Archives For international center for law & economics

The Apple E-Books Antitrust Case: Implications for Antitrust Law and for the Economy

February 15, 2016

truthonthemarket.com

The appellate court’s 2015 decision affirming the district court’s finding of per se liability in United States v. Apple provoked controversy over the legal and economic merits of the case, its significance for antitrust jurisprudence, and its implications for entrepreneurs, startups, and other economic actors throughout the economy. Apple has filed a cert petition with the Supreme Court, which will decide on February 19th whether to hear the case.

On Monday, February 15, Truth on the Market and the International Center for Law and Economics will present a blog symposium discussing the case and its implications.

We’ve lined up an outstanding and diverse group of scholars, practitioners and other experts to participate in the symposium. They are:

  • Alden Abbott
  • Andrew Albanese
  • David Balto
  • Richard Epstein
  • Tom Hazlett
  • Keith Hylton
  • Jon Jacobson
  • William Kolasky
  • Geoffrey Manne
  • Morgan Reed
  • Chris Sagers

Other participants may join, as well.

And see our previous posts at Truth on the Market discussing the Apple e-books case for a preview of many of the issues to be discussed.

A number of blockbuster mergers have received (often negative) attention from media and competition authorities in recent months. From the recently challenged Staples-Office Depot merger to the abandoned Comcast-Time Warner merger to the heavily scrutinized Aetna-Humana merger (among many others), there has been a wave of potential mega-mergers throughout the economy—many of them met with regulatory resistance. We’ve discussed several of these mergers at TOTM (see, e.g., here, here, here and here).

Many reporters, analysts, and even competition authorities have adopted various degrees of the usual stance that big is bad, and bigger is even badder. But worse yet, once this presumption applies, agencies have been skeptical of claimed efficiencies, placing a heightened burden on the merging parties to prove them and often ignoring them altogether. And, of course (and perhaps even worse still), there is the perennial problem of (often questionable) market definition — which tanked the Sysco/US Foods merger and which undergirds the FTC’s challenge of the Staples/Office Depot merger.

All of these issues are at play in the proposed acquisition of British aluminum can manufacturer Rexam PLC by American can manufacturer Ball Corp., which has likewise drawn the attention of competition authorities around the world — including those in Brazil, the European Union, and the United States.

But the Ball/Rexam merger has met with some important regulatory successes. Just recently the members of CADE, Brazil’s competition authority, unanimously approved the merger with limited divestitures. The most recent reports also indicate that the EU will likely approve it, as well. It’s now largely down to the FTC, which should approve the merger and not kill it or over-burden it with required divestitures on the basis of questionable antitrust economics.

The proposed merger raises a number of interesting issues in the surprisingly complex beverage container market. But this merger merits regulatory approval.

The International Center for Law & Economics recently released a research paper entitled, The Ball-Rexam Merger: The Case for a Competitive Can Market. The white paper offers an in-depth assessment of the economics of the beverage packaging industry; the place of the Ball-Rexam merger within this remarkably complex, global market; and the likely competitive effects of the deal.

The upshot is that the proposed merger is unlikely to have anticompetitive effects, and any competitive concerns that do arise can be readily addressed by a few targeted divestitures.

The bottom line

The production and distribution of aluminum cans is a surprisingly dynamic industry, characterized by evolving technology, shifting demand, complex bargaining dynamics, and significant changes in the costs of production and distribution. Despite the superficial appearance that the proposed merger will increase concentration in aluminum can manufacturing, we conclude that a proper understanding of the marketplace dynamics suggests that the merger is unlikely to have actual anticompetitive effects.

All told, and as we summarize in our Executive Summary, we found at least seven specific reasons for this conclusion:

  1. Because the appropriately defined product market includes not only stand-alone can manufacturers, but also vertically integrated beverage companies, as well as plastic and glass packaging manufacturers, the actual increase in concentration from the merger will be substantially less than suggested by the change in the number of nationwide aluminum can manufacturers.
  2. Moreover, in nearly all of the relevant geographic markets (which are much smaller than the typically nationwide markets from which concentration numbers are derived), the merger will not affect market concentration at all.
  3. While beverage packaging isn’t a typical, rapidly evolving, high-technology market, technological change is occurring. Coupled with shifting consumer demand (often driven by powerful beverage company marketing efforts), and considerable (and increasing) buyer power, historical beverage packaging market shares may have little predictive value going forward.
  4. The key importance of transportation costs and the effects of current input prices suggest that expanding demand can be effectively met only by expanding the geographic scope of production and by economizing on aluminum supply costs. These, in turn, suggest that increasing overall market concentration is consistent with increased, rather than decreased, competitiveness.
  5. The markets in which Ball and Rexam operate are dominated by a few large customers, who are themselves direct competitors in the upstream marketplace. These companies have shown a remarkable willingness and ability to invest in competing packaging supply capacity and to exert their substantial buyer power to discipline prices.
  6. For this same reason, complaints leveled against the proposed merger by these beverage giants — which are as much competitors as they are customers of the merging companies — should be viewed with skepticism.
  7. Finally, the merger should generate significant managerial and overhead efficiencies, and the merged firm’s expanded geographic footprint should allow it to service larger geographic areas for its multinational customers, thus lowering transaction costs and increasing its value to these customers.

Distinguishing Ardagh: The interchangeability of aluminum and glass

An important potential sticking point for the FTC’s review of the merger is its recent decision to challenge the Ardagh-Saint Gobain merger. The cases are superficially similar, in that they both involve beverage packaging. But Ardagh should not stand as a model for the Commission’s treatment of Ball/Rexam. The FTC made a number of mistakes in Ardagh (including market definition and the treatment of efficiencies — the latter of which brought out a strenuous dissent from Commissioner Wright). But even on its own (questionable) terms, Ardagh shouldn’t mean trouble for Ball/Rexam.

As we noted in our December 1st letter to the FTC on the Ball/Rexam merger, and as we discuss in detail in the paper, the situation in the aluminum can market is quite different than the (alleged) market for “(1) the manufacture and sale of glass containers to Brewers; and (2) the manufacture and sale of glass containers to Distillers” at issue in Ardagh.

Importantly, the FTC found (almost certainly incorrectly, at least for the brewers) that other container types (e.g., plastic bottles and aluminum cans) were not part of the relevant product market in Ardagh. But in the markets in which aluminum cans are a primary form of packaging (most notably, soda and beer), our research indicates that glass, plastic, and aluminum are most definitely substitutes.

The Big Four beverage companies (Coca-Cola, PepsiCo, Anheuser-Busch InBev, and MillerCoors), which collectively make up 80% of the U.S. market for Ball and Rexam, are all vertically integrated to some degree, and provide much of their own supply of containers (a situation significantly different than the distillers in Ardagh). These companies exert powerful price discipline on the aluminum packaging market by, among other things, increasing (or threatening to increase) their own container manufacturing capacity, sponsoring new entry, and shifting production (and, via marketing, consumer demand) to competing packaging types.

For soda, Ardagh is obviously inapposite, as soda packaging wasn’t at issue there. But the FTC’s conclusion in Ardagh that aluminum cans (which in fact make up 56% of the beer packaging market) don’t compete with glass bottles for beer packaging is also suspect.

For aluminum can manufacturers Ball and Rexam, aluminum can’t be excluded from the market (obviously), and much of the beer in the U.S. that is packaged in aluminum is quite clearly also packaged in glass. The FTC claimed in Ardagh that glass and aluminum are consumed in distinct situations, so they don’t exert price pressure on each other. But that ignores the considerable ability of beer manufacturers to influence consumption choices, as well as the reality that consumer preferences for each type of container (whether driven by beer company marketing efforts or not) are merging, with cost considerations dominating other factors.

In fact, consumers consume beer in both packaging types largely interchangeably (with a few limited exceptions — e.g., poolside drinking demands aluminum or plastic), and beer manufacturers readily switch between the two types of packaging as the relative production costs shift.

Craft brewers, to take one important example, are rapidly switching to aluminum from glass, despite a supposed stigma surrounding canned beers. Some craft brewers (particularly the larger ones) do package at least some of their beers in both types of containers, or simultaneously package some of their beers in glass and some of their beers in cans, while for many craft brewers it’s one or the other. Yet there’s no indication that craft beer consumption has fallen off because consumers won’t drink beer from cans in some situations — and obviously the prospect of this outcome hasn’t stopped craft brewers from abandoning bottles entirely in favor of more economical cans, nor has it induced them, as a general rule, to offer both types of packaging.

A very short time ago it might have seemed that aluminum wasn’t in the same market as glass for craft beer packaging. But, as recent trends have borne out, that differentiation wasn’t primarily a function of consumer preference (either at the brewer or end-consumer level). Rather, it was a function of bottling/canning costs (until recently the machinery required for canning was prohibitively expensive), materials costs (at various times glass has been cheaper than aluminum, depending on volume), and transportation costs (which cut against glass, but the relative attractiveness of different packaging materials is importantly a function of variable transportation costs). To be sure, consumer preference isn’t irrelevant, but the ease with which brewers have shifted consumer preferences suggests that it isn’t a strong constraint.

Transportation costs are key

Transportation costs, in fact, are a key part of the story — and of the conclusion that the Ball/Rexam merger is unlikely to have anticompetitive effects. First of all, transporting empty cans (or bottles, for that matter) is tremendously inefficient — which means that the relevant geographic markets for assessing the competitive effects of the Ball/Rexam merger are essentially the largely non-overlapping 200 mile circles around the companies’ manufacturing facilities. Because there are very few markets in which the two companies both have plants, the merger doesn’t change the extent of competition in the vast majority of relevant geographic markets.

But transportation costs are also relevant to the interchangeability of packaging materials. Glass is more expensive to transport than aluminum, and this is true not just for empty bottles, but for full ones, of course. So, among other things, by switching to cans (even if it entails up-front cost), smaller breweries can expand their geographic reach, potentially expanding sales enough to more than cover switching costs. The merger would further lower the costs of cans (and thus of geographic expansion) by enabling beverage companies to transact with a single company across a wider geographic range.

The reality is that the most important factor in packaging choice is cost, and that the packaging alternatives are functionally interchangeable. As a result, and given that the direct consumers of beverage packaging are beverage companies rather than end-consumers, relatively small cost changes readily spur changes in packaging choices. While there are some switching costs that might impede these shifts, they are readily overcome. For large beverage companies that already use multiple types and sizes of packaging for the same product, the costs are trivial: They already have packaging designs, marketing materials, distribution facilities and the like in place. For smaller companies, a shift can be more difficult, but innovations in labeling, mobile canning/bottling facilities, outsourced distribution and the like significantly reduce these costs.  

“There’s a great future in plastics”

All of this is even more true for plastic — even in the beer market. In fact, in 2010, 10% of the beer consumed in Europe was sold in plastic bottles, as was 15% of all beer consumed in South Korea. We weren’t able to find reliable numbers for the U.S., but particularly for cheaper beers, U.S. brewers are increasingly moving to plastic. And plastic bottles are the norm at stadiums and arenas. Whatever the exact numbers, clearly plastic holds a small fraction of the beer container market compared to glass and aluminum. But that number is just as clearly growing, and as cost considerations impel them (and technology enables them), giant, powerful brewers like AB InBev and MillerCoors are certainly willing and able to push consumers toward plastic.

Meanwhile soda companies like Coca-cola and Pepsi have successfully moved their markets so that today a majority of packaged soda is sold in plastic containers. There’s no evidence that this shift came about as a result of end-consumer demand, nor that the shift to plastic was delayed by a lack of demand elasticity; rather, it was primarily a function of these companies’ ability to realize bigger profits on sales in plastic containers (not least because they own their own plastic packaging production facilities).

And while it’s not at issue in Ball/Rexam because spirits are rarely sold in aluminum packaging, the FTC’s conclusion in Ardagh that

[n]on-glass packaging materials, such as plastic containers, are not in this relevant product market because not enough spirits customers would switch to non-glass packaging materials to make a SSNIP in glass containers to spirits customers unprofitable for a hypothetical monopolist

is highly suspect — which suggests the Commission may have gotten it wrong in other ways, too. For example, as one report notes:

But the most noteworthy inroads against glass have been made in distilled liquor. In terms of total units, plastic containers, almost all of them polyethylene terephthalate (PET), have surpassed glass and now hold a 56% share, which is projected to rise to 69% by 2017.

True, most of this must be tiny-volume airplane bottles, but by no means all of it is, and it’s clear that the cost advantages of plastic are driving a shift in distilled liquor packaging, as well. Some high-end brands are even moving to plastic. Whatever resistance (and this true for beer, too) that may have existed in the past because of glass’s “image,” is breaking down: Don’t forget that even high-quality wines are now often sold with screw-tops or even in boxes — something that was once thought impossible.

The overall point is that the beverage packaging market faced by can makers like Ball and Rexam is remarkably complex, and, crucially, the presence of powerful, vertically integrated customers means that past or current demand by end-users is a poor indicator of what the market will look like in the future as input costs and other considerations faced by these companies shift. Right now, for example, over 50% of the world’s soda is packaged in plastic bottles, and this margin is set to increase: The global plastic packaging market (not limited to just beverages) is expected to grow at a CAGR of 5.2% between 2014 and 2020, while aluminum packaging is expected to grow at just 2.9%.

A note on efficiencies

As noted above, the proposed Ball/Rexam merger also holds out the promise of substantial efficiencies (estimated at $300 million by the merging parties, due mainly to decreased transportation costs). There is a risk, however, that the FTC may effectively disregard those efficiencies, as it did in Ardagh (and in St. Luke’s before it), by saddling them with a higher burden of proof than it requires of its own prima facie claims. If the goal of antitrust law is to promote consumer welfare, competition authorities can’t ignore efficiencies in merger analysis.

In his Ardagh dissent, Commissioner Wright noted that:

Even when the same burden of proof is applied to anticompetitive effects and efficiencies, of course, reasonable minds can and often do differ when identifying and quantifying cognizable efficiencies as appears to have occurred in this case.  My own analysis of cognizable efficiencies in this matter indicates they are significant.   In my view, a critical issue highlighted by this case is whether, when, and to what extent the Commission will credit efficiencies generally, as well as whether the burden faced by the parties in establishing that proffered efficiencies are cognizable under the Merger Guidelines is higher than the burden of proof facing the agencies in establishing anticompetitive effects. After reviewing the record evidence on both anticompetitive effects and efficiencies in this case, my own view is that it would be impossible to come to the conclusions about each set forth in the Complaint and by the Commission — and particularly the conclusion that cognizable efficiencies are nearly zero — without applying asymmetric burdens.

The Commission shouldn’t make the same mistake here. In fact, here, where can manufacturers are squeezed between powerful companies both upstream (e.g., Alcoa) and downstream (e.g., AB InBev), and where transportation costs limit the opportunities for expanding the customer base of any particular plant, the ability to capitalize on economies of scale and geographic scope is essential to independent manufacturers’ abilities to efficiently meet rising demand.

Read our complete assessment of the merger’s effect here.

Today the International Center for Law & Economics (ICLE) submitted an amicus brief to the Supreme Court of the United States supporting Apple’s petition for certiorari in its e-books antitrust case. ICLE’s brief was signed by sixteen distinguished scholars of law, economics and public policy, including an Economics Nobel Laureate, a former FTC Commissioner, ten PhD economists and ten professors of law (see the complete list, below).

Background

Earlier this year a divided panel of the Second Circuit ruled that Apple “orchestrated a conspiracy among [five major book] publishers to raise ebook prices… in violation of § 1 of the Sherman Act.” Significantly, the court ruled that Apple’s conduct constituted a per se unlawful horizontal price-fixing conspiracy, meaning that the procompetitive benefits of Apple’s entry into the e-books market was irrelevant to the liability determination.

Apple filed a petition for certiorari with the Supreme Court seeking review of the ruling on the question of

Whether vertical conduct by a disruptive market entrant, aimed at securing suppliers for a new retail platform, should be condemned as per se illegal under Section 1 of the Sherman Act, rather than analyzed under the rule of reason, because such vertical activity also had the alleged effect of facilitating horizontal collusion among the suppliers.

Summary of Amicus Brief

The Second Circuit’s ruling is in direct conflict with the Supreme Court’s 2007 Leegin decision, and creates a circuit split with the Third Circuit based on that court’s Toledo Mack ruling. ICLE’s brief urges the Court to review the case in order to resolve the significant uncertainty created by the Second Circuit’s ruling, particularly for the multi-sided platform companies that epitomize the “New Economy.”

As ICLE’s brief discusses, the Second Circuit committed several important errors in its ruling:

First, As the Supreme Court held in Leegin, condemnation under the per se rule is appropriate “only for conduct that would always or almost always tend to restrict competition” and “only after courts have had considerable experience with the type of restraint at issue.” Neither is true in this case. Businesses often employ one or more forms of vertical restraints to make entry viable, and the Court has blessed such conduct, categorically holding in Leegin that “[v]ertical price restraints are to be judged according to the rule of reason.”

Furthermore, the conduct at issue in this case — the use of “Most-Favored Nation Clauses” in Apple’s contracts with the publishers and its adoption of the so-called “agency model” for e-book pricing — have never been reviewed by the courts in a setting like this one, let alone found to “always or almost always tend to restrict competition.” There is no support in the case law or economic literature for the proposition that agency models or MFNs used to facilitate entry by new competitors in platform markets like this one are anticompetitive.

Second, the negative consequences of the court’s ruling will be particularly acute for modern, high-technology sectors of the economy, where entrepreneurs planning to deploy new business models will now face exactly the sort of artificial deterrents that the Court condemned in Trinko: “Mistaken inferences and the resulting false condemnations are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” Absent review by the Supreme Court to correct the Second Circuit’s error, the result will be less-vigorous competition and a reduction in consumer welfare.

This case involves vertical conduct essentially indistinguishable from conduct that the Supreme Court has held to be subject to the rule of reason. But under the Second Circuit’s approach, the adoption of these sorts of efficient vertical restraints could be challenged as a per se unlawful effort to “facilitate” horizontal price fixing, significantly deterring their use. The lower court thus ignored the Supreme Court’s admonishment not to apply the antitrust laws in a way that makes the use of a particular business model “more attractive based on the per se rule” rather than on “real market conditions.”

Third, the court based its decision that per se review was appropriate largely on the fact that e-book prices increased following Apple’s entry into the market. But, contrary to the court’s suggestion, it has long been settled that such price increases do not make conduct per se unlawful. In fact, the Supreme Court has held that the per se rule is inappropriate where, as here, “prices can be increased in the course of promoting procompetitive effects.”  

Competition occurs on many dimensions other than just price; higher prices alone don’t necessarily suggest decreased competition or anticompetitive effects. Instead, higher prices may accompany welfare-enhancing competition on the merits, resulting in greater investment in product quality, reputation, innovation or distribution mechanisms.

The Second Circuit presumed that Amazon’s e-book prices before Apple’s entry were competitive, and thus that the price increases were anticompetitive. But there is no support in the record for that presumption, and it is not compelled by economic reasoning. In fact, it is at least as likely that the change in Amazon’s prices reflected the fact that Amazon’s business model pre-entry resulted in artificially low prices, and that the price increases following Apple’s entry were the product of a more competitive market.

Previous commentary on the case

For my previous writing and commentary on the the case, see:

  • “The Second Circuit’s Apple e-books decision: Debating the merits and the meaning,” American Bar Association debate with Fiona Scott-Morton, DOJ Chief Economist during the Apple trial, and Mark Ryan, the DOJ’s lead litigator in the case, recording here
  • Why I think the Apple e-books antitrust decision will (or at least should) be overturned, Truth on the Market, here
  • Why I think the government will have a tough time winning the Apple e-books antitrust case, Truth on the Market, here
  • The procompetitive story that could undermine the DOJ’s e-books antitrust case against Apple, Truth on the Market, here
  • How Apple can defeat the DOJ’s e-book antitrust suit, Forbes, here
  • The US e-books case against Apple: The procompetitive story, special issue of Concurrences on “E-books and the Boundaries of Antitrust,” here
  • Amazon vs. Macmillan: It’s all about control, Truth on the Market, here

Other TOTM authors have also weighed in. See, e.g.:

  • The Second Circuit Misapplies the Per Se Rule in U.S. v. Apple, Alden Abbott, here
  • The Apple E-Book Kerfuffle Meets Alfred Marshall’s Principles of Economics, Josh Wright, here
  • Apple and Amazon E-Book Most Favored Nation Clauses, Josh Wright, here

Amicus Signatories

  • Babette E. Boliek, Associate Professor of Law, Pepperdine University School of Law
  • Henry N. Butler, Dean and Professor of Law, George Mason University School of Law
  • Justin (Gus) Hurwitz, Assistant Professor of Law, Nebraska College of Law
  • Stan Liebowitz, Ashbel Smith Professor of Economics, School of Management, University of Texas-Dallas
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Scott E. Masten, Professor of Business Economics & Public Policy, Stephen M. Ross School of Business, The University of Michigan
  • Alan J. Meese, Ball Professor of Law, William & Mary Law School
  • Thomas D. Morgan, Professor Emeritus, George Washington University Law School
  • David S. Olson, Associate Professor of Law, Boston College Law School
  • Joanna Shepherd, Professor of Law, Emory University School of Law
  • Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics,  The George L. Argyros School of Business and Economics and Professor of Economics and Law, Dale E. Fowler School of Law, Chapman University
  • Michael E. Sykuta, Associate Professor, Division of Applied Social Sciences, University of Missouri-Columbia
  • Alex Tabarrok, Bartley J. Madden Chair in Economics at the Mercatus Center and Professor of Economics, George Mason University
  • David J. Teece, Thomas W. Tusher Professor in Global Business and Director, Center for Global Strategy and Governance, Haas School of Business, University of California Berkeley
  • Alexander Volokh, Associate Professor of Law, Emory University School of Law
  • Joshua D. Wright, Professor of Law, George Mason University School of Law

Remember when net neutrality wasn’t going to involve rate regulation and it was crazy to say that it would? Or that it wouldn’t lead to regulation of edge providers? Or that it was only about the last mile and not interconnection? Well, if the early petitions and complaints are a preview of more to come, the Open Internet Order may end up having the FCC regulating rates for interconnection and extending the reach of its privacy rules to edge providers.

On Monday, Consumer Watchdog petitioned the FCC to not only apply Customer Proprietary Network Information (CPNI) rules originally meant for telephone companies to ISPs, but to also start a rulemaking to require edge providers to honor Do Not Track requests in order to “promote broadband deployment” under Section 706. Of course, we warned of this possibility in our joint ICLE-TechFreedom legal comments:

For instance, it is not clear why the FCC could not, through Section 706, mandate “network level” copyright enforcement schemes or the DNS blocking that was at the heart of the Stop Online Piracy Act (SOPA). . . Thus, it would appear that Section 706, as re-interpreted by the FCC, would, under the D.C. Circuit’s Verizon decision, allow the FCC sweeping power to regulate the Internet up to and including (but not beyond) the process of “communications” on end-user devices. This could include not only copyright regulation but everything from cybersecurity to privacy to technical standards. (emphasis added).

While the merits of Do Not Track are debatable, it is worth noting that privacy regulation can go too far and actually drastically change the Internet ecosystem. In fact, it is actually a plausible scenario that overregulating data collection online could lead to the greater use of paywalls to access content.  This may actually be a greater threat to Internet Openness than anything ISPs have done.

And then yesterday, the first complaint under the new Open Internet rule was brought against Time Warner Cable by a small streaming video company called Commercial Network Services. According to several news stories, CNS “plans to file a peering complaint against Time Warner Cable under the Federal Communications Commission’s new network-neutrality rules unless the company strikes a free peering deal ASAP.” In other words, CNS is asking for rate regulation for interconnectionshakespeare. Under the Open Internet Order, the FCC can rule on such complaints, but it can only rule on a case-by-case basis. Either TWC assents to free peering, or the FCC intervenes and sets the rate for them, or the FCC dismisses the complaint altogether and pushes such decisions down the road.

This was another predictable development that many critics of the Open Internet Order warned about: there was no way to really avoid rate regulation once the FCC reclassified ISPs. While the FCC could reject this complaint, it is clear that they have the ability to impose de facto rate regulation through case-by-case adjudication. Whether it is rate regulation according to Title II (which the FCC ostensibly didn’t do through forbearance) is beside the point. This will have the same practical economic effects and will be functionally indistinguishable if/when it occurs.

In sum, while neither of these actions were contemplated by the FCC (they claim), such abstract rules are going to lead to random complaints like these, and companies are going to have to use the “ask FCC permission” process to try to figure out beforehand whether they should be investing or whether they’re going to be slammed. As Geoff Manne said in Wired:

That’s right—this new regime, which credits itself with preserving “permissionless innovation,” just put a bullet in its head. It puts innovators on notice, and ensures that the FCC has the authority (if it holds up in court) to enforce its vague rule against whatever it finds objectionable.

I mean, I don’t wanna brag or nothin, but it seems to me that we critics have been right so far. The reclassification of broadband Internet service as Title II has had the (supposedly) unintended consequence of sweeping in far more (both in scope of application and rules) than was supposedly bargained for. Hopefully the FCC rejects the petition and the complaint and reverses this course before it breaks the Internet.

Recently, Commissioner Pai praised the introduction of bipartisan legislation to protect joint sales agreements (“JSAs”) between local television stations. He explained that

JSAs are contractual agreements that allow broadcasters to cut down on costs by using the same advertising sales force. The efficiencies created by JSAs have helped broadcasters to offer services that benefit consumers, especially in smaller markets…. JSAs have served communities well and have promoted localism and diversity in broadcasting. Unfortunately, the FCC’s new restrictions on JSAs have already caused some stations to go off the air and other stations to carry less local news.

fccThe “new restrictions” to which Commissioner Pai refers were recently challenged in court by the National Association of Broadcasters (NAB), et. al., and on April 20, the International Center for Law & Economics and a group of law and economics scholars filed an amicus brief with the D.C. Circuit Court of Appeals in support of the petition, asking the court to review the FCC’s local media ownership duopoly rule restricting JSAs.

Much as it did with with net neutrality, the FCC is looking to extend another set of rules with no basis in sound economic theory or established facts.

At issue is the FCC’s decision both to retain the duopoly rule and to extend that rule to certain JSAs, all without completing a legally mandated review of the local media ownership rules, due since 2010 (but last completed in 2007).

The duopoly rule is at odds with sound competition policy because it fails to account for drastic changes in the media market that necessitate redefinition of the market for television advertising. Moreover, its extension will bring a halt to JSAs currently operating (and operating well) in nearly 100 markets.  As the evidence on the FCC rulemaking record shows, many of these JSAs offer public interest benefits and actually foster, rather than stifle, competition in broadcast television markets.

In the world of media mergers generally, competition law hasn’t yet caught up to the obvious truth that new media is competing with old media for eyeballs and advertising dollars in basically every marketplace.

For instance, the FTC has relied on very narrow market definitions to challenge newspaper mergers without recognizing competition from television and the Internet. Similarly, the generally accepted market in which Google’s search conduct has been investigated is something like “online search advertising” — a market definition that excludes traditional marketing channels, despite the fact that advertisers shift their spending between these channels on a regular basis.

But the FCC fares even worse here. The FCC’s duopoly rule is premised on an “eight voices” test for local broadcast stations regardless of the market shares of the merging stations. In other words, one entity cannot own FCC licenses to two or more TV stations in the same local market unless there are at least eight independently owned stations in that market, even if their combined share of the audience or of advertising are below the level that could conceivably give rise to any inference of market power.

Such a rule is completely unjustifiable under any sensible understanding of competition law.

Can you even imagine the FTC or DOJ bringing an 8 to 7 merger challenge in any marketplace? The rule is also inconsistent with the contemporary economic learning incorporated into the 2010 Merger Guidelines, which looks at competitive effects rather than just counting competitors.

Not only did the FCC fail to analyze the marketplace to understand how much competition there is between local broadcasters, cable, and online video, but, on top of that, the FCC applied this outdated duopoly rule to JSAs without considering their benefits.

The Commission offers no explanation as to why it now believes that extending the duopoly rule to JSAs, many of which it had previously approved, is suddenly necessary to protect competition or otherwise serve the public interest. Nor does the FCC cite any evidence to support its position. In fact, the record evidence actually points overwhelmingly in the opposite direction.

As a matter of sound regulatory practice, this is bad enough. But Congress directed the FCC in Section 202(h) of the Telecommunications Act of 1996 to review all of its local ownership rules every four years to determine whether they were still “necessary in the public interest as the result of competition,” and to repeal or modify those that weren’t. During this review, the FCC must examine the relevant data and articulate a satisfactory explanation for its decision.

So what did the Commission do? It announced that, instead of completing its statutorily mandated 2010 quadrennial review of its local ownership rules, it would roll that review into a new 2014 quadrennial review (which it has yet to perform). Meanwhile, the Commission decided to retain its duopoly rule pending completion of that review because it had “tentatively” concluded that it was still necessary.

In other words, the FCC hasn’t conducted its mandatory quadrennial review in more than seven years, and won’t, under the new rules, conduct one for another year and a half (at least). Oh, and, as if nothing of relevance has changed in the market since then, it “tentatively” maintains its already suspect duopoly rule in the meantime.

In short, because the FCC didn’t conduct the review mandated by statute, there is no factual support for the 2014 Order. By relying on the outdated findings from its earlier review, the 2014 Order fails to examine the significant changes both in competition policy and in the market for video programming that have occurred since the current form of the rule was first adopted, rendering the rulemaking arbitrary and capricious under well-established case law.

Had the FCC examined the record of the current rulemaking, it would have found substantial evidence that undermines, rather than supports, the FCC’s rule.

Economic studies have shown that JSAs can help small broadcasters compete more effectively with cable and online video in a world where their advertising revenues are drying up and where temporary economies of scale (through limited contractual arrangements like JSAs) can help smaller, local advertising outlets better implement giant, national advertising campaigns. A ban on JSAs will actually make it less likely that competition among local broadcasters can survive, not more.

OfficialPaiCommissioner Pai, in his dissenting statement to the 2014 Order, offered a number of examples of the benefits of JSAs (all of them studiously ignored by the Commission in its Order). In one of these, a JSA enabled two stations in Joplin, Missouri to use their $3.5 million of cost savings from a JSA to upgrade their Doppler radar system, which helped save lives when a devastating tornado hit the town in 2011. But such benefits figure nowhere in the FCC’s “analysis.”

Several econometric studies also provide empirical support for the (also neglected) contention that duopolies and JSAs enable stations to improve the quality and prices of their programming.

One study, by Jeff Eisenach and Kevin Caves, shows that stations operating under these agreements are likely to carry significantly more news, public affairs, and current affairs programming than other stations in their markets. The same study found an 11 percent increase in audience shares for stations acquired through a duopoly. Meanwhile, a study by Hal Singer and Kevin Caves shows that markets with JSAs have advertising prices that are, on average, roughly 16 percent lower than in non-duopoly markets — not higher, as would be expected if JSAs harmed competition.

And again, Commissioner Pai provides several examples of these benefits in his dissenting statement. In one of these, a JSA in Wichita, Kansas enabled one of the two stations to provide Spanish-language HD programming, including news, weather, emergency and community information, in a market where that Spanish-language programming had not previously been available. Again — benefit ignored.

Moreover, in retaining its duopoly rule on the basis of woefully outdated evidence, the FCC completely ignores the continuing evolution in the market for video programming.

In reality, competition from non-broadcast sources of programming has increased dramatically since 1999. Among other things:

  • VideoScreensToday, over 85 percent of American households watch TV over cable or satellite. Most households now have access to nearly 200 cable channels that compete with broadcast TV for programming content and viewers.
  • In 2014, these cable channels attracted twice as many viewers as broadcast channels.
  • Online video services such as Netflix, Amazon Prime, and Hulu have begun to emerge as major new competitors for video programming, leading 179,000 households to “cut the cord” and cancel their cable subscriptions in the third quarter of 2014 alone.
  • Today, 40 percent of U.S. households subscribe to an online streaming service; as a result, cable ratings among adults fell by nine percent in 2014.
  • At the end of 2007, when the FCC completed its last quadrennial review, the iPhone had just been introduced, and the launch of the iPad was still more than two years away. Today, two-thirds of Americans have a smartphone or tablet over which they can receive video content, using technology that didn’t even exist when the FCC last amended its duopoly rule.

In the face of this evidence, and without any contrary evidence of its own, the Commission’s action in reversing 25 years of agency practice and extending its duopoly rule to most JSAs is arbitrary and capricious.

The law is pretty clear that the extent of support adduced by the FCC in its 2014 Rule is insufficient. Among other relevant precedent (and there is a lot of it):

The Supreme Court has held that an agency

must examine the relevant data and articulate a satisfactory explanation for its action, including a rational connection between the facts found and the choice made.

In the DC Circuit:

the agency must explain why it decided to act as it did. The agency’s statement must be one of ‘reasoning’; it must not be just a ‘conclusion’; it must ‘articulate a satisfactory explanation’ for its action.

And:

[A]n agency acts arbitrarily and capriciously when it abruptly departs from a position it previously held without satisfactorily explaining its reason for doing so.

Also:

The FCC ‘cannot silently depart from previous policies or ignore precedent’ . . . .”

And most recently in Judge Silberman’s concurrence/dissent in the 2010 Verizon v. FCC Open Internet Order case:

factual determinations that underly [sic] regulations must still be premised on demonstrated — and reasonable — evidential support

None of these standards is met in this case.

It will be noteworthy to see what the DC Circuit does with these arguments given the pending Petitions for Review of the latest Open Internet Order. There, too, the FCC acted without sufficient evidentiary support for its actions. The NAB/Stirk Holdings case may well turn out to be a bellwether for how the court views the FCC’s evidentiary failings in that case, as well.

The scholars joining ICLE on the brief are:

  • Babette E. Boliek, Associate Professor of Law, Pepperdine School of Law
  • Henry N. Butler, George Mason University Foundation Professor of Law and Executive Director of the Law & Economics Center, George Mason University School of Law (and newly appointed dean).
  • Richard Epstein, Laurence A. Tisch Professor of Law, Classical Liberal Institute, New York University School of Law
  • Stan Liebowitz, Ashbel Smith Professor of Economics, University of Texas at Dallas
  • Fred McChesney, de la Cruz-Mentschikoff Endowed Chair in Law and Economics, University of Miami School of Law
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics, Emory University
  • Michael E. Sykuta, Associate Professor in the Division of Applied Social Sciences and Director of the Contracting and Organizations Research Institute, University of Missouri

The full amicus brief is available here.

Last week, the FTC announced its complaint and consent decree with Nomi Technologies for failing to allow consumers to opt-out of cell phone tracking while shopping in retail stores. Whatever one thinks about Nomi itself, the FTC’s enforcement action represents another step in the dubious application of its enforcement authority against deceptive statements.

In response, Geoffrey Manne, Ben Sperry, and Berin Szoka have written a new ICLE White Paper, titled, In the Matter of Nomi, Technologies, Inc.: The Dark Side of the FTC’s Latest Feel-Good Case.

Nomi Technologies offers retailers an innovative way to observe how customers move through their stores, how often they return, what products they browse and for how long (among other things) by tracking the Wi-Fi addresses broadcast by customers’ mobile phones. This allows stores to do what websites do all the time: tweak their configuration, pricing, purchasing and the like in response to real-time analytics — instead of just eyeballing what works. Nomi anonymized the data it collected so that retailers couldn’t track specific individuals. Recognizing that some customers might still object, even to “anonymized” tracking, Nomi allowed anyone to opt-out of all Nomi tracking on its website.

The FTC, though, seized upon a promise made within Nomi’s privacy policy to provide an additional, in-store opt out and argued that Nomi’s failure to make good on this promise — and/or notify customers of which stores used the technology — made its privacy policy deceptive. Commissioner Wright dissented, noting that the majority failed to consider evidence that showed the promise was not material, arguing that the inaccurate statement was not important enough to actually affect consumers’ behavior because they could opt-out on the website anyway. Both Commissioners Wright’s and Commissioner Ohlhausen’s dissents argued that the FTC majority’s enforcement decision in Nomi amounted to prosecutorial overreach, imposing an overly stringent standard of review without any actual indication of consumer harm.

The FTC’s deception authority is supposed to provide the agency with the authority to remedy consumer harms not effectively handled by common law torts and contracts — but it’s not a blank check. The 1983 Deception Policy Statement requires the FTC to demonstrate:

  1. There is a representation, omission or practice that is likely to mislead the consumer;
  2. A consumer’s interpretation of the representation, omission, or practice is considered reasonable under the circumstances; and
  3. The misleading representation, omission, or practice is material (meaning the inaccurate statement was important enough to actually affect consumers’ behavior).

Under the DPS, certain types of claims are treated as presumptively material, although the FTC is always supposed to “consider relevant and competent evidence offered to rebut presumptions of materiality.” The Nomi majority failed to do exactly that in its analysis of the company’s claims, as Commissioner Wright noted in his dissent:

the Commission failed to discharge its commitment to duly consider relevant and competent evidence that squarely rebuts the presumption that Nomi’s failure to implement an additional, retail-level opt out was material to consumers. In other words, the Commission neglects to take into account evidence demonstrating consumers would not “have chosen differently” but for the allegedly deceptive representation.

As we discuss in detail in the white paper, we believe that the Commission committed several additional legal errors in its application of the Deception Policy Statement in Nomi, over and above its failure to adequately weigh exculpatory evidence. Exceeding the legal constraints of the DPS isn’t just a legal problem: in this case, it’s led the FTC to bring an enforcement action that will likely have the very opposite of its intended result, discouraging rather than encouraging further disclosure.

Moreover, as we write in the white paper:

Nomi is the latest in a long string of recent cases in which the FTC has pushed back against both legislative and self-imposed constraints on its discretion. By small increments (unadjudicated consent decrees), but consistently and with apparent purpose, the FTC seems to be reverting to the sweeping conception of its power to police deception and unfairness that led the FTC to a titanic clash with Congress back in 1980.

The Nomi case presents yet another example of the need for FTC process reforms. Those reforms could ensure the FTC focuses on cases that actually make consumers better off. But given the FTC majority’s unwavering dedication to maximizing its discretion, such reforms will likely have to come from Congress.

Find the full white paper here.

Last week the International Center for Law & Economics, joined by TechFreedom, filed comments with the Federal Aviation Administration (FAA) in its Operation and Certification of Small Unmanned Aircraft Systems (“UAS” — i.e, drones) proceeding to establish rules for the operation of small drones in the National Airspace System.

We believe that the FAA has failed to appropriately weigh the costs and benefits, as well as the First Amendment implications, of its proposed rules.

The FAA’s proposed drones rules fail to meet (or even undertake) adequate cost/benefit analysis

FAA regulations are subject to Executive Order 12866, which, among other things, requires that agencies:

  • “consider incentives for innovation,”
  • “propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs”;
  • “base [their] decisions on the best reasonably obtainable scientific, technical, economic, and other information”; and
  • “tailor [their} regulations to impose the least burden on society,”

The FAA’s proposed drone rules fail to meet these requirements.

An important, and fundamental, problem is that the proposed rules often seem to import “scientific, technical, economic, and other information” regarding traditional manned aircraft, rather than such knowledge specifically applicable to drones and their uses — what FTC Commissioner Maureen Ohlhausen has dubbed “The Procrustean Problem with Prescriptive Regulation.”

As such, not only do the rules often not make sense as a practical matter, they also seek to simply adapt existing standards, rules and understandings promulgated for manned aircraft to regulate drones — insufficiently tailoring the rules to “impose the least burden on society.”

In some cases the rules would effectively ban obviously valuable uses outright, disregarding the rules’ effect on innovation (to say nothing of their effect on current uses of drones) without adequately defending such prohibitions as necessary to protect public safety.

Importantly, the proposed rules would effectively prohibit the use of commercial drones for long-distance services (like package delivery and scouting large agricultural plots) and for uses in populated areas — undermining what may well be drones’ most economically valuable uses.

As our comments note:

By prohibiting UAS operation over people who are not directly involved in the drone’s operation, the rules dramatically limit the geographic scope in which UAS may operate, essentially limiting commercial drone operations to unpopulated or extremely sparsely populated areas. While that may be sufficient for important agricultural and forestry uses, for example, it effectively precludes all possible uses in more urban areas, including journalism, broadcasting, surveying, package delivery and the like. Even in nonurban areas, such a restriction imposes potentially insurmountable costs.

Mandating that operators not fly over other individuals not involved in the UAS operation is, in fact, the nail in the coffin of drone deliveries, an industry that is likely to offer a significant fraction of this technology’s potential economic benefit. Imposing such a blanket ban thus improperly ignores the important “incentives for innovation” suggested by Executive Order 12866 without apparent corresponding benefit.

The FAA’s proposed drone rules fail under First Amendment scrutiny

The FAA’s failure to tailor the rules according to an appropriate analysis of their costs and benefits also causes them to violate the First Amendment. Without proper tailoring based on the unique technological characteristics of drones and a careful assessment of their likely uses, the rules are considerably more broad than the Supreme Court’s “time, place and manner” standard would allow.

Several of the rules constitute a de facto ban on most — indeed, nearly all — of the potential uses of drones that most clearly involve the collection of information and/or the expression of speech protected by the First Amendment. As we note in our comments:

While the FAA’s proposed rules appear to be content-neutral, and will thus avoid the most-exacting Constitutional scrutiny, the FAA will nevertheless have a difficult time demonstrating that some of them are narrowly drawn and adequately tailored time, place, and manner restrictions.

Indeed, many of the rules likely amount to a prior restraint on protected commercial and non-commercial activity, both for obvious existing applications like news gathering and for currently unanticipated future uses.

Our friends Eli Dourado, Adam Thierer and Ryan Hagemann at Mercatus also filed comments in the proceeding, raising similar and analogous concerns:

As far as possible, we advocate an environment of “permissionless innovation” to reap the greatest benefit from our airspace. The FAA’s rules do not foster this environment. In addition, we believe the FAA has fallen short of its obligations under Executive Order 12866 to provide thorough benefit-cost analysis.

The full Mercatus comments, available here, are also recommended reading.

Read the full ICLE/TechFreedom comments here.

Earlier this week Senators Orrin Hatch and Ron Wyden and Representative Paul Ryan introduced bipartisan, bicameral legislation, the Bipartisan Congressional Trade Priorities and Accountability Act of 2015 (otherwise known as Trade Promotion Authority or “fast track” negotiating authority). The bill would enable the Administration to negotiate free trade agreements subject to appropriate Congressional review.

Nothing bridges partisan divides like free trade.

Top presidential economic advisors from both parties support TPA. And the legislation was greeted with enthusiastic support from the business community. Indeed, a letter supporting the bill was signed by 269 of the country’s largest and most significant companies, including Apple, General Electric, Intel, and Microsoft.

Among other things, the legislation includes language calling on trading partners to respect and protect intellectual property. That language in particular was (not surprisingly) widely cheered in a letter to Congress signed by a coalition of sixteen technology, content, manufacturing and pharmaceutical trade associations, representing industries accounting for (according to the letter) “approximately 35 percent of U.S. GDP, more than one quarter of U.S. jobs, and 60 percent of U.S. exports.”

Strong IP protections also enjoy bipartisan support in much of the broader policy community. Indeed, ICLE recently joined sixty-seven think tanks, scholars, advocacy groups and stakeholders on a letter to Congress expressing support for strong IP protections, including in free trade agreements.

Despite this overwhelming support for the bill, the Internet Association (a trade association representing 34 Internet companies including giants like Google and Amazon, but mostly smaller companies like coinbase and okcupid) expressed concern with the intellectual property language in TPA legislation, asserting that “[i]t fails to adopt a balanced approach, including the recognition that limitations and exceptions in copyright law are necessary to promote the success of Internet platforms both at home and abroad.”

But the proposed TPA bill does recognize “limitations and exceptions in copyright law,” as the Internet Association is presumably well aware. Among other things, the bill supports “ensuring accelerated and full implementation of the Agreement on Trade-Related Aspects of Intellectual Property Rights,” which specifically mentions exceptions and limitations on copyright, and it advocates “ensuring that the provisions of any trade agreement governing intellectual property rights that is entered into by the United States reflect a standard of protection similar to that found in United States law,” which also recognizes copyright exceptions and limitations.

What the bill doesn’t do — and wisely so — is advocate for the inclusion of mandatory fair use language in U.S. free trade agreements.

Fair use is an exception under U.S. copyright law to the normal rule that one must obtain permission from the copyright owner before exercising any of the exclusive rights in Section 106 of the Copyright Act.

Including such language in TPA would require U.S. negotiators to demand that trading partners enact U.S.-style fair use language. But as ICLE discussed in a recent White Paper, if broad, U.S.-style fair use exceptions are infused into trade agreements they could actually increase piracy and discourage artistic creation and innovation — particularly in nations without a strong legal tradition implementing such provisions.

All trade agreements entered into by the U.S. since 1994 include a mechanism for trading partners to enact copyright exceptions and limitations, including fair use, should they so choose. These copyright exceptions and limitations must conform to a global standard — the so-called “three-step test,” — established under the auspices of the 1994 Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement, and with roots going back to the 1967 amendments to the 1886 Berne Convention.

According to that standard,

Members shall confine limitations or exceptions to exclusive rights to

  1. certain special cases, which
  2. do not conflict with a normal exploitation of the work and
  3. do not unreasonably prejudice the legitimate interests of the right holder.

This three-step test provides a workable standard for balancing copyright protections with other public interests. Most important, it sets flexible (but by no means unlimited) boundaries, so, rather than squeezing every jurisdiction into the same box, it accommodates a wide range of exceptions and limitations to copyright protection, ranging from the U.S.’ fair use approach to the fair dealing exception in other common law countries to the various statutory exceptions adopted in civil law jurisdictions.

Fair use is an inherently common law concept, developed by case-by-case analysis and a system of binding precedent. In the U.S. it has been codified by statute, but only after two centuries of common law development. Even as codified, fair use takes the form of guidance to judicial decision-makers assessing whether any particular use of a copyrighted work merits the exception; it is not a prescriptive statement, and judicial interpretation continues to define and evolve the doctrine.

Most countries in the world, on the other hand, have civil law systems that spell out specific exceptions to copyright protection, that don’t rely on judicial precedent, and that are thus incompatible with the common law, fair use approach. The importance of this legal flexibility can’t be understated: Only four countries out of the 166 signatories to the Berne Convention have adopted fair use since 1967.

Additionally, from an economic perspective the rationale for fair use would seem to be receding, not expanding, further eroding the justification for its mandatory adoption via free trade agreements.

As digital distribution, the Internet and a host of other technological advances have reduced transaction costs, it’s easier and cheaper for users to license copyrighted content. As a result, the need to rely on fair use to facilitate some socially valuable uses of content that otherwise wouldn’t occur because of prohibitive costs of contracting is diminished. Indeed, it’s even possible that the existence of fair use exceptions may inhibit the development of these sorts of mechanisms for simple, low-cost agreements between owners and users of content – with consequences beyond the material that is subject to the exceptions. While, indeed, some socially valuable uses, like parody, may merit exceptions because of rights holders’ unwillingness, rather than inability, to license, U.S.-style fair use is in no way necessary to facilitate such exceptions. In short, the boundaries of copyright exceptions should be contracting, not expanding.

It’s also worth noting that simple marketplace observations seem to undermine assertions by Internet companies that they can’t thrive without fair use. Google Search, for example, has grown big enough to attract the (misguided) attention of EU antitrust regulators, despite no European country having enacted a U.S-style fair use law. Indeed, European regulators claim that the company has a 90% share of the market — without fair use.

Meanwhile, companies like Netflix contend that their ability to cache temporary copies of video content in order to improve streaming quality would be imperiled without fair use. But it’s impossible to see how Netflix is able to negotiate extensive, complex contracts with copyright holders to actually show their content, but yet is somehow unable to negotiate an additional clause or two in those contracts to ensure the quality of those performances without fair use.

Properly bounded exceptions and limitations are an important aspect of any copyright regime. But given the mix of legal regimes among current prospective trading partners, as well as other countries with whom the U.S. might at some stage develop new FTAs, it’s highly likely that the introduction of U.S.-style fair use rules would be misinterpreted and misapplied in certain jurisdictions and could result in excessively lax copyright protection, undermining incentives to create and innovate. Of course for the self-described consumer advocates pushing for fair use, this is surely the goal. Further, mandating the inclusion of fair use in trade agreements through TPA legislation would, in essence, force the U.S. to ignore the legal regimes of its trading partners and weaken the protection of copyright in trade agreements, again undermining the incentive to create and innovate.

There is no principled reason, in short, for TPA to mandate adoption of U.S-style fair use in free trade agreements. Congress should pass TPA legislation as introduced, and resist any rent-seeking attempts to include fair use language.

Earlier this week the International Center for Law & Economics, along with a group of prominent professors and scholars of law and economics, filed an amicus brief with the Ninth Circuit seeking rehearing en banc of the court’s FTC, et al. v. St Luke’s case.

ICLE, joined by the Medicaid Defense Fund, also filed an amicus brief with the Ninth Circuit panel that originally heard the case.

The case involves the purchase by St. Luke’s Hospital of the Saltzer Medical Group, a multi-specialty physician group in Nampa, Idaho. The FTC and the State of Idaho sought to permanently enjoin the transaction under the Clayton Act, arguing that

[T]he combination of St. Luke’s and Saltzer would give it the market power to demand higher rates for health care services provided by primary care physicians (PCPs) in Nampa, Idaho and surrounding areas, ultimately leading to higher costs for health care consumers.

The district court agreed and its decision was affirmed by the Ninth Circuit panel.

Unfortunately, in affirming the district court’s decision, the Ninth Circuit made several errors in its treatment of the efficiencies offered by St. Luke’s in defense of the merger. Most importantly:

  • The court refused to recognize St. Luke’s proffered quality efficiencies, stating that “[i]t is not enough to show that the merger would allow St. Luke’s to better serve patients.”
  • The panel also applied the “less restrictive alternative” analysis in such a way that any theoretically possible alternative to a merger would discount those claimed efficiencies.
  • Finally, the Ninth Circuit panel imposed a much higher burden of proof for St. Luke’s to prove efficiencies than it did for the FTC to make out its prima facie case.

As we note in our brief:

If permitted to stand, the Panel’s decision will signal to market participants that the efficiencies defense is essentially unavailable in the Ninth Circuit, especially if those efficiencies go towards improving quality. Companies contemplating a merger designed to make each party more efficient will be unable to rely on an efficiencies defense and will therefore abandon transactions that promote consumer welfare lest they fall victim to the sort of reasoning employed by the panel in this case.

The following excerpts from the brief elaborate on the errors committed by the court and highlight their significance, particularly in the health care context:

The Panel implied that only price effects can be cognizable efficiencies, noting that the District Court “did not find that the merger would increase competition or decrease prices.” But price divorced from product characteristics is an irrelevant concept. The relevant concept is quality-adjusted price, and a showing that a merger would result in higher product quality at the same price would certainly establish cognizable efficiencies.

* * *

By placing the ultimate burden of proving efficiencies on the defendants and by applying a narrow, impractical view of merger specificity, the Panel has wrongfully denied application of known procompetitive efficiencies. In fact, under the Panel’s ruling, it will be nearly impossible for merging parties to disprove all alternatives when the burden is on the merging party to address any and every untested, theoretical less-restrictive structural alternative.

* * *

Significantly, the Panel failed to consider the proffered significant advantages that health care acquisitions may have over contractual alternatives or how these advantages impact the feasibility of contracting as a less restrictive alternative. In a complex integration of assets, “the costs of contracting will generally increase more than the costs of vertical integration.” (Benjamin Klein, Robert G. Crawford, and Armen A. Alchian, Vertical Integration, Appropriable Rents, and the Competitive Contracting Process, 21 J. L. & ECON. 297, 298 (1978)). In health care in particular, complexity is a given. Health care is characterized by dramatically imperfect information, and myriad specialized and differentiated products whose attributes are often difficult to measure. Realigning incentives through contract is imperfect and often unsuccessful. Moreover, the health care market is one of the most fickle, plagued by constantly changing market conditions arising from technological evolution, ever-changing regulations, and heterogeneous (and shifting) consumer demand. Such uncertainty frequently creates too many contingencies for parties to address in either writing or enforcing contracts, making acquisition a more appropriate substitute.

* * *

Sound antitrust policy and law do not permit the theoretical to triumph over the practical. One can always envision ways that firms could function to achieve potential efficiencies…. But this approach would harm consumers and fail to further the aims of the antitrust laws.

* * *

The Panel’s approach to efficiencies in this case demonstrates a problematic asymmetry in merger analysis. As FTC Commissioner Wright has cautioned:

Merger analysis is by its nature a predictive enterprise. Thinking rigorously about probabilistic assessment of competitive harms is an appropriate approach from an economic perspective. However, there is some reason for concern that the approach applied to efficiencies is deterministic in practice. In other words, there is a potentially dangerous asymmetry from a consumer welfare perspective of an approach that embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other. (Dissenting Statement of Commissioner Joshua D. Wright at 5, In the Matter of Ardagh Group S.A., and Saint-Gobain Containers, Inc., and Compagnie de Saint-Gobain)

* * *

In this case, the Panel effectively presumed competitive harm and then imposed unduly high evidentiary burdens on the merging parties to demonstrate actual procompetitive effects. The differential treatment and evidentiary burdens placed on St. Luke’s to prove competitive benefits is “unjustified and counterproductive.” (Daniel A. Crane, Rethinking Merger Efficiencies, 110 MICH. L. REV. 347, 390 (2011)). Such asymmetry between the government’s and St. Luke’s burdens is “inconsistent with a merger policy designed to promote consumer welfare.” (Dissenting Statement of Commissioner Joshua D. Wright at 7, In the Matter of Ardagh Group S.A., and Saint-Gobain Containers, Inc., and Compagnie de Saint-Gobain).

* * *

In reaching its decision, the Panel dismissed these very sorts of procompetitive and quality-enhancing efficiencies associated with the merger that were recognized by the district court. Instead, the Panel simply decided that it would not consider the “laudable goal” of improving health care as a procompetitive efficiency in the St. Luke’s case – or in any other health care provider merger moving forward. The Panel stated that “[i]t is not enough to show that the merger would allow St. Luke’s to better serve patients.” Such a broad, blanket conclusion can serve only to harm consumers.

* * *

By creating a barrier to considering quality-enhancing efficiencies associated with better care, the approach taken by the Panel will deter future provider realignment and create a “chilling” effect on vital provider integration and collaboration. If the Panel’s decision is upheld, providers will be considerably less likely to engage in realignment aimed at improving care and lowering long-term costs. As a result, both patients and payors will suffer in the form of higher costs and lower quality of care. This can’t be – and isn’t – the outcome to which appropriate antitrust law and policy aspires.

The scholars joining ICLE on the brief are:

  • George Bittlingmayer, Wagnon Distinguished Professor of Finance and Otto Distinguished Professor of Austrian Economics, University of Kansas
  • Henry Butler, George Mason University Foundation Professor of Law and Executive Director of the Law & Economics Center, George Mason University
  • Daniel A. Crane, Associate Dean for Faculty and Research and Professor of Law, University of Michigan
  • Harold Demsetz, UCLA Emeritus Chair Professor of Business Economics, University of California, Los Angeles
  • Bernard Ganglmair, Assistant Professor, University of Texas at Dallas
  • Gus Hurwitz, Assistant Professor of Law, University of Nebraska-Lincoln
  • Keith Hylton, William Fairfield Warren Distinguished Professor of Law, Boston University
  • Thom Lambert, Wall Chair in Corporate Law and Governance, University of Missouri
  • John Lopatka, A. Robert Noll Distinguished Professor of Law, Pennsylvania State University
  • Geoffrey Manne, Founder and Executive Director of the International Center for Law and Economics and Senior Fellow at TechFreedom
  • Stephen Margolis, Alumni Distinguished Undergraduate Professor, North Carolina State University
  • Fred McChesney, de la Cruz-Mentschikoff Endowed Chair in Law and Economics, University of Miami
  • Tom Morgan, Oppenheim Professor Emeritus of Antitrust and Trade Regulation Law, George Washington University
  • David Olson, Associate Professor of Law, Boston College
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics, Emory University
  • D. Daniel Sokol, Professor of Law, University of Florida
  • Mike Sykuta, Associate Professor and Director of the Contracting and Organizations Research Institute, University of Missouri

The amicus brief is available here.

Today, the International Center for Law & Economics released a white paper, co-authored by Executive Director Geoffrey Manne and Senior Fellow Julian Morris, entitled Dangerous Exception: The detrimental effects of including “fair use” copyright exceptions in free trade agreements.

Dangerous Exception explores the relationship between copyright, creativity and economic development in a networked global marketplace. In particular, it examines the evidence for and against mandating a U.S.-style fair use exception to copyright via free trade agreements like the Trans-Pacific Partnership (TPP), and through “fast-track” trade promotion authority (TPA).

In the context of these ongoing trade negotiations, some organizations have been advocating for the inclusion of dramatically expanded copyright exceptions in place of more limited language requiring that such exceptions conform to the “three-step test” implemented by the 1994 TRIPs Agreement.

The paper argues that if broad fair use exceptions are infused into trade agreements they could increase piracy and discourage artistic creation and innovation — especially in nations without a strong legal tradition implementing such provisions.

The expansion of digital networks across borders, combined with historically weak copyright enforcement in many nations, poses a major challenge to a broadened fair use exception. The modern digital economy calls for appropriate, but limited, copyright exceptions — not their expansion.

The white paper is available here. For some of our previous work on related issues, see: