Google and the next big thing:Investigating the search giant, cloud storage and how to

regulate

Course: Research Seminar in International Political Economy 1: The Politics of Global Business Regulation

Term: Spring 2013

STU count: 27214

Page count: 9

Rasmus Corlin Christensen

M.Sc. International Business and Politics

Copenhagen Business School

Deadline:

31 May 2013, 12:00 noon

IntroductionIn less than 20 years, Google has grown from garage start-up to the 25 th most valuable company in the world, offering more than 175 different products and services, and their next big thing is cloud storage. Cloud storage is storage provided centrally over the internet to decentralized locales, but more importantly, it represents the next stage in the digital economy: the centralization of computing power and services. This paper investigates Google’s recent move into cloud storage and what it means for policy, guided by the following research question: Why has Google moved into cloud storage, and what are the implications for cloud storage regulation?

Like electricity and other public utilities before it, technology and economies of scale are changing computing power and services from being provided locally (resident hardware) to via central grand plants (“the cloud”) (Carr 2008). Cloud storage also stands to become a massive industry, with the market rising toward an estimated $46.8bn value in 2018 (M&M 2013) – almost the equivalent of Google’s entire annual revenue. However, cloud storage raises concerns for regulators, in particular regarding data privacy, antitrust and innovation. What are regulators to consider when looking at cloud storage and Google, a vastly different company from electricity providers? Because it is a relatively new market, answers are few. One approach is to understand Google’s strategy, as explanations of firm behavior have significant regulatory importance. It is such explanation that this paper attempts to provide.

Drawing on two theories, mainstream strategic management, represented by the competitive forces perspective, and a heterodox Veblenian perspective on business strategy, Google’s strategy is analyzed and the implications of these different strategy understandings for regulation are considered. The policy perspectives offered are general in nature; a comprehensive assessment of policy recommendations in different legal regimes are beyond the scope of this paper.

The argument presented here is that competitive forces fails to capture the comprehensive nature of competition in cloud storage, which is essentially about control over online user data. Rather than a business strategy to exploit natural market imperfections to the benefit of firm and (to some extent) society, Google’s move into cloud storage represents tactical maneuvering to control central community resources. Consequently, significant regulatory action is necessary, e.g. breaking up Google or imposing common carrier duties, as opposed to the

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conventional laissez-faire approach. However, antitrust regulators are principally informed by mainstream understandings of firm behavior, and therefore Google remains problematically unregulated.

The paper is structured as follows: First, the mainstream strategic management perspective is presented and applied to the case, and implications for cloud storage regulation are considered. This is contrasted with the Veblenian perspective, which is argued to be more suitable, and its regulatory consequences. Finally, a conclusion is provided.

Competitive Forces, Google’s strategy and cloud storage regulationThe field of strategic management deals with “the major intended and emergent initiatives, taken by general managers on behalf of owners, involving utilization of resources, to enhance performance of firms, in their external environments” (Nag et al. 2007). Although a very diverse field, one main perspectives has dominated business-level strategy research: the competitive forces (CV) perspective.

Influenced by the Industrial Organization (IO) view and neoclassical economics, CV views firms as hierarchical structures that strive to exploit advantageous market positions at the industry-level, arising from natural market imperfections such as bounded rationality, transactions costs, entry barriers as well as the firm’s own specific (intangible) assets (Forsgren 2008:15-20). Resulting profits are Chamberlinean (monopoly) rents (ibid., Teece et al. 1997). Business strategy is about coping with competition: “the corporate strategist’s goal is to find a position in the industry where his or her company can best defend itself against these [competitive] forces or can influence them in its favor” (Porter 1979:137).

Analyzing industry competitive forces is popularly done by applying Porter’s “Five Forces” framework, which focuses on the threat of entry, threat of substitutes, and bargaining power of suppliers and buyers (Porter 1979), cf. figure 1. This is done below for cloud storage.

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Figure 1: Porter's Five Forces

Note: Adapted from De Wit & Meyer (2010:266)

Threat of new entrantsThe immediate threat of entry itself is high, with a plethora of large and small providers recently entering (Kushida et al. 2011), but the long-term competitive ability of new entrants is questionable. First, economies of scale are necessary to be efficient in cloud storage because of large entry costs and decreasing average costs as the user count rises. Entry entails massive investments, at about $500 million per datacenter (ibid.:213), which Google had begun with its “Project 2” already in 2005 (Carr 2008). By doing so, Google seized the fact that cloud computing’s “scale efficiency effect can provide a significant competitive advantage to early movers who attract a large customer base” (Kushida et al. 2011:215). Furthermore, 46% of all internet users use Google services (Fuchs 2011), and Google’s ability to effectively monetize this traffic by selling ads – from which it made $46bn in 2012 (Google 2012) – reinforces their economies of scale in cloud storage. Second, a number of government privacy policies must be complied with (Winkler 2012), most of which Google will have been familiar with from its other business. Third, well-known and fiercely competitive firms dominate the market: Apple, Microsoft, Amazon and Google1. Fourth, services 1 According to Benzinga (2013), Apple, Dropbox, Amazon and Google accounted for for 70% of the 2012-Q3 US consumer market with no other service having more than a 4% share.

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are tied to and leveraged through existing products and services, thereby creating proprietary systems and raising entry barriers. Apple’s iCloud is tied to iPhone and iPad, Microsoft’s SkyDrive to Windows 8, Amazon’s Cloud Drive to Kindle, and Google Drive is tied both directly to Google Account (which comprises all of Google’s most important services) and indirectly to their open-source mobile OS Android via the integrated Google Drive app.

Threat of substitutes and bargaining power of buyersThe available substitutes are local and traditional physical data storage, which are becoming increasingly outdated, but still relevant because of the switching costs and (privacy) risks of moving data into the cloud2. Differentiation between cloud services currently rests on brand and existing services portfolio, as most services offer similar free storage space, service levels and functionality. However, Google (and others) are working to decrease costs of moving data to the cloud, while at the same time increasing cloud-to-cloud switching costs by erecting data portability barriers via proprietary systems (cf. above). The dominance of famous brand is equally a barrier to switch, and Google has carefully crafted its brand as associated with trusted, user-friendly online services, exactly what cloud storage is about. The brands of Microsoft (operating systems and business software), Amazon (retailing), and Apple (design and easy-to-use interfaces) are less relevant for cloud storage. The substitutability between cloud storage services is therefore quite low in general, which Google can exploit, including through its brand profile. Consequently, buyer’s bargaining power is also low. Because of similarity in services and high switching costs, buyers are mostly directed through general reputational information and existing services.

Bargaining power of suppliersAt the hardware level, IT infrastructure vendors like Cisco and Hewlett-Packard supply the necessary network components (servers, switches etc.). The component markets have dominant players but are all competitive (Kushida et al. 2011:230). Software-wise, operating systems are largely unimportant for the servers; Google’s machines run a modified version of the open-source Linux (Carr 2008). Virtualization software replaces much of the necessary features, and such programs are readily available commodities. The general threat of suppliers, then, is low.

Microsoft’s SkyDrive was not included in the survey, but it probably accounts for a significant portion.2 The survey also showed that only 45% of respondents had actually used cloud storage (ibid.)

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Industry competitive rivalryThe competitive rivalry in cloud storage is fierce and heating up. Large resourceful brands are the main competitors because of natural entry barriers such as start-up costs, economies of scale, government regulation, but also because of lock-in through proprietary systems, leveraged via brands and existing services. The competitor diversity is intriguing, with Microsoft (a software giant) moving from simple online services (such as webmail) to cloud storage, Amazon (a retailer) spinning cloud storage off retail, Apple (a hardware-software firm) entering through mobile apps, and Google through its capital investments in search (Kushida et al. 2011). The latter is primed to obtain a defensible position in the market because of this immense data infrastructure and its well-suited brand.

CV and cloud storage regulationThe relevance of the analysis for policy-making is high. CV rests on neoclassical assumptions, a standard frame of reference for policy-makers, and IO, which is closely entwined with antitrust law (Kovacic & Shapiro 1999, Hovenkamp 1989). It is useful then, to assess the implications for regulation of the insights from the analysis above.

From the CV perspective, data privacy/secrecy constitutes a government-created entry barrier (because of the resources associated with compliance). Data privacy regulation is imperative for consumers because of the scale of data centralization with third parties in cloud storage (providers), but most governments are legally entitled to disclosure of stored information. In the US, the Patriot Act allows disclosure with no exceptions, and the EU has a stringent privacy policy (Kushida et al. 2011). Furthermore, thousands of different firms are subject to this regulation, and so it cannot be considered a great nor insurmountable entry barrier.

The analysis moreover sheds light on antitrust concerns. Antitrust regulation evaluates firm conduct and market consequences in order to ensure fair competition (Mazzeo & McDevitt 2012). From the CV analysis, cloud storage is mostly unproblematic for antitrust. Under the standard “relevant market” delimitation of substitutable services, by characteristics, price and intended use in sufficiently homogenous geographic markets (EC 1997), the market also encompasses local and physical data storage, as mentioned above, constituting a global and diverse market. It can hardly be argued that any firm has dominant power in such a market. Even if delimited to cloud storage, there are a handful of large competitors, which is mainly because of natural market imperfections, and

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there are no indications of anticompetitive market power or cartels between these competitors. Furthermore, mergers and acquisitions are few, as are intellectual property struggles, and there seem to be no excessive bargaining power by or over suppliers.

On the other hand, there might be concerns regarding lock-in, as the competitors are all tying and leveraging their cloud services with existing products and services, creating proprietary systems and raising switching costs. Similar cases have been brought against Microsoft by EU and US antitrust authorities for tying Windows Media Player and Internet Explorer, respectively, to Windows (EUR-Lex 2007, Justia.com 2001). However, in these cases, Windows was found to have a dominant market share in excess of, respectively, 60% and 80%, which no cloud storage provider has.

Regarding innovation, a dominant market player is not necessarily bad from the CV perspective. Oligopolistic industries, like cloud storage, are particularly attractive for firms because they allow for profitable exploitation of market imperfections, but the very existence of such firms and markets is also both a consequence and source of innovation, and therefore it can contribute to overall welfare (Forsgren 2008:18-19). Indeed, cloud computing can be a driver of innovation because it decreases barriers to innovation by decentralizing the gains from central scale and efficiency (Kushida et al. 2011).

At present, then, cloud storage brings few regulatory concerns from the CV perspective. Natural entry barriers are present, but these do not immediately give rise to anticompetitive behavior. Lock-in strategies, perhaps, might amount to that, particularly if a dominant player rises through brand profile and economies of scale. Google might be in a position do so to. Lock-in could also stifle innovation if it effectively creates segregated proprietary systems. If so, antitrust action or, if that is not capable, regulation might be necessary. However, at present, regulation should accord to prevailing economic thinking that “public policies should set market-friendly “rules of the game” and then stay out of the way” (Breznitz et al. 2011:206).

A Veblenian alternativeFor Thorstein Veblen, neoclassical economics could not explain the early 20 th

century US capitalism he was observing. Studying the entrenched oligarchs of the oil, gas and steel industries, he opposed the mainstream assumptions of

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rational utility-maximizers, optimal competition and marginal utility. He argued that a central divide existed between industry (production), an inherently social undertaking for efficiency, and business, the power struggle over community resources. Capital, he claimed, was a symbol of this power struggle rather than a measure of productivity. As such, business activity from a Veblenian perspective is a power struggle for control over these strategic community resources:

“The business man aims to gain control of a given block of industrial equipment − as, e.g., given railway lines or iron mills that are strategically important − as a basis for further transactions out of which gain is expected” (Veblen 1904:21).

For Veblen, this gain (rent) flows from the control over community resources and value, through the ability to “sabotage” the business system and choose “withdrawal of efficiency” (Veblen 1921:11).

In today’s economy, the industrial input and machine industries that Veblen studied have been surpassed as the most strategically important resources. Gagnon (2007), re-interpreting Veblen, argues that the modern economy expresses not new forms of productivity but new forms of control over community resources, in particular knowledge itself, by assigning it value and manufacturing scarcity. Indeed, three of the top five most valuable companies in the world (Apple, Microsoft and IBM) operate essentially in virtual knowledge markets, software and computer technology (FT 2012). Business strategy analysis from a Veblenian perspective is about identifying these struggles for control over knowledge.

These underlying assumptions are vastly different from the CV perspective, which adopts the neoclassical economics’ assumptions of (boundedly) rational actors and holds that profits flow from natural market friction and entry barriers. In contrast, Veblen saw the natural state of competition as inherently unequal and concerning power struggles for community resources rather than productivity under constraints.

There are a number of compelling reasons to regard the cloud storage market and Google’s move into it as an expression of a Veblenian power struggle. First, cloud storage is essentially a market for online user data, a strategic community resource. Cloud storage gives control over massive amounts of data, which can be monetized (e.g. through advertisement). Therefore, the market is contested by resourceful IT giants Apple, Microsoft, Amazon and Google, all of which have extensive histories of power struggles in online user data markets (see, e.g. Wu

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2010, Manjoo 2012, Arthur 2012). Their trajectories differ, starting with, respectively, PC manufacturing, operating systems, retail and online search, but today they all fight in markets for user data through content and services (cloud storage, books, apps, video, maps, office suite, music, social network, payment), and infrastructure/device markets to control information flows (tablet, phone, operating system, browser) – see appendix 1. The timing and convergence of strategies simply cannot be explained in conventional terms; this is clearly a Veblenian fight for user data.

Furthermore, Google’s (and competitors’) efforts to lock-in cloud storage users are about more than raising entry barriers and switching costs. Google’s leveraging through Google Account and Android (and possibly Google Search3) is about establishing Google’s proprietary system as the standard. As Ferguson (2005) details, the prize for establishing preference of one’s own system is architectural dominance, such as Intel’s microprocessor and Microsoft’s operating system, which can last indefinitely. In fact, fights have already broken out over barriers to data portability between other competing services (see e.g. Silicon Report 2010)

For Google, Google Account (by proxy of Gmail) and Android each have upwards of half a billion users (Google blog 2012, Willard 2012). Furthermore, at Google Play, from which more 1 billion apps are downloaded each month (Google blog 2011), Google Drive is currently the first recommended app (Google Play 2013). This creates a massive uptake base and pushes users to Google’s service. The tie to Android, an open source project, is particularly revealing because it was built to be a “truly open” system where “all applications are created equal” (OHA 2013), yet it remains centrally tied to Google’s project (Goggin 2012).

Thus, Google are using all available levers, even ones created for entirely opposite purposes, to entrench its position in cloud storage. These levers effectively become control points, or “moats”, that protect Google’s “economic castle”, that is, user data monetized through ads (Newman 2011). It should come as no surprise, then, that Google impressively snatched a 10% share of the US consumer market in barely five months, which is certain to have risen since 2012-Q3 as Google are primed to assert their dominance.

From the Veblenian perspective, this favorable position stems not from exploitation of an advantageous market position, but from Google’s ability to en 3 Anecdotally, Google’s cloud storage services also show up in two of the top three results from a googling of “cloud storage”. Google has previously been investigated for skewing search results to its own services (FTC 2013).

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masse centralize (i.e. manufacturing scarcity) and monetize (i.e. assigning value to) community knowledge (user data), of which cloud storage offers lots. Almost all of Google’s 178 products and services serve this purpose, either directly by harvesting data or by directing traffic to data-harvesting services. As Carr observes:

“For Google, literally everything that happens on the internet is a complement to its main business. The more things that people and companies do online, the more ads they see and the more money Google makes. In addition, as internet activity increases, Google collects more data on consumers’ needs and behavior and can tailor its ads more precisely, strengthening its competitive advantage and increasing its income” (as quoted in Arthur 2012:70).

Yet the expansion into cloud storage is of added importance. Cloud storage, unlike e.g. search or webmail, is permanently moving previously offline user activity onto the Web – and not just file storage, but also service production and knowledge creation. Cloud storage provides a real alternative to the local model, contributing to “the services transformation” of the economy, converting the internet from a communication tool to a platform for service production, and moving an ever larger volume and value of economic activity online (Kushida & Zysman 2009). Notably, Google’s cloud storage services includes a software development kit to create and save apps and app data in numerous code languages, extending Google’s control over the arena for knowledge production (of internet content and apps), which is increasingly online, social and collaborative.

Importantly, Google’s move into cloud storage is also about control over the functioning of the economy itself and society. Cloud storage centralizes information, and information is vital to both markets and society in general. As Bracha & Pasquale argue, “Concentrated control over the flow of information, coupled with the ability to manipulate this flow, may reduce economic efficiency by stifling competition” (2008:1173). For society in general, information and control over it structures what and how we are exposed to information, who gets heard, and it has significant implications for free speech (Wu 2010:12-14). These two last points could not be captured by the CV framework because of its narrow focus on the industry-level. As we shall see below, the analytical narrowness has consequences for regulatory perspective.

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In combination, the extensive control that cloud storage allows Google to obtain extends the velocity of the virtuous Google-internet circle detailed by Carr, and exacerbate Google’s control over the economy’s most precious resource (knowledge) by acquiring property over a large slice of it as it passes through Google’s services. This strive for extensive control over knowledge is exactly what explains Google’s move into cloud storage from a Veblenian perspective.

Implications for cloud storage regulationWhilst mainstream economic and strategic management thinking holds that current regulation is largely sufficient, the Veblenian perspective is more critical.

The ability of Google (and others) to exploit user data is inherently problematic for privacy. Google has previously used its size and access to data in cloud storage (and other knowledge markets) to provide governments with access to this data. Most recently in the “NSA Prism” scandal, Google, amongst others, are implicated (Morris 2013). Moreover, such “spying” is actually made easier through data centralization, (Wu 2010:249-52). From a Veblenian perspective, then, there are certainly reasons to strengthen data privacy in regulation.

Regarding antitrust, the “relevant market” might include considerations of other sources of control over user data. Of course, consumers do not substitute knowledge X from knowledge Y, but firms do; Google’s access to knowledge can be from search or webmail or cloud storage. Google arguably have a dominant position in this broader market through its more than 175 different products and services. Although Google do not hold dominant market power in any one market beyond search, they have significant shares in many different ones, most of which generate user data. These add up to Google being a dominant market power, which is evident from the fact that Google’s market share of online advertisements, the way Google monetizes user data, is 75% (eMarketer 2013). As a generator of vast quantities of user data, cloud storage is an important augmentation to this position.

The narrow conception of “fair competition” in traditional analysis can also be redefined in Veblenian terms. As unequal power struggles are normal, antitrust should be concerning with obstructing central control over community resources. If Google is a dominant power in the online user data market, and if cloud storage is an augmentation to that, Google’s extensive lock-in strategy is certainly anticompetitive. Furthermore, cloud storage’s data centralization is

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problematic in a broader sense, impairing economic efficiency by hampering information flows and restricting free speech.

Policy-wise, it then becomes imperative that user data is protected from exploitation, that proprietary systems are not allowed entrenchment as standards, and that economic efficiency and freedoms are not restricted. There are precedents for alleviating such problems via antitrust action against dominant infrastructure firms. As mentioned, Microsoft has previously been targeted, but “common carrier” responsibilities have also been imposed on infrastructure firms, and in some cases, firms have even been broken up (Wu 2010). Google might similarly be broken up, separating its largest user data businesses (e.g. search, cloud services and webmail). Common carrier duties could also be imposed on Google (and possibly other cloud providers), entailing data portability requirements to remove switching costs and ensure openness.

Finally, as opposed to CV, which sees innovation as a benefit of market power, the Veblenian approach sees few if any benefits flowing to general society from Google’s cloud storage move. Although some dominant market powers have proven innovative, e.g. AT&T’s Bell Labs, such firms are generally poor innovators (Wu 2010:195). Indeed, Wu argues that the innovative ability of Bell Labs was not fully taken advantage of until after AT&T was broken up (ibid.). Similarly, Zittrain argues that decentralized, generative systems are far superior in innovation (Zittrain 2008). From this perspective, innovation policy should then strive to offset the negative innovation effects of data centralization and proprietary systems, which might be achieved via measures discussed above regarding antitrust: break-up and/or common carrier duties.

ConclusionThis paper has analyzed Google’s entry in to the cloud storage market from two competing perspectives on firm behavior in order to shed light on how to regulate the market. The analysis shows that the competitive forces approach and the heterodox Veblenian approach produce widely different answers. Whilst the former perceives Google’s strategy as one of exploiting natural barriers, such as economies of scale, through brand profile and proprietary systems, the latter views Google’s move as tactical maneuvering to control online user data, a central community resource, and to augment Google’s entrenched position as a dominant market power. From the conventional strategy perspective, regulation is not immediately necessary. On the other hand, the Veblenian approach demands far-reaching action, e.g. breaking up Google or imposing common

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carrier duties, in order to ensure data privacy, avoid anticompetitive behavior and foster innovation.

The argument presented here is that the conventional approach fails to capture the comprehensive nature of competition in the cloud storage, which is essentially about control over online user data. However, these views have not quite reached policy-makers, who are principally informed by mainstream understandings of firm behavior (Kovacic & Shapiro 1999, Oberholzer-Gee & Yao 2010). Consequently, Google and the cloud storage market remain problematically under-regulated.

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