“Theory and
practice should not contradict one another.” George J. Stigler

Sometimes researchers
make claims that can grab headlines, but upon further investigation, their theories
don’t line up with reality.

A recent paper
and accompanying blog
follow this pattern. They conclude that merger policy in tech should block more
mergers, including mergers that would make consumers better off, because doing
so increases innovation. That’s pretty surprising! Even if each approved merger
makes consumers better off, the overall effect is consumer harm? How could that
be?

The paper
develops a theory in which blocking even good mergers makes more consumers drop
their old services in favor of those offered by new entrants, leading to more successful
startups. More startups mean more innovation because incumbents never innovate,
according to this paper’s theory.

To show that
the theory works in practice, the paper looks at nine tech acquisitions and
concludes that, true to the theory, investment in startups declined once an
acquisition occurred. Less investment means fewer startups, which means less
innovation, according to the paper.

But does the
theory really align with the cases as the paper and blog claim? No.

The theory
makes a few key assumptions that drive its results. These include:

1. The entrant offers the same type of product as
   the incumbent, but better.
2. Early adopters have to spend money to learn to
   use the entrant’s new product, but only if there is no merger. There is no cost
   to learning about the upgraded product if there is a merger.
3. Customers can choose either the entrant’s
   product or the incumbent’s product, but not both (i.e., no multi-homing).
4. Customers don’t know how good the entrant’s
   product is before trying it and once they try it, they cannot switch back to
   the incumbent if they are disappointed. And if customers don’t leave the
   incumbent at their first opportunity, they never leave.
5. The incumbent never innovates.

These
assumptions (and others) are pretty questionable. But let’s see if they align
with the cases. The cases involve either Google (whose core products are search
and associated advertising) or Facebook (whose core products are social media
and associated advertising).

Of the nine
acquisitions considered, none of the five key assumptions apply to:

• Google’s acquisition of YouTube (core product
  was video sharing)
• Google’s acquisition of Postini (core product
  was filtering email for spam and malware) [Note: It is unclear that Google was
  doing much in this space before the acquisition]
• Google’s acquisition of Waze (core product was
  crowdsourced mapping service) [Note: Customers appear to be divided on whether
  pre-Google Waze was better than Google Maps, but both continue to exist]
• Facebook’s acquisition of Instagram (core
  product was sharing photos linked into stories) [Note: Customers appear to be
  divided on their preferences for Facebook or Instagram, but both continue to
  exist]
• Facebook’s acquisition of WhatsApp (core product
  was texting using the internet)

Only the
first assumption, and none of the others, applies to:

• Google’s acquisition of DoubleClick (core
  product was online advertising)
• Google’s acquisition of AdMob (core product was
  mobile advertising)
• Google’s acquisition of ITA Software (core
  product was searching for airline prices) [Note: Google’s general search might
  have been useable for finding prices, but probably not.]
• Google’s acquisition of Apigee (core product was
  web programming interfaces and analytics)

So four of
the five important assumptions listed above apply to none of the cases. And the
first assumption applies to only four of the nine cases. So the “theory” in the
paper isn’t even a theory. As economist George Stigler said, a real theory
aligns with evidence. Otherwise, what is offered as a theory doesn’t even rise
to the level of fable.

There are
other reasons to be skeptical of how the paper and blog use these cases. For
example, Instagram has leapt in value since the Facebook acquisition, implying
that Facebook improved the product (or at least its business model). And
innovation is more than just an idea: Innovation requires an idea, turning the
idea into a real product, developing a viable business plan, and executing the
business plan.

Sometimes
incumbents can do a better job with the last two steps than entrants, making an
acquisition a good thing for all affected parties, including consumers.
Microsoft’s acquisition of DOS is a clear example.

What’s the bottom line? As I have explained before, profit potential drives startups. And options have value to startups, including options of selling an idea or product to an incumbent that has proven business acumen.

(Disclosure statement: Mark Jamison provided
consulting for Google in 2012 regarding whether Google should be considered a
public utility.)

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