What do Facebook and the Ultimate Fighting Championship (UFC) have in common? Each exists in a highly concentrated market. More than 70% of social media usage occurs on Facebook, and the UFC is alleged to control 90% of the mixed martial arts market. If you look hard enough, concentrated markets are everywhere, but it’s not clear this is cause for concern.
Market concentration has increasingly been at the forefront of political and academic discourse, and the Biden administration enacted an executive order charging the whole of government with addressing this issue. Worry over concentration often arises from the notion that when there are too few firms in a market, companies can exploit consumers or workers by charging higher prices, selling lower-quality products or paying lower wages.
Some concentrated markets are characterized by this paradigm, but economics fundamentals tell a subtler story. Clearly defining markets and understanding the nuances of competition can help us better frame current antitrust debates and understand why many presumed monopolies are no reason for alarm.
Defining a Market
Defining what is included in a particular market can sometimes be a tricky endeavor. Defined too broadly, sports cars are in the same market as toilet paper—both are consumer goods. Too narrowly, and every book on the shelf is a market of its own. Fundamentally, market definition is about two things: substitutes and proximity. The more narrowly we define a market, the more concentrated it will appear because there are fewer substitutes within the market. By contrast, since there are many competing companies in a broadly defined market, consumers have a great deal of choice among substitutes.
Proximity can help determine which specific companies are part of a market. Companies in different geographic locations are less likely to compete with one another; however, because the internet enables consumers to purchase products from anywhere in the world, the importance of geographic proximity has lessened in recent decades.
The bottom line is, if we define markets narrowly enough, we’ll see monopolies everywhere, and if we define markets broadly enough, we’ll see them nowhere. For a market definition to tell us anything of substance, it must at least consider the number of available substitutes and the proximity of those substitutes. But we must also question whether a company faces enough competitive pressure to constrain its temptation to exploit workers and consumers. Statistics about market concentration can be misleading because alone, they don’t provide a sufficient answer to this question.
What Counts as Competition?
Even if there is agreement on the definition of a market, it’s a common mistake to presume that the amount of competitive pressure a company faces is perfectly correlated with the number of firms in a market. Through experiments, Nobel Laureate Vernon Smith famously showed that markets can achieve competitive conditions with as few as four buyers and sellers. This finding contrasts with certain antitrust enforcers’ claims that sometimes four firms is too few.
Economist William Baumol researched how even verifiable monopolies will hesitate to exploit consumers if there is a continuous risk that new entrants could undercut a monopolist’s profits. When it’s easy for rivals to enter a market, the inadequacies of a monopolist’s product become profit opportunities for competitors. Without considering the number of potential new rivals, some of whom are uncountable because they don’t exist yet, we may underestimate competition.
Of course, market concentration can lead to exploitation when competition is insufficient. When there are barriers to enter a market or high costs of transacting, concentration can lead to higher prices or lower wages. But statements about concentration and company size alone fail to consider these basic concepts. Competition is complicated, and looking only at market concentration will yield an incomplete picture of competitive vigor.
Producer Concentration and Consumer Exploitation
The biggest topic on the Hill right now is competition. From pharmaceuticals to the aviation industry, no sector of the economy is safe from regulatory scrutiny. However, no industry has been in as much hot water lately as Big Tech. Multiple bills have been introduced to kneecap the largest platforms and restore competition, but if we look at Big Tech through an economic lens, the need for intervention becomes less clear.
In its current case against Facebook (now Meta), the Federal Trade Commission (FTC) argues that Facebook bought Instagram and WhatsApp to save itself from future competition in the social media market. The effect of this acquisition, the FTC claims, is the suppression of competition. However, the FTC, along with some in Congress, has the benefit of hindsight. The rise of Instagram and WhatsApp was not a foregone conclusion at the time of their acquisition, and moreover, the alleged dominance of Instagram is under serious attack from the likes of TikTok. In the FTC’s lawsuit, the market is narrowly defined to deliberately exclude TikTok.
As a former Facebook policy director has explained, competition in social media markets extends far beyond the big social media platforms; it is about competing for the user’s time. In this regard, YouTube, Twitter, news websites and even email compete with Facebook, and if Facebook is not able to withstand this competition, it will face the same fate as Google+ and Myspace—competitive irrelevance.
Further, Instagram and WhatsApp are extremely different today from what they were when acquired by Facebook, bringing increases in quality and functionality to users that were not guaranteed pre-acquisition, when these platforms had not yet turned a profit.
The idea that Facebook rigged the system by turning an unprofitable lump of coal into a diamond is only part of an incomplete story. Acquisitions of nascent competitors, those companies that may pose a competitive threat in the future, is a practice that has been around for a long time but has broken into the mainstream with the rise of the platform economy.
When a company is acquired, it is valued more by the buyer than the seller. The buyer believes it can improve the seller’s product or offer it for a lower cost by integrating the seller’s technology into its own. When Facebook acquired Instagram, the latter brought additional value through better photo-sharing capabilities on Facebook, better advertising on Instagram and a larger user base for both platforms.
As the size and resource pool of large platform companies increases, so too will the valuations of nascent competitors, since the startup founders will likely hold out for more money. This is exactly what has happened in the past few years and is similar to what occurred in the late ’90s in Silicon Valley. While companies today are certainly more cautious to offer gigantic sums of money for untested business models, startup valuations are still at an all-time high. In this case, the fact that large platforms offer huge sums and are unable to acquire companies cheaply is a sign of competition, not the lack thereof. Competitive pressure is driving up valuations, attracting investors and posing real threats to the established platforms in the economy.
Employer Concentration and Worker Exploitation
Antitrust authorities have also expressed concern about growing concentration in labor markets. When employers compete to hire workers, wages rise. However, when a group of workers has only one potential employer, those workers are at risk of being paid less due to a lack of competition. The same economic principles that govern producer concentration and competition can also be applied to labor.
Take the finding that local hospital mergers have led to lower wages for nurses. Workers’ ability to substitute one job for another depends on the proximity of that job, how specialized their skillset is, the costs of moving and other potential barriers to entry. Becoming a nurse requires a unique degree and license; moving to another state often requires transferring that license; and most importantly, nurses work in a heavily regulated industry that often restricts potential employers from entering. With barriers to entry restricting the number of substitute jobs, it’s unsurprising that hospital concentration could lead to nurses’ exploitation in the form of low wages.
On the other hand, let’s consider the claim that the UFC is underpaying its fighters. While the economics of pro-athlete contracts is unique, and many states require both fighters and promoters to be licensed, there are a few notable differences between the situation of UFC fighters and that of nurses.
One, many professional fighters have traditional second jobs, meaning that the UFC has to compete with restaurants, fire departments and even IT companies for these individuals’ labor. Low fighter pay might be an indication of a low demand for fighting or, more likely, a high supply of fighters, rather than exploitation on the part of the UFC.
Two, even if we look only at the market for combat sports, being a mixed martial artist (MMA) gives a fighter a varied skillset that may allow for an easier transition into other combat sports, such as boxing. Notably, the recent trend has been for former UFC fighters to switch to boxing; few professional boxers have decided to switch to MMA.
Finally, if barriers to enter the MMA field are low, exploitative behavior by the UFC could become a profit opportunity for new competitors. Given the rise of several other MMA organizations, including Eagle FC, which was founded by former UFC champion Khabib Nurmagomedov, this may already be occurring. As Nurmagomedov recently said, “If they don’t treat their fighters good, Eagle FC is here.”
Prevent Monopolies by Making Markets Freer
Markets tend to work as they should, incentivizing new entrants to seek out profit opportunities, lowering prices paid by consumers, increasing the quality of products and driving innovation and growth. Just like the new entrants into the MMA market and platforms such as TikTok that encroach on Instagram, there is often another company waiting in the wings to one-up the establishment.
That’s not to say, however, that no action is needed. Regulatory barriers to entry, such as certificate-of-need laws and privacy and security regulations, make it harder for new competitors to enter the market, increasing the probability of economic harm to consumers and workers. Without the threat of new competition, there is little stopping companies from raising prices, lowering wages or suppressing innovation.
If you go looking for monopolies around every corner, you will find them with ease. But don’t assume exploitation just because there is market concentration. If misbehavior seems to be occurring, policymakers should ask themselves why: It may be that regulatory barriers are blocking entry of new companies into the market, leading to fewer substitutes and less competition.