Publication date: 28 October 2019
Online market failures and harms
An economic perspective on the challenges and
opportunities in regulating online services
Online market failures and harms – Welsh overview available
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Online market failures and harms, Summaries of Remedies
This paper examines how harms that arise online could relate to each other, by exploring common industry characteristics and market failures ...
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Publication date: 28 October 2019
An economic perspective on the challenges and
opportunities in regulating online services
Online market failures and harms – Welsh overview available
Contents
Section
1. Overview 1
2. Key characteristics of online services 10
3. Market failures that can arise online 19
4. Harms that arise online 24
5. Challenges and opportunities for regulation of online services 37
overlaps and tensions between policy aims. These are challenges for existing regulators, as well as for any future regulation of online services being considered by Government.
Interventions to address harms should be carefully designed to overcome these challenges and avoid undesirable unintended consequences. Interventions will need to be flexible to deal with fast- evolving services and markets, and regulators can use new techniques to understand the complexity of online business models and consumers’ decisions. The scale and variety of online services mean they overlap with the remits of existing regulators. Regulators need to recognise the potential links between online harms as they design their rules, and work closely alongside each other.
The context for this paper
1.1 Online services have revolutionised people’s personal and working lives, generating significant benefits to society and the economy. But features of some online services may cause or exacerbate a range of harms to individuals and society, captured in part by the following UK policy reviews:
- the Furman panel, a group of experts appointed by HM Treasury and led by the economist Jason Furman, explained how consumers may be harmed in online markets where competition is limited;^1
- the Cairncross review, in which the then Prime Minister asked Dame Frances Cairncross to examine the sustainability of high-quality journalism as consumers increasingly access media online;^2 and
- the Department for Digital, Culture, Media and Sport and the Home Office proposed in a white paper to further regulate technology companies, with a view to protecting people from harmful content and conduct online.^3
1.2 There have also been similar reviews in other countries, reflecting common challenges internationally. For example, the Stigler Center based at the University of Chicago formed a Committee which assessed the impact of digital platforms on: the economy, privacy and data protection, news media and the functioning of democracy.^4 The Australian Competition & Consumer Commission published a report on its inquiry into digital platforms, which looked at the effect of search engines, social media and other digital content aggregation platforms on competition in the media and advertising markets.^5 The European Commission commissioned a report which explores how competition policy should evolve to promote innovation to the benefit of consumers in the digital age.^6
1.3 As the UK communications regulator, Ofcom has powers and duties relevant to some online services. We regulate the infrastructure over which online services are delivered
(^1) The Furman Report, Unlocking digital competition, March 2019 (^2) Cairncross Review, A Sustainable Future for Journalism , February 2019 (^3) UK Government, Online Harms White Paper , April 2019 (^4) The Stigler Center, Stigler Committee on Digital Platforms Final Report, May 2019 (^5) Australian Competition & Consumer Commission, Digital platforms inquiry , July 2019 (^6) Cremer J., de Montjoye Y., Schweitzer H., European Commission, Competition policy for the digital era , 2019
and we set the standards for some categories of online content. For example, we ensure that streaming services such as BBC iPlayer and Amazon Prime Video meet certain content standards. Our powers to enforce competition law and conduct market studies include some services delivered online. We also have duties to promote awareness and understanding of all types of electronic communications media. We are doing this through our Making Sense of Media Programme, working with fellow regulators, Government, industry, the third sector and academics.
1.4 As consumers continue to shift more daily activities online, they benefit from new and innovative forms of communication. Online services therefore will become increasingly relevant when we intervene to promote competition in communications markets. We need to consider how these online services interact with, and possibly even reshape, existing communications markets. We will also have to address challenges posed by some online communications services themselves. For example, if the new European Electronic Communications Code is transposed, we will need to consider consumers’ experience of internet-based communications services such as WhatsApp. We are also considering how online services and capabilities can benefit consumers. For example, following the Government’s smart data consultation, we are considering how consumers may benefit from sharing data on how they use communications services with third parties such as price comparison websites.
1.5 This paper provides a broad overview of online policy issues to inform this work. It explains from an economic perspective how market failures in online services may cause a wide range of harms to individuals and society. It also looks to contribute to the wider debate by highlighting the complexity of this area and the potential for unintended consequences if regulation fails to take a holistic perspective.
1.6 We also draw on our experience as a regulator to describe the challenges we should navigate when we consider online services under our existing powers. Some of these challenges are similar to those we face in regulating traditional services, but we recognise that in some circumstances online services will require us to adapt our approach.
1.7 While this paper provides a conceptual approach that we can use to analyse online harms which fall under our remit, it will be part of a broader policy assessment as we look to evidence and address harms where they arise. For example, an analysis of market failures can complement the framework of rights and responsibilities that has underpinned standards regulation in traditional media.
1.8 We hope this paper can also assist policymakers and fellow regulators as they consider the unique challenges associated with developing effective regulation in this area. As its focus is to provide a conceptual overview of harms and their potential sources, this paper does not seek to provide new evidence that such harms arise online. Nor do we hold a view on how future regulation of online services should be structured or assigned, which are matters for Government and Parliament.
- Market power. Where a service is concentrated with one or a few providers, they may have market power. That may be because the threat that an entrant will displace the incumbent is weak. For instance, the UK’s Competition and Markets Authority (CMA) is investigating whether certain online platforms enjoy market power in consumer-facing markets and digital advertising, in part because of the entry barriers that may arise from the need to access data on a large number of users to improve service quality.^7
- Barriers to switching. Some factors can increase the cost to users of switching between online providers. This may degrade the user experience and make it less likely that they will consider switching to an alternative service. For example, changing social media account might mean users lose contacts or personal media in the process.
- Information asymmetry. Consumers might not choose the best course of action if they do not have all the relevant information or technical knowledge they need when choosing products. For instance, consumers often accept terms and conditions without reading them, and therefore are often unaware of how much data they are sharing as they access services online. The impact of this is particularly relevant online, where connected devices combined with data analytics allow providers to observe and infer more about consumers than what is typically feasible offline.
- Behavioural biases. There are several well-documented behavioural biases which mean that consumers do not always choose the best course of action. For example, people may find it difficult to trade off the immediate benefits of accessing a ‘free’ service (such as social media) with the potential longer-term costs of sharing their data (such as the risks of fraud following a data breach). Access to data and data analytics allow online providers to understand consumer biases in more immediate and intricate ways. The potential to test the impact of changes to services at lower cost, sometimes in a personalised way, means that there is more scope for online providers to leverage these biases to influence consumers’ choices in novel ways.
- Externalities. Online consumers and providers may not always consider the impact of their actions on wider society. This may be the case if content-curation algorithms which seek to maximise consumer attention do not account for potential harm to individual users’ wellbeing, for example, where consumers’ attention may be captured most strongly by harmful content. These algorithms may also fail to acknowledge the potential for wider societal impacts arising, for example, from disinformation.
How market failures combine to create online harms
1.13 In cases where an online service is characterised by the presence of one or several market failures, there may be harm to consumers or society. The definition of online harm in this paper is wide, and it includes a broader set of harms than the content and conduct harms discussed in the Online Harms White Paper.^8
1.14 The rows in Figure 1 list a range of consumer and societal harms that could arise online. These are harms identified by UK policy reviews, alongside related issues raised as part of
(^7) Competition and Markets Authority, Online platforms and digital advertising market study, July 2019 (^8) UK Government, The Online Harms White Paper, April 2019
the wider public debate. The columns of the figure indicate the market failures that could be a source of, or an exacerbating factor for, each harm.
Figure 1: Market failures that can contribute to consumer and societal harms online
Source: Ofcom.
1.15 Figure 1 shows that an individual consumer or societal harm can result from (or be exacerbated by) a range of different market failures, either individually or in combination. The figure also illustrates that a given type of market failure can contribute to multiple harms across different policy areas.
1.16 This generates the potential for complex interactions between market failures and harms, which can create links between hams and their policy areas. There are three related factors that mean these links may be stronger in online services:
- The tendency towards concentrated markets. Where concentration results in market power, providers may be able to charge higher prices or offer poorer quality, choice and innovation – in some cases by distorting competition against rivals. In some circumstances, weak competition might reduce the incentive for firms to invest in dimensions of quality which some consumers may value. This may include underinvestment in protection from harmful content that consumers prefer not to see. Market power, if exploited, can also create harms through impacts on other firms. For instance, where it could undermine the sustainability of high-quality journalism.
- The drive for data and attention. If access to data gives incumbents a significant competitive advantage, this can make it harder for other companies to enter and
- Tackling several harms at once. Understanding the interactions between market failures and harms may allow regulators to capitalise on synergies that could exist from targeting a remedy at a market failure or industry feature which is at the basis of several harms. This could promote efficient remedy design, possibly reducing the number and cost of interventions. It could also reduce the burden of regulation. For example, limiting the ability to personalise the curation of certain content may improve people’s exposure to a variety of views, which can allow for more informed political views. This variety can also reduce the impact of disinformation, for example where it increases people’s ability to critically assess the content they are served online. In this example, any reduction to the quality of service experienced by users would also need to be considered.
- Trading off harms. Interventions are less likely to cause unintended consequences if regulators understand the links between harms. Where a remedy cannot be developed to limit these unintended effects, regulators may need to balance the need to address a given harm with competing policy aims. For example, the operational cost associated with content regulation may undermine the ability for smaller content providers to compete effectively, possibly entrenching market power of larger incumbents.
1.20 The characteristics of online services can themselves challenge effective regulation, requiring careful consideration before regulators intervene in online services which have provided significant consumer benefits. In some cases, providers also take voluntary action to tackle some online harms. Where regulators nonetheless decide intervention is needed, the risk of regulatory failure could be particularly high for several reasons:
- Complex business models can generate links between different services, which can make it harder to identify sources of harm and can challenge traditional approaches to regulation. This means that in most cases services should not be reviewed in isolation. Regulators could use new techniques to test theories of harm and potential remedies.
- There is a wide variety of online services, acknowledging the differences between them can be relevant in identifying harm and designing effective remedies. Regulators may have to prioritise appropriately and take a proportionate approach where the scale of an online service may make it more difficult to eradicate harms entirely. More generally, the internet’s global nature and the scale of major online players mean that some remedies can be more effective and efficient if coordinated internationally.
- In dynamic and fast-moving services future outcomes can be hard to predict , which may require regulators to take decisions under greater uncertainty. The role of dynamic competition can mean that it is particularly important for regulators to consider the effects of their remedies on entry or innovation. It also means that interventions need to be timely to address harms and may require updating as services develop.
- Bias in consumer decision making due to information asymmetry and behavioural biases can lead consumers and producers to respond to remedies in unanticipated ways. Regulators need to be conscious of these potential effects when intervening online. In some cases, field trials and data analytics may help identify the impact of consumer decision bias, which in turn can promote the design of effective remedies.
1.21 Government and Parliament are currently considering the need for additional regulation of online services. But the variety of online services mean they already overlap with the remit of existing regulators. There are likely to be benefits from these regulators working together to share knowledge and tackle issues which touch on several policy objectives. We are already working closely with the ICO and the CMA – sharing expertise on communications services, ex-ante competition regulation and data privacy. Regardless of any decisions Government and Parliament take on the future regulatory framework, online issues will continue to be relevant to existing regulators. So this type of collaboration will remain important.
1.22 We explore these observations further in the remainder of this paper:
- Section 2 identifies the main characteristics of online services that are relevant to policy interventions.
- Section 3 describes the market failures that can stem from these characteristics.
- Section 4 describes the consumer and societal harms that could arise online and explains how a common set of industry characteristics and market failures leads to links between these harms.
- Section 5 identifies the challenges to designing effective interventions online which limit negative unintended consequences.
cases will vary. This paper does not draw conclusions about individual services, and examples are used to illustrate points rather than suggest concerns.
The scale and variety of online services
2.5 The internet reduces obstacles to a wide range of interactions between its users. For example, it allows people to assess many products and services without the need for physical store visits. This has facilitated connections between businesses and consumers on a global scale and across a variety of commercial transactions, which is reflected by the fact that worldwide internet usage has increased from 16% to 48% from 2005 to 2017.^13
2.6 The impact of digitisation is particularly noteworthy in the context of the creation and distribution of content. Technological progress has significantly facilitated the creation of content by individual consumers (for example, due to video editing on mobile handsets). Combined with the emergence of online content sharing platforms (such as YouTube), the internet has promoted the distribution of user-generated content at a lower cost, and therefore much greater scale, than previously experienced.
2.7 The emergence of audio-visual streaming and online news means that a significant proportion of consumers now access content online. To illustrate, Ofcom’s review of news consumption by UK adults found that the internet is the second most-used platform to access news (66%).^14 Moreover, Ofcom found that 92% of UK internet users access YouTube every month, spending on average 27 minutes per day on the site.^15
2.8 The extent of interactions that take place online, and its impact on our economy, is also apparent in the advertising sector. As illustrated in Figure 2, the digital advertising market now commands the largest share of advertising spend in the UK.
(^13) International Telecommunications Union, ICT Facts and Figures 2017 , 2017 [accessed 11/10/2019]. Percentages given are the proportion of the world population accessing the internet from any device via a fixed or mobile network in the past three months. (^14) Ofcom, News Consumption in the UK: 2019 , July 2019, p. 15 (^15) Ofcom, Online Nation report, May 2019, p. 10
Figure 2: Share of total UK advertising spending by medium, 2017
Source: IAB UK / PwC Digital Adspend Study.
2.9 In addition to advertising, online providers generate revenue using subscription business models (for example, Spotify Premium) and transactional business models (for example, Amazon and Uber).^16
The role of data and algorithms
2.10 Access to large datasets and advanced data analytics (that is, artificial intelligence and machine learning) can be an important input in delivering online services. Data can be used to promote providers’ ability to generate revenue by improving services, enhancing targeting, or informing new product development.
2.11 This can be particularly relevant for providers which generate revenue through advertising. Data may allow these providers to improve their services and attract consumer attention; and it can allow them to target advertising more effectively at those consumers. We use a broad definition of ‘attention’ in this context, which covers all types of interaction with a service that could be monetised, by providing opportunities for advertising, sales or other ways of generating revenue. For example, time spent consuming content or instances of search queries.
2.12 While access to data and the use of data analytics is not unique to online services, the scale and more immediate nature of this access sets online services apart from most traditional services. Providers of online services can use this data to derive increasingly more sophisticated and accurate predictions of user preferences, which allows them to target their services at users who most value them.
2.13 Moreover, these observations on user preferences can inform product development. They can allow providers to adjust their services to promote user interaction, in some cases on
(^16) Some business models generate revenue from multiple sources (for example, Amazon generates revenue from Prime subscriptions alongside transactional revenue). There are also other options for generating revenue which are not widely used currently but may have a more important role in the future, such as donations (for example, Wikipedia) or integrating cryptocurrency or tokens into protocols.
Twitter are considered more valuable to individual users the greater the number of other known users also active on the platform.
2.19 But they can also be ‘indirect’, where the value for users on one side of the platform increases with the number of users on the other side of the platform. For example, an online marketplace will be more attractive to business users the greater the number and uniqueness of potential customers that access that platform.
2.20 Another example is YouTube, where the value of the platform for viewers increases with the amount of content they can access, as long as they can navigate the content. The greater the audience the platform can provide access to, the more attractive it is to content providers and advertisers.
2.21 The presence of network effects implies that, all else equal, larger platforms offer users a better product. As a result, markets can be concentrated if they ‘tip’ in favour of one or a few platforms (‘winner takes all’ or ‘winner takes most’). This is more likely where users are active on only one platform (‘single-homing’). Consumers might have preferences for single-homing due to several factors, such as cases where engaging with multiple services is perceived as more complicated or time consuming, or if status quo bias makes consumers less likely to try new alternatives.^22
2.22 In markets susceptible to tipping, competition is often ‘for the market’. In such cases, competitive constraints on incumbents come from the threat of being displaced by a rival or an entrant. For example, when a significant fraction of consumers switched from social networking site Myspace, to an innovative and disruptive entrant Facebook.^23
Economies of scale and scope
2.23 Online services can be subject to significant economies of scale where providers incur a high up-front cost of creating a service, coupled with low or near-zero marginal costs of serving additional users.^24 In these cases, providers benefit from lower average costs as their user base grows, which can contribute to market concentration.
2.24 Separately, some online services can benefit from economies of scope, where a provider can reduce costs or enhance service quality by expanding its presence across a range of related services. This can be achieved by using existing customer and supplier relationships, sharing of technical expertise, and the sharing and merging of data. 25
(^22) Online services can sometimes reduce the impact of these factors and, in principle, facilitate multi-homing. For example, the ability to download multiple apps on a mobile phone can allow consumers to engage more easily with a range of communications services, compared with fixed telephony. (^23) The Furman Report, Unlocking digital competition, March 2019, paragraph 1. (^24) The Furman Report, Unlocking digital competition, March 2019, paragraph 1. (^25) The Furman Report, Unlocking digital competition, March 2019, paragraphs 1.68-1.
The dynamic nature of the industry
2.25 The digitisation of our economy has created new products and services, as well as novel ways to distribute existing services. This has revolutionised a wide range of consumers’ daily activities, ranging from online dating to app-based ride hailing.
2.26 As existing services increasingly move online and new services emerge, these innovations continue to deliver substantial benefits to consumers. They can also be a source of competitive constraint on incumbents, if entrants can launch products that are disruptive to the offerings of existing providers.
2.27 Providers of online services have been a source of ongoing innovation, and some feature amongst those companies with the highest levels of R&D expenditure globally. Research from PwC indicates that Amazon, Google, Microsoft, Apple and Facebook are amongst the largest global spenders on R&D.^26 Their investment in projects such as self-driving cars suggests that these companies have the potential to develop the next disruptive innovation that could alter how our society functions.
2.28 Furthermore, major online providers regularly acquire other players. The Furman review reports that the five largest online providers have made over 400 acquisitions globally in the last 10 years.^27 These acquisitions may allow them to expand the services they offer and improve their existing products. They have also raised competition concerns in cases where incumbents bought businesses which might have become credible competitors, thus eliminating potential competitive threats (some refer to these as ‘killer acquisitions’^28 ).
The role of ecosystems
2.29 Some platforms have expanded the range of services offered to users and developed into increasingly complex ecosystems.^29 Based on Ofcom desk research, the figure below shows a stylised and partial illustration of Google’s ecosystem as an example. It illustrates how Google offers consumers a wide range of services (for example, maps, search, email, mobile OS, YouTube, etc.), which consumers can access in several ways, through a combination of Google and rivals' devices and operating systems. These services allow it to capture consumer attention and collect data that can be used to improve its range of services or generate revenue through targeted advertising. The type of data collected can vary according to the relevant services used, such as information on a consumer’s: demographic details, location, search query (which could indicate a purchase intention) or content viewing (which could reveal an individual's preferences).
(^26) PwC, The 2018 Global Innovation 1000 study , October 2018 (^27) The Furman Report, Unlocking digital competition, March 2019, p. 12 (^28) For example, Cunningham C., Ederer F., Ma S., Killer acquisitions , 2018. This is an empirical study in pharmaceuticals. (^29) We define ecosystem as a set of services offered by a single company or corporate group, with links across these services on the supply and / or demand side.
services (for example, a shopping service) by integrating them with products that interface with consumers directly (for example, voice operated assistants).
2.31 The development of platforms into ecosystems is relevant for policy analysis where it:
- Promotes the convergence between services. For example, a person’s feed on Facebook can include messages from friends, as well as links to online content and advertising. That said, providers can differentiate their offering by aggregating services in different ways. This can complicate the delineation of relevant ‘markets’ for the purpose of a competition assessment.
- Generates complex supply-side links between services across the online value chain. For example, several services may be offered to consumers for free as providers can generate revenue from advertising. Likewise, data collected from one service can enhance the performance of another service. For instance, YouTube recommendations are influenced by a person’s activity on YouTube, Google and Chrome.^31 As a result, the analysis of a given online service may require an understanding of other services that are inherently linked to it through a provider’s ecosystem.
- Creates a dynamic environment where platforms that hold a leading position in one service expand to offer services in which another platform holds a leading position. Figure 4 illustrates how ecosystems of major online providers can overlap in several services. This may suggest that, at least in part, competition also occurs amongst ecosystems. Even where providers do not offer the same range of services as part of their ecosystem, they may still compete to attract and retain consumer attention.
(^31) YouTube Help, Manage your recommendations and search results - Computer - YouTube Help [accessed 8/10/2019]
Figure 4: Presence of major online platforms across software and hardware products
Source: Ofcom, drawing on Varian, Use and abuse of network effects, 2017, p. 13