Regulating Platform Ecosystems

Platform regulation requires still a wider perspective. As platforms create ecosystems around themselves, regulation should not only focus on the platform itself, or on the underlying intermediated companies, but also on the entire ecosystem. This is particularly relevant in the traditional network industries, as they have always been subject to regulation for the protection and promotion of the general interest. Platformization will not change this.

However, new institutions and new techniques will have to be developed to ensure the effectiveness of platform regulation. Traditional antitrust and sector-specific regulators at a national level might not be in the position to regulate platforms, other than in very large countries (US, China, and Russia). Platform regulation requires more transparency and control over the working of algorithms. Europe is currently in the lead in terms of developing such institutions and techniques.

Promoting Network Effects

Platform regulation should take into account the entire ecosystem around platforms, something we could call the digital ecosystem. Public authorities should not impede and should instead protect and promote the creation of network effects by platforms in multisided markets. Scale is necessary for the creation of network effects. Public authorities should protect and promote investments to build scale in all sides of multi-sided markets. Unnecessary regulatory restrictions to pool supply and demand should be eliminated. Furthermore, public authorities should not restrain, but instead provide the necessary freedom for platforms to find the right balance in the distribution of the value derived from network effects across the ecosystem.

On the supply side, the provision of goods and services is subject to all kinds of regulatory obligations. These obligations were defined in the industrial era and do not take into consideration the new organization model led by platforms. Regulation has to be adapted to the new reality.

Platforms empower non-professional individuals to provide goods and services previously provided only by professional providers. Platforms are at the center of the so-called “sharing economy.” Consumers of services such as transportation, accommodation, etc. contract with their peers, with non-professional service providers.

In the industrial era, service providers required scale, which was necessary to reduce the average cost of goods and services. Mass-production, massive advertising, andsophisticated distribution systems, all coordinated inside a large hierarchical corporation, were the source of efficiency. Corporate law, labor law, and tax law were tailored to this industrial production model.

In the digital era, scale is built by platforms as they coordinate multi-sided markets. The service providers do not have to build scale in order to reduce transaction costs. Small service providers can obtain the benefits of scale by using platforms pooling together large pools of consumers. Even non-professional service providers can now join the market and compete with well-established corporations. Individuals can generate audiovisual content and monetize it, provide transport services through Uber, accommodation services through Airbnb, etc.

However, non-professional and small service providers face substantial regulatory obstacles to enter the market, as market access conditions were defined for the industrial era. Regulatory requirements were often imposed in order to protect consumers against information asymmetries and, more generally, risks related to poor services. Nevertheless, platforms reduce information asymmetries, often in a more satisfactory way than traditional regulation. For example, platforms provide a lot of information about accommodation, including pictures, evaluations by other users, etc., which clearly improves the guarantees provided by traditional regulation such as hotel ratings in the form of stars, minimum quality requirements, etc.

Particularly relevant are restrictions in the form of licenses or authorizations when they are limited in number according to the traditional demand of the service, as is the case with taxi services. Platforms transform the industries in which they operate. Network effects reduce costs, which leads to price reductions, which attract new demand. As a consequence, traditional quantitative restrictions make it impossible to meet all the new demand. These type of restrictions impede the creation of new network effects. Coming back to the example of Uber, regulatory restrictions in the supply of taxis and private hire vehicles in most European cities make it impossible to provide UberPooL services. European citizens do not benefit from the low prices that their American and Asians counterparts enjoy.

Platforms are not limited to the sharing economy and the coordination of non-professional service providers. Google’s long-lasting CEO, Eric Schmidt - one of the individuals who best understands platforms in multi-sided markets - thought that platforms had the potential to disrupt any industry.1 This is also the case of industries that rely on long-established network effects, such as telecommunications, transport, or energy. Platforms can create even larger network effects, particularly by pooling together the existing service providers and their networks, to provide access to more sophisticated and efficient services.

It is legitimate to ask whether public authorities should promote the construction of network effects by forcing traditional players to join a platform and make their services available through the platform. Such a measure would certainly facilitate growth, as platforms would not have to invest to attract suppliers. This is not a rhetorical question. Mobility-as-a-service platforms are calling for the introduction of such an obligation. Net neutrality obligations imposed on telecommunications carriers have a similar effect in their relation with communications platforms.

Platforms claim that traditional players active in the network industries often have exclusive or special rights, or at least a position of market power. By refusing to work with platforms, these players would be breaching antitrust rules,2 as they would be refusing to deal with no objective reason, or refusing access to an essential facility. Furthermore, as common carriers or services of general interest, they might be often under an obligation to provide their services to everyone, also to platforms trying to intermediate their services.

As these legal bases might not be always clear, platforms are lobbying for the adoption of legislation imposing upon traditional players the obligation to work with platforms. The best example is the Transport Law adopted in Finland, which imposes upon the traditional transport services providers (railways, bus services, etc.) the obligation to make their services and their data available to platforms.

While we believe that public authorities should promote the construction of network effects by platforms, it might be a step too far to impose upon traditional players a general obligation to deal with platforms. On one hand, it would not be sufficient to define the obligation to work with platforms. Once the obligation would be defined, and as the actors would not always reach an agreement, public authorities would have to define the conditions for the provision of the service. Coming back to transport, should platforms have access to services at the same conditions as the final users? Should platforms benefit of discounts granted to final users, such as monthly passes, etc., which are often publicly subsidized? Should platforms benefit of have even better terms than final users, as wholesalers often do when they contract larger volumes?

On the other hand, the relationship between service providers and platforms is highly strategic. Service providers are reluctant to work with platforms, as they are aware of the risk of becoming platformed; that is, of seeing their service commoditized by a platform that coordinates the multi-sided market and acquires market power, so as to be able to set the contracting conditions. The balance of power between platforms and the underlying service providers will be one of the most relevant evolutions in the platform economy. Platforms have the potential to become dominant, as has happened in other industries (newspapers, music, etc.). Voluntary contracting under market conditions seems better fitted to determine the contracting conditions and the balance of power between platforms and traditional service providers. Only under exceptional circumstances, when absolute refusals to deal by dominant companies take place, should public intervention be recommended.

On the demand side, obstacles to growing scale can derive from fragmentation. Fragmentation can derive from differences in language or consumption habits, which is why platforms tend to originate in large national markets such as the US and China. Even if European consumers are as sophisticated and as eager to use platforms as their American and Asian counterparts, it is more difficult for European platforms to grow scale on the demand side, as they have to work across languages, consumption habits, and regulations. Local regulations are another obstacle to aggregate demand across borders and the obstacle is particularly relevant during the period of construction of the customer base of a new platform.

In any case, fragmentation is a challenge, but also an opportunity, as platforms can build seamless customer experiences across borders, reducing the effects of fragmentation on the supply side. Airbnb is a good example of how a global seamless service for consumers can be built over the most fragmented of supplies: individual homes across the world, owned by individuals of different nationalities, different languages, subject to different legislations, etc. It is part of the business of a platform to identify how to overcome fragmentation in supply for the benefit of demand.

It is not sufficient to promote the aggregation of supply and demand. Platforms must also be given the necessary freedom to experiment and identify the right balance among all the interests in the ecosystem, particularly when supply is highly fragmented and subject to different conditions and regulations.

Platforms have the ability to create colossal value, but the key to success is how value is distributed across the ecosystem. Platforms must identify the key parameters driving the use of the platform for each side of the market and be in the position to meet the expectations of all parties. It is not sufficient to embark on one side in the platform, such as demand attracted by low prices. It is also necessary to attract supply and to grant some benefit to suppliers so as to make their participation in the platform attractive. Good access to demand might be sufficient sometimes, but might be insufficient on other occasions. Supply tends to be the weakest side, in that the platform must firstly invest to attract supply and, once the platform is more mature, share a significant part of the value created by the platform with the underlying service providers.

To further complicate matters, the balance in the distribution of the value created by the platform is dynamic. It changes over time as the platform matures and, even after that point, it might change as markets evolve and new circumstances (such as new competition) might make it necessary to redefine the balance. Platforms are constantly redefining their proposition. They are constantly testing with some users or at a small scale in one town or country, the conditions of the provision of the service, to identify how to keep all sides of the multi-sided market engaged and active in the platform.

Over-regulation kills network effects, not only when regulation limits supply or fragments demand, but also when over-regulation is imposed upon the intermediation service itself. Public authorities might be tempted to intervene too early and too much in the process of construction and curation of the multi-sided market by digital platforms.

Over-regulation is particularly dangerous at the initial phase of the creation and growth of a platform. A new platform with a small number of users does not create significant network effects. Platforms must invest to attract users. If regulatory obstacles are introduced at this stage, it will take longer to reach the minimum scale to create network effects. Regulatory obligations might even make it impossible to grow and reach such critical mass.

We are at the early stages of developing the new industrial organization model. Platforms are still only mature in the primary data industries (search engines, social networks, communications and alike). Platforms intermediating physical goods and services are still in their infancy, so it is too early to systematically regulate all platforms.

Even when platforms become mature, they need room to adapt their terms and conditions to the unstable and evolving circumstances of multi-sided markets. Regulation that ossifies the conditions provided to supply and demand might reduce the competitiveness of the platform. Just as network effects create virtuous cycles when they grow, they can turn into a vicious cycle if regulation introduces rigidity and reduces the number of active members in the platform.

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