For the authors of the Dynamic Competition School, using static concentration measures to guide antitrust enforcement and merger control may lead to more fragmented markets and, possibly, though not necessarily, lower prices in the short term, but it likely will chill innovation and reduce consumer welfare in the long run, since consumers benefit more from innovation than from low prices. In their opinion, competition agencies should not obsess over existing market structure; rather, they should ensure that the assets needed to innovate are not monopolized by incumbents, so that the markets remain contestable and the incumbents are compelled to operate under the threat of disruptive innovation and entry. This is because the possibility of unfettered competition for the market is sufficient to ensure that market outcomes are beneficial to consumers, even if the incumbent maintains a dominant or a monopoly position over time.
The second school of thought, which we refer to as the “Mainstream School,” recognizes that the threat of preemptive innovation may, in principle, have an impact on existing market participants, but it takes the position that any impact is unlikely to be determinative in the markets in which leading online platforms operate because those markets are also characterized by factors such as network effects, economies of scale and scope, and switching costs that make entry ineffective. In short, this second school seems to argue that a market should not be considered dynamically competitive unless we observe fluctuations in market share or, in other words, only if we observe “action–reaction”—i.e., when the market leader tends to lose market share over time and the market never tips to monopoly.
The Dynamic Competition School disagrees, explaining that, in markets structured in terms of innovation races, we see stable or even increasing market shares and a lot of innovation and other positive market outcomes. That is, dynamic industries may be characterized by “increasing dominance”—i.e., the market leader’s share grows over time and the market eventually tips to monopoly—rather than action–reaction. In fact, in markets in which new entry is won through significant innovation, incumbents are likely to invest significant amounts in research and development (R&D) to protect their rents. This, according to the Dynamic Competition School, is important and explains why potential entrants can have a significant influence on market behavior such that even high shares that are stable over the course of several years do not alone indicate a lack of competition.
This article focuses on the key question of how to determine whether the threat of preemptive innovation is conditioning incumbents. We do this by examining the R&D expenditures of 25 companies in five sectors, including the so-called big tech companies, software and business-to-business (B2B), and pharma. We examine expenditures in absolute terms and, more importantly, normalized by revenues.
More specifically, we examine whether the R&D investments of companies like Google, Amazon, Meta, and others have declined since 2000, as one would expect to observe if—as many contend—the markets in which these firms operate are not (or are no longer) characterized by dynamic competition. The evidence shows that these companies invest heavily in R&D, both in absolute and relative terms, especially when compared with other highly innovative sectors like pharma. The evidence also shows that these companies have continued to invest with similar, if not growing, intensity over time, even in periods in which these companies’ market shares and power have allegedly been growing. The key takeaway from our article is that high R&D expenditure ratios by market leaders suggests that the markets are highly dynamic and innovative and can be an indicator of contestable markets. In other words, we find no correlation between R&D ratios of leading online platforms and measures of static market power.
Our analysis has limitations because it is based on publicly available data, specifically, financial information from 10-Ks. This article is intended as a starting point in the hopes that it persuades competition agencies to consider R&D expenditure ratios, including at the product level and taking into account the nature of the spend—two types of information that will be available to agencies through subpoena powers. Our hope is also that this article spurs additional empirical work, including analysis of whether the absence of a correlation between R&D ratios and measures of static market power is driven by the omission of other control variables such as lower interest rates, changes in technological opportunities (e.g., emergence of AI), actual entry, and/or changes in tax codes or other regulatory frameworks.
This article is structured as follows. In Part I, we introduce the competing schools of thought. In Part II, we consider the evidence needed to test the Dynamic Competition School’s fundamental claim that market concentration is not a reliable indicator of market contestability or, in other words, that a contestable market may exhibit persistent market leadership. We conclude that falsifying that proposition requires studying the evolution of innovation by incumbents. This is what we do in Part III, where we investigate whether the R&D investments of market leaders in business-to-consumer (B2C), B2B, and software markets, including the “MAAMAs” (Microsoft, Alphabet, Amazon, Meta, and Apple), have declined since 2000. In our conclusion, we provide recommendation for future study.
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