Archives For antitrust

The Federal Trade Commission’s (FTC) June 23 Workshop on Conditional Pricing Practices featured a broad airing of views on loyalty discounts and bundled pricing, popular vertical business practices that recently have caused much ink to be spilled by the antitrust commentariat.  In addition to predictable academic analyses featuring alternative theoretical anticompetitive effects stories, the Workshop commendably included presentations by Benjamin Klein that featured procompetitive efficiency explanations for loyalty programs and by Daniel Crane that stressed the importance of (1) treating discounts hospitably and (2) requiring proof of harmful foreclosure.  On balance, however, the Workshop provided additional fuel for enforcers who are enthused about applying new anticompetitive effects models to bring “problematic” discounting and bundling to heel.

Before U.S. antitrust enforcement agencies launch a new crusade against novel vertical discounting and bundling contracts, however, they may wish to ponder a few salient factors not emphasized in the Workshop.

First, the United States has the most efficient marketing and distribution system in the world, and it has been growing more efficient in recent decades (this is the one part of the American economy that has been a bright spot).  Consumers have benefited from more shopping convenience and higher quality/lower priced offerings due to the advent of  “big box” superstores, Internet sales engines (and e-commerce in general), and other improvements in both on-line and “bricks and mortar” sales methods.

Second, and relatedly, the Supreme Court’s recognition of vertical contractual efficiencies in GTE-Sylvania (1977) ushered in a period of greatly reduced potential liability for vertical restraints, undoubtedly encouraging economically beneficial marketing improvements.  A new government emphasis on investigating and litigating the merits of novel vertical practices (particularly practices that emphasize discounting, which presumptively benefits consumers) could inject costly new uncertainty into the marketing side of business planning, spawn risk aversion, and deter marketing innovations that reduce costs, thereby harming welfare.  These harms would mushroom to the extent courts mistakenly “bought into” new theories and incorrectly struck down efficient practices.

Third, in applying new theories of competitive harm, the antitrust enforcers should be mindful of Ronald Coase’s admonition that “if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation.  And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.”  Competition is a discovery procedure.  Entrepreneurial businesses constantly seek improvements not just in productive efficiency, but in distribution and marketing efficiencies, in order to eclipse their rivals.  As such, entrepreneurs may experiment with new contractual forms (such as bundling and loyalty discounts) in an effort to expand their market shares and grow their firms.  Business persons may not know ex ante which particular forms will work.  They may try out alternatives, sticking with those that succeed and discarding those that fail, without necessarily being able to articulate precisely the reasons for success or failure.  Real results in the market, rather than arcane economic theorems, may be expected to drive their decision-making.   Distribution and marketing methods that are successful will be emulated by others and spread.  Seen in this light (and relatedly, in light of transaction cost economics explanations for “non-standard” contracts), widespread adoption of new vertical contractual devices most likely indicates that they are efficient (they improve distribution, and imitation is the sincerest form of flattery), not that they represent some new competitive threat.  Since an economic model almost always can be ginned up to explain why some new practice may reduce consumer welfare in theory, enforcers should instead focus on hard empirical evidence that output and quality have been reduced due to a restraint before acting.  Unfortunately, the mere threat of costly misbegotten investigations may chill businesses’ interest in experimenting with new and potentially beneficial vertical contractual arrangements, reducing innovation and slowing welfare enhancement (consistent with point two, above).

Fourth, decision theoretic considerations should make enforcers particularly wary of pursuing conditional pricing contracts cases.  Consistent with decision theory, optimal antitrust enforcement should adopt an error cost framework that seeks to minimize the sum of the costs attributable to false positives, false negatives, antitrust administrative costs, and disincentive costs imposed on third parties (the latter may also be viewed as a subset of false positives).  Given the significant potential efficiencies flowing from vertical restraints, and the lack of empirical showing that they are harmful, antitrust enforcers should exercise extreme caution in entertaining proposals to challenge new vertical arrangements, such as conditional pricing mechanisms.  In particular, they should carefully assess the cumulative weight of the high risk of false positives in this area, the significant administrative costs that attend investigations and prosecutions, and the disincentives toward efficient business arrangements (see points two and three above).  Taken together, these factors strongly suggest that the aggressive pursuit of conditional pricing practice investigations would flunk a reasonable cost-benefit calculus.

Fifth, a new U.S. antitrust enforcement crusade against conditional pricing could be used by foreign competition agencies to justify further attacks on efficient vertical practices.  This could add to the harm suffered by companies (including, of course, U.S.-based multinationals) which would be deterred from maintaining and creating new welfare-beneficial distribution methods.  Foreign consumers, of course, would suffer as well.

My caveats should not be read to suggest that the FTC should refrain from pursuing new economic learning on loyalty discounting and bundled pricing, nor on other novel business practices.  Nor should it necessarily eschew all enforcement in the vertical restraints area – although that might not be such a bad idea, given error cost and resource constraint issues.  (Vertical restraints that are part of a cartel enforcement scheme should be treated as cartel conduct, and, as such, should be fair game, of course.)  In order optimally to allocate scarce resources, however, the FTC might benefit by devoting relatively greater attention to the most welfare-inimical competitive abuses – namely, anticompetitive arrangements instigated, shielded, or maintained by government authority.  (Hard core private cartel activity is best left to the Justice Department, which can deploy powerful criminal law tools against such schemes.)

U.S. antitrust law focuses primarily on private anticompetitive restraints, leaving the most serious impediments to a vibrant competitive process – government-initiated restraints – relatively free to flourish.  Thus the Federal Trade Commission (FTC) should be commended for its July 16 congressional testimony that spotlights a fast-growing and particularly pernicious species of (largely state) government restriction on competition – occupational licensing requirements.  Today such disciplines (to name just a few) as cat groomers, flower arrangers, music therapists, tree trimmers, frozen dessert retailers, eyebrow threaders, massage therapists (human and equine), and “shampoo specialists,” in addition to the traditional categories of doctors, lawyers, and accountants, are subject to professional licensure.  Indeed, since the 1950s, the coverage of such rules has risen dramatically, as the percentage of Americans requiring government authorization to do their jobs has risen from less than five percent to roughly 30 percent.

Even though some degree of licensing responds to legitimate health and safety concerns (i.e., no fly-by-night heart surgeons), much occupational regulation creates unnecessary barriers to entry into a host of jobs.  Excessive licensing confers unwarranted benefits on fortunate incumbents, while effectively barring large numbers of capable individuals from the workforce.  (For example, many individuals skilled in natural hair braiding simply cannot afford the 2,100 hours required to obtain a license in Iowa, Nebraska, and South Dakota.)  It also imposes additional economic harms, as the FTC’s testimony explains:  “[Occupational licensure] regulations may lead to higher prices, lower quality services and products, and less convenience for consumers.  In the long term, they can cause lasting damage to competition and the competitive process by rendering markets less responsive to consumer demand and by dampening incentives for innovation in products, services, and business models.”  Licensing requirements are often enacted in tandem with other occupational regulations that unjustifiably limit the scope of beneficial services particular professionals can supply – for instance, a ban on tooth cleaning by dental hygienists not acting under a dentist’s supervision that boosts dentists’ income but denies treatment to poor children who have no access to dentists.

What legal and policy tools are available to chip away at these pernicious and costly laws and regulations, which largely are the fruit of successful special interest lobbying?  The FTC’s competition advocacy program, which responds to requests from legislators and regulators to assess the economic merits of proposed laws and regulations, has focused on unwarranted regulatory restrictions in such licensed professions as real estate brokers, electricians, accountants, lawyers, dentists, dental hygienists, nurses, eye doctors, opticians, and veterinarians.  Retrospective reviews of FTC advocacy efforts suggest it may have helped achieve some notable reforms (for example, 74% of requestors, regulators, and bill sponsors surveyed responded that FTC advocacy initiatives influenced outcomes).  Nevertheless, advocacy’s reach and effectiveness inherently are limited by FTC resource constraints, by the need to obtain “invitations” to submit comments, and by the incentive and ability of licensing scheme beneficiaries to oppose regulatory and legislative reforms.

Former FTC Chairman Kovacic and James Cooper (currently at George Mason University’s Law and Economics Center) have suggested that federal and state antitrust experts could be authorized to have ex ante input into regulatory policy making.  As the authors recognize, however, several factors sharply limit the effectiveness of such an initiative.  In particular, “the political feasibility of this approach at the legislative level is slight”, federal mandates requiring ex ante reviews would raise serious federalism concerns, and resource constraints would loom large.

Antitrust law challenges to anticompetitive licensing schemes likewise offer little solace.  They are limited by the antitrust “state action” doctrine, which shields conduct undertaken pursuant to “clearly articulated” state legislative language that displaces competition – a category that generally will cover anticompetitive licensing requirements.  Even a Supreme Court decision next term (in North Carolina Dental v. FTC) that state regulatory boards dominated by self-interested market participants must be actively supervised to enjoy state action immunity would have relatively little bite.  It would not limit states from issuing simple statutory commands that create unwarranted occupational barriers, nor would it prevent states from implementing “adequate” supervisory schemes that are designed to approve anticompetitive state board rules.

What then is to be done?

Constitutional challenges to unjustifiable licensing strictures may offer the best long-term solution to curbing this regulatory epidemic.  As Clark Neily points out in Terms of Engagement, there is a venerable constitutional tradition of protecting the liberty interest to earn a living, reflected in well-reasoned late 19th and early 20th century “Lochner-era” Supreme Court opinions.  Even if Lochner is not rehabilitated, however, there are a few recent jurisprudential “straws in the wind” that support efforts to rein in “irrational” occupational licensure barriers.  Perhaps acting under divine inspiration, the Fifth Circuit in St. Joseph Abbey (2013) ruled that Louisiana statutes that required all casket manufacturers to be licensed funeral directors – laws that prevented monks from earning a living by making simple wooden caskets – served no other purpose than to protect the funeral industry, and, as such, violated the 14th Amendment’s Equal Protection and Due Process Clauses.  In particular, the Fifth Circuit held that protectionism, standing alone, is not a legitimate state interest sufficient to establish a “rational basis” for a state statute, and that absent other legitimate state interests, the law must fall.  Since the Sixth and Ninth Circuits also have held that intrastate protectionism standing alone is not a legitimate purpose for rational basis review, but the Tenth Circuit has held to the contrary, the time may soon be ripe for the Supreme Court to review this issue and, hopefully, delegitimize pure economic protectionism.  Such a development would place added pressure on defenders of protectionist occupational licensing schemes.  Other possible avenues for constitutional challenges to protectionist licensing regimes (perhaps, for example, under the Dormant Commerce Clause) also merit being explored, of course.  The Institute of Justice already is performing yeoman’s work in litigating numerous cases involving unjustified licensing and other encroachments on economic liberty; perhaps their example can prove an inspiration for pro bono efforts by others.

Eliminating anticompetitive occupational licensing rules – and, more generally, vindicating economic liberties that too long have been neglected – is obviously a long-term project, and far-reaching reform will not happen in the near term.  Nevertheless, while we the currently living may in the long run be dead (pace Keynes), our posterity will be alive, and we owe it to them to pursue the vindication of economic liberties under the Constitution.

The International Center for Law & Economics (ICLE) and TechFreedom filed two joint comments with the FCC today, explaining why the FCC has no sound legal basis for micromanaging the Internet and why “net neutrality” regulation would actually prove counter-productive for consumers.

The Policy Comments are available here, and the Legal Comments are here. See our previous post, Net Neutrality Regulation Is Bad for Consumers and Probably Illegal, for a distillation of many of the key points made in the comments.

New regulation is unnecessary. “An open Internet and the idea that companies can make special deals for faster access are not mutually exclusive,” said Geoffrey Manne, Executive Director of ICLE. “If the Internet really is ‘open,’ shouldn’t all companies be free to experiment with new technologies, business models and partnerships?”

“The media frenzy around this issue assumes that no one, apart from broadband companies, could possibly question the need for more regulation,” said Berin Szoka, President of TechFreedom. “In fact, increased regulation of the Internet will incite endless litigation, which will slow both investment and innovation, thus harming consumers and edge providers.”

Title II would be a disaster. The FCC has proposed re-interpreting the Communications Act to classify broadband ISPs under Title II as common carriers. But reinterpretation might unintentionally ensnare edge providers, weighing them down with onerous regulations. “So-called reclassification risks catching other Internet services in the crossfire,” explained Szoka. “The FCC can’t easily forbear from Title II’s most onerous rules because the agency has set a high bar for justifying forbearance. Rationalizing a changed approach would be legally and politically difficult. The FCC would have to simultaneously find the broadband market competitive enough to forbear, yet fragile enough to require net neutrality rules. It would take years to sort out this mess — essentially hitting the pause button on better broadband.”

Section 706 is not a viable option. In 2010, the FCC claimed Section 706 as an independent grant of authority to regulate any form of “communications” not directly barred by the Act, provided only that the Commission assert that regulation would somehow promote broadband. “This is an absurd interpretation,” said Szoka. “This could allow the FCC to essentially invent a new Communications Act as it goes, regulating not just broadband, but edge companies like Google and Facebook, too, and not just neutrality but copyright, cybersecurity and more. The courts will eventually strike down this theory.”

A better approach. “The best policy would be to maintain the ‘Hands off the Net’ approach that has otherwise prevailed for 20 years,” said Manne. “That means a general presumption that innovative business models and other forms of ‘prioritization’ are legal. Innovation could thrive, and regulators could still keep a watchful eye, intervening only where there is clear evidence of actual harm, not just abstract fears.” “If the FCC thinks it can justify regulating the Internet, it should ask Congress to grant such authority through legislation,” added Szoka. “A new communications act is long overdue anyway. The FCC could also convene a multistakeholder process to produce a code enforceable by the Federal Trade Commission,” he continued, noting that the White House has endorsed such processes for setting Internet policy in general.

Manne concluded: “The FCC should focus on doing what Section 706 actually commands: clearing barriers to broadband deployment. Unleashing more investment and competition, not writing more regulation, is the best way to keep the Internet open, innovative and free.”

For some of our other work on net neutrality, see:

“Understanding Net(flix) Neutrality,” an op-ed by Geoffrey Manne in the Detroit News on Netflix’s strategy to confuse interconnection costs with neutrality issues.

“The Feds Lost on Net Neutrality, But Won Control of the Internet,” an op-ed by Berin Szoka and Geoffrey Manne in Wired.com.

“That startup investors’ letter on net neutrality is a revealing look at what the debate is really about,” a post by Geoffrey Manne in Truth on the Market.

Bipartisan Consensus: Rewrite of ‘96 Telecom Act is Long Overdue,” a post on TF’s blog highlighting the key points from TechFreedom and ICLE’s joint comments on updating the Communications Act.

The Net Neutrality Comments are available here:

ICLE/TF Net Neutrality Policy Comments

TF/ICLE Net Neutrality Legal Comments

With Berin Szoka.

TechFreedom and the International Center for Law & Economics will shortly file two joint comments with the FCC, explaining why the FCC has no sound legal basis for micromanaging the Internet—now called “net neutrality regulation”—and why such regulation would be counter-productive as a policy matter. The following summarizes some of the key points from both sets of comments.

No one’s against an open Internet. The notion that anyone can put up a virtual shingle—and that the good ideas will rise to the top—is a bedrock principle with broad support; it has made the Internet essential to modern life. Key to Internet openness is the freedom to innovate. An open Internet and the idea that companies can make special deals for faster access are not mutually exclusive. If the Internet really is “open,” shouldn’t all companies be free to experiment with new technologies, business models and partnerships? Shouldn’t the FCC allow companies to experiment in building the unknown—and unknowable—Internet of the future?

The best approach would be to maintain the “Hands off the Net” approach that has otherwise prevailed for 20 years. That means a general presumption that innovative business models and other forms of “prioritization” are legal. Innovation could thrive, and regulators could still keep a watchful eye, intervening only where there is clear evidence of actual harm, not just abstract fears. And they should start with existing legal tools—like antitrust and consumer protection laws—before imposing prior restraints on innovation.

But net neutrality regulation hurts more than it helps. Counterintuitively, a blanket rule that ISPs treat data equally could actually harm consumers. Consider the innovative business models ISPs are introducing. T-Mobile’s unRadio lets users listen to all the on-demand music and radio they want without taking a hit against their monthly data plan. Yet so-called consumer advocates insist that’s a bad thing because it favors some content providers over others. In fact, “prioritizing” one service when there is congestion frees up data for subscribers to consume even more content—from whatever source. You know regulation may be out of control when a company is demonized for offering its users a freebie.

Treating each bit of data neutrally ignores the reality of how the Internet is designed, and how consumers use it.  Net neutrality proponents insist that all Internet content must be available to consumers neutrally, whether those consumers (or content providers) want it or not. They also argue against usage-based pricing. Together, these restrictions force all users to bear the costs of access for other users’ requests, regardless of who actually consumes the content, as the FCC itself has recognized:

[P]rohibiting tiered or usage-based pricing and requiring all subscribers to pay the same amount for broadband service, regardless of the performance or usage of the service, would force lighter end users of the network to subsidize heavier end users. It would also foreclose practices that may appropriately align incentives to encourage efficient use of networks.

The rules that net neutrality advocates want would hurt startups as well as consumers. Imagine a new entrant, clamoring for market share. Without the budget for a major advertising blitz, the archetypical “next Netflix” might never get the exposure it needs to thrive. But for a relatively small fee, the startup could sign up to participate in a sponsored data program, with its content featured and its customers’ data usage exempted from their data plans. This common business strategy could mean the difference between success and failure for a startup. Yet it would be prohibited by net neutrality rules banning paid prioritization.

The FCC lacks sound legal authority. The FCC is essentially proposing to do what can only properly be done by Congress: invent a new legal regime for broadband. Each of the options the FCC proposes to justify this—Section 706 of the Telecommunications Act and common carrier classification—is deeply problematic.

First, Section 706 isn’t sustainable. Until 2010, the FCC understood Section 706 as a directive to use its other grants of authority to promote broadband deployment. But in its zeal to regulate net neutrality, the FCC reversed itself in 2010, claiming Section 706 as an independent grant of authority. This would allow the FCC to regulate any form of “communications” in any way not directly barred by the Act — not just broadband but “edge” companies like Google and Facebook. This might mean going beyond neutrality to regulate copyright, cybersecurity and more. The FCC need only assert that regulation would somehow promote broadband.

If Section 706 is a grant of authority, it’s almost certainly a power to deregulate. But even if its power is as broad as the FCC claims, the FCC still hasn’t made the case that, on balance, its proposed regulations would actually do what it asserts: promote broadband. The FCC has stubbornly refused to conduct serious economic analysis on the net effects of its neutrality rules.

And Title II would be a disaster. The FCC has asked whether Title II of the Act, which governs “common carriers” like the old monopoly telephone system, is a workable option. It isn’t.

In the first place, regulations that impose design limitations meant for single-function networks simply aren’t appropriate for the constantly evolving Internet. Moreover, if the FCC re-interprets the Communications Act to classify broadband ISPs as common carriers, it risks catching other Internet services in the cross-fire, inadvertently making them common carriers, too. Surely net neutrality proponents can appreciate the harmful effects of treating Skype as a common carrier.

Forbearance can’t clean up the Title II mess. In theory the FCC could “forbear” from Title II’s most onerous rules, promising not to apply them when it determines there’s enough competition in a market to make the rules unnecessary. But the agency has set a high bar for justifying forbearance.

Most recently, in 2012, the Commission refused to grant Qwest forbearance even in the highly competitive telephony market, disregarding competition from wireless providers, and concluding that a cable-telco “duopoly” is inadequate to protect consumers. It’s unclear how the FCC could justify reaching the opposite conclusion about the broadband market—simultaneously finding it competitive enough to forbear, yet fragile enough to require net neutrality rules. Such contradictions would be difficult to explain, even if the FCC generally gets discretion on changing its approach.

But there is another path forward. If the FCC can really make the case for regulation, it should go to Congress, armed with the kind of independent economic and technical expert studies Commissioner Pai has urged, and ask for new authority. A new Communications Act is long overdue anyway. In the meantime, the FCC could convene the kind of multistakeholder process generally endorsed by the White House to produce a code enforceable by the Federal Trade Commission. A consensus is possible — just not inside the FCC, where the policy questions can’t be separated from the intractable legal questions.

Meanwhile, the FCC should focus on doing what Section 706 actually demands: clearing barriers to broadband deployment and competition. The 2010 National Broadband Plan laid out an ambitious pro-deployment agenda. It’s just too bad the FCC was so obsessed with net neutrality that it didn’t focus on the plan. Unleashing more investment and competition, not writing more regulation, is the best way to keep the Internet open, innovative and free.

[Cross-posted at TechFreedom.]

Last Monday, a group of nineteen scholars of antitrust law and economics, including yours truly, urged the U.S. Court of Appeals for the Eleventh Circuit to reverse the Federal Trade Commission’s recent McWane ruling.

McWane, the largest seller of domestically produced iron pipe fittings (DIPF), would sell its products only to distributors that “fully supported” its fittings by carrying them exclusively.  There were two exceptions: where McWane products were not readily available, and where the distributor purchased a McWane rival’s pipe along with its fittings.  A majority of the FTC ruled that McWane’s policy constituted illegal exclusive dealing.

Commissioner Josh Wright agreed that the policy amounted to exclusive dealing, but he concluded that complaint counsel had failed to prove that the exclusive dealing constituted unreasonably exclusionary conduct in violation of Sherman Act Section 2.  Commissioner Wright emphasized that complaint counsel had produced no direct evidence of anticompetitive harm (i.e., an actual increase in prices or decrease in output), even though McWane’s conduct had already run its course.  Indeed, the direct evidence suggested an absence of anticompetitive effect, as McWane’s chief rival, Star, grew in market share at exactly the same rate during and after the time of McWane’s exclusive dealing.

Instead of focusing on direct evidence of competitive effect, complaint counsel pointed to a theoretical anticompetitive harm: that McWane’s exclusive dealing may have usurped so many sales from Star that Star could not achieve minimum efficient scale.  The only evidence as to what constitutes minimum efficient scale in the industry, though, was Star’s self-serving statement that it would have had lower average costs had it operated at a scale sufficient to warrant ownership of its own foundry.  As Commissioner Wright observed, evidence in the record showed that other pipe fitting producers had successfully entered the market and grown market share substantially without owning their own foundry.  Thus, actual market experience seemed to undermine Star’s self-serving testimony.

Commissioner Wright also observed that complaint counsel produced no evidence showing what percentage of McWane’s sales of DIPF might have gone to other sellers absent McWane’s exclusive dealing policy.  Only those “contestable” sales – not all of McWane’s sales to distributors subject to the full support policy – should be deemed foreclosed by McWane’s exclusive dealing.  Complaint counsel also failed to quantify sales made to McWane’s rivals under the generous exceptions to its policy.  These deficiencies prevented complaint counsel from adequately establishing the degree of market foreclosure caused by McWane’s policy – the first (but not last!) step in establishing the alleged anticompetitive harm.

In our amicus brief, we antitrust scholars take Commissioner Wright’s side on these matters.  We also observe that the Commission failed to account for an important procompetitive benefit of McWane’s policy:  it prevented rival DIPF sellers from “cherry-picking” the most popular, highest margin fittings and selling only those at prices that could be lower than McWane’s because the cherry-pickers didn’t bear the costs of producing the full line of fittings.  Such cherry-picking is a form of free-riding because every producer’s fittings are more highly valued if a full line is available.  McWane’s policy prevented the sort of free-riding that would have made its production of a full line uneconomical.

In short, the FTC’s decision made it far too easy to successfully challenge exclusive dealing arrangements, which are usually procompetitive, and calls into question all sorts of procompetitive full-line forcing arrangements.  Hopefully, the Eleventh Circuit will correct the Commission’s mistake.

Other professors signing the brief include:

  • Tom Arthur, Emory Law
  • Roger Blair, Florida Business
  • Don Boudreaux, George Mason Economics (and Café Hayek)
  • Henry Butler, George Mason Law
  • Dan Crane, Michigan Law (and occasional TOTM contributor)
  • Richard Epstein, NYU and Chicago Law
  • Ken Elzinga, Virginia Economics
  • Damien Geradin, George Mason Law
  • Gus Hurwitz, Nebraska Law (and TOTM)
  • Keith Hylton, Boston University Law
  • Geoff Manne, International Center for Law and Economics (and TOTM)
  • Fred McChesney, Miami Law
  • Tom Morgan, George Washington Law
  • Barack Orbach, Arizona Law
  • Bill Page, Florida Law
  • Paul Rubin, Emory Economics (and TOTM)
  • Mike Sykuta, Missouri Economics (and TOTM)
  • Todd Zywicki, George Mason Law (and Volokh Conspiracy)

The brief’s “Summary of Argument” follows the jump. Continue Reading…

Today the FTC filed its complaint in federal district court in Washington against Amazon, alleging that the company’s in-app purchasing system permits children to make in-app purchases without parental “informed consent” constituting an “unfair practice” under Section 5 of the FTC Act.

As I noted in my previous post on the case, in bringing this case the Commission is doubling down on the rule it introduced in Apple that effectively converts the balancing of harms and benefits required under Section 5 of the FTC Act to a per se rule that deems certain practices to be unfair regardless of countervailing benefits. Similarly, it is attempting to extend the informed consent standard it created in Apple that essentially maintains that only specific, identified practices (essentially, distinct notification at the time of purchase or opening of purchase window, requiring entry of a password to proceed) are permissible under the Act.

Such a standard is inconsistent with the statute, however. The FTC’s approach forecloses the ability of companies like Amazon to engage in meaningful design decisions and disregards their judgment about which user interface designs will, on balance, benefit consumers. The FTC Act does not empower the Commission to disregard the consumer benefits of practices that simply fail to mimic the FTC’s preconceived design preferences. While that sort of approach might be defensible in the face of manifestly harmful practices like cramming, it is wholly inappropriate in the context of app stores like Amazon’s that spend considerable resources to design every aspect of their interaction with consumers—and that seek to attract, not to defraud, consumers.

Today’s complaint occasions a few more observations:

  1. Amazon has a very strong case. Under Section 5 of the FTC Act, the Commission will have to prevail on all three elements required to prove unfairness under Section 5: that there is substantial injury, that consumers can’t reasonably avoid the injury and that any countervailing benefits don’t outweigh the injury. But, consistent with its complaint and consent order in Apple, the Amazon complaint focuses almost entirely on only the first of these. While that may have been enough to induce Apple to settle out of court, the FTC will actually have to make out a case on reasonable avoidance and countervailing benefits at trial. It’s not at all clear that the agency will be able to do so on the facts alleged here.
  2. On reasonable avoidance, over and above Amazon’s general procedures that limit unwanted in-app purchases, the FTC will have a tough time showing that Amazon’s Kindle Free Time doesn’t provide parents with more than enough ability to avoid injury. In fact, the complaint doesn’t mention Free Time at all.
  3. Among other things, the complaint asserts that Amazon knew about issues with in-app purchasing by December of 2011 and claims that “[n]ot until June 2014 did Amazon change its in-app charge framework to obtain account holders’ informed consent for in-app charges on its newer mobile devices.” But Kindle Free Time was introduced in September of 2012. While four FTC Commissioners may believe that Free Time isn’t a sufficient response to the alleged problem, it is clearly a readily available, free and effective (read: reasonable) mechanism for parents to avoid the alleged harms. It may not be what the design mavens at the FTC would have chosen to do, but it seems certain that avoiding unauthorized in-app purchases by children was part of what motivated Amazon’s decision to create and offer Free Time.
  4. On countervailing benefits, as Commissioner Wright discussed in detail in his dissent from the Apple consent order, the Commission seems to think that it can simply assert that there are no countervailing benefits to Amazon’s design choices around in-app purchases. Here the complaint doesn’t mention 1-Click at all, which is core to Amazon’s user interface design and essential to evaluating the balance of harms and benefits required by the statute.
  5. Even if it can show that Amazon’s in-app purchase practices caused harm, the Commission will still have to demonstrate that Amazon’s conscious efforts to minimize the steps required to make purchases doesn’t benefit consumers on balance. In Apple, the FTC majority essentially (and improperly) valued these sorts of user-interface benefits at zero. It implicitly does so again here, but a court will require more than such an assertion.
  6. Given these lapses, there is even a chance that the complaint will be thrown out on a motion to dismiss. It’s a high bar, but if the court agrees that there are insufficient facts in the complaint to make out a plausible case on all three elements, Amazon could well prevail on a motion to dismiss. The FTC’s approach in the Apple consent order effectively maintains that the agency can disregard reasonable avoidance and countervailing benefits in contravention of the statute. By following the same approach here in actual litigation, the FTC may well meet resistance from the courts, which have not yet so cavalierly dispensed with the statute’s requirements.

Whereas the antitrust rules on a number of once-condemned business practices (e.g., vertical non-price restraints, resale price maintenanceprice squeezes) have become more economically sensible in the last few decades, the law on tying remains an embarrassment.  The sad state of the doctrine is evident in a federal district court’s recent denial of Viacom’s motion to dismiss a tying action by Cablevision.

According to Cablevision’s complaint, Viacom threatened to impose a substantial financial “penalty” (probably by denying a discount) unless Cablevision licensed Viacom’s less popular television programming (the “Suite Networks”) along with its popular “Core Networks” of Nickelodeon, Comedy Central, BET, and MTV.  This arrangement, Cablevision insisted, amounted to a per se illegal tie-in of the Suite Networks to the Core Networks.

Similar tying actions based on cable bundling have failed, and I have previously explained why cable bundling like this is, in fact, efficient.  But putting aside whether  the tie-in at issue here was efficient, the district court’s order is troubling because it illustrates how very unconcerned with efficiency tying doctrine is.

First, the district court rejected–correctly, under ill-founded precedents–Viacom’s argument that Cablevision was required to plead an anticompetitive effect.  It concluded that Cablevision had to allege only four elements: separate tying and tied products, coercion by the seller to force purchase of the tied product along with the tying product, the seller’s possession of market power in the tying product market, and the involvement of a “not insubstantial” dollar volume of commerce in the tied product market.  Once these elements are alleged, the court said,

plaintiffs need not allege, let alone prove, facts addressed to the anticompetitive effects element.  If a plaintiff succeeds in establishing the existence of sufficient market power to create a per se violation, the plaintiff is also relieved of the burden of rebutting any justification the defendant may offer for the tie.

In other words, if a tying plaintiff establishes the four elements listed above, the efficiency of the challenged tie-in is completely irrelevant.  And if a plaintiff merely pleads those four elements, it is entitled to proceed to discovery, which can be crippling for antitrust defendants and often causes them to settle even non-meritorious cases. Given that a great many tie-ins involving the four elements listed above are, in fact, efficient, this is a terrible rule.  It is, however, the law as established in the Supreme Court’s Jefferson Parish decision.  The blame for this silliness therefore rests on that Court, not the district court here.

But the Cablevision order includes a second unfortunate feature for which the district court and the Supreme Court share responsibility.  Having concluded that Cablevision was not required to plead anticompetitive effect, the court went on to say that Cablevision “ha[d], in any event, pleaded facts sufficient to support plausibly an inference of anticompetitive effect.”  Those alleged facts were that Cablevision would have bought content from another seller but for the tie-in:

Cablevision alleges that if it were not forced to carry the Suite Networks, it “would carry other networks on the numerous channel slots that Viacom’s Suite Networks currently occupy.”  (Compl. par. 10.)  Cablevision also alleges that Cablevision would buy other “general programming networks” from Viacom’s competitors absent the tying arrangement.  (Id.)

In other words, the district court reasoned, Cablevision alleged anticompetitive harm merely by pleading that Viacom’s conduct reduced some sales opportunities for its rivals.

But harm to a competitor, standing alone, is not harm to competition.  To establish true anticompetitive harm, Cablevision would have to show that Viacom’s tie-in reduced its rivals’ sales by so much that they lost scale efficiencies so that their average per-unit costs rose.  To make that showing, Cablevision would have to show (or allege, at the motion to dismiss stage) that Viacom’s tying occasioned substantial foreclosure of sales opportunities in the tied product market. “Some” reduction in sales to rivals–while perhaps anticompetitor–is simply not sufficient to show anticompetitive harm.

Because the Supreme Court has emphasized time and again that mere harm to a competitor is not harm to competition, the gaffe here is primarily the district court’s fault.  But at least a little blame should fall on the Supreme Court.  That Court has never precisely specified the potential anticompetitive harm from tying: that a tie-in may enhance market power in the tied or tying product markets if, but only if, it results in substantial foreclosure of sales opportunities in the tied product market.

If the Court were to do so, and were to jettison the silly quasi-per se rule of Jefferson Parish, tying doctrine would be far more defensible.

[NOTE: For a more detailed explanation of why substantial tied market foreclosure is a prerequisite to anticompetitive harm from tie-ins, see my article, Appropriate Liability Rules for Tying and Bundled Discounting, 72 Ohio St. L. J. 909 (2011).]

The Wall Street Journal reports this morning that Amazon is getting — and fighting – the “Apple treatment” from the FTC for its design of its in-app purchases:

Amazon.com Inc. is bucking a request from the Federal Trade Commission that it tighten its policies for purchases made by children while using mobile applications.

In a letter to the FTC Tuesday, Amazon said it was prepared to “defend our approach in court,” rather than agree to fines and additional record keeping and disclosure requirements over the next 20 years, according to documents reviewed by The Wall Street Journal.

According to the documents, Amazon is facing a potential lawsuit by the FTC, which wants the Seattle retailer to accept terms similar to those that Apple Inc. agreed to earlier this year regarding so-called in-app purchases.

From what I can tell, the Commission has voted to issue a complaint, and Amazon has informed the Commission that it will not accept its proposed settlement.

I am thrilled that Amazon seems to have decided to fight the latest effort by a majority of the FTC to bring every large tech company under 20-year consent decree. I should say: I’m disappointed in the FTC, sorry for Amazon, but thrilled for consumers and the free marketplace that Amazon is choosing to fight rather than acquiesce.

As I wrote earlier this year about the FTC’s case against Apple in testimony before the House Commerce Committee:

What’s particularly notable about the Apple case – and presumably will be in future technology enforcement actions predicated on unfairness – is the unique relevance of the attributes of the conduct at issue to its product. Unlike past, allegedly similar, cases, Apple’s conduct was not aimed at deceiving consumers, nor was it incidental to its product offering. But by challenging the practice, particularly without the balancing of harms required by Section 5, the FTC majority failed to act with restraint and substituted its own judgment, not about some manifestly despicable conduct, but about the very design of Apple’s products. This is the sort of area where regulatory humility is more — not less — important.

In failing to observe common sense limits in Apple, the FTC set a dangerous precedent that, given the agency’s enormous regulatory scope and the nature of technologically advanced products, could cause significant harm to consumers.

Here that failure is even more egregious. Amazon has built its entire business around the “1-click” concept — which consumers love — and implemented a host of notification and security processes hewing as much as possible to that design choice, but nevertheless taking account of the sorts of issues raised by in-app purchases. Moreover — and perhaps most significantly — it has implemented an innovative and comprehensive parental control regime (including the ability to turn off all in-app purchases) — Kindle Free Time — that arguably goes well beyond anything the FTC required in its Apple consent order. I use Kindle Free Time with my kids and have repeatedly claimed to anyone who will listen that it is the greatest thing since sliced bread. Other consumers must feel similarly. Finally, regardless of all of that, Amazon has nevertheless voluntarily implemented additional notification procedures intended to comply with the Apple settlement, even though it didn’t apply to Amazon.

If the FTC asserts, in the face of all of that, that it’s own vision of what “appropriate” in-app purchase protections must look like is the only one that suffices to meet the standard required by Section 5′s Unfairness language, it is either being egregiously disingenuous, horrifically vain, just plain obtuse, or some combination of the three.

As I wrote in my testimony:

The application of Section 5’s “unfair acts and practices” prong (the statute at issue in Apple) is circumscribed by Section 45(n) of the FTC Act, which, among other things, proscribes enforcement where injury is “not outweighed by countervailing benefits to consumers or to competition.”

And as Commissioner Wright noted in his dissent in the Apple case,

[T]he Commission effectively rejects an analysis of tradeoffs between the benefits of additional guidance and potential harm to some consumers or to competition from mandating guidance…. I respectfully disagree. These assumptions adopt too cramped a view of consumer benefits under the Unfairness Statement and, without more rigorous analysis to justify their application, are insufficient to establish the Commission’s burden.

We won’t know until we see the complaint whether the FTC has failed to undertake the balancing it neglected to perform in Apple and that it is required to perform under the statute. But it’s hard to believe that it could mount a case against Amazon in light of the facts if it did perform such a balancing. There’s no question that Amazon has implemented conscious and consumer-welfare-enhancing design choices here. The FTC’s effort to nevertheless mandate a different design (and put Amazon under a 20 year consent decree) based on a claim that Amazon’s choices impose greater harms than benefits on consumers seems manifestly unsupportable.

Such a claim almost certainly represents an abuse of the agency’s discretion, and I expect Amazon to trounce the FTC if this case goes to trial.

In recent years, antitrust enforcers in Europe and the United States have made public pronouncements and pursued enforcement initiatives that undermine the ability of patentees to earn maximum profits through the unilateral exercise of rights within the scope of their patents, as discussed in separate recent articles by me and by Professor Nicolas Petit of the University of Liege. (Similar sorts of concerns have been raised by Federal Trade Commissioner Joshua Wright.) This represents a change in emphasis away from restraints on competition among purveyors of rival patented technologies and toward the alleged “exploitation” of a patentee’s particular patented technology. It is manifested, for example, in enforcers’ rising enthusiasm for limiting patent royalties (based on hypothetical ex ante comparisons to “next best” technologies, or the existence of standards on which patents “read”), for imposing compulsory licensing remedies, and for constraining the terms of private patent litigation settlements involving a single patented technology. (Not surprisingly, given its broader legal mandate to attack abuses of dominant positions, the European Commission has been more aggressive than United States antitrust agencies.) This development has troubling implications for long-term economic welfare and innovation, and merits far greater attention than it has received thus far.

What explains this phenomenon? Public enforcers are motivated by research that purports to demonstrate fundamental flaws in the workings of the patent system (including patent litigation) and the poor quality of many patents, as described, for example, in 2003 and 2011 U.S. Federal Trade Commission (FTC) Reports. Central to this scholarship is the notion that patents are “highly uncertain” and merely “probabilistic” (read “second class”) property rights that should be deemed to convey only a right to try to exclude. This type of thinking justifies a greater role for prosecutors to “look inside” the patent “black box” and use antitrust to “correct” perceived patent “abuses,” including supposed litigation excesses.

This perspective is problematic, to say the least. Government patent agencies, not antitrust enforcers, are best positioned to (and have taken steps to) rein in litigation excesses and improve patent quality, and the Supreme Court continues to issue rulings clarifying patent coverage. More fundamentally, as Professor Petit and I explain, this new patent-specific interventionist trend ignores a robust and growing law and economics literature that highlights the benefits of the patent system in enabling technology commercialization, signaling value to capital markets and innovators, and reducing information and transaction costs. It also fails to confront empirical studies that by and large suggest stronger patent regimes are associated with faster economic growth and innovation. Furthermore, decision theory and error cost considerations indicate that antitrust agencies are ill-equipped to second guess unilateral exercises of property rights that fall within the scope of a patent. Finally, other antitrust jurisdictions, such as China, are all too likely to cite new United States and European constraints on unilateral patent right assertions as justifications for even more intrusive limitations on patent rights.

What, then, should the U.S. antitrust enforcement agencies do? Ideally, they should announce that they are redirecting their emphasis to prosecuting inefficient competitive restraints involving rival patented technologies, the central thrust of the 1995 FTC-U.S. Justice Department Patent-Antitrust Licensing Guidelines. In so doing, they should state publicly that an individual patentee should be entitled to the full legitimate returns flowing from the legal scope of its patent, free from antitrust threat. (The creation of patent-specific market power through deception or fraud is not a legitimate return on patent rights, of course, and should be subject to antitrust prosecution when found.) One would hope that eventually the European Commission (and, dare we suggest, other antitrust authorities as well) would be inspired to adopt a similar program. Additional empirical research documenting the economy-wide benefits of encouraging robust unilateral patent assertions could prove helpful in this regard.

Earlier this week the New Jersey Assembly unanimously passed a bill to allow direct sales of Tesla cars in New Jersey. (H/T Marina Lao). The bill

Allows a manufacturer (“franchisor,” as defined in P.L.1985, c.361 (C.56:10-26 et seq.)) to directly buy from or sell to consumers a zero emission vehicle (ZEV) at a maximum of four locations in New Jersey.  In addition, the bill requires a manufacturer to own or operate at least one retail facility in New Jersey for the servicing of its vehicles. The manufacturer’s direct sale locations are not required to also serve as a retail service facility.

The bill amends current law to allow any ZEV manufacturer to directly or indirectly buy from and directly sell, offer to sell, or deal to a consumer a ZEV if the manufacturer was licensed by the New Jersey Motor Vehicle Commission (MVC) on or prior to January 1, 2014.  This bill provides that ZEVs may be directly sold by certain manufacturers, like Tesla Motors, and preempts any rule or regulation that restricts sales exclusively to franchised dealerships.  The provisions of the bill would not prevent a licensed franchisor from operating under an existing license issued by the MVC.

At first cut, it seems good that the legislature is responding to the lunacy of the Christie administration’s previous decision to enforce a rule prohibiting direct sales of automobiles in New Jersey. We have previously discussed that decision at length in previous posts here, here, here and here. And Thom and Mike have taken on a similar rule in their home state of Missouri here and here.

In response to New Jersey’s decision to prohibit direct sales, the International Center for Law & Economics organized an open letter to Governor Christie based in large part on Dan Crane’s writings on the topic here at TOTM and discussing the faulty economics of such a ban. The letter was signed by more than 70 law professors and economists.

But it turns out that the legislative response is nearly as bad as the underlying ban itself.

First, a quick recap.

In our letter we noted that

The Motor Vehicle Commission’s regulation was aimed specifically at stopping one company, Tesla Motors, from directly distributing its electric cars. But the regulation would apply equally to any other innovative manufacturer trying to bring a new automobile to market, as well. There is no justification on any rational economic or public policy grounds for such a restraint of commerce. Rather, the upshot of the regulation is to reduce competition in New Jersey’s automobile market for the benefit of its auto dealers and to the detriment of its consumers. It is protectionism for auto dealers, pure and simple.

While enforcement of the New Jersey ban was clearly aimed directly at Tesla, it has broader effects. And, of course, its underlying logic is simply indefensible, regardless of which particular manufacturer it affects. The letter explains at length the economics of retail distribution and the misguided, anti-consumer logic of the regulation, and concludes by noting that

In sum, we have not heard a single argument for a direct distribution ban that makes any sense. To the contrary, these arguments simply bolster our belief that the regulations in question are motivated by economic protectionism that favors dealers at the expense of consumers and innovative technologies. It is discouraging to see this ban being used to block a company that is bringing dynamic and environmentally friendly products to market. We strongly encourage you to repeal it, by new legislation if necessary.

Thus it seems heartening that the legislature did, indeed, take up our challenge to repeal the ban.

Except that, in doing so, the legislature managed to write a bill that reflects no understanding whatever of the underlying economic issues at stake. Instead, the legislative response appears largely to be the product of rent seeking,pure and simple, offering only a limited response to Tesla’s squeaky wheel (no pun intended) and leaving the core defects of the ban completely undisturbed.

Instead of acknowledging the underlying absurdity of the limit on direct sales, the bill keeps the ban in place and simply offers a limited exception for Tesla (or other zero emission cars). While the innovative and beneficial nature of Tesla’s cars was an additional reason to oppose banning their direct sale, the specific characteristics of the cars is a minor and ancillary reason to oppose the ban. But the New Jersey legislative response is all about the cars’ emissions characteristics, and in no way does it reflect an appreciation for the fundamental economic defects of the underlying rule.

Moreover, the bill permits direct sales at only four locations (why four? No good reason whatever — presumably it was a political compromise, never the stuff of economic reason) and requires Tesla to operate a service center for its cars in the state. In other words, the regulators are still arbitrarily dictating aspects of car manufacturers’ business organization from on high.

Even worse, however, the bill is constructed to be nothing more than a payoff for a specific firm’s lobbying efforts, thus ensuring that the next (non-zero-emission) Tesla to come along will have to undertake the same efforts to pander to the state.

Far from addressing the serious concerns with the direct sales ban, the bill just perpetuates the culture of political rent seeking such regulations create.

Perhaps it’s better than nothing. Certainly it’s better than nothing for Tesla. But overall, I’d say it’s about the worst possible sort of response, short of nothing.