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2016

Disruptive Innovation
and Competition
Policy: Friend or Foe
CCS-ESS ESSAY COMPETITION

Pwee Inn LOY (CCS)

10/5/2016
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Executive Summary:

This essay first explores the nature of disruptive innovation and juxtaposes it against

traditional forms of competition with a focus on the different parameters of competition,

before pointing out that regulators have to venture out of their comfort zones and re-

examine their assumptions underpinning existing competition regulations.

This essay proceeds to explore the various benefits of disruptive innovation,

emphasizing how markets are more readily penetrated today and argues that the

traditional emphasis of competition law on static competition within the market risk

muzzling dynamic competition.

Thereafter, the reasons why traditional regulation is ill-equipped to deal with dynamic

innovation are considered. A call is then made for the definition of the market to better

reflect the interconnected nature of the internet market-place today and for more

appropriate indices of competition to be adopted.

To ensure that regulations are more effective and less likely to be side-stepped, this

essay reviews the fundamental tenets of competition law. Besides explaining the

challenges posed to regulators by disruptive innovation in its bid to regulate mergers

that substantially lessen competition, market abuses and other practices that distort or

prevent competition. This essay also makes several proposals to not only better

harness the potential of disruptive innovation but also preserving the competitive spirit

of markets in the future. Such proposals include a shift in focus of competition law from

anti-trust enforcement to regulating market dominance, the creation of a more effective

regulatory regime for R&D or innovation markets, as well as a review of the patent and

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IPR assignment process to prevent new incumbents from extending their reign into

other markets, or even foreclosing future innovation, thus fortifying its position.

Besides pushing for a level playing field, this essay concludes with a call for a

fundamental re-think of the values that competition policy seeks to defend.

(299 words)

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A) What constitutes disruptive innovation?

Since the discovery of the steam engine, the world has been buffeted incessantly by

Schumpeterian waves of creative destruction. As opposed to gradual improvements in

the quality of the product within a market (sustaining innovations), creative destruction,

promotes the creation of new markets, cannibalizing old markets in the process. This

phenomenon of disruptive innovation where new entrants touting new technologies,

products and even new business models, bring about radical, unforeseen changes to

supposedly moated markets is no stranger to the global economy

The difference today, however, lies in the unprecedented speed by which new

innovations can rapidly scale up and pose a credible threat to incumbent firms. Owing to

the steep fall in transport and communication costs in an increasingly integrated digital

economy, technological cycles have accelerated. New innovations which start out as a

niche market1 can quickly infiltrate into the mainstream. The rise of the internet and the

ubiquity of social media has leveled the playing field in favour of maverick firms

enabling them to advertise their products to a global audience. This enables their

products to gain a sufficiently large following and by extension, greater interest and

investment into these products until they are comparable in performance to the

incumbents. Identifying new needs formerly unknown even to consumers themselves,

disruptive innovations succeed in redefining value. Its subsequent exponential growth

can eventually displace market leaders. The decline of Kodak, a once dominant firm in

1
Since disruptive innovation usually fares more poorly than traditional products on at least one metric, they do not
gain immediate popularity.

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the photography industry is a case in point. Kodak floundered upon the onslaught of

digital cameras that could produce images of comparable quality to film.

In addition to novel products and processes, new business models, widely considered

as the most insidious of them all for their wide-ranging impact across several markets

should also be considered. From the self-assembling model to furniture retailing that

IKEA pioneered to the rise of multi-sided platforms - spaces that promise to make the

middle-men redundant by enabling direct interaction between multiple users, all loosely

affiliated to the same platform - new business models not only allow for significant

improvements in cost efficiency, they help co-ordinate demand and supply forces,

maximize economies of scale and double-up as a new model for other businesses to

contemplate. Riding on the coattails of a burgeoning sharing economy, many firms,

including top online retailer, Amazon, are drifting away from a pure, traditional growth model

of vertical integration in favour of MSPs.

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B) Implication on Competition Regulation

Caught off-guard, regulators today have to decide whether regulations should be

adapted to accommodate these innovations or should appropriate standards in keeping

with existing regulations be imposed to mitigate the impact of the disruption on the

incumbents. Though not mutually exclusive, promoting static competition in dynamic

markets risks encouraging a race to the bottom, dampening the large profits necessary

to induce firms to venture into unchartered waters. Furthermore, overly cumbersome

legacy regulations may prematurely foreclose innovation.

Regardless, the general consensus is that existing regulation founded on the basic

premise that firms essentially compete within fixed markets, on the basis of price and

output2 (vertical competition) are ill-equipped to deal with the new realities of dynamic

competition for a market in the making and may as we will discuss later do more

harm than good.

2
In fact, under most circumstances, internet-based platforms grant free access to consumers in view of its non-
rivarlous nature as well as the network effects from increased usage.

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C) Benefits of Disruptive Innovation

Apart from the increase in consumer choice and product variety in markets, disruptive

innovation has the effect of compelling incumbents to up-their game to better-compete

against the new-comers, culminating in an overall across the board improvement in

technological levels, rise in productivity and increased consumer welfare.

Since new innovative business models3 are likely to be accompanied with significant

improvements in efficiency, their cost structures are likely be significantly different from

the incumbent. With lower marginal costs, these new-comers can afford to charge lower

prices even without compromising on their profit margins4 (unlike predatory pricing).

Applying the kinked demands curve model, technological innovations that take the cost

curve out of the discontinuity gap will drive down prices, inducing the incumbent to

review its cost structure.

Lastly, moated markets are becoming more susceptible to competition as barriers to

entry become more impervious as evident from the incursion of new virtual telco: Circles

Life. The rise of new asset-lite models has rendered the high financial cost of building

and maintaining mobile infrastructure less of an entry barrier.

Thus, the message is that regulators should give sufficient room for market dynamism

to run its course.

3
The rise of e-commerce has threatened the survival of brick and mortar shops (evident from rising vacancy rates
even in prime shopping areas like the Orchard belt), since not only do e- firms not have to bear the overhead
rental cost, their product offerings are not constrained by space.
4
In his book, the zero Marginal Cost Society and the Third Industrial Revolution, Jeremy Rifkin explains how
consumers can produce and shire goods within a digital community at near zero marginal cost. He projects that
when the energy grids and the transport networks are tethered together, the convergence of these trends will
further optimization resources, reducing marginal cost further.

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D) Rethinking competition law

Before we can understand how policy responses can be calibrated in an age of

disruptive innovations, we must first appreciate the problems that can arise when

applying competition law mechanically to the analysis of new markets. Overtly-focused

on traditional market competition, disruptive innovators can circumvent existing

regulations or render them irrelevant

1. A Market Without Boundaries

Disruptive innovation today, especially in the ICT industry, hails from synergizing the

features of existing technologies that are valued by consumers to produce new self-

complementing products or by leveraging upon the internet of things, linking up existing

technologies to promote a more integrated and unique customer experience, effectively

transcending market boundaries.

The use of the hypothetical monopolist test to simulate the effect of a price rise on the

sales of a firm in current competition enforcement both to measure the level of

monopolist power and to identify the various substitutes across related markets has its

own failings when applied to innovation markets. For one, since regulators lack domain

knowledge, they are inclined to the assumption of continuity in consumer expectations

and behavior, neglecting the potential for disruptive innovation to exist within an

ecosystem of intertwined markets that may on first sight appear only tangentially related.

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Thus, we should take into account all entities which still exert competitive pressure on

its players5.

For instance, even though Google and Apple were formerly not perceived to be a threat

to the dominance of Microsoft in the operating systems industry, the entry of their

respective Android and iOS system into the fray, on the backs of tablets and smart

phones disrupted the operating systems markets. Now, internet services are effectively

co-opted with mainframe PCs and smart-phones alike, calling for a re-think in the ways

we define markets.

2. Market share

Over-reliance on market share, the percentage of total industry sales earned by a

company as a proxy for the level of competition is generally ineffective in responding to

disruptive innovation, not least because the markets in which they compete in are either

non-existent or because the market share of these mavericks are too small to warrant

the attention of regulators. Since firms have an increasing proclivity for start-ups, such

as the acquisition of Pie, a mobile work-based chat app, by Google, it is easy for

regulators to overlook their potential for disruption. Consequently, anti-trust enforcement

of mergers may become unduly permissive.

Furthermore, unlike static industries, the distribution of market power within dynamic

industries is not cast in stone, but is merely ephemeral given its high contestability,

making existing market share less relevant in competition enforcement. In an age of

competition for the market, it can be argued that high barriers to entry do not immunize

5
In MSPs, any action on one side of the market, will affect interaction between buyers and sellers and have
repercussions across markets.

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incumbents from potential competition and may even reinforce the incentive of new

entrants to capture the market, keeping incumbents on their toes.

Thus, to measure the market concentration of innovation driven markets, regulators also

have to focus on the rival R&D activities of other firms. These competitive pressures

within the innovation markets ensure that there is sufficient impetus for the incumbent

not to rest on his laurels. Measuring the credibility of the threat posed by other firms will

require a measure of its R&D capabilities and their abilities to commercialize it. As the

basis for R&D, regulators should keep a keen eye on the strategic assets of firms such

as their access to capital, human resources, R&D facilities as well as patents.

For instance, regulators should proscribe the acquisition of the creative assets of a

smaller firm, even if their collective market share falls below the threshold, so long as it

can be proven that the incumbent is likely to be lured into complacency and retard its

own R&D post-merger. In many of such non-linear markets, the prevailing market share

at the point of co-operation tends to understate their future market power.

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E) Reviewing the Tenets of Competition Law

Having identified the ambiguities in competition laws that are frisked out by disruptive

innovations, we will now focus our attention on how these ambiguities complicate its

enforcement with reference to the three main activities prohibited, followed by

proposals on how these challenges can be addressed.

A) Mergers and Acquisitions

Amidst the trend towards non-horizontal conglomerate mergers, such as the acquisition

of Local-mind, a travel app by Airbnb especially among multi-sided platform, which

thrive on size and scope, regulators find themselves in a dilemma. Even though the

synergies reaped from the expansion of its holdings combined with the potential

network effects6 from an enlarged user base can improve consumer welfare, the steep

network economies of scale reaped from its wider appeal into related markets risks

deterring new entrants and amplifying its multi-market dominance possibly running in

the face of its claim that such mergers are rarely anti-competitive. As much as the

exclusionary effects7 of such networks are well documented in economic literature,

regulators must be careful not to conflate market dominance with its abuse.

B) Abuse of Market Dominance

6
The value of the network to consumers increases as more people adopt it.
7
These include the high cost of switching to a rival network that can potentially offer superior functionality. In
addition, there is a possibility of biases and self-fulfilling expectations among consumers and businesses that
renders the incumbent complacent in the long run. For instance, if everyone expects Microsoft to maintain its
dominant position, business are likely to develop software compatible with its OS and consumers are likely to stick
to it, even if reality contradicts such expectations.

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Since the network effects are likely to be diffused, leaving the burden of proof of merger

efficiencies on firms risk emphasizing its offensive effects on competition. Regulators

should instead regulate market behavior, focusing on the deliberate creation of

incompatibility whether through exclusive arrangements8, inter- operability denials, as

well as tying that are aimed at denying rival firms access to a critical mass of customers.

Since the modus operandi of dynamic markets lies less in eliminating competitors and

more in reinforcing barriers to entry to delay the next Schumpeterian wave of

destruction, dominant firms focus more on controlling the direction and tempo of

innovation rather than on traditional parameters of competition, like price and customer

satisfaction9. In fact, disruptive innovation has increased transparency in the traditional

parameters of competition, possibly deterring price collusion and expediting

enforcement.

However, significant information asymmetry still exists between firms and regulators

over their R&D direction, rendering it difficult to demarcate the R&D market. This opacity

may embolden the incumbent to deny potential competitors access to limited R&D

facilities.

In this respect, Singapore competition law should also provide greater clarity over R&D

agreement mirroring its European counterparts, beyond a passing reference to

technical development and innovation markets. Such a regime could detail the extent

of R&D co-operation allowed the duration of such co-operation, the extent of overlap in

their existing R&D activities, and their R&D capabilities to better balance the risk-
8
The tying of the Microsoft web browser to its operating system to keep out competitors like the Netscape
browser is a case in point.
9
Uber, a ride-sharing app, allows for customers to review their drivers, enabling some degree of self-regulation.

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bearing economies of scale against the possibility of foreclosing future innovation.

Reviewing the degree of concentration of specialized assets among competitors and

promote greater diffusion of such assets, can help ensure an optimal, sustainable R&D

scene, especially by opening up opportunities for greater collaboration between firms

and our local universities or research institutes, especially through greater investments

in basic research10.

C) Agreements that Restrict, Prevent or Distort Competition

As much as intellectual property rights (IPRs) are central to maintaining the incentive to

innovate, care should be taken when disruptive innovators seek to establish standards

within the markets that are defined based on technologies governed by IPRs, denying

other competitors access to the very technologies necessary to satisfy the standard,

making it a de-facto monopolist. Furthermore, should the standards be designed to be

overly-complex, thereby precluding rivals from meeting it, it may potentially fore-close

future innovation.

To maintain a fair hand between encouraging sustaining and dynamic innovation,

without compromising on our leading position as an IPR hub, we have to involve as

many stake-holders as possible in standard creation. A two pronged approach that

grants competitors access to the primary technologies through licensing arrangements

while supporting promising start-ups that break the mold, may be necessary to usher in

the next wave of creative destruction.

10
Basic research has substantial positive externalities that can help maintain the momentum for further dynamic
breakthroughs. For instance, if the new knowledge earned is shared across the market, competing firms can apply
them differently to suit their needs.

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F) Competition Law Enforcement in an Age of Uncertainty

Many of the issues raised by disruptive innovation are not novel. Regulators always

had to ride a tight-rope between the cost savings from economies of scale and the

negative welfare effects of monopoly power. The unprecedented scale and intensity of

disruptive innovations today, however, have cast these age-old paradoxes into the

spotlight again and exposed the inadequacies of competition law.

Many of the issues raised have practical implications that cannot be resolved by an

appeal to economic theory. To better harness the potential of disruptive innovation as a

key economic driver and better protect alternative forms of dynamic competition, it is

timely to return to basics and start a conversation on the role of competition law in

society.

Rather than insulating the market from one from of competition, favoring one parameter

of competition or selecting one market model over another, regulators should give free-

rein over the competition process within the boundaries of fair-play. So long as

monopolies do not funnel their market power into bulwark building, so long as firms

compete on an equal footing on their own merits and so long as there is sufficient

attention given to competition advocacy, the entrepreneurs dream can be kept alive.

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