Google and Facebook’s “Kill Zone”: “We've Taken the Focus Off of Rewarding Genius and Innovation to Rewarding Capital and Scale”

A Stigler Center panel explores the implications of tech giants’ dominance on innovation and startups.

Earlier this week, Treasury Secretary Steven Mnuchin joined a growing number of public officials concerned about the impact of Internet monopolies when he called on the Justice Department to look into the power that digital platforms like Google have over the US economy. “These are issues the Justice Department needs to look at seriously,” he told CNBC, “not for any one company, but obviously as these technology companies have a greater and greater impact on the economy, I think that you have to look at the power they have.”

Mnuchin’s comments followed a 60 Minutes report that examined the enormous power Google wields over potential competitors thanks to its monopoly in online search and search advertising. “If I were starting out today, I would have no shot of building Yelp,” said Jeremy Stoppelman, co-founder and CEO of Yelp, during the segment. Yelp has long argued that Google has abused its dominance in local search to favor its own services over competitors such as itself, and is currently attempting to convince European competition authorities to launch a fresh antitrust case against the company.

“If you provide great content in one of these categories that is lucrative to Google, and seen as potentially threatening, they will snuff you out,” added Stoppelman. “They will make you disappear. They will bury you.”

The sentiment that startups effectively have no chance of competing against the “Big Five” tech giants—Alphabet, Amazon, Apple, Facebook, and Microsoft—is one that has become increasingly common among tech entrepreneurs and venture capitalists in recent years. “People are not getting funded because Amazon might one day compete with them,” one founder told The Guardian. “If it was startup versus startup, it would have been a fair fight, but startup versus Amazon and it’s game over.” As the author and media scholar Jonathan Taplin pointed out in an interview with ProMarket, the very notion that someone could start a new search engine that competes with Google “is just laughed at by the venture capital community.”

Investors and entrepreneurs, said the venture capitalist Albert Wenger during a panel discussion at the Stigler Center’s annual antitrust conference last month, are now wary of entering into direct competition with giants like Google and Facebook. Both companies, along with Amazon and Apple, effectively have a “Kill Zone” around them—areas not worth operating or investing in, since defeat is guaranteed.

Tech platforms, after all, have endless resources at their disposal to either purchase or crush new upstarts they perceive as threats. Increasingly, startups that operate in areas coveted by tech giants face a similar choice: sell—or get crushed. The Big Five have made over 436 acquisitions in the last decade, with little to no challenge from antitrust authorities. When startups refuse to sell, they find themselves facing an unlevel playing field. Snapchat, which turned down a $3 billion acquisition offer from Facebook in 2013 (and a $30 billion bid from Google in 2016), is a case in point: after it failed to acquire Snapchat, Facebook simply cloned many of Snapchat’s key features, using its vast reach to completely undercut its growth. This is not an uncommon occurrence.

“The Kill Zone is a real thing,” said Wenger, a managing partner at Union Square Ventures and an early investor in Twitter. “The scale of these companies and their impact on what can be funded, and what can succeed, is massive.” He went on to quote one angel investor who told him that he only invests “in things that are not in Facebook’s, Apple’s, Amazon’s or Google’s kill zone.”

The kill zone, noted Wenger, is not a new phenomenon. Microsoft had a similar kill zone around it when it dominated the tech industry in the late 1990s. “It was a similar playbook, where Microsoft would see, ‘What kind of things are doing well on my platform?’” he said. “Then they would just absorb those into the platform itself. That is a playbook that’s being exercised by Amazon, by Google, by Facebook, by all the big digital platforms.”

All this has profound implications for the startup ecosystem and for the future of innovation. Is the dominance of digital platforms, routinely hailed as the most innovative companies in the world, actually hindering innovation? Much of the Stigler Center panel, moderated by Fortune magazine’s executive editor Adam Lashinsky, revolved around this very question. In addition to Wenger, it featured patent expert Elvir Causevic, managing director and co-head of Houlihan Lokey’s Tech+IP Advisory practice; Glen Weyl, a principal researcher at Microsoft Research New England and a senior research scholar at Yale’s economics department and law school; and Matt Perault, director of public policy at Facebook.

While opinions as to how to address the power of digital platforms and spur innovation varied wildly, most of the panelists seemed to agree on one basic premise: the size and scope of digital platforms has become an impediment to innovation.

“Small Companies No Longer Have Access to Patent Protection”

Innovation used to be associated with small companies and entrepreneurs. There’s a reason why the garage has taken such an important place in the mythology of the tech industry: Silicon Valley, as we know it, is the product of entrepreneurs starting companies in their garages, from Bill Hewlett and Dave Packard in the late 1930s, through Steve Jobs and Steve Wozniak in the 1970s, to Larry Page and Sergey Brin in the 1990s.

But the vaunted garage is little more than a myth in today’s Silicon Valley. The rise of digital platforms has been correlated with a historic decline in startups: new business formation in the US has declined by more than 40 percent since the late 1970s and is near a 40-year low. At the same time, as the New York Times’ Farhad Manjoo pointed out last year, the technology industry has gradually become “a playground for giants.”

Many economists are naturally concerned about this decline in entrepreneurship: startups are an important driver of both jobs and innovation. A lack of startups is often associated with rigidity and a lack of economic dynamism. Another result, however, is that big firms have seemingly taken the mantle as the most innovative in the world.

“The label of innovation has been grabbed by Big Tech,” said Causevic, who argued that big tech firms use the US patent system to stifle innovation. “We’ve taken the focus off of rewarding genius and innovation to rewarding capital and scale.”

Historically, he noted, large companies used to abuse the patent system to entrench their position. But the patent system also served an important function: it provided small innovators with an effective tool to fight big firms that tried to infringe on their patents. Recent changes in US patent laws, however—in particular the America Invents Act (AIA) that was signed into law by President Obama in 2011—have created a situation where “small companies no longer have access to patent protection.” In order to deal with patent trolls, he said, the AIA has “eviscerated” the ability of small companies to enjoy patent protection, making it lucrative for big tech firms to be on the side of anti-patent enforcement.

“You have nothing to lose. You’re better off just infringing. As a matter of fact, it might be less expensive to infringe than it might be to pay royalties, given how the current case law is set up,” said Causevic. “Throughout my career, it was always the patents that made the big difference when the little guys [fought] against the big guys. Now you don’t have that.” It’s not only small companies that are affected by this, contended Causevic—even middle-market firms are at risk.

To illustrate this point, Causevic used the recent example of Apple and Immersion. Immersion, which developed the feedback technologies that are used in many wearable devices, sued Apple in 2016, alleging that Apple’s iPhones and iWatch devices were infringing on its haptic feedback patents. The companies reached a settlement earlier this year. “That technology was largely invented by Immersion, a middle-market company that has been been around for 20 years, has 1,000 patents. Apple worked with them, paid them a license for years, but decided to stop paying and said, ‘No, we’ll just do it ourselves,’” said Causevic. “[Immersion’s] market cap dropped 60 percent and Apple did a piddly settlement with this company for peanuts. The company’s really in a lot of pain. It used to be a $500 million company.”

The larger question, said Causevic, is not really the patent system per se, which he acknowledged might be outdated, but the question of how to reward innovation and what type of innovation gets rewarded. “Do we want to reward innovation or do we want to reward capital, and network, and market power?” he asked.

Our current system, he contended, created winner-take-all markets where margins are shifted away from the rest of the supply chain toward superstar companies. This, he said, is the “huge blind spot” missing from contemporary debates about innovation: the “entire ecosystem of suppliers, software companies, innovators, all the way down to universities that feed the top of the machine.” One potential path forward, he added, could be seen in the movie industry: “Everybody, when making a movie, gets a little cut of the royalties of the movie, because those rights were negotiated through unions. I don’t know that that’s the right approach here, but everybody in that ecosystem is able to participate.”

A “Lack of Imagination” Among Antitrust Enforcers   

Weyl, co-author of the new book Radical Markets: Uprooting Capitalism and Democracy for a Just Society, laid much of the blame on the lack of antitrust enforcement in the past 40 years. Enforcers, he said, have focused too much on consumer welfare instead of competition, and thus failed to anticipate how crucial new industries might develop. This manifested in the approval of a number of mergers that fundamentally altered the course of the digital economy: Google’s purchase of DoubleClick in 2007 and Waze in 2013, Facebook’s acquisitions of Instagram in 2012 and WhatsApp in 2014, and Microsoft’s acquisition of Skype in 2011.

“Had those companies not been absorbed,” said Weyl, “they might have changed the texture of the way that competition took place within those relevant marketplaces. In fact, the prospect of that happening was part of the basis of the funding and expansion of those companies.”

A “lack of imagination” among antitrust enforcers, however, led these mergers to be cleared. “Skype is a case that should have [been] thought about much more carefully because there are clear ways in which Skype, for example, compete[d] with significant other Microsoft products like Lync—what’s now Skype For Business—and could potentially have disrupted the role that Microsoft played in being central to business communications,” said Weyl.

One possible solution, said Weyl, is to have fewer economists involved in antitrust enforcement and “more people who think like venture capitalists” and are able to analyze potential trajectories for industry development. “Maybe that sounds imponderable, but people manage to do it for a living. They actually sometimes make money doing that,” he said. “I don’t see a reason why we can’t learn to think and behave in that way.”

Wenger, for his part, agreed with Weyl that competition policy should ultimately become more of “a dynamic view of what’s the next potential S-curve, and how the current incumbents potentially impede that S-curve from taking off.” Currently, he said, there are “structural issues” that are impeding innovation. One of them, “without a doubt,” is that tech platforms having too much power.

Wenger, however, was ultimately skeptical regarding the ability of conventional tools like merger reviews to get to the root of the problem. Regulators, said Wenger, should consider new tools that are more in line with the changing nature of technology and competition in the digital economy. One such tool, he said, is mandatory APIs.

“Regulators need to think about how can I, as a consumer, interact with the services that are out there?” he said. “Today, every one of us carries a supercomputer in their pocket. That supercomputer, you pay for it, you pay for the power to charge it, you pay for the data plan, or your company pays for it. [Yet] something very strange happens: you hit the app icon of any of these apps, and this computer stops working for you, and just works for that company, basically. You have no programmatic control over your interactions.”

This, said Wenger, creates a “fundamental asymmetry” that impacts the ability of entrepreneurs to innovate: “Facebook’s position is not contestable by a new startup, because I, as a new startup, can’t create software that would let people participate simultaneously without extra effort in both my system and Facebook’s system, because Facebook can shut me out.”

Cryptocurrencies, said Wenger, though often hailed as a revolutionary, disruptive technology, serve as a good example of how structural issues could be impeding innovation. “How are you ultimately as a consumer going to access this? Through your phone. How do you get apps on your phone? There are exactly two companies in the world that let you get apps on your phone. Those companies have no interest in letting you do cryptocurrencies easily and well, because they’re taking a 20 to 30 percent cut of everything that happens on the app store. We have structural issues that I think are impeding, potentially, some of these S-curves that are coming.”

Can Facebook Change?

The antitrust conference took place days after Facebook CEO Mark Zuckerberg’s testimony before Congress. With the public outrage over the company’s collection and misuse of personal user data dominating news headlines, Perault said he is “optimistic” about the Facebook’s ability to address “some of the drawbacks of the platform that we’ve created.”

Perault, the head of Facebook’s global public policy development team, then faced a barrage of criticism from conference attendants. In one tense exchange, legendary antitrust lawyer Gary Reback repeatedly asked him to commit that Facebook would stop collecting the data of non-users without permission: “I am not on Facebook. I don’t want to be on Facebook. I’ve never shared any data with you. The only time i’ve ever gone on Facebook is to check some Stanford University sites that are only on Facebook. I don’t want anything to do with you … you’re nevertheless profiling me. You’re inputting data about me. You’re selling information about me. Would you commit today to stop doing that?”

When Perault responded by saying “you can opt out of that type of advertising,” Reback countered: “I never opted in!” A little later, Perault added that following Europe’s General Data Protection Regulation (GDPR) Facebook would allow users to stay on its platforms while only sharing minimal data about themselves. Facebook has since begun to roll out GDPR-related privacy alert to its users worldwide.

Wenger, however, was not too optimistic about Europe’s latest privacy push, saying that it would “ensconce Facebook’s position, and Google’s position, much more fervently than ever before. The EU’s privacy policies and its competition policies are completely at odds with each other.”

When it comes to charges of anticompetitive mergers, Perault used Facebook’s acquisition of Instagram as an example for a merger that has “pro-competitive” benefits. “People assume that the Instagram that we have today was inevitable, and that that’s not at all the result of Facebook being able to invest in the company, growing the engineering team, that they were able to use Facebook infrastructure wasn’t actually an advantage for Instagram in growing and becoming the business it is now,” he said.

Facebook’s “primary concern right now,” he claimed, is not profits, but “making sure that people have a good experience on the service.” He added: “We have recognized as a really profound issue, and one that we need to solve in order to be a viable business for the long run.” In response, Lashinsky said the statement is “self-serving in a literal sense. The current debate is an existential threat, so you have to address it.”

The larger problem underlying the issues that many have with Facebook’s business model, said Wenger, is one of market structure. “Nobody can compete with Facebook on the basis of saying, ‘We have a different model, and a model where our incentives are more aligned with your incentives,’” he said. “As long as we don’t find a way of solving that, we can’t rely on the market to let people compete.”

Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.