Search Results For Leegin

With the passing of Justice Ruth Bader Ginsburg, many have already noted her impact on the law as an advocate for gender equality and women’s rights, her importance as a role model for women, and her civility. Indeed, a key piece of her legacy is that she was a jurist in the classic sense of the word: she believed in using coherent legal reasoning to reach a result. And that meant Justice Ginsburg’s decisions sometimes cut against partisan political expectations. 

This is clearly demonstrated in our little corner of the law: RBG frequently voted in the majority on antitrust cases in a manner that—to populist leftwing observers—would be surprising. Moreover, she authored an important case on price discrimination that likewise cuts against the expectation of populist antitrust critics and demonstrates her nuanced jurisprudence.

RBG’s record on the Court shows a respect for the evolving nature of antitrust law

In the absence of written opinions of her own, it is difficult to discern what was actually in Justice Ginsburg’s mind as she encountered antitrust issues. But, her voting record represents at least a willingness to approach antitrust in an apolitical manner. 

Over the last several decades, Justice Ginsburg joined the Supreme Court majority in many cases dealing with a wide variety of antitrust issues, including the duty to deal doctrine, vertical restraints, joint ventures, and mergers. In many of these cases, RBG aligned herself with judgments of the type that the antitrust populists criticize.

The following are major consumer welfare standard cases that helped shape the current state of antitrust law in which she joined the majority or issued a concurrence: 

  • Verizon Commc’ns Inc. v. Law Offices of Curtis Trinko, LLP, 540 U.S. 398 (2004) (unanimous opinion heightening the standard for finding a duty to deal)
  • Pacific Bell Tel. Co v. linkLine Commc’ns, Inc.,  555 U.S. 438 (2009) (Justice Ginsburg joined the concurrence finding there was no “price squeeze” but suggesting the predatory pricing claim should be remanded)
  • Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co., Inc., 549 U.S. 312 (2007) (unanimous opinion finding predatory buying claims are still subject to the dangerous probability of recoupment test from Brooke Group)
  • Apple, Inc. v. Robert Pepper, 139 S.Ct. 1514 (2019) (part of majority written by Justice Kavanaugh finding that iPhone owners were direct purchasers under Illinois Brick that may sue Apple for alleged monopolization)
  • State Oil Co. v. Khan, 522 U.S. 3 (1997) (unanimous opinion overturning per se treatment of vertical maximum price fixing under Albrecht and applying rule of reason standard)
  • Texaco Inc. v. Dagher, 547 U.S. 1 (2006) (unanimous opinion finding it is not per se illegal under §1 of the Sherman Act for a lawful, economically integrated joint venture to set the prices at which it sells its products)
  • Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006) (unanimous opinion finding a patent does not necessarily confer market power upon the patentee, in all cases involving a tying arrangement, the plaintiff must prove that the defendant has market power in the tying product)
  • U.S. v. Baker Hughes, Inc., 908 F. 2d 981 (D.C. Cir. 1990) (unanimous opinion written by then-Judge Clarence Thomas while both were on the D.C. Circuit of Appeals finding against the government’s argument that the defendant in a Section 7 merger challenge can rebut a prima facie case only by a clear showing that entry into the market by competitors would be quick and effective)

Even where she joined the dissent in antitrust cases, she did so within the ambit of the consumer welfare standard. Thus, while she was part of the dissent in cases like Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877 (2007), Bell Atlantic Corp v. Twombly, 550 U.S. 544 (2007), and Ohio v. American Express Co., 138 S.Ct. 2274 (2018), she still left a legacy of supporting modern antitrust jurisprudence. In those cases, RBG simply  had a different vision for how best to optimize consumer welfare. 

Justice Ginsburg’s Volvo Opinion

The 2006 decision Volvo Trucks North America, Inc. v. Reeder-Simco GMC, Inc. was one of the few antitrust decisions authored by RBG and shows her appreciation for the consumer welfare standard. In particular, Justice Ginsburg affirmed the notion that antitrust law is designed to protect competition not competitors—a lesson that, as of late, needs to be refreshed. 

Volvo, a 7-2 decision, dealt with the Robinson-Patman Act’s prohibition on price discimination. Reeder-Simco, a retail car dealer that sold Volvos, alleged that Volvo Inc. was violating the Robinson-Patman Act by selling cars to them at different prices than to other Volvo dealers.

The Robinson-Patman Act is frequently cited by antitrust populists as a way to return antitrust law to its former glory. A main argument of Lina Khan’s Amazon’s Antitrust Paradox was that the Chicago School had distorted the law on vertical restraints generally, and price discrimination in particular. One source of this distortion in Khan’s opinion has been the Supreme Court’s mishandling of the Robinson-Patman Act.

Yet, in Volvo we see Justice Ginsburg wrestling with the Robinson-Patman Act in a way to give effect to the law as written, which may run counter to some of the contemporary populist impulse to revise the Court’s interpretation of antitrust laws. Justice Ginsburg, citing Brown & Williamson, first noted that: 

Mindful of the purposes of the Act and of the antitrust laws generally, we have explained that Robinson-Patman does not “ban all price differences charged to different purchasers of commodities of like grade and quality.”

Instead, the Robinson-Patman Act was aimed at a particular class of harms that Congress believed existed when large chain-stores were able to exert something like monopsony buying power. Moreover, Justice Ginsburg noted, the Act “proscribes ‘price discrimination only to the extent that it threatens to injure competition’[.]”

Under the Act, plaintiffs needed to demonstrate evidence of Volvo Inc. systematically treating plaintiffs as “disfavored” purchasers as against another set of “favored” purchasers. Instead, all plaintiffs could produce was anecdotal and inconsistent evidence of Volvo Inc. disfavoring them. Thus, the plaintiffs— and theoretically other similarly situated Volvo dealers— were in fact harmed in a sense by Volvo Inc. Yet, Justice Ginsburg was unwilling to rewrite the Act on Congress’s behalf to incorporate new harms later discovered (a fact which would not earn her accolades in populist circles these days). 

Instead, Justice Ginsburg wrote that:

Interbrand competition, our opinions affirm, is the “primary concern of antitrust law.”… The Robinson-Patman Act signals no large departure from that main concern. Even if the Act’s text could be construed in the manner urged by [plaintiffs], we would resist interpretation geared more to the protection of existing competitors than to the stimulation of competition. In the case before us, there is no evidence that any favored purchaser possesses market power, the allegedly favored purchasers are dealers with little resemblance to large independent department stores or chain operations, and the supplier’s selective price discounting fosters competition among suppliers of different brands… By declining to extend Robinson-Patman’s governance to such cases, we continue to construe the Act “consistently with broader policies of the antitrust laws.” Brooke Group, 509 U.S., at 220… (cautioning against Robinson-Patman constructions that “extend beyond the prohibitions of the Act and, in doing so, help give rise to a price uniformity and rigidity in open conflict with the purposes of other antitrust legislation”).

Thus, interested in the soundness of her jurisprudence in the face of a well-developed body of antitrust law, Justice Ginsburg chose to continue to develop that body of law rather than engage in judicial policymaking in favor of a sympathetic plaintiff. 

It must surely be tempting for a justice on the Court to adopt less principled approaches to the law in any given case, and it is equally as impressive that Justice Ginsburg consistently stuck to her principles. We can only hope her successor takes note of Justice Ginsburg’s example.

Antitrust populists have a long list of complaints about competition policy, including: laws aren’t broad enough or tough enough, enforcers are lax, and judges tend to favor defendants over plaintiffs or government agencies. The populist push got a bump with the New York Times coverage of Lina Khan’s “Amazon’s Antitrust Paradox” in which she advocated breaking up Amazon and applying public utility regulation to platforms. Khan’s ideas were picked up by Sen. Elizabeth Warren, who has a plan for similar public utility regulation and promised to unwind earlier acquisitions by Amazon (Whole Foods and Zappos), Facebook (WhatsApp and Instagram), and Google (Waze, Nest, and DoubleClick).

Khan, Warren, and the other Break Up Big Tech populists don’t clearly articulate how consumers, suppliers — or anyone for that matter — would be better off with their mandated spinoffs. The Khan/Warren plan, however, requires a unique alignment of many factors: Warren must win the White House, Democrats must control both houses of Congress, and judges must substantially shift their thinking. It’s like turning a supertanker on a dime in the middle of a storm. Instead of publishing manifestos and engaging in antitrust hashtag hipsterism, maybe — just maybe — the populists can do something.

The populists seem to have three main grievances:

  • Small firms cannot enter the market or cannot thrive once they enter;
  • Suppliers, including workers, are getting squeezed; and
  • Speculation that someday firms will wake up, realize they have a monopoly, and begin charging noncompetitive prices to consumers.

Each of these grievances can be, and has been, already addressed by antitrust and competition litigation. And, in many cases these grievances were addressed in private antitrust litigation. For example:

In the US, private actions are available for a wide range of alleged anticompetitive conduct, including coordinated conduct (e.g., price-fixing), single-firm conduct (e.g., predatory pricing), and mergers that would substantially lessen competition. 

If the antitrust populists are so confident that concentration is rising and firms are behaving anticompetitively and consumers/suppliers/workers are being harmed, then why don’t they organize an antitrust lawsuit against the worst of the worst violators? If anticompetitive activity is so obvious and so pervasive, finding compelling cases should be easy.

For example, earlier this year, Shaoul Sussman, a law student at Fordham University, published “Prime Predator: Amazon and the Rationale of Below Average Variable Cost Pricing Strategies Among Negative-Cash Flow Firms” in the Journal of Antitrust Enforcement. Why not put Sussman’s theory to the test by building an antitrust case around it? The discovery process would unleash a treasure trove of cost data and probably more than a few “hot docs.”

Khan argues:

While predatory pricing technically remains illegal, it is extremely difficult to win predatory pricing claims because courts now require proof that the alleged predator would be able to raise prices and recoup its losses. 

However, in her criticism of the court in the Apple e-books litigation, she lays out a clear rationale for courts to revise their thinking on predatory pricing [emphasis added]:

Judge Cote, who presided over the district court trial, refrained from affirming the government’s conclusion. Still, the government’s argument illustrates the dominant framework that courts and enforcers use to analyze predation—and how it falls short. Specifically, the government erred by analyzing the profitability of Amazon’s e-book business in the aggregate and by characterizing the conduct as “loss leading” rather than potentially predatory pricing. These missteps suggest a failure to appreciate two critical aspects of Amazon’s practices: (1) how steep discounting by a firm on a platform-based product creates a higher risk that the firm will generate monopoly power than discounting on non-platform goods and (2) the multiple ways Amazon could recoup losses in ways other than raising the price of the same e-books that it discounted.

Why not put Khan’s cross-subsidy theory to the test by building an antitrust case around it? Surely there’d be a document explaining how the firm expects to recoup its losses. Or, maybe not. Maybe by the firm’s accounting, it’s not losing money on the discounted products. Without evidence, it’s just speculation.

In fairness, one can argue that recent court decisions have made pursuing private antitrust litigation more difficult. For example, the Supreme Court’s decision in Twombly requires an antitrust plaintiff to show more than mere speculation based on circumstantial evidence in order to move forward to discovery. Decisions in matters such as Ashcroft v. Iqbal have made it more difficult for plaintiffs to maintain antitrust claims. Wal-Mart v. Dukes and Comcast Corp v Behrend subject antitrust class actions to more rigorous analysis. In Ohio v. Amex the court ruled antitrust plaintiffs can’t meet the burden of proof by showing only some effect on some part of a two-sided market.

At the same time Jeld-Wen indicates third party plaintiffs can be awarded damages and obtain divestitures, even after mergers clear. In Jeld-Wen, a competitor filed suit to challenge the consummated Jeld-Wen/Craftmaster merger four years after the DOJ approved the merger without conditions. The challenge was lengthy, but successful, and a district court ordered damages and the divestiture of one of the combined firm’s manufacturing facilities six years after the merger was closed.

Despite the possible challenges of pursuing a private antitrust suit, Daniel Crane’s review of US federal court workload statistics concludes the incidence of private antitrust enforcement in the United States has been relatively stable since the mid-1980s — in the range of 600 to 900 new private antitrust filings a year. He also finds resolution by trial has been relatively stable at an average of less than 1 percent a year. Thus, it’s not clear that recent decisions have erected insurmountable barriers to antitrust plaintiffs.

In the US, third parties may fund private antitrust litigation and plaintiffs’ attorneys are allowed to work under a contingency fee arrangement, subject to court approval. A compelling case could be funded by deep-pocketed supporters of the populists’ agenda, big tech haters, or even investors. Perhaps the most well-known example is Peter Thiel’s bankrolling of Hulk Hogan’s takedown of Gawker. Before that, the savings and loan crisis led to a number of forced mergers which were later challenged in court, with the costs partially funded by the issuance of litigation tracking warrants.

The antitrust populist ranks are chock-a-block with economists, policy wonks, and go-getter attorneys. If they are so confident in their claims of rising concentration, bad behavior, and harm to consumers, suppliers, and workers, then they should put those ideas to the test with some slam dunk litigation. The fact that they haven’t suggests they may not have a case.

For a few months I have thought that the Apple eBooks case would find an easy fit within the Supreme Court’s antitrust decisions. The case that seems closest to me is Business Electronics v. Sharp Electronics, an unfortunately under-appreciated piece of antitrust precedent. One sign of its under-appreciation is its absence in some recent editions of antitrust casebooks.

In Business Electronics, the Court looked at a vertical relationship in which a manufacturer agreed with one of its retailers to terminate another retailer for failing to comply with the manufacturer’s suggested minimum prices. The Court held that such an agreement could not be ruled per se illegal unless the plaintiff could prove that the non-terminated retailer had agreed with the manufacturer to set its resale price at some level. The Court was reluctant to apply the per se test to this sort of case because of the potential efficiencies that might justify the manufacturer’s minimum retail prices. To allow some leeway for these efficiencies to be realized, the Court erected a high burden of proof under the per se test. Now, of course, the Court no longer applies the per se test to vertical arrangements like that in Business Electronics because of its decision in Leegin to adopt rule of reason analysis for vertical restraints.

The Apple eBooks case falls under Business Electronics. Apple offered the book publishers a contract that left Amazon with a choice of complying with a pricing system closer to the publisher’s preferences or terminating its relationship with the publishers. In other words, the Apple contract, with its famous most-favored-nations clause, effectively presented Amazon with an ultimatum similar to the one observed in Business Electronics. The ultimatum worked: Amazon was forced to comply with the pricing scheme preferred by the publishers and Apple. It follows from Business Electronics, and from Leegin, that the burden of proof in this case should be set high – a bit higher than the trial court set it in this case. Further, Leegin suggests that rule of reason analysis should apply because the relationship at issue is vertical.

Justice Scalia’s passing may have affected the Apple eBooks case already. Scalia was the author of Business Electronics, and presumably the Supreme Court Justice most likely to have noticed the similarity between Business Electronics and Apple eBooks.

In the hands of a wise philosopher-king, the Sherman Act’s hard-to-define prohibitions of “restraints of trade” and “monopolization” are tools that will operate inevitably to advance the public interest in competitive markets. In the hands of real-world litigators, regulators and judges, those same words can operate to advance competitors’ private interests in securing commercial advantages through litigation that could not be secured through competition in the marketplace. If successful, this strategy may yield outcomes that run counter to antitrust law’s very purpose.

The antitrust lawsuit filed by Epic Games against Apple in August 2020, and Apple’s antitrust lawsuit against Qualcomm (settled in April 2019), suggest that antitrust law is heading in this unfortunate direction.

From rent-minimization to rent-maximization

The first step in converting antitrust law from an instrument to minimize rents to an instrument to maximize rents lies in expanding the statute’s field of application on the apparently uncontroversial grounds of advancing the public interest in “vigorous” enforcement. In surprisingly short order, this largely unbounded vision of antitrust’s proper scope has become the dominant fashion in policy discussions, at least as expressed by some legislators, regulators, and commentators.

Following the new conventional wisdom, antitrust law has pursued over the past decades an overly narrow path, consequently overlooking and exacerbating a panoply of social ills that extend well beyond the mission to “merely” protect the operation of the market pricing mechanism. This line of argument is typically coupled with the assertion that courts, regulators and scholars have been led down this path by incumbents that welcome the relaxed scrutiny of a purportedly deferential antitrust policy.

This argument, and related theory of regulatory capture, has things roughly backwards.

Placing antitrust law at the service of a largely undefined range of social purposes set by judicial and regulatory fiat threatens to render antitrust a tool that can be easily deployed to favor the private interests of competitors rather than the public interest in competition. Without the intellectual discipline imposed by the consumer welfare standard (and, outside of per se illegal restraints, operationalized through the evidentiary requirement of competitive harm), the rhetoric of antitrust provides excellent cover for efforts to re-engineer the rules of the game in lieu of seeking to win the game as it has been played.

Epic Games v. Apple

A nascent symptom of this expansive form of antitrust is provided by the much-publicized lawsuit brought by Epic Games, the maker of the wildly popular video game, Fortnite, against Apple, the operator of the even more wildly popular App Store. On August 13, 2020, Epic added a “direct” payment processing services option to its Fortnite game, which violated the developer terms of use that govern the App Store. In response, Apple exercised its contractual right to remove Fortnite from the App Store, triggering Fortnite’s antitrust suit. The same sequence has ensued between Epic Games and Google in connection with the Google Play Store. Both litigations are best understood as a breach of contract dispute cloaked in the guise of an antitrust cause of action.

In suggesting that a jury trial would be appropriate in Epic Games’ suit against Apple, the district court judge reportedly stated that the case is “on the frontier of antitrust law” and [i]t is important enough to understand what real people think.” That statement seems to suggest that this is a close case under antitrust law. I respectfully disagree. Based on currently available information and applicable law, Epic’s argument suffers from two serious vulnerabilities that would seem to be difficult for the plaintiff to overcome.

A contestably narrow market definition

Epic states three related claims: (1) Apple has a monopoly in the relevant market, defined as the App Store, (2) Apple maintains its monopoly by contractually precluding developers from distributing iOS-compatible versions of their apps outside the App Store, and (3) Apple maintains a related monopoly in the payment processing services market for the App Store by contractually requiring developers to use Apple’s processing service.

This market definition, and the associated chain of reasoning, is subject to significant doubt, both as a legal and factual matter.

Epic’s narrow definition of the relevant market as the App Store (rather than app distribution platforms generally) conveniently results in a 100% market share for Apple. Inconveniently, federal case law is generally reluctant to adopt single-brand market definitions. While the Supreme Court recognized in 1992 a single-brand market in Eastman Kodak Co. v. Image Technical Services, the case is widely considered to be an outlier in light of subsequent case law. As a federal district court observed in Spahr v. Leegin Creative Leather Products (E.D. Tenn. 2008): “Courts have consistently refused to consider one brand to be a relevant market of its own when the brand competes with other potential substitutes.”

The App Store would seem to fall into this typical category. The customer base of existing and new Fortnite users can still accessthe gamethrough multiple platforms and on multiple devices other than the iPhone, including a PC, laptop, game console, and non-Apple mobile devices. (While Google has also removed Fortnite from the Google Play store due to the added direct payment feature, users can, at some inconvenience, access the game manually on Android phones.)

Given these alternative distribution channels, it is at a minimum unclear whether Epic is foreclosed from reaching a substantial portion of its consumer base, which may already access the game on alternative platforms or could potentially do so at moderate incremental transaction costs. In the language of platform economics, it appears to be technologically and economically feasible for the target consumer base to “multi-home.” If multi-homing and related switching costs are low, even a 100% share of the App Store submarket would not translate into market power in the broader and potentially more economically relevant market for app distribution generally.

An implausible theory of platform lock-in

Even if it were conceded that the App Store is the relevant market, Epic’s claim is not especially persuasive, both as an economic and a legal matter. That is because there is no evidence that Apple is exploiting any such hypothetically attributed market power to increase the rents extracted from developers and indirectly impose deadweight losses on consumers.

In the classic scenario of platform lock-in, a three-step sequence is observed: (1) a new firm acquires a high market share in a race for platform dominance, (2) the platform winner is protected by network effects and switching costs, and (3) the entrenched platform “exploits” consumers by inflating prices (or imposing other adverse terms) to capture monopoly rents. This economic model is reflected in the case law on lock-in claims, which typically requires that the plaintiff identify an adverse change by the defendant in pricing or other terms after users were allegedly locked-in.

The history of the App Store does not conform to this model. Apple has always assessed a 30% fee and the same is true of every other leading distributor of games for the mobile and PC market, including Google Play Store, App Store’s rival in the mobile market, and Steam, the dominant distributor of video games in the PC market. This long-standing market practice suggests that the 30% fee is most likely motivated by an efficiency-driven business motivation, rather than seeking to entrench a monopoly position that Apple did not enjoy when the practice was first adopted. That is: even if Apple is deemed to be a “monopolist” for Section 2 purposes, it is not taking any “illegitimate” actions that could constitute monopolization or attempted monopolization.

The logic of the 70/30 split

Uncovering the business logic behind the 70/30 split in the app distribution market is not too difficult.

The 30% fee appears to be a low transaction-cost practice that enables the distributor to fund a variety of services, including app development tools, marketing support, and security and privacy protections, all of which are supplied at no separately priced fee and therefore do not require service-by-service negotiation and renegotiation. The same rationale credibly applies to the integrated payment processing services that Apple supplies for purposes of in-app purchases.

These services deliver significant value and would otherwise be difficult to replicate cost-effectively, protect the App Store’s valuable stock of brand capital (which yields positive spillovers for app developers on the site), and lower the costs of joining and participating in the App Store. Additionally, the 30% fee cross-subsidizes the delivery of these services to the approximately 80% of apps on the App Store that are ad-based and for which no fee is assessed, which in turn lowers entry costs and expands the number and variety of product options for platform users. These would all seem to be attractive outcomes from a competition policy perspective.

Epic’s objection

Epic would object to this line of argument by observing that it only charges a 12% fee to distribute other developers’ games on its own Epic Games Store.

Yet Epic’s lower fee is reportedly conditioned, at least in some cases, on the developer offering the game exclusively on the Epic Games Store for a certain period of time. Moreover, the services provided on the Epic Games Store may not be comparable to the extensive suite of services provided on the App Store and other leading distributors that follow the 30% standard. Additionally, the user base a developer can expect to access through the Epic Games Store is in all likelihood substantially smaller than the audience that can be reached through the App Store and other leading app and game distributors, which is then reflected in the higher fees charged by those platforms.

Hence, even the large fee differential may simply reflect the higher services and larger audiences available on the App Store, Google Play Store and other leading platforms, as compared to the Epic Games Store, rather than the unilateral extraction of market rents at developers’ and consumers’ expense.

Antitrust is about efficiency, not distribution

Epic says the standard 70/30 split between game publishers and app distributors is “excessive” while others argue that it is historically outdated.

Neither of these are credible antitrust arguments. Renegotiating the division of economic surplus between game suppliers and distributors is not the concern of antitrust law, which (as properly defined) should only take an interest if either (i) Apple is colluding on the 30% fee with other app distributors, or (ii) Apple is taking steps that preclude entry into the apps distribution market and lack any legitimate business justification. No one claims evidence for the former possibility and, without further evidence, the latter possibility is not especially compelling given the uniform use of the 70/30 split across the industry (which, as noted, can be derived from a related set of credible efficiency justifications). It is even less compelling in the face of evidence that output is rapidly accelerating, not declining, in the gaming app market: in the first half of 2020, approximately 24,500 new games were added to the App Store.

If this conclusion is right, then Epic’s lawsuit against Apple does not seem to have much to do with the public interest in preserving market competition.

But it clearly has much to do with the business interest of an input supplier in minimizing its distribution costs and maximizing its profit margin. That category includes not only Epic Games but Tencent, the world’s largest video game publisher and the holder of a 40% equity stake in Epic. Tencent also owns Riot Games (the publisher of “League of Legends”), an 84% stake in Supercell (the publisher of “Clash of Clans”), and a 5% stake in Activision Blizzard (the publisher of “Call of Duty”). It is unclear how an antitrust claim that, if successful, would simply redistribute economic value from leading game distributors to leading game developers has any necessary relevance to antitrust’s objective to promote consumer welfare.

The prequel: Apple v. Qualcomm

Ironically (and, as Dirk Auer has similarly observed), there is a symmetry between Epic’s claims against Apple and the claims previously pursued by Apple (and, concurrently, the Federal Trade Commission) against Qualcomm.

In that litigation, Apple contested the terms of the licensing arrangements under which Qualcomm made available its wireless communications patents to Apple (more precisely, Foxconn, Apple’s contract manufacturer), arguing that the terms were incompatible with Qualcomm’s commitment to “fair, reasonable and nondiscriminatory” (“FRAND”) licensing of its “standard-essential” patents (“SEPs”). Like Epic v. Apple, Apple v. Qualcomm was fundamentally a contract dispute, with the difference that Apple was in the position of a third-party beneficiary of the commitment that Qualcomm had made to the governing standard-setting organization. Like Epic, Apple sought to recharacterize this contractual dispute as an antitrust question, arguing that Qualcomm’s licensing practices constituted anticompetitive actions to “monopolize” the market for smartphone modem chipsets.

Theory meets evidence

The rhetoric used by Epic in its complaint echoes the rhetoric used by Apple in its briefs and other filings in the Qualcomm litigation. Apple (like the FTC) had argued that Qualcomm imposed a “tax” on competitors by requiring that any purchaser of Qualcomm’s chipsets concurrently enter into a license for Qualcomm’s SEP portfolio relating to 3G and 4G/LTE-enabled mobile communications devices.

Yet the history and performance of the mobile communications market simply did not track Apple’s (and the FTC’s continuing) characterization of Qualcomm’s licensing fee as a socially costly drag on market growth and, by implication, consumer welfare.

If this assertion had merit, then the decades-old wireless market should have exhibited a dismal history of increasing prices, slow user adoption and lagging innovation. In actuality, the wireless market since its inception has grown relentlessly, characterized by declining quality-adjusted prices, expanding output, relentless innovation, and rapid adoption across a broad range of income segments.

Given this compelling real-world evidence, the only remaining line of argument (still being pursued by the FTC) that could justify antitrust intervention is a theoretical conjecture that the wireless market might have grown even faster under some alternative IP licensing arrangement. This assertion rests precariously on the speculative assumption that any such arrangement would have induced the same or higher level of aggregate investment in innovation and commercialization activities. That fragile chain of “what if” arguments hardly seems a sound basis on which to rewrite the legal infrastructure behind the billions of dollars of licensing transactions that support the economically thriving smartphone market and the even larger ecosystem that has grown around it.

Antitrust litigation as business strategy

Given the absence of compelling evidence of competitive harm from Qualcomm’s allegedly anticompetitive licensing practices, Apple’s litigation would seem to be best interpreted as an economically rational attempt by a downstream producer to renegotiate a downward adjustment in the fees paid to an upstream supplier of critical technology inputs. (In fact, those are precisely the terms on which Qualcomm in 2015 settled the antitrust action brought against it by China’s competition regulator, to the obvious benefit of local device producers.) The Epic Games litigation is a mirror image fact pattern in which an upstream supplier of content inputs seeks to deploy antitrust law strategically for the purposes of minimizing the fees it pays to a leading downstream distributor.

Both litigations suffer from the same flaw. Private interests concerning the division of an existing economic value stream—a business question that is matter of indifference from an efficiency perspective—are erroneously (or, at least, reflexively) conflated with the public interest in preserving the free play of competitive forces that maximizes the size of the economic value stream.

Conclusion: Remaking the case for “narrow” antitrust

The Epic v. Apple and Apple v. Qualcomm disputes illustrate the unproductive rent-seeking outcomes to which antitrust law will inevitably be led if, as is being widely advocated, it is decoupled from its well-established foundation in promoting consumer welfare—and not competitor welfare.

Some proponents of a more expansive approach to antitrust enforcement are convinced that expanding the law’s scope of application will improve market efficiency by providing greater latitude for expert regulators and courts to reengineer market structures to the public benefit. Yet any substitution of top-down expert wisdom for the bottom-up trial-and-error process of market competition can easily yield “false positives” in which courts and regulators take actions that counterproductively intervene in markets that are already operating under reasonably competitive conditions. Additionally, an overly expansive approach toward the scope of antitrust law will induce private firms to shift resources toward securing advantages over competitors through lobbying and litigation, rather than seeking to win the race to deliver lower-cost and higher-quality products and services. Neither outcome promotes the public’s interest in a competitive marketplace.

By Chris Sagers

United States v. Apple has fascinated me continually ever since the instantly-sensational complaint was made public, more than three years ago. Just one small, recent manifestation of the larger theme that makes it so interesting is the improbable range of folks who apparently consider certiorari rather likely—not least some commenters here, and even SCOTUSblog, which listed the case on their “Petitions We’re Watching.” It seems improbable, I say, not because reasonable people couldn’t differ on the policy issues. In this day and age somebody pops up to doubt every antitrust case brought against anybody no matter what. Rather, on the traditional criteria, the case just seems really ill-suited for cert.[*]

But it is in keeping with the larger story that people might expect the Court to take this basically hum-drum fact case in which there’s no circuit split. People have been savaging this case since its beginnings, despite the fact that to almost all antitrust lawyers it was such a legal slam dunk that so long as the government could prove its facts, it couldn’t lose.

And so I’m left with questions I’ve been asking since the case came out. Why, given the straightforward facts, nicely fitting a per se standard generally thought to be well-settled, involving conduct that on the elaborate trial record had no plausible effect except a substantial price increase,[**] do so many people hate this case? Why, more specifically, do so many people think there is something special about it, such that it shouldn’t be subject to the same rules that would apply to anybody else who did what these defendants did?

To be clear, I think the case is interesting. Big time. But what is interesting is not its facts or the underlying conduct or anything about book publishing or technological change or any of that. In other words, I don’t think the case is special. Like Jonathan Jacobson, I think it is simple.  What is remarkable is the reactions it has generated, across the political spectrum.

In the years of its pendency, on any number of panels and teleconferences and brown-bags and so on we’ve heard BigLaw corporate defense lawyers talking about the case like they’re Louis Brandeis. The problem, you see, is not a naked horizontal producer cartel coordinated by a retail entrant with a strong incentive to discipline its retail rival. No, no, no. The problem was actually Amazon, and the problem with Amazon was that it is big. Moreover, this case is about entry, they say, and entry is what antitrust is all about. Entry must be good, because numerosity in and of itself is competition. Consider too the number of BigLaw antitrust partners who’ve publicly argued that Amazon is in fact a monopolist, and that it engaged in predatory pricing, of all things.

When has anyone ever heard this group of people talk like that?

For another example, consider how nearly identical have been the views of left-wing critics like the New America Foundation’s Barry Lynn to those of the Second Circuit dissenter in Apple, the genteel, conservative Bush appointee, Judge Dennis Jacobs. They both claim, as essentially their only argument, that Amazon is a powerful firm, which can be tamed only if publishers can set their own retail prices (even if they do so collusively).

And there are so many other examples. The government’s case was condemned by no less than a Democrat and normally pro-enforcement member of the Senate antitrust committee, as it was by two papers as otherwise divergent as the Wall Street Journal and the New York Times. Meanwhile, the damnedest thing about the case, as I’ll show in a second, is that it frequently causes me to talk like Robert Bork.

So what the hell is going on?

I have a theory.  We in America have almost as our defining character, almost uniquely among developed nations, a commitment to markets, competition, and individual enterprise. But we tend to forget until a case like Apple reminds us that markets, when they work as they are supposed to, are machines for producing pain. Firms fail, people lose jobs, valuable institutions—like, perhaps, the paper book—are sometimes lost. And it can be hard to believe that such a free, decentralized mess will somehow magically optimize organization, distribution, and innovation. I think the reason people find a case like Apple hard to support is that, because we find all that loss and anarchy so hard to swallow, we as a people do not actually believe in competition at all.

I think it helps in making this point to work through the individual arguments that the Apple defendants and their supporters have made, in court and out. For my money, what we find is not only that most of the arguments are not really that strong, but that they are the same arguments that all defendants make, all the time. As it turns out, there has never been an antitrust defendant that didn’t think its market was special.

Taking the arguments I’ve heard, roughly in increasing order of plausibility:

  • Should it matter that discipline of Amazon’s aggressive pricing might help keep the publisher defendants in business? Hardly. While the lamentations of the publishers seem overblown—they may be forced to adapt, and it may not be painless, but that is much more likely at the moment than their insolvency—if they are forced out because they cannot compete on a price basis, then that is exactly what is supposed to happen. Econ 101.
  • Was Apple’s entry automatically good just because it was entry? Emphatically no. There is no rule in antitrust that entry is inherently good, and a number of strong rules to the contrary (consider, for example, the very foundation of the Brook Group predation standard, which is that we should provide no legal protection to less efficient competitors, including entrants). That is for a simple reason: entry is good when causes quality-adjusted price to go down. The opposite occurred in Apple[***]
  • Is Amazon the real villain, so obviously that we should allow its suppliers to regulate its power through horizontal cartel? I rather think not. While I have no doubt that Amazon is a dangerous entity, that probably will merit scrutiny on any number of grounds now or in the future, it seems implausible that it priced e-books predatorily, surely not on the legal standard that currently prevails in the United States. In fact, an illuminating theme in The Everything Store, Brad Stone’s comprehensive study of the company, was the ubiquity of supplier allegations of Amazon’s predation in all kinds of products, complaints that have gone on throughout the company’s two-decade existence. I don’t believe Amazon is any hero or that it poses no threats, but what it’s done in these cases is just charge lower prices. It’s been able to do so in a sustained manner mainly through innovation in distribution. And in any case, whether Amazon is big and bad or whatever, the right tool to constrain it is not a price fixing cartel. No regulator cares less about the public interest.
  • Does it make the case special in some way that a technological change drove the defendants to their conspiracy? No. The technological change afoot was in effect just a change in costs. It is much cheaper to deliver content electronically than in hard copy, not least because as things have unfolded, consumers have actually paid for and own most of the infrastructure. To that extent there’s nothing different about Apple than any case in which an innovation in production or distribution has given one player a cost advantage. In fact, the publishers’ primary need to defend against pricing of e-books at some measure of their actual cost is that the publishers’ whole structure is devoted to an expensive intermediating function that becomes largely irrelevant with digital distribution.
  • Is there reason to believe that a horizontal cartel orchestrated by a powerful distributor will achieve better quality-adjusted prices, which I take to be Geoff Manne’s overall theme? I mean, come on. This is essentially a species of destructive competition argument, that otherwise healthy markets can be so little trusted efficiently to supply products that customers want that we’ll put the government to a full rule of reason challenge to attack a horizontal cartel? Do we believe in competition at all?
  • Should it matter that valuable cultural institutions may be at risk, including the viability of paper books, independent bookstores, and perhaps the livelihoods of writers or even literature itself? This seems more troubling than the other points, but hardly is unique to the case or a particularly good argument for self-help by cartel. Consider, if you will, another, much older case. The sailing ship industry was thousands of years old and of great cultural and human significance when it met its demise in the 1870s at the hands of the emerging steamship industry. Ships that must await the fickle winds cannot compete with those that can offer the reliable, regular departures that shipper customers desire. There followed a period of desperate price war following which the sail industry was destroyed. That was sad, because tall-masted sailing ships are very swashbuckling and fun, and were entwined in our literature and culture. But should we have allowed the two industries to fix their prices, to preserve sailing ships as a living technology?

There are other arguments, and we could keep working through them one by one, but the end result is the same. The arguments mostly are weak, and even those with a bit more heft do nothing more than pose the problem inherent in that very last point. Healthy markets sometimes produce pain, with genuinely regrettable consequences.  But that just forces us to ask: do we believe in competition or don’t we?

___________

[*] Except possibly for one narrow issue, Apple is at this point emphatically a fact case, and the facts were resolved on an extensive record by an esteemed trial judge, in a long and elaborate opinion, and left undisturbed on appeal (even in the strongly worded dissent). The one narrow issue that is actually a legal one, and that Apple mainly stresses in its petition—whether in the wake of Leegin the hub in a hub-and-spoke arrangement can face per se liability—is one on which I guess people could plausibly disagree. But even when that is the case this Court virtually never grants cert. in the absence of a significant circuit split, and here there isn’t one.

Apple points only to one other Circuit decision, the Third Circuit’s Toledo Mack. It is true as Apple argues that a passage in Toledo Mack seemed to read language from Leegin fairly broadly, and to apply even when there is horizontal conspiracy at the retail level. But Toledo Mack was not a hub-and-spoke case. While plaintiff alleged a horizontal conspiracy among retailers of heavy trucks, and Mack Trucks later acquiescence in it, Mack played no role in coordinating the conspiracy. Separately, whether Toledo Mack really conflicts with Apple or not, the law supporting the old per se rule against hub-and-spoke conspiracies is pretty strong (take a look, for example, at pp. 17-18 of the Justice Department’s opposition brief.

So, I suppose one might think there is no distinction between a hub-and-spoke and a case like Toledo Mack, in which a manufacturer merely agreed after the fact to assist an existing retail conspiracy, and that there is therefore a circuit split, but that would be rather in contrast to a lot of Supreme Court authority. On the other hand, if there is some legal difference between a hub-and-spoke and the facts of Toledo Mack, then Toledo Mack is relevant only if it is understood to have read Leegin to apply to all “vertical” conduct, including true hub-and-spoke agreements. But that would be a broad reading indeed of both Leegin and Toledo Mack. It would require believing that Leegin reversed sub silentio a number of important decisions on an issue that was not before the Court in Leegin. It would also make a circuit split out of a point that would be only dicta in Toledo Mack. And yes, yes, yes, I know, Judge Jacobs in dissent below himself said that his panel’s decision created a circuit split with Toledo Mack. But I mean, come on. A circuit split means that two holdings are in conflict, not that one bit of dicta commented on some other bit of dicta.

A whole different reason cert. seems improbable is that the issue presented is whether per se treatment was appropriate. But the trial court specifically found the restraint to have been unreasonable under a rule of reason standard. Of course that wouldn’t preclude the Court from reversing the trial court’s holding that the per se rule applies, but it would render a reversal almost certainly academic in the case actually before the Court.

Don’t get me wrong. Nothing the courts do really surprises me anymore, and there are still four members of the Court, even in the wake of Justice Scalia’s passing, who harbor open animosity for antitrust and a strong fondness for Leegin. It is also plausible that those four will see the case Apple’s way, and favor reversing Interstate Circuit (though that seems unlikely to me; read a case like Ticor or North Carolina Dental Examiners if you want to know how Anthony Kennedy feels about naked cartel conduct). But the ideological affinities of the Justices, in and of themselves, just don’t usually turn an otherwise ordinary case into a cert-worthy one.

[**] Yes, yes, yes, Grasshopper, I know, Apple argued that in fact its entry increased quality and consumer choice, and also put on an argument that the output of e-books actually expanded during the period of the publishers’ conspiracy. But, a couple of things. First, as the government observed in some juicy briefing in the case, and Judge Cote found in specific findings, each of Apple’s purported quality enhancements turned out to involve either other firms’ innovations or technological enhancements that appeared in the iPad before Apple ever communicated with the publishers. As for the expanded output argument, it was fairly demolished by the government’s experts, a finding not disturbed even in Judge Jacobs’ dissent.

In any case, any benefit Apple did manage to supply came at the cost of a price increase of fifty freaking percent, across thousands of titles, that were sustained for the entire two years that the conspiracy survived.

[***] There have also been the usual squabbles over factual details that are said to be very important, but these points are especially uninteresting. E.g., the case involved “MFNs” and “agency contracts,” and there is supposed to be some magic in either their vertical nature or the great uncertainty of their consequences that count against per se treatment. There isn’t. Neither the government’s complaint, the district court, nor the Second Circuit attacked the bilateral agreements in and of themselves; on the contrary, both courts emphatically stressed that they only found illegal the horizontal price fixing conspiracy and Apple’s role in coordinating it.

Likewise, some stress that the publisher defendants in fact earned slightly less per price-fixed book under their agency agreements than they had with Apple. Why would they do that, if there weren’t some pro-competitive reason? Simple. The real money in trade publishing was not then or now in the puny e-book sector, but in hard-cover, new-release best sellers, which publishers have long sold at very significant mark-ups over cost. Those margins were threatened by Amazon’s very low e-book prices, and the loss on agency sales was worth it to preserve the real money makers.

By Thomas Hazlett

The Apple e-books case is throwback to Dr. Miles, the 1911 Supreme Court decision that managed to misinterpret the economics of competition and so thwart productive activity for over a century. The active debate here at TOTM reveals why.

The District Court and Second Circuit have employed a per se rule to find that the Apple e-books agreement with five major publishers constituted a violation of Section 1 of the Sherman Act. Citing the active cooperation in contract negotiations involving multiple horizontal competitors (publishers) and the Apple offer, which appears to have raised prices paid for e-books, the conclusion that this is a case of horizontal collusion appears a slam dunk to some. “Try as one may,” writes Jonathan Jacobson, “it is hard to find an easier antitrust case than United States v. Apple.”

I’m guessing that that is what Charles Evans Hughes thought about the Dr. Miles case in 1911.

Upon scrutiny, the apparent simplicity in either instance evaporates. Dr. Miles has been revised as per GTE Sylvania, Leegin, and (thanks, Keith Hylton) Business Electronics v. Sharp Electronics. Let’s here look at the pending Apple dispute.

First, the Second Circuit verdict was not only a split decision on application of the per se rule, the dissent ably stated a case for why the Apple e-books deal should be regarded as pro-competitive and, thus, legal.

Second, the price increase cited as determinative occurred in a two-sided market; the fact asserted does not establish a monopolistic restriction of output. Further analysis, as called for under the rule of reason, is needed to flesh out the totality of the circumstances and the net impact of the Apple-publisher agreement on consumer welfare. That includes evidence regarding what happens to total revenues as market structure and prices change.

Third, a new entrant emerged as per the actions undertaken — the agreements pointedly did not “lack…. any redeeming virtue” (Northwest Wholesale Stationers, 1985), the justification for per se illegality. The fact that a new platform — Apple challenging Amazon’s e-book dominance — was both cause and effect of the alleged anti-competitive behavior is a textbook example of ancillarity. The “naked restraints” that publishers might have imposed had Apple not brought new products and alternative content distribution channels into the mix thus dressed up. It is argued by some that the clothes were skimpy. But that fashion statement is what a rule of reason analysis is needed to determine.

Fourth, the successful market foray that came about in the two-sided e-book market is a competitive victory not to be trifled. As the Supreme Court determined in Leegin: A “per se rule cannot be justified by the possibility of higher prices absent a further showing of anticompetitive conduct. The antitrust laws are designed to protect interbrand competition from which lower prices can later result.” The Supreme Court need here overturn U.S. v. Apple as decided by the Second Circuit in order that the “later result” be reasonably examined.

Fifth, lock-in is avoided with a rule of reason. As the Supreme Court said in Leegin:

As courts gain experience considering the effects of these restraints by applying the rule of reason… they can establish the litigation structure to ensure the rule operates to eliminate anticompetitive restraints….

The lock-in, conversely, comes with per se rules that nip the analysis in the bud, assuming simplicity where complexity obtains.

Sixth, Judge Denise Cote, who issued the District Court ruling against Apple, shows why the rule of reason is needed to counter her per se approach:

Here we have every necessary component: with Apple’s active encouragement and assistance, the Publisher Defendants agreed to work together to eliminate retail price competition and raise e-book prices, and again with Apple’s knowing and active participation, they brought their scheme to fruition.

But that cannot be “every necessary component.” It is not in Apple’s interest to raise prices, but to lower prices paid. Something more has to be going on. Indeed, in raising prices the judge unwittingly cites an unarguable pro-competitive aspect of Apple’s foray: It is competing with Amazon and bidding resources from a rival. Indeed, the rival is, arguably, an incumbent with market power. This cannot be the end of the analysis. That it is constitutes a throwback to the anti-competitive per se rule of Dr. Miles.

Seventh, in oral arguments at the Second Circuit, Judge Raymond J. Lohier, Jr. directed a question to Justice Department counsel, asking how Apple and the publishers “could have broken Amazon’s monopoly of the e-book market without violating antitrust laws.” The DOJ attorney responded, according to an article in The New Yorker, by advising that

Apple could have let the competition among companies play out naturally without pursuing explicit strategies to push prices higher—or it could have sued, or complained to the Justice Department and to federal regulatory authorities.

But the DOJ itself brought no complaint against Amazon — it, instead, sued Apple. And the admonition that an aggressive innovator should sit back and let things “play out naturally” is exactly what will kill efficiency enhancing “creative destruction.” Moreover, the government’s view that Apple “pursued an explicit strategy to push prices higher” fails to acknowledge that Apple was the buyer. Such as it was, Apple’s effort was to compete, luring content suppliers from a rival. The response of the government is to recommend, on the one hand, litigation it will not itself pursue and, on the other, passive acceptance that avoids market disruption. It displays the error, as Judge Jacobs’ Second Circuit dissent puts it, “That antitrust law is offended by gloves off competition.” Why might innovation not be well served by this policy?

Eighth, the choice of rule of reason does not let Apple escape scrutiny, but applies it to both sides of the argument. It adds important policy symmetry. Dr. Miles impeded efficient market activity for nearly a century. The creation of new platforms in Internet markets ought not to have such handicaps. It should be recalled that, in introducing its iTunes platform and its vertically linked iPod music players, circa 2002, the innovative Apple likewise faced attack from competition policy makers (more in Europe, indeed, than the U.S.). Happily, progress in the law had loosened barriers to business model innovation, and the revolutionary ecosystem was allowed to launch. Key to that progressive step was the bulk bargain struck with music labels. Richard Epstein thinks that such industry-wide dealing now endangers Apple’s more recent platform launch. Perhaps. But there is no reason to jump to that conclusion, and much to find out before we embrace it.

As ICLE argued in its amicus brief, the Second Circuit’s ruling in United States v. Apple Inc. is in direct conflict with the Supreme Court’s 2007 Leegin decision, and creates a circuit split with the Third Circuit based on that court’s Toledo Mack ruling. Moreover, the negative consequences of the court’s ruling will be particularly acute for modern, high-technology sectors of the economy, where entrepreneurs planning to deploy new business models will now face exactly the sort of artificial deterrents that the Court condemned in Trinko:

Mistaken inferences and the resulting false condemnations are especially costly, because they chill the very conduct the antitrust laws are designed to protect.

Absent review by the Supreme Court to correct the Second Circuit’s error, the result will be less-vigorous competition and a reduction in consumer welfare. The Court should grant certiorari.

The Second Circuit committed a number of important errors in its ruling.

First, as the Supreme Court held in Leegin, condemnation under the per se rule is appropriate

only for conduct that would always or almost always tend to restrict competition… [and] only after courts have had considerable experience with the type of restraint at issue.

Neither is true in this case. The use of MFNs in Apple’s contracts with the publishers and its adoption of the so-called “agency model” for e-book pricing have never been reviewed by the courts in a setting like this one, let alone found to “always or almost always tend to restrict competition.” There is no support in the case law or economic literature for the proposition that agency models or MFNs used to facilitate entry by new competitors in platform markets like this one are anticompetitive.

Second, the court of appeals emphasized that in some cases e-book prices increased after Apple’s entry, and it viewed that fact as strong support for application of the per se rule. But the Court in Leegin made clear that the per se rule is inappropriate where, as here, “prices can be increased in the course of promoting procompetitive effects.”  

What the Second Circuit missed is that competition occurs on many planes other than price; higher prices do not necessarily suggest decreased competition or anticompetitive effects. As Josh Wright points out:

[T]the multi-dimensional nature of competition implies that antitrust analysis seeking to maximize consumer or total welfare must inevitably calculate welfare tradeoffs when innovation and price effects run in opposite directions.

Higher prices may accompany welfare-enhancing “competition on the merits,” resulting in greater investment in product quality, reputation, innovation, or distribution mechanisms.

While the court acknowledged that “[n]o court can presume to know the proper price of an ebook,” its analysis nevertheless rested on the presumption that Amazon’s prices before Apple’s entry were competitive. The record, however, offered no support for that presumption, and thus no support for the inference that post-entry price increases were anticompetitive.

In fact, as Alan Meese has pointed out, a restraint might increase prices precisely because it overcomes a market failure:

[P]roof that a restraint alters price or output when compared to the status quo ante is at least equally consistent with an alternative explanation, namely, that the agreement under scrutiny corrects a market failure and does not involve the exercise or creation of market power. Because such failures can result in prices that are below the optimum, or output that is above it, contracts that correct or attenuate market failure will often increase prices or reduce output when compared to the status quo ante. As a result, proof that such a restraint alters price or other terms of trade is at least equally consistent with a procompetitive explanation, and thus cannot give rise to a prima facie case under settled antitrust doctrine.

Before Apple’s entry, Amazon controlled 90% of the e-books market, and the publishers had for years been unable to muster sufficient bargaining power to renegotiate the terms of their contracts with Amazon. At the same time, Amazon’s pricing strategies as a nascent platform developer in a burgeoning market (that it was, in practical effect, trying to create) likely did not always produce prices that would be optimal under evolving market conditions as the market matured. The fact that prices may have increased following the alleged anticompetitive conduct cannot support an inference that the conduct was anticompetitive.

Third, the Second Circuit also made a mistake in dismissing Apple’s defenses. The court asserted that

this defense — that higher prices enable more competitors to enter a market — is no justification for a horizontal price‐fixing conspiracy.

But the court is incorrect. As Bill Kolasky points out in his post, it is well-accepted that otherwise-illegal agreements that are ancillary to a procompetitive transaction should be evaluated under the rule of reason.

It was not that Apple couldn’t enter unless Amazon’s prices (and its own) were increased. Rather, the contention made by Apple was that it could not enter unless it was able to attract a critical mass of publishers to its platform – a task which required some sharing of information among the publishers – and unless it was able to ensure that Amazon would not artificially lower its prices to such an extent that it would prevent Apple from attracting a critical mass of readers to its platform. The MFN and the agency model were thus ancillary restraints that facilitated the transactions between Apple and the publishers and between Apple and iPad purchasers. In this regard they are appropriately judged under the rule of reason and, under the rule of reason, offer a valid procompetitive justification for the restraints.

And it was the fact of Apple’s entry, not the use of vertical restraints in its contracts, that enabled the publishers to wield the bargaining power sufficient to move Amazon to the agency model. The court itself noted that the introduction of the iPad and iBookstore “gave publishers more leverage to negotiate for alternative sales models or different pricing.” And as Ben Klein noted at trial,

Apple’s entry probably gave the publishers an increased ability to threaten [Amazon sufficiently that it accepted the agency model]…. The MFN [made] a trivial change in the publishers’ incentives…. The big change that occurs is the change on the other side of the bargaining situation after Apple comes in where Amazon now cannot just tell them no.

Fourth, the purpose of applying the per se rule is to root out activities that always or almost always harm competition. Although it’s possible that a horizontal agreement that facilitates entry and increases competition could be subject to the per se rule, in this case its application was inappropriate. The novelty of Apple’s arrangement with the publishers, coupled with the weakness of proof of any sort of actual price fixing fails to meet even a minimal threshold that would require application of the per se rule.

Not all horizontal arrangements are per se illegal. If an arrangement is relatively novel, facilitates entry, and is patently different from naked price fixing, it should be reviewed under the rule of reason. See BMI. All of those conditions are met here.

The conduct of the publishers – distinct from their agreements with Apple – to find some manner of changing their contracts with Amazon is not itself price fixing, either. The prices themselves would be set only subsequent to whatever new contracts were adopted. At worst, the conduct of the publishers in working toward new contracts with Amazon can be characterized as a facilitating practice.

But even then, the precedent of the Court counsels against applying the per se rule to facilitating practices such as the mere dissemination of price information or, as in this case, information regarding the parties’ preferred, bilateral, contractual relationships. As the Second Circuit itself once held, following the Supreme Court,  

[the] exchange of information is not illegal per se, but can be found unlawful under a rule of reason analysis.

In other words, even the behavior of the publishers should be analyzed under a rule of reason – and Apple’s conduct in facilitating that behavior cannot be imbued with complicity in a price-fixing scheme that may not have existed at all.

Fifth, in order for conduct to “eliminate price competition,” there must be price competition to begin with. But as the district court itself noted, the publishers do not compete on price. This point is oft-overlooked in discussions of the case. It is perhaps possible to say that the contract terms at issue and the publishers’ pressure on Amazon affected price competition between Apple and Amazon – but even then it cannot be said to have reduced competition, because, absent Apple’s entry, there was no competition at all between Apple and Amazon.

It’s true that, if all Apple’s entry did was to transfer identical e-book sales from Amazon to Apple, at higher prices and therefore lower output, it might be difficult to argue that Apple’s entry was procompetitive. But the myopic focus on e-book titles without consideration of product differentiation is mistaken, as well.

The relevant competition here is between Apple and Amazon at the platform level. As explained above, it is misleading to look solely at prices in evaluating the market’s competitiveness. Provided that switching costs are low enough and information about the platforms is available to consumers, consumer welfare may have been enhanced by competition between the platforms on a range of non-price dimensions, including, for example: the Apple iBookstore’s distinctive design, Apple’s proprietary file format, features on Apple’s iPad that were unavailable on Kindle Readers, Apple’s use of a range of marketing incentives unavailable to Amazon, and Apple’s algorithmic matching between its data and consumers’ e-book purchases.

While it’s difficult to disentangle Apple’s entry from other determinants of consumers’ demand for e-books, and even harder to establish with certainty the “but-for” world, it is nonetheless telling that the e-book market has expanded significantly since Apple’s entry, and that purchases of both iPads and Kindles have increased, as well.

There is, in other words, no clear evidence that consumers viewed the two products as perfect substitutes, and thus there is no evidence that Apple’s entry merely caused a non-welfare-enhancing substitution from Amazon to Apple. At minimum, there is no basis for treating the contract terms that facilitated Apple’s entry under a per se standard.

***

The point, in sum, is that there is in fact substantial evidence that Apple’ entry was pro-competitive, that there was no price-fixing scheme of which Apple was a part, and absolutely no evidence that the vertical restraints at issue in the case were the sort that should presumptively give rise to liability. Not only was application of the per se rule inappropriate, but, to answer Richard Epstein, there is strong evidence that Apple should win under a rule of reason analysis, as well.

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

Background

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

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

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

Summary of Amicus Brief

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

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

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

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

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

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

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

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

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

Previous commentary on the case

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

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

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

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

Amicus Signatories

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

The American Bar Association Antitrust Section’s Presidential Transition Report (“Report”), released on January 24, provides a helpful practitioners’ perspective on the state of federal antitrust and consumer protection enforcement, and propounds a variety of useful recommendations for marginal improvements in agency practices, particularly with respect to improving enforcement transparency and reducing enforcement-related costs.  It also makes several good observations on the interplay of antitrust and regulation, and commendably notes the importance of promoting U.S. leadership in international antitrust policy.  This is all well and good.  Nevertheless, the Report’s discussion of various substantive topics poses a number of concerns that seriously detract from its utility, which I summarize below.  Accordingly, I recommend that the new Administration accord respectful attention to the Report’s discussion of process improvements, and international developments, but ignore the Report’s discussion of novel substantive antitrust theories, vertical restraints, and intellectual property.

1.  The Big Picture: Too Much Attention Paid to Antitrust “Possibility Theorems”

In discussing substance, the Report trots out all the theoretical stories of possible anticompetitive harm raised over the last decade or so, such as “product hopping” (“minor” pharmaceutical improvements based on new patents that are portrayed as exclusionary devices), “contracts that reference rivals” (discount schemes that purportedly harm competition by limiting sourcing from a supplier’s rivals), “hold-ups” by patentees (demands by patentees for “overly high” royalties on their legitimate property rights), and so forth.  What the Report ignores is the costs that these new theories impose on the competitive system, and, in particular, on incentives to innovate.  These new theories often are directed at innovative novel business practices that may have the potential to confer substantial efficiency benefits – including enhanced innovation and economic growth – on the American economy.  Unproven theories of harm may disincentivize such practices and impose a hidden drag on the economy.  (One is reminded of Nobel Laureate Ronald Coase’s lament (see here) that “[i]f an economist finds something . . . that he does not understand, he looks for a monopoly explanation. And as in this field we are rather ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on monopoly explanations frequent.”)  Although the Report generally avoids taking a position on these novel theories, the lip service it gives implicitly encourages federal antitrust agency investigations designed to deploy these shiny new antitrust toys.  This in turn leads to a misallocation of resources (unequivocally harmful activity, especially hard core cartel conduct, merits the highest priority) and generates potentially high error and administrative costs, at odds with a sensible decision-theoretic approach to antitrust administration (see here and here).  In sum, the Trump Administration should pay no attention to the Report’s commentary on new substantive antitrust theories.

2.  Vertical Contractual Restraints

The Report inappropriately (and, in my view, amazingly) suggests that antitrust enforcers should give serious attention to vertical contractual restraints:

Recognizing that the current state of RPM law in both minimum and maximum price contexts requires sophisticated balancing of pro- and anti-competitive tendencies, the dearth of guidance from the Agencies in the form of either guidelines or litigated cases leaves open important questions in an area of law that can have a direct and substantial impact on consumers. For example, it would be beneficial for the Agencies to provide guidance on how they think about balancing asserted quality and service benefits that can flow from maintaining minimum prices for certain types of products against the potential that RPM reduces competition to the detriment of consumers. Perhaps equally important, the Agencies should provide guidance on how they would analyze the vigor of interbrand competition in markets where some producers have restricted intrabrand competition among distributors of their products.    

The U.S. Justice Department (DOJ) and Federal Trade Commission (FTC) largely have avoided bringing pure contractual vertical restraints cases in recent decades, and for good reason.  Although vertical restraints theoretically might be used to facilitate horizontal collusion (say, to enforce a distributors’ cartel) or anticompetitive exclusion (say, to enable a dominant manufacturer to deny rivals access to efficient distribution), such cases appear exceedingly rare.  Real world empirical research suggests vertical restraints generally are procompetitive (see, for example, here).  What’s more, a robust theoretical literature supports efficiency-based explanations for vertical restraints (see, for example, here), as recognized by the U.S. Supreme Court in its 2007 Leegin decision.  An aggressive approach to vertical restraints enforcement would ignore this economic learning, likely yield high error costs, and dissuade businesses from considering efficient vertical contracts, to the detriment of social welfare.  Moreover, antitrust prosecutorial resources are limited, and optimal policy indicates they should be directed to the most serious competitive problems.  The Report’s references to “open important questions” and the need for “guidance” on vertical restraints appears oblivious to these realities.  Furthermore, the Report’s mention of “balancing” interbrand versus intrabrand effects reflects a legalistic approach to vertical contracts that is at odds with modern economic analysis.

In short, the Report’s discussion of vertical restraints should be accorded no weight by new enforcers, and antitrust prosecutors would be well advised not to include vertical restraints investigations on their list of priorities.

3.  IP Issues

The Report recommends that the DOJ and FTC (“Agencies”) devote substantial attention to issues related to the unilateral exercise of patent rights, “holdup” and “holdout”:

We . . . recommend that the Agencies gather reliable and credible information on—and propose a framework for evaluating—holdup and holdout, and the circumstances in which either may be anticompetitive. The Agencies are particularly well-suited to gather evidence and assess competitive implications of such practices, which could then inform policymaking, advocacy, and potential cases. The Agencies’ perspectives could contribute valuable insights to the larger antitrust community.

Gathering information with an eye to bringing potential antitrust cases involving the unilateral exercise of patent rights through straightforward patent licensing involves a misapplication of resources.  As Professor Josh Wright and Judge Douglas Ginsburg, among others, have pointed out, antitrust is not well-suited to dealing with disputes between patentees and licensees over licensing rates – private law remedies are best designed to handle such contractual controversies (see, for example, here).  Furthermore, using antitrust law to depress returns to unilateral patent licenses threatens to reduce dynamic efficiency and create disincentives for innovation (see FTC Commissioner (and currently Acting Chairman) Maureen Ohlhausen’s thoughtful article, here).  The Report regrettably ignores this important research.  The Report instead should have called upon the FTC and DOJ to drop their ill-conceived recent emphasis on unilateral patent exploitation, and to focus instead on problems of collusion among holders of competing patented technologies.

That is not all.  The Report’s “suggest[ion] that the [federal antitrust] Agencies consider offering guidance to the ITC [International Trade Commission] about potential SEP holdup and holdout” is a recipe for weakening legitimate U.S. patent rights that are threatened by foreign infringers.  American patentees already face challenges from over a decade’s worth of Supreme Court decisions that have constrained the value of their holdings.  As I have explained elsewhere, efforts to limit the ability of the ITC to issue exclusion orders in the face of infringement overseas further diminishes the value of American patents and disincentivizes innovation (see here).  What’s worse, the Report is not only oblivious of this reality, it goes out of its way to “put a heavy thumb on the scale” in favor of patent infringers, stating (footnote omitted):

If the ITC were to issue exclusion orders to SEP owners under circumstances in which injunctions would not be appropriate under the [Supreme Court’s] eBay standard [for patent litigation], the inconsistency could induce SEP owners to strategically use the ITC in an effort to achieve settlements of patent disputes on terms that might require payment of supracompetitive royalties.  Though it is not likely how likely this is or whether the risk has led to supracompetitive prices in the past, this dynamic could lead to holdup by SEP owners and unconscionably higher royalties.

This commentary on the possibility of “unconscionable” royalties reads like a press release authored by patent infringers.  In fact, there is a dearth of evidence of hold-up, let alone hold-up-related “unconscionable” royalties.  Moreover, it is most decidedly not the role of antitrust enforcers to rule on the “unconscionability” of the unilateral pricing decision of a patent holder (apparently the Report writers forgot to consult Justice Scalia’s Trinko opinion, which emphasizes the right of a monopolist to charge a monopoly price).  Furthermore, not only is this discussion wrong-headed, it flies in the face of concerns expressed elsewhere in the Report regarding ill-advised mandates imposed by foreign antitrust enforcement authorities.  (Recently certain foreign enforcers have shown themselves all too willing to countenance “excessive” patent royalty claims in cases involving American companies).

Finally, other IP-related references in the Report similarly show a lack of regulatory humility.  Theoretical harms from the disaggregation of complementary patents, and from “product hopping” patents (see above), among other novel practices, implicitly encourage the FTC and DOJ (not to mention private parties) to consider bringing cases based on expansive theories of liability, without regard to the costs of the antitrust system as a whole (including the chilling of innovative business activity).  Such cases might benefit the antitrust bar, but prioritizing them would be at odds with the key policy objective of antitrust, the promotion of consumer welfare.

 

Today, in Kimble v. Marvel Entertainment, a case involving the technology underlying the Spider-Man Web-Blaster, the Supreme Court invoked stare decisis to uphold an old precedent based on bad economics. In so doing, the Court spun a tangled web of formalism that trapped economic common sense within it, forgetting that, as Spider-Man was warned in 1962, “with great power there must also come – great responsibility.”

In 1990, Stephen Kimble obtained a patent on a toy that allows children (and young-at-heart adults) to role-play as “a spider person” by shooting webs—really, pressurized foam string—“from the palm of [the] hand.” Marvel Entertainment made and sold a “Web-Blaster” toy based on Kimble’s invention, without remunerating him. Kimble sued Marvel for patent infringement in 1997, and the parties settled, with Marvel agreeing to buy Kimble’s patent for a lump sum (roughly a half-million dollars) plus a 3% royalty on future sales, with no end date set for the payment of royalties.

Marvel subsequently sought a declaratory judgment in federal district court confirming that it could stop paying Kimble royalties after the patent’s expiration date. The district court granted relief, the Ninth Circuit Court of Appeals affirmed, and the Supreme Court affirmed the Ninth Circuit. In an opinion by Justice Kagan, joined by Justices Scalia, Kennedy, Ginsburg, Breyer, and Sotomayor, the Court held that a patentee cannot continue to receive royalties for sales made after his patent expires. Invoking stare decisis, the Court reaffirmed Brulotte v. Thys (1964), which held that a patent licensing agreement that provided for the payment of royalties accruing after the patent’s expiration was illegal per se, because it extended the patent monopoly beyond its statutory time period. The Kimble Court stressed that stare decisis is “the preferred course,” and noted that though the Brulotte rule may prevent some parties from entering into deals they desire, parties can often find ways to achieve similar outcomes.

Justice Alito, joined by Chief Justice Roberts and Justice Thomas, dissented, arguing that Brulotte is a “baseless and damaging precedent” that interferes with the ability of parties to negotiate licensing agreements that reflect the true value of a patent. More specifically:

“There are . . . good reasons why parties sometimes prefer post-expiration royalties over upfront fees, and why such arrangements have pro-competitive effects. Patent holders and licensees are often unsure whether a patented idea will yield significant economic value, and it often takes years to monetize an innovation. In those circumstances, deferred royalty agreements are economically efficient. They encourage innovators, like universities, hospitals, and other institutions, to invest in research that might not yield marketable products until decades down the line. . . . And they allow producers to hedge their bets and develop more products by spreading licensing fees over longer periods. . . . By prohibiting these arrangements, Brulotte erects an obstacle to efficient patent use. In patent law and other areas, we have abandoned per se rules with similarly disruptive effects. . . . [T]he need to avoid Brulotte is an economic inefficiency in itself. . . . And the suggested alternatives do not provide the same benefits as post-expiration royalty agreements. . . . The sort of agreements that Brulotte prohibits would allow licensees to spread their costs, while also allowing patent holders to capitalize on slow-developing inventions.”

Furthermore, the Supreme Court was willing to overturn a nearly century-old antitrust precedent that absolutely barred resale price maintenance in the Leegin case, despite the fact that the precedent was extremely well know (much better known than the Brulotte rule) and had prompted a vast array of contractual workarounds. Given the seemingly greater weight of the Leegin precedent, why was stare decisis set aside in Leegin, but not in Kimble? The Kimble majority’s argument that stare decisis should weigh more heavily in patent than in antitrust because, unlike the antitrust laws, “the patent laws do not turn over exceptional law-shaping authority to the courts”, is unconvincing. As the dissent explains:

“[T]his distinction is unwarranted. We have been more willing to reexamine antitrust precedents because they have attributes of common-law decisions. I see no reason why the same approach should not apply where the precedent at issue, while purporting to apply a statute, is actually based on policy concerns. Indeed, we should be even more willing to reconsider such a precedent because the role implicitly assigned to the federal courts under the Sherman [Antitrust] Act has no parallel in Patent Act cases.”

Stare decisis undoubtedly promotes predictability and the rule of law and, relatedly, institutional stability and efficiency – considerations that go to the costs of administering the legal system and of formulating private conduct in light of prior judicial precedents. The cost-based efficiency considerations underlying applying stare decisis to any particular rule, must, however, be weighed against the net economic benefits associated with abandonment of that rule. The dissent in Kimble did this, but the majority opinion regrettably did not.

In sum, let us hope that in the future the Court keeps in mind its prior advice, cited in Justice Alito’s dissent, that “stare decisis is not an ‘inexorable command’,” and that “[r]evisiting precedent is particularly appropriate where . . . a departure would not upset expectations, the precedent consists of a judge-made rule . . . , and experience has pointed up the precedent’s shortcomings.”

By William Kolasky

In my view, the Second Circuit’s decision in Apple e-Books, if not reversed by the Supreme Court, threatens to undo a half century of progress in reforming antitrust doctrine. In decision after decision, from White Motors through Leegin and Actavis, the Supreme Court has repeatedly held—in cases involving both horizontal and vertical restraints—that the only test for whether an agreement can be found per se unlawful under Section 1 is whether it is “a naked [restraint] of trade with no purpose except stifling competition,” or whether it is instead “ancillary to the legitimate and competitive purposes” of a business association. Dagher. The cases in which the Court has consistently applied this test read like a litany of antitrust decisions we all now study in law school: White Motors, Topco, GTE Sylvania, Professional Engineers, BMI, Maricopa, NCAA, Business Electronics, ARCO, California Dental, Dagher, Leegin, American Needle, and, most recently, Actavis. Significantly, more than two-thirds of these cases involved horizontal, not vertical restraints.

In these decisions, the Court has also repeatedly warned that this test cannot be applied by simply asking whether the defendants “have literally ‘fixed’ a ‘price,” or otherwise agreed not to compete. Warning that “[l]iteralness is overly simplistic and often overbroad,” the Court insisted in BMI that courts instead focus on “the effect and, because it tends to show effect…, on the purpose of the practice” to determine whether “the practice facially appears to be one that would always or almost always tend to restrict competition and decrease output… or instead one designed to ‘increase economic efficiency and render markets more, rather than less, competitive.”

In applying this test the Court has also repeatedly emphasized that a court should classify an alleged restraint—whether horizontal or vertical—as per se unlawful “only after considerable experience” with the particular restraint at issue. In addition, the Court has repeatedly emphasized that all that is necessary for a restraint to escape per se illegality is that there be a “plausible” procompetitive purpose behind it. See, e.g., Cal Dental; Business Electronics; Northwest Wholesale Stationers.

By focusing so much attention in their cert. papers on whether the agreements between Apple and the publishers should be characterized as “vertical” or “horizontal,” both Apple and the DOJ seem to have lost sight of the fundamental teachings of this long line of Supreme Court decisions—namely, that even if an agreement is horizontal, it can be found to be per se unlawful only if it is a naked agreement that, on its face, serves no purpose other than to restrict competition and restrain output. This is particularly important where, as in this case, the alleged agreements have both horizontal and vertical elements. In such cases, the right question is not whether the agreements can be labeled a “hub-and-spoke conspiracy,” but instead what the nature and purpose of those agreements were.

In this case, the nature of the arrangement between Apple and the publishers by which they all appointed Apple as their common sales agent is not fundamentally different from the an agreement among a group of competitors to appoint a joint sales agent. While such an arrangement can, in some circumstances, be used to facilitate cartel behavior, it can also serve legitimate pro-competitive purposes by enabling those competitors to market their goods or services more efficiently. The courts and antitrust enforcement agencies have, therefore, recognized—ever since the Supreme Court’s decision in Appalachian Coals—that these joint sales arrangements must generally be evaluated under the rule of reason and cannot in all instances be condemned as per se unlawful. See, e.g., FTC/DOJ, Competitor Collaboration Guidelines(For those of you who remember the criticisms that used to be directed at that decision by your antitrust professor in law school, I urge you to read Sheldon Kimmel’s excellent revisionist article, How and Why the Per Se Rule Against Price Fixing Went Wrong, showing that the Court’s holding was perfectly consistent with its more recent rulings in BMI and its progeny.

Viewing this as an agreement among the publishers to appoint Apple as their common sales agent might have helped the lower courts to have focused on what should have been the key issues in the case. The first is whether the agency arrangement was a “naked” agreement to “restrict competition and decrease output,” or could “plausibly” have been intended to serve other legitimate pro-competitive business purposes. The second is whether, if so, the restraints that were part of this arrangement—such as price caps and most-favored nation clauses—were ancillary to those legitimate purposes.

Based on the record as I read it, it appears to me that the answers to these two questions are obvious, and that they compel the conclusion that this common sales agent arrangement could not be classified as per se unlawful, but would need to be evaluated under a full-blown rule of reason analysis. Let me address each issue in turn.

Was the common sales agent arrangement between Apple and the five publishers a naked agreement to fix prices and restrict output?

Neither the lower courts nor the parties in their cert papers address this key issue in any detail, choosing instead to spend page after page debating whether the agreement between Apple and the publishers was horizontal or vertical. Fortunately, the amicus briefs that were filed in support of Apple’s cert. petition by ICLE and by a group of antitrust economists do address the issue at considerable length.

Those briefs make a convincing argument that the common sale agent arrangements between the publishers and Apple were designed to serve at least two pro-competitive purposes. The first was to introduce greater competition into the downstream market for the distribution of e-books by ending Amazon’s below-cost pricing of e-books at the retail level. The second was to give the publishers greater control over the downstream pricing of their e-books in order to prevent below-cost pricing of e-books from cannibalizing the sales of their print books.

The common sale agent arrangement served to introduce more competition into the downstream market for the distribution of e-books

This one is easy. No one disputes that before Apple entered, Amazon dominated the downstream market for e-books with a 90% market share, giving it a virtual monopoly. Hopefully, few, if any, would dispute that Amazon’s loss-leader strategy of selling e-books at well below cost served to entrench its near monopoly position in that market. It is easy to understand why publishers of e-books would not want to allow Amazon’s monopoly to continue, leaving them with only a sole distributor for their products.

The record below makes it clear that Apple did not believe it could profitably enter the e-book market so long as Amazon continued to maintain its first-mover advantage by selling e-books below cost. Apple and the publishers therefore had a common interest in moving from the existing wholesale model of e-book distribution to a new agency model under which the publishers, not Amazon, would control the retail pricing of e-books and could set those prices at a level that would enable other competitors, such as Apple, to enter. That seems pro-competitive to me.

The record also makes it clear that this objective could not be accomplished through a simple vertical agency agreement between Apple and one or two individual publishers. In order to enter successfully, Apple needed a critical mass of titles, which it could have only by securing the agreement of most of the leading publishers to appoint it as their common sale agent. Apple, therefore, had a legitimate pro-competitive business reason to facilitate—or, as the Second Circuit charged, “orchestrate” —agreements among the publishers to switch to an agency model and to appoint Apple as their common non-exclusive agent for the sale of their e-books.

The common sales agent arrangement gave the publishers control over the retail prices of e-books, protecting them from harms to their businesses that could otherwise be caused by below-cost pricing by a single dominant retailer.

The Second Circuit and DOJ both make much of the fact that the publishers wanted to control the retail prices of e-books in order to raise those prices above the level set by Amazon’s loss-leader pricing strategy. They both seem to believe that this alone is enough to characterize their conduct as a “naked price fixing scheme.” But it is not. As the Supreme Court held in Leegin, resale price maintenance can be pro-competitive even if it leads to higher prices if it is designed promote competition by creating a more efficient and competitive distribution system.

As Areeda and Hovenkamp teach in their treatise, Fundamentals of Antitrust Law, the same principle applies to agreements among a group of horizontal competitors to appoint a single sales agent. Those competitors will frequently “have to agree with each other that they will not accept less than a certain minimum price, or sometimes may even have to agree on the entire price schedule,” and these prices may sometimes be higher than the prices at which they were previously selling the products individually. See Areeda & Hovenkamp (2015 Supp.), at 19:31-32. But even if these agreements result in an increase in price, they argue that it should not be found illegal if the effect on output is positive. Their argument is supported by the language in BMI, in which the Court focused on the effect of a restraint on output, not price, in describing what was necessary to classify an alleged restraint as a per se illegal naked price-fixing agreement.

Here, although the district court found that prices went up and output went down in the short run after the publishers switched from their wholesale model to an agency model, these immediate, short-term effects do not necessarily show that the switch to the new agency model might not, over the long-term, have resulted in an increase in output. DOJ concedes that since Apple’s entry, e-book sales have grown exponentially, but speculates that this growth might have occurred even if Amazon had continued to maintain its monopoly position in the retail sale of e-books. As someone who reads e-books on my iPad, I doubt that, but this is the type of issue that can only be resolved through a full rule-of-reason analysis, not through the application of a conclusive presumption of illegality under the per se doctrine.

Here, as the amicus briefs argue, there are several ways Amazon’s loss-leader pricing strategy could have depressed the output of both e-book and print books long-term. First, of course, once its monopoly was fully entrenched, Amazon could have sought to recoup its losses by raising its e-book prices above a competitive level. Second, if instead Amazon continued to cannibalize print sales through below-cost e-book pricing, publishers might have been forced to reduce the royalties they pay authors, giving those authors less reason to continue writing, thus reducing the output of all books. Again, these are the types of issues that require a full rule of reason analysis, not summary condemnation under the per se doctrine.

Were the price caps and most-favored nation clauses ancillary restraints that may have been reasonably necessary to the legitimate pro-competitive purposes of the common sales agent arrangement?

The ancillary nature of the terms that were included in Apple’s agency agreements with the publishers, and which the publishers may have agreed among themselves to accept, is equally easy to show.

The price caps on which Apple insisted were obviously designed to protect it from opportunistic behavior by the publishers in charging higher prices for their e-books than what Apple felt the market would accept, thereby preventing it from selling a sufficient volume of e-books to make its entry successful. Such opportunistic behavior by the publishers could also have made it harder to convince consumers to buy Apple’s new iPad, the success of which was critical to its future.

The most favored nation clauses on which Apple insisted, and which the publishers may also have agreed among themselves to accept, were likewise arguably necessary to protect Apple from the risk of having to compete against an established competitor offering lower prices than it could, thereby impeding its successful entry and damaging its goodwill with consumers.

In both cases, these are classic and legitimate reasons for ancillary restraints. Whether or not these particular restraints were reasonably necessary to Apple’s successful entry is a question that could only be decided on the basis of a full rule of reason analysis. All that is needed to avoid per se condemnation is that there be a plausible argument that they were, and that, again, should be something that no one could dispute.

* * *

Given the way the case was litigated, I recognize that it may be difficult to introduce at the Supreme Court level a whole new way of looking at the facts of the case. But if the Court does grant cert., I would hope that Apple and the amici supporting it would try to refocus the Court’s attention away from a sterile argument over whether the restraints in question were vertical or horizontal, and to focus it instead on whether they were a “naked” attempt to fix prices and restrict output or were instead ancillary to a pro-competitive business relationship.

 

 

 

 

 

 

 

Today, for the first time in its 100-year history, the FTC issued enforcement guidelines for cases brought by the agency under the Unfair Methods of Competition (“UMC”) provisions of Section 5 of the FTC Act.

The Statement of Enforcement Principles represents a significant victory for Commissioner Joshua Wright, who has been a tireless advocate for defining and limiting the scope of the Commission’s UMC authority since before his appointment to the FTC in 2013.

As we’ve noted many times before here at TOTM (including in our UMC Guidelines Blog Symposium), FTC enforcement principles for UMC actions have been in desperate need of clarification. Without any UMC standards, the FTC has been free to leverage its costly adjudication process into settlements (or short-term victories) and businesses have been left in the dark as to what what sorts of conduct might trigger enforcement. Through a series of unadjudicated settlements, UMC unfairness doctrine (such as it is) has remained largely within the province of FTC discretion and without judicial oversight. As a result, and either by design or by accident, UMC never developed a body of law encompassing well-defined goals or principles like antitrust’s consumer welfare standard.

Commissioner Wright has long been at the forefront of the battle to rein in the FTC’s discretion in this area and to promote the rule of law. Soon after joining the Commission, he called for Section 5 guidelines that would constrain UMC enforcement to further consumer welfare, tied to the economically informed analysis of competitive effects developed in antitrust law.

Today’s UMC Statement embodies the essential elements of Commissioner Wright’s proposal. Under the new guidelines:

  1. The Commission will make UMC enforcement decisions based on traditional antitrust principles, including the consumer welfare standard;
  2. Only conduct that would violate the antitrust rule of reason will give rise to enforcement, and the Commission will not bring UMC cases without evidence demonstrating that harm to competition outweighs any efficiency or business justifications for the conduct at issue; and
  3. The Commission commits to the principle that it is more appropriate to bring cases under the antitrust laws than under Section 5 when the conduct at issue could give rise to a cause of action under the antitrust laws. Notably, this doesn’t mean that the agency gets to use UMC when it thinks it might lose under the Sherman or Clayton Acts; rather, it means UMC is meant only to be a gap-filler, to be used when the antitrust statutes don’t apply at all.

Yes, the Statement is a compromise. For instance, there is no safe harbor from UMC enforcement if any cognizable efficiencies are demonstrated, as Commissioner Wright initially proposed.

But by enshrining antitrust law’s consumer welfare standard in future UMC caselaw, by obligating the Commission to assess conduct within the framework of the well-established antitrust rule of reason, and by prioritizing antitrust over UMC when both might apply, the Statement brings UMC law into the world of modern antitrust analysis. This is a huge achievement.

It’s also a huge achievement that a Statement like this one would be introduced by Chairwoman Ramirez. As recently as last year, Ramirez had resisted efforts to impose constraints on the FTC’s UMC enforcement discretion. In a 2014 speech Ramirez said:

I have expressed concern about recent proposals to formulate guidance to try to codify our unfair methods principles for the first time in the Commission’s 100 year history. While I don’t object to guidance in theory, I am less interested in prescribing our future enforcement actions than in describing our broad enforcement principles revealed in our recent precedent.

The “recent precedent” that Ramirez referred to is precisely the set of cases applying UMC to reach antitrust-relevant conduct that led to Commissioner Wright’s efforts. The common law of consent decrees that make up the precedent Ramirez refers to, of course, are not legally binding and provide little more than regurgitated causes of action.

But today, under Congressional pressure and pressure from within the agency led by Commissioner Wright, Chairwoman Ramirez and the other two Democratic commissioners voted for the Statement.

Competitive Effects Analysis Under the Statement

As Commissioner Ohlhausen argues in her dissenting statement, the UMC Statement doesn’t remove all enforcement discretion from the Commission — after all, enforcement principles, like standards in law generally, have fuzzy boundaries.

But what Commissioner Ohlhausen seems to miss is that, by invoking antitrust principles, the rule of reason and competitive effects analysis, the Statement incorporates by reference 125 years of antitrust law and economics. The Statement itself need not go into excessive detail when, with only a few words, it brings modern antitrust jurisprudence embodied in cases like Trinko, Leegin, and Brooke Group into UMC law.

Under the new rule of reason approach for UMC, the FTC will condemn conduct only when it causes or is likely to cause “harm to competition or the competitive process, taking into account any associated cognizable efficiencies and business justifications.” In other words, the evidence must demonstrate net harm to consumers before the FTC can take action. That’s a significant constraint.

As noted above, Commissioner Wright originally proposed a safe harbor from FTC UMC enforcement whenever cognizable efficiencies are present. The Statement’s balancing test is thus a compromise. But it’s not really a big move from Commissioner Wright’s initial position.

Commissioner Wright’s original proposal tied the safe harbor to “cognizable” efficiencies, which is an exacting standard. As Commissioner Wright noted in his Blog Symposium post on the subject:

[T]he efficiencies screen I offer intentionally leverages the Commission’s considerable expertise in identifying the presence of cognizable efficiencies in the merger context and explicitly ties the analysis to the well-developed framework offered in the Horizontal Merger Guidelines. As any antitrust practitioner can attest, the Commission does not credit “cognizable efficiencies” lightly and requires a rigorous showing that the claimed efficiencies are merger-specific, verifiable, and not derived from an anticompetitive reduction in output or service. Fears that the efficiencies screen in the Section 5 context would immunize patently anticompetitive conduct because a firm nakedly asserts cost savings arising from the conduct without evidence supporting its claim are unwarranted. Under this strict standard, the FTC would almost certainly have no trouble demonstrating no cognizable efficiencies exist in Dan’s “blowing up of the competitor’s factory” example because the very act of sabotage amounts to an anticompetitive reduction in output.

The difference between the safe harbor approach and the balancing approach embodied in the Statement is largely a function of administrative economy. Before, the proposal would have caused the FTC to err on the side of false negatives, possibly forbearing from bringing some number of welfare-enhancing cases in exchange for a more certain reduction in false positives. Now, there is greater chance of false positives.

But the real effect is that more cases will be litigated because, in the end, both versions would require some degree of antitrust-like competitive effects analysis. Under the Statement, if procompetitive efficiencies outweigh anticompetitive harms, the defendant still wins (and the FTC is to avoid enforcement). Under the original proposal fewer actions might be brought, but those that are brought would surely settle. So one likely outcome of choosing a balancing test over the safe harbor is that more close cases will go to court to be sorted out. Whether this is a net improvement over the safe harbor depends on whether the social costs of increased litigation and error are offset by a reduction in false negatives — as well as the more robust development of the public good of legal case law.  

Reduced FTC Discretion Under the Statement

The other important benefit of the Statement is that it commits the FTC to a regime that reduces its discretion.

Chairwoman Ramirez and former Chairman Leibowitz — among others — have embraced a broader role for Section 5, particularly in order to avoid the judicial limits on antitrust actions arising out of recent Supreme Court cases like Trinko, Leegin, Brooke Group, Linkline, Weyerhaeuser and Credit Suisse.

For instance, as former Chairman Leibowitz said in 2008:

[T]he Commission should not be tied to the more technical definitions of consumer harm that limit applications of the Sherman Act when we are looking at pure Section 5 violations.

And this was no idle threat. Recent FTC cases, including Intel, N-Data, Google (Motorola), and Bosch, could all have been brought under the Sherman Act, but were brought — and settled — as Section 5 cases instead. Under the new Statement, all four would likely be Sherman Act cases.

There’s little doubt that, left unfettered, Section 5 UMC actions would only have grown in scope. Former Chairman Leibowitz, in his concurring opinion in Rambus, described UMC as

a flexible and powerful Congressional mandate to protect competition from unreasonable restraints, whether long-since recognized or newly discovered, that violate the antitrust laws, constitute incipient violations of those laws, or contravene those laws’ fundamental policies.

Both Leibowitz and former Commissioner Tom Rosch (again, among others) often repeated their views that Section 5 permitted much the same actions as were available under Section 2 — but without the annoyance of those pesky, economically sensible, judicial limitations. (Although, in fairness, Leibowitz also once commented that it would not “be wise to use the broader [Section 5] authority whenever we think we can’t win an antitrust case, as a sort of ‘fallback.’”)

In fact, there is a long and unfortunate trend of FTC commissioners and other officials asserting some sort of “public enforcement exception” to the judicial limits on Sherman Act cases. As then Deputy Director for Antitrust in the Bureau of Economics, Howard Shelanski, told Congress in 2010:

The Commission believes that its authority to prevent “unfair methods of competition” through Section 5 of the Federal Trade Commission Act enables the agency to pursue conduct that it cannot reach under the Sherman Act, and thus avoid the potential strictures of Trinko.

In this instance, and from the context (followed as it is by a request for Congress to actually exempt the agency from Trinko and Credit Suisse!), it seems that “reach” means “win.”

Still others have gone even further. Tom Rosch, for example, has suggested that the FTC should challenge Patent Assertion Entities under Section 5 merely because “we have a gut feeling” that the conduct violates the Act and it may not be actionable under Section 2.

Even more egregious, Steve Salop and Jon Baker advocate using Section 5 to implement their preferred social policies — in this case to reduce income inequality. Such expansionist views, as Joe Sims recently reminded TOTM readers, hearken back to the troubled FTC of the 1970s:  

Remember [former FTC Chairman] Mike Pertschuck saying that Section 5 could possibly be used to enforce compliance with desirable energy policies or environmental requirements, or to attack actions that, in the opinion of the FTC majority, impeded desirable employment programs or were inconsistent with the nation’s “democratic, political and social ideals.” The two speeches he delivered on this subject in 1977 were the beginning of the end for increased Section 5 enforcement in that era, since virtually everyone who heard or read them said:  “Whoa! Is this really what we want the FTC to be doing?”

Apparently, for some, it is — even today. But don’t forget: This was the era in which Congress actually briefly shuttered the FTC for refusing to recognize limits on its discretion, as Howard Beales reminds us:

The breadth, overreaching, and lack of focus in the FTC’s ambitious rulemaking agenda outraged many in business, Congress, and the media. Even the Washington Post editorialized that the FTC had become the “National Nanny.” Most significantly, these concerns reverberated in Congress. At one point, Congress refused to provide the necessary funding, and simply shut down the FTC for several days…. So great were the concerns that Congress did not reauthorize the FTC for fourteen years. Thus chastened, the Commission abandoned most of its rulemaking initiatives, and began to re-examine unfairness to develop a focused, injury-based test to evaluate practices that were allegedly unfair.

A truly significant effect of the Policy Statement will be to neutralize the effort to use UMC to make an end-run around antitrust jurisprudence in order to pursue non-economic goals. It will now be a necessary condition of a UMC enforcement action to prove a contravention of fundamental antitrust policies (i.e., consumer welfare), rather than whatever three commissioners happen to agree is a desirable goal. And the Statement puts the brakes on efforts to pursue antitrust cases under Section 5 by expressing a clear policy preference at the FTC to bring such cases under the antitrust laws.

Commissioner Ohlhausen’s objects that

the fact that this policy statement requires some harm to competition does little to constrain the Commission, as every Section 5 theory pursued in the last 45 years, no matter how controversial or convoluted, can be and has been couched in terms of protecting competition and/or consumers.

That may be true, but the same could be said of every Section 2 case, as well. Commissioner Ohlhausen seems to be dismissing the fact that the Statement effectively incorporates by reference the last 45 years of antitrust law, too. Nothing will incentivize enforcement targets to challenge the FTC in court — or incentivize the FTC itself to forbear from enforcement — like the ability to argue Trinko, Leegin and their ilk. Antitrust law isn’t perfect, of course, but making UMC law coextensive with modern antitrust law is about as much as we could ever reasonably hope for. And the Statement basically just gave UMC defendants blanket license to add a string of “See Areeda & Hovenkamp” cites to every case the FTC brings. We should count that as a huge win.

Commissioner Ohlhausen also laments the brevity and purported vagueness of the Statement, claiming that

No interpretation of the policy statement by a single Commissioner, no matter how thoughtful, will bind this or any future Commission to greater limits on Section 5 UMC enforcement than what is in this exceedingly brief, highly general statement.

But, in the end, it isn’t necessarily the Commissioners’ self-restraint upon which the Statement relies; it’s the courts’ (and defendants’) ability to take the obvious implications of the Statement seriously and read current antitrust precedent into future UMC cases. If every future UMC case is adjudicated like a Sherman or Clayton Act case, the Statement will have been a resounding success.

Arguably no FTC commissioner has been as successful in influencing FTC policy as a minority commissioner — over sustained opposition, and in a way that constrains the agency so significantly — as has Commissioner Wright today.