Why did the FTC sue Facebook, again? Facebook lacks innovation.
On December 9, 2020, The FTC (Federal Trade Commission) and 46 states sued Facebook for Illegal Monopolization. Facebook was charged with three major accusations of eliminating threats to its monopoly: acquiring Instagram, acquiring Whatsapp, and forcing anti-competitive conditions on software developers. However, six months later, Facebook soared to a trillion-dollar valuation because the judge dismissed the case. The judge’s reason was comically fundamental: the FTC did not prove Facebook was a monopoly.
After the judge’s dismissal, an invigorating figure ‘instantly’ entered the chat. Lina Khan was appointed to be the FTC Chairperson in June 2021, and two months later, the FTC refiled the Facebook suit. Lina Khan is awesome.
She has been a prolific writer about antitrust issues, especially as they related to big tech companies. In fact, she authored a paper, “Amazon’s Antitrust Paradox,” that went viral in legal antitrust circles. She proposed an industry-shifting view on illegal monopolies as an unknown law student at Yale only 4 years ago. Now she’s leading the Facebook suit, and Facebook has already tried to get her recused.
There are two baffling questions so far. Why does the FTC need to prove Facebook is a monopoly? Isn’t it obviously one? The second question: Why is Lina Khan prosecuting Facebook and not the other big tech companies?
To answer these questions, I will explore the FTC’s definition of anti-competitive practices and illuminate why the FTC argues that Facebook is an uninventive company that has succeeded chiefly through monopolistic acquisitions.
This is going to be an educative rollercoaster. Buckle in. Also, feel free to utilize the subscribe button above. I hear it does stuff like send you more interesting articles.
Facebook Origins: Facebook has foundations in unoriginality
thefacebook.com was launched on February 4, 2004, when Mark Zuckerberg was a sophomore at Harvard. Right from the founding of the company, Facebook has been entangled in innovation controversy. Specifically, some seniors at Harvard, Cameron and Tyler Winklevoss and Divya Narendra, accused Mark of stealing the idea behind Facebook. You might remember the Winklevoss twins from The Social Network movie, where Jesse Eisenberg plays Mark Zuckerberg.
Yes, Facebook has grown rapidly. It earned $85.9 billion in revenue in 2020 and has 2.9 billion monthly active users. The widespread use of Facebook has served its mission of bringing the world closer together, but this growth has been checkered with controversy. Many Americans are still vexed at Facebook’s role in the Cambridge Analytica scandal and spreading fake news.
The FTC argues that Facebook is impervious to these accusations specifically because it has a chokehold monopoly. But the FTC suit was dismissed specifically because they struggled to prove this. Why is it necessary to prove monopoly status? Let’s dive into the fine print.
Understanding Illegal Anti-competitive practices: Why the FTC needs to prove FB is a monopoly
The goal of the Federal Trade Commission, simplified, is to prevent and stop unfair business practices that reduce competition, lead to higher prices, reduce the quality of service, or result in less innovation.
Unfair business practices cover two categories: horizontal and single-firm conduct. Horizontal conduct involves illegal collaboration between competing firms. These are intuitive. Don’t fix prices. Don’t divide the market between you and your competitor. Single-firm conduct, also known as monopolization, is trickier.
Under monopolization, it is illegal to monopolize trade, but it is legal to have a monopoly. In the FTC’s words, a company may have a monopoly, charge high prices, and even achieve monopoly aggressively. However, they cannot exclude competitors or prevent new entrants. Fundamentally, you can win, but you can’t hinder others from winning.
This means that a company must be a monopoly to be capable of monopolizing trade. Think about the assumptions. Monopolizing trade involves leveraging market power, and non-monopolies do not have this power. They also lack interest in stifling competition because they are concerned with competing with competitors with significant market share.
So the FTC fixed their Facebook monopoly definition, but how exactly did Facebook monopolize trade with seemingly innocent acquisitions?
Facebook’s Acquisition Spree: They buy, not develop, innovation
Between 2010 and 2016, Facebook acquired 63 companies and, throughout its existence, has spent $23.4 billion on acquisitions. Whatsapp and Instagram have the lion’s share of the funds. Whatsapp was acquired for $19 billion in 2014, and Instagram was acquired for $1 billion in 2012.
Professor of Marketing at NYU Stern School of Business, Scott Galloway, who is also the author of the enlightening book, which I recommend reading: “The Four: The Hidden DNA of Amazon, Apple, Facebook, and Google” said:
“Instagram is arguably the best acquisition in the history of tech.”
Instagram was growing so fast that it reached a million users in three short months. This posed an existential threat to Facebook, so they bought Instagram. Hear it from Mark:
“There are network effects around social products and a finite number of different social mechanics to invent. Once someone wins at a specific mechanic, it’s difficult for others to supplant them without doing something different.”
The specific mechanic mentioned is photo-sharing. I will revisit the degree of Instagram’s innovation but hold on to the idea of Facebook not “doing something different” — the thesis of the FTC’s accusations.
Another intriguing acquisition is not really the $2.3 billion acquisition of Oculus in 2014. It’s all the small Virtual Reality Developer Firms that Facebook bought like a child at the candy store. I wrote more about Oculus, Facebook’s VR developer acquisitions, and the VR ecosystem here. 3 months later, Facebook has bought yet another major developer.
Thus far, we know the idea for Facebook was somewhat stolen and that Facebook mostly acquired its strengths.
But it’s not illegal to acquire businesses. Why then is Lina Khan’s FTC prosecuting Facebook for monopolistic acquisitions that hinder competition?
Evidence of Facebook’s Anti-competitive acquisitions
The FTC defines 5 types of evidence for anti-competitive mergers. I will review the Instagram acquisition through this lens, but first, a quote from the FTC:
“The unifying theme of these Guidelines is that mergers should not be permitted to create, enhance, or entrench market power or to facilitate its exercise… A merger can enhance market power simply by eliminating competition between the merging parties. This effect can arise even if the merger causes no changes in the way other firms behave”
This definition has a major shortcoming: it is intentionally vague. However, each evidence type below will clarify some of the vagueness and also explain why the language is vague:
Actual effects observed in Consummated Mergers: The FTC asks the question: in the case of a merger, are there actual or potential price increases or adverse customer effects?
The actual effects thus far are debatable, but for potential effects, the FTC clarifies that
“a consummated merger may be anticompetitive even if such effects have not yet been observed, perhaps because the merged firm may be aware of the possibility of post-merger antitrust review and moderating its conduct”
After the Oculus acquisition, users were required to log in with a Facebook account instead of the default option of an Oculus account. This outraged users, especially since Oculus founder, Palmer Luckey, had promised otherwise pre-acquisition. Facebook can repeat this with Instagram and Whatsapp, leading to less choice, competition, and innovation. Reread the quote above if you doubt this possibility.
Direct Comparisons Based on Experience: The world has transformed as the Internet Age took off in the last 30 years. Historical precedence, therefore, provides limited evidence hence, why the acquisition language is vague.
Market Shares and Concentration in a Relevant Market: The FTC is expected to define multiple markets where a merger might have anti-competitive effects, but defining markets for the Facebook case is dicey. Moreover, I do not have access to the 80-page lawsuit that would contain the FTC’s fixes to their market definition.
Substantial Head-to-Head Competition: Despite the struggle of defining the market, Instagram is invariably a competitor. Both Facebook and Instagram fundamentally have platforms that attract and retain user attention, and leverage this scarce resource, attention, to serve digital advertisements.
Disruptive Role of a Merging Party: The FTC disapproves acquisitions of ‘Merging Parties’ that are mavericks: “a firm that plays a disruptive role in the market to the benefit of customers.” Instagram pioneered the execution of photo-sharing features in a social media app after pivoting from Burbn. This distinction from “a random increase in popularity” is important. Instagram innovated to succeed in photo-sharing. Facebook did not. It’s worth repeating Zuckerberg’s words:
“There are network effects around social products and a finite number of different social mechanics to invent. Once someone wins at a specific mechanic, it’s difficult for others to supplant them without doing something different.”
Instagram’s mastery of the photo-sharing feature was far from trivial. They were, in fact, the next Facebook.
Conclusion
We started with two questions:
Why does the FTC need to prove Facebook is a monopoly? Isn’t it obviously one?
Why is Lina Khan prosecuting Facebook and not the other big tech companies?
So far, we understand that the FTC’s first case was dismissed because they defined the market shoddily. Hence, it wasn’t clear Facebook is a monopoly — and you can’t monopolize trade if you don’t have the monopoly power to do it.
We can also see various evidence of Facebook’s bias to buy innovation rather than develop it. (Facebook can be quite sluggish — a good example being mobile). The FTC has had enough of Facebook’s throwing money at competitors. You know Zuckerberg tried to buy Snapchat, right? Possibly more than once.
The final piece is the question: Why not the other big tech companies? There’s a flurry of reasons. One critical issue is that Facebook is buying competitors: stifling competition. This is exactly why Microsoft was sued in the ’90s. Though, Microsoft stifled competition by making it difficult to switch from Internet explorer.
But Microsoft has spent many more billions than Facebook on acquisitions. They acquired Skype for $8.5 billion in 2011, Linkedin in 2016 for $26.2 billion, and Github in 2018 for $7.5 billion.
The main difference: Microsoft innovated within its market and acquired companies in separate markets. Facebook bought out competitors because, according to the FTC, they lack innovation.
PS: Lina Khan is also going after Amazon.
Further watching: