The Amazon investigation and Europe’s “Big Tech” Crusade

Dirk Auer —  21 October 2018 — 1 Comment

The dust has barely settled on the European Commission’s record-breaking €4.3 Billion Google Android fine, but already the European Commission is gearing up for its next high-profile case. Last month, Margrethe Vestager dropped a competition bombshell: the European watchdog is looking into the behavior of Amazon. Should the Commission decide to move further with the investigation, Amazon will likely join other US tech firms such as Microsoft, Intel, Qualcomm and, of course, Google, who have all been on the receiving end of European competition enforcement.

The Commission’s move – though informal at this stage – is not surprising. Over the last couples of years, Amazon has become one of the world’s largest and most controversial companies. The animosity against it is exemplified in a paper by Lina Khan, which uses the example of Amazon to highlight the numerous ills that allegedly plague modern antitrust law. The paper is widely regarded as the starting point of the so-called “hipster antitrust” movement.

But is there anything particularly noxious about Amazon’s behavior, or is it just the latest victim of a European crusade against American tech companies?

Where things stand so far

As is often the case in such matters, publicly available information regarding the Commission’s “probe” (the European watchdog is yet to open a formal investigation) is particularly thin. What we know so far comes from a number of declarations made by Margrethe Vestager (here and here) and a leaked questionnaire that was sent to Amazon’s rivals. Going on this limited information, it appears that the Commission is preoccupied about the manner in which Amazon uses the data that it gathers from its online merchants. In Vestager’s own words:

The question here is about the data, because if you as Amazon get the data from the smaller merchants that you host […] do you then also use this data to do your own calculations? What is the new big thing, what is it that people want, what kind of offers do they like to receive, what makes them buy things.

These concerns relate to the fact that Amazon acts as both a retailer in its own right and a platform for other retailers, which allegedly constitutes a “conflict of interest”. As a retailer, Amazon sells a wide range of goods directly to consumers. Meanwhile, its marketplace platform enables third party merchants to offer their goods in exchange for referral fees when items are sold (these fees typically range from 8% to 15%, depending on the type of good). Merchants can either execute theses orders themselves or opt for fulfilment by Amazon, in which case it handles storage and shipping. In addition to its role as a platform operator,  As of 2017, more than 50% of units sold on the Amazon marketplace where fulfilled by third-party sellers, although Amazon derived three times more revenue from its own sales than from those of third parties (note that Amazon Web Services is still by far its largest source of profits).

Mirroring concerns raised by Khan, the Commission worries that Amazon uses the data it gathers from third party retailers on its platform to outcompete them. More specifically, the concern is that Amazon might use this data to identify and enter the most profitable segments of its online platform, excluding other retailers in the process (or deterring them from joining the platform in the first place). Although there is some empirical evidence to support such claims, it is far from clear that this is in any way harmful to competition or consumers. Indeed, the authors of the paper that found evidence in support of the claims note:

Amazon is less likely to enter product spaces that require greater seller efforts to grow, suggesting that complementors’ platform‐specific investments influence platform owners’ entry decisions. While Amazon’s entry discourages affected third‐party sellers from subsequently pursuing growth on the platform, it increases product demand and reduces shipping costs for consumers.

Thou shalt not punish efficient behavior

The question is whether Amazon using data on rivals’ sales to outcompete them should raise competition concerns? After all, this is a standard practice in the brick-and-mortar industry, where most large retailers use house brands to go after successful, high-margin third-party brands. Some, such as Costco, even eliminate some third-party products from their shelves once they have a successful own-brand product. Granted, as Khan observes, Amazon may be doing this more effectively because it has access to vastly superior data. But does that somehow make Amazon’s practice harmful to social social welfare? Absent further evidence, I believe not.

The basic problem is the following. Assume that Amazon does indeed have a monopoly in the market for online retail platforms (or, in other words, that the Amazon marketplace is a bottleneck for online retailers). Why would it move into direct retail competition against its third party sellers if it is less efficient than them? Amazon would either have to sell at a loss or hope that consumers saw something in its products that warrants a higher price. A more profitable alternative would be to stay put and increase its fees. It could thereby capture all the profits of its independent retailers. Not that Amazon would necessarily want to do so, as this could potentially deter other retailers from joining its platform. The upshot is that Amazon has little incentive to exclude more efficient retailers.

Astute readers, will have observed that this is simply a restatement of the Chicago school’s Single Monopoly Theory, which broadly holds that, absent efficiencies, a monopolist in one line of commerce cannot increase its profits by entering the competitive market for a complementary good. Although the theory has drawn some criticism, it remains a crucial starting point with which enforcers must contend before they conclude that a monopolist’s behavior is anticompetitive.

So why does Amazon move into retail segments that are already occupied by its rivals? The most likely explanation is simply that it can source and sell these goods more efficiently than them, and that these efficiencies cannot be achieved through contracts with the said rivals. Once we accept the possibility that Amazon is simply more efficient, the picture changes dramatically. The sooner it overthrows less efficient rivals the better. Doing so creates valuable surplus that can flow to either itself or its consumers. This is true regardless of whether Amazon has a marketplace monopoly or not. Even if it does have a monopoly (which is doubtful given competition from the likes of Zalando, AliExpress, Google Search and eBay), at least some of these efficiencies will likely be passed on to consumers. Such a scenario is also perfectly compatible with increased profits for Amazon. The real test is whether output increases when Amazon enters segments that were previously occupied by rivals.

Of course, the usual critiques voiced against the “Single Monopoly Profit” theory apply here. It is plausible that, by excluding its retail rivals, Amazon is simply seeking to protect its alleged platform monopoly. However, the anecdotal evidence that has been raised thus far does not support this conclusion.

But what about innovation?

Possibly sensing the weakness of the “inefficiency” line of arguments against Amazon, critics will likely put put forward a second theory of harm. The claim is that by capturing the rents of potentially innovative retailers, Amazon may hamper their incentives to innovate and will therefore harm consumer choice. Margrethe Vestager intimated this much in a Bloomberg interview. Though this framing might seem tempting at first, it falters under close inspection.

The effects of Amazon’s behavior could first be framed in terms of appropriability — that is: the extent to which an innovator captures the social benefits of its innovation. The higher its share of those benefits, the larger its incentives to innovate. By forcing out its retail rivals, it is plausible that Amazon is reducing the returns which they earn on their potential innovations.

Another potential framing is that of holdup theory. Applied to this case, one could argue that rival retailers made sunk investments (potentially innovation-related) to join the Amazon platform, and that Amazon is behaving opportunistically by capturing their surplus. With hindsight, merchants might thus have opted to stay out of the Amazon marketplace.

Unfortunately for Amazon’s critics, there are numerous objections to these two framings. For a start, the business implication of both the appropriability and holdup theories is that firms can and should take sensible steps to protect their investments. The recent empirical paper mentioned above stresses that these actions are critical for the sake of Amazon’s retailers.

Potential solutions abound. Retailers could in principle enter into long-term exclusivity agreements with their suppliers (which would keep Amazon out of the market if there are no alternative suppliers). Alternatively, they could sign non-compete clauses with Amazon, exchange assets, or even outright merge. In fact, there is at least some evidence of this last possibility occurring, as Amazon has acquired some of its online retailers. The fact that some retailers have not opted for these safety measures (or other methods of appropriability) suggests that they either don’t perceive a threat or are unwilling to make the necessary investments. It might also be due to bad business judgement on their part).

Which brings us to the big question. Should competition law step into the breach in those cases where firms have refused to take even basic steps to protect their investments? The answer is probably no.

For a start, condoning this poor judgement encourages firms to rely on competition enforcement rather than private solutions  to solve appropriability and holdup issues. This is best understood with reference to moral hazard. By insuring firms against the capture of their profits, competition authorities disincentivize all forms of risk-mitigation on the part of those firms. This will ultimately raise enforcement costs (as firms become increasingly reliant on the antitrust system for protection).

It is also informationally much more burdensome, as authorities will systematically have to rule on the appropriate share of profits between parties to a case.

Finally, overprotecting these investments would go against the philosophy of the European Court of Justice’s Huawei ruling.  Albeit in the specific context of injunctions relating to SEPs, the Court conditioned competition liability on firms showing that they have taken a series of reasonable steps to sort out their disputes privately.

Concluding remarks

This is not to say that competition intervention should categorically be proscribed. But rather that the capture of a retailer’s investments by Amazon is an insufficient condition for enforcement actions. Instead, the Commission should question whether Amazon’s actions are truly detrimental to consumer welfare and output. Absent strong evidence that an excluded retailer offered superior products, or that Amazon’s move was merely a strategic play to prevent entry, competition authorities should let the chips fall where they may.

As things stand, there is simply no evidence to indicate that anything out of the ordinary is occurring on the Amazon marketplace. By shining the spotlight on Amazon, the Commission is putting itself under tremendous political pressure to move forward with a formal investigation (all the more so, given the looming European Parliament elections). This is regrettable, as there are surely more pressing matters for the European regulator to deal with. The Commission would thus do well to recall the words of Shakespeare in the Merchant of Venice: “All that glisters is not gold”. Applied in competition circles this translates to “all that is big is not inefficient”.

Dirk Auer

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Dirk Auer is a research fellow the Liege Competition and Innovation Institute. He is currently finishing a PhD that focuses on the “Innovation Defense” in European competition law and US antitrust law. Prior to joining the LCII, Dirk completed LLMs at the University of Chicago Law School (2014) and at the University of Liège (2011). He also worked in the competition practices of two international law firms.

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