Rohan Silva’s anxiety about Amazon is unwarranted
23 February 2016
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One of the most harmful misunderstandings in current economic debates is that the job of competition authorities is to protect incumbent businesses rather than consumers. We see this fallacious argument on display in discussions about EU policy towards Google. It is also reflected in calls by black cab drivers for the government to curtail “unfair competition” by Uber. The latest argument in this vain comes from Rohan Silva, a former No 10 advisor turned entrepreneur. Silva accuses online retailer Amazon of abusing its allegedly dominant position in both book-buying from small publishers and book-selling and calls for the competition watchdog to intervene.
One might point out that Silva is not merely a disinterested observer. Rather, as the owner of a new bookstore, his commercial interests lie very much on one side of the argument.
But let us consider Silva’s claims on their merits. When trying to establish whether a firm is abusing its market power as a seller, competition authorities look at a number of indicators. Two salient ones are prices for the goods sold by the alleged monopolist, and the profits made from its activity. This is because in a monopolistic context where one firm is dominant, we would expect it to be able to push up prices in order to boost its bottom line. Because it has a dominant position it is considered a price-setter rather than a price-taker, so none of the smaller competitors could prevent it from such abuse, which would make consumers worse off.
There is no evidence of such practices in the case of Amazon. Even though the U.S. firm has had a large share of the UK book market for a number of years, book prices have hardly spiked. Indeed, they declined for much of 2014 and 2015, aided by the drop in fuel prices, which is an important cost for any retailer. The latest figure we have for book price changes from the ONS, from January 2016, is -4.1 per cent. Sure enough, the figures were positive in some of the previous months, but the trend over 2014 and 2015 pointed towards broadly stable rather than rising prices.
How about profitability? In its latest available financial year, 2014, Amazon made a net loss of $241m on revenues of $88bn. This followed net earnings of $274m on $75bn of revenues in 2013, and a loss of $39m on turnover of $61bn in 2012. The first thing that these figures reveal is that Amazon’s margins are wafer-thin even in the good years, and that in most years it is likely to make a loss. Indeed, Amazon shareholders periodically chastise management for their relaxed attitude about the bottom line. But it also shows that Amazon is focused on expanding sales, if need be by pushing prices down enough that its profit margin vanishes.
One may or may not agree with Amazon’s business strategy, but it is hard to argue that it is harmful to consumers. Indeed, one would suspect that the main reason customers have flocked to the Amazon website since it launched in the mid-1990s is the convenience of ordering from an immense catalogue from the comfort of one’s home, with efficient browsing tools, accurate algorithmic suggestions, and cheap, straightforward and rapid delivery. These are all technology-enabled innovations which unambiguously enhance the welfare of consumers. It may be bad for those competitors who are not able to offer a similar level of services and are therefore shunned by readers. But it is not the task the competition watchdog to pick winners and losers.
What about the other side of the argument? This says that Amazon is a monopsonist, with significant market power over those it buys books from – enabling it to exploit publishers by ruthlessly squeezing margins. Silva’s argument here echoes that of Paul Krugman, who argued in a New York Times column that Amazon were utilising “robber-baron-type market power” in the book world to squeeze its suppliers until the pips squeak.
There are various economic considerations here. Firstly, even if Amazon is using its significant buying power to bargain hard with publishers, this has clearly not come to the detriment of consumers in terms of pricing. In fact, as noted above, Amazon has facilitated huge welfare gains through its extensive distribution networks. It’s certainly possible that this may have squeezed the margins of some of the publishers it buys from. But that is the nature of competitive markets, and competition authorities have no business defending the interests of certain producers.
Yet some claim that they should, because over time this squeeze on the margins will restrict the supply or the diversity of publishers. But that ignores the fact that the mere existence of Amazon itself has made it much easier for small and independent publishers to distribute their own products, in turn hugely expanding their potential marketplace. And for the bigger publishers, we must remember that inherent in the book world is the fact that copyrights themselves are an effective monopoly power. In such a world, the countervailing balance of a buyer of books with significant power might not be such a bad thing overall.
As interesting as all these points and counterpoints are, the downstream competition concerns essentially boil down to one question: is the market for the purchase and distribution of books contestable? Are there low enough barriers to entry, and easy access to the necessary technologies, such that competitors to Amazon could develop? The answer is clearly yes. This, not the number of firms at any one time, or their power over downstream suppliers, is what really matters.
Finally, Silva’s argument misses a more technical point about Amazon, which is that it is not really competing against bookstores, or publishers for that matter. Rather, Amazon’s big battle is with other technology firms who are trying to bring goods and services to users in the cheapest, most convenient way. Amazon is thus up against Google, Apple, Netflix, Uber and any other entrepreneurial venture seeking to harness new technologies to revolutionise a particular market, be it books, video-streaming, transport or big data software.
There is no reason why small publishers and booksellers cannot thrive in the 21st century. Technology has vastly expanded the opportunities for profitable activity. Furthermore, smaller players can gain a competitive edge by offering more personal customer service and focusing on niche categories or higher-end products. What those competing with Amazon need to focus on is winning the favour of consumers, not of competition authorities.
Diego Zuluaga is the IEA’s Financial Services Research Fellow and Head of Research at EPICENTER. Ryan Bourne is the IEA’s Head of Public Policy.
One might point out that Silva is not merely a disinterested observer. Rather, as the owner of a new bookstore, his commercial interests lie very much on one side of the argument.
But let us consider Silva’s claims on their merits. When trying to establish whether a firm is abusing its market power as a seller, competition authorities look at a number of indicators. Two salient ones are prices for the goods sold by the alleged monopolist, and the profits made from its activity. This is because in a monopolistic context where one firm is dominant, we would expect it to be able to push up prices in order to boost its bottom line. Because it has a dominant position it is considered a price-setter rather than a price-taker, so none of the smaller competitors could prevent it from such abuse, which would make consumers worse off.
There is no evidence of such practices in the case of Amazon. Even though the U.S. firm has had a large share of the UK book market for a number of years, book prices have hardly spiked. Indeed, they declined for much of 2014 and 2015, aided by the drop in fuel prices, which is an important cost for any retailer. The latest figure we have for book price changes from the ONS, from January 2016, is -4.1 per cent. Sure enough, the figures were positive in some of the previous months, but the trend over 2014 and 2015 pointed towards broadly stable rather than rising prices.
How about profitability? In its latest available financial year, 2014, Amazon made a net loss of $241m on revenues of $88bn. This followed net earnings of $274m on $75bn of revenues in 2013, and a loss of $39m on turnover of $61bn in 2012. The first thing that these figures reveal is that Amazon’s margins are wafer-thin even in the good years, and that in most years it is likely to make a loss. Indeed, Amazon shareholders periodically chastise management for their relaxed attitude about the bottom line. But it also shows that Amazon is focused on expanding sales, if need be by pushing prices down enough that its profit margin vanishes.
One may or may not agree with Amazon’s business strategy, but it is hard to argue that it is harmful to consumers. Indeed, one would suspect that the main reason customers have flocked to the Amazon website since it launched in the mid-1990s is the convenience of ordering from an immense catalogue from the comfort of one’s home, with efficient browsing tools, accurate algorithmic suggestions, and cheap, straightforward and rapid delivery. These are all technology-enabled innovations which unambiguously enhance the welfare of consumers. It may be bad for those competitors who are not able to offer a similar level of services and are therefore shunned by readers. But it is not the task the competition watchdog to pick winners and losers.
What about the other side of the argument? This says that Amazon is a monopsonist, with significant market power over those it buys books from – enabling it to exploit publishers by ruthlessly squeezing margins. Silva’s argument here echoes that of Paul Krugman, who argued in a New York Times column that Amazon were utilising “robber-baron-type market power” in the book world to squeeze its suppliers until the pips squeak.
There are various economic considerations here. Firstly, even if Amazon is using its significant buying power to bargain hard with publishers, this has clearly not come to the detriment of consumers in terms of pricing. In fact, as noted above, Amazon has facilitated huge welfare gains through its extensive distribution networks. It’s certainly possible that this may have squeezed the margins of some of the publishers it buys from. But that is the nature of competitive markets, and competition authorities have no business defending the interests of certain producers.
Yet some claim that they should, because over time this squeeze on the margins will restrict the supply or the diversity of publishers. But that ignores the fact that the mere existence of Amazon itself has made it much easier for small and independent publishers to distribute their own products, in turn hugely expanding their potential marketplace. And for the bigger publishers, we must remember that inherent in the book world is the fact that copyrights themselves are an effective monopoly power. In such a world, the countervailing balance of a buyer of books with significant power might not be such a bad thing overall.
As interesting as all these points and counterpoints are, the downstream competition concerns essentially boil down to one question: is the market for the purchase and distribution of books contestable? Are there low enough barriers to entry, and easy access to the necessary technologies, such that competitors to Amazon could develop? The answer is clearly yes. This, not the number of firms at any one time, or their power over downstream suppliers, is what really matters.
Finally, Silva’s argument misses a more technical point about Amazon, which is that it is not really competing against bookstores, or publishers for that matter. Rather, Amazon’s big battle is with other technology firms who are trying to bring goods and services to users in the cheapest, most convenient way. Amazon is thus up against Google, Apple, Netflix, Uber and any other entrepreneurial venture seeking to harness new technologies to revolutionise a particular market, be it books, video-streaming, transport or big data software.
There is no reason why small publishers and booksellers cannot thrive in the 21st century. Technology has vastly expanded the opportunities for profitable activity. Furthermore, smaller players can gain a competitive edge by offering more personal customer service and focusing on niche categories or higher-end products. What those competing with Amazon need to focus on is winning the favour of consumers, not of competition authorities.
Diego Zuluaga is the IEA’s Financial Services Research Fellow and Head of Research at EPICENTER. Ryan Bourne is the IEA’s Head of Public Policy.
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