Presentation delivered before the Southern Economic Association on November 16, 2012. Examines concerns about vertical integration in the tech economy and specifically addresses regulatory proposals set forth by Tim Wu (arguing for a "separations principle" for the tech economy) & Jonathan ZIttrain (arguing for "API neutrality" for social media and digital platforms. This presentation is based on two papers published by the Mercatus Center at George Mason University: “Uncreative Destruction: The Misguided War on Vertical Integration in the Information Economy” & “The Perils of Classifying Social Media Platforms as Public Utilities." Both are available at www.Mercatus.org.

1. The War on Vertical Integration
in the Digital Economy
Adam Thierer
Senior Research Fellow
Mercatus Center
November 16, 2012
Presentation before the Southern Economic Association

2. Purpose of Talk
• Identify important new regulatory proposals
in the field of information technology policy
• Identify common themes that unite those calls
for government action
• Rebut those fears using economic / historical
evidence
2

3. This talk derived from two Mercatus Center papers …
• “Uncreative Destruction: The
Misguided War on Vertical
Integration in the Information
Economy” (forthcoming Federal
Communications Law Journal)
• “The Perils of Classifying Social
Media Platforms as Public Utilities”
www.Mercatus.org/research/tech-policy
3

4. Growing Calls for Digital Regulation
• from Net neutrality & search neutrality to “API neutrality”
(J. Zittrain) & “social network neutrality” (J. Levine) &
“algorithmic neutrality” (T. Gillespie)
• “social utility” or “social commons” arguments (D. Boyd,
Z. Tufekci)
• “digital essential facilities” / “digital public utilities”
• “separations principle” for digital economy to prevent all
possible vertical integration / power (Tim Wu)
• Major push for regulation of online advertising / digital
privacy
• Calls for a “Federal Search Commission” (F. Pasquale) or
“Federal Internet Commission”
4

5. Two Emerging Themes
1. Vertical integration in information technology
sector is dangerous. Based on…
– Economic power concerns (“big is bad”)
– Free speech concerns (“information industries are
special”)
2. Increased government scrutiny of information
platforms is necessary
– Administrative regulation (+ lots of “nudges”)
– Stepped-up antitrust intervention
5

6. Two Specific Proposals Addressed
in This Presentation
1. “API neutrality”
– Jonathan Zittrain, The Future of
the Internet and How to Stop It
(2009)
2. “Separations principle”
– Tim Wu, The Master Switch
(2010)
These are the 2 most influential books being widely assigned today in
cyberlaw , media studies, and digital econ courses.
6

7. API Neutrality
API’s = application programming interface (code & standards that
allow digital interoperability)
7

8. Zittrain’s “API Neutrality” Premise
• Explicit assumption: We might need to require “API
neutrality” to ensure “fair and non-discriminatory”
access to certain online services or digital platforms.
• Implicit assumption: Certain social media platforms
or digital devices are a sort of essential facility, public
utility, or common carrier (or at least should be).
8

9. Zittrain’s concern (part 1)
• Zittrain worried that vertical foreclosure threatens
“generative” technologies or networks, which invite
or allow tinkering and all sorts of creative secondary
uses.
• worried about “appliancized systems,” or digital
technologies or networks that discourage or disallow
tinkering / interoperability.
• primary examples are proprietary devices like Apple’s
iPhone or the TiVo, or online walled gardens like the
old AOL or Facebook today.
9

10. Zittrain’s concern (part 2)
• He says such devices or platforms threaten
“openness” & allow easier control by either large
corporate intermediaries or government officials.
• Thus, the “future of the Internet” Zittrain is hoping to
“stop” is a world dominated by tethered digital
appliances and walled gardens, because they are too
easily controlled by other actors.
• How to accomplish? = Constrain vertical foreclosure
of platforms / devices.
10

11. Zittrain’s proposal: API Neutrality
• “Should we consider network neutrality-style
mandates for appliancized systems?” he asks.
– “The answer lies in that subset of appliancized systems
that seeks to gain the benefits of third-party contributions
while reserving the right to exclude it later... Those who
offer open APIs on the Net in an attempt to harness the
generative cycle ought to remain application-neutral after
their efforts have succeeded, so all those who built on
top of their interface can continue to do so on equal
terms.”
11

12. API Neutrality as Adverse Possession
for Digital Platforms
• Zittrain even alludes to the possibility of applying the
common law principle of adverse possession more
broadly in these contexts.
• users who openly occupy another’s private property
can, after a lengthy period of time on that property,
come to legitimately acquire (or at least share) it.
= converts Facebook, Twitter & other services into a commons
• He does not make it clear when that principle would
be triggered as it pertains to digital platforms
12

13. Separations Principle
13

14. Wu’s concerns
• Wu contends that “information monopolies”
are pervasive in the information economy.
• These “monopolists” include Facebook, Apple,
Google, and even Twitter
• “Information industries . . . can never be
properly understood as ‘normal’ industries;”
require extensive regulation to prevent
monopolistic abuse
14

15. Wu’s proposal
“A Separations Principle would mean the creation of a
salutary distance between each of the major functions or
layers in the information economy. It would mean that
those who develop information, those who own the network
infrastructure on which it travels, and those who control the
tools or venues of access must be kept apart from one
another.” – Wu, Master Switch, p. 304
Goal: to prevent “one layer from smothering the others”
through a reinvigorated regulatory enforcement to address
“the corrupting effects of vertically integrated power” in
the information sectors.
15

16. Wu’s 3 Segregated Buckets
Content
• Movies / Music / Games / Software
Distribution
• Conduit / Networks
Hardware
• Handsets / Devices
16

17. Separations Principle Implementation
1. FCC is primary enforcer; should block mergers &
compel divestitures to prevent harms associate with
vertical integration / foreclosure.
2. If FCC fails to prevent integration across categories
or fail to enforce separations, FTC & DOJ step in and
do so.
3. Finally, Wu also hopes industry players would adopt
norms of openness and compliance and even
voluntary separations.
17

18. Wu Calls It a “Constitutional”
Approach
• Wu insists that this structural remedy “is not a
regulatory approach but rather a constitutional
approach to the information economy” because he
models it on the separation of powers found in the
U.S. Constitution.
• He concedes it’s a “radical” proposal but says it is in
line with earlier ideas regarding the dangers of
vertical concentration and power. (Jackson,
Roosevelt, etc.)
18

19. Example: Apple
iPhone
iOS
iPad
Safari
iPod
Content division Content Hardware Macs
Division Division AppleTV
Distribution
Division
Apple App Store
iTunes
19

20. Example: Microsoft
Windows
Office
Microsoft Studios (video games)
Internet Explorer
Hotmail
Content Hardware
Division Division
Xbox consoles
Surface tablet
Keyboards
Mice & peripherals
20

21. Example: Amazon
Amazon Publishing
Amazon apps
Content Hardware Kindle
Division Division
Distribution
Division
Amazon.com
Amazon Web Services
21

22. Example: Google
Google search Motorola devices
YouTube Google TV
Google Maps Chromebooks
Android software
Content Hardware
Gmail
Division Division
Chrome browser
Distribution
Division
Google Play store
Google Fiber broadband network
22

23. Example: Comcast
NBC-Universal properties
Set-top boxes
Content Hardware
Division Division
Distribution
Division
Comcast broadband & video networks
23

24. Responses
24

25. Some Basic (Post-Chicago) Economics
• vertical restraints & integration are very rarely
considered dangerous or illegal anymore
• Traditional concerns with vertical integration have
been “essentially forgotten” by academics, agencies
& courts
• vertical arrangements can increase interbrand
competition, promote efficiencies & expand options
• vertical restraints and excessive foreclosure are
constrained by competition from other producers
(Schumpeterian creative destruction / contestability)
25

26. Structural Separation Increasingly
Frowned Upon as Remedy
• Structural separation of vertically integrated
firms is a rarely used remedy in antitrust
• Sherman Act structural remedies very costly &
fail to improve the competitive landscape or
consumer welfare (Crandall, 2001)
• Structural separation now considered nuclear
option of antitrust; absolute last resort
26

27. Is There Really a Problem Here?
• Even Wu admits that we “live in what is in some
ways an informational golden age.”
• More choices and innovation than ever flowing
from this sector.
• Consumers clearly aren’t clamoring for breakups!
• Vertical integration appears to be offering them
many benefits.
• Schumpeterian creative destruction is alive and
well.
27

28. Dynamic Responses to Foreclosure
Excessive foreclosure has real-world trade-offs / downsides:
• Might limit profit potential: Information ecosystems make
themselves more attractive to users and advertisers by
providing platforms with plentiful opportunities for diverse
interactions and innovations. Foreclosure can limit that.
• Reputational effects: Firms do not want to incur the wrath of
those who built on top of their interfaces (or the wrath of
customers, press, academics.)
• Opportunistic entry / “leapfrogging” effects: Locking down
platforms can spur more entry and innovation as other app
developers and users seek out more open, pro-generative
alternatives.
28

29. Apple case study
• Apple was originally entirely closed to 3rd party development
but quickly reversed itself and opened its iPhone platform
• The result was an outpouring of innovation. Customers in
more than 123 countries had downloaded more than
eighteen billion apps from Apple’s App Store at a rate of more
than 1 billion apps per month as of late 2011
• no obvious incentive for Apple to completely foreclose third-
party development now, especially as its application
ecosystem is a key element of Apple’s success in the
smartphone and tablet sectors.
• + huge pressure from Android, Microsoft, Apple & others
29

30. Remember AOL-TW?
Part 1: IM Interoperability Fears
• A decade ago, similar angst surrounded AOL’s growing
power in the instant-messaging (IM) marketplace.
• Many feared AOL would monopolize the market and
exclude competitors by denying interconnection.
• Markets evolved quickly to offer choices &
interoperability.
• Today, anyone can download free chat clients to
manage IM services from multiple services, all within a
single interface, essentially making it irrelevant which
chat service your friends use.
30

31. Remember AOL-TW?
Part 2: Internet Access Fears
• Vertical integration of AOL narrowband Net
access + Time Warner content led to fears of
“new totalitarianism” & “corporate Big Brother”
• But AOL-TW totally missed the broadband &
search revolutions
• Merger produced zero synergies but massive
losses (over $100 billion within 2 ½ yrs)
• Voluntary vertically separated in 2009
31

32. Evolution of Web Portals
to Search & Social Networking
Web Portals /
Early Search
AOL
CompuServe
Prodigy
Geocities
Lycos
Go.com
AskJeeves
Search Social Networking Platforms
Google First Second
Microsoft Bing Generation Generation
Yahoo! Six Degrees Facebook
Ask Friendster LinkedIn
DuckDuckGo Live Journal Google+
Blekko MySpace Twitter
32

33. The Rise & Fall of Video Game Platforms
Video Game Consoles
First Era Second Era Third Era
Magnavox (Odyssey) Nintendo (NES / N54) Sony (PlayStation)
Atari (2600) Sega (Genesis / Dreamcast) Microsoft (Xbox)
Mattel (Intellivision) Atari (Jaguar) Nintendo (Wii)
Coleco (ColecoVision) Apple (Pippin)
+ a vibrant PC & smartphone gaming
market exists now, too.

34. Evolution of the Computing Value Chain (1975 – 2012)
Source: Horace Dediu, Asymco
34

35. Smartphone Platform Competition (2009-present)
35
Source: Horace Dediu, Asymco

36. Likely Consequenes of Regulation
API neutrality or a separations principle…
• would send signal to digital entrepreneurs that their platforms
are theirs in name only and could be coercively commoditized
once they are popular enough.
• would significantly undermine the firm’s right and ability to
control one of its most valuable assets (perhaps its only
monetizable asset).
• would create massive marketplace uncertainty and constitute
a serious disincentive to future innovation / investment
• could force paywalls / prices to go up for consumers or
choices to be diminished.
36

37. Conclusions
• Even if some platform owners vertically integrate or move to
some sort of walled garden, there is no reason to classify such a
move as anticompetitive foreclosure or illegal leveraging.
• Because many digital providers do not charge for the services
they provide, some limited steps to lock down their platforms or
vertically integrate might help them earn a return on their
investments by better monetizing traffic on their own platforms.
• Marketplace experimentation in search of a sustainable
business model should not be made illegal.
• We should instead continue to place our faith in the dynamic
nature of digital markets and the unprecedented Schumpeterian
change we’ve already seen.
37

38. And oh, by the way, the economics
don’t really matter!
Whether API neutrality or separations principle…
• Likely impossible to enforce these regimes
globally; easy to relocate.
– These firms are going to vertically integrate
somewhere; it might as well be here in the U.S.!
• Also, huge 1st Amendment (free speech) & 5th
Amendment (takings) issues here.
– courts would like rule all this unconstitutional
38