Source: Economic Times

At Carnegie India’s Global Technology Summit late last year, Sachin Bansal and Bhavish Aggarwal created ripples for alleging ‘capital dumping’ by their bigger, foreign competitors.

While the absence of Indian-ness in a Flipkart or Ola works as a fitting response, the allegation has implications beyond an India-versus-others debate. On its own terms, ‘capital dumping’ compels us to think of what would qualify as a desirable use of capital.

Innovation is fine but not dumping to facilitate market capture, appears to be the underlying rationale to this refrain. Construed thus, ‘capital dumping’ is no longer about MNCs versus Indian companies but bigger versus smaller players, regardless of founder origins and nationalistic pleas. More perspective is, therefore, needed on ‘capital dumping’ in the unique context of a digital economy.

Here, solutions tend to derive value from large user base, repeat use and big data, rather than exchange value for the service or product. For users, network effects maximise the attractiveness of the solution.

These effects, present when one agent’s adoption of a good benefits existing adopters and enhances potential benefits to new adopters, drive the success of digital economy solutions.

What stops technology companies from building on these network effects, becoming natural monopolies and locking down innovation? The answer lies in switching costs.

Consumers face switching costs between sellers when an investment specific to their current seller must be duplicated for a new one, either in the form of fresh learning costs or renewed transaction costs.

With the digital economy, learning to use another mobile app or solution is generally no big hassle. There are no extensive transaction charges or initial investment for users to ‘belong’ to a network.

Facebook managed to upstage Orkut, and WhatsApp triumphed over several earlier and bigger players, because of low switching costs coupled with smart innovation.

Network effects and switching costs considerably explain the strategic behaviour of digital economy players. By offering heavy discounts and loyalty rewards in their early days of operation, they expand the user base and maximise network effects.

Through ‘capital dumping’, ability whereof is a function of venture/debt funding, they hope to minimise the growth of competitor networks. When competitor networks respond in like fashion, consumers benefit because of the offers lavished on them.

During this phase, solution providers start bundling value-added services to network users, gradually introducing switching costs to the equation. Customer inertia takes care of the rest, usually leading to ‘winner controls all’. From a consumer standpoint, ‘capital dumping’ works well during the nascent stages of the business cycle.

Prices are low because of constant wooing by digital economy players. Even in the long run, customers will benefit so long as new entrants can innovate and provide cheaper solutions.

Innovation cycles often act as a check on digital economy players from hiking prices once the battle is won. And this takes us to a more real concern: lobbying by digital economy players, who survive long enough post the capital dumping strategy, for favourable regulations that permit recouping of below-cost prices and/or creation of switching costs for consumers by slowing the entry of incumbents.

The recent report of the committee on taxi policy submitted to the ministry of road transport reveals keen awareness of these possibilities. It has recommended liberal grant of city taxi permits, keeping a window for consumers to switch from aggregators to direct hailing of cabs, in the event of dissatisfaction with the winner of the aggregator contest.

While accepting a dynamic price structure, the committee has suggested upper limits on surge pricing for both day- and night-time fares. It has also recommended audit of aggregator algorithms used for distance and fare calculation by the Standardisation Testing and Quality Certification Directorate.

More than surge pricing per se, the aggregator’s policy behind such pricing needs scrutiny. And in the digital economy, algorithm is policy. Self-regulatory measures by digital economy players to open up algorithms for technical inspection can go a long way in building trust.

In sectors such as mobility, healthcare, energy and agriculture, disruptive solutions are important, but even more important is the consumer need for multiple solutions and fair competition, and respect for privacy and security concerns. The report serves as a healthy template to regulate the digital economy in key sectors.

This article was originally published in the Economic Times.