Archives For Antitrust & Competition

Others already have noted that the Federal Trade Commission’s (FTC) recently released 6(b) report on the privacy practices of Internet service providers (ISPs) fails to comprehend that widespread adoption of privacy-enabling technology—in particular, Hypertext Transfer Protocol Secure (HTTPS) and DNS over HTTPS (DoH), but also the use of virtual private networks (VPNs)—largely precludes ISPs from seeing what their customers do online.

But a more fundamental problem with the report lies in its underlying assumption that targeted advertising is inherently nefarious. Indeed, much of the report highlights not actual violations of the law by the ISPs, but “concerns” that they could use customer data for targeted advertising much like Google and Facebook already do. The final subheading before the report’s conclusion declares: “Many ISPs in Our Study Can Be At Least As Privacy-Intrusive as Large Advertising Platforms.”

The report does not elaborate on why it would be bad for ISPs to enter the targeted advertising market, which is particularly strange given the public focus regulators have shone in recent months on the supposed dominance of Google, Facebook, and Amazon in online advertising. As the International Center for Law & Economics (ICLE) has argued in past filings on the issue, there simply is no justification to apply sector-specific regulations to ISPs for the mere possibility that they will use customer data for targeted advertising.

ISPs Could be Competition for the Digital Advertising Market

It is ironic to witness FTC warnings about ISPs engaging in targeted advertising even as there are open antitrust cases against Google for its alleged dominance of the digital advertising market. In fact, news reports suggest the U.S. Justice Department (DOJ) is preparing to join the antitrust suits against Google brought by state attorneys general. An obvious upshot of ISPs engaging in a larger amount of targeted advertising if that they could serve as a potential source of competition for Google, Facebook, and Amazon.

Despite the fears raised in the 6(b) report of rampant data collection for targeted ads, ISPs are, in fact, just a very small part of the $152.7 billion U.S. digital advertising market. As the report itself notes: “in 2020, the three largest players, Google, Facebook, and Amazon, received almost two-third of all U.S. digital advertising,” while Verizon pulled in just 3.4% of U.S. digital advertising revenues in 2018.

If the 6(b) report is correct that ISPs have access to troves of consumer data, it raises the question of why they don’t enjoy a bigger share of the digital advertising market. It could be that ISPs have other reasons not to engage in extensive advertising. Internet service provision is a two-sided market. ISPs could (and, over the years in various markets, some have) rely on advertising to subsidize Internet access. That they instead rely primarily on charging users directly for subscriptions may tell us something about prevailing demand on either side of the market.

Regardless of the reasons, the fact that ISPs have little presence in digital advertising suggests that it would be a misplaced focus for regulators to pursue industry-specific privacy regulation to crack down on ISP data collection for targeted advertising.

What’s the Harm in Targeted Advertising, Anyway?

At the heart of the FTC report is the commission’s contention that “advertising-driven surveillance of consumers’ online activity presents serious risks to the privacy of consumer data.” In Part V.B of the report, five of the six risks the FTC lists as associated with ISP data collection are related to advertising. But the only argument the report puts forth for why targeted advertising would be inherently pernicious is the assertion that it is contrary to user expectations and preferences.

As noted earlier, in a two-sided market, targeted ads could allow one side of the market to subsidize the other side. In other words, ISPs could engage in targeted advertising in order to reduce the price of access to consumers on the other side of the market. This is, indeed, one of the dominant models throughout the Internet ecosystem, so it wouldn’t be terribly unusual.

Taking away ISPs’ ability to engage in targeted advertising—particularly if it is paired with rumored net neutrality regulations from the Federal Communications Commission (FCC)—would necessarily put upward pricing pressure on the sector’s remaining revenue stream: subscriber fees. With bridging the so-called “digital divide” (i.e., building out broadband to rural and other unserved and underserved markets) a major focus of the recently enacted infrastructure spending package, it would be counterproductive to simultaneously take steps that would make Internet access more expensive and less accessible.

Even if the FTC were right that data collection for targeted advertising poses the risk of consumer harm, the report fails to justify why a regulatory scheme should apply solely to ISPs when they are such a small part of the digital advertising marketplace. Sector-specific regulation only makes sense if the FTC believes that ISPs are uniquely opaque among data collectors with respect to their collection practices.

Conclusion

The sector-specific approach implicitly endorsed by the 6(b) report would limit competition in the digital advertising market, even as there are already legal and regulatory inquiries into whether that market is sufficiently competitive. The report also fails to make the case the data collection for target advertising is inherently bad, or uniquely bad when done by an ISP.

There may or may not be cause for comprehensive federal privacy legislation, depending on whether it would pass cost-benefit analysis, but there is no reason to focus on ISPs alone. The FTC needs to go back to the drawing board.

“Edinburgh, Great Britain – July 7, 2010: Statue of Adam Smith in Edinburgh in front of St. Giles Cathedral at Parliament Square.”

The interplay among political philosophy, competition, and competition law remains, with some notable exceptions, understudied in the literature. Indeed, while examinations of the intersection between economics and competition law have taught us much, relatively little has been said about the value frameworks within which different visions of competition and competition law operate.

As Ronald Coase reminds us, questions of economics and political philosophy are interrelated, so that “problems of welfare economics must ultimately dissolve into a study of aesthetics and morals.” When we talk about economics, we talk about political philosophy, and vice versa. Every political philosophy reproduces economic prescriptions that reflect its core tenets. And every economic arrangement, in turn, evokes the normative values that undergird it. This is as true for socialism and fascism as it is for liberalism and neoliberalism.

Many economists have understood this. Milton Friedman, for instance, who spent most of his career studying social welfare, not ethics, admitted in Free to Choose that he was ultimately concerned with the preservation of a value: the liberty of the individual. Similarly, the avowed purpose of Friedrich Hayek’s The Constitution of Liberty was to maximize the state of human freedom, with coercion—i.e., the opposite of freedom—described as evil. James Buchanan fought to preserve political philosophy within the economic discipline, particularly worrying that:

Political economy was becoming unmoored from the types of philosophic and institutional analysis which were previously central to the field. In its flight from reality, Buchanan feared economics was in danger of abandoning social-philosophic issues for exclusively technical questions.

— John Kroencke, “Three Essays in the History of Economics”

Against this background, I propose to look at competition and competition law from a perspective that explicitly recognizes this connection. The goal is not to substitute, but rather to complement, our comparatively broad understanding of competition economics with a better grasp of the deeper normative implications of regulating competition in a certain way. If we agree with Robert Bork that antitrust is a subcategory of ideology that reflects and reacts upon deeper tensions in our society, the exercise might also be relevant beyond the relatively narrow confines of antitrust scholarship (which, on the other hand, seem to be getting wider and wider).

The Classical Liberal Revolution and the Unshackling of Competition

Mercantilism

When Adam Smith’s The Wealth of Nations was published in 1776, heavy economic regulation of the market through laws, by-laws, tariffs, and special privileges was the norm. Restrictions on imports were seen as protecting national wealth by preventing money from flowing out of the country—a policy premised on the conflation of money with wealth. A morass of legally backed and enforceable monopoly rights, granted either by royal decree or government-sanctioned by-laws, marred competition. Guilds reigned over tradesmen by restricting entry into the professions and segregating markets along narrow geographic lines. At every turn, economic activity was shot through with rules, restrictions, and regulations.

The Revolution in Political Economy

Classical liberals like Smith departed from the then-dominant mercantilist paradigm by arguing that nations prospered through trade and competition, and not protectionism and monopoly privileges. He demonstrated that both the seller and the buyer benefited from trade; and theorized the market as an automatic mechanism that allocated resources efficiently through the spontaneous, self-interested interaction of individuals.

Undergirding this position was the notion of the natural order, which Smith carried over from his own Theory of Moral Sentiments and which elaborated on arguments previously espoused by the French physiocrats (a neologism meaning “the rule of nature”), such as Anne Robert Jacques Turgot, François Quesnay, and Jacques Claude Marie Vincent de Gournay. The basic premise was that there existed a harmonious order of things established and maintained by means of subconscious balancing of the egoism of the individual and the greatest welfare for all.

The implications of this modest insight, which clashed directly with established mercantilist orthodoxy, were tremendous. If human freedom maximized social welfare, the justification for detailed government intervention in the economy was untenable. The principles of laissez-faire (a term probably coined by Gournay, who had been Turgot’s mentor) instead prescribed that the government should adopt a “night watchman” role, tending to modest tasks such as internal and external defense, the mediation of disputes, and certain public works that were not deemed profitable for the individual.

Freeing Competition from the Mercantilist Yoke

Smith’s general attitude also carried over to competition. Following the principles described above, classical liberals believed that price and product adjustments following market interactions among tradesmen (i.e., competition) would automatically maximize social utility. As Smith argued:

In general, if any branch of trade, or any division of labor, be advantageous to the public, the freer and more general the competition, it will always be the more so.

This did not mean that competition occurred in a legal void. Rather, Smith’s point was that there was no need to construct a comprehensive system of competition regulation, as markets would oversee themselves so long as a basic legal and institutional framework was in place and government refrained from actively abetting monopolies. Under this view, the only necessary “competition law” would be those individual laws that made competition possible, such as private property rights, contracts, unfair competition laws, and the laws against government and guild restrictions.

Liberal Political Philosophy: Utilitarian and Deontological Perspectives on Liberty and Individuality

Of course, this sort of volte face in political economy needed to be buttressed by a robust philosophical conception of the individual and the social order. Such ontological and moral theories were articulated in, among others, the Theory of Moral Sentiments and John Stuart Mill’s On Liberty. At the heart of the liberal position was the idea that undue restrictions on human freedom and individuality were not only intrinsically despotic, but also socially wasteful, as they precluded men from enjoying the fruits of the exercise of such freedoms. For instance, infringing the freedom to trade and to compete would rob the public of cheaper goods, while restrictions on freedom of expression would arrest the development of thoughts and ideas through open debate.

It is not clear whether the material or the ethical argument for freedom came first. In other words, whether classical liberalism constituted an ex-post rationalization of a moral preference for individual liberty, or precisely the reverse. The question may be immaterial, as classical liberals generally believed that the deontological and the consequentialist cases for liberty—save in the most peripheral of cases (e.g., violence against others)—largely overlapped.

Conclusion

In sum, classical liberalism offered a holistic, integrated view of societies, markets, morals, and individuals that was revolutionary for the time. The notion of competition as a force to be unshackled—rather than actively constructed and chaperoned—flowed organically from that account and its underlying values and assumptions. These included such values as personal freedom and individualism, along with foundational metaphysical presuppositions, such as the existence of a harmonious natural order that seamlessly guided individual actions for the benefit of the whole.

Where such base values and presumptions are eroded, however, the notion of a largely spontaneous, self-sustaining competitive process loses much of its rational, ethical, and moral legitimacy. Competition thus ceases to be tenable on its “own two feet” and must either be actively engineered and protected, or abandoned altogether as a viable organizing principle. In this sense, the crisis of liberalism the West experienced in the late 19th and early 20th centuries—which attacked the very foundations of classical liberal doctrine—can also be read as a crisis of competition.

In my next post, I’ll discuss the collectivist backlash against liberalism.

The European Commission and its supporters were quick to claim victory following last week’s long-awaited General Court of the European Union ruling in the Google Shopping case. It’s hard to fault them. The judgment is ostensibly an unmitigated win for the Commission, with the court upholding nearly every aspect of its decision. 

However, the broader picture is much less rosy for both the Commission and the plaintiffs. The General Court’s ruling notably provides strong support for maintaining the current remedy package, in which rivals can bid for shopping box placement. This makes the Commission’s earlier rejection of essentially the same remedy  in 2014 look increasingly frivolous. It also pours cold water on rivals’ hopes that it might be replaced with something more far-reaching.

More fundamentally, the online world continues to move further from the idealistic conception of an “open internet” that regulators remain determined to foist on consumers. Indeed, users consistently choose convenience over openness, thus rejecting the vision of online markets upon which both the Commission’s decision and the General Court’s ruling are premised. 

The Google Shopping case will ultimately prove to be both a pyrrhic victory and a monument to the pitfalls of myopic intervention in digital markets.

Google’s big remedy win

The main point of law addressed in the Google Shopping ruling concerns the distinction between self-preferencing and refusals to deal. Contrary to Google’s defense, the court ruled that self-preferencing can constitute a standalone abuse of Article 102 of the Treaty on the Functioning of the European Union (TFEU). The Commission was thus free to dispense with the stringent conditions laid out in the 1998 Bronner ruling

This undoubtedly represents an important victory for the Commission, as it will enable it to launch new proceedings against both Google and other online platforms. However, the ruling will also constrain the Commission’s available remedies, and rightly so.

The origins of the Google Shopping decision are enlightening. Several rivals sought improved access to the top of the Google Search page. The Commission was receptive to those calls, but faced important legal constraints. The natural solution would have been to frame its case as a refusal to deal, which would call for a remedy in which a dominant firm grants rivals access to its infrastructure (be it physical or virtual). But going down this path would notably have required the Commission to show that effective access was “indispensable” for rivals to compete (one of the so-called Bronner conditions)—something that was most likely not the case here. 

Sensing these difficulties, the Commission framed its case in terms of self-preferencing, surmising that this would entail a much softer legal test. The General Court’s ruling vindicates this assessment (at least barring a successful appeal by Google):

240    It must therefore be concluded that the Commission was not required to establish that the conditions set out in the judgment of 26 November 1998, Bronner (C‑7/97, EU:C:1998:569), were satisfied […]. [T]he practices at issue are an independent form of leveraging abuse which involve […] ‘active’ behaviour in the form of positive acts of discrimination in the treatment of the results of Google’s comparison shopping service, which are promoted within its general results pages, and the results of competing comparison shopping services, which are prone to being demoted.

This more expedient approach, however, entails significant limits that will undercut both the Commission and rivals’ future attempts to extract more far-reaching remedies from Google.

Because the underlying harm is no longer the denial of access, but rivals being treated less favorably, the available remedies are much narrower. Google must merely ensure that it does not treat itself more preferably than rivals, regardless whether those rivals ultimately access its infrastructure and manage to compete. The General Court says this much when it explains the theory of harm in the case at hand:

287. Conversely, even if the results from competing comparison shopping services would be particularly relevant for the internet user, they can never receive the same treatment as results from Google’s comparison shopping service, whether in terms of their positioning, since, owing to their inherent characteristics, they are prone to being demoted by the adjustment algorithms and the boxes are reserved for results from Google’s comparison shopping service, or in terms of their display, since rich characters and images are also reserved to Google’s comparison shopping service. […] they can never be shown in as visible and as eye-catching a way as the results displayed in Product Universals.

Regulation 1/2003 (Art. 7.1) ensures the European Commission can only impose remedies that are “proportionate to the infringement committed and necessary to bring the infringement effectively to an end.” This has obvious ramifications for the Google Shopping remedy.

Under the remedy accepted by the Commission, Google agreed to auction off access to the Google Shopping box. Google and rivals would thus compete on equal footing to display comparison shopping results.

Illustrations taken from Graf & Mostyn, 2020

Rivals and their consultants decried this outcome; and Margrethe Vestager intimated the commission might review the remedy package. Both camps essentially argued the remedy did not meaningfully boost traffic to rival comparison shopping services (CSSs), because those services were not winning the best auction slots:

All comparison shopping services other than Google’s are hidden in plain sight, on a tab behind Google’s default comparison shopping page. Traffic cannot get to them, but instead goes to Google and on to merchants. As a result, traffic to comparison shopping services has fallen since the remedy—worsening the original abuse.

Or, as Margrethe Vestager put it:

We may see a show of rivals in the shopping box. We may see a pickup when it comes to clicks for merchants. But we still do not see much traffic for viable competitors when it comes to shopping comparison

But these arguments are entirely beside the point. If the infringement had been framed as a refusal to supply, it might be relevant that rivals cannot access the shopping box at what is, for them,  cost-effective price. Because the infringement was framed in terms of self-preferencing, all that matters is whether Google treats itself equally.

I am not aware of a credible claim that this is not the case. At best, critics have suggested the auction mechanism favors Google because it essentially pays itself:

The auction mechanism operated by Google to determine the price paid for PLA clicks also disproportionately benefits Google. CSSs are discriminated against per clickthrough, as they are forced to cede most of their profit margin in order to successfully bid […] Google, contrary to rival CSSs, does not, in reality, have to incur the auction costs and bid away a great part of its profit margins.

But this reasoning completely omits Google’s opportunity costs. Imagine a hypothetical (and oversimplified) setting where retailers are willing to pay Google or rival CSSs 13 euros per click-through. Imagine further that rival CSSs can serve these clicks at a cost of 2 euros, compared to 3 euros for Google (excluding the auction fee). Google is less efficient in this hypothetical. In this setting, rivals should be willing to bid up to 11 euros per click (the difference between what they expect to earn and their other costs). Critics claim Google will accept to bid higher because the money it pays itself during the auction is not really a cost (it ultimately flows to Google’s pockets). That is clearly false. 

To understand this, readers need only consider Google’s point of view. On the one hand, it could pay itself 11 euros (and some tiny increment) to win the auction. Its revenue per click-through would be 10 euros (13 euros per click-through, minus its cost of 3 euros). On the other hand, it could underbid rivals by a tiny increment, ensuring they bid 11 euros. When its critics argue that Google has an advantage because it pays itself, they are ultimately claiming that 10 is larger than 11.

Google’s remedy could hardly be more neutral. If it wins more auction slots than rivals CSSs, the appropriate inference should be that it is simply more efficient. Nothing in the Commission’s decision or the General Court’s ruling precludes that outcome. In short, while Google has (for the time being, at least) lost its battle to appeal the Commission’s decision, the remedy package—the same it put forward way back in 2014—has never looked stronger.

Good news for whom?

The above is mostly good news for both Google and consumers, who will be relieved that the General Court’s ruling preserves Google’s ability to show specialized boxes (of which the shopping unit is but one example). But that should not mask the tremendous downsides of both the Commission’s case and the court’s ruling. 

The Commission and rivals’ misapprehensions surrounding the Google Shopping remedy, as well as the General Court’s strong stance against self-preferencing, are revealing of a broader misunderstanding about online markets that also permeates through other digital regulation initiatives like the Digital Markets Act and the American Choice and Innovation Act. 

Policymakers wrongly imply that platform neutrality is a good in and of itself. They assume incumbent platforms generally have an incentive to favor their own services, and that preventing them from doing so is beneficial to both rivals and consumers. Yet neither of these statements is correct.

Economic research suggests self-preferencing is only harmful in exceptional circumstances. That is true of the traditional literature on platform threats (here and here), where harm is premised on the notion that rivals will use the downstream market, ultimately, to compete with an upstream incumbent. It’s also true in more recent scholarship that compares dual mode platforms to pure marketplaces and resellers, where harm hinges on a platform being able to immediately imitate rivals’ offerings. Even this ignores the significant efficiencies that might simultaneously arise from self-preferencing and closed platforms, more broadly. In short, rules that categorically prohibit self-preferening by dominant platforms overshoot the mark, and the General Court’s Google Shopping ruling is a troubling development in that regard.

It is also naïve to think that prohibiting self-preferencing will automatically benefit rivals and consumers (as opposed to harming the latter and leaving the former no better off). If self-preferencing is not anticompetitive, then propping up inefficient firms will at best be a futile exercise in preserving failing businesses. At worst, it would impose significant burdens on consumers by destroying valuable synergies between the platform and its own downstream service.

Finally, if the past years teach us anything about online markets, it is that consumers place a much heavier premium on frictionless user interfaces than on open platforms. TikTok is arguably a much more “closed” experience than other sources of online entertainment, like YouTube or Reddit (i.e. users have less direct control over their experience). Yet many observers have pinned its success, among other things, on its highly intuitive and simple interface. The emergence of Vinted, a European pre-owned goods platform, is another example of competition through a frictionless user experience.

There is a significant risk that, by seeking to boost “choice,” intervention by competition regulators against self-preferencing will ultimately remove one of the benefits users value most. By increasing the information users need to process, there is a risk that non-discrimination remedies will merely add pain points to the underlying purchasing process. In short, while Google Shopping is nominally a victory for the Commission and rivals, it is also a testament to the futility and harmfulness of myopic competition intervention in digital markets. Consumer preferences cannot be changed by government fiat, nor can the fact that certain firms are more efficient than others (at least, not without creating significant harm in the process). It is time this simple conclusion made its way into European competition thinking.

In the U.S. system of dual federal and state sovereigns, a normative analysis reveals principles that could guide state antitrust-enforcement priorities, to promote complementarity in federal and state antitrust policy, and thereby advance consumer welfare.

Discussion

Positive analysis reveals that state antitrust enforcement is a firmly entrenched feature of American antitrust policy. The U.S. Supreme Court (1) has consistently held that federal antitrust law does not displace state antitrust law (see, for example, California v. ARC America Corp. (U.S., 1989) (“Congress intended the federal antitrust laws to supplement, not displace, state antitrust remedies”)); and (2) has upheld state antitrust laws even when they have some impact on interstate commerce (see, for example, Exxon Corp. v. Governor of Maryland (U.S., 1978)).

The normative question remains, however, as to what the appropriate relationship between federal and state antitrust enforcement should be. Should federal and state antitrust regimes be complementary, with state law enforcement enhancing the effectiveness of federal enforcement? Or should state antitrust enforcement compete with federal enforcement, providing an alternative “vision” of appropriate antitrust standards?

The generally accepted (until very recently) modern American consumer-welfare-centric antitrust paradigm (see here) points to the complementary approach as most appropriate. In other words, if antitrust is indeed the “magna carta” of American free enterprise (see United States v. Topco Associates, Inc., U.S. (U.S. 1972), and if consumer welfare is the paramount goal of antitrust (a position consistently held by the Supreme Court since Reiter v. Sonotone Corp., (U.S., 1979)), it follows that federal and state antitrust enforcement coexist best as complements, directed jointly at maximizing consumer-welfare enhancement. In recent decades it also generally has made sense for state enforcers to defer to U.S. Justice Department (DOJ) and Federal Trade Commission (FTC) matter-specific consumer-welfare assessments. This conclusion follows from the federal agencies’ specialized resource advantage, reflected in large staffs of economic experts and attorneys with substantial industry knowledge.

The reality, nevertheless, is that while state enforcers often have cooperated with their federal colleagues on joint enforcement, state enforcement approaches historically have been imperfectly aligned with federal policy. That imperfect alignment has been at odds with consumer welfare in key instances. Certain state antitrust schemes, for example, continue to treat resale price maintenance (RPM)  as per se illegal (see, for example, here), a position inconsistent with the federal consumer welfare-centric rule of reason approach (see Leegin Creative Leather Products, Inc. v. PSKS, Inc. (U.S., 2007)). The disparate treatment of RPM has a substantial national impact on business conduct, because commercially important states such as California and New York are among those that continue to flatly condemn RPM.

State enforcers also have from time to time sought to oppose major transactions that received federal antitrust clearance, such as several states’ unsuccessful opposition to the merger of Sprint and T-Mobile merger (see here). Although the states failed to block the merger, they did extract settlement concessions that imposed burdens on the merging parties, in addition to the divestiture requirements impose by the DOJ in settling the matter (see here). Inconsistencies between federal and state antitrust-enforcement decisions on cases of nationwide significance generate litigation waste and may detract from final resolutions that optimize consumer welfare.

If consumer-welfare optimization is their goal (which I believe it should be in an ideal world), state attorneys general should seek to direct their limited antitrust resources to their highest valued uses, rather than seeking to second guess federal antitrust policy and enforcement decisions.

An optimal approach might focus first and foremost on allocating state resources to combat primarily intrastate competitive harms that are clear and unequivocal (such as intrastate bid rigging, hard core price fixing, and horizontal market division). This could free up federal resources to focus on matters that are primarily interstate in nature, consistent with federalism. (In this regard, see a thoughtful proposal by D. Bruce Johnsen and Moin A. Yaha.)

Second, state enforcers could also devote some resources to assist federal enforcers in developing state-specific evidence in support of major national cases. (This would allow state attorneys general to publicize their “big case” involvement in a productive manner.)

Third, but not least, competition advocacy directed at the removal of anticompetitive state laws and regulations could prove an effective means of seeking to improve the competitive climate within individual states (see, for example, here). State antitrust enforcers could advance advocacy through amicus curiae briefs, and (where politically feasible) through interventions (perhaps informal) with peer officials who oversee regulation. Subject to this general guidance, the nature of state antitrust resource allocations would depend upon the specific competitive problems particular to each state.

Of course, in the real world, public choice considerations and rent seeking may at times influence antitrust enforcement decision-making by state (and federal) officials. Nonetheless, the capsule idealized normative summary of a suggested ideal state antitrust-enforcement protocol is useful in that it highlights how state enforcers could usefully complement (assumed) sound federal antitrust initiatives.

Great minds think alike. A well-crafted and much more detailed normative exploration of ideal state antitrust enforcement is found in a recently released Pelican Institute policy brief by Ted Bolema and Eric Peterson. Entitled The Proper Role for States in Antitrust Lawsuits, the brief concludes (in a manner consistent with my observations):

This review of cases and leading commentaries shows that states should focus their involvement in antitrust cases on instances where:

· they have unique interests, such as local price-fixing

· play a unique role, such as where they can develop evidence about how alleged anticompetitive behavior uniquely affects local markets

· they can bring additional resources to bear on existing federal litigation.

States can also provide a useful check on overly aggressive federal enforcement by providing courts with a traditional perspective on antitrust law — a role that could become even more important as federal agencies aggressively seek to expand their powers. All of these are important roles for states to play in antitrust enforcement, and translate into positive outcomes that directly benefit consumers.

Conversely, when states bring significant, novel antitrust lawsuits on their own, they don’t tend to benefit either consumers or constituents. These novel cases often move resources away from where they might be used more effectively, and states usually lose (as with the recent dismissal with prejudice of a state case against Facebook). Through more strategic antitrust engagement, with a focus on what states can do well and where they can make a positive difference antitrust enforcement, states would best serve the interests of their consumers, constituents, and taxpayers.

Conclusion

Under a consumer-welfare-centric regime, an appropriate role can be identified for state antitrust enforcement that would helpfully complement federal efforts in an optimal fashion. Unfortunately, in this tumultuous period of federal antitrust policy shifts, in which the central role of the consumer welfare standard has been called into question, it might appear fatuous to speculate on the ideal melding of federal and state approaches to antitrust administration. One should, however, prepare for the time when a more enlightened, economically informed approach will be reinstituted. In anticipation of that day, serious thinking about antitrust federalism should not be neglected.

[Judge Douglas Ginsburg was invited to respond to the Beesley Lecture given by Andrea Coscelli, chief executive of the U.K. Competition and Markets Authority (CMA). Both the lecture and Judge Ginsburg’s response were broadcast by the BBC on Oct. 28, 2021. The text of Mr. Coscelli’s Beesley lecture is available on the CMA’s website. Judge Ginsburg’s response follows below.]

Thank you, Victoria, for the invitation to respond to Mr. Coscelli and his proposal for a legislatively founded Digital Markets Unit. Mr. Coscelli is one of the most talented, successful, and creative heads a competition agency has ever had. In the case of the DMU [ed., Digital Markets Unit], however, I think he has let hope triumph over experience and prudence. This is often the case with proposals for governmental reform: Indeed, it has a name, the Nirvana Fallacy, which comes from comparing the imperfectly functioning marketplace with the perfectly functioning government agency. Everything we know about the regulation of competition tells us the unintended consequences may dwarf the intended benefits and the result may be a less, not more, competitive economy. The precautionary principle counsels skepticism about such a major and inherently risky intervention.

Mr. Coscelli made a point in passing that highlights the difference in our perspectives: He said the SMS [ed., strategic market status] merger regime would entail “a more cautious standard of proof.” In our shared Anglo-American legal culture, a more cautious standard of proof means the government would intervene in fewer, not more, market activities; proof beyond a reasonable doubt in criminal cases is a more cautious standard than a mere preponderance of the evidence. I, too, urge caution, but of the traditional kind.

I will highlight five areas of concern with the DMU proposal.

I. Chilling Effects

The DMU’s ability to designate a firm as being of strategic market significance—or SMS—will place a potential cloud over innovative activity in far more sectors than Mr. Coscelli could mention in his lecture. He views the DMU’s reach as limited to a small number of SMS-designated firms; and that may prove true, but there is nothing in the proposal limiting DMU’s reach.

Indeed, the DMU’s authority to regulate digital markets is surely going to be difficult to confine. Almost every major retail activity or consumer-facing firm involves an increasingly significant digital component, particularly after the pandemic forced many more firms online. Deciding which firms the DMU should cover seems easy in theory, but will prove ever more difficult and cumbersome in practice as digital technology continues to evolve. For instance, now that money has gone digital, a bank is little more than a digital platform bringing together lenders (called depositors) and borrowers, much as Amazon brings together buyers and sellers; so, is every bank with market power and an entrenched position to be subject to rules and remedies laid down by the DMU as well as supervision by the bank regulators? Is Aldi in the crosshairs now that it has developed an online retail platform? Match.com, too? In short, the number of SMS firms will likely grow apace in the next few years.

II. SMS Designations Should Not Apply to the Whole Firm

The CMA’s proposal would apply each SMS designation firm-wide, even if the firm has market power in a single line of business. This will inhibit investment in further diversification and put an SMS firm at a competitive disadvantage across all its businesses.

Perhaps company-wide SMS designations could be justified if the unintended costs were balanced by expected benefits to consumers, but this will not likely be the case. First, there is little evidence linking consumer harm to lines of business in which large digital firms do not have market power. On the contrary, despite the discussion of Amazon’s supposed threat to competition, consumers enjoy lower prices from many more retailers because of the competitive pressure Amazon brings to bear upon them.

Second, the benefits Mr. Coscelli expects the economy to reap from faster government enforcement are, at best, a mixed blessing. The proposal, you see, reverses the usual legal norm, instead making interim relief the rule rather than the exception. If a firm appeals its SMS designation, then under the CMA’s proposal, the DMU’s SMS designations and pro-competition interventions, or PCIs, will not be stayed pending appeal, raising the prospect that a firm’s activities could be regulated for a significant period even though it was improperly designated. Even prevailing in the courts may be a Pyrrhic victory because opportunities will have slipped away. Making matters worse, the DMU’s designation of a firm as SMS will likely receive a high degree of judicial deference, so that errors may never be corrected.

III. The DMU Cannot Be Evidence-based Given its Goals and Objectives

The DMU’s stated goal is to “further the interests of consumers and citizens in digital markets by promoting competition and innovation.”[1] DMU’s objectives for developing codes of conduct are: fair trading, open choices, and trust and transparency.[2] Fairness, openness, trust, and transparency are all concepts that are difficult to define and probably impossible to quantify. Therefore, I fear Mr. Coscelli’s aspiration that the DMU will be an evidence-based, tailored, and predictable regime seem unrealistic. The CMA’s idea of “an evidence-based regime” seems destined to rely mostly upon qualitative conjecture about the potential for the code of conduct to set “rules of the game” that encourage fair trading, open choices, trust, and transparency. Even if the DMU commits to considering empirical evidence at every step of its process, these fuzzy, qualitative objectives will allow it to come to virtually any conclusion about how a firm should be regulated.

Implementing those broad goals also throws into relief the inevitable tensions among them. Some potential conflicts between DMU’s objectives for developing codes of conduct are clear from the EU’s experience. For example, one of the things DMU has considered already is stronger protection for personal data. The EU’s experience with the GDPR shows that data protection is costly and, like any costly requirement, tends to advantage incumbents and thereby discourage new entry. In other words, greater data protections may come at the expense of start-ups or other new entrants and the contribution they would otherwise have made to competition, undermining open choices in the name of data transparency.

Another example of tension is clear from the distinction between Apple’s iOS and Google’s Android ecosystems. They take different approaches to the trade-off between data privacy and flexibility in app development. Apple emphasizes consumer privacy at the expense of allowing developers flexibility in their design choices and offers its products at higher prices. Android devices have fewer consumer-data protections but allow app developers greater freedom to design their apps to satisfy users and are offered at lower prices. The case of Epic Games v. Apple put on display the purportedly pro-competitive arguments the DMU could use to justify shutting down Apple’s “walled garden,” whereas the EU’s GDPR would cut against Google’s open ecosystem with limited consumer protections. Apple’s model encourages consumer trust and adoption of a single, transparent model for app development, but Google’s model encourages app developers to choose from a broader array of design and payment options and allows consumers to choose between the options; no matter how the DMU designs its code of conduct, it will be creating winners and losers at the cost of either “open choices” or “trust and transparency.” As experience teaches is always the case, it is simply not possible for an agency with multiple goals to serve them all at the same time. The result is an unreviewable discretion to choose among them ad hoc.

Finally, notice that none of the DMU’s objectives—fair trading, open choices, and trust and transparency—revolves around quantitative evidence; at bottom, these goals are not amenable to the kind of rigor Mr. Coscelli hopes for.

IV. Speed of Proposals

Mr. Coscelli has emphasized the slow pace of competition law matters; while I empathize, surely forcing merging parties to prove a negative and truncating their due process rights is not the answer.

As I mentioned earlier, it seems a more cautious standard of proof to Mr. Coscelli is one in which an SMS firm’s proposal to acquire another firm is presumed, or all but presumed, to be anticompetitive and unlawful. That is, the DMU would block the transaction unless the firms can prove their deal would not be anticompetitive—an extremely difficult task. The most self-serving version of the CMA’s proposal would require it to prove only that the merger poses a “realistic prospect” of lessening competition, which is vague, but may in practice be well below a 50% chance. Proving that the merged entity does not harm competition will still require a predictive forward-looking assessment with inherent uncertainty, but the CMA wants the costs of uncertainty placed upon firms, rather than it. Given the inherent uncertainty in merger analysis, the CMA’s proposal would pose an unprecedented burden of proof on merging parties.

But it is not only merging parties the CMA would deprive of due process; the DMU’s so-called pro-competitive interventions, or PCI, SMS designations, and code-of-conduct requirements generally would not be stayed pending appeal. Further, an SMS firm could overturn the CMA’s designation only if it could overcome substantial deference to the DMU’s fact-finding. It is difficult to discern, then, the difference between agency decisions and final orders.

The DMU would not have to show or even assert an extraordinary need for immediate relief. This is the opposite of current practice in every jurisdiction with which I am familiar.  Interim orders should take immediate effect only in exceptional circumstances, when there would otherwise be significant and irreversible harm to consumers, not in the ordinary course of agency decision making.

V. Antitrust Is Not Always the Answer

Although one can hardly disagree with Mr. Coscelli’s premise that the digital economy raises new legal questions and practical challenges, it is far from clear that competition law is the answer to them all. Some commentators of late are proposing to use competition law to solve consumer protection and even labor market problems. Unfortunately, this theme also recurs in Mr. Coscelli’s lecture. He discusses concerns with data privacy and fair and reasonable contract terms, but those have long been the province of consumer protection and contract law; a government does not need to step in and regulate all realms of activity by digital firms and call it competition law. Nor is there reason to confine needed protections of data privacy or fair terms of use to SMS firms.

Competition law remedies are sometimes poorly matched to the problems a government is trying to correct. Mr. Coscelli discusses the possibility of strong interventions, such as forcing the separation of a platform from its participation in retail markets; for example, the DMU could order Amazon to spin off its online business selling and shipping its own brand of products. Such powerful remedies can be a sledgehammer; consider forced data sharing or interoperability to make it easier for new competitors to enter. For example, if Apple’s App Store is required to host all apps submitted to it in the interest of consumer choice, then Apple loses its ability to screen for security, privacy, and other consumer benefits, as its refusal   to deal is its only way to prevent participation in its store. Further, it is not clear consumers want Apple’s store to change; indeed, many prefer Apple products because of their enhanced security.

Forced data sharing would also be problematic; the hiQ v. LinkedIn case in the United States should serve as a cautionary tale. The trial court granted a preliminary injunction forcing LinkedIn to allow hiQ to scrape its users’ profiles while the suit was ongoing. LinkedIn ultimately won the suit because it did not have market power, much less a monopoly, in any relevant market. The court concluded each theory of anticompetitive conduct was implausible, but meanwhile LinkedIn had been forced to allow hiQ to scrape its data for an extended period before the final decision. There is no simple mechanism to “unshare” the data now that LinkedIn has prevailed. This type of case could be common under the CMA proposal because the DMU’s orders will go into immediate effect.

There is potentially much redeeming power in the Digital Regulation Co-operation Forum as Mr. Coscelli described it, but I take a different lesson from this admirable attempt to coordinate across agencies: Perhaps it is time to look beyond antitrust to solve problems that are not based upon market power. As the DRCF highlights, there are multiple agencies with overlapping authority in the digital market space. ICO and Ofcom each have authority to take action against a firm that disseminates fake news or false advertisements. Mr. Coscelli says it would be too cumbersome to take down individual bad actors, but, if so, then the solution is to adopt broader consumer protection rules, not apply an ill-fitting set of competition law rules. For example, the U.K. could change its notice-and-takedown rules to subject platforms to strict liability if they host fake news, even without knowledge that they are doing so, or perhaps only if they are negligent in discharging their obligation to police against it.

Alternatively, the government could shrink the amount of time platforms have to take down information; France gives platforms only about an hour to remove harmful information. That sort of solution does not raise the same prospect of broadly chilling market activity, but still addresses one of the concerns Mr. Coscelli raises with digital markets.

In sum, although Mr. Coscelli is of course correct that competition authorities and governments worldwide are considering whether to adopt broad reforms to their competition laws, the case against broadening remains strong. Instead of relying upon the self-corrective potential of markets, which is admittedly sometimes slower than anyone would like, the CMA assumes markets need regulation until firms prove otherwise. Although clearly well-intentioned, the DMU proposal is in too many respects not met to the task of protecting competition in digital markets; at worst, it will inhibit innovation in digital markets to the point of driving startups and other innovators out of the U.K.


[1] See Digital markets Taskforce, A new pro-competition regime for digital markets, at 22, Dec. 2020, available at: https://assets.publishing.service.gov.uk/media/5fce7567e90e07562f98286c/Digital_Taskforce_-_Advice.pdf; Oliver Dowden & Kwasi Kwarteng, A New Pro-competition Regime for Digital Markets, July 2021, available from: https://www.gov.uk/government/consultations/a-new-pro-competition-regime-for-digital-markets, at ¶ 27.

[2] Sam Bowman, Sam Dumitriu & Aria Babu, Conflicting Missions:The Risks of the Digital Markets Unit to Competition and Innovation, Int’l Center for L. & Econ., June 2021, at 13.

There has been a rapid proliferation of proposals in recent years to closely regulate competition among large digital platforms. The European Union’s Digital Markets Act (DMA, which will become effective in 2023) imposes a variety of data-use, interoperability, and non-self-preferencing obligations on digital “gatekeeper” firms. A host of other regulatory schemes are being considered in Australia, France, Germany, and Japan, among other countries (for example, see here). The United Kingdom has established a Digital Markets Unit “to operationalise the future pro-competition regime for digital markets.” Recently introduced U.S. Senate and House Bills—although touted as “antitrust reform” legislation—effectively amount to “regulation in disguise” of disfavored business activities by very large companies,  including the major digital platforms (see here and here).

Sorely missing from these regulatory proposals is any sense of the fallibility of regulation. Indeed, proponents of new regulatory proposals seem to implicitly assume that government regulation of platforms will enhance welfare, ignoring real-life regulatory costs and regulatory failures (see here, for example). Without evidence, new regulatory initiatives are put forth as superior to long-established, consumer-based antitrust law enforcement.

The hope that new regulatory tools will somehow “solve” digital market competitive “problems” stems from the untested assumption that established consumer welfare-based antitrust enforcement is “not up to the task.” Untested assumptions, however, are an unsound guide to public policy decisions. Rather, in order to optimize welfare, all proposed government interventions in the economy, including regulation and antitrust, should be subject to decision-theoretic analysis that is designed to minimize the sum of error and decision costs (see here). What might such an analysis reveal?

Wonder no more. In a just-released Mercatus Center Working Paper, Professor Thom Lambert has conducted a decision-theoretic analysis that evaluates the relative merits of U.S. consumer welfare-based antitrust, ex ante regulation, and ongoing agency oversight in addressing the market power of large digital platforms. While explaining that antitrust and its alternatives have their respective costs and benefits, Lambert concludes that antitrust is the welfare-superior approach to dealing with platform competition issues. According to Lambert:

This paper provides a comparative institutional analysis of the leading approaches to addressing the market power of large digital platforms: (1) the traditional US antitrust approach; (2) imposition of ex ante conduct rules such as those in the EU’s Digital Markets Act and several bills recently advanced by the Judiciary Committee of the US House of Representatives; and (3) ongoing agency oversight, exemplified by the UK’s newly established “Digital Markets Unit.” After identifying the advantages and disadvantages of each approach, this paper examines how they might play out in the context of digital platforms. It first examines whether antitrust is too slow and indeterminate to tackle market power concerns arising from digital platforms. It next considers possible error costs resulting from the most prominent proposed conduct rules. It then shows how three features of the agency oversight model—its broad focus, political susceptibility, and perpetual control—render it particularly vulnerable to rent-seeking efforts and agency capture. The paper concludes that antitrust’s downsides (relative indeterminacy and slowness) are likely to be less significant than those of ex ante conduct rules (large error costs resulting from high informational requirements) and ongoing agency oversight (rent-seeking and agency capture).

Lambert’s analysis should be carefully consulted by American legislators and potential rule-makers (including at the Federal Trade Commission) before they institute digital platform regulation. One also hopes that enlightened foreign competition officials will also take note of Professor Lambert’s well-reasoned study. 

Why do digital industries routinely lead to one company having a very large share of the market (at least if one defines markets narrowly)? To anyone familiar with competition policy discussions, the answer might seem obvious: network effects, scale-related economies, and other barriers to entry lead to winner-take-all dynamics in platform industries. Accordingly, it is that believed the first platform to successfully unlock a given online market enjoys a determining first-mover advantage.

This narrative has become ubiquitous in policymaking circles. Thinking of this sort notably underpins high-profile reports on competition in digital markets (here, here, and here), as well ensuing attempts to regulate digital platforms, such as the draft American Innovation and Choice Online Act and the EU’s Digital Markets Act.

But are network effects and the like the only ways to explain why these markets look like this? While there is no definitive answer, scholars routinely overlook an alternative explanation that tends to undercut the narrative that tech markets have become non-contestable.

The alternative model is simple: faced with zero prices and the almost complete absence of switching costs, users have every reason to join their preferred platform. If user preferences are relatively uniform and one platform has a meaningful quality advantage, then there is every reason to expect that most consumers will all join the same one—even though the market remains highly contestable. On the other side of the equation, because platforms face very few capacity constraints, there are few limits to a given platform’s growth. As will be explained throughout this piece, this intuition is as old as economics itself.

The Bertrand Paradox

In 1883, French mathematician Joseph Bertrand published a powerful critique of two of the most high-profile economic thinkers of his time: the late Antoine Augustin Cournot and Léon Walras (it would be another seven years before Alfred Marshall published his famous principles of economics).

Bertrand criticized several of Cournot and Walras’ widely accepted findings. This included Cournot’s conclusion that duopoly competition would lead to prices above marginal cost—or, in other words, that duopolies were imperfectly competitive.

By reformulating the problem slightly, Bertand arrived at the opposite conclusion. He argued that each firm’s incentive to undercut its rival would ultimately lead to marginal cost pricing, and one seller potentially capturing the entire market:

There is a decisive objection [to Cournot’s model]: According to his hypothesis, no [supracompetitive] equilibrium is possible. There is no limit to price decreases; whatever the joint price being charged by firms, a competitor could always undercut this price and, with few exceptions, attract all consumers. If the competitor is allowed to get away with this [i.e. the rival does not react], it will double its profits.

This result is mainly driven by the assumption that, unlike in Cournot’s model, firms can immediately respond to their rival’s chosen price/quantity. In other words, Bertrand implicitly framed the competitive process as price competition, rather than quantity competition (under price competition, firms do not face any capacity constraints and they cannot commit to producing given quantities of a good):

If Cournot’s calculations mask this result, it is because of a remarkable oversight. Referring to them as D and D’, Cournot deals with the quantities sold by each of the two competitors and treats them as independent variables. He assumes that if one were to change by the will of one of the two sellers, the other one could remain fixed. The opposite is evidently true.

This later came to be known as the “Bertrand paradox”—the notion that duopoly-market configurations can produce the same outcome as perfect competition (i.e., P=MC).

But while Bertrand’s critique was ostensibly directed at Cournot’s model of duopoly competition, his underlying point was much broader. Above all, Bertrand seemed preoccupied with the notion that expressing economic problems mathematically merely gives them a veneer of accuracy. In that sense, he was one of the first economists (at least to my knowledge) to argue that the choice of assumptions has a tremendous influence on the predictions of economic models, potentially rendering them unreliable:

On other occasions, Cournot introduces assumptions that shield his reasoning from criticism—scholars can always present problems in a way that suits their reasoning.

All of this is not to say that Bertrand’s predictions regarding duopoly competition necessarily hold in real-world settings; evidence from experimental settings is mixed. Instead, the point is epistemological. Bertrand’s reasoning was groundbreaking because he ventured that market structures are not the sole determinants of consumer outcomes. More broadly, he argued that assumptions regarding the competitive process hold significant sway over the results that a given model may produce (and, as a result, over normative judgements concerning the desirability of given market configurations).

The Theory of Contestable Markets

Bertrand is certainly not the only economist to have suggested market structures alone do not determine competitive outcomes. In the early 1980s, William Baumol (and various co-authors) went one step further. Baumol argued that, under certain conditions, even monopoly market structures could deliver perfectly competitive outcomes. This thesis thus rejected the Structure-Conduct-Performance (“SCP”) Paradigm that dominated policy discussions of the time.

Baumol’s main point was that industry structure is not the main driver of market “contestability,” which is the key determinant of consumer outcomes. In his words:

In the limit, when entry and exit are completely free, efficient incumbent monopolists and oligopolists may in fact be able to prevent entry. But they can do so only by behaving virtuously, that is, by offering to consumers the benefits which competition would otherwise bring. For every deviation from good behavior instantly makes them vulnerable to hit-and-run entry.

For instance, it is widely accepted that “perfect competition” leads to low prices because firms are price-takers; if one does not sell at marginal cost, it will be undercut by rivals. Observers often assume this is due to the number of independent firms on the market. Baumol suggests this is wrong. Instead, the result is driven by the sanction that firms face for deviating from competitive pricing.

In other words, numerous competitors are a sufficient, but not necessary condition for competitive pricing. Monopolies can produce the same outcome when there is a present threat of entry and an incumbent’s deviation from competitive pricing would be sanctioned. This is notably the case when there are extremely low barriers to entry.

Take this hypothetical example from the world of cryptocurrencies. It is largely irrelevant to a user whether there are few or many crypto exchanges on which to trade coins, nonfungible tokens (NFTs), etc. What does matter is that there is at least one exchange that meets one’s needs in terms of both price and quality of service. This could happen because there are many competing exchanges, or because a failure to meet my needs by the few (or even one) exchange that does exist would attract the entry of others to which I could readily switch—thus keeping the behavior of the existing exchanges in check.

This has far-reaching implications for antitrust policy, as Baumol was quick to point out:

This immediately offers what may be a new insight on antitrust policy. It tells us that a history of absence of entry in an industry and a high concentration index may be signs of virtue, not of vice. This will be true when entry costs in our sense are negligible.

Given what precedes, Baumol surmised that industry structure must be driven by endogenous factors—such as firms’ cost structures—rather than the intensity of competition that they face. For instance, scale economies might make monopoly (or another structure) the most efficient configuration in some industries. But so long as rivals can sanction incumbents for failing to compete, the market remains contestable. Accordingly, at least in some industries, both the most efficient and the most contestable market configuration may entail some level of concentration.

To put this last point in even more concrete terms, online platform markets may have features that make scale (and large market shares) efficient. If so, there is every reason to believe that competition could lead to more, not less, concentration. 

How Contestable Are Digital Markets?

The insights of Bertrand and Baumol have important ramifications for contemporary antitrust debates surrounding digital platforms. Indeed, it is critical to ascertain whether the (relatively) concentrated market structures we see in these industries are a sign of superior efficiency (and are consistent with potentially intense competition), or whether they are merely caused by barriers to entry.

The barrier-to-entry explanation has been repeated ad nauseam in recent scholarly reports, competition decisions, and pronouncements by legislators. There is thus little need to restate that thesis here. On the other hand, the contestability argument is almost systematically ignored.

Several factors suggest that online platform markets are far more contestable than critics routinely make them out to be.

First and foremost, consumer switching costs are extremely low for most online platforms. To cite but a few examples: Changing your default search engine requires at most a couple of clicks; joining a new social network can be done by downloading an app and importing your contacts to the app; and buying from an alternative online retailer is almost entirely frictionless, thanks to intermediaries such as PayPal.

These zero or near-zero switching costs are compounded by consumers’ ability to “multi-home.” In simple terms, joining TikTok does not require users to close their Facebook account. And the same applies to other online services. As a result, there is almost no opportunity cost to join a new platform. This further reduces the already tiny cost of switching.

Decades of app development have greatly improved the quality of applications’ graphical user interfaces (GUIs), to such an extent that costs to learn how to use a new app are mostly insignificant. Nowhere is this more apparent than for social media and sharing-economy apps (it may be less true for productivity suites that enable more complex operations). For instance, remembering a couple of intuitive swipe motions is almost all that is required to use TikTok. Likewise, ridesharing and food-delivery apps merely require users to be familiar with the general features of other map-based applications. It is almost unheard of for users to complain about usability—something that would have seemed impossible in the early 21st century, when complicated interfaces still plagued most software.

A second important argument in favor of contestability is that, by and large, online platforms face only limited capacity constraints. In other words, platforms can expand output rapidly (though not necessarily costlessly).

Perhaps the clearest example of this is the sudden rise of the Zoom service in early 2020. As a result of the COVID pandemic, Zoom went from around 10 million daily active users in early 2020 to more than 300 million by late April 2020. Despite being a relatively data-intensive service, Zoom did not struggle to meet this new demand from a more than 30-fold increase in its user base. The service never had to turn down users, reduce call quality, or significantly increase its price. In short, capacity largely followed demand for its service. Online industries thus seem closer to the Bertrand model of competition, where the best platform can almost immediately serve any consumers that demand its services.

Conclusion

Of course, none of this should be construed to declare that online markets are perfectly contestable. The central point is, instead, that critics are too quick to assume they are not. Take the following examples.

Scholars routinely cite the putatively strong concentration of digital markets to argue that big tech firms do not face strong competition, but this is a non sequitur. As Bertrand and Baumol (and others) show, what matters is not whether digital markets are concentrated, but whether they are contestable. If a superior rival could rapidly gain user traction, this alone will discipline the behavior of incumbents.

Markets where incumbents do not face significant entry from competitors are just as consistent with vigorous competition as they are with barriers to entry. Rivals could decline to enter either because incumbents have aggressively improved their product offerings or because they are shielded by barriers to entry (as critics suppose). The former is consistent with competition, the latter with monopoly slack.

Similarly, it would be wrong to presume, as many do, that concentration in online markets is necessarily driven by network effects and other scale-related economies. As ICLE scholars have argued elsewhere (here, here and here), these forces are not nearly as decisive as critics assume (and it is debatable that they constitute barriers to entry).

Finally, and perhaps most importantly, this piece has argued that many factors could explain the relatively concentrated market structures that we see in digital industries. The absence of switching costs and capacity constraints are but two such examples. These explanations, overlooked by many observers, suggest digital markets are more contestable than is commonly perceived.

In short, critics’ failure to meaningfully grapple with these issues serves to shape the prevailing zeitgeist in tech-policy debates. Cournot and Bertrand’s intuitions about oligopoly competition may be more than a century old, but they continue to be tested empirically. It is about time those same standards were applied to tech-policy debates.

Large group of people in the shape of two puzzle pieces on a white background.

The Federal Trade Commission (FTC) has taken another step away from case-specific evaluation of proposed mergers and toward an ex ante regulatory approach in its Oct. 25 “Statement of the Commission on Use of Prior Approval Provisions in Merger Orders.” Though not unexpected, this unfortunate initiative once again manifests the current FTC leadership’s disdain for long-accepted economically sound antitrust-enforcement principles.

Discussion

High levels of merger activity should, generally speaking, be viewed as a symptom of a vibrant economy, not a reason for economic concern. Horizontal mergers typically are driven by the potential to realize real cost savings, unrelated to anticompetitive reductions in output.

Non-horizontal mergers often put into force welfare-enhancing reductions of double marginalization, while uniting complements and achieving synergies in ways that seek efficiencies. More generally, proposed acquisitions frequently reflect an active market for corporate control that seeks to reallocate scarce resources to higher-valued uses (see, for example, Henry Manne’s seminal article on “Mergers and the Market for Corporate Control”). Finally, by facilitating cost reductions, synergies, and improvements in resource allocations within firms, mergers may allow the new consolidated entity to compete more effectively in the marketplace, thereby enhancing competition.

Given the economic benefits frequently generated by mergers, government antitrust enforcers should not discourage them, nor should they intervene to block them, absent a strong showing that a particular transaction would likely reduce competition and harm consumer welfare. In the United States, the Hart-Scott-Rodino Premerger Notification Act of 1976 (HSR) and its implementing regulations generally have reflected this understanding. They have done this by requiring that proposed transactions above a certain size threshold be notified to the FTC and the U.S. Justice Department (DOJ), and by providing a framework for timely review, allowing most notified mergers to close promptly.

In the relatively few cases where agency enforcement staff have identified competitive problems, the HSR framework usually has enabled timely negotiation of possible competitive fixes (divestitures and, less typically, behavioral remedies). Where fixes have not been feasible, filing parties generally have been able to decide whether to drop a transaction or prepare for litigation within a reasonable time period. Under the HSR framework, enforcers generally have respected the time sensitivity of merger proposals and acted expeditiously (with a few exceptions) to review complicated and competitively sensitive transactions. The vast majority of HSR filings that facially raise no plausible competitive issues historically have been dealt with swiftly—often through “early termination” policies that provide the merging parties an antitrust go-ahead well before the end of HSR’s initial 30-day review period.

In short, although far from perfect, HSR processes have sought to minimize regulatory impediments to merger activity, consistent with the statutory mandate to identify and prevent anticompetitive mergers.      

Regrettably, under the leadership of Chair Lina M. Khan, the FTC has taken unprecedented steps to undermine the well-understood HSR framework. As I wrote recently:

For decades, parties proposing mergers that are subject to statutory Hart-Scott-Rodino (HSR) Act pre-merger notification requirements have operated under the understanding that:

1. The FTC and U.S. Justice Department (DOJ) will routinely grant “early termination” of review (before the end of the initial 30-day statutory review period) to those transactions posing no plausible competitive threat; and

2. An enforcement agency’s decision not to request more detailed documents (“second requests”) after an initial 30-day pre-merger review effectively serves as an antitrust “green light” for the proposed acquisition to proceed.

Those understandings, though not statutorily mandated, have significantly reduced antitrust uncertainty and related costs in the planning of routine merger transactions. The rule of law has been advanced through an effective assurance that business combinations that appear presumptively lawful will not be the target of future government legal harassment. This has advanced efficiency in government, as well; it is a cost-beneficial optimal use of resources for DOJ and the FTC to focus exclusively on those proposed mergers that present a substantial potential threat to consumer welfare.

Two recent FTC pronouncements (one in tandem with DOJ), however, have generated great uncertainty by disavowing (at least temporarily) those two welfare-promoting review policies. Joined by DOJ, the FTC on Feb. 4 announced that the agencies would temporarily suspend early terminations, citing an “unprecedented volume of filings” and a transition to new leadership. More than six months later, this “temporary” suspension remains in effect.

Citing “capacity constraints” and a “tidal wave of merger filings,” the FTC subsequently published an Aug. 3 blog post that effectively abrogated the 30-day “green lighting” of mergers not subject to a second request. It announced that it was sending “warning letters” to firms reminding them that FTC investigations remain open after the initial 30-day period, and that “[c]ompanies that choose to proceed with transactions that have not been fully investigated are doing so at their own risk.”

The FTC’s actions interject unwarranted uncertainty into merger planning and undermine the rule of law. Preventing early termination on transactions that have been approved routinely not only imposes additional costs on business; it hints that some transactions might be subject to novel theories of liability that fall outside the antitrust consensus.

The FTC’s merger-review reign of error continues. Most recently, it released a policy guidance statement that effectively transforms the commission into a merger regulator whose assent is required for a specific category of mergers. This policy is at odds with HSR, which is designed to facilitate merger reviews, not to serve as a regulatory-approval mechanism. As the FTC explains in its Oct. 25 statement(citation to 1995 Statement omitted) (approved by a 3-2 vote, with Commissioners Noah Joshua Phillips and Christine S. Wilson dissenting):

On July 21, 2021, the Commission voted to rescind the 1995 Policy Statement on Prior Approval and Prior Notice Provisions (“1995 Statement”). The 1995 Statement ended the Commission’s then-longstanding practice of incorporating prior approval and prior notice provisions in Commission orders addressing mergers. With the rescission of the 1995 statement, the Commission returns now to its prior practice of routinely requiring merging parties subject to a Commission order to obtain prior approval from the FTC before closing any future transaction affecting each relevant market for which a violation was alleged. . . .

In addition, from now on, in matters where the Commission issues a complaint to block a merger and the parties subsequently abandon the transaction, the agency will engage in a case-specific determination as to whether to pursue a prior approval order, focusing on the factors identified below with respect to use of broader prior approval provisions. The fact that parties may abandon a merger after litigation commences does not guarantee that the

Commission will not subsequently pursue an order incorporating a prior approval provision. . . .
In some situations where stronger relief is needed, the Commission may decide to seek a prior approval provision that covers product and geographic markets beyond just the relevant product and geographic markets affected by the merger. No single factor is dispositive; rather, the Commission will take a holistic view of the circumstances when determining the length and breadth of prior approval provisions. [Six factors listed include the nature of the transaction; the level of market concentration; the degree to which the transaction increases concentration; the degree to which one of the parties pre-merger likely had market power; the parties’ history of acquisitiveness; and evidence of anticompetitive market dynamics.]

The Oct. 25 Statement is highly problematic in several respects. Its oversight requirements may discourage highly effective consent decree “fixes” of potential mergers, leading to wasteful litigation—or, alternatively, the abandonment of efficient transactions. What’s more, the threat of FTC prior approval orders (based on multiple criteria subject to manipulation by the FTC), even when parties abandon a proposed transaction (and thus, effectively have “done nothing”), smacks of unwarranted regulation of future corporate plans of disfavored firms, raising questions of fundamental fairness.

All told, the new requirements, combined with the FTC’s policies to end early terminations and to stop “greenlighting” routine merger transactions after a 30-day review, are yet signs that the well-understood HSR consensus has been unilaterally abandoned by the FTC, based on purely partisan commission votes, despite the lack of any public consultation. The FTC’s abrupt and arbitrary merger-review-related actions will harm the economy by discouraging welfare-promoting consolidations. These actions also fly in the face of sound public administration.  

Conclusion

The FTC continues to move from its historic role of antitrust enforcer to that of antitrust regulator at warp speed, based on a series of 3-2 votes. In particular, the commission’s abandonment of a well-established bipartisan approach to HSR policy is particularly troublesome, given the new risks it creates for private parties considering acquisitions. These new risks will likely deter an unknown number of efficiency-enhancing, innovative combinations that could have benefited consumers and substantially strengthened the American economy.

Perhaps the imminent confirmation of Jonathan Kanter—an individual with many years of practical experience as a leading antitrust practitioner—to be assistant attorney general for antitrust will bring a more reasonable perspective to antitrust agency HSR policies. It may even convince a majority of the commission to return to the bipartisan HSR merger-review framework that has served the American economy well.

If not, perhaps congressional overseers might wish to investigate the implications for the American innovation economy and the rule of law stemming from the FTC’s de facto abandonment of HSR principles. Whether to fundamentally alter merger-review procedures should be up to Congress, not to three unelected officials.    

The leading contribution to sound competition policy made by former Assistant U.S. Attorney General Makan Delrahim was his enunciation of the “New Madison Approach” to patent-antitrust enforcement—and, in particular, to the antitrust treatment of standard essential patent licensing (see, for example, here, here, and here). In short (citations omitted):

The New Madison Approach (“NMA”) advanced by former Assistant Attorney General for Antitrust Makan Delrahim is a simple analytical framework for understanding the interplay between patents and antitrust law arising out of standard setting. A key aspect of the NMA is its rejection of the application of antitrust law to the “hold-up” problem, whereby patent holders demand supposedly supra-competitive licensing fees to grant access to their patents that “read on” a standard – standard essential patents (“SEPs”). This scenario is associated with an SEP holder’s prior commitment to a standard setting organization (“SSO”), that is: if its patented technology is included in a proposed new standard, it will license its patents on fair, reasonable, and non-discriminatory (“FRAND”) terms. “Hold-up” is said to arise subsequently, when the SEP holder reneges on its FRAND commitment and demands that a technology implementer pay higher-than-FRAND licensing fees to access its SEPs.

The NMA has four basic premises that are aimed at ensuring that patent holders have adequate incentives to innovate and create welfare-enhancing new technologies, and that licensees have appropriate incentives to implement those technologies:

1. Hold-up is not an antitrust problem. Accordingly, an antitrust remedy is not the correct tool to resolve patent licensing disputes between SEP-holders and implementers of a standard.

2. SSOs should not allow collective actions by standard-implementers to disfavor patent holders in setting the terms of access to patents that cover a new standard.

3. A fundamental element of patent rights is the right to exclude. As such, SSOs and courts should be hesitant to restrict SEP holders’ right to exclude implementers from access to their patents, by, for example, seeking injunctions.

4. Unilateral and unconditional decisions not to license a patent should be per se legal.

Delrahim emphasizes that the threat of antitrust liability, specifically treble damages, distorts the incentives associated with good faith negotiations with SSOs over patent inclusion. Contract law, he goes on to note, is perfectly capable of providing an ex post solution to licensing disputes between SEP holders and implementers of a standard. Unlike antitrust law, a contract law framework allows all parties equal leverage in licensing negotiations.

As I have explained elsewhere, the NMA is best seen as a set of policies designed to spark dynamic economic growth:

[P]atented technology serves as a catalyst for the wealth-creating diffusion of innovation. This occurs through numerous commercialization methods; in the context of standardized technologies, the development of standards is a process of discovery. At each [SSO], the process of discussion and negotiation between engineers, businesspersons, and all other relevant stakeholders reveals the relative value of alternative technologies and tends to result in the best patents being integrated into a standard.

The NMA supports this process of discovery and implementation of the best patented technology born of the labors of the innovators who created it. As a result, the NMA ensures SEP valuations that allow SEP holders to obtain an appropriate return for the new economic surplus that results from the commercialization of standard-engendered innovations. It recognizes that dynamic economic growth is fostered through the incentivization of innovative activities backed by patents.

In sum, the NMA seeks to promote innovation by offering incentives for SEP-driven technological improvements. As such, it rejects as ill-founded prior Federal Trade Commission (FTC) litigation settlements and Obama-era U.S. Justice Department (DOJ) Antitrust Division policy statements that artificially favored implementor licensees’ interests over those of SEP licensors (see here).

In light of the NMA, DOJ cooperated with the U.S. Patent and Trademark Office and National Institute of Standards and Technology (NIST) in issuing a 2019 SEP Policy Statement clarifying that an SEP holder’s promise to license a patent on fair, reasonable, and non-discriminatory (FRAND) terms does not bar it from seeking any available remedy for patent infringement, including an injunction. This signaled that SEPs and non-SEP patents enjoy equivalent legal status.

DOJ also issued a 2020 supplement to its 2015 Institute of Electrical and Electronics Engineers (IEEE) business review letter. The 2015 letter had found no legal fault with revised IEEE standard-setting policies that implicitly favored implementers of standardized technology over SEP holders. The 2020 supplement characterized key elements of the 2015 letter as “outdated,” and noted that the anti-SEP bias of that document could “harm competition and chill innovation.”   

Furthermore, DOJ issued a July 2019 Statement of Interest before the 9th U.S. Circuit Court of Appeals in FTC v. Qualcomm, explaining that unilateral and unconditional decisions not to license a patent are legal under the antitrust laws. In October 2020, the 9th Circuit reversed a district court decision and rejected the FTC’s monopolization suit against Qualcomm. The circuit court, among other findings, held that Qualcomm had no antitrust duty to license its SEPs to competitors.

Regrettably, the Biden Administration appears to be close to rejecting the NMA and to reinstituting the anti-strong patents SEP-skeptical views of the Obama administration (see here and here). DOJ already has effectively repudiated the 2020 supplement to the 2015 IEEE letter and the 2019 SEP Policy Statement. Furthermore, written responses to Senate Judiciary Committee questions by assistant attorney general nominee Jonathan Kanter suggest support for renewed antitrust scrutiny of SEP licensing. These developments are highly problematic if one supports dynamic economic growth.

Conclusion

The NMA represents a pro-American, pro-growth innovation policy prescription. Its abandonment would reduce incentives to invest in patents and standard-setting activities, to the detriment of the U.S. economy. Such a development would be particularly unfortunate at a time when U.S. Supreme Court decisions have weakened American patent rights (see here); China is taking steps to strengthen Chinese patents and raise incentives to obtain Chinese patents (see here); and China is engaging in litigation to weaken key U.S. patents and undermine American technological leadership (see here).

The rejection of NMA would also be in tension with the logic of the 5th U.S. Circuit Court of Appeals’ 2021 HTC v. Ericsson decision, which held that the non-discrimination portion of the FRAND commitment required Ericsson to give HTC the same licensing terms as given to larger mobile-device manufacturers. Furthermore, recent important European court decisions are generally consistent with NMA principles (see here).

Given the importance of dynamic competition in an increasingly globalized world economy, Biden administration officials may wish to take a closer look at the economic arguments supporting the NMA before taking final action to condemn it. Among other things, the administration might take note that major U.S. digital platforms, which are the subject of multiple U.S. and foreign antitrust enforcement investigations, tend to firmly oppose strong patents rights. As one major innovation economist recently pointed out:

If policymakers and antitrust gurus are so concerned about stemming the rising power of Big Tech platforms, they should start by first stopping the relentless attack on IP. Without the IP system, only the big and powerful have the privilege to innovate[.]

A debate has broken out among the four sitting members of the Federal Trade Commission (FTC) in connection with the recently submitted FTC Report to Congress on Privacy and Security. Chair Lina Khan argues that the commission “must explore using its rulemaking tools to codify baseline protections,” while Commissioner Rebecca Kelly Slaughter has urged the FTC to initiate a broad-based rulemaking proceeding on data privacy and security. By contrast, Commissioners Noah Joshua Phillips and Christine Wilson counsel against a broad-based regulatory initiative on privacy.

Decisions to initiate a rulemaking should be viewed through a cost-benefit lens (See summaries of Thom Lambert’s masterful treatment of regulation, of which rulemaking is a subset, here and here). Unless there is a market failure, rulemaking is not called for. Even in the face of market failure, regulation should not be adopted unless it is more cost-beneficial than reliance on markets (including the ability of public and private litigation to address market-failure problems, such as data theft). For a variety of reasons, it is unlikely that FTC rulemaking directed at privacy and data security would pass a cost-benefit test.

Discussion

As I have previously explained (see here and here), FTC rulemaking pursuant to Section 6(g) of the FTC Act (which authorizes the FTC “to make rules and regulations for the purpose of carrying out the provisions of this subchapter”) is properly read as authorizing mere procedural, not substantive, rules. As such, efforts to enact substantive competition rules would not pass a cost-benefit test. Such rules could well be struck down as beyond the FTC’s authority on constitutional law grounds, and as “arbitrary and capricious” on administrative law grounds. What’s more, they would represent retrograde policy. Competition rules would generate higher error costs than adjudications; could be deemed to undermine the rule of law, because the U.S. Justice Department (DOJ) could not apply such rules; and innovative efficiency-seeking business arrangements would be chilled.

Accordingly, the FTC likely would not pursue 6(g) rulemaking should it decide to address data security and privacy, a topic which best fits under the “consumer protection” category. Rather, the FTC presumably would most likely initiate a “Magnuson-Moss” rulemaking (MMR) under Section 18 of the FTC Act, which authorizes the commission to prescribe “rules which define with specificity acts or practices which are unfair or deceptive acts or practices in or affecting commerce within the meaning of Section 5(a)(1) of the Act.” Among other things, Section 18 requires that the commission’s rulemaking proceedings provide an opportunity for informal hearings at which interested parties are accorded limited rights of cross-examination. Also, before commencing an MMR proceeding, the FTC must have reason to believe the practices addressed by the rulemaking are “prevalent.” 15 U.S.C. Sec. 57a(b)(3).

MMR proceedings, which are not governed under the Administrative Procedure Act (APA), do not present the same degree of legal problems as Section 6(g) rulemakings (see here). The question of legal authority to adopt a substantive rule is not raised; “rule of law” problems are far less serious (the DOJ is not a parallel enforcer of consumer-protection law); and APA issues of “arbitrariness” and “capriciousness” are not directly presented. Indeed, MMR proceedings include a variety of procedures aimed at promoting fairness (see here, for example). An MMR proceeding directed at data privacy predictably would be based on the claim that the failure to adhere to certain data-protection norms is an “unfair act or practice.”

Nevertheless, MMR rules would be subject to two substantial sources of legal risk.

The first of these arises out of federalism. Three states (California, Colorado, and Virginia) recently have enacted comprehensive data-privacy laws, and a large number of other state legislatures are considering data-privacy bills (see here). The proliferation of state data-privacy statutes would raise the risk of inconsistent and duplicative regulatory norms, potentially chilling business innovations addressed at data protection (a severe problem in the Internet Age, when business data-protection programs typically will have interstate effects).

An FTC MMR data-protection regulation that successfully “occupied the field” and preempted such state provisions could eliminate that source of costs. The Magnuson–Moss Warranty Act, however, does not contain an explicit preemption clause, leaving in serious doubt the ability of an FTC rule to displace state regulations (see here for a summary of the murky state of preemption law, including the skepticism of textualist Supreme Court justices toward implied “obstacle preemption”). In particular, the long history of state consumer-protection and antitrust laws that coexist with federal laws suggests that the case for FTC rule-based displacement of state data protection is a weak one. The upshot, then, of a Section 18 FTC data-protection rule enactment could be “the worst of all possible worlds,” with drawn-out litigation leading to competing federal and state norms that multiplied business costs.

The second source of risk arises out of the statutory definition of “unfair practices,” found in Section 5(n) of the FTC Act. Section 5(n) codifies the meaning of unfair practices, and thereby constrains the FTC’s application of rulemakings covering such practices. Section 5(n) states:

The Commission shall have no authority . . . to declare unlawful an act or practice on the grounds that such an act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. In determining whether an act or practice is unfair, the Commission may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.

In effect, Section 5(n) implicitly subjects unfair practices to a well-defined cost-benefit framework. Thus, in promulgating a data-privacy MMR, the FTC first would have to demonstrate that specific disfavored data-protection practices caused or were likely to cause substantial harm. What’s more, the commission would have to show that any actual or likely harm would not be outweighed by countervailing benefits to consumers or competition. One would expect that a data-privacy rulemaking record would include submissions that pointed to the efficiencies of existing data-protection policies that would be displaced by a rule.

Moreover, subsequent federal court challenges to a final FTC rule likely would put forth the consumer and competitive benefits sacrificed by rule requirements. For example, rule challengers might point to the added business costs passed on to consumers that would arise from particular rule mandates, and the diminution in competition among data-protection systems generated by specific rule provisions. Litigation uncertainties surrounding these issues could be substantial and would cast into further doubt the legal viability of any final FTC data protection rule.

Apart from these legal risk-based costs, an MMR data privacy predictably would generate error-based costs. Given imperfect information in the hands of government and the impossibility of achieving welfare-maximizing nirvana through regulation (see, for example, here), any MMR data-privacy rule would erroneously condemn some economically inefficient business protocols and disincentivize some efficiency-seeking behavior. The Section 5(n) cost-benefit framework, though helpful, would not eliminate such error. (For example, even bureaucratic efforts to accommodate some business suggestions during the rulemaking process might tilt the post-rule market in favor of certain business models, thereby distorting competition.) In the abstract, it is difficult to say whether the welfare benefits of a final MMA data-privacy rule (measured by reductions in data-privacy-related consumer harm) would outweigh the costs, even before taking legal costs into account.

Conclusion

At least two FTC commissioners (and likely a third, assuming that President Joe Biden’s highly credentialed nominee Alvaro Bedoya will be confirmed by the U.S. Senate) appear to support FTC data-privacy regulation, even in the absence of new federal legislation. Such regulation, which presumably would be adopted as an MMR pursuant to Section 18 of the FTC Act, would probably not prove cost-beneficial. Not only would adoption of a final data-privacy rule generate substantial litigation costs and uncertainty, it would quite possibly add an additional layer of regulatory burdens above and beyond the requirements of proliferating state privacy rules. Furthermore, it is impossible to say whether the consumer-privacy benefits stemming from such an FTC rule would outweigh the error costs (manifested through competitive distortions and consumer harm) stemming from the inevitable imperfections of the rule’s requirements. All told, these considerations counsel against the allocation of scarce FTC resources to a Section 18 data-privacy rulemaking initiative.

But what about legislation? New federal privacy legislation that explicitly preempted state law would eliminate costs arising from inconsistencies among state privacy rules. Ideally, if such legislation were to be pursued, it should to the extent possible embody a cost-benefit framework designed to minimize the sum of administrative (including litigation) and error costs. The nature of such a possible law, and the role the FTC might play in administering it, however, is a topic for another day.

Still from Squid Game, Netflix and Siren Pictures Inc., 2021

Recent commentary on the proposed merger between WarnerMedia and Discovery, as well as Amazon’s acquisition of MGM, often has included the suggestion that the online content-creation and video-streaming markets are excessively consolidated, or that they will become so absent regulatory intervention. For example, in a recent letter to the U.S. Justice Department (DOJ), the American Antitrust Institute and Public Knowledge opine that:

Slow and inadequate oversight risks the streaming market going the same route as cable—where consumers have little power, few options, and where consolidation and concentration reign supreme. A number of threats to competition are clear, as discussed in this section, including: (1) market power issues surrounding content and (2) the role of platforms in “gatekeeping” to limit competition.

But the AAI/PK assessment overlooks key facts about the video-streaming industry, some of which suggest that, if anything, these markets currently suffer from too much fragmentation.

The problem is well-known: any individual video-streaming service will offer only a fraction of the content that viewers want, but budget constraints limit the number of services that a household can afford to subscribe to. It may be counterintuitive, but consolidation in the market for video-streaming can solve both problems at once.

One subscription is not enough

Surveys find that U.S. households currently maintain, on average, four video-streaming subscriptions. This explains why even critics concede that a plethora of streaming services compete for consumer eyeballs. For instance, the AAI and PK point out that:

Today, every major media company realizes the value of streaming and a bevy of services have sprung up to offer different catalogues of content.

These companies have challenged the market leader, Netflix and include: Prime Video (2006), Hulu (2007), Paramount+ (2014), ESPN+ (2018), Disney+ (2019), Apple TV+ (2019), HBO Max (2020), Peacock (2020), and Discovery+ (2021).

With content scattered across several platforms, multiple subscriptions are the only way for households to access all (or most) of the programs they desire. Indeed, other than price, library sizes and the availability of exclusive content are reportedly the main drivers of consumer purchase decisions.

Of course, there is nothing inherently wrong with the current equilibrium in which consumers multi-home across multiple platforms. One potential explanation is demand for high-quality exclusive content, which requires tremendous investment to develop and promote. Production costs for TV series routinely run in the tens of millions of dollars per episode (see here and here). Economic theory predicts these relationship-specific investments made by both producers and distributors will cause producers to opt for exclusive distribution or vertical integration. The most sought-after content is thus exclusive to each platform. In other words, exclusivity is likely the price that users must pay to ensure that high-quality entertainment continues to be produced.

But while this paradigm has many strengths, the ensuing fragmentation can be detrimental to consumers, as this may lead to double marginalization or mundane issues like subscription fatigue. Consolidation can be a solution to both.

Substitutes, complements, or unrelated?

As Hal Varian explains in his seminal book, the relationship between two goods can range among three extremes: perfect substitutes (i.e., two goods are perfectly interchangeable); perfect complements (i.e., there is no value to owning one good without the other); or goods that exist in independent markets (i.e., the price of one good does not affect demand for the other).

These distinctions are critical when it comes to market concentration. All else equal—which is obviously not the case in reality—increased concentration leads to lower prices for complements, and higher prices for substitutes. Finally, if demand for two goods is unrelated, then bringing them under common ownership should not affect their price.

To at least some extent, streaming services should be seen as complements rather than substitutes—or, at least, as services with unrelated demand. If they were perfect substitutes, consumers would be indifferent between two Netflix subscriptions or one Netflix plan and one Amazon Prime plan. That is obviously not the case. Nor are they perfect complements, which would mean that Netflix is worthless without Amazon Prime, Disney+, and other services.

However, there is reason to believe there exists some complementarity between streaming services, or at least that demand for them is independent. Most consumers subscribe to multiple services, and almost no one subscribes to the same service twice:

SOURCE: Finance Buzz

This assertion is also supported by the ubiquitous bundling of subscriptions in the cable distribution industry, which also has recently been seen in video-streaming markets. For example, in the United States, Disney+ can be purchased in a bundle with Hulu and ESPN+.

The key question is: is each service more valuable, less valuable, or as valuable in isolation than they are when bundled? If households place some additional value on having a complete video offering (one that includes child entertainment, sports, more mature content, etc.), and if they value the convenience of accessing more of their content via a single app, then we can infer these services are to some extent complementary.

Finally, it is worth noting that any complementarity between these services would be largely endogenous. If the industry suddenly switched to a paradigm of non-exclusive content—as is broadly the case for audio streaming—the above analysis would be altered (though, as explained above, such a move would likely be detrimental to users). Streaming services would become substitutes if they offered identical catalogues.

In short, the extent to which streaming services are complements ultimately boils down to an empirical question that may fluctuate with industry practices. As things stand, there is reason to believe that these services feature some complementarities, or at least that demand for them is independent. In turn, this suggests that further consolidation within the industry would not lead to price increases and may even reduce them.

Consolidation can enable price discrimination

It is well-established that bundling entertainment goods can enable firms to better engage in price discrimination, often increasing output and reducing deadweight loss in the process.

Take George Stigler’s famous explanation for the practice of “block booking,” in which movie studios sold multiple films to independent movie theatres as a unit. Stigler assumes the underlying goods are neither substitutes nor complements:

Stigler, George J. (1963) “United States v. Loew’s Inc.: A Note on Block-Booking,” Supreme Court Review: Vol. 1963 : No. 1 , Article 2.

The upshot is that, when consumer tastes for content are idiosyncratic—as is almost certainly the case for movies and television series, movies—it can counterintuitively make sense to sell differing content as a bundle. In doing so, the distributor avoids pricing consumers out of the content upon which they place a lower value. Moreover, this solution is more efficient than price discriminating on an unbundled basis, as doing so would require far more information on the seller’s part and would be vulnerable to arbitrage.

In short, bundling enables each consumer to access a much wider variety of content. This, in turn, provides a powerful rationale for mergers in the video-streaming space—particularly where they can bring together varied content libraries. Put differently, it cuts in favor of more, not less, concentration in video-streaming markets (at least, up to a certain point).

Finally, a wide array of scale-related economies further support the case for concentration in video-streaming markets. These include potential economies of scale, network effects, and reduced transaction costs.

The simplest of these ideas is that the cost of video streaming may decrease at the margin (i.e., serving each marginal viewer might be cheaper than the previous one). In other words, mergers of video-streaming services mayenable platforms to operate at a more efficient scale. There has notably been some discussion of whether Netflix benefits from scale economies of this sort. But this is, of course, ultimately an empirical question. As I have written with Geoffrey Manne, we should not assume that this is the case for all digital platforms, or that these increasing returns are present at all ranges of output.

Likewise, the fact that content can earn greater revenues by reaching a wider audience (or a greater number of small niches) may increase a producer’s incentive to create high-quality content. For example, Netflix’s recent hit series Squid Game reportedly cost $16.8 million to produce a total of nine episodes. This is significant for a Korean-language thriller. These expenditures were likely only possible because of Netflix’s vast network of viewers. Video-streaming mergers can jump-start these effects by bringing previously fragmented audiences onto a single platform.

Finally, operating at a larger scale may enable firms and consumers to economize on various transaction and search costs. For instance, consumers don’t need to manage several subscriptions, and searching for content is easier within a single ecosystem.

Conclusion

In short, critics could hardly be more wrong in assuming that consolidation in the video-streaming industry will necessarily harm consumers. To the contrary, these mergers should be presumptively welcomed because, to a first approximation, they are likely to engender lower prices and reduce deadweight loss.

Critics routinely draw parallels between video streaming and the consolidation that previously moved through the cable industry. They suggest these events as evidence that consolidation was (and still is) inefficient and exploitative of consumers. As AAI and PK frame it:

Moreover, given the broader competition challenges that reside in those markets, and the lessons learned from a failure to ensure competition in the traditional MVPD markets, enforcers should be particularly vigilant.

But while it might not have been ideal for all consumers, the comparatively laissez-faire approach to competition in the cable industry arguably facilitated the United States’ emergence as a global leader for TV programming. We are now witnessing what appears to be a similar trend in the online video-streaming market.

This is mostly a good thing. While a single streaming service might not be the optimal industry configuration from a welfare standpoint, it would be equally misguided to assume that fragmentation necessarily benefits consumers. In fact, as argued throughout this piece, there are important reasons to believe that the status quo—with at least 10 significant players—is too fragmented and that consumers would benefit from additional consolidation.

A lawsuit filed by the State of Texas and nine other states in December 2020 alleges, among other things, that Google has engaged in anticompetitive conduct related to its online display-advertising business.

Broadly, the Texas complaint (previously discussed in this TOTM symposium) alleges that Google possesses market power in ad-buying tools and in search, illustrated in the figure below.

The complaint also alleges anticompetitive conduct by Google with respect to YouTube in a separate “inline video-advertising market.” According to the complaint, this market power is leveraged to force transactions through Google’s exchange, AdX, and its network, Google Display Network. The leverage is further exercised by forcing publishers to license Google’s ad server, Google Ad Manager.

Although the Texas complaint raises many specific allegations, the key ones constitute four broad claims: 

  1. Google forces publishers to license Google’s ad server and trade in Google’s ad exchange;
  2. Google uses its control over publishers’ inventory to block exchange competition;
  3. Google has disadvantaged technology known as “header bidding” in order to prevent publishers from accessing its competitors; and
  4. Google prevents rival ad-placement services from competing by not allowing them to buy YouTube ad space.

Alleged harms

The Texas complaint alleges Google’s conduct has caused harm to competing networks, exchanges, and ad servers. The complaint also claims that the plaintiff states’ economies have been harmed “by depriving the Plaintiff States and the persons within each Plaintiff State of the benefits of competition.”

In a nod to the widely accepted Consumer Welfare Standard, the Texas complaint alleges harm to three categories of consumers:

  1. Advertisers who pay for their ads to be displayed, but should be paying less;
  2. Publishers who are paid to provide space on their sites to display ads, but should be paid more; and
  3. Users who visit the sites, view the ads, and purchase or use the advertisers’ and publishers’ products and services.

The complaint claims users are harmed by above-competitive prices paid by advertisers, in that these higher costs are passed on in the form of higher prices and lower quality for the products and services they purchase from those advertisers. The complaint simultaneously claims that users are harmed by the below-market prices received by publishers in the form of “less content (lower output of content), lower-quality content, less innovation in content delivery, more paywalls, and higher subscription fees.”

Without saying so explicitly, the complaint insinuates that if intermediaries (e.g., Google and competing services) charged lower fees for their services, advertisers would pay less, publishers would be paid more, and consumers would be better off in the form of lower prices and better products from advertisers, as well as improved content and lower fees on publishers’ sites.

Effective competition is not an antitrust offense

A flawed premise underlies much of the Texas complaint. It asserts that conduct by a dominant incumbent firm that makes competition more difficult for competitors is inherently anticompetitive, even if that conduct confers benefits on users.

This amounts to a claim that Google is acting anti-competitively by innovating and developing products and services to benefit one or more display-advertising constituents (e.g., advertisers, publishers, or consumers) or by doing things that benefit the advertising ecosystem more generally. These include creating new and innovative products, lowering prices, reducing costs through vertical integration, or enhancing interoperability.

The argument, which is made explicitly elsewhere, is that Google must show that it has engineered and implemented its products to minimize obstacles its rivals face, and that any efficiencies created by its products must be shown to outweigh the costs imposed by those improvements on the company’s competitors.

Similarly, claims that Google has acted in an anticompetitive fashion rest on the unsupportable notion that the company acts unfairly when it designs products to benefit itself without considering how those designs would affect competitors. Google could, it is argued, choose alternate arrangements and practices that would possibly confer greater revenue on publishers or lower prices on advertisers without imposing burdens on competitors.

For example, a report published by the Omidyar Network sketching a “roadmap” for a case against Google claims that, if Google’s practices could possibly be reimagined to achieve the same benefits in ways that foster competition from rivals, then the practices should be condemned as anticompetitive:

It is clear even to us as lay people that there are less anticompetitive ways of delivering effective digital advertising—and thereby preserving the substantial benefits from this technology—than those employed by Google.

– Fiona M. Scott Morton & David C. Dinielli, “Roadmap for a Digital Advertising Monopolization Case Against Google”

But that’s not how the law—or the economics—works. This approach converts beneficial aspects of Google’s ad-tech business into anticompetitive defects, essentially arguing that successful competition and innovation create barriers to entry that merit correction through antitrust enforcement.

This approach turns U.S. antitrust law (and basic economics) on its head. As some of the most well-known words of U.S. antitrust jurisprudence have it:

A single producer may be the survivor out of a group of active competitors, merely by virtue of his superior skill, foresight and industry. In such cases a strong argument can be made that, although, the result may expose the public to the evils of monopoly, the Act does not mean to condemn the resultant of those very forces which it is its prime object to foster: finis opus coronat. The successful competitor, having been urged to compete, must not be turned upon when he wins.

– United States v. Aluminum Co. of America, 148 F.2d 416 (2d Cir. 1945)

U.S. antitrust law is intended to foster innovation that creates benefits for consumers, including innovation by incumbents. The law does not proscribe efficiency-enhancing unilateral conduct on the grounds that it might also inconvenience competitors, or that there is some other arrangement that could be “even more” competitive. Under U.S. antitrust law, firms are “under no duty to help [competitors] survive or expand.”  

To be sure, the allegations against Google are couched in terms of anticompetitive effect, rather than being described merely as commercial disagreements over the distribution of profits. But these effects are simply inferred, based on assumptions that Google’s vertically integrated business model entails an inherent ability and incentive to harm rivals.

The Texas complaint claims Google can surreptitiously derive benefits from display advertisers by leveraging its search-advertising capabilities, or by “withholding YouTube inventory,” rather than altruistically opening Google Search and YouTube up to rival ad networks. The complaint alleges Google uses its access to advertiser, publisher, and user data to improve its products without sharing this data with competitors.

All these charges may be true, but they do not describe inherently anticompetitive conduct. Under U.S. law, companies are not obliged to deal with rivals and certainly are not obliged to do so on those rivals’ preferred terms

As long ago as 1919, the U.S. Supreme Court held that:

In the absence of any purpose to create or maintain a monopoly, the [Sherman Act] does not restrict the long recognized right of [a] trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal.

– United States v. Colgate & Co.

U.S. antitrust law does not condemn conduct on the basis that an enforcer (or a court) is able to identify or hypothesize alternative conduct that might plausibly provide similar benefits at lower cost. In alleging that there are ostensibly “better” ways that Google could have pursued its product design, pricing, and terms of dealing, both the Texas complaint and Omidyar “roadmap” assert that, had the firm only selected a different path, an alternative could have produced even more benefits or an even more competitive structure.

The purported cure of tinkering with benefit-producing unilateral conduct by applying an “even more competition” benchmark is worse than the supposed disease. The adjudicator is likely to misapply such a benchmark, deterring the very conduct the law seeks to promote.

For example, Texas complaint alleges: “Google’s ad server passed inside information to Google’s exchange and permitted Google’s exchange to purchase valuable impressions at artificially depressed prices.” The Omidyar Network’s “roadmap” claims that “after purchasing DoubleClick, which became its publisher ad server, Google apparently lowered its prices to publishers by a factor of ten, at least according to one publisher’s account related to the CMA. Low prices for this service can force rivals to depart, thereby directly reducing competition.”

In contrast, as current U.S. Supreme Court Associate Justice Stephen Breyer once explained, in the context of above-cost low pricing, “the consequence of a mistake here is not simply to force a firm to forego legitimate business activity it wishes to pursue; rather, it is to penalize a procompetitive price cut, perhaps the most desirable activity (from an antitrust perspective) that can take place in a concentrated industry where prices typically exceed costs.”  That commentators or enforcers may be able to imagine alternative or theoretically more desirable conduct is beside the point.

It has been reported that the U.S. Justice Department (DOJ) may join the Texas suit or bring its own similar action against Google in the coming months. If it does, it should learn from the many misconceptions and errors in the Texas complaint that leave it on dubious legal and economic grounds.