Facebook’s $19 billion acquisition of WhatsApp in 2014 seemed to set the stage for a 21st-century gold rush by venture capitalists seeking a big payday. Instead, the deal created a kill zone—a space where even the most eager investors refused to tread.

The traditional economic model where high-priced buyouts helped drive innovation in industries such as software development and computer chips doesn’t work anymore—and may have started breaking down when big technology companies started dominating the economy in the early 2000s, according to Chicago Booth’s Raghuram G. Rajan, Luigi Zingales, and Booth research professional Sai Krishna Kamepalli. Whenever Apple, Facebook, or Google acquired a startup, especially an app company, it may have created a kill zone, stifling innovation, the researchers argue.

The finding is timely, as the Federal Trade Commission in February broadened a review of big tech deals, demanding information about hundreds of smaller transactions over the past decade by Amazon, Apple, Facebook, Google, and Microsoft. FTC trustbusters as well as members of Congress, state attorneys general, and the Justice Department are looking into the tech industry’s “killer acquisitions,” in which big players eliminate competitive threats by simply buying out upstarts.

Before big tech, the prospect of a lucrative buyout provided ample incentive for venture capitalists to invest in business startups. VC investments helped drive innovation while generating big returns, keeping investors and the industry happy.

The kill-zone phenomenon reflects the difference between conventional businesses and digital platforms such as mobile apps, the researchers suggest. For one thing, apps don’t charge consumers money for their products, instead collecting data on users to sell to advertisers. This removes a key element from competition, as Facebook or Twitter can’t go after each other’s customers by cutting prices or fees, and neither can innovative app developers. Besides that, customers often face switching costs if they want to trade one app for another.

In this environment, early adopters of an app or platform take on an outsize role, the researchers note. These “techies” take the time and effort to learn and test new apps. If techies latch onto something innovative, it drives other users to adopt it. But if techies expect a new app to be snapped up by one of the big players, they may not invest time in learning the new product, and thus won’t recommend it to other users, driving down the value of a startup, the researchers suggest. When platforms control access to the consumer, buyouts will then take place at a fraction of the fundamental value, providing weaker incentives for innovation.

Kamepalli, Rajan, and Zingales develop a model to show how the tech sector could become more innovative and attract more investment if mergers such as that between Facebook and WhatsApp were blocked. They analyze nine apps—including YouTube, Instagram, and WhatsApp—that were bought out by Google or Facebook from 2006 to 2016, in deals valued between $625 million and $19 billion. The researchers create a timeline, starting with the techies’ recognition of the software, to the merger, to the startup’s software becoming mainstream. Applying the timetable and variables to an equation, the researchers conclude that acquisitions may take place at too low a price, discouraging innovation.

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When a startup was bought by Google or Facebook, VC investments in the same space dropped by 46 percent in the following three years, and the number of deals by 42 percent.

There could be an alternative explanation for this, Kamepalli, Rajan, and Zingales note: it’s possible that companies existed solely to be acquired. In this case, if a competitor was bought up instead, dimming their own prospects, they might lose financing and shutter.

While it may seem that a prohibition on acquisitions is the obvious policy response, the researchers argue that it could prevent customers from benefiting fully from larger networks. Instead, they recommend a focus on ensuring networks are interoperable, and allowing consumers to own their data whenever possible.

It is “dangerous to apply 20th century economic intuitions to 21st century economic problems,” the researchers caution, else there may be fewer incentives to innovate.

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