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The Trade-Offs in Sen. Warren’s Plan: Strict Separation Has Costs

There are now several proposals that include a strict structural separation rule in the tech industry (e.g. Sen. Warren’s proposal). These proposals would mean a complete bar on many types of acquisitions that are currently permissible. While much has been written on these proposals, I thought it would be useful to provide some trade-off analysis examining the strict separation rule as a policy preference.

Policy is about priorities and trade-offs, and these trade-offs are important to understand and communicate. For example, in 1912 the Federal Trade Commission broke up the Standard Oil monopoly into 34 smaller firms by decree. Following this break-up, the prices of gasoline rose so dramatically that the FTC was obliged to issue a report explaining it. In retrospect, we generally look back on this structural separation as a success story for antitrust policy despite the trade-offs involved. In the 1990s, the federal government sued Microsoft for violating the antitrust laws. The government eventually reached a settlement that did not include structural separation, as was originally pursued. This policy decision has also been heralded as a success story for antitrust enforcement, despite the lack of structural separation. Sen. Warren herself credits this case for helping to “clear a path for Internet companies like Google and Facebook to emerge.”

We should start with defining what we mean as a strict separation rule. Current antitrust laws police acquisitions where the effect may substantially lessen competition. This is generally applied as a merger where the likely effect would be to raise prices, reduce quality, or decrease innovation in a market. However, mergers are permitted that are unlikely to harm competition, or whose benefits outweigh the specific harms they may create. Some mergers can be beneficial, making a company more efficient, cost effective, or better at innovating. It is generally accepted that competition, as long as it remains, will force companies to pass these benefits on to the consumer.

Strict separation, on the other hand, is a rule that categorically bars companies from certain acquisitions regardless of evidence that they could yield consumer benefits. A strict separation rule represents a policy preference for more companies in a market and, by preserving independent players, an attempt to create greater odds for an independent young company to grow to overthrow an incumbent company. Strict separation is industrial organization that is generally not aligned with prioritizing consumer welfare, as we expect some consumer welfare to be lost to preserve more market players. This preference necessarily creates trade-offs, some obvious and some not-so-obvious.

Strict separation will change how investors fund startups

One of the factors that makes startups attractive for investors is the opportunity to cash out if the startup attracts the interest of an acquirer. Prof. Sokol’s article “Vertical Mergers and Entrepreneurial Exit” explains that exit via vertical merger is now the most common form of liquidity event for founders and venture capitalists. Liquidity events, or moments when investors can cash out, are important for a healthy investment ecosystem. These liquidity events allow investors to receive returns on their investments and to then recycle that money into new startups. A ban on acquisition would discourage investors who rely on the current cycle of scaling a startup to the point of exit and then recycling those profits into the next promising venture. This effect could be substantial, as the other primary form of exit – IPO – is becoming rarer. Sokol explains that there are far fewer IPOs and public companies in general than there have been historically, which Sokol believes could be related to compliance costs associated with the modern Sarbanes-Oxley regime (although others have put forth several explanations).

A strict separation rule will discourage investors that rely on the current availability of acquisitions for exit. This is a point raised by several investors in reaction to Sen. Warren’s proposal. And with IPOs trending downward, there may not be a strong alternative exit to fill the gap. Without viable forms of exit, investors will be more likely to have their funds tied up in long term projects and the beneficial recycling of capital will be substantially diminished.

Strict separation will change how startups develop

Sokol’s paper also makes the important point that some business models of current startups are built around the availability of acquisition by a larger tech company in a related field. Many startups that are incredibly successful in terms of popularity of product don’t generate profit and some don’t even have a clear monetization plan that will lead them to profitability. The tech startup mantra in some areas might well be “users first, find out how to make money later.” Sokol believes that there is strong incentive for startups to position themselves to be acquired. Under this strategy, “[t]he objective of the entrepreneurial firm is to create a bidding war for its  specialized assets among potential acquirers.”

These incentives are not necessarily bad. Some startups may emerge to provide valuable innovations that work best as features of a larger product. Monetization is also difficult in tech markets, and the entrepreneurs that can build the next big product may not be the best suited to develop a monetization strategy. Indeed, some monetization strategies rely on a degree of scale and know-how that startups don’t have access to without acquisition. As Sokol explains, larger firms tend to be poor at product innovation but excel in process innovation. The current market allows larger firms to acquire product innovations and startup founders to pass off their products to those that can develop the process to make the product long term viable.

“Professionalization” of startups that are ready to reach maturity is also important to long term success. A paper by Professors Michael Ewens and Matt Marx shows a causal link between founder replacement and startup performance. The likely reason is that the talent that is skilled at creating the next innovative product is not necessarily the talent with the skills in running an established company.

Startups will have to adjust their business strategies if there isn’t the same potential for acquisition as an exit. This may mean more focus on monetization at an early stage, which may slow adoption. It also may mean more focus on process development. Acquisitions are a good source of professionalization that will also diminish.

Strict separation will mean more startup failures, which could harm innovation

Another problem with strict separation is that good ideas could be lost when startups that can’t sell their companies to established vertical companies later fail due to problems in execution. A good real world example of this issue is the smartwatch startup Pebble. Pebble was a scrappy and beloved startup that released the smartwatch to beat before incumbent tech firms were seriously in the smartwatch market. They had the innovative idea to build a watch using smart paper for the display, a decision that greatly extended its battery life and solved one of the biggest problems preventing consumer adoption of smartwatch technology – the need to constantly charge your watch. Pebble had other innovations as well. However, the company faced problems with building the market alongside reported internal issues with supply chain management. Acquisition was a viable option for Pebble, but they didn’t take it in time. Pebble eventually sold to Fitbit at a fire-sale price of $40 million and most of Pebble’s employees were laid off. Support for Pebble was ended last June and many of the things people loved about Pebble have not been replicated in a Fitbit device. In fact, there is a fan project to keep Pebble watches alive by unofficially supporting the platform.

The Pebble story illustrates an aspect of startup acquisitions that may be underappreciated. When an established company buys a startup, they often invest substantially in building it out in terms of long-term viability. This means figuring out how to monetize it so it makes a profit. It also means building out markets, building out the product’s reputation to make it attractive to more than just early adopters, building out supply chains, lowering production costs, etc. There are many startups that are now owned by established companies that may not have been as successful without this support. Consumers benefit from this product development by acquiring companies, and without it some features that consumers love can be lost.

Under a strict separation regime, some companies will stumble and fail taking their beloved products with them. Without the availability of buyers in related markets, some companies with great ideas but without the ability to make them long-term viable will simply go out of business.


It’s important that strict separation policies are debated with an honest look at the potential trade-offs. It may be decided that the concerns warrant such a policy shift, trade-offs and all. But consumers are already rejecting Sen. Warren’s proposal. A recent NBC News/Wall Street Journal Poll shows that “Americans disagree that the likes of Apple, Amazon, Facebook and Google should be split into smaller competing companies because they have too much influence on American life,” and “a more emphatic 68% to 28%, respondents said such decisions should be left to the free market rather than government.” If such policies are adopted without explaining the trade-offs to consumers, then the blame will likely fall on antitrust enforcement policy. This would harm future efforts to police all markets.


Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.