Earlier this month, Google announced a 7.7% stake in Reliance’s Jio Platforms, weeks after a similar deal by Facebook. Given that both these tech giants have a history of buying stake in other firms, the phenomenon is not new. However, such big buyouts may not really help the digital platforms sector: as a new study suggests, they tend to create a “kill-zone” that drives out start-ups’ incentive to innovate.
The study, whose authors include former Reserve Bank of India governor Raghuram Rajan, was published as a working paper by the US National Bureau of Economic Research. It uses data on seven startups acquired by Google and two by Facebook between 2006 and 2018, for over $500 million each.
The paper finds that in the three years after a typical Facebook or Google acquisition, venture capital (VC) investments in start-ups in the market space of the acquired firm fell 40% on average and there were 20% fewer deals in the sector.
New start-ups in the digital space depend on the network effect to attract users, wherein a new user values a platform based on the number of users already on it. When a tech giant acquires a new platform, it incorporates the platform’s innovative features. This, the authors say, discourages users from switching to new platforms, brings down the valuation of start-ups and drives out funding. This also discourages technological innovation, the authors add.
The study recommends three key policy solutions to reverse this trend. First, interoperability would reduce the customers’ cost of switching platforms and give them access to wider networks. Second, if users are allowed to sell their own data, digital platforms can use it to improve their technology. Finally, the study proposes antitrust regulations to keep foreign giants out of domestic markets as a solution to foster innovation in the start-up space.
Also read: Kill Zone
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