Digitalization of the Global Economy: Monopolies, Personalized Prices and Fake Valuations
The use of digital technologies is causing the global economy to grow ever closer together. For consumers, this has several advantages, but it also some serious risks. The challenge is to shape the macroeconomic framework conditions in such a way that opportunities for consumers can be exploited and risks minimized.
Market power of local suppliers is reduced
Digitization can reduce the market power of individual providers. If only one provider of electrical appliances operates a store in a rural area within a radius of 50 kilometers, she can charge surcharges for her products and thus increase her profits. However, if there are internet-based search engines and online platforms, interested parties can search for other offers of equal quality and exploit price differences.
As digital technologies also reduce costs associated with shipping a product purchased online and handling payment, consumers can benefit from the significantly expanded relevant market. The local electrical retailer loses market power and has to adapt to the internationally applicable market price.
The danger of digital monopolies is growing
On the other hand, digital goods and the platform markets often associated with them have characteristics that make it easier to create monopolies:
- The construction of networks is associated with very high initial costs. The same applies to the development of operating systems and application software. However, the reproduction and delivery of a computer program is often done via a download (like with music) and has a marginal cost close to zero. As a result, the company that offers the greatest quantity has the lowest unit costs and can demand the lowest price. Long-term, only a few or even just one supplier can survive in the market.
- Digital platforms often have a network characteristic. The more participants in a social network or an online file-sharing platform, the more attractive it is for people to join the correspondingly large network. In the end, the company that has the most participants prevails (“Winner takes all” phenomenon).
Monopolists demand higher prices because they have no competition. For consumers, this means a loss of purchasing power. Without competition, there is no need for a monopolist to improve quality and/or lower prices through technological progress. Therefore the central advantage of the market economy for consumers — an improved range of products at lower prices — is not realized.
Market transparency is increased
The theoretical ideal in economics is to attain a state of perfect competition. One assumption of “perfect competition” is market transparency. If all market participants have all market-relevant information for a particular good, at any given time, there is only one price for a good that is traded on the market.
Without complete market transparency, companies can demand different prices from different consumers and increase their profits. For those consumers who pay a higher price, this means a loss of purchasing power. However, if digitization increases market transparency, ultimately, companies can demand only one specific market price.
New information asymmetries arise
Although digitization, in principle, can increase market transparency, it may lead to the emergence of new information asymmetries. For example, providers can use systematic big-data analysis to obtain information about potential customers’ maximum willingness to pay.
This information can, in turn, be used to demand an individual price from each interested party, which is as close as possible to the maximum price that the potential customer is prepared to pay. This “personalized pricing” increases the profit of providers at the expense of consumers. Consumers cannot deduce from the information available on the internet the production costs of suppliers making it more difficult for them to assess whether the price demanded is reasonable or not.
Likewise, platforms can spy on competitors‘ business models and build successful ideas by using their larger financial power. Such approaches are used amongst others by Amazon and Delivery Hero. Amazon can collect information on products consumers demand via offers by external suppliers on its Marketplace. This kind of digital market power exploitation was criticized in a recent report by the US Democrats, who recommended that Amazon should not offer its products on its Marketplace.
Another example is Delivery Hero, which offers an online ordering platform for food. The large number of restaurants that use Delivery Hero’s platform to deliver food means that the company collects large amounts of data on the food orders which consumers place. Delivery Hero can use this information to open “ghost kitchens,” which exist solely to produce food for online orders.
These two examples are likely to result in short-term price reductions so that competitors can be forced out of the market. However, once competitors have been forced out of the market in the medium- to long-term, consumers are likely to experience rising prices as well as less product variety and innovation.
Consumers do not know the value of their data
Many online services offer their services without demanding a price expressed in monetary units, but users pay anyway when they provide data. Service providers use this data for their business models, which are based on the collection, analysis, and exploitation of user data. The use of customer data enables them to estimate the value of user data reasonably well.
However, users are not fully aware of the value their personal information has to companies. If users do not know the value of their personal information, they cannot assess whether the price for the service they are using is reasonable. There is a risk that consumers are giving up their data for a price that is below its true value and simply increasing the profits of online service providers.
Fake ratings lead to wrong consumer decisions
On many platforms, users can evaluate offers and thus provide information about the quality of services offered to other potential buyers. From the consumer’s point of view, the given ratings must be meaningful. However, this is by no means guaranteed: Companies have a high interest in good ratings that can increase their sales. There are two possible ways of doing this:
- Companies can commission customers or service providers to evaluate their services as better than they are.
- Companies have an interest in negative ratings for competitors and can pay third parties to give negative reviews.
With such fake reviews a risk exists that consumers rely on the judgment of other customers and no longer make efforts to find out about the actual quality of their desired product. The result can be the purchase of a product of worse quality than expected.
Conclusion and outlook
The fundamentally positive effects of digitization technologies are countered by several economic risks. To realize the potential benefits for consumers, we must counteract too strong monopolization tendencies, the adverse effects of personalized prices, and fake valuations via appropriate regulations.