-Microsoft software.
The following chart depicts the rapid rise of Microsoft’s revenue and earnings before, during, and after the settlement.
It is clear that being forced by the government to alter business practices did not impair Microsoft’s business. We expect the story will be similar for the current crop of anti-trust investigations because for the most part, the market power possessed by Google and Facebook is derived not from illegally restraining competition, but from leveraging scale to provide consumers with superior products and services.
To highlight this point, let’s look at how Google is faring with European regulators more recently. In 2018, European regulators deemed Google’s search ad results for shopping queries were an abuse of monopoly power because they excluded comparison shopping websites. Google argued that consumers preferred Google’s search results, and if consumers wanted results from comparison shopping sites, they would either search for them or visit those sites directly. Regulators disagreed and mandated that Google allow comparison shopping sites into shopping ad results.
Unsurprisingly, this did not lead to the reemergence of comparison shopping sites. Initially, user behavior changed. According to European Commissioner for Competition, Margrethe Vestager, soon after the ruling went into effect, “We know from our monitoring there’s been a steady increase in the numbers over the last few months. The most recent figures show at least one rival appears in about one-third of new shopping boxes as compared to 15 percent of the shopping boxes back in March… Similarly the share of clicks of products of rivals in Google shopping boxes also increased from 2.5 percent in February to 6.1 percent now.”
However, just a few months later, the better user experience won out, as Vestager lamented, “We may see a show of rivals in the shopping box. We may see a pickup when it comes to clicks for merchants. But we still do not see much traffic for viable competitors when it comes to shopping comparison.” Consumers have clearly voted in favor of Google with their clicks.
While we are sympathetic with many of the arguments made by companies impacted by the emergence of large technology platforms, companies like Facebook and Google have largely earned and maintained their positions through economies of scale and the quality of their services, not illegal anti-competitive behavior. As a result, we don’t expect regulation or anti-trust action is likely to impair these business models.
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Advisor Group Manager