Regulatory arbitrage in internet companies

A significant part of the profitability of internet firms like AirBnB, Uber, Facebook, Amazon, Google etc can be traced back to high-entry barriers arising from network effects, entrenched incumbency, and regulatory arbitrage. More on this in posts to follow. 

The likes of Facebook and Amazon enjoy the benefits of being in the publishing business without being a publisher. Regulatory provisions like the Section 230 of the US Communications Decency Act 1996 shields them from from what others post or sell in their platforms. 

Dipayan Ghosh writes about the need to regulate the likes of Facebook and Google as publishers,

Facebook and Google... have, until now, been regarded as open platforms, which allow any and all speech (different kinds of views/all shades of opinion)but can remove whatever they wish — a conceptualisation originally stemming from Section 230 of the Communications Decency Act, a 1996 US law that simultaneously affirms that Internet companies won’t “be treated as the publisher or speaker of any information” and won’t “be held liable on account of any action voluntarily taken in good faith to restrict access to or availability of material”... This benevolent regulatory framework has enabled Facebook to claim it acts as a publisher and reap the censorship rights thereof, but turn around and also claim it is an undiscerning platform to reap the benefits of free speech leniency. A more just regime might, instead of giving the firm a free pass on both ends, hold its feet to the fire on both counts. There can be no doubt the company acts as some novel form of entity in between; even the company’s lawyers have suggested that the company possesses a “quintessential publisher function” over the “protected” practice of determining “what to publish and the decision of what not to publish” — while Facebook CEO Mark Zuckerberg has also contended the company “should err on the side of greater expression.”

Amazon (and fellow e-commerce peers), while extracting its commissions on sales using its marketplace, has for long struggled with managing the quality of products being sold on its platform by third party vendors or price gouging by vendors during shortages. Amazon's strategy to address such criticisms has been to rely on cheap algorithm tweaks and relying on it to achieve the results. But given human ingenuity, such algorithm tweaks are easily overcome. 

Sample this about how the benefits of choice are being offset by the social costs and why cheap algorithmic fixes are no answer,

... former Amazon employees painted a picture of an online shopping bazaar that’s just too big and too complex for Amazon to police 100 percent... Justin Leigh, a former Amazon employee... (says) “The greater the tech, the greater the work it has to do to do its job. As a technologist, I’m constantly saying, ‘It’s tech, not magic.’”... Amazon appears to be taking two different actions against sellers on its marketplace who are marking up prices. One action involves removing the so-called “Buy Box” for an item, meaning that Amazon does not display the normal “Add to Cart” and “Buy Now” buttons on the right side of the product page. In place of those buttons, Amazon displays a “See All Buying Options,” which requires customers to visit an extra page to view different prices for the product sold by various sellers. This action often means that Amazon’s technology has determined that the price of the item is too high compared to prices elsewhere on the web or the manufacturer’s recommended retail price. It’s meant, in part, to signal to shoppers that the price might not be a good one, while still allowing the option to buy it anyway... Sometimes, however, enterprising sellers are bundling together several units of a product into custom packs that aren’t sold anywhere else. In those cases, Amazon’s price-monitoring tech has nothing to compare the current price to. “Amazon’s price-checking tools are heavily dependent on being able to look at list price information (if it exists) and comparing that to the actual selling price,” said James Thomson, who worked at Amazon for more than five years...

Amazon’s other action is having employees completely remove a product listing from the site. It’s still unclear how Amazon is determining when to simply remove the Buy Box versus when to completely remove a listing. And it appears that the rate at which schemers are uploading new high-priced offers has outpaced whatever monitoring the company is doing. “Realistically, [it’s] too much manual work for Amazon,” Thomson said, explaining why some high-priced listings are having the Buy Box removed rather than being banned from the site completely. “They already took down 1 million items, but [it’s a] constant cat-and-mouse game.”

Or sample this,

Problems that have long plagued the site, like third-party sellers who try to game Amazon’s software, continue as well. Some of the tricks are more visible than normal because they appear among so many items that are out of stock. Hand sanitizer listings have been categorized as “box wrenches,” “outdoor clocks” and “cupcake toppers” to try to game Amazon’s systems to get the “best seller” label that can boost sales.

Evidently this requires far greater and more-than-technology based (and therefore costly) layers of internal controls within Amazon. In fact, these algorithmic fixes are convenient and cheap cop-outs for Amazon every time such complaints surface. Experts argue that it may not be possible to exercise rigorous and meaningful enough oversight of a platform as big as Amazon's and therefore Amazon is too big to manage. This is one of the arguments in favour of breaking it up. 

The incentives too are mis-aligned. Amazon takes higher commissions from higher priced sales and would commercially benefit from such practices till they get detected. Even when detected consistently as has been the case now, given its size, it gets marginalised as a concern to live with. In fact, as this NYT article highlights, Amazon itself has resorted to price gouging in its own direct sales during the initial days of the Covid 19 outbreak. 

In fact, not only are the likes of Amazon not able to police price gouging, they are also providing a convenient outlet for hoarding and indulging in price gouging for third party vendors like this who can go around and clean up retail store shelves on specific products in anticipation of a spike in demand. See also this and this.

Can any brick and mortar company get away with such lapses?

The likes of AirBnB and Uber enjoy the benefits of employing people (the power balance of an employer and employee) without assuming the costs of being an employer, by treating their workers as 'independent contractor'.

While Uber drivers are locked into vehicles bought on hire purchase schemes, AirBnB hosts are locked into properties purchased on mortgage. Neither internalises the costs associated with the business cycle downturns. They can shed their "assets" like the flick of a switch, and leave others to bear the costs. Besides, the impact of Uber on traffic congestion and AirBnB on property prices, even if localised, is now widely acknowledged. There are also questions being asked about the impact of AirBnB on the mortgage market.

Governments, national and local, have started to take notice and whittle down such regulatory arbitrage. Uber and AirBnB have been the target of major regulatory spotlight. A high profile battle is being fought in California,

It sued Uber Technologies Inc. and Lyft Inc. in state court on Tuesday, contending that the ride-hailing companies violated a new state law by improperly designating drivers as independent contractors rather than employees to save on labor costs. The law in question is Assembly Bill 5, which requires companies to classify workers as employees unless they can establish that the work is outside the company’s usual course of business and that workers are free from the company’s control, among other factors.

There’s a lot riding on the distinction. Employees are entitled to minimum wage, overtime pay and other benefits, whereas contractors are not. Multiply the difference in cost by millions of drivers and the savings add up to a huge competitive advantage. So it’s not surprising that Uber is doing everything possible to bolster the case that it’s not responsible for drivers. Since California enacted the law, Uber has experimented with letting drivers set their own fares to demonstrate their independence. Its chief lawyer even claimed that “drivers’ work is outside the usual course of Uber’s business.”

Another example of regulatory arbitrage is under attack,

On Monday, Australia announced that it will now force technology giants such as Facebook and Google to pay news companies for using content. This, the government said, was meant to ensure a “level playing field”, and came after an 18 month investigation into the power of these digital platforms by the country’s competition and consumer commission. Earlier this month, France’s top competition authority asked Google to negotiate with media companies, both publishers and agencies, for using snippets on its search engine and news aggregator and pay them proper remuneration.

It is only inevitable that such arbitrage opportunities get closed down in the years ahead. The only reason why they have not been closed down already are the toxic combination of regulatory capture and the lobbying power of these large companies in the the largest and trend-setting market, the United States.