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Digitalization and market power

Article by Thieß Petersen, Senior Advisor, Global Economic Dynamics Project, Bertelsmann Stiftung, Germany and Lecturer, European University Viadrina

The use of digital technologies increases market transparency for consumers and enlarges the relevant market. This strengthens their negotiating position vis-à-vis companies. However, there exists also the risk that large technology companies will develop into global monopolies that exploit their market power at the expense of consumers.

Digitalization reduces the market power of local companies

On the one hand, digitalization can reduce the market power of individual providers. If only one supplier of electrical appliances operates a store within a thirty miles radius in a rural region, she can charge mark-ups for her products and thus increase her profits. However, if there are internet-based search engines and online platforms, interested customers can search for offers of equal quality and take advantage of price differences.

Digital technologies also reduce the costs associated with delivering a product purchased online and handling payment. Consumers can therefore significantly expand the market that is relevant to them. For example, a local electronics retailer loses market power and has to adjust her price to the national or even worldwide market price.

A further weakening of the market power of local providers results from the possibility that private individuals offer goods and services on digital platforms. If they appear on the market as additional suppliers, this has an impact on the established commercial providers. For them, the additional supply represents competition that forces them to reduce their prices.

Digitalization can result in global monopolies

On the other hand, the characteristics of digital goods can have the effect that only one provider dominates a market in the long-term, thus creating a monopoly. There are two central reasons for this.

(1) The development of digital infrastructures or new computer programs involves high fixed costs. Once the computer program exists, the duplication and distribution of further copies of the program involves very low additional costs. With this cost structure, the increase in production volume results in decreasing costs per unit. This means that the supplier who produces the largest quantity has the lowest costs per unit and can therefore demand the lowest price. Therefore, only one supplier survives on the market.

(2) Digital platforms often rely on network effects. This means: The benefit for the consumer depends on the size of the network. The more participants there are in a social network or an online platform such as Airbnb, the more attractive it is for people to join the network. In the end, the company that has the most participants wins – and displaces all other providers

Disadvantages of monopolies for consumers

Monopolies have a number of economic disadvantages for consumers, other companies, and employees.

First, monopolists demand higher prices because they have no competition. For consumers, this means a loss of purchasing power, which reduces the opportunities for consumption.

Secondly, a monopolist also has market power as a buyer, with which it can lower the prices of inputs and wages. There are indications that the emergence of so-called superstar companies such as Google, Apple, Amazon, Facebook, and Uber is putting pressure on wages or on wage increases.

Thirdly, for a monopolist without competition, there is no need to improve the quality of its products and lower the prices of its products through technological progress. The central advantage of a market economy for consumers – an improved product offering at lower prices – is thus not realized.

Fourthly, monopoly profits imply high financial resources. This financial power can be used to buy up potential competitors at an early stage and thus restrict competition. The financial resources can also be used to acquire companies and enter entirely new markets that are not part of the actual business area.

Finally, economic power can become a political power. Monopolies are important economic actors as employers and taxpayers. This increases the probability that political decision-makers will listen to these companies and their partial interests. This can result in political decisions that are at the expense of consumers, employees, and small businesses.

Conclusion and outlook

The increased use of digital technologies offers a number of economic advantages. These include, above all, an improved supply of goods and services. As digitalization progresses, people are being offered a greater variety of products, can consume a larger quantity of products, and have to pay lower prices. Greater market transparency strengthens the position of consumers vis-à-vis companies and reduces prices further.

The economic risks of digitalization include monopolization tendencies, which can be at the expense of consumers and employees. A key economic policy challenge is therefore to use competition policy instruments to prevent the exploitation of market power so that the price-reducing and welfare-enhancing effects of increasing digitization can be realized.

Note: This is a shortened and revised version of the article “Digitalization of the Global Economy: Monopolies, Personalized Prices and Fake Valuations“, which was published on the project page of “Global Economic Dynamics” on October 30, 2020.

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