Facebook: “Breaking Up is Hard to Do” In Some Industries, But Not This One

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The fuss over Facebook offers lessons about the abuses of monopoly power and how best to avoid them.  The authorities have two options: (1) force breakups, thereby inviting competition to discipline bad behavior, or (2) regulate the monopolies and thus guard directly against abuses.  A third approach might use a combination of both, which is probably what is necessary for the monster that is Facebook.

Facebook clearly holds a monopoly position, or as close to one as a company can get.  It earns fully 80 percent of the world’s social network revenues.  Though it may have thus far avoided the historical associations of monopoly — price gouging and the abuse of employees – Facebook has certainly abused its customers’ trust and privacy, and that in itself should be enough for a call to action.  Recently the matter has come up dramatically when Chris Hughes, one of Facebook’s founders, characterized the firm’s power as “unprecedented and un-American,” and described Facebook CEO Mark Zuckerberg as all-powerful within the company.  According to Hughes, Zuckerberg and Facebook, are “unaccountable,” particularly on questions of “privacy and election interference.”  He wants Washington to impose regulations on the social network industry and break up Facebook.

Hughes has a point.  Unlike some businesses, competition would offer a lasting discipline with social media.  The crucial issue is the cost of entry into the business.  When it is reasonable, as with social media, competition can persist after a breakup.  Problems arise only when costs of entry are high.  In such cases, the industry itself has a persistent natural tendency toward monopoly.  Take electric utilities.  In that industry, firms must construct generating equipment, string wires, and connect to homes and businesses before they can ever earn a dime. Airlines are another example.  These firms have to buy planes, build maintenance facilities, and contract for terminal space in many cities before making money.  To spread these fixed, up-front costs over as many paying customers as possible the firms present in the industry will undercut each other ruthlessly and keep doing so until most of the competition is driven out of business.  The remaining firm (or firms) then has no difficulty raising prices and improving profitability.   If government were to impose a breakup on such “natural monopolies,” it would only invite another round of vicious price-cutting that would continue until a new monopoly forms.  In such cases, breaking up is indeed hard to do.

This fact of economic life is why government is best advised to count on regulation instead of the discipline of competition to keep such industries from engaging in abuse.  Rather than fight this natural tendency, government tolerates the presence of a single firm in the market, but insists on pricing guidelines and standards of service.  Just about all power and electric utilities work this way.

The problem has become clear since the breakup of AT&T in the 1980s.  Right after the breakup was ordered, the rump of the original monopoly and all the so-called “baby bells” would seem to have offered adequate competition.  But the undercutting stated almost immediately and over time the number of firms in the industry has shrunk from what it looked like right after the breakup.  The pattern will doubtless continue until there is only one or a handful of companies, what we call an oligopoly.  Then, in reaction, it is likely that more regulation will return.  Similarly, the competition unleashed among airlines when the industry was deregulated in the 1970s has in time reduced the number of firms in the industry to an oligopoly in which most cities in the country have only one carrier servicing them.  Because breakups in such industries naturally devolve into monopoly or oligopoly, regulation is required to maintain competitive discipline.

This is not the situation with social media and other Internet applications. Forcing break-ups to increase competition might offer a lasting way to alleviate today’s abuses.  The industry has none of the natural barriers to entry that exist in, say, the prodigious cost of constructing a utility network.  If people had more choices, customers who resent the abuse of privacy so apparent with Facebook could simply switch to a competitor’s platform.  Indeed, competitors could market themselves on their reputation for privacy protections. Given the ease with which customers could switch, the slightest hint of impropriety could destroy a firm.  This fear inspires firms like Facebook to gobble up clever new players before they turn into formidable competitors.

No doubt, Facebook CEO Zuckerberg realizes such dangers to his firm’s position, which is why he has made pleas for regulation instead of a break-up.  With regulation, he knows he will retain a measure of control –– which he would lose in a truly competitive environment.  Zuckerberg of course would prefer to go on as he has, peddling his Facebook’s clients’ information and gobbling up smaller firms.  But because that is no longer in the cards, he sees regulation less as a potential check on his behavior than as a way to maintain control of the process. He and his colleagues in the world of social networks know that the new regulators would have to work with those established in the industry to set the standards, because only the established players have the necessary expertise to write the new rules.  This kind of “consultation” has always been the case in the past when industries have come under regulation. Though not all those new rules would necessarily please Facebook, they would suit it better than if another firm pointed up Zuckerberg’s abuses and making the case that it would run a more respectful platform than Facebook.

Even more appealing to Zuckerberg is that new regulations imposed by Washington would make it more difficult for new social media companies to establish themselves; the new rules would in fact raise the cost of entry and help make the social network industry a natural monopoly, in which case Facebook would need trouble itself less about competitors than it would have in the past.  The regulators would effectively protect Facebook, if inadvertently.

But if more competition would do much to correct the abuses of Facebook and other Internet giants, regulation still may have a role to play.  So much in these companies happens behind what is for most of us an impenetrable curtain of technology.  A regulatory review, such as when the Securities Exchange Commission (SEC) or the Federal Reserve examines a financial firm, could presumably lift the technology curtain in ways even an investigative journalist could not.

So it seems that a combination of breakup and regulation would best serve to overcome these abuses.  Consumers could go where reputations are best. Regulators, by peering behind the technological curtain, would uncover abuses that might have remained disguised or hidden, or the regulators could scotch false rumors of abuse. The social media industry would still have its problems, but the dominance and the abuses that it invites and that Facebook seems to have engaged in, would, if not disappear, at least impose on us less.