Economies of Scale in the Tech Industry: How Big Tech Firms Achieve Dominance through Network Expansion
The media often popularizes the story of the tiny tech start-up that makes it big, becoming a household name and winning millions of loyal fans and customers. The 1970s and early 1980s saw PC pioneers like Apple and Microsoft emerge and grow, and the early 2000s saw MySpace and Facebook surge to dominate our Internet browsers in the social media revolution. But why are start-ups that make it big so cyclical, with only a handful becoming large firms at the beginning of each new digital era? Why is it not a steady trickle?
Various factors give the tech industry, both hardware and software, an oligopoly market structure. In an oligopoly, a few large firms dominate the market and each firm has enough market share to affect the pricing and product decisions of its rivals. For example, to maximize revenue and/or profits, Microsoft must consider what Apple is doing or is likely to do. Video game creators like Electronic Arts and Take Two Interactive must consider what games the other is likely to release, at what prices, and with what features. But why is the tech industry, where software is made on a computer, an oligopoly? Can’t any programmer enter the industry with a laptop and a dream?
High Barriers to Entry Hinder Start-Up Success
Unlike the 1970s and early 1980s, today’s tech industry is no longer the realm of the lone programmer who can slam out enough to code to make a popular video game or addictive app in his or her garage or basement. The complexities of software and video games have significantly increased with each decade, making it more difficult for “indie developers” to compete with the polished products released by existing tech giants. To make products that are competitive today, where consumers are inundated with apps, games, videos, and software on a near-constant base, start-ups need lots of money.
Unlike some other firms, tech firms need a fully finished product before they make any revenue. Some entrepreneurs can do jobs when only partially funded or equipped, such as a lawn care service with just a push mower and an old weed-whacker, but few consumers or investors are interested in a partially-finished app or game. Therefore, tech can be an all-or-nothing competition, especially for start-ups. If the first app or game is not highly popular, there may not be enough money to create a second.
The high risk of start-up failure can create a vicious reinforcement effect by dissuading skilled programmers and designers from joining these firms. This may force many start-ups to be one or two software developers instead of larger teams, making it more difficult for start-ups to compete against “Big Tech.” Competition becomes tiny start-ups of 1-3 developers versus 100+ developer teams at established firms.
Network Effects
Today, most Western consumers have multiple computer devices, from smartphones to tablets to laptops to desktops. Many even have smartwatches, as well as display systems in their cars that automatically sync to their smartphones. Consumers want their devices to work easily together and synchronize their data and settings. This demand leads to a network effect, where the value of a product is increased the more widely it is used. Demand increases with confidence that a device will automatically work with a larger percentage of existing technology.
New tech may suffer from low demand due to consumer fears that it will not synchronize well with their existing appliances or programs. For example, an indie game may be highly popular with a devoted fan base of tech nerds, but is it available on all the app stores for the general public? Is it available on different consoles? Is it downloadable to PC? What about Macs? Sometimes, “Big Tech” may collude to block start-ups from accessing these markets.
Mergers and Acquisitions vs. Anti-Competition Risks
If a start-up does produce a quality product, it may be faced with a difficult choice: allow a merger with or acquisition by a Big Tech rival, or risk attempts to push it out of the market. Big Tech is widely known for purchasing many start-ups to incorporate their products, skilled developers, and research-and-development discoveries. Even if most of these acquisitions do not result in a revenue-generating product, the Big Tech purchasers likely benefit in the long run by reducing competition. Buying a start-up today, even at an inflated price, can pay for itself in the long run by reducing substitutes and keeping the price for one’s original product higher.
A start-up may refuse to be bought, setting up the risk of facing Big Tech’s anti-competitive retaliation. These are illegal actions where a larger firm intentionally tries to block a smaller firm from the market. An example in the tech industry is making a smaller rival’s products inoperable with one’s own, larger platform. This could go as far as blocking Internet users’ ability to discover rivals’ products during an online search.
For hardware especially, Big Tech can hurt rivals’ sales by engaging in anti-competitive pricing, also known as predatory pricing. Thanks to their reserves of cash, a Big Tech firm can afford to charge consumers artificially low prices for its own products, even below the cost of production, for a significant period of time. A start-up can hardly hope to survive, even with a superior product. Consumers will gravitate toward the low-price Big Tech product, with the deal literally “too good to be true.” In the long run, it is: when the start-up goes out of business, the Big Tech firm will raise its price back up - perhaps even higher than where it was before.
Big Tech firms can also create bundling deals that serve a similar purpose. While they are not charging an artificially low price for a product, they are adding features that automatically substitute for rivals’ products. Why buy additional goods or services if the Big Tech version has it all in one package? Typically, the bundling is structured so that it is difficult, if not impossible, to remove the added feature and purchase a substitute.
Antitrust Efforts and Consumer Welfare
It is illegal to attempt to create a monopoly using anti-competitive behavior. In the late 1990s, Microsoft was famously charged by the United States federal government with violating antitrust (anti-monopoly) laws because it forced computer manufacturers who used Microsoft’s Windows operating system to include the Microsoft Explorer Internet browser. This essentially blocked a rival product, Netscape Navigator, from the market. Periodically, the U.S. government charges tech firms with violating antitrust laws, which were established in 1890 with the Sherman Antitrust Act.
Monopolies are considered economically harmful because they result in higher prices for consumers by limiting market output. The single firm in the market can keep prices high by restricting its own production, causing artificial scarcity. Having a monopoly also puts society at risk of shortages if something hinders that monopoly’s output, such as a labor strike or bankruptcy. Monopoly markets also have less innovation due to lack of competition, stifling technological progress. As a result, Western societies have typically criticized monopolies in most industries as harmful to consumer welfare.
Today, the most common tool governments use to prevent monopolies are merger reviews, which occur when regulatory agencies, such as the Federal Trade Commission (FTC) in the United States, are allowed to block mergers and acquisitions by publicly-traded companies. Publicly-traded companies can be blocked from purchasing controlling shares in other firms on the antirust or even national security grounds. Despite these regulatory guidelines, many consider Big Tech giants like Microsoft, Apple, Google, Meta, and Amazon to practically be monopolies.
Allegedly, these firms have enough market power to engage in abusive practices while holding consumers “hostage” to their services. Exclusive or long-term contracts with these firms for commercial services, such as data storage, may dissuade customers from leaving them, especially if they fear that these companies may keep copies of their data. While many consumers like the convenience of only having to rely on a few Big Tech firms (and remember only a few passwords), there is likely a financial price to pay for this convenience.