The Web’s New Monopolists

Just because Facebook and Google are innovative now doesn’t mean they won’t strangle growth and harm us all—if we let them.

In May 1998, professing to be heavily influenced by Arthur’s work, Assistant Attorney General Joel Klein sued Microsoft. The central offense involved Netscape, the maker of a new kind of software called a browser that was used to navigate a new communications network called the Internet. As it had done before, Microsoft built a copycat product, Internet Explorer, and used its operating-system dominance to wrest control of the market.

The trial that ensued was such a headline-grabbing sensation that it is remarkable how few people even remember the outcome (I didn’t until I looked it up). Microsoft lost the case decisively in U.S. district court, where Judge Thomas Penfield Jackson ordered that it be split in two. That wasn’t the end, though. Jackson had openly criticized Microsoft in interviews, and the court of appeals blasted his behavior as “rampant disregard” for judicial ethics, vacated parts of Jackson’s ruling, and handed the case over to a different judge. Microsoft was still found to have violated the law, but the remedy fell far short of a breakup or even serious punishment.

There were reasonable economic arguments for leaving the company be. In its 2001 ruling vacating Jackson’s decision, the appeals court described the quandary at the heart of the case. Citing the literature on network effects, the judges acknowledged that, in some tech markets, “once a product or standard achieves wide acceptance, it becomes more or less entrenched.” That made software companies a bit like utilities—where competition is not “within the field” but “for the field.” On the other hand, citing Schumpeter at some length, the judges noted that, in technologically dynamic markets, “such entrenchment may be temporary, because innovation may alter the field altogether.”

For the next few years, Schumpeter looked like a pretty good guide. Microsoft continued to mint money from Windows and Office, but it missed out on almost every new digital opportunity. Apple rose from its deathbed on the strength of better products and a new way of selling music online.

Then there was the Internet, which seemed mainly to reward upstarts that built good products. Google, the first of these upstarts to break through in the new millennium, hardly looked like a trust worth busting. By and large, it didn’t make use of network effects. It also didn’t lock users in. Yes, Google enjoyed increasing returns to scale. But if another company were to come along with a dramatically better search technology (just as Google once did), it might well take over the market.

Other businesses that arose in Google’s wake, however, did focus on creating network effects. Facebook’s business is built entirely around them—its value for users resides in the presence of other users, period. As you build up an online identity on Facebook, the costs of switching to another network rise, too. Other, less universally ambitious businesses, from Yelp to Evernote to Airbnb, similarly have tried to establish themselves at the center of unique new ecosystems. And in recent years—with Gmail, Google Places, the Chrome browser, the Android smartphone operating system, and other products—Google has been trying increasingly hard to build a network that customers will find tough to abandon.

So what, if anything, should we do about all these budding monopolists? The prevailing attitude among regulators over the past decade has been: very little. One reason is that firms don’t always know how to transform the network effects they’ve been creating into empire-entrenching profits. Microsoft’s approach—charging for its software—is not open to most of today’s firms, at least not at first. To build a network big enough to exploit, you usually need to offer something for free. So we get lots of “freemium” businesses that charge only heavy users. We get Apple, which has learned to build networks around music and movies and apps, but makes most of its money selling the devices that access those networks. We get Amazon, which is building similar networks around books and other media, and is selling its devices for no profit. And we get Google and Facebook, which have such staggering numbers of users that they are able, by smart targeting, to make serious money selling ads—although so far they’ve had less success with ads on mobile devices than on computers. With the situation so dynamic and uncertain, we may be tempted just to shrug and let the market take us where it will.

The rise of Google and Facebook was possible at least in part because Microsoft didn’t feel free to strangle them as it had Netscape a decade before.

But to assume that this hyperfast Schumpeterian capitalism is the new normal, and that government or civic action can only get in the way, is to ignore or misread history. (If you need to do some remedial reading, as I did, I recommend Tim Wu’s The Master Switch and Richard R. John’s Network Nation.) We have repeatedly seen new communications technologies go from open and chaotic to closed and, in many cases, censored. This happened with newspapers, radio, TV, movies, even the telephone system. Just because the Internet has succeeded in blowing up some of these established communications monopolies and oligopolies doesn’t mean it won’t create its own.

Declaring that the new utilities of the Internet age thus require regulation can be problematic. As Wu puts it, “Regulation is often a way to keep a dominant firm in place.” At this stage, a set of rules on how search engines are supposed to work would probably just entrench Google. But other tools are available. We can, for example, agree on principles of how the online world should develop. The best-known of these is “network neutrality”—the idea, coined by Wu, that broadband providers shouldn’t be allowed to favor some Internet businesses over others. Still incipient is the principle, espoused by the open-source advocate Doc Searls and others, that customer data should belong to customers rather than to retailers, social networks, search engines, and the like. Third-party providers should store your information, and share it only when you want them to. This would lower your switching costs, and could upend the business models of Google, Facebook, and others that profit from hoarding user data. It might also deliver a better consumer experience at a lower cost.

And let’s not forget antitrust enforcement. It is now fashionable to dismiss it as pointless—look what happened with Microsoft. But look more closely, and it’s possible to spin a credible tale of antitrust lawyers enabling disruption and innovation. The Justice Department may have given up its 13-year struggle with IBM in 1982, but pressure from Washington helped push the company to unbundle its software from its hardware, speeding the development of an independent software industry. The 1980s breakup of AT&T created fertile ground for the growth of the Internet. The spectacular rise of Google and Facebook, and the resurgence of Apple, were possible at least in part because Microsoft didn’t feel free to strangle them as it had Netscape a decade before.

The virtual world is so new that it still seems boundless, and its continued exploration and colonization are providing new tools and new entertainments for us all, along with great fortunes for the explorers and colonizers. Yet, if we are inattentive, today’s landgrabs could crowd out opportunity, innovation, and even economic growth in the future. It’s one thing to acknowledge that the way ahead is uncertain, and that what looks like a permanent monopoly today might be roadkill tomorrow. It is quite another to assume that everything will work out for the best as long as market forces are allowed to work their magic.

So all praise to today’s would-be utilities and monopolies, as they try to build enterprises that own their markets and that we can’t do without. But when they actually succeed, don’t think we shouldn’t be sniffing around in their business. At a certain point, it becomes our business, too.

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Justin Fox is the editorial director of the Harvard Business Review.

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