Archives For intellectual property

Too much ink has been spilled in an attempt to gin up antitrust controversies regarding efforts by holders of “standard essential patents” (SEPs, patents covering technologies that are adopted as part of technical standards relied upon by manufacturers) to obtain reasonable returns to their property. Antitrust theories typically revolve around claims that SEP owners engage in monopolistic “hold-up” when they threaten injunctions or seek “excessive” royalties (or other “improperly onerous” terms) from potential licensees in patent licensing negotiations, in violation of pledges (sometimes imposed by standard-setting organizations) to license on “fair, reasonable, and non-discriminatory” (FRAND) terms. As Professors Joshua Wright and Douglas Ginsburg, among others, have explained, contract law, tort law, and patent law are far better placed to handle “FRAND-related” SEP disputes than antitrust law. Adding antitrust to the litigation mix generates unnecessary costs and inefficiently devalues legitimate private property rights.

Concerns by antitrust mavens that other areas of law are insufficient to cope adequately with SEP-FRAND disputes are misplaced. A fascinating draft law review article by Koren Wrong-Ervin, Director of the Scalia Law School’s Global Antitrust Institute, and Anne Layne-Farrar, Vice President of Charles River Associates, does an admirable job of summarizing key decisions by U.S. and foreign courts involved in determining FRAND rates in SEP litigation, and in highlighting key economic concepts underlying these holdings. As explained in the article’s abstract:

In the last several years, courts around the world, including in China, the European Union, India, and the United States, have ruled on appropriate methodologies for calculating either a reasonable royalty rate or reasonable royalty damages on standard-essential patents (SEPs) upon which a patent holder has made an assurance to license on fair, reasonable and nondiscriminatory (FRAND) terms. Included in these decisions are determinations about patent holdup, licensee holdout, the seeking of injunctive relief, royalty stacking, the incremental value rule, reliance on comparable licenses, the appropriate revenue base for royalty calculations, and the use of worldwide portfolio licensing. This article provides an economic and comparative analysis of the case law to date, including the landmark 2013 FRAND-royalty determination issued by the Shenzhen Intermediate People’s Court (and affirmed by the Guangdong Province High People’s Court) in Huawei v. InterDigital; numerous U.S. district court decisions; recent seminal decisions from the United States Court of Appeals for the Federal Circuit in Ericsson v. D-Link and CISCO v. CSIRO; the six recent decisions involving Ericsson issued by the Delhi High Court; the European Court of Justice decision in Huawei v. ZTE; and numerous post- Huawei v. ZTE decisions by European Union member states. While this article focuses on court decisions, discussions of the various agency decisions from around the world are also included throughout.   

To whet the reader’s appetite, key economic policy and factual “takeaways” from the article, which are reflected implicitly in a variety of U.S. and foreign judicial holdings, are as follows:

  • Holdup of any form requires lock-in, i.e., standard-implementing companies with asset-specific investments locked in to the technologies defining the standard or SEP holders locked in to licensing in the context of a standard because of standard-specific research and development (R&D) leading to standard-specific patented technologies.
  • Lock-in is a necessary condition for holdup, but it is not sufficient. For holdup in any guise to actually occur, there also must be an exploitative action taken by the relevant party once lock-in has happened. As a result, the mere fact that a license agreement was signed after a patent was included in a standard is not enough to establish that the patent holder is practicing holdup—there must also be evidence that the SEP holder took advantage of the licensee’s lock-in, for example by charging supra-FRAND royalties that it could not otherwise have charged but for the lock-in.
  • Despite coming after a particular standard is published, the vast majority of SEP licenses are concluded in arm’s length, bilateral negotiations with no allegations of holdup or opportunistic behavior. This follows because market mechanisms impose a number of constraints that militate against acting on the opportunity for holdup.
  • In order to support holdup claims, an expert must establish that the terms and conditions in an SEP licensing agreement generate payments that exceed the value conveyed by the patented technology to the licensor that signed the agreement.
  • The threat of seeking injunctive relief, on its own, cannot lead to holdup unless that threat is both credible and actionable. Indeed, the in terrorem effect of filing for an injunction depends on the likelihood of its being granted. Empirical evidence shows a significant decline in the number of injunctions sought as well as in the actual rate of injunctions granted in the United States following the Supreme Court’s 2006 decision in eBay v. MercExchange LLC, which ended the prior nearly automatic granting of injunctions to patentees and instead required courts to apply a traditional four-part equitable test for granting injunctive relief.
  • The Federal Circuit has recognized that an SEP holder’s ability to seek injunctive relief is an important safeguard to help prevent potential licensee holdout, whereby an SEP infringer unilaterally refuses a FRAND royalty or unreasonably delays negotiations to the same effect.
  • Related to the previous point, seeking an injunction against a licensee who is delaying or not negotiating in good faith need not actually result in an injunction. The fact that a court finds a licensee is holding out and/or not engaging in good faith licensing discussions can be enough to spur a license agreement as opposed to a permanent injunction.
  • FRAND rates should reflect the value of the SEPs at issue, so it makes no economic sense to estimate an aggregate rate for a standard by assuming that all SEP holders would charge the same rate as the one being challenged in the current lawsuit.
  • Moreover, as the U.S. Court of Appeals for the Federal Circuit has held, allegations of “royalty stacking” – the allegedly “excessive” aggregate burden of high licensing fees stemming from multiple patents that cover a single product – should be backed by case-specific evidence.
  • Most importantly, when a judicial FRAND assessment is focused on the value that the SEP portfolio at issue has contributed to the standard and products embodying the standard, the resulting rates and terms will necessarily avoid both patent holdup and royalty stacking.

In sum, the Wong-Ervin and Layne-Farrar article highlights economic insights that are reflected in the sounder judicial opinions dealing with the determination of FRAND royalties.  The article points the way toward methodologies that provide SEP holders sufficient returns on their intellectual property to reward innovation and maintain incentives to invest in technologies that enhance the value of standards.  Read it and learn.

R Street’s Sasha Moss recently posted a piece on TechDirt describing the alleged shortcomings of the Register of Copyrights Selection and Accountability Act of 2017 (RCSAA) — proposed legislative adjustments to the Copyright Office, recently passed in the House and introduced in the Senate last month (with identical language).

Many of the article’s points are well taken. Nevertheless, they don’t support the article’s call for the Senate to “jettison [the bill] entirely,” nor the assertion that “[a]s currently written, the bill serves no purpose, and Congress shouldn’t waste its time on it.”

R Street’s main complaint with the legislation is that it doesn’t include other proposals in a House Judiciary Committee whitepaper on Copyright Office modernization. But condemning the RCSAA simply for failing to incorporate all conceivable Copyright Office improvements fails to adequately take account of the political realities confronting Congress — in other words, it lets the perfect be the enemy of the good. It also undermines R Street’s own stated preference for Copyright Office modernization effected through “targeted and immediately implementable solutions.”

Everyone — even R Street — acknowledges that we need to modernize the Copyright office. But none of the arguments in favor of a theoretical, “better” bill is undermined or impeded by passing this bill first. While there is certainly more that Congress can do on this front, the RCSAA is a sensible, targeted piece of legislation that begins to build the new foundation for a twenty-first century Copyright Office.

Process over politics

The proposed bill is simple: It would make the Register of Copyrights a nominated and confirmed position. For reasons almost forgotten over the last century and a half, the head of the Copyright Office is currently selected at the sole discretion of the Librarian of Congress. The Copyright Office was placed in the Library merely as a way to grow the Library’s collection with copies of copyrighted works.

More than 100 years later, most everyone acknowledges that the Copyright Office has lagged behind the times. And many think the problem lies with the Office’s placement within the Library, which is plagued with information technology and other problems, and has a distinctly different mission than the Copyright Office. The only real question is what to do about it.

Separating the the Copyright Office from the Library is a straightforward and seemingly apolitical step toward modernization. And yet, somewhat inexplicably, R Street claims that the bill

amounts largely to a partisan battle over who will have the power to select the next Register: [Current Librarian of Congress] Hayden, who was appointed by Barack Obama, or President Donald Trump.

But this is a pretty farfetched characterization.

First, the House passed the bill 378-48, with 145 Democrats joining 233 Republicans in support. That’s more than three-quarters of the Democratic caucus.

Moreover, legislation to make the Register a nominated and confirmed position has been under discussion for more than four years — long before either Dr. Hayden was nominated or anyone knew that Donald Trump (or any Republican at all, for that matter) would be president.

R Street also claims that the legislation

will make the register and the Copyright Office more politicized and vulnerable to capture by special interests, [and that] the nomination process could delay modernization efforts [because of Trump’s] confirmation backlog.

But precisely the opposite seems far more likely — as Sasha herself has previously recognized:

Clarifying the office’s lines of authority does have the benefit of making it more politically accountable…. The [House] bill takes a positive step forward in promoting accountability.

As far as I’m aware, no one claims that Dr. Hayden was “politicized” or that Librarians are vulnerable to capture because they are nominated and confirmed. And a Senate confirmation process will be more transparent than unilateral appointment by the Librarian, and will give the electorate a (nominal) voice in the Register’s selection. Surely unilateral selection of the Register by the Librarian is more susceptible to undue influence.

With respect to the modernization process, we should also not forget that the Copyright Office currently has an Acting Register in Karyn Temple Claggett, who is perfectly capable of moving the modernization process forward. And any limits on her ability to do so would arise from the very tenuousness of her position that the RCSAA is intended to address.

Modernizing the Copyright Office one piece at a time

It’s certainly true, as the article notes, that the legislation doesn’t include a number of other sensible proposals for Copyright Office modernization. In particular, it points to ideas like forming a stakeholder advisory board, creating new chief economist and technologist positions, upgrading the Office’s information technology systems, and creating a small claims court.

To be sure, these could be beneficial reforms, as ICLE (and many others) have noted. But I would take some advice from R Street’s own “pragmatic approach” to promoting efficient government “with the full realization that progress on the ground tends to be made one inch at a time.”

R Street acknowledges that the legislation’s authors have indicated that this is but a beginning step and that they plan to tackle the other issues in due course. At a time when passage of any legislation on any topic is a challenge, it seems appropriate to defer to those in Congress who affirmatively want more modernization about how big a bill to start with.

In any event, it seems perfectly sensible to address the Register selection process before tackling the other issues, which may require more detailed discussions of policy and cost. And with the Copyright Office currently lacking a permanent Register and discussions underway about finding a new one, addressing any changes Congress deems necessary in the selection process seems like the most pressing issue, if they are to be resolved prior to the next pick being made.

Further, because the Register would presumably be deeply involved in the selection and operation of any new advisory board, chief economist and technologist, IT system, or small claims process, Congress can also be forgiven for wanting to address the Register issue first. Moreover, a Register who can be summarily dismissed by the Librarian likely doesn’t have the needed autonomy to fully and effectively implement the other proposals from the whitepaper. Why build a house on a shaky foundation when you can fix the foundation first?

Process over substance

All of which leaves the question why R Street opposes a bill that was passed by a bipartisan supermajority in the House; that effects precisely the kind of targeted, incremental reform that R Street promotes; and that implements a specific reform that R Street favors.

The legislation has widespread support beyond Congress, although the TechDirt piece gives this support short shrift. Instead, it notes that “some” in the content industry support the legislation, but lists only the Motion Picture Association of America. There is a subtle undercurrent of the typical substantive copyright debate, in which “enlightened” thinking on copyright is set against the presumptively malicious overreach of the movie studios. But the piece neglects to mention the support of more than 70 large and small content creators, technology companies, labor unions, and free market and civil rights groups, among others.

Sensible process reforms should be implementable without the rancor that plagues most substantive copyright debates. But it’s difficult to escape. Copyright minimalists are skeptical of an effectual Copyright Office if it is more likely to promote policies that reinforce robust copyright, even if they support sensible process reforms and more-accountable government in the abstract. And, to be fair, copyright proponents are thrilled when their substantive positions might be bolstered by promotion of sensible process reforms.

But the truth is that no one really knows how an independent and accountable Copyright Office will act with respect to contentious, substantive issues. Perhaps most likely, increased accountability via nomination and confirmation will introduce more variance in its positions. In other words, on substance, the best guess is that greater Copyright Office accountability and modernization will be a wash — leaving only process itself as a sensible basis on which to assess reform. And on that basis, there is really no reason to oppose this widely supported, incremental step toward a modern US Copyright Office.

Today the International Center for Law & Economics (ICLE) Antitrust and Consumer Protection Research Program released a new white paper by Geoffrey A. Manne and Allen Gibby entitled:

A Brief Assessment of the Procompetitive Effects of Organizational Restructuring in the Ag-Biotech Industry

Over the past two decades, rapid technological innovation has transformed the industrial organization of the ag-biotech industry. These developments have contributed to an impressive increase in crop yields, a dramatic reduction in chemical pesticide use, and a substantial increase in farm profitability.

One of the most striking characteristics of this organizational shift has been a steady increase in consolidation. The recent announcements of mergers between Dow and DuPont, ChemChina and Syngenta, and Bayer and Monsanto suggest that these trends are continuing in response to new market conditions and a marked uptick in scientific and technological advances.

Regulators and industry watchers are often concerned that increased consolidation will lead to reduced innovation, and a greater incentive and ability for the largest firms to foreclose competition and raise prices. But ICLE’s examination of the underlying competitive dynamics in the ag-biotech industry suggests that such concerns are likely unfounded.

In fact, R&D spending within the seeds and traits industry increased nearly 773% between 1995 and 2015 (from roughly $507 million to $4.4 billion), while the combined market share of the six largest companies in the segment increased by more than 550% (from about 10% to over 65%) during the same period.

Firms today are consolidating in order to innovate and remain competitive in an industry replete with new entrants and rapidly evolving technological and scientific developments.

According to ICLE’s analysis, critics have unduly focused on the potential harms from increased integration, without properly accounting for the potential procompetitive effects. Our brief white paper highlights these benefits and suggests that a more nuanced and restrained approach to enforcement is warranted.

Our analysis suggests that, as in past periods of consolidation, the industry is well positioned to see an increase in innovation as these new firms unite complementary expertise to pursue more efficient and effective research and development. They should also be better able to help finance, integrate, and coordinate development of the latest scientific and technological developments — particularly in rapidly growing, data-driven “digital farming” —  throughout the industry.

Download the paper here.

And for more on the topic, revisit TOTM’s recent blog symposium, “Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries,” here.

According to Cory Doctorow over at Boing Boing, Tim Wu has written an open letter to W3C Chairman Sir Timothy Berners-Lee, expressing concern about a proposal to include Encrypted Media Extensions (EME) as part of the W3C standards. W3C has a helpful description of EME:

Encrypted Media Extensions (EME) is currently a draft specification… [for] an Application Programming Interface (API) that enables Web applications to interact with content protection systems to allow playback of encrypted audio and video on the Web. The EME specification enables communication between Web browsers and digital rights management (DRM) agent software to allow HTML5 video play back of DRM-wrapped content such as streaming video services without third-party media plugins. This specification does not create nor impose a content protection or Digital Rights Management system. Rather, it defines a common API that may be used to discover, select and interact with such systems as well as with simpler content encryption systems.

Wu’s letter expresses his concern about hardwiring DRM into the technical standards supporting an open internet. He writes:

I wanted to write to you and respectfully ask you to seriously consider extending a protective covenant to legitimate circumventers who have cause to bypass EME, should it emerge as a W3C standard.

Wu asserts that this “protective covenant” is needed because, without it, EME will confer too much power on internet “chokepoints”:

The question is whether the W3C standard with an embedded DRM standard, EME, becomes a tool for suppressing competition in ways not expected…. Control of chokepoints has always and will always be a fundamental challenge facing the Internet as we both know… It is not hard to recall how close Microsoft came, in the late 1990s and early 2000s, to gaining de facto control over the future of the web (and, frankly, the future) in its effort to gain an unsupervised monopoly over the browser market.”

But conflating the Microsoft case with a relatively simple browser feature meant to enable all content providers to use any third-party DRM to secure their content — in other words, to enhance interoperability — is beyond the pale. If we take the Microsoft case as Wu would like, it was about one firm controlling, far and away, the largest share of desktop computing installations, a position that Wu and his fellow travelers believed gave Microsoft an unreasonable leg up in forcing usage of Internet Explorer to the exclusion of Netscape. With EME, the W3C is not maneuvering the standard so that a single DRM provider comes to protect all content on the web, or could even hope to do so. EME enables content distributors to stream content through browsers using their own DRM backend. There is simply nothing in that standard that enables a firm to dominate content distribution or control huge swaths of the Internet to the exclusion of competitors.

Unless, of course, you just don’t like DRM and you think that any technology that enables content producers to impose restrictions on consumption of media creates a “chokepoint.” But, again, this position is borderline nonsense. Such a “chokepoint” is no more restrictive than just going to Netflix’s app (or Hulu’s, or HBO’s, or Xfinity’s, or…) and relying on its technology. And while it is no more onerous than visiting Netflix’s app, it creates greater security on the open web such that copyright owners don’t need to resort to proprietary technologies and apps for distribution. And, more fundamentally, Wu’s position ignores the role that access and usage controls are playing in creating online markets through diversified product offerings

Wu appears to believe, or would have his readers believe, that W3C is considering the adoption of a mandatory standard that would modify core aspects of the network architecture, and that therefore presents novel challenges to the operation of the internet. But this is wrong in two key respects:

  1. Except in the extremely limited manner as described below by the W3C, the EME extension does not contain mandates, and is designed only to simplify the user experience in accessing content that would otherwise require plug-ins; and
  2. These extensions are already incorporated into the major browsers. And of course, most importantly for present purposes, the standard in no way defines or harmonizes the use of DRM.

The W3C has clearly and succinctly explained the operation of the proposed extension:

The W3C is not creating DRM policies and it is not requiring that HTML use DRM. Organizations choose whether or not to have DRM on their content. The EME API can facilitate communication between browsers and DRM providers but the only mandate is not DRM but a form of key encryption (Clear Key). EME allows a method of playback of encrypted content on the Web but W3C does not make the DRM technology nor require it. EME is an extension. It is not required for HTML nor HMTL5 video.

Like many internet commentators, Tim Wu fundamentally doesn’t like DRM, and his position here would appear to reflect his aversion to DRM rather than a response to the specific issues before the W3C. Interestingly, in arguing against DRM nearly a decade ago, Wu wrote:

Finally, a successful locking strategy also requires intense cooperation between many actors – if you protect a song with “superlock,” and my CD player doesn’t understand that, you’ve just created a dead product. (Emphasis added)

In other words, he understood the need for agreements in vertical distribution chains in order to properly implement protection schemes — integration that he opposes here (not to suggest that he supported them then, but only to highlight the disconnect between recognizing the need for coordination and simultaneously trying to prevent it).

Vint Cerf (himself no great fan of DRM — see here, for example) has offered a number of thoughtful responses to those, like Wu, who have objected to the proposed standard. Cerf writes on the ISOC listserv:

EMEi is plainly very general. It can be used to limit access to virtually any digital content, regardless of IPR status. But, in some sense, anyone wishing to restrict access to some service/content is free to do so (there are other means such as login access control, end/end encryption such as TLS or IPSEC or QUIC). EME is yet another method for doing that. Just because some content is public domain does not mean that every use of it must be unprotected, does it?

And later in the thread he writes:

Just because something is public domain does not mean someone can’t lock it up. Presumably there will be other sources that are not locked. I can lock up my copy of Gulliver’s Travels and deny you access except by some payment, but if it is public domain someone else may have a copy you can get. In any case, you can’t deny others the use of the content IF THEY HAVE IT. You don’t have to share your copy of public domain with anyone if you don’t want to.

Just so. It’s pretty hard to see the competition problems that could arise from facilitating more content providers making content available on the open web.

In short, Wu wants the W3C to develop limitations on rules when there are no relevant rules to modify. His dislike of DRM obscures his vision of the limited nature of the EME proposal which would largely track, rather than lead, the actions already being undertaken by the principal commercial actors on the internet, and which merely creates a structure for facilitating voluntary commercial transactions in ways that enhance the user experience.

The W3C process will not, as Wu intimates, introduce some pernicious, default protection system that would inadvertently lock down content; rather, it would encourage the development of digital markets on the open net rather than (or in addition to) through the proprietary, vertical markets where they are increasingly found today. Wu obscures reality rather than illuminating it through his poorly considered suggestion that EME will somehow lead to a new set of defaults that threaten core freedoms.

Finally, we can’t help but comment on Wu’s observation that

My larger point is that I think the history of the anti-circumvention laws suggests is (sic) hard to predict how [freedom would be affected]– no one quite predicted the inkjet market would be affected. But given the power of those laws, the potential for anti-competitive consequences certainly exists.

Let’s put aside the fact that W3C is not debating the laws surrounding circumvention, nor, as noted, developing usage rules. It remains troubling that Wu’s belief there are sometimes unintended consequences of actions (and therefore a potential for harm) would be sufficient to lead him to oppose a change to the status quo — as if any future, potential risk necessarily outweighs present, known harms. This is the Precautionary Principle on steroids. The EME proposal grew out of a desire to address impediments that prevent the viability and growth of online markets that sufficiently ameliorate the non-hypothetical harms of unauthorized uses. The EME proposal is a modest step towards addressing a known universe. A small step, but something to celebrate, not bemoan.

The Scalia Law School’s Global Antitrust Institute (GAI) has once again penned a trenchant law and economics-based critique of a foreign jurisdiction’s competition policy pronouncement.  On April 28, the GAI posted a comment (GAI Comment) in response to a “Communication from the [European] Commission (EC) on Standard Essential Patents (SEPs) for a European Digitalised Economy” (EC Communication).  The EC Communication centers on the regulation of SEPs, patents which cover standards that enable mobile wireless technologies (in particular, smartphones), in the context of the development and implementation of the 5th generation or “5G” broadband wireless standard.

The GAI Comment expresses two major concerns with the EC’s Communication.

  1. The Communication’s Ill-Considered Opposition to Competition in Standards Development

First, the Comment notes that the EC Communication appears to view variation in intellectual property rights (IPR) policies among standard-development organizations (SDOs) as a potential problem that may benefit from best practice recommendations.  The GAI Comment strongly urges the EC to reconsider this approach.  It argues that the EC instead should embrace the procompetitive benefits of variation among SDO policies, and avoid one-size fits all best practice recommendations that may interfere with or unduly influence choices regarding specific rules that best fit the needs of individual SDOs and their members.

  1. The Communication’s Failure to Address the Question of Market Imperfections

Second, the Comment points out that the EC Communication refers to the need for “better regulation,” without providing evidence of an identifiable market imperfection, which is a necessary but not sufficient basis for economic regulation.  The Comment stresses that the smartphone market, which is both standard and patent intensive, has experienced exponential output growth, falling market concentration, and a decrease in wireless service prices relative to the overall consumer price index.  These indicators, although not proof of causation, do suggest caution prior to potentially disrupting the carefully balanced fair, reasonable, and non-discriminatory (FRAND) ecosystem that has emerged organically.

With respect to the three specific areas identified in the Communication (i.e., best practice recommendations on (1) “increased transparency on SEP exposure,” including “more precision and rigour into the essentiality declaration system in particular for critical standards”; (2) boundaries of FRAND and core valuation principles; and (3) enforcement in areas such as mutual obligations in licensing negotiations before recourse to injunctive relief, portfolio licensing, and the role of alternative dispute resolution mechanisms), the Comment recommends that the EC broaden the scope of its consultation to elicit specific evidence of identifiable market imperfections.

The GAI Comment also points out that, in some cases, specific concerns mentioned in the Consultation seem to be contradicted by the EC’s own published research.  For example, with respect to the asserted problems arising from over-declaration of essential patents, the EC recently published research noting the lack of “any reliable evidence that licensing costs increase significantly if SEP owners over-declare,” and concluding “that, per se the negative impact of over-declaration is likely to be minimal.”  Even assuming there is an identifiable market imperfection in this area, it is important to consider that determining essentiality is a resource and time-intensive exercise and there are likely significant transaction-cost savings from the use of blanket declarations, which also serve to avoid liability for patent-ambush (i.e., deceptive failure to disclose essential patents during the standard-setting process).

  1. Concluding Thoughts

The GAI Comment implicitly highlights a flaw inherent in the EC’s efforts to promote high tech innovation in Europe through its “Digital Agenda,” characterized as a pillar of the Europe “2020 Strategy” that sets objectives for the growth of the European Union by 2020.  The EC’s strategy emphasizes government-centric “growth through regulatory oversight,” rather than reliance on untrammeled competition.  This emphasis is at odds with the fact that detailed regulatory oversight has been associated with sluggish economic growth within the European Union.  It also ignores the fact that some of the most dynamic, innovative industries in recent decades have been those enabled by the Internet, which until recently has largely avoided significant regulation.  The EC may want to rethink its approach, if it truly wants to generate the innovation and economic gains long-promised to its consumers and producers.

On Thursday, March 30, Friday March 31, and Monday April 3, Truth on the Market and the International Center for Law and Economics presented a blog symposium — Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries — discussing three proposed agricultural/biotech industry mergers awaiting judgment by antitrust authorities around the globe. These proposed mergers — Bayer/Monsanto, Dow/DuPont and ChemChina/Syngenta — present a host of fascinating issues, many of which go to the core of merger enforcement in innovative industries — and antitrust law and economics more broadly.

The big issue for the symposium participants was innovation (as it was for the European Commission, which cleared the Dow/DuPont merger last week, subject to conditions, one of which related to the firms’ R&D activities).

Critics of the mergers, as currently proposed, asserted that the increased concentration arising from the “Big 6” Ag-biotech firms consolidating into the Big 4 could reduce innovation competition by (1) eliminating parallel paths of research and development (Moss); (2) creating highly integrated technology/traits/seeds/chemicals platforms that erect barriers to new entry platforms (Moss); (3) exploiting eventual network effects that may result from the shift towards data-driven agriculture to block new entry in input markets (Lianos); or (4) increasing incentives to refuse to license, impose discriminatory restrictions in technology licensing agreements, or tacitly “agree” not to compete (Moss).

Rather than fixating on horizontal market share, proponents of the mergers argued that innovative industries are often marked by disruptions and that investment in innovation is an important signal of competition (Manne). An evaluation of the overall level of innovation should include not only the additional economies of scale and scope of the merged firms, but also advancements made by more nimble, less risk-averse biotech companies and smaller firms, whose innovations the larger firms can incentivize through licensing or M&A (Shepherd). In fact, increased efficiency created by economies of scale and scope can make funds available to source innovation outside of the large firms (Shepherd).

In addition, innovation analysis must also account for the intricately interwoven nature of agricultural technology across seeds and traits, crop protection, and, now, digital farming (Sykuta). Combined product portfolios generate more data to analyze, resulting in increased data-driven value for farmers and more efficiently targeted R&D resources (Sykuta).

While critics voiced concerns over such platforms erecting barriers to entry, markets are contestable to the extent that incumbents are incentivized to compete (Russell). It is worth noting that certain industries with high barriers to entry or exit, significant sunk costs, and significant costs disadvantages for new entrants (including automobiles, wireless service, and cable networks) have seen their prices decrease substantially relative to inflation over the last 20 years — even as concentration has increased (Russell). Not coincidentally, product innovation in these industries, as in ag-biotech, has been high.

Ultimately, assessing the likely effects of each merger using static measures of market structure is arguably unreliable or irrelevant in dynamic markets with high levels of innovation (Manne).

Regarding patents, critics were skeptical that combining the patent portfolios of the merging companies would offer benefits beyond those arising from cross-licensing, and would serve to raise rivals’ costs (Ghosh). While this may be true in some cases, IP rights are probabilistic, especially in dynamic markets, as Nicolas Petit noted:

There is no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change.

In spite of these uncertainties, deals such as the pending ag-biotech mergers provide managers the opportunity to evaluate and reorganize assets to maximize innovation and return on investment in such a way that would not be possible absent a merger (Sykuta). Neither party would fully place its IP and innovation pipeline on the table otherwise.

For a complete rundown of the arguments both for and against, the full archive of symposium posts from our outstanding and diverse group of scholars, practitioners and other experts is available at this link, and individual posts can be easily accessed by clicking on the authors’ names below.

We’d like to thank all of the participants for their excellent contributions!

Nicolas Petit is Professor of Law at the University of Liege (Belgium) and Research Professor at the University of South Australia (UniSA)

This symposium offers a good opportunity to look again into the complex relation between concentration and innovation in antitrust policy. Whilst the details of the EC decision in Dow/Dupont remain unknown, the press release suggests that the issue of “incentives to innovate” was central to the review. Contrary to what had leaked in the antitrust press, the decision has apparently backed off from the introduction of a new “model”, and instead followed a more cautious approach. After a quick reminder of the conventional “appropriability v cannibalizationframework that drives merger analysis in innovation markets (1), I make two sets of hopefully innovative remarks on appropriability and IP rights (2) and on cannibalization in the ag-biotech sector (3).

Appropriability versus cannibalization

Antitrust economics 101 teach that mergers affect innovation incentives in two polar ways. A merger may increase innovation incentives. This occurs when the increment in power over price or output achieved through merger enhances the appropriability of the social returns to R&D. The appropriability effect of mergers is often tied to Joseph Schumpeter, who observed that the use of “protecting devices” for past investments like patent protection or trade secrecy constituted a “normal elemen[t] of rational management”. The appropriability effect can in principle be observed at firm – specific incentives – and industry – general incentives – levels, because actual or potential competitors can also use the M&A market to appropriate the payoffs of R&D investments.

But a merger may decrease innovation incentives. This happens when the increased industry position achieved through merger discourages the introduction of new products, processes or services. This is because an invention will cannibalize the merged entity profits in proportions larger as would be the case in a more competitive market structure. This idea is often tied to Kenneth Arrow who famously observed that a “preinvention monopoly power acts as a strong disincentive to further innovation”.

Schumpeter’s appropriability hypothesis and Arrow’s cannibalization theory continue to drive much of the discussion on concentration and innovation in antitrust economics. True, many efforts have been made to overcome, reconcile or bypass both views of the world. Recent studies by Carl Shapiro or Jon Baker are worth mentioning. But Schumpeter and Arrow remain sticky references in any discussion of the issue. Perhaps more than anything, the persistence of their ideas denotes that both touched a bottom point when they made their seminal contribution, laying down two systems of belief on the workings of innovation-driven markets.

Now beyond the theory, the appropriability v cannibalization gravitational models provide from the outset an appealing framework for the examination of mergers in R&D driven industries in general. From an operational perspective, the antitrust agency will attempt to understand if the transaction increases appropriability – which leans in favour of clearance – or cannibalization – which leans in favour of remediation. At the same time, however, the downside of the appropriability v cannibalization framework (and of any framework more generally) may be to oversimplify our understanding of complex phenomena. This, in turn, prompts two important observations on each branch of the framework.

Appropriability and IP rights

Any antitrust agency committed to promoting competition and innovation should consider mergers in light of the degree of appropriability afforded by existing protecting devices (essentially contracts and entitlements). This is where Intellectual Property (“IP”) rights become relevant to the discussion. In an industry with strong IP rights, the merging parties (and its rivals) may be able to appropriate the social returns to R&D without further corporate concentration. Put differently, the stronger the IP rights, the lower the incremental contribution of a merger transaction to innovation, and the higher the case for remediation.

This latter proposition, however, rests on a heavy assumption: that IP rights confer perfect appropriability. The point is, however, far from obvious. Most of us know that – and our antitrust agencies’ misgivings with other sectors confirm it – IP rights are probabilistic in nature. There is (i) no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change. Arrow himself called for caution, noting that “Patent laws would have to be unimaginably complex and subtle to permit [such] appropriation on a large scale”. A thorough inquiry into the specific industry-strength of IP rights that goes beyond patent data and statistics thus constitutes a necessary step in merger review.

But it is not a sufficient one. The proposition that strong IP rights provide appropriability is essentially valid if the observed pre-merger market situation is one where several IP owners compete on differentiated products and as a result wield a degree of market power. In contrast, the proposition is essentially invalid if the observed pre-merger market situation leans more towards the competitive equilibrium and IP owners compete at prices closer to costs. In both variants, the agency should thus look carefully at the level and evolution of prices and costs, including R&D ones, in the pre-merger industry. Moreover, in the second variant, the agency ought to consider as a favourable appropriability factor any increase of the merging entity’s power over price, but also any improvement of its power over cost. By this, I have in mind efficiency benefits, which can arise as the result of economies of scale (in manufacturing but also in R&D), but also when the transaction combines complementary technological and marketing assets. In Dow/Dupont, no efficiency argument has apparently been made by the parties, so it is difficult to understand if and how such issues have played a role in the Commission’s assessment.

Cannibalization, technological change, and drastic innovation

Arrow’s cannibalization theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fails to capture that successful inventions create new technology frontiers, and with them entirely novel needs that even a monopolist has an incentive to serve. This can be understood with an example taken from the ag-biotech field. It is undisputed that progress in crop protection science has led to an expanding range of resistant insects, weeds, and pathogens. This, in turn, is one (if not the main) key drivers of ag-tech research. In a 2017 paper published in Pest Management Science, Sparks and Lorsbach observe that:

resistance to agrochemicals is an ongoing driver for the development of new chemical control options, along with an increased emphasis on resistance management and how these new tools can fit into resistance management programs. Because resistance is such a key driver for the development of new agrochemicals, a highly prized attribute for a new agrochemical is a new MoA [method of action] that is ideally a new molecular target either in an existing target site (e.g., an unexploited binding site in the voltage-gated sodium channel), or new/under-utilized target site such as calcium channels.

This, and other factors, leads them to conclude that:

even with fewer companies overall involved in agrochemical discovery, innovation continues, as demonstrated by the continued introduction of new classes of agrochemicals with new MoAs.

Sparks, Hahn, and Garizi make a similar point. They stress in particular that the discovery of natural products (NPs) which are the “output of nature’s chemical laboratory” is today a main driver of crop protection research. According to them:

NPs provide very significant value in identifying new MoAs, with 60% of all agrochemical MoAs being, or could have been, defined by a NP. This information again points to the importance of NPs in agrochemical discovery, since new MoAs remain a top priority for new agrochemicals.

More generally, the point is not that Arrow’s cannibalization theory is wrong. Arrow’s work convincingly explains monopolists’ low incentives to invest in substitute invention. Instead, the point is that Arrow’s cannibalization theory is narrower than often assumed in the antitrust policy literature. Admittedly, Arrow’s cannibalization theory is relevant in industries primarily driven by a process of cumulative innovation. But it is much less helpful to understand the incentives of a monopolist in industries subject to technological change. As a result of this, the first question that should guide an antitrust agency investigation is empirical in nature: is the industry under consideration one driven by cumulative innovation, or one where technology disruption, shocks, and serendipity incentivize drastic innovation?

Note that exogenous factors beyond technological frontiers also promote drastic innovation. This point ought not to be overlooked. A sizeable amount of the specialist scientific literature stresses the powerful innovation incentives created by changing dietary habits, new diseases (e.g. the Zika virus), global population growth, and environmental challenges like climate change and weather extremes. In 2015, Jeschke noted:

In spite of the significant consolidation of the agrochemical companies, modern agricultural chemistry is vital and will have the opportunity to shape the future of agriculture by continuing to deliver further innovative integrated solutions. 

Words of wisdom caution for antitrust agencies tasked with the complex mission of reviewing mergers in the ag-biotech industry?

Shubha Ghosh is Crandall Melvin Professor of Law and Director of the Technology Commercialization Law Program at Syracuse University College of Law

How should patents be taken into consideration in merger analysis? When does the combining of patent portfolios lead to anticompetitive concerns? Two principles should guide these inquiries. First, as the Supreme Court held in its 2006 decision Independent Ink, ownership of a patent does not confer market power. This ruling came in the context of a tying claim, but it is generalizable. While ownership of a patent can provide advantages in the market, such as access to techniques that are more effective than what is available to a competitor or the ability to keep competitors from making desirable differentiations in existing products, ownership of a patent or patent portfolio does not per se confer market power. Competitors might have equally strong and broad patent portfolios. The power to limit price competition is possibly counterweighted by competition over technology and product quality.

A second principle about patents and markets, however, bespeaks more caution in antitrust analysis. Patents can create information problems while at the same time potentially resolving some externality problems arising from knowledge spillovers. Information problems arise because patents are not well-defined property rights with clear boundaries. While patents are granted to novel, nonobvious, useful, and concrete inventions (as opposed to abstract, disembodied ideas), it is far from clear when a patented invention is actually nonobvious. Patent rights extend to several possible embodiments of a novel, useful, and nonobvious conception. While in theory this problem could be solved by limiting patent rights to narrow embodiments, the net result would be increased uncertainty through patent thickets and divided ownership. Inventions do not come in readily discernible units or engineered metes and bounds (despite the rhetoric).

The information problems created by patents do not create traditional market power in the sense of having some control over the price charged to consumers, but they do impose costs on competitors that can give a patent owner some control over market entry and the market conditions confronting consumers. The Court’s perhaps sanguine decoupling of patents and market power in its 2006 decision has some valence in a market setting where patent rights are somewhat equally distributed among competitors. In such a setting, each firm faces the same uncertainties that arise from patents. However, if patent ownership is imbalanced among firms, competition authorities need to act with caution. The challenge is identifying an unbalanced patent position in the marketplace.

Mergers among patent-owning firms invite antitrust scrutiny for these reasons. Metrics of patent ownership focusing solely on the quantity of patents owned, adjusting for the number of claims, can offer a snapshot of ownership distribution. But patent numbers need to be connected to the costs of operating the firm. Patents can lower a firm’s costs, create a niche for a particular differentiated product, and give a firm a head start in the next generation of technologies. Mergers that lead to an increased concentration of patent ownership may raise eyebrows, but those that lead to significant increase in costs to competitors and create potential impediments to market entry require a response from competition authorities. This response could be a blocking of the merger or perhaps more practically, in most instances, a divestment of the patent portfolio through requirements of licensing. This last approach is particularly appropriate where the technologies at issue are analogous to standard essential patents in the standard setting with FRAND context.

Claims of synergies should, in many instances, be met with skepticism when the patent portfolios of the merging companies are combined. While the technologies may be complementary, yielding benefits that go beyond those arising from a cross-licensing arrangement, the integration of portfolios may serve to raise costs for potential rivals in the marketplace. These barriers to entry may arise even in the case of vertical integration when the firms internalize contracting costs for technology transfer through ownership. Vertical integration of patent portfolios may raise costs for rivals both at the manufacturing and the distribution levels.

These ideas are set forth as propositions to be tested, but also general policy guidance for merger review involving companies with substantial patent portfolios. The ChemChina-Syngenta merger perhaps opens up global markets, but may likely impose barriers for companies in the agriculture market. The Bayer-Monsanto and Dow-DuPont mergers have questionable synergies. Even if potential synergies, these projected benefits need to be weighed against the very identifiable sources for market foreclosure. While patents may not create market power per se, according to the Supreme Court, the potential for mischief should not be underestimated.

Truth on the Market is pleased to announce its next blog symposium:

Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries

March 30 & 31, 2017

Earlier this week the European Commission cleared the merger of Dow and DuPont, subject to conditions including divestiture of DuPont’s “global R&D organisation.” As the Commission noted:

The Commission had concerns that the merger as notified would have reduced competition on price and choice in a number of markets for existing pesticides. Furthermore, the merger would have reduced innovation. Innovation, both to improve existing products and to develop new active ingredients, is a key element of competition between companies in the pest control industry, where only five players are globally active throughout the entire research & development (R&D) process.

In addition to the traditional focus on price effects, the merger’s presumed effect on innovation loomed large in the EC’s consideration of the Dow/DuPont merger — as it is sure to in its consideration of the other two pending mergers in the agricultural biotech and chemicals industries between Bayer and Monsanto and ChemChina and Syngenta. Innovation effects are sure to take center stage in the US reviews of the mergers, as well.

What is less clear is exactly how antitrust agencies evaluate — and how they should evaluate — mergers like these in rapidly evolving, high-tech industries.

These proposed mergers present a host of fascinating and important issues, many of which go to the core of modern merger enforcement — and antitrust law and economics more generally. Among other things, they raise issues of:

  • The incorporation of innovation effects in antitrust analysis;
  • The relationship between technological and organizational change;
  • The role of non-economic considerations in merger review;
  • The continued relevance (or irrelevance) of the Structure-Conduct-Performance paradigm;
  • Market definition in high-tech markets; and
  • The patent-antitrust interface

Beginning on March 30, Truth on the Market and the International Center for Law & Economics will host a blog symposium discussing how some of these issues apply to these mergers per se, as well as the state of antitrust law and economics in innovative-industry mergers more broadly.

As in the past (see examples of previous TOTM blog symposia here), we’ve lined up an outstanding and diverse group of scholars to discuss these issues:

  • Allen Gibby, Senior Fellow for Law & Economics, International Center for Law & Economics
  • Shubha Ghosh, Crandall Melvin Professor of Law and Director of the Technology Commercialization Law Program, Syracuse University College of Law
  • Ioannis Lianos,  Chair of Global Competition Law and Public Policy, Faculty of Laws, University College London
  • John E. Lopatka (tent.), A. Robert Noll Distinguished Professor of Law, Penn State Law
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Diana L. Moss, President, American Antitrust Institute
  • Nicolas Petit, Professor of Law, Faculty of Law, and Co-director, Liege Competition and Innovation Institute, University of Liege
  • Levi A. Russell, Assistant Professor, Agricultural & Applied Economics, University of Georgia
  • Joanna M. Shepherd, Professor of Law, Emory University School of Law
  • Michael Sykuta, Associate Professor, Agricultural and Applied Economics, and Director, Contracting Organizations Research Institute, University of Missouri

Initial contributions to the symposium will appear periodically on the 30th and 31st, and the discussion will continue with responsive posts (if any) next week. We hope to generate a lively discussion, and readers are invited to contribute their own thoughts in comments to the participants’ posts.

The symposium posts will be collected here.

We hope you’ll join us!

What does it mean to “own” something? A simple question (with a complicated answer, of course) that, astonishingly, goes unasked in a recent article in the Pennsylvania Law Review entitled, What We Buy When We “Buy Now,” by Aaron Perzanowski and Chris Hoofnagle (hereafter “P&H”). But how can we reasonably answer the question they pose without first trying to understand the nature of property interests?

P&H set forth a simplistic thesis for their piece: when an e-commerce site uses the term “buy” to indicate the purchase of digital media (instead of the term “license”), it deceives consumers. This is so, the authors assert, because the common usage of the term “buy” indicates that there will be some conveyance of property that necessarily includes absolute rights such as alienability, descendibility, and excludability, and digital content doesn’t generally come with these attributes. The authors seek to establish this deception through a poorly constructed survey regarding consumers’ understanding of the parameters of their property interests in digitally acquired copies. (The survey’s considerable limitations is a topic for another day….)

The issue is more than merely academic: NTIA and the USPTO have just announced that they will hold a public meeting

to discuss how best to communicate to consumers regarding license terms and restrictions in connection with online transactions involving copyrighted works… [as a precursor to] the creation of a multistakeholder process to establish best practices to improve consumers’ understanding of license terms and restrictions in connection with online transactions involving creative works.

Whatever the results of that process, it should not begin, or end, with P&H’s problematic approach.

Getting to their conclusion that platforms are engaged in deceptive practices requires two leaps of faith: First, that property interests are absolute and that any restraint on the use of “property” is inconsistent with the notion of ownership; and second, that consumers’ stated expectations (even assuming that they were measured correctly) alone determine the appropriate contours of legal (and economic) property interests. Both leaps are meritless.

Property and ownership are not absolute concepts

P&H are in such a rush to condemn downstream restrictions on the alienability of digital copies that they fail to recognize that “property” and “ownership” are not absolute terms, and are capable of being properly understood only contextually. Our very notions of what objects may be capable of ownership change over time, along with the scope of authority over owned objects. For P&H, the fact that there are restrictions on the use of an object means that it is not properly “owned.” But that overlooks our everyday understanding of the nature of property.

Ownership is far more complex than P&H allow, and ownership limited by certain constraints is still ownership. As Armen Alchian and Harold Demsetz note in The Property Right Paradigm (1973):

In common speech, we frequently speak of someone owning this land, that house, or these bonds. This conversational style undoubtedly is economical from the viewpoint of quick communication, but it masks the variety and complexity of the ownership relationship. What is owned are rights to use resources, including one’s body and mind, and these rights are always circumscribed, often by the prohibition of certain actions. To “own land” usually means to have the right to till (or not to till) the soil, to mine the soil, to offer those rights for sale, etc., but not to have the right to throw soil at a passerby, to use it to change the course of a stream, or to force someone to buy it. What are owned are socially recognized rights of action. (Emphasis added).

Literally, everything we own comes with a range of limitations on our use rights. Literally. Everything. So starting from a position that limitations on use mean something is not, in fact, owned, is absurd.

Moreover, in defining what we buy when we buy digital goods by reference to analog goods, P&H are comparing apples and oranges, without acknowledging that both apples and oranges are bought.

There has been a fair amount of discussion about the nature of digital content transactions (including by the USPTO and NTIA), and whether they are analogous to traditional sales of objects or more properly characterized as licenses. But this is largely a distinction without a difference, and the nature of the transaction is unnecessary in understanding that P&H’s assertion of deception is unwarranted.

Quite simply, we are accustomed to buying licenses as well as products. Whenever we buy a ticket — e.g., an airline ticket or a ticket to the movies — we are buying the right to use something or gain some temporary privilege. These transactions are governed by the terms of the license. But we certainly buy tickets, no? Alchian and Demsetz again:

The domain of demarcated uses of a resource can be partitioned among several people. More than one party can claim some ownership interest in the same resource. One party may own the right to till the land, while another, perhaps the state, may own an easement to traverse or otherwise use the land for specific purposes. It is not the resource itself which is owned; it is a bundle, or a portion, of rights to use a resource that is owned. In its original meaning, property referred solely to a right, title, or interest, and resources could not be identified as property any more than they could be identified as right, title, or interest. (Emphasis added).

P&H essentially assert that restrictions on the use of property are so inconsistent with the notion of property that it would be deceptive to describe the acquisition transaction as a purchase. But such a claim completely overlooks the fact that there are restrictions on any use of property in general, and on ownership of copies of copyright-protected materials in particular.

Take analog copies of copyright-protected works. While the lawful owner of a copy is able to lend that copy to a friend, sell it, or even use it as a hammer or paperweight, he or she can not offer it for rental (for certain kinds of works), cannot reproduce it, may not publicly perform or broadcast it, and may not use it to bludgeon a neighbor. In short, there are all kinds of restrictions on the use of said object — yet P&H have little problem with defining the relationship of person to object as “ownership.”

Consumers’ understanding of all the terms of exchange is a poor metric for determining the nature of property interests

P&H make much of the assertion that most users don’t “know” the precise terms that govern the allocation of rights in digital copies; this is the source of the “deception” they assert. But there is a cost to marking out the precise terms of use with perfect specificity (no contract specifies every eventuality), a cost to knowing the terms perfectly, and a cost to caring about them.

When we buy digital goods, we probably care a great deal about a few terms. For a digital music file, for example, we care first and foremost about whether it will play on our device(s). Other terms are of diminishing importance. Users certainly care whether they can play a song when offline, for example, but whether their children will be able to play it after they die? Not so much. That eventuality may, in fact, be specified in the license, but the nature of this particular ownership relationship includes a degree of rational ignorance on the users’ part: The typical consumer simply doesn’t care. In other words, she is, in Nobel-winning economist Herbert Simon’s term, “boundedly rational.” That isn’t deception; it’s a feature of life without which we would be overwhelmed by “information overload” and unable to operate. We have every incentive and ability to know the terms we care most about, and to ignore the ones about which we care little.

Relatedly, P&H also fail to understand the relationship between price and ownership. A digital song that is purchased from Amazon for $.99 comes with a set of potentially valuable attributes. For example:

  • It may be purchased on its own, without the other contents of an album;
  • It never degrades in quality, and it’s extremely difficult to misplace;
  • It may be purchased from one’s living room and be instantaneously available;
  • It can be easily copied or transferred onto multiple devices; and
  • It can be stored in Amazon’s cloud without taking up any of the consumer’s physical memory resources.

In many ways that matter to consumers, digital copies are superior to analog or physical ones. And yet, compared to physical media, on a per-song basis (assuming one could even purchase a physical copy of a single song without purchasing an entire album), $.99 may represent a considerable discount. Moreover, in 1982 when CDs were first released, they cost an average of $15. In 2017 dollars, that would be $38. Yet today most digital album downloads can be found for $10 or less.

Of course, songs purchased on CD or vinyl offer other benefits that a digital copy can’t provide. But the main thing — the ability to listen to the music — is approximately equal, and yet the digital copy offers greater convenience at (often) lower price. It is impossible to conclude that a consumer is duped by such a purchase, even if it doesn’t come with the ability to resell the song.

In fact, given the price-to-value ratio, it is perhaps reasonable to think that consumers know full well (or at least suspect) that there might be some corresponding limitations on use — the inability to resell, for example — that would explain the discount. For some people, those limitations might matter, and those people, presumably, figure out whether such limitations are present before buying a digital album or song For everyone else, however, the ability to buy a digital song for $.99 — including all of the benefits of digital ownership, but minus the ability to resell — is a good deal, just as it is worth it to a home buyer to purchase a house, regardless of whether it is subject to various easements.

Consumers are, in fact, familiar with “buying” property with all sorts of restrictions

The inability to resell digital goods looms inordinately large for P&H: According to them, by virtue of the fact that digital copies may not be resold, “ownership” is no longer an appropriate characterization of the relationship between the consumer and her digital copy. P&H believe that digital copies of works are sufficiently similar to analog versions, that traditional doctrines of exhaustion (which would permit a lawful owner of a copy of a work to dispose of that copy as he or she deems appropriate) should apply equally to digital copies, and thus that the inability to alienate the copy as the consumer wants means that there is no ownership interest per se.

But, as discussed above, even ownership of a physical copy doesn’t convey to the purchaser the right to make or allow any use of that copy. So why should we treat the ability to alienate a copy as the determining factor in whether it is appropriate to refer to the acquisition as a purchase? P&H arrive at this conclusion only through the illogical assertion that

Consumers operate in the marketplace based on their prior experience. We suggest that consumers’ “default” behavior is based on the experiences of buying physical media, and the assumptions from that context have carried over into the digital domain.

P&H want us to believe that consumers can’t distinguish between the physical and virtual worlds, and that their ability to use media doesn’t differentiate between these realms. But consumers do understand (to the extent that they care) that they are buying a different product, with different attributes. Does anyone try to play a vinyl record on his or her phone? There are perceived advantages and disadvantages to different kinds of media purchases. The ability to resell is only one of these — and for many (most?) consumers not likely the most important.

And, furthermore, the notion that consumers better understood their rights — and the limitations on ownership — in the physical world and that they carried these well-informed expectations into the digital realm is fantasy. Are we to believe that the consumers of yore understood that when they bought a physical record they could sell it, but not rent it out? That if they played that record in a public place they would need to pay performance royalties to the songwriter and publisher? Not likely.

Simply put, there is a wide variety of goods and services that we clearly buy, but that have all kinds of attributes that do not fit P&H’s crabbed definition of ownership. For example:

  • We buy tickets to events and membership in clubs (which, depending upon club rules, may not be alienated, and which always lapse for non-payment).
  • We buy houses notwithstanding the fact that in most cases all we own is the right to inhabit the premises for as long as we pay the bank (which actually retains more of the incidents of “ownership”).
  • In fact, we buy real property encumbered by a series of restrictive covenants: Depending upon where we live, we may not be able to build above a certain height, we may not paint the house certain colors, we may not be able to leave certain objects in the driveway, and we may not be able to resell without approval of a board.

We may or may not know (or care) about all of the restrictions on our use of such property. But surely we may accurately say that we bought the property and that we “own” it, nonetheless.

The reality is that we are comfortable with the notion of buying any number of limited property interests — including the purchasing of a license — regardless of the contours of the purchase agreement. The fact that some ownership interests may properly be understood as licenses rather than as some form of exclusive and permanent dominion doesn’t suggest that a consumer is not involved in a transaction properly characterized as a sale, or that a consumer is somehow deceived when the transaction is characterized as a sale — and P&H are surely aware of this.

Conclusion: The real issue for P&H is “digital first sale,” not deception

At root, P&H are not truly concerned about consumer deception; they are concerned about what they view as unreasonable constraints on the “rights” of consumers imposed by copyright law in the digital realm. Resale looms so large in their analysis not because consumers care about it (or are deceived about it), but because the real object of their enmity is the lack of a “digital first sale doctrine” that exactly mirrors the law regarding physical goods.

But Congress has already determined that there are sufficient distinctions between ownership of digital copies and ownership of analog ones to justify treating them differently, notwithstanding ownership of the particular copy. And for good reason: Trade in “used” digital copies is not a secondary market. Such copies are identical to those traded in the primary market and would compete directly with “pristine” digital copies. It makes perfect sense to treat ownership differently in these cases — and still to say that both digital and analog copies are “bought” and “owned.”

P&H’s deep-seated opposition to current law colors and infects their analysis — and, arguably, their failure to be upfront about it is the real deception. When one starts an analysis with an already-identified conclusion, the path from hypothesis to result is unlikely to withstand scrutiny, and that is certainly the case here.