Challenging a NYT Column Singing the Praises of Platforms and Dismissing Their Network Effects

The September 4, 2021 edition of the New York Times contains an article written by Professor Jonathan A. Knee entitled Network Effects are Overrated.  The author generally dismisses as benign, or ineffectual just about anything platform intermediaries have undertaken, despite the prevailing view that these ventures impose significant costs and benefits on consumers and society.

Professor Knee appears to dismiss the ability of platform operators to lock in subscribers and create incentives for more consumers to “get on the bandwagon.”  He also dismisses any sense that high market shares reflect a “winner take all” sweepstakes in play. Apparently, the ability to accrue scale efficiencies is not the same thing as exploiting network effects, the ability to expand the subscriber base at low incremental costs.

Professor Knee has great optimism in the ability of market entrants to capture market share and for consumers to vote with their eyes, ears, and pocketbooks and churn out of dominant platforms such as Netflix, Google, Facebook, EBay, PayPal, Uber and others.

The column curiously ignores one of the fundamental characteristics of platform intermediaries: the ability to profit from operating in a two-sided market serving both downstream consumers and upstream advertisers, data analytics firms, election meddlers, purveyors of disinformation, government surveillance agencies, and vendors.

Broadband platform intermediaries have unprecedented opportunities to get multiple bites of the apple as exemplified by Google’s ability to sell advertising, but also generate fees as the auctioneer of ad placements.  Put another way, platform intermediaries can spread fixed costs and accrue positive network effects while also generating multiple profit centers up and down a complete market “food chain.” 

Previous platform intermediaries had limited opportunities to exploit both sides of a market without jeopardizing profits.  Fior example, cable television operators and newspaper owners had to calibrate both advertising and subscription rates to maximize profits.  Attempts at gouging typically would reduce overall profits as consumers and advertisers pursued better value propositions.

Lastly, some readers of this blog may remember with fondness how Word Perfect software offered a better user experience than Microsoft Word. That notwithstanding, network effects over time forced people like me to get on the Word bandwagon, because sticking with Word Perfect guaranteed conversion and compatibility hassles.

Never underestimate the power of firms able to exploit network effects, economics of scale, and access to both sides of an integrated platform marketplace.

Misrepresentations in the Rat You Out Economy

            Most readers over the age of 30 probably know the meaning of “rat you out.”  In crime movies and elsewhere, someone discloses to law enforcement and other authorities the crimes and indiscretions committed by someone else. The rat saves himself from criminal prosecution, or something less hazardous, such as embarrassment.

            We live in a rat you out economy where just about every commercial and even presumed private transaction has an informant with a financial incentive to disclose any and all wants, needs, desires, interests, locations traversed, political affiliation and even crimes that law enforcement would never uncover.   Even trusted intermediaries reserve the option in their service agreements, for which consumers have no option other than “take it or leave it.”  In this world, cellphone carriers can leverage their need to track subscribers’ locations not just to maintain reliable service, but also to create new profit centers from the sale of locational information to willing buyers. 

            A curious example: a political party wanted to know the identities of frequent visitors to Roman Catholic churches.  Despite carriers claims that they anonymize subscriber location information, data analytics firms can use multiple sources to identify individuals, frequenting the churches.  With this amalgamated information, a political party opposed to abortion can target like-minded voters through locational data generated by cellphones, collected by wireless carriers and mined by other data analytics firms.

            Plenty more intrusive, risky and potentially deadly rat you out scenarios exist given the ease in which cellphone location data can identify travel patterns.  A bail bondsman might have an easier time finding someone who ignored a court appearance, but so too can a spurned spouse or lover track and potentially harm the rejecting former partner.

            Bear in mind that consumers have to accept such privacy intrusions and surveillance as part of the cost in participating wireless commerce.  Verizon and other carriers reserve the option of monetizing location data, without discounting service, or the cost of the smartphone.  Wireless carriers accrue real monetary benefits as do Internet firms that offer something “free,” provided subscribers agreed to one-sided terms and conditions. Clearly, the value proposition experienced by consumers contains both benefits and costs.

            If you agree to the last sentence above, perhaps you might see the problem in the relentless campaign by sponsored researchers and policy advocates to remind us about all the upside with nary an acknowledgement about the downside.  A recent consumer surplus love fest was expressed in a Wall Street Journal op-ed bemoaning antitrust scrutiny of large technology firms; see https://www.wsj.com/articles/the-misguided-antitrust-attack-on-big-tech-11600125182.  The authors tout the wondrous monetary savings and life enhancements generously offered by Big Tech firms.  Remarkably, the authors make no reference to offsetting financial benefits transferred from consumer to vendor.  They do not seem to comprehend how the rat you out economy works: consumers benefit from something offered freely, or at less cost, but only if they allow valuable commercial surveillance to occur. 

            I will readily acknowledge that consumers might still come out ahead in a final accounting that offsets benefits with costs, but the authors apparently do not want you to know that negative offsets exist.  Even if the authors had mentioned offsetting costs, they might have dismissed them as insignificant. 

            In the broader world of politics and global business such false accounting joins the rate you out economy.  Apparently the espionage in the surveillance by Huawei, ZTE and TikTok is a perilous threat to national security, but the enhanced value proposition from Big Tech deserves a major Thank You! with no need for antitrust scrutiny.

Walking on Egg Shells, Failing a Litmus Test and Shown the Door

FCC Commissioner Mike O’Rielly probably will leave the FCC far sooner than anyone would have anticipated a few days ago.  See https://www.wsj.com/articles/white-house-nixes-fcc-nominee-who-questioned-bid-to-regulate-social-media-11596556660. The President had nominated him for a second term with only one legislator in any way agitated.  Republican Oklahoma Senator Inhofe held up a vote in light of Commissioner O’ Rielly’s support for a 5G competitor with plans on using radio spectrum near GPS frequencies, but sufficiently separated to avoid the potential for interference.  See https://spacenews.com/inhofe-blocks-nomination-of-fcc-commissioner-over-ligado-order/.

The FCC established a 23 MHz “guardband” separating the proposed Ligado wireless service and GPS position location frequencies.  That safeguard apparently was not enough for incumbent government and private users, absent some major cash inducement.  See  https://arstechnica.com/tech-policy/2020/05/millions-of-gps-devices-at-risk-from-fcc-approved-5g-network-military-says/.

Commissioner O’Reilly and I can agree to disagree on many issues, including his antipathy directed at the International Telecommunication Union; see e.g., https://www.fcc.gov/news-events/blog/2016/01/15/2015-world-radiocommunication-conference-troubling-direction.  Nevertheless, I deplore his shabby treatment and the state of telecommunications planning in the United States.  The Wall Street Journal and I uncharacteristically agree that “[i]n saner times few on the right [or left] would dispute . . . [the] points” he made.

Commissioner O’Reilly’s cardinal sin: expressing discomfort with an initiative by President Trump and the National Telecommunications Administration (part of the Commerce Department) to make the FCC a congressionally authorized regulator of Internet content.  See  https://www.ntia.gov/fcc-filing/2020/ntia-petition-rulemaking-clarify-provisions-section-230-communications-act.  NTIA wants the FCC to interpret Sec. 230 of the Communications Decency Act as conferring direct jurisdiction to investigate whether Internet Service Providers and platform operators, such as Facebook, can lose a liability exemption for unmoderated content passing through their networks.

On a bipartisan basis, most people agree that Sec. 230 does not give the FCC any sort of jurisdiction.  Even if it did have some hook, the Commission deems Internet access off limits, as a largely unregulated information service.  Previously, few on the Right or Left would ignore the First Amendment value in depriving government of any role in adjudicating fairness and sanctioning debatable media bias.  Could NTIA and the FCC find a way to sanction anti-conservative bias, but have no grounds to punish Fox for pro-conservative bias on its web site?

Commissioner O’Reilly has to walk on eggshells lest he upset the President and Executive Branch officials.  Apparently, his appointment to an independent, regulatory agency, created by Congress, accords him little insulation from litmus tests and quick dismissal.

Sad.

Adventures in Algorithms: My Word Against the ATM

            Once upon a time, when we regularly used CD and DVD disc drives, most of us occasionally experienced the frustration of not getting a drive to open, or close.  These devices use springs and other moving parts that sometimes do not work seamlessly.  Typically, drive failure does not result in a calamity and with some luck we can get the device to work.

            It may surprise you that the Automated Teller Machines have similar moving parts and springs, particularly where they dispense cash, accept checks and issue receipts.  I still use ATMs frequently as I like cash transactions, even though my research of credit card platforms informs me that I am subsidizing card users.  ATMs rarely fail and the most likely culprit is insufficient cash to dispense.

            Imagine my surprise when an ATM cash dispenser did not open to disperse the cash I requested: lots of beeps, followed by confiscation of my ATM card.  Lucky for me, the ATM machine failed during banker’s hours.  I made my way to a live teller, but she had little good news for me.

            In a nutshell, the ATM machine documented my transaction as completed with no problem. 

Accordingly, I have to “dispute” the debit of funds from my bank account, because the burden of proof lies with me. It’s my word versus the machine’s documentation. I will recover my $300 if and only if a manual, human accounting of transactions shows a $300 surplus.  Then and only then, will a bank manager accept my work and credit my account.  Any anomaly, like the absence of a correct surplus amount, and I am out the money.

            A non-negotiable contract governs ATM users and the transactions they generate.  I am sure that somewhere in this unread document, I have agreed that the ATM documentation trumps my word, I have no redress in court and the bank—or more accurately-- the bank’s software will establish the definitive outcome.  Put another way, I am a liar until proven innocent.

            Wish me luck.

What’s a Fair Burden of Proof in Forecasting Future Benefits, or Harms?

           On many occasions, the FCC and reviewing courts have to decide who bears the burden of proving something, what they have to prove and how convincing they have to be. Far too often, this process lacks science, or any semblance of discipline.  The various stakeholders march their researchers who offer economic “rules,” specific to the last dime cost or benefit estimates and vicious attacks on the credibility of other experts with opposing views.

            This high stakes game has profound impacts on consumers and the degree of competitiveness in various sectors of the economy.  In many instances the burden lies with the party opposing a merger and other types of official blessings required before a commercial transaction can take place.

            Consider this real world scenario.  Comcast has an ownership interest in the Golf Channel.  It stands to reason that Comcast would want to maximize viewership of this network.  It can benefit the Golf Channel, itself and its cable television subscribers by including this network in the basic service tier, rather than a more expensive one having fewer subscribers and a higher monthly subscription price. Arguably, we have a win/win/win situation.  So far, so good.

            Along comes another specialized sport network in which Comcast does not have an ownership interest.  In this scenario, Comcast has to undertake a more granular financial analysis: does adding this channel generate more revenues for the company in the basic tier than in a more expensive sport tier?  Comcast presumably uses math and “real economics” to calculate the financial benefits in any advertising revenue sharing with the network, plus revenues from advertising it sells, plus any possible increase in the basic tier monthly subscription rate, plus savings in its costs of carrying the network in the sports tier.  If Comcast can generate such a composite figure, it then must subtract the per subscriber per month cost of adding carriage of this network in the basic tier.  Bear in mind, the cost of carriage can vary as a function of tier placement.

            In reality, there are additional factors, not easily quantified even if Comsat wanted to undertake the calculation (which it most certainly would not want to do so if obligated to share it with the FCC).  Comcast benefits on both sides of its cable television platform when it places the Golf Channel in the basic tier.  Comcast Cable pays Comcast the programmer of the Golf Channel.  Comcast Cable also receives payments from its cable subscribers.  For sport networks, which Comcast does not have an ownership interest, only one revenue flow exists: subscription payments from cable subscribers.

             It does not take an economist, antitrust expert, or rocket scientist to infer that Comcast has a vested financial interest to favor its golf programming over other sports programming generated by unaffiliated ventures. Some might call it a conflict of interest.  At the very least, a simple “smell test” detects a disincentive to carry competing content which does impose some minor additional programming cost for the basic tier.

             However, the appellate court considering the merits of tennis versus golf programming established a near impossible set of burdens on the unaffiliated network relegated to the more expensive sports tier. § 616 of the Communications Act unambiguously prohibits multichannel video programming networks (like Comcast) from “unreasonably restrain[ing] the ability of an unaffiliated video programming vendor to compete fairly.” Notwithstanding this mandate, the D.C. Circuit Court of Appeals imposed a remarkably high burden of proof on the Tennis Channel (which previously had convinced an FCC Administrative Law Judge that discrimination had occurred only to have that finding overturned by a majority of Commissioners.)  See https://www.cadc.uscourts.gov/internet/opinions.nsf/EC6B700AE22F118585257B790052AFB0/$file/12-1337-1438011.pdf; and https://www.cadc.uscourts.gov/internet/opinions.nsf/AFBD6CE03C0BF51585257FE7005038A6/$file/15-1067-1622957.pdf.

             The court-imposed burden required the Tennis Channel to prove that Comcast would accrue a financial benefit by changing the tier location of the network.  How can one meet that burden of proof?  The experts retained by the Tennis Channel would have to come up with a plausible mathematical equation proving that Comcast would earn more money if it re-tiered the Tennis Channel, i.e., that Comcast could raise the basic tier rate, or accrue more advertising revenues that would offset the cost of placing the network in a cheaper, but more heavily subscribed tier.

             I do not see how counsel for the Tennis Channel could create a formula and an accompanying narrative showing how increased viewership of the Tennis Channel and a commensurate increase in advertising rates would satisfy the financial benefit to Comcast burden of proof.

             The bottom line: Comcast can handicap a competing sport network through a seemingly innocent and business-driven program tiering decision.  Of course corporate non-affiliation had nothing to do with such decision making.