Earlier this month, Google announced that it had picked up a 7.7% stake in Reliances Jio Platforms, weeks after a similar deal by Facebook. Given that both the tech giants have a history of buying stakes in other firms, the phenomenon is not new. However, such big deals may not really help the digital platforms sector: a new study suggests that they tend to create a kill-zone" that drives out startups 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 more than $500 million each.

The paper finds that in the three years after a typical Facebook or Google acquisition, venture capital investments in startups in the market space of the acquired firm fell 40% on average and there were 20% fewer deals in the sector.

New startups 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 platforms innovative features. This, the authors say, discourages users from switching to new platforms, bringing down the valuation of startups, and driving 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 were 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 startup space.

Also read: Kill Zone

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How buyouts by big tech stifle innovation - Livemint