The future of TMT regulation: from telecom operator networks to OTT network effects

Luca Schiavoni, senior analyst for regulatory policy at Ovum, said: "If you still think that market failure can be addressed by limiting regulation to telecom operators' physical networks and their services, you may want to reconsider.

Regulators’ scrutiny of OTT services is not just about leveling the playing field with telecom operators. They are also working to lower barriers to entry into the internet services market and ensure that today’s startups can enjoy the same favorable market conditions that Google, Facebook and Amazon enjoyed when they first entered the market.

If 2016 was the year regulators began to scrutinize online platforms to identify potential market failures where they could intervene, 2017 was the year competition issues around these platforms began to be addressed. Under existing competition law, operational penalties and remedies can be applied to a company and its day-to-day activities.

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In recent cases, the EU has fined Facebook €100 million and Google €2.4 billion, respectively. Facebook is being fined for not being clear about its ability to share data between WhatsApp and Facebook, despite agreeing on the terms of its merger, while Google was fined because the EU believes it manipulated search results to benefit the company's own comparison shopping service, thereby undermining competition.

In both cases, regulators explicitly mentioned network effects. Network effects will be a key competition issue to be addressed in the future, and if current competition laws do not work, regulators will take an early (i.e., preemptive) regulatory approach as they view big data as a barrier to entry.

There are three reasons for this:

Network effects are crucial to the success of internet services, but they can also lead to customer lock-in. Online platforms connect suppliers and users and thrive through the existence of network effects. Thus, increased scale itself is the basis for further growth in a particular market. For example, Facebook was able to grow because individual users wanted to join their friends on a platform and then communicate with them more easily.

As more people join a platform, advertisers and content providers become more interested in the potential audience on that platform. Network effects are a key part of a platform's success, but they can also cause users to become increasingly locked in. Social network users tend to communicate through a single platform, and Uber and Airbnb users are less willing to explore alternative products because most drivers or hosts are on their respective mainstream platforms.

Regulators will continue to protect competition as a driver of innovation. While technology markets continue to evolve rapidly, regulators are still concerned with two main things: promoting competition and protecting consumers. When they are dissatisfied with their own market drivers on these two fronts, they intervene. Telecom regulators have spent decades ensuring that access to bottlenecks is as open as possible, thereby promoting competition and creating incentives. In the same way, the European Commission and other regulators are now working to ensure that today's startups can enjoy the same favorable market environment that today's giants thrived in 10-15 years ago. They are now looking for ways to achieve this effectively.

Data may not be scarce, but it can still create a competitive advantage. In theory, data assets could be a great resource, and there is nothing stopping companies from collecting data and building increasingly large and comprehensive data assets. The more data a company has, the better it can offer innovative and powerful services, undermining competition from new entrants. Regulators are increasingly paying attention to this aspect, especially when they analyze data-driven mergers based on the potential of the merged company's data assets. This is because the increase in the size and scope of data may become an insurmountable barrier for challengers.

We expect these factors to result in the following trends:

Regulators will identify network effects as a competition issue and take action to address it. This is already evident in recent cases, such as the EU’s fines against Facebook and Google. When the EU fined Facebook €100 million in May this year, it was clear that the decision was unrelated to the data protection investigations being conducted by EU member state authorities at the time. Similarly, the regulation of Google’s dominance and the resulting fines were justified because the existence of network effects will help create barriers to entry.

The issue has also come up in regulators’ position papers, which have gone to great lengths to categorize network effects. In a 2016 workshop, the U.S. Federal Trade Commission identified four categories of network effects. The Dutch government came to similar conclusions, albeit using different criteria, when outlining the distinction between single-sided and multi-sided platforms, which directly or indirectly generate network effects.

Online platforms will continue to exploit network effects as long as regulation allows. While regulators are stepping up their scrutiny, online platforms will continue to rely on network effects because it is a key part of their business model. It is both the cause and the result of their growth. It is therefore both the reason for their profits and the reason for their further investment. Moreover, it is clear that regulators have not yet figured out the most effective way to deal with this problem.

While the €2.4 billion fine on Google may seem shocking, it actually only represents a small fraction of the company's annual revenue. What's more, while the EU intends to monitor the company's behavior within 90 days of the ruling, the European Commission has not yet been able to explain how it will monitor Google's compliance with its obligations to stop favoring its own price comparison service. In other words, the regulator will go through a trial and error period, which will give the Internet giant some time.

EU regulators must be mindful of the unintended effects of regulation. Although the EC has repeatedly stated its intention to create a favorable environment for online platforms, it must be careful to avoid over-regulation. It is clear that regions where regulators are more active are also where online platforms are less developed. Currently, most online platforms are located in Asia or the United States, where they are able to enter the market and face a more relaxed regulatory environment.

Compared to Asia and the US, Europe has so far lacked a vibrant local platform market. Crucially, despite the number of potential consumers in Europe, few platforms have started there or are based in the region. The European market is currently five times smaller than the Asian market and nearly 20 times smaller than the US market. Flexibility in licensing and related policies could be a driving force for the European market to flourish.