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Podcast October 20, 2021

Tell Me How: BigTech Mergers - Part 1: Is BigTech Buying Out the Competition?

View all episodes on our Tell Me How: The Infrastructure Podcast Series homepage

In this first episode of three on BigTech mergers, we discuss the impact of BigTech mergers and acquisitions on the market and on consumers; how should competition authorities think about developments in these markets if they seek to support competition and innovation?

This podcast series is produced by Fernando Di Laudo and Jonathan Davidar. 

Listen to this episode on your favorite platforms: Amazon MusicApple PodcastsGoogle PodcastsPodbean, and Spotify


Roumeen Islam: This is the World Bank’s Infrastructure Podcast. In today's episode, the first of three on this topic, we discuss why it's important for competition authorities to look carefully at Big Tech Mergers and Acquisitions.

Yesterday was a typical day. I opened my phone in the morning and checked my messages on text, WhatsApp, Instagram, and Twitter. Then, I used Google to search for the nearest gourmet coffee shop. I went to the store but couldn't find what I wanted. So, I ordered it on Amazon Prime. Later in the day, I caught up on my reading on Kindle.

I also went for a run, listening to my favorite podcasts on Spotify. Then, I logged onto my computer to catch up with work on Microsoft Office before Monday’s onslaught. For dinner, I found a nice recipe online and afterwards finished an episode on a Netflix series I love. And you know what I thought? Big tech was everywhere.

My Apple News update said that we needed to make sure that markets worked well, that there was enough competition in tech markets. So, I thought let's find out how to do this.

Good morning and welcome. Our guest today is Professor Michael Katz from Berkeley's Economics Department and Haas School of Business. Among other positions he has held, he was Deputy Assistant Attorney General for economic analysis at the Antitrust Division of the Department of Justice and Chief Economist of the Federal Communications Commission of the U.S.

He will speak to us on big tech, mergers, and competition policy. Welcome, Michael.

Michael Katz: Thank you. It's a pleasure to be here.

Roumeen Islam: It's lovely to have you here with us. So, in this first part of the podcast, Michael, I'd like to talk about big tech and why looking at mergers and acquisitions (I'm just going to refer to both as “mergers”) may be important for competition policy. But first, could you tell me what exactly is big tech and what's so special about them?

Michael Katz: I'd be delighted to. Before I do, I would like to issue a disclaimer. And that is, that I work both for and against the firms that are identified as big tech and I just think it's important that people know that, and that, as I put forth various arguments and we discuss these issues, I just want people to think about the merits of what I'm saying and evaluate that on their own. Don't believe me because I'm the one saying it; believe it because I think I am making sound arguments and arguments that are based on facts.

Now, in terms of your question about what’s big tech, I think that right now people tend to mean Amazon, Alphabet, or Google -as it's more commonly known- Apple and Facebook. People used to also include Netflix and sometimes Microsoft, but they've fallen off.

So, then the question is: “what's special about those two firms, why them?” And I think there are two answers. One is that in the popular imagination those firms are now instilling fear in a lot of people. They think the firms are too big, that they have too much money, that they're dominating the markets in which they compete, that they're too important in our lives. And there's also, I think, a running concern now that these firms are going to dominate in general purpose technologies, particularly artificial intelligence, and that is going to allow them to take over huge parts of the economy.

Now, as I say, I think that's the concern in the popular imagination. I think

However, they do all have the following in common: there are big economies of scale in software and Intellectual Property (IP) and those are really important for these firms. They benefit from network effects where the more people using the service, the more valuable the service is to other people. And also, there is what’s known as “data economies of scale”.

Roumeen Islam: And thank you for that, Michael. Now, you mentioned several big tech firms that are American, but of course there are many in other parts of the world - to name one- Alibaba. Would you say that this was a big tech firm as well?

Michael Katz: That's a very interesting question. In fact, I was thinking about that earlier when I was thinking: “What do we mean by big tech?”

There clearly is a set of firms in China which are the Chinese equivalent of big tech, although I think that when most people talk about big tech, they actually do mean the four American firms. And that is why, I think, there's an international politics overlay to this issue. There are certainly some tensions between the U.S. and Europe, for example, as to what extent it is the American nature of the firms that is affecting how they're viewed and how they're treated.

I think there are analogs in China. I think, though, that it's somewhat different and because a lot of the Chinese firms are so oriented towards the Chinese market, I think they tend to raise fewer issues internationally. Obviously, there's some big issues such as claims about national security and such, but I do think that there's a pretty significant difference in how people think about the Chinese analogs to the American big tech firms. But you're right, they do have many of the same features.

Roumeen Islam: Okay. They're the same features, but American firms tend to be far more globalized, is what we’re saying. What happens to competition in the presence of such increasing returns to scale?

Michael Katz: One of the big things that can happen is that we see what are known as “positive feedback cycles”. And let me give you an example to illustrate. When Apple came out with the iPhone and its iOS software platform, some app developers saw that as a good platform to be on and they developed apps that could run on your iPhone because they said “oh, there’s a bunch of people using the iPhone and the iPhone is a good programming environment.”

Then because those apps were available, more consumers said “the iPhone is something I wanted to buy, because look, it has all these apps”. And then additional app developers said that “look at all these potential customers who have iPhones. I should develop apps for the iPhone!”

And so, you have this back and forth that more iPhone owners leads to more apps, which leads to more iPhone owners, which leads to more apps. So, you see this virtuous cycle. And so that's where I think we see that there can be this advantage of size and this can affect competition, because it could also have firms that don't get that cycle going.

So, with mobile phone systems, we see that this has happened with iOS and Apple. We also see it happen with Google's Android system, but then Microsoft had something known as Windows Phone, and it never took off. And in fact, it collapsed because they couldn't attract enough app developers to really get the cycle going.

So, what happens here is that there are these benefits of size and the firms that succeed could start taking off, but if you don't get one of these feedback cycles going, you may ultimately disappear or just be a weak competitor.

Roumeen Islam: Okay. So, this is an important point. Could you go a bit more into why positive feedback cycles actually matter for competition in the market or for the market?

Michael Katz: Because of this effect, you can get “winner take all”, or “winner take most”  outcomes, where the firms that get the positive feedback cycles pull away from everybody else which then raises a concern about whether we're going to see competition, or we're going to just see in every market one firm that is the winner, and it dominates.

And, that is a big concern. But on the other hand, people say, “well, maybe we need to think about competition differently in markets like this.” And rather than think of a bunch of different firms competing with one another at the same time to attract customers, we have this succession of temporarily dominant firms.

Roumeen Islam: I guess what you're saying is that even if you have winner taking all, it may not necessarily be bad. That's my next question. Is it all good or bad?

Michael Katz: I would say in a sense it's neither, because it's just a consequence of the fact that we have big returns to scale. While I say it's neither, we still do need to recognize that it can lead to problems in terms of competition.  And it can raise issues that we need to watch for, because And so,

Roumeen Islam: So how do firms actually compete to become the next dominant firm. Suppose there is a dominant firm in the market, how does that firm retain its dominance, or how does the next dominant firm enter.

Michael Katz: So, typically it's going to be some form of innovation. And in fact, this competition for the market is also sometimes called Schumpeterian competition named after Joseph Schumpeter, who wrote about the gales of creative destruction.

By that, what he meant is that you could have these firms that seem, large and permanent. And yet the creative destruction is this process of innovation coming in with an innovator coming in and displacing the incumbent. And so that's how we often think about the competition in this sort of market. It's the innovation competition that is really the critical aspect.

Roumeen Islam: All right. So, you're saying that small firms or new entrants try to innovate to become the dominant firm. However, aren't they at a disadvantage already, given the benefits of size that you've just spoken about? I'm still finding it hard to see how they become the dominant firm, just by bringing a new innovation. How did they get others to try it, to know about it?

Michael Katz: You've hit on something that can definitely be a problem in a market like this. And it's something of a paradox because we’re saying, “look, in in a market like this, entry is really important to industry performance” because the bulk of competition is not different incumbents, fighting with each other for market share. The core of competition is new firms coming in with new ideas.

So, entry in these markets is vitally important, yet at the same time, for the reasons you identified, entry can be really difficult. The entrants by definition don't yet have the scale. And that's why

Consumers may recognize this and expect you to be the new winner. And if everybody starts thinking you're going to be the new winner, that makes you attractive to them, and then you can start a positive feedback cycle of your own. If you think about it,

Alta Vista was a market leader, for example, in search. Google came in with what was seen as a better search. That's one of the things that made people go to them and they got the feedback effects going. The same thing with Facebook, displacing Myspace.

So, it can be done, but one should not minimize the difficulties. That is one of the reasons why there's concern in these areas. You frequently will hear people say things like “well, that's fine. In the past, we had successive waves of innovation. And we had new firms that emerged as the dominant firm, but now this time around the process is stopped and there'll never be another Google, or there'll never be another Facebook.” And people do have that sort of concern.

Roumeen Islam: Well, if you look at human history, I'm not sure that I would buy that. There's always going to be more and more innovation, I think. Are there other ways for entrants to overcome the lack of scale?

Michael Katz: Yes. And one of them is what's known as two-stage entry and in a sense, what you do is you try to build up scale somewhere else, and then let that scale serve you as you become an entrant in a new market.

The way you do that, is you either build up a base of users in another market or with another product, and then you transfer those users over to the business you're trying to enter, or you use the data you've collected from those people to do it.

Let me give you an example, or at least what some people think as an example. They think that Instagram was on its way to doing this before Facebook bought Instagram. They are saying Instagram is building up a base of users and it's collecting data on those users and it might be able to use that user base and that information to itself become a full-blown social network and compete with Facebook.

So that's a way in this two-stage entry: phase one is being a photo sharing app and then phase two is going fully into social networking. And then of course there could actually be more than two stages. But the idea there is that you build up success somewhere else to get some of these benefits of scale, and then once you've built yourself up in these other areas, you use that to launch an attack in the new market.

Roumeen Islam: That's a very interesting strategy and I can see why it works. Now when there is a new entrant, we seen some big firms coexisting in the same space. So obviously they can co-exist and I guess it doesn't always have to be that the winner takes all. So, could we talk a little bit about this?

Michael Katz: That's absolutely correct. I think there are people who've pushed back and say this concern about “winner takes all” is overblown. I would say there are certainly people who do make too much of it, but we do see it happen.

But we also see the other way, where That they're offering products where one firm's products may appeal to a certain type of consumer and another firm's products appeal to a different one. I think we see that, for example, with Android and iOS, right? The Google and Apple mobile phone operating systems.

There are a huge economies of scale and increasing returns in mobile phone operating systems. Yet both of those systems are prospering because they offer different things to different consumers. So, some people pick one and some people pick the other and you don't see the market fully tip one way or the other.

So, the key there though is that you have some sort of differentiation, so that different consumers make different choices.

Roumeen Islam: I understand that having differentiated products matters, but I also wanted to think a little bit about these big companies where they operate in many markets. You gave one example of that I think earlier on.

Because they operate in many markets. They could have FinTech versus e-commerce versus something else. So maybe some of these are better in some markets than others, and they learn from these other markets to compete in the market in which they may not have been as good. Could you speak a bit about that? Is that true?

Michael Katz: Yeah, actually I hadn't thought about this before you raise your question, but it's a really thought-provoking question. In a sense, what a lot of people are worried about with these big tech firms is that they have such good resources and capabilities that they can pursue two-stage entry strategies to enter almost anything.

And I do know, for example, that Google has made various efforts to use their voice recognition technology and their ability to scan documents (they have the software to act as if it understands the documents and to extract information from it) to enter into a really wide range of industries.

Because you think about understanding documents— it’s just huge for all sorts of financial transactions. For example, if you're going to get a mortgage, there’s all sorts of information that the potential lender has to review, and Google has skills that allow them to read the documents and store them.

Also, in healthcare in probably most nations, I think it's still the case, there's an awful lot of stuff that's written down by hand or that's in forms that are not in any sort of rigorous order, or any sort of centralized database. And so, the ability to “read documents and make sense of them with software” is something that just could be hugely important in a lot of different industries.

So yes, there is this concern. That's where there's something of a paradox and I think that people who are concerned about it are going a little bit overboard. Because normally we think that this is great, we're worried there's not enough entry and we're worried about firms that do have the ability to do two stage entry somehow being blocked or bought out or stopped from doing it—and I suspect we will come back and talk about Instagram. Yet here people are worried that these firms are going to engage in too much two-stage entry.

Roumeen Islam: So, most of these firms are multi-sided platforms. Are there any additional issues you'd like to bring up regarding multi-sided platforms?

Michael Katz: When we say they're multi-sided platforms, what we mean is that these firms are often operating the service that brings two different distinct sets of users together.

In the case of Google and search, you have people who are engaged in search (it can be any one of us who's listening to this) and then you also have people who are advertisers, and it's bringing those two sides together. Or, Amazon is bringing together potential sellers and buyers.

And the fact that they're dealing with multiple groups at once, does raise a bunch of issues. My own view is: in a way it's just more of the same—any firm has to do something to attract its users. Now here, the firms may have to do different things to attract multiple sets of users.

And what that means is that competition authorities need to keep track of more things. They need to think about how all the different user groups are affected by various policies. I would say I'm a little torn on this. I think there are people out there who say “oh, multi-sided platforms, it's all new, we need to throw out the old playbook. Competition policy will never be the same.” And I think that's wrong.

I think an awful lot of competition policy carries over. At the same time, it does raise complexities, because the fact is that we have to keep track of multiple user groups at once and we need to be careful. But I think we have a big knowledge base on which we can build.

Roumeen Islam: What you just said, Michael, makes me think that all of the effects that we've been talking about actually did exist in some form in markets before. And the reason we're talking about them now is because the digital economy has made the costs of acquiring customers and advertisers and data just exponentially cheaper. And that's why these problems have become much bigger. Is that right?

Michael Katz: Yeah. I would agree with that. These are all forces that you could point to in the past. There were big economies of scale in having railroads and they were the equivalent of network effects in railroads. And in fact, railroads dominated in a lot of ways.

There were big economies of scale in producing automobiles. And -certainly at the American economy- it used to just be dominated at the very top. What would be big tech today would have been the big automobile manufacturers and oil companies.

We have seen these things before. As you were saying, the big difference is just the degree of it. The fact that because of the internet, these firms can just operate at such a global scale. The other thing I think is triggering the public policy concerns though, is that these firms are collecting almost unprecedented amounts of information about us.

And the reason I say “almost unprecedented” is I don't think most people understand just how much information was collected about them in the past by credit agencies and potential lenders. I remember reading about one American bank that had something like 20 or 30 single-spaced type pages of information about everybody in its database.

Now it's true today that you might have gigabytes of data about individuals, but still, even if it's not, unprecedented, there's just so much data about people that at least on the policymaking side, people are more concerned about it than they used to be. And also, just that these firms just are so big, but again, as you said, I think it really is a matter of degree. These are issues generally that we've seen before.

Roumeen Islam: You're right. These big tech mergers have been getting a lot of attention. Let's talk about Facebook's acquisition of Instagram and WhatsApp. There are calls to unwind these, and I want to ask you: What are the implications of this and what are the pros and cons of mergers? What are the pros of allowing mergers like this to happen?

Michael Katz: When I think about the arguments for or against mergers, I think it's useful to think about what the merger's doing in two different categories.

One is what I'll call “post-merger effects”, which is traditionally what merger policy has been concerned with. What I mean by that is you ask, “if the firms merge, what happens after they merge.” And the arguments that are typically made for mergers is that the merger is going to lead to some sort of efficiency that the merging parties are going to combine some sort of complimentary assets, whether those could be physical assets, they could be their customer bases, they could be intellectual property. Or it could be things like know-how: one firm has best practices in one area, and another had best practices in a different area, and they can get together and combine best practices.

The argument is that those sorts of efficiencies can lead to lower costs or higher quality products, which will then benefit consumers. So, I think that's the biggest argument that's made for mergers or the biggest pro in terms of post-merger effects. I will note that there used to be an argument that I haven't heard in a long time that mergers are useful in what's known as the market for corporate control. The idea is that sometimes you'll just have bad management become entrenched and the only way to get rid of the bad management is for another firm to buy up that poorly managed firm and throw them out, but we don't hear that so much anymore. I think it’s really much more about efficiencies in terms of post-merger effects.

As you could guess, if they're post-merger effects, they're also pre-merger effects to talk about. And what I mean by that is that merger policy—meaning the overall way that government treats mergers—can affect how firms behave before they even proposed to merge.

One of the things that many people consider to be a big benefit of allowing these mergers is that you can have small firms innovate where the firm says: “Look, there's no way I'm going to become the new dominant firm or displace the existing one. If that's what I have to do, forget it, I'm going home. But if I know that if I start to develop a successful product, some other firm (one of these big tech firms for example), is going to come along and buy me because they want the intellectual property that I've developed, that gives me an incentive to innovate.” That is called entry for buyout.

One of the things that more conservative commentators on competition policy are concerned about, is that if we ban big tech from acquiring smaller firms, that will stifle investment in this sort of innovation where you have these little firms saying, “Look, our exit strategy is to be bought out by a big tech firm and that's what's motivating us to generate new intellectual property and come up with these innovations.”

So, in summary, those are the two arguments post-merger that we're going to combine assets in a way that's going to make us more efficient and a stronger competitor. And that pre-merger, it's going to incentivize investment in entry for buyout.

Roumeen Islam: This effect, this incentive for being bought out is actually quite present in many types of countries, not just in America, but other places where startups may find it hard to grow into full-size firms. I've actually heard entrepreneurs say that they would like to be bought up by Google or Facebook or whatever, because it's very difficult to actually grow in their domestic economies and reap the benefits of that growth. Now, what about the cons of allowing mergers?

Michael Katz: So again, I can talk about it and both post-merger effects and pre-merger effects.

In terms of post-merger effects, the biggest concern is that a merger may eliminate competition. If they didn't merge, the two firms would be going head-to-head, trying to attract customers. That head-to-head competition would benefit those customers. And that's a concern people have raised with respect to Facebook's past acquisitions of Instagram and WhatsApp.

There's a concern that had Facebook not acquired either of those firms, they might've evolved into competing social networks, and that consumers would have benefited from that competition. We've also seen in the U.S., there have been hundreds of hospital mergers that have ended up being improved and there's been real concern that by merging and ceasing to compete in various local markets, that those hospitals have been able to raise prices and haven't been pushed as hard to have high quality services. That's really the biggest concern.

I should also mention something that we have already talked about eliminating competition, harming the people who were buying the firm's products. There's also increasing concern about the loss of competition to hire employees. If you let firms merge, that could be bad for workers.

I want to distinguish two forms of workers. I think that at least for someone like me, they are different. One is that, when the firms become more efficient producers, they may just need fewer workers. And I think it's important not to use that as a reason to object to mergers, because if you're going to stop innovation and stop technological progress, ultimately that's going to be bad for workers because they're going to be less productive.

But what I think absolutely is a problem is what happens where two firms merge and they say “now that we're one firm, let’s stop competing with each other by offering workers higher wages, to try to get them to one of us over the other.” That loss of competition absolutely is a bad thing.

That's the post-merger effect, the loss of competition.

There's also a concern with pre-merger that, while we talked about entry for buyout as a pro, some people think of entry for buyout as a con in the following sense: “if I knew I couldn't be bought out, maybe what I do is I would go for what Americans call “home run” and British call, “a boundary”.

You would try to have a major innovation that would allow you to get a positive feedback cycle going, that would allow you to become the new dominant firm, but if the option to sell out to the incumbent is there, you may say, “look, that's the more profitable path for us, let's go for a smaller innovation. Something that we know will complement what the incumbents do. We will not try to replace them, but let's develop something that the incumbent would like, so they'll buy it from us.” So, the possibility of merging as your exit strategy may make you less ambitious. And ultimately that could end up being bad for the economy.

Roumeen Islam: Thank you, Michael. That was a very good lesson in why we look at mergers as part of competition policy. I think we're going to end the first part of our podcast here, and until the next episode where we do the second part. Thank you.

Michael Katz: Thank you. This has really been a pleasure.

Roumeen Islam: Well, listeners, what did we learn today?

Firstly, And of course, by supporting innovation. Secondly, mergers, which could make a dominant firm larger may have an impact on both efficiency and innovation. Thirdly, even in tech markets with large firms and large economies of scale and scope, smaller, innovative firms have found ways to enter and two stage entry is one way to do this successfully.

Thank you and bye for now.

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