Admirers of the late Supreme Court Justice Louis Brandeis and other antitrust populists often trace the history of American anti-monopoly sentiments from the Founding Era through the Progressive Era’s passage of laws to fight the scourge of 19th century monopolists. For example, Matt Stoller of the American Economic Liberties Project, both in his book Goliath and in other writings, frames the story of America essentially as a battle between monopolists and anti-monopolists.
According to this reading, it was in the late 20th century that powerful corporations and monied interests ultimately succeeded in winning the battle in favor of monopoly power against antitrust authorities, aided by the scholarship of the “ideological” Chicago school of economics and more moderate law & economics scholars like Herbert Hovenkamp of the University of Pennsylvania Law School.
It is a framing that leaves little room for disagreements about economic theory or evidence. One is either anti-monopoly or pro-monopoly, anti-corporate power or pro-corporate power.
What this story muddles is that the dominant anti-monopoly strain from English common law, which continued well into the late 19th century, was opposed specifically to government-granted monopoly. In contrast, today’s “anti-monopolists” focus myopically on alleged monopolies that often benefit consumers, while largely ignoring monopoly power granted by government. The real monopoly problem antitrust law fails to solve is its immunization of anticompetitive government policies. Recovering the older anti-monopoly tradition would better focus activists today.
Common Law Anti-Monopoly Tradition
Scholars like Timothy Sandefur of the Goldwater Institute have written about the right to earn a living that arose out of English common law and was inherited by the United States. This anti-monopoly stance was aimed at government-granted privileges, not at successful business ventures that gained significant size or scale.
For instance, 1602’s Darcy v. Allein, better known as the “Case of Monopolies,” dealt with a “patent” originally granted by Queen Elizabeth I in 1576 to Ralph Bowes, and later bought by Edward Darcy, to make and sell playing cards. Darcy did not innovate playing cards; he merely had permission to be the sole purveyor. Thomas Allein, who attempted to sell playing cards he created, was sued for violating Darcy’s exclusive rights. Darcy’s monopoly ultimately was held to be invalid by the court, which refused to convict Allein.
Edward Coke, who actually argued on behalf of the patent in Darcy v. Allen, wrote that the case stood for the proposition that:
All trades, as well mechanical as others, which prevent idleness (the bane of the commonwealth) and exercise men and youth in labour, for the maintenance of themselves and their families, and for the increase of their substance, to serve the Queen when occasion shall require, are profitable for the commonwealth, and therefore the grant to the plaintiff to have the sole making of them is against the common law, and the benefit and liberty of the subject. (emphasis added)
In essence, Coke’s argument was more closely linked to a “right to work” than to market structures, business efficiency, or firm conduct.
The courts largely resisted royal monopolies in 17th century England, finding such grants to violate the common law. For instance, in The Case of the Tailors of Ipswich, the court cited Darcy and found:
…at the common law, no man could be prohibited from working in any lawful trade, for the law abhors idleness, the mother of all evil… especially in young men, who ought in their youth, (which is their seed time) to learn lawful sciences and trades, which are profitable to the commonwealth, and whereof they might reap the fruit in their old age, for idle in youth, poor in age; and therefore the common law abhors all monopolies, which prohibit any from working in any lawful trade. (emphasis added)
The principles enunciated in these cases were eventually codified in the Statute of Monopolies, which prohibited the crown from granting monopolies in most circumstances. This was especially the case when the monopoly prevented the right to otherwise lawful work.
This common-law tradition also had disdain for private contracts that created monopoly by restraining the right to work. For instance, the famous Dyer’s case of 1414 held that a contract in which John Dyer promised not to practice his trade in the same town as the plaintiff was void for being an unreasonable restraint on trade.The judge is supposed to have said in response to the plaintiff’s complaint that he would have imprisoned anyone who had claimed such a monopoly on his own authority.
Over time, the common law developed analysis that looked at the reasonableness of restraints on trade, such as the extent to which they were limited in geographic reach and duration, as well as the consideration given in return. This part of the anti-monopoly tradition would later constitute the thread pulled on by the populists and progressives who created the earliest American antitrust laws.
Early American Anti-Monopoly Tradition
American law largely inherited the English common law system. It also inherited the anti-monopoly tradition the common law embodied. The founding generation of American lawyers were trained on Edward Coke’s commentary in “The Institutes of the Laws of England,” wherein he strongly opposed government-granted monopolies.
This sentiment can be found in the 1641 Massachusetts Body of Liberties, which stated: “No monopolies shall be granted or allowed amongst us, but of such new Inventions that are profitable to the Countrie, and that for a short time.” In fact, the Boston Tea Party itself was in part a protest of the monopoly granted to the East India Company, which included a special refund from duties by Parliament that no other tea importers enjoyed.
This anti-monopoly tradition also can be seen in the debates at the Constitutional Convention. A proposal to give the federal government power to grant “charters of incorporation” was voted down on fears it could lead to monopolies. Thomas Jefferson, George Mason, and several Antifederalists expressed concerns about the new national government’s ability to grant monopolies, arguing that an anti-monopoly clause should be added to the Constitution. Six states wanted to include provisions that would ban monopolies and the granting of special privileges in the Constitution.
Coinciding with the Industrial Revolution, liberalization of corporate law made it easier for private persons to organize firms that were not simply grants of exclusive monopoly. But discontent with industrialization and other social changes contributed to the birth of a populist movement, and later to progressives like Brandeis, who focused on private combinations and corporate power rather than government-granted privileges. This is the strand of anti-monopoly sentiment that continues to dominate the rhetoric today.
What This Means for Today
Modern anti-monopoly advocates have largely forgotten the lessons of the long Anglo-American tradition that found government is often the source of monopoly power. Indeed, American law privileges government’s ability to grant favors to businesses through licensing, the tax code, subsidies, and even regulation. The state action doctrine from Parker v. Brown exempts state and municipal authorities from antitrust lawsuits even where their policies have anticompetitive effects. And the Noerr-Pennington doctrine protects the rights of industry groups to lobby the government to pass anticompetitive laws.
As a result, government is often used to harm competition, with no remedy outside of the political process that created the monopoly. Antitrust law is used instead to target businesses built by serving consumers well in the marketplace.
Recovering this older anti-monopoly tradition would help focus the anti-monopoly movement on a serious problem modern antitrust misses. While the consumer-welfare standard that modern antitrust advocates often decry has helped to focus the law on actual harms to consumers, antitrust more broadly continues to encourage rent-seeking by immunizing state action and lobbying behavior.
With the COVID-19 vaccine made by Moderna joining the one from Pfizer and BioNTech in gaining approval from the U.S. Food and Drug Administration, it should be time to celebrate the U.S. system of pharmaceutical development. The system’s incentives—notably granting patent rights to firms that invest in new and novel discoveries—have worked to an astonishing degree, producing not just one but as many as three or four effective approaches to end a viral pandemic that, just a year ago, was completely unknown.
Alas, it appears not all observers agree. Now that we have the vaccines, some advocate suspending or limiting patent rights—for example, by imposing a compulsory licensing scheme—with the argument that this is the only way for the vaccines to be produced in mass quantities worldwide. Some critics even assert that abolishing or diminishing property rights in pharmaceuticals is needed to end the pandemic.
In truth, we can effectively and efficiently distribute the vaccines while still maintaining the integrity of our patent system.
What the false framing ignores are the important commercialization and distribution functions that patents provide, as well as the deep, long-term incentives the patent system provides to create medical innovations and develop a robust pharmaceutical supply chain. Unless we are sure this is the last pandemic we will ever face, repealing intellectual property rights now would be a catastrophic mistake.
The supply chains necessary to adequately scale drug production are incredibly complex, and do not appear overnight. The coordination and technical expertise needed to support worldwide distribution of medicines depends on an ongoing pipeline of a wide variety of pharmaceuticals to keep the entire operation viable. Public-spirited officials may in some cases be able to piece together facilities sufficient to produce and distribute a single medicine in the short term, but over the long term, global health depends on profit motives to guarantee the commercialization pipeline remains healthy.
But the real challenge is in maintaining proper incentives to develop new drugs. It has long been understood that information goods like intellectual property will be undersupplied without sufficient legal protections. Innovators and those that commercialize innovations—like researchers and pharmaceutical companies—have less incentive to discover and market new medicines as the likelihood that they will be able to realize a return for their efforts diminishes. Without those returns, it’s far less certain the COVID vaccines would have been produced so quickly, or at all. The same holds for the vaccines we will need for the next crisis or badly needed treatments for other deadly diseases.
Patents are not the only way to structure incentives, as can be seen with the current vaccines. Pharmaceutical companies also took financial incentives from various governments in the form of direct payment or in purchase guarantees. But this enhances, rather than diminishes, the larger argument. There needs to be adequate returns for those who engage in large, risky undertakings like creating a new drug.
Some critics would prefer to limit pharmaceutical companies’ returns solely to those early government investments, but there are problems with this approach. It is difficult for governments to know beforehand what level of profit is needed to properly incentivize firms to engage in producing these innovations. To the extent that direct government investment is useful, it often will be as an additional inducement that encourages new entry by multiple firms who might each pursue different technologies.
Thus, in the case of coronavirus vaccines, government subsidies may have enticed more competitors to enter more quickly, or not to drop out as quickly, in hopes that they would still realize a profit, notwithstanding the risks. Where there might have been only one or two vaccines produced in the United States, it appears likely we will see as many as four.
But there will always be necessary trade-offs. Governments cannot know how to set proper incentives to encourage development of every possible medicine for every possible condition by every possible producer. Not only do we not know which diseases and which firms to prioritize, but we have no idea how to determine which treatment approaches to encourage.
The COVID-19 vaccines provide a clear illustration of this problem. We have seen development of both traditional vaccines and experimental mRNA treatments to combat the virus. Thankfully, both have shown positive results, but there was no way to know that in March. In this perennial state of ignorance,t markets generally have provided the best—though still imperfect—way to make decisions.
The patent system’s critics sometimes claim that prizes would offer a better way to encourage discovery. But if we relied solely on government-directed prizes, we might never have had the needed research into the technology that underlies mRNA. As one recent report put it, “before messenger RNA was a multibillion-dollar idea, it was a scientific backwater.” Simply put, without patent rights as the backstop to purely academic or government-led innovation and commercialization, it is far less likely that we would have seen successful COVID vaccines developed as quickly.
It is difficult for governments to be prepared for the unknown. Abolishing or diminishing pharmaceutical patents would leave us even less prepared for the next medical crisis. That would only add to the lasting damage that the COVID-19 pandemic has already wrought on the world.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
As one of the few economic theorists in this symposium, I believe my comparative advantage is in that: economic theory. In this post, I want to remind people of the basic economic theories that we have at our disposal, “off the shelf,” to make sense of the U.S. Department of Justice’s lawsuit against Google. I do not mean this to be a proclamation of “what economics has to say about X,” but merely just to help us frame the issue.
In particular, I’m going to focus on the economic concerns of Google paying phone manufacturers (Apple, in particular) to be the default search engine installed on phones. While there is not a large literature on the economic effects of default contracts, there is a large literature on something that I will argue is similar: trade promotions, such as slotting contracts, where a manufacturer pays a retailer for shelf space. Despite all the bells and whistles of the Google case, I will argue that, from an economic point of view, the contracts that Google signed are just trade promotions. No more, no less. And trade promotions are well-established as part of a competitive process that ultimately helps consumers.
However, it is theoretically possible that such trade promotions hurt customers, so it is theoretically possible that Google’s contracts hurt consumers. Ultimately, the theoretical possibility of anticompetitive behavior that harms consumers does not seem plausible to me in this case.
There are two reasons that Google paying Apple to be its default search engine is similar to a trade promotion. First, the deal brings awareness to the product, which nudges certain consumers/users to choose the product when they would not otherwise do so. Second, the deal does not prevent consumers from choosing the other product.
In the case of retail trade promotions, a promotional space given to Coca-Cola makes it marginally easier for consumers to pick Coke, and therefore some consumers will switch from Pepsi to Coke. But it does not reduce any consumer’s choice. The store will still have both items.
This is the same for a default search engine. The marginal searchers, who do not have a strong preference for either search engine, will stick with the default. But anyone can still install a new search engine, install a new browser, etc. It takes a few clicks, just as it takes a few steps to walk down the aisle to get the Pepsi; it is still an available choice.
If we were to stop the analysis there, we could conclude that consumers are worse off (if just a tiny bit). Some customers will have to change the default app. We also need to remember that this contract is part of a more general competitive process. The retail stores are also competing with one another, as are smartphone manufacturers.
Despite popular claims to the contrary, Apple cannot charge anything it wants for its phone. It is competing with Samsung, etc. Therefore, Apple has to pass through some of Google’s payments to customers in order to compete with Samsung. Prices are lower because of this payment. As I phrased it elsewhere, Google is effectively subsidizing the iPhone. This cross-subsidization is a part of the competitive process that ultimately benefits consumers through lower prices.
These contracts lower consumer prices, even if we assume that Apple has market power. Those who recall your Econ 101 know that a monopolist chooses a quantity where the marginal revenue equals marginal cost. With a payment from Google, the marginal cost of producing a phone is lower, therefore Apple will increase the quantity and lower price. This is shown below:
One of the surprising things about markets is that buyers’ and sellers’ incentives can be aligned, even though it seems like they must be adversarial. Companies can indirectly bargain for their consumers. Commenting on Standard Fashion Co. v. Magrane-Houston Co., where a retail store contracted to only carry Standard’s products, Robert Bork (1978, pp. 306–7) summarized this idea as follows:
The store’s decision, made entirely in its own interest, necessarily reflects the balance of competing considerations that determine consumer welfare. Put the matter another way. If no manufacturer used exclusive dealing contracts, and if a local retail monopolist decided unilaterally to carry only Standard’s patterns because the loss in product variety was more than made up in the cost saving, we would recognize that decision was in the consumer interest. We do not want a variety that costs more than it is worth … If Standard finds it worthwhile to purchase exclusivity … the reason is not the barring of entry, but some more sensible goal, such as obtaining the special selling effort of the outlet.
How trade promotions could harm customers
Since Bork’s writing, many theoretical papers have shown exceptions to Bork’s logic. There are times that the retailers’ incentives are not aligned with the customers. And we need to take those possibilities seriously.
The most common way to show the harm of these deals (or more commonly exclusivity deals) is to assume:
There are large, fixed costs so that a firm must acquire a sufficient number of customers in order to enter the market; and
An incumbent can lock in enough customers to prevent the entrant from reaching an efficient size.
Consumers can be locked-in because there is some fixed cost of changing suppliers or because of some coordination problems. If that’s true, customers can be made worse off, on net, because the Google contracts reduce consumer choice.
To understand the logic, let’s simplify the model to just search engines and searchers. Suppose there are two search engines (Google and Bing) and 10 searchers. However, to operate profitably, each search engine needs at least three searchers. If Google can entice eight searchers to use its product, Bing cannot operate profitably, even if Bing provides a better product. This holds even if everyone knows Bing would be a better product. The consumers are stuck in a coordination failure.
We should be skeptical of coordination failure models of inefficient outcomes. The problem with any story of coordination failures is that it is highly sensitive to the exact timing of the model. If Bing can preempt Google and offer customers an even better deal (the new entrant is better by assumption), then the coordination failure does not occur.
To argue that Bing could not execute a similar contract, the most common appeal is that the new entrant does not have the capital to pay upfront for these contracts, since it will only make money from its higher-quality search engine down the road. That makes sense until you remember that we are talking about Microsoft. I’m skeptical that capital is the real constraint. It seems much more likely that Google just has a more popular search engine.
The other problem with coordination failure arguments is that they are almost non-falsifiable. There is no way to tell, in the model, whether Google is used because of a coordination failure or whether it is used because it is a better product. If Google is a better product, then the outcome is efficient. The two outcomes are “observationally equivalent.” Compare this to the standard theory of monopoly, where we can (in principle) establish an inefficiency if the price is greater than marginal cost. While it is difficult to measure marginal cost, it can be done.
There is a general economic idea in these models that we need to pay attention to. If Google takes an action that prevents Bing from reaching efficient size, that may be an externality, sometimes called a network effect, and so that action may hurt consumer welfare.
I’m not sure how seriously to take these network effects. If more searchers allow Bing to make a better product, then literally any action (competitive or not) by Google is an externality. Making a better product that takes away consumers from Bing lowers Bing’s quality. That is, strictly speaking, an externality. Surely, that is not worthy of antitrust scrutiny simply because we find an externality.
And Bing also “takes away” searchers from Google, thus lowering Google’s possible quality. With network effects, bigger is better and it may be efficient to have only one firm. Surely, that’s not an argument we want to put forward as a serious antitrust analysis.
Put more generally, it is not enough to scream “NETWORK EFFECT!” and then have the antitrust authority come in, lawsuits-a-blazing. Well, it shouldn’t be enough.
For me to take the network effect argument seriously from an economic point of view, compared to a legal perspective, I would need to see a real restriction on consumer choice, not just an externality. One needs to argue that:
No competitor can cover their fixed costs to make a reasonable search engine; and
These contracts are what prevent the competing search engines from reaching size.
That’s the challenge I would like to put forward to supporters of the lawsuit. I’m skeptical.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
On October 20, 2020, the U.S. Department of Justice (DOJ) and eleven states with Republican attorneys general sued Google for monopolizing and attempting to monopolize the markets for general internet search services, search advertising, and “general search text” advertising (i.e., ads that resemble search results). Last week, California joined the lawsuit, making it a bipartisan affair.
DOJ and the states (collectively, “the government”) allege that Google has used contractual arrangements to expand and cement its dominance in the relevant markets. In particular, the government complains that Google has agreed to share search ad revenues in exchange for making Google Search the default search engine on various “search access points.”
Google has entered such agreements with Apple (for search on iPhones and iPads), manufacturers of Android devices and the mobile service carriers that support them, and producers of web browsers. Google is also pursuing default status on new internet-enabled consumer products, such as voice assistants and “smart” TVs, appliances, and wearables. In the government’s telling, this all amounts to Google’s sharing of monopoly profits with firms that can ensure its continued monopoly by imposing search defaults that users are unlikely to alter.
There are several obvious weaknesses with the government’s case. One is that preset internet defaults are super easy to change and, in other contexts, are regularly altered. For example, while 88% of desktop and laptop computers use the Windows operating system, which defaults to a Microsoft browser (Internet Explorer or Edge), Google’s Chrome browser commands a 69% market share on desktops and laptops, compared to around 13% for Internet Explorer and Edge combined. Changing a default search engine is as easy as changing a browser default—three simple steps on an iPhone!—and it seems consumers will change defaults they don’t actually prefer.
A second obvious weakness, related to the first, is that the government has alleged no facts suggesting that Google’s search rivals—primarily Bing, Yahoo, and DuckDuckGo—would have enjoyed more success but for Google’s purportedly exclusionary agreements. Even absent default status, people likely would have selected Google Search because it’s the better search engine. It doesn’t seem the challenged arrangements caused Google’s search dominance.
Admittedly, the standard of causation in monopolization cases (at least those seeking only injunctive relief) is low. The D.C. Circuit’s Microsoft decision described it as “edentulous” or, less pretentiously, toothless. Nevertheless, the government is unlikely to prevail in its action against Google—and that’s a good thing. Below, I highlight the central deficiency in the government’s Google case and point out problems with the government’s challenges to each of Google’s purportedly exclusionary arrangements.
The Lawsuit’s Overarching Deficiency
We’ve all had the experience of typing a query only to have Google, within a few key strokes, accurately predict what we were going to ask and provide us with exactly the answer we were looking for. It’s both eerie and awesome, and it keeps us returning to Google time and again.
But it’s not magic. Nor has Google hacked our brains. Google is so good at predicting our questions and providing responsive search results because its top-notch algorithms process gazillions of searches and can “learn” from users’ engagement. Scale is thus essential to Google’s quality.
The government’s complaint concedes as much. It acknowledges that “[g]reater scale improves the quality of a general search engine’s algorithms” (¶35) and that “[t]he additional data from scale allows improved automated learning for algorithms to deliver more relevant results, particularly on ‘fresh’ queries (queries seeking recent information), location-based queries (queries asking about something in the searcher’s vicinity), and ‘long-tail’ queries (queries used infrequently)” (¶36). The complaint also asserts that “[t]he most effective way to achieve scale is for the general search engine to be the preset default on mobile devices, computers, and other devices…” (¶38).
Oddly, though, the government chides Google for pursuing “[t]he most effective way” of securing the scale that concededly “improves the quality of a general search engine’s algorithms.” Google’s efforts to ensure and enhance its own product quality are improper, the government says, because “they deny rivals scale to compete effectively” (¶8). In the government’s view, Google is legally obligated to forego opportunities to make its own product better so as to give its rivals a chance to improve their own offerings.
This is inconsistent with U.S. antitrust law. Just as firms are not required to hold their prices high to create a price umbrella for their less efficient rivals, they need not refrain from efforts to improve the quality of their own offerings so as to give their rivals a foothold.
Antitrust does forbid anticompetitive foreclosure of rivals—i.e., business-usurping arrangements that are not the result of efforts to compete on the merits by reducing cost or enhancing quality. But firms are, and should be, free to make their products better, even if doing so makes things more difficult for their rivals. Antitrust, after all, protects competition, not competitors.
The central deficiency in the government’s case is that it concedes that scale is crucial to search engine quality, but it does not assert that there is a “minimum efficient scale”—i.e., a point at which scale economies are exhausted. If a firm takes actions to enhance its own scale beyond minimum efficient scale, and if its efforts may hold its rivals below such scale, then it may have engaged in anticompetitive foreclosure. But a firm that pursues scale that makes its products better is simply competing on the merits.
The government likely did not allege that there is a minimum efficient scale in general internet search services because returns to scale go on indefinitely, or at least for a very long time. But the absence of such an allegation damns the government’s case against Google, for it implies that Google’s efforts to secure the distribution, and thus the greater use, of its services make those services better.
In this regard, the Microsoft case, which the government points to as a model for its action against Google (¶10), is inapposite. Inthat case, the government alleged that Microsoft had entered license agreements that foreclosed Netscape, a potential rival, from the best avenues of browser distribution: original equipment manufacturers (OEMs) and internet access providers. The government here similarly alleges that Google has foreclosed rival search engines from the best avenues of search distribution: default settings on mobile devices and web browsers. But a key difference (in addition to the fact that search defaults are quite easy to change) is that Microsoft’s license restrictions foreclosed Netscape without enhancing the quality of Microsoft’s offerings. Indeed, the court emphasized that the challenged Microsoft agreements were anticompetitive because they “reduced rival browsers’ usage share not by improving [Microsoft’s] own product but, rather, by preventing OEMs from taking actions that could increase rivals’ share of usage” (emphasis added). Here, any foreclosure of Google’s search rivals is incidental to Google’s efforts to improve its product by enhancing its scale.
Now, the government might contend that the anticompetitive harms from raising rivals’ distribution costs exceed the procompetitive benefits of enhancing the quality of Google’s search services. Courts, though, have generally been skeptical of claims that exclusion-causing product enhancements are anticompetitive because they do more harm than good. There’s a sound reason for this: courts are ill-equipped to weigh the benefits of product enhancements against the costs of competition reductions resulting from product-enhancement efforts. For that reason, they should—and likely will—stick with the rule that this sort of product-enhancing conduct is competition on the merits, even if it has the incidental effect of raising rivals’ costs. And if they do so, the government will lose this case.
Problems with the Government’s Specific Challenges
Agreements with Android OEMs and Wireless Carriers
The government alleges that Google has foreclosed its search rivals from distribution opportunities on the Android platform. It has done so, the government says, by entering into exclusion-causing agreements with OEMs that produce Android products (Samsung, Motorola, etc.) and with carriers that provide wireless service for Android devices (AT&T, Verizon, etc.).
Android is an open source operating system that is owned by Google and licensed, for free, to producers of mobile internet devices. Under the terms of the challenged agreements, Google’s counterparties promise not to produce Android “forks”—operating systems that are Android-based but significantly alter or “fragment” the basic platform—in order to get access to proprietary Google apps that Android users typically desire and to certain application protocol interfaces (APIs) that enable various functionalities. In addition to these “anti-forking agreements,” counterparties enter various “pre-installation agreements” obligating them to install a suite of Google apps that use Google Search as a default. Installing that suite is a condition for obtaining the right to pre-install Google’s app store (Google Play) and other must-have apps. Finally, OEMs and carriers enter “revenue sharing agreements” that require the use of Google Search as the sole preset default on a number of search access points in exchange for a percentage of search ad revenue derived from covered devices. Taken together, the government says, these anti-forking, pre-installation, and revenue-sharing agreements preclude the emergence of Android rivals (from forks) and ensure the continued dominance of Google Search on Android devices.
Eliminating these agreements, though, would likely harm consumers by reducing competition in the market for mobile operating systems. Within that market, there are two dominant players: Apple’s iOS and Google’s Android. Apple earns money off iOS by selling hardware—iPhones and iPads that are pre-installed with iOS. Google licenses Android to OEMs for free but then earns advertising revenue off users’ searches (which provide an avenue for search ads) and other activities (which generate user data for better targeted display ads). Apple and Google thus compete on revenue models. As Randy Picker has explained, Microsoft tried a third revenue model—licensing a Windows mobile operating system to OEMs for a fee—but it failed. The continued competition between Apple and Google, though, allows for satisfaction of heterogenous consumer preferences: Apple products are more expensive but more secure (due to Apple’s tight control over software and hardware); Android devices are cheaper (as the operating system is ad-supported) and offer more innovations (as OEMs have more flexibility), but tend to be less secure. Such variety—a result of business model competition—is good for consumers.
If the government were to prevail and force Google to end the agreements described above, thereby reducing the advertising revenue Google derives from Android, Google would have to either copy Apple’s vertically integrated model so as to recoup its Android investments through hardware sales, charge OEMs for Android (a la Microsoft), or cut back on its investments in Android. In each case, consumers would suffer. The first option would take away an offering preferred by many consumers—indeed most globally, as Android dominates iOS on a worldwide basis. The second option would replace Google’s business model with one that failed, suggesting that consumers value it less. The third option would reduce product quality in the market for mobile operating systems.
In the end, then, the government’s challenge to Google’s Android agreements is myopic and misguided. Competition among business models, like competition along any dimension, inures to the benefit of consumers. Precluding it as the government is demanding would be silly.
Agreements with Browser Producers
Web browsers like Apple’s Safari and Mozilla’s Firefox are a primary distribution channel for search engines. The government claims that Google has illicitly foreclosed rival search engines from this avenue of distribution by entering revenue-sharing agreements with the major non-Microsoft browsers (i.e., all but Microsoft’s Edge and Internet Explorer). Under those agreements, Google shares up to 40% of ad revenues generated from a browser in exchange for being the preset default on both computer and mobile versions of the browser.
Surely there is no problem, though, with search engines paying royalties to web browsers. That’s how independent browsers like Opera and Firefox make money! Indeed, 95% of Firefox’s revenue comes from search royalties. If browsers were precluded from sharing in search engines’ ad revenues, they would have to find an alternative source of financing. Producers of independent browsers would likely charge license fees, which consumers would probably avoid. That means the only available browsers would be those affiliated with an operating system (Microsoft’s Edge, Apple’s Safari) or a search engine (Google’s Chrome). It seems doubtful that reducing the number of viable browsers would benefit consumers. The law should therefore allow payment of search royalties to browsers. And if such payments are permitted, a browser will naturally set its default search engine so as to maximize its payout.
Google’s search rivals can easily compete for default status on a browser by offering a better deal to the browser producer. In 2014, for example, search engine Yahoo managed to wrest default status on Mozilla’s Firefox away from Google. The arrangement was to last five years, but in 2017, Mozilla terminated the agreement and returned Google to default status because so many Firefox users were changing the browser’s default search engine from Yahoo to Google. This historical example undermines the government’s challenges to Google’s browser agreements by showing (1) that other search engines can attain default status by competing, and (2) that defaults aren’t as “sticky” as the government claims—at least, not when the default is set to a search engine other than the one most people prefer.
In short, there’s nothing anticompetitive about Google’s browser agreements, and enjoining such deals would likely injure consumers by reducing competition among browsers.
Agreements with Apple
That brings us to the allegations that have gotten the most attention in the popular press: those concerning Google’s arrangements with Apple. The complaint alleges that Google pays Apple $8-12 billion a year—a whopping 15-20% of Apple’s net income—for granting Google default search status on iOS devices. In the government’s telling, Google is agreeing to share a significant portion of its monopoly profits with Apple in exchange for Apple’s assistance in maintaining Google’s search monopoly.
An alternative view, of course, is that Google is just responding to Apple’s power: Apple has assembled a giant installed base of loyal customers and can demand huge payments to favor one search engine over another on its popular mobile devices. In that telling, Google may be paying Apple to prevent it from making Bing or another search engine the default on Apple’s search access points.
If that’s the case, what Google is doing is both procompetitive and a boon to consumers. Microsoft could easily outbid Google to have Bing set as the default search engine on Apple’s devices. Microsoft’s market capitalization exceeds that of Google parent Alphabet by about $420 billion ($1.62 trillion versus $1.2 trillion), which is roughly the value of Walmart. Despite its ability to outbid Google for default status, Microsoft hasn’t done so, perhaps because it realizes that defaults aren’t that sticky when the default service isn’t the one most people prefer. Microsoft knows that from its experience with Internet Explorer and Edge (which collectively command only around 13% of the desktop browser market even though they’re the defaults on Windows, which has a 88% market share on desktops and laptops), and from its experience with Bing (where “Google” is the number one search term). Nevertheless, the possibility remains that Microsoft could outbid Google for default status, improve its quality to prevent users from changing the default (or perhaps pay users for sticking with Bing), and thereby take valuable scale from Google, impairing the quality of Google Search. To prevent that from happening, Google shares with Apple a generous portion of its search ad revenues, which, given the intense competition for mobile device sales, Apple likely passes along to consumers in the form of lower phone and tablet prices.
If the government succeeds in enjoining Google’s payments to Apple for default status, other search engines will presumably be precluded from such arrangements as well. After all, the “foreclosure” effect of paying for default search status on Apple products is the same regardless of which search engine does the paying, and U.S. antitrust law does not “punish” successful firms by forbidding them from engaging in competitive activities that are open to their rivals.
Ironically, then, the government’s success in its challenge to Google’s Apple payments would benefit Google at the expense of consumers: Google would almost certainly remain the default search engine on Apple products, as it is most preferred by consumers and no rival could pay to dislodge it; Google would not have to pay a penny to retain its default status; and Apple would lose revenues that it likely passes along to consumers in the form of lower prices. The courts are unlikely to countenance this perverse result by ruling that Google’s arrangements with Apple violate the antitrust laws.
Arrangements with Producers of Internet-Enabled “Smart” Devices
The final part of the government’s case against Google starkly highlights a problem that is endemic to the entire lawsuit. The government claims that Google, having locked up all the traditional avenues of search distribution with the arrangements described above, is now seeking to foreclose search distribution in the new avenues being created by internet-enabled consumer products like wearables (e.g., smart watches), voice assistants, smart TVs, etc. The alleged monopolistic strategy is similar to those described above: Google will share some of its monopoly profits in exchange for search default status on these smart devices, thereby preventing rival search engines from attaining valuable scale.
It’s easy to see in this context, though, why Google’s arrangements are likely procompetitive. Unlike web browsers, mobile phones, and tablets, internet-enabled smart devices are novel. Innovators are just now discovering new ways to embed internet functionality into everyday devices.
Putting oneself in the position of these innovators helps illuminate a key beneficial aspect of Google’s arrangements: They create an incentive to develop new and attractive means of distributing search. Innovators currently at work on internet-enabled devices are no doubt spurred on by the possibility of landing a lucrative distribution agreement with Google or another search engine. Banning these sorts of arrangements—the consequence of governmental success in this lawsuit—would diminish the incentive to innovate.
But that can be said of every single one of the arrangements the government is challenging. Because of Google’s revenue-sharing with search distributors, each of them has an added incentive to make their distribution channels desirable to consumers. Android OEMs and Apple will work harder to produce mobile devices that people will want to use for internet searches; browser producers will endeavor to improve their offerings. By paying producers of search access points a portion of the search ad revenues generated on their platforms, Google motivates them to generate more searches, which they can best do by making their products as attractive as possible.
At the end of the day, then, the government’s action against Google seeks to condemn conduct that benefits consumers. Because of the challenged arrangements, Google makes its own search services better, is able to license Android for free, ensures the continued existence of independent web browsers like Firefox and Opera, helps lower the price of iPhones and iPads, and spurs innovators to develop new “Internet of Things” devices that can harness the power of the web.
The Biden administration would do well to recognize this lawsuit for what it is: a poorly conceived effort to appear to be “doing something” about a Big Tech company that has drawn the ire (for different reasons) of both progressives and conservatives. DOJ and its state co-plaintiffs should seek dismissal of this action.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
U.S. antitrust regulators have a history of narrowly defining relevant markets—often to the point of absurdity—in order to create market power out of thin air. The Federal Trade Commission (FTC) famously declared that Whole Foods and Wild Oats operated in the “premium natural and organic supermarkets market”—a narrowly defined market designed to exclude other supermarkets carrying premium natural and organic foods, such as Walmart and Kroger. Similarly, for the Staples-Office Depot merger, the FTC
narrowly defined the relevant market as “office superstore” chains, which excluded general merchandisers such as Walmart, K-Mart and Target, who at the time accounted for 80% of office supply sales.
Texas Attorney General Ken Paxton’s complaint against Google’s advertising business, joined by the attorneys general of nine other states, continues this tradition of narrowing market definition to shoehorn market dominance where it may not exist.
For example, one recent paper critical of Google’s advertising business narrows the relevant market first from media advertising to digital advertising, then to the “open” supply of display ads and, finally, even further to the intermediation of the open supply of display ads. Once the market has been sufficiently narrowed, the authors conclude Google’s market share is “perhaps sufficient to confer market power.”
While whittling down market definitions may achieve the authors’ purpose of providing a roadmap to prosecute Google, one byproduct is a mishmash of market definitions that generates as many as 16 relevant markets for digital display and video advertising, in many of which Google doesn’t have anything approaching market power (and in some of which, in fact, Facebook, and not Google, is the most dominant player).
The Texas complaint engages in similar relevant-market gerrymandering. It claims that, within digital advertising, there exist several relevant markets and that Google monopolizes four of them:
Publisher ad servers, which manage the inventory of a publisher’s (e.g., a newspaper’s website or a blog) space for ads;
Display ad exchanges, the “marketplace” in which auctions directly match publishers’ selling of ad space with advertisers’ buying of ad space;
Display ad networks, which are similar to exchanges, except a network acts as an intermediary that collects ad inventory from publishers and sells it to advertisers; and
Display ad-buying tools, which include demand-side platforms that collect bids for ad placement with publishers.
The complaint alleges, “For online publishers and advertisers alike, the different online advertising formats are not interchangeable.” But this glosses over a bigger challenge for the attorneys general: Is online advertising a separate relevant market from offline advertising?
Digital advertising, of which display advertising is a small part, is only one of many channels through which companies market their products. About half of today’s advertising spending in the United States goes to digital channels, up from about 10% a decade ago. Approximately 30% of ad spending goes to television, with the remainder going to radio, newspapers, magazines, billboards and other “offline” forms of media.
Physical newspapers now account for less than 10% of total advertising spending. Traditionally, newspapers obtained substantial advertising revenues from classified ads. As internet usage increased, newspaper classifieds have been replaced by less costly and more effective internet classifieds—such as those offered by Craigslist—or targeted ads on Google Maps or Facebook.
The price of advertising has fallen steadily over the past decade, while output has risen. Spending on digital advertising in the United States grew from $26 billion in 2010 to nearly $130 billion in 2019, an average increase of 20% a year. Over the same period, the producer price index (PPI) for internet advertising sales declined by nearly 40%. Rising spending in the face of falling prices indicates the number of ads bought and sold increased by approximately 27% a year.
Since 2000, advertising spending has been falling as a share of gross domestic product, with online advertising growing as a share of that. The combination of increasing quantity, decreasing cost and increasing total revenues are consistent with a growing and increasingly competitive market, rather than one of rising concentration and reduced competition.
There is little or no empirical data evaluating the extent to which online and offline advertising constitute distinct markets or the extent to which digital display is a distinct submarket of online advertising. As a result, analysis of adtech competition has relied on identifying several technical and technological factors—as well as the say-so of participants in the business—that the analysts assert distinguish online from offline and establish digital display (versus digital search) as a distinct submarket. This approach has been used and accepted, especially in cases in which pricing data has not been available.
But the pricing information that is available raises questions about the extent to which online advertising is a distinct market from offline advertising. For example, Avi Goldfarb and Catherine Tucker find that, when local regulations prohibit offline direct advertising, search advertising is more expensive, indicating that search and offline advertising are substitutes. In other research, they report that online display advertising circumvents, in part, local bans on offline billboard advertising for alcoholic beverages. In both studies, Goldfarb and Tucker conclude their results suggest online and offline advertising are substitutes. They also conclude this substitution suggests that online and offline markets should be considered together in the context of antitrust.
While this information is not sufficient to define a broader relevant market, it raises questions regarding solely relying on the technical or technological distinctions and the say-so of market participants.
In the United States, plaintiffs do not get to define the relevant market. That is up to the judge or the jury. Plaintiffs have the burden to convince the court that a proposed narrow market definition is the correct one. With strong evidence that online and offline ads are substitutes, the court should not blindly accept the gerrymandered market definitions posited by the attorneys general.
The European Commission has unveiled draft legislation (the Digital Services Act, or “DSA”) that would overhaul the rules governing the online lives of its citizens. The draft rules are something of a mixed bag. While online markets present important challenges for law enforcement, the DSA would significantly increase the cost of doing business in Europe and harm the very freedoms European lawmakers seek to protect. The draft’s newly proposed “Know Your Business Customer” (KYBC) obligations, however, will enable smoother operation of the liability regimes that currently apply to online intermediaries.
These reforms come amid a rash of headlines about election meddling, misinformation, terrorist propaganda, child pornography, and other illegal and abhorrent content spread on digital platforms. These developments have galvanized debate about online liability rules.
Existing rules, codified in the e-Commerce Directive, largely absolve “passive” intermediaries that “play a neutral, merely technical and passive role” from liability for content posted by their users so long as they remove it once notified. “Active” intermediaries have more legal exposure. This regime isn’t perfect, but it seems to have served the EU well in many ways.
With its draft regulation, the European Commission is effectively arguing that those rules fail to address the legal challenges posed by the emergence of digital platforms. As the EC’s press release puts it:
The landscape of digital services is significantly different today from 20 years ago, when the eCommerce Directive was adopted. […] Online intermediaries […] can be used as a vehicle for disseminating illegal content, or selling illegal goods or services online. Some very large players have emerged as quasi-public spaces for information sharing and online trade. They have become systemic in nature and pose particular risks for users’ rights, information flows and public participation.
Online platforms initially hoped lawmakers would agree to some form of self-regulation, but those hopes were quickly dashed. Facebook released a white paper this Spring proposing a more moderate path that would expand regulatory oversight to “ensure companies are making decisions about online speech in a way that minimizes harm but also respects the fundamental right to free expression.” The proposed regime would not impose additional liability for harmful content posted by users, a position that Facebook and other internet platforms reiterated during congressional hearings in the United States.
European lawmakers were not moved by these arguments. EU Commissioner for Internal Market and Services Thierry Breton, among other European officials, dismissed Facebook’s proposal within hours of its publication, saying:
It’s not enough. It’s too slow, it’s too low in terms of responsibility and regulation.
Against this backdrop, the draft DSA includes many far-reaching measures: transparency requirements for recommender systems, content moderation decisions, and online advertising; mandated sharing of data with authorities and researchers; and numerous compliance measures that include internal audits and regular communication with authorities. Moreover, the largest online platforms—so-called “gatekeepers”—will have to comply with a separate regulation that gives European authorities new tools to “protect competition” in digital markets (the Digital Markets Act, or “DMA”).
The upshot is that, if passed into law, the draft rules will place tremendous burdens upon online intermediaries. This would be self-defeating.
Excessive regulation or liability would significantly increase their cost of doing business, leading to significantly smaller networks and significantly increased barriers to access for many users. Stronger liability rules would also encourage platforms to play it safe, such as by quickly de-platforming and refusing access to anyone who plausibly engaged in illegal activity. Such an outcome would harm the very freedoms European lawmakers seek to protect.
This could prove particularly troublesome for small businesses that find it harder to compete against large platforms due to rising compliance costs. In effect, the new rules will increase barriers to entry, as has already been seen with the GDPR.
In the commission’s defense, some of the proposed reforms are more appealing. This is notably the case with the KYBC requirements, as well as the decision to leave most enforcement to member states, where services providers have their main establishments. The latter is likely to preserve regulatory competition among EU members to attract large tech firms, potentially limiting regulatory overreach.
Indeed, while the existing regime does, to some extent, curb the spread of online crime, it does little for the victims of cybercrime, who ultimately pay the price. Removing illegal content doesn’t prevent it from reappearing in the future, sometimes on the same platform. Importantly, hosts have no obligation to provide the identity of violators to authorities, or even to know their identity in the first place. The result is an endless game of “whack-a-mole”: illegal content is taken down, but immediately reappears elsewhere. This status quo enables malicious users to upload illegal content, such as that which recently led card networks to cut all ties with Pornhub.
Victims arguably need additional tools. This is what the Commission seeks to achieve with the DSA’s “traceability of traders” requirement, a form of KYBC:
Where an online platform allows consumers to conclude distance contracts with traders, it shall ensure that traders can only use its services to promote messages on or to offer products or services to consumers located in the Union if, prior to the use of its services, the online platform has obtained the following information: […]
Instead of rewriting the underlying liability regime—with the harmful unintended consequences that would likely entail—the draft DSA creates parallel rules that require platforms to better protect victims.
Under the proposed rules, intermediaries would be required to obtain the true identity of commercial clients (as opposed to consumers) and to sever ties with businesses that refuse to comply (rather than just take down their content). Such obligations would be, in effect, a version of the “Know Your Customer” regulations that exist in other industries. Banks, for example, are required to conduct due diligence to ensure scofflaws can’t use legitimate financial services to further criminal enterprises. It seems reasonable to expect analogous due diligence from the Internet firms that power so much of today’s online economy.
Obligations requiring platforms to vet their commercial relationships may seem modest, but they’re likely to enable more effective law enforcement against the actual perpetrators of online harms without diminishing platform’s innovation and the economic opportunity they provide (and that everyone agrees is worth preserving).
There is no silver bullet. Illegal activity will never disappear entirely from the online world, just as it has declined, but not vanished, from other walks of life. But small regulatory changes that offer marginal improvements can have a substantial effect. Modest informational requirements would weed out the most blatant crimes without overly burdening online intermediaries. In short, it would make the Internet a safer place for European citizens.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
It is my endeavor to scrutinize the questionable assessment articulated against default settings in the U.S. Justice Department’s lawsuit against Google. Default, I will argue, is no antitrust fault. Default in the Google case drastically differs from default referred to in the Microsoft case. In Part I, I argue the comparison is odious. Furthermore, in Part II, it will be argued that the implicit prohibition of default settings echoes, as per listings, the explicit prohibition of self-preferencing in search results. Both aspects – default’s implicit prohibition and self-preferencing’s explicit prohibition – are the two legs of a novel and integrated theory of sanctioning corporate favoritism. The coming to the fore of such theory goes against the very essence of the capitalist grain. In Part III, I note the attempt to instill some corporate selflessness is at odds with competition on the merits and the spirit of fundamental economic freedoms.
When Default is No-Fault
The recent complaint filed by the DOJ and 11 state attorneys general claims that Google has abused its dominant position on the search-engine market through several ways, notably making Google the default search engine both in Google Chrome web browser for Android OS and in Apple’s Safari web browser for iOS. Undoubtedly, default setting confers a noticeable advantage for users’ attraction – it is sought and enforced on purpose. Nevertheless, the default setting confers an unassailable position unless the product remains competitive. Furthermore, the default setting can hardly be proven to be anticompetitive in the Google case. Indeed, the DOJ puts considerable effort in the complaint to make the Google case resemble the 20-year-old Microsoft case. Former Federal Trade Commission Chairman William Kovacic commented: “I suppose the Justice Department is telling the court, ‘You do not have to be scared of this case. You’ve done it before […] This is Microsoft part 2.”
However, irrespective of the merits of the Microsoft case two decades ago, the Google default setting case bears minimal resemblance to the Microsoft default setting of Internet Explorer. First, as opposed to the Microsoft case, where default by Microsoft meant pre-installed software (i.e., Internet Explorer), the Google case does not relate to the pre-installment of the Google search engine (since it is just a webpage) but a simple setting. This technical difference is significant: although “sticky”, the default setting, can be outwitted with just one click. It is dissimilar to the default setting, which can only be circumvented by uninstalling software, searching and installing a new one. Moreover, with no certainty that consumers will effectively use Google search engine, default settings come with advertising revenue sharing agreements between Google and device manufacturers, mobile phone carriers, competing browsers and Apple. These mutually beneficial deals represent a significant cost with no technical exclusivity . In other words, the antitrust treatment of a tie-in between software and hardware in the Microsoft case cannot be convincingly extrapolated to the default setting of a “webware” as relevant in the Google case.
Second, the Google case cannot legitimately resort to extrapolating the Microsoft case for another technical (and commercial) aspect: the Microsoft case was a classic tie-in case where the tied product (Internet Explorer) was tied into the main product (Windows). As a traditional tie-in scenario, the tied product (Internet Explorer) was “consistently offered, promoted, and distributed […] as a stand-alone product separate from, and not as a component of, Windows […]”. In contrast, Google has never sold Google Chrome or Android OS. It offered both Google Chrome and Android OS for free, necessarily conditional to Google search engine as default setting. The very fact that Google Chrome or Android OS have never been “stand-alone” products, to use the Microsoft case’s language, together with the absence of software installation, dramatically differentiates the features pertaining to the Google case from those of the Microsoft case. The Google case is not a traditional tie-in case: it is a case against default setting when both products (the primary and related products) are given for free, are not saleable, are neither tangible nor intangible goods but only popular digital services due to significant innovativeness and ease of usage. The Microsoft “complaint challenge[d] only Microsoft’s concerted attempts to maintain its monopoly in operating systems and to achieve dominance in other markets, not by innovation and other competition on the merits, but by tie-ins.” Quite noticeably, the Google case does not mention tie-in ,as per Google Chrome or Android OS.
The complaint only refers to tie-ins concerning Google’s app being pre-installed on Android OS. Therefore, concerning Google’s dominance on the search engine market, it cannot be said that the default setting of Google search in Android OS entails tie-in. Google search engine has no distribution channel (since it is only a website) other than through downstream partnerships (i.e., vertical deals with Android device manufacturers). To sanction default setting on downstream trading partners is tantamount to refusing legitimate means to secure distribution channels of proprietary and zero-priced services. To further this detrimental logic, it would mean that Apple may no longer offer its own apps in its own iPhones or, in offline markets, that a retailer may no longer offer its own (default) bags at the till since it excludes rivals’ sale bags. Products and services naked of any adjacent products and markets (i.e., an iPhone or Android OS with no app or a shopkeeper with no bundled services) would dramatically increase consumers’ search costs while destroying innovators’ essential distribution channels for innovative business models and providing few departures from the status quo as long as consumers will continue to value default products.
Default should not be an antitrust fault: the Google case makes default settings a new line of antitrust injury absent tie-ins. In conclusion, as a free webware, Google search’s default setting cannot be compared to default installation in the Microsoft case since minimal consumer stickiness entails (almost) no switching costs. As free software, Google’s default apps cannot be compared to Microsoft case either since pre-installation is the sine qua non condition of the highly valued services (Android OS) voluntarily chosen by device manufacturers. Default settings on downstream products can only be reasonably considered as antitrust injury when the dominant company is erroneously treated as a de facto essential facility – something evidenced by the similar prohibition of self-preferencing.
When Self-Preference is No Defense
Self-preferencing is to listings what the default setting is to operating systems. They both are ways to market one’s own products (i.e., alternative to marketing toward end-consumers). While default setting may come with both free products and financial payments (Android OS and advertising revenue sharing), self-preferencing may come with foregone advertising revenues in order to promote one’s own products. Both sides can be apprehended as the two sides of the same coin: generating the ad-funded main product’s distribution channels – Google’s search engine. Both are complex advertising channels since both venues favor one’s own products regarding consumers’ attention. Absent both channels, the payments made for default agreements and the foregone advertising revenues in self-preferencing one’s own products would morph into marketing and advertising expenses of Google search engine toward end-consumers.
The DOJ complaint lambasts that “Google’s monopoly in general search services also has given the company extraordinary power as the gateway to the internet, which uses to promote its own web content and increase its profits.” This blame was at the core of the European Commission’s Google Shopping decision in 2017: it essentially holds Google accountable for having, because of its ad-funded business model, promoted its own advertising products and demoted organic links in search results. According to which Google’s search results are no longer relevant and listed on the sole motivation of advertising revenue
But this argument is circular: should these search results become irrelevant, Google’s core business would become less attractive, thereby generating less advertising revenue. This self-inflicted inefficiency would deprive Google of valuable advertising streams and incentivize end-consumers to switch to search engine rivals such as Bing, DuckDuckGo, Amazon (product search), etc. Therefore, an ad-funded company such as Google needs to reasonably arbitrage between advertising objectives and the efficiency of its core activities (here, zero-priced organic search services). To downplay (the ad-funded) self-referencing in order to foster (the zero-priced) organic search quality would disregard the two-sidedness of the Google platform: it would harm advertisers and the viability of the ad-funded business model without providing consumers and innovation protection it aims at providing. The problematic and undesirable concept of “search neutrality” would mean algorithmic micro-management for the sake of an “objective” listing considered acceptable only to the eyes of the regulator.
Furthermore, self-preferencing entails a sort of positive discrimination toward one’s own products. If discrimination has traditionally been antitrust lines of injuries, self-preferencing is an “epithet” outside antitrust remits for good reasons. Indeed, should self-interested (i.e., rationally minded) companies and individuals are legally complied to self-demote their own products and services? If only big (how big?) companies are legally complied to self-demote their products and services, to what extent will exempted companies involved in self-preferencing become liable to do so?
Indeed, many uncertainties, legal and economic ones, may spawn from the emerging prohibition of self-preferencing. More fundamentally, antitrust liability may clash with basic corporate governance principles where self-interestedness allows self-preferencing and command such self-promotion. The limits of antitrust have been reached when two sets of legal regimes, both applicable to companies, suggest contradictory commercial conducts. To what extent may Amazon no longer promote its own series on Amazon Video in a similar manner Netflix does? To what extent can Microsoft no longer promote Bing’s search engine to compete with Google’s search engine effectively? To what extent Uber may no longer promote UberEATS in order to compete with delivery services effectively? Not only the business of business is doing business, but also it is its duty for which shareholders may hold managers to account.
The self is moral; there is a corporate morality of business self-interest. In other words, corporate selflessness runs counter to business ethics since corporate self-interest yields the self’s rivalrous positioning within a competitive order. Absent a corporate self-interest, self-sacrifice may generate value destruction for the sake of some unjustified and ungrounded claims. The emerging prohibition of self-preferencing, similar to the established ban on the default setting on one’s own products into other proprietary products, materializes the corporate self’s losing. Both directions coalesce to instill the legally embedded duty of self-sacrifice for the competitor’s welfare instead of the traditional consumer welfare and the dynamics of innovation, which never unleash absent appropriabilities. In conclusion, to expect firms, however big or small, to act irrespective of their identities (i.e., corporate selflessness) would constitute an antitrust error and would be at odds with capitalism.
Toward an Integrated Theory of Disintegrating Favoritism
The Google lawsuit primarily blames Google for default settings enforced via several deals. The lawsuit also makes self-preferencing anticompetitive conduct under antitrust rules. These two charges are novel and dubious in their remits. They nevertheless represent a fundamental catalyst for the development of a new and problematic unified antitrust theory prohibiting favoritism: companies may no longer favor their products and services, both vertically and horizontally, irrespective of consumer benefits, irrespective of superior efficiency arguments, and irrespective of dynamic capabilities enhancement. Indeed, via an unreasonably expanded vision of leveraging, antitrust enforcement is furtively banning a company to favor its own products and services based on greater consumer choice as a substitute to consumer welfare, based on the protection of the opportunities of rivals to innovate and compete as a substitute to the essence of competition and innovation, and based on limiting the outreach and size of companies as a substitute to the capabilities and efficiencies of these companies. Leveraging becomes suspicious and corporate self-favoritism under accusation. The Google lawsuit materializes this impractical trend, which further enshrines the precautionary approach to antitrust enforcement.
 Jessica Guynn, Google Justice Department antitrust lawsuit explained: this is what it means for you. USA Today, October 20, 2020.
 The software (Internet Explorer) was tied in the hardware (Windows PC).
U.S. v Google LLC, Case A:20, October 20, 2020, 3 (referring to default settings as “especially sticky” with respect to consumers’ willingness to change).
 While the DOJ affirms that “being the preset default general search engine is particularly valuable because consumers rarely change the preset default”, it nevertheless provides no evidence of the breadth of such consumer stickiness. To be sure, search engine’s default status does not necessarily lead to usage as evidenced by the case of South Korea. In this country, despite Google’s preset default settings, the search engine Naver remains dominant in the national search market with over 70% of market shares. The rivalry exerted by Naver on Google demonstrates that limits of consumer stickiness to default settings. See Alesia Krush, Google vs. Naver: Why Can’t Google Dominate Search in Korea? Link-Assistant.Com, available at: https://www.link-assistant.com/blog/google-vs-naver-why-cant-google-dominate-search-in-korea/ . As dominant search engine in Korea, Naver is subject to antitrust investigations with similar leveraging practices as Google in other countries, see Shin Ji-hye, FTC sets up special to probe Naver, Google, The Korea Herald, November 19, 2019, available at : http://www.koreaherald.com/view.php?ud=20191119000798 ; Kim Byung-wook, Complaint against Google to be filed with FTC, The Investor, December 14, 2020, available at : https://www.theinvestor.co.kr/view.php?ud=20201123000984 (reporting a complaint by Naver and other Korean IT companies against Google’s 30% commission policy on Google Play Store’s apps).
 For instance, the then complaint acknowledged that “Microsoft designed Windows 98 so that removal of Internet Explorer by OEMs or end users is operationally more difficult than it was in Windows 95”, in U.S. v Microsoft Corp., Civil Action No 98-1232, May 18, 1998, para.20.
 The DOJ complaint itself quotes “one search competitor” who is reported to have noted consumer stickiness “despite the simplicity of changing a default setting to enable customer choice […]” (para.47). Therefore, default setting for search engine is remarkably simple to bypass but consumers do not often do so, either due to satisfaction with Google search engine and/or due to search and opportunity costs.
 Such outcome would frustrate traditional ways of offering computers and mobile devices as acknowledged by the DOJ itself in the Google complaint: “new computers and new mobile devices generally come with a number of preinstalled apps and out-of-the-box setting. […] Each of these search access points can and almost always does have a preset default general search engine”, at para. 41. Also, it appears that present default general search engine is common commercial practices since, as the DOJ complaint itself notes when discussing Google’s rivals (Microsoft’s Bing and Amazon’s Fire OS), “Amazon preinstalled its own proprietary apps and agreed to make Microsoft’s Bing the preset default general search engine”, in para.130. The complaint fails to identify alternative search engines which are not preset defaults, thus implicitly recognizing this practice as a widespread practice.
 To use Vesterdof’s language, see Bo Vesterdorf, Theories of Self-Preferencing and Duty to Deal – Two Sides of the Same Coin, Competition Law & Policy Debate 1(1) 4, (2015). See also Nicolas Petit, Theories of Self-Preferencing under Article 102 TFEU: A Reply to Bo Vesterdorf, 5-7 (2015).
 Case 39740 Google Search (Shopping). Here the foreclosure effects of self-preferencing are only speculated: « the Commission is not required to prove that the Conduct has the actual effect of decreasing traffic to competing comparison shopping services and increasing traffic to Google’s comparison-shopping service. Rather, it is sufficient for the Commission to demonstrate that the Conduct is capable of having, or likely to have, such effects.” (para.601 of the Decision). See P. Ibáñez Colomo, Indispensability and Abuse of Dominance: From Commercial Solvents to Slovak Telekom and Google Shopping, 10 Journal of European Competition Law & Practice 532 (2019); Aurelien Portuese, When Demotion is Competition: Algorithmic Antitrust Illustrated, Concurrences, no 2, May 2018, 25-37; Aurelien Portuese, Fine is Only One Click Away, Symposium on the Google Shopping Decision, Case Note, 3 Competition and Regulatory Law Review, (2017).
 For a general discussion on law and economics of self-preferencing, see Michael A. Salinger, Self-Preferencing, Global Antitrust Institute Report, 329-368 (2020).
Pablo Ibanez Colomo, Self-Preferencing: Yet Another Epithet in Need of Limiting Principles, 43 World Competition (2020) (concluding that self-preferencing is « misleading as a legal category »).
 See, for instances, Pedro Caro de Sousa, What Shall We Do About Self-Preferencing? Competition Policy International, June 2020.
 Milton Friedman, The Social Responsibility of Business is to Increase Its Profits, New York Times, September 13, 1970. This echoes Adam Smith’s famous statement that « It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard for their own self-interest » from the 1776 Wealth of Nations. In Ayn Rand’s philosophy, the only alternative to rational self-interest is to sacrifice one’s own interests either for fellowmen (altruism) or for supernatural forces (mysticism). See Ayn Rand, The Objectivist Ethics, in The Virtue of Selfishness, Signet, (1964).
 Aurelien Portuese, European Competition Enforcement and the Digital Economy : The Birthplace of Precautionary Antitrust, Global Antitrust Institute’s Report on the Digital Economy, 597-651.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
Judges sometimes claim that they do not pick winners when they decide antitrust cases. Nothing could be further from the truth.
Competitive conduct by its nature harms competitors, and so if antitrust were merely to prohibit harm to competitors, antitrust would then destroy what it is meant to promote.
What antitrust prohibits, therefore, is not harm to competitors but rather harm to competitors that fails to improve products. Only in this way is antitrust able to distinguish between the good firm that harms competitors by making superior products that consumers love and that competitors cannot match and the bad firm that harms competitors by degrading their products without offering consumers anything better than what came before.
That means, however, that antitrust must pick winners: antitrust must decide what is an improvement and what not. And a more popular search engine is a clear winner.
But one should not take its winningness for granted. For once upon a time there was another winner that the courts always picked, blocking antitrust case after antitrust case. Until one day the courts stopped picking it.
That was the economy of scale.
The Structure of the Google Case
Like all antitrust cases that challenge the exercise of power, the government’s case against Google alleges denial of an input to competitors in some market. Here the input is default search status in smartphones, the competitors are rival search providers, and the market is search advertising. The basic structure of the case is depicted in the figure below.
Although brought as a monopolization case under Section 2 of the Sherman Act, this is at heart an exclusive dealing case of the sort normally brought under Section 1 of the Sherman Act: the government’s core argument is that Google uses contracts with smartphone makers, pursuant to which the smartphone makers promise to make Google, and not competitors, the search default, to harm competing search advertising providers and by extension competition in the search advertising market.
The government must show anticompetitive conduct, monopoly power, and consumer harm in order to prevail.
Let us assume that there is monopoly power. The company has more than 70% of the search advertising market, which is in the zone normally required to prove that element of a monopolization claim.
The problem of anticompetitive conduct is only slightly more difficult.
Anticompetitive conduct is only ever one thing in antitrust: denial of an essential input to a competitor. There is no other way to harm rivals.
(To be sure, antitrust prohibits harm to competition, not competitors, but that means only that harm to competitors necessary but insufficient for liability. The consumer harm requirement decides whether the requisite harm to competitors is also harm to competition.)
It is not entirely clear just how important default search status really is to running a successful search engine, but let us assume that it is essential, as the government suggests.
Then the question whether Google’s contracts are anticompetitive turns on how much of the default search input Google’s contracts foreclose to rival search engines. If a lot, then the rivals are badly harmed. If a little, then there may be no harm at all.
The answer here is that there is a lot of foreclosure, at least if the government’s complaint is to be believed. Through its contracts with Apple and makers of Android phones, Google has foreclosed default search status to rivals on virtually every single smartphone.
That leaves consumer harm. And here is where things get iffy.
Usage as a Product Improvement: A Very Convenient Argument
The inquiry into consumer harm evokes measurements of the difference between demand curves and price lines, or extrapolations of compensating and equivalent variation using indifference curves painstakingly pieced together based on the assumptions of revealed preference.
But while the parties may pay experts plenty to spin such yarns, and judges may pretend to listen to them, in the end, for the judges, it always comes down to one question only: did exclusive dealing improve the product?
If it did, then the judge assumes that the contracts made consumers better off and the defendant wins. And if it did not, then off with their heads.
So, does foreclosing all this default search space to competitors make Google search advertising more valuable to advertisers?
Those who leap to Google’s defense say yes, for default search status increases the number of people who use Google’s search engine. And the more people use Google’s search engine, the more Google learns about how best to answer search queries and which advertisements will most interest which searchers. And that ensures that even more people will use Google’s search engine, and that Google will do an even better job of targeting ads on its search engine.
And that in turn makes Google’s search advertising even better: able to reach more people and to target ads more effectively to them.
None of that would happen if defaults were set to other engines and users spurned Google, and so foreclosing default search space to rivals undoubtedly improves Google’s product.
This is a nice argument. Indeed, it is almost too nice, for it seems to suggest that almost anything Google might do to steer users away from competitors and to itself deserves antitrust immunity. Suppose Google were to brandish arms to induce you to run your next search on Google. That would be a crime, but, on this account, not an antitrust crime. For getting you to use Google does make Google better.
The argument that locking up users improves the product is of potential use not just to Google but to any of the many tech companies that run on advertising—Facebook being a notable example—so it potentially immunizes an entire business model from antitrust scrutiny.
It turns out that has happened before.
Economies of Scale as a Product Improvement: Once a Convenient Argument
Once upon a time, antitrust exempted another kind of business for which products improve the more people used them. The business was industrial production, and it differs from online advertising only in the irrelevant characteristic that the improvement that comes with expanding use is not in the quality of the product but in the cost per unit of producing it.
The hallmark of the industrial enterprise is high fixed costs and low marginal costs. The textile mill differs from pre-industrial piecework weaving in that once a $10 million investment in machinery has been made, the mill can churn out yard after yard of cloth for pennies. The pieceworker, by contrast, makes a relatively small up-front investment—the cost of raising up the hovel in which she labors and making her few tools—but spends the same large amount of time to produce each new yard of cloth.
Large fixed costs and low marginal costs lie at the heart of the bounty of the modern age: the more you produce, the lower the unit cost, and so the lower the price at which you can sell your product. This is a recipe for plenty.
But it also means that, so long as consumer demand in a given market is lower than the capacity of any particular plant, driving buyers to a particular seller and away from competitors always improves the product, in the sense that it enables the firm to increase volume and reduce unit cost, and therefore to sell the product at a lower price.
If the promise of the modern age is goods at low prices, then the implication is that antitrust should never punish firms for driving rivals from the market and taking over their customers. Indeed, efficiency requires that only one firm should ever produce in any given market, at least in any market for which a single plant is capable of serving all customers.
For antitrust in the late 19th and early 20th centuries, beguiled by this advantage to size, exclusive dealing, refusals to deal, even the knife in a competitor’s back: whether these ran afoul of other areas of law or not, it was all for the better because it allowed industrial enterprises to achieve economies of scale.
It is no accident that, a few notable triumphs aside, antitrust did not come into its own until the mid-1930s, 40 years after its inception, on the heels of an intellectual revolution that explained, for the first time, why it might actually be better for consumers to have more than one seller in a market.
These theories suggested that consumers might care as much about product quality as they do about product cost, and indeed would be willing to abandon a low-cost product for a higher-quality, albeit more expensive, one.
From this perspective, the world of economies of scale and monopoly production was the drab world of Soviet state-owned enterprises churning out one type of shoe, one brand of cleaning detergent, and so on.
The world of capitalism and technological advance, by contrast, was one in which numerous firms produced batches of differentiated products in amounts sometimes too small fully to realize all scale economies, but for which consumers were nevertheless willing to pay because the products better fit their preferences.
What is more, the striving of monopolistically competitive firms to lure away each other’s customers with products that better fit their tastes led to disruptive innovation— “creative destruction” was Schumpeter’s famous term for it—that brought about not just different flavors of the same basic concept but entirely new concepts. The competition to create a better flip phone, for example, would lead inevitably to a whole new paradigm, the smartphone.
This reasoning combined with work in the 1940s and 1950s on economic growth that quantified for the first time the key role played by technological change in the vigor of capitalist economies—the famous Solow residual—to suggest that product improvements, and not the cost reductions that come from capital accumulation and their associated economies of scale, create the lion’s share of consumer welfare. Innovation, not scale, was king.
Antitrust responded by, for the first time in its history, deciding between kinds of product improvements, rather than just in favor of improvements, casting economies of scale out of the category of improvements subject to antitrust immunity, while keeping quality improvements immune.
Casting economies of scale out of the protected product improvement category gave antitrust something to do for the first time. It meant that big firms had to plead more than just the cost advantages of being big in order to obtain license to push their rivals around. And government could now start reliably to win cases, rather than just the odd cause célèbre.
It is this intellectual watershed, and not Thurman Arnold’s tenacity, that was responsible for antitrust’s emergence as a force after World War Two.
Usage-Based Improvements Are Not Like Economies of Scale
The improvements in advertising that come from user growth fall squarely on the quality side of the ledger—the value they create is not due to the ability to average production costs over more ad buyers—and so they count as the kind of product improvements that antitrust continues to immunize today.
But given the pervasiveness of this mode of product improvement in the tech economy—the fact that virtually any tech firm that sells advertising can claim to be improving a product by driving users to itself and away from competitors—it is worth asking whether we have not reached a new stage in economic development in which this form of product improvement ought, like economies of scale, to be denied protection.
Shouldn’t the courts demand more and better innovation of big tech firms than just the same old big-data-driven improvements they serve up year after year?
Galling as it may be to those who, like myself, would like to see more vigorous antitrust enforcement in general, the answer would seem to be “no.” For what induced the courts to abandon antitrust immunity for economies of scale in the mid-20th century was not the mere fact that immunizing economies of scale paralyzed antitrust. Smashing big firms is not, after all, an end in itself.
Instead, monopolistic competition, creative destruction and the Solow residual induced the change, because they suggested both that other kinds of product improvement are more important than economies of scale and, crucially, that protecting economies of scale impedes development of those other kinds of improvements.
A big firm that excludes competitors in order to reach scale economies not only excludes competitors who might have produced an identical or near-identical product, but also excludes competitors who might have produced a better-quality product, one that consumers would have preferred to purchase even at a higher price.
To cast usage-based improvements out of the product improvement fold, a case must be made that excluding competitors in order to pursue such improvements will block a different kind of product improvement that contributes even more to consumer welfare.
If we could say, for example, that suppressing search competitors suppresses more-innovative search engines that ad buyers would prefer, even if those innovative search engines were to lack the advantages that come from having a large user base, then a case might be made that user growth should no longer count as a product improvement immune from antitrust scrutiny.
And even then, the case against usage-based improvements would need to be general enough to justify an epochal change in policy, rather than be limited to a particular technology in a particular lawsuit. For the courts hate to balance in individual cases, statements to the contrary in their published opinions notwithstanding.
But there is nothing in the Google complaint, much less the literature, to suggest that usage-based improvements are problematic in this way. Indeed, much of the value created by the information revolution seems to inhere precisely in its ability to centralize usage.
Americans Keep Voting to Centralize the Internet
In the early days of the internet, theorists mistook its decentralized architecture for a feature, rather than a bug. But internet users have since shown, time and again, that they believe the opposite.
For example, the basic protocols governing email were engineered to allow every American to run his own personal email server.
But Americans hated the freedom that created—not least the spam—and opted instead to get their email from a single server: the one run by Google as Gmail.
The basic protocols governing web traffic were also designed to allow every American to run whatever other communications services he wished—chat, video chat, RSS, webpages—on his own private server in distributed fashion.
But Americans hated the freedom that created—not least having to build and rebuild friend networks across platforms–—and they voted instead overwhelmingly to get their social media from a single server: Facebook.
Indeed, the basic protocols governing internet traffic were designed to allow every business to store and share its own data from its own computers, in whatever form.
But American businesses hated that freedom—not least the cost of having to buy and service their own data storage machines—and instead 40% of the internet is now stored and served from Amazon Web Services.
Similarly, advertisers have the option of placing advertisements on the myriad independently-run websites that make up the internet—known in the business as the “open web”—by placing orders through competitive ad exchanges. But advertisers have instead voted mostly to place ads on the handful of highly centralized platforms known as “walled gardens,” including Facebook, Google’s YouTube and, of course, Google Search.
The communications revolution, they say, is all about “bringing people together.” It turns out that’s true.
And that Google should win on consumer harm.
Remember the Telephone
Indeed, the same mid-20th century antitrust that thought so little of economies of scale as a defense immunized usage-based improvements when it encountered them in that most important of internet precursors: the telephone.
The telephone, like most internet services, gets better as usage increases. The more people are on a particular telephone network, the more valuable the network becomes to subscribers.
Just as with today’s internet services, the advantage of a large user base drove centralization of telephone services a century ago into the hands of a single firm: AT&T. Aside from a few business executives who liked the look of a desk full of handsets, consumers wanted one phone line that they could use to call everyone.
Although the government came close to breaking AT&T up in the early 20th century, the government eventually backed off, because a phone system in which you must subscribe to the right carrier to reach a friend just doesn’t make sense.
Instead, Congress and state legislatures stepped in to take the edge off monopoly by regulating phone pricing. And when antitrust finally did break AT&T up in 1982, it did so in a distinctly regulatory fashion, requiring that AT&T’s parts connect each other’s phone calls, something that Congress reinforced in the Telecommunications Act of 1996.
The message was clear: the sort of usage-based improvements one finds in communications are real product improvements. And antitrust can only intervene if it has a way to preserve them.
The equivalent of interconnection in search, that the benefits of usage, in the form of data and attention, be shared among competing search providers, might be feasible. But it is hard to imagine the court in the Google case ordering interconnection without the benefit of decades of regulatory experience with the defendant’s operations that the district court in 1982 could draw upon in the AT&T case.
The solution for the tech giants today is the same as the solution for AT&T a century ago: to regulate rather than to antitrust.
Microsoft Not to the Contrary, Because Users Were in Common
Parallels to the government’s 1990s-era antitrust case against Microsoft are not to the contrary.
As Sam Weinstein has pointed out to me, Microsoft, like Google, was at heart an exclusive dealing case: Microsoft contracted with computer manufacturers to prevent Netscape Navigator, an early web browser, from serving as the default web browser on Windows PCs.
That prevented Netscape, the argument went, from growing to compete with Windows in the operating system market, much the way the Google’s Chrome browser has become a substitute for Windows on low-end notebook computers today.
The D.C. Circuit agreed that default status was an essential input for Netscape as it sought eventually to compete with Windows in the operating system market.
The court also accepted the argument that the exclusive dealing did not improve Microsoft’s operating system product.
This at first seems to contradict the notion that usage improves products, for, like search advertising, operating systems get better as their user bases increase. The more people use an operating system, the more application developers are willing to write for the system, and the better the system therefore becomes.
It seems to follow that keeping competitors off competing operating systems and on Windows made Windows better. If the court nevertheless held Microsoft liable, it must be because the court refused to extend antitrust immunity to usage-based improvements.
The trouble with this line of argument is that it ignores the peculiar thing about the Microsoft case: that while the government alleged that Netscape was a potential competitor of Windows, Netscape was also an application that ran on Windows.
That means that, unlike Google and rival search engines, Windows and Netscape shared users.
So, Microsoft’s exclusive dealing did not increase its user base and therefore could not have improved Windows, at least not by making Windows more appealing for applications developers. Driving Netscape from Windows did not enable developers to reach even one more user. Conversely, allowing Netscape to be the default browser on Windows would not have reduced the number of Windows users, because Netscape ran on Windows.
By contrast, a user who runs a search in Bing does not run the same search simultaneously in Google, and so Bing users are not Google users. Google’s exclusive dealing therefore increases its user base and improves Google’s product, whereas Microsoft’s exclusive dealing served only to reduce Netscape’s user base and degrade Netscape’s product.
Indeed, if letting Netscape be the default browser on Windows was a threat to Windows, it was not because it prevented Microsoft from improving its product, but because Netscape might eventually have become an operating system, and indeed a better operating system, than Windows, and consumers and developers, who could be on both at the same time if they wished, might have nevertheless chosen eventually to go with Netscape alone.
Though it does not help the government in the Google case, Microsoft still does offer a beacon of hope for those concerned about size, for Microsoft’s subsequent history reminds us that yesterday’s behemoth is often today’s also ran.
And the favorable settlement terms Microsoft ultimately used to escape real consequences for its conduct 20 years ago imply that, at least in high-tech markets, we don’t always need antitrust for that to be true.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
Google is facing a series of lawsuits in 2020 and 2021 that challenge some of the most fundamental parts of its business, and of the internet itself — Search, Android, Chrome, Google’s digital-advertising business, and potentially other services as well.
The U.S. Justice Department (DOJ) has brought a case alleging that Google’s deals with Android smartphone manufacturers, Apple, and third-party browsers to make Google Search their default general search engine are anticompetitive (ICLE’s tl;dr on the case is here), and the State of Texas has brought a suit against Google’s display advertising business. These follow a market study by the United K’s Competition and Markets Authority that recommended an ex ante regulator and code of conduct for Google and Facebook. At least one more suit is expected to follow.
These lawsuits will test ideas that are at the heart of modern antitrust debates: the roles of defaults and exclusivity deals in competition; the costs of self-preferencing and its benefits to competition; the role of data in improving software and advertising, and its role as a potential barrier to entry; and potential remedies in these markets and their limitations.
This Truth on the Market symposium asks contributors with wide-ranging viewpoints to comment on some of these issues as they arise in the lawsuits being brought—starting with the U.S. Justice Department’s case against Google for alleged anticompetitive practices in search distribution and search-advertising markets—and continuing throughout the duration of the lawsuits.
The Finnish consultancy Rewheel periodically issues reports using mobile wireless pricing information to make claims about which countries’ markets are competitive and which are not. For example, Rewheel claims Canada and Greece have the “least competitive monthly prices” while the United Kingdom and Finland have the most competitive.
Rewheel often claims that the number of carriers operating in a country is the key determinant of wireless pricing.
Their pricing studies attract a great deal of attention. For example, in February 2019 testimony before the U.S. House Energy and Commerce Committee, Phillip Berenbroick of Public Knowledge asserted: “Rewheel found that consumers in markets with three facilities-based providers paid twice as much per gigabyte as consumers in four firm markets.” So, what’s wrong with Rewheel? An earlier post highlights some of the flaws in Rewheel’s methodology. But there’s more.
Rewheel creates fictional market baskets of mobile plans for each provider in a county. Country-by-country comparisons are made by evaluating the lowest-priced basket for each country and the basket with the median price.
Rewheel’s market baskets are hypothetical packages that say nothing about which plans are actually chosen by consumers or what the actual prices paid by those consumers were. This is not a new criticism. In 2014, Pauline Affeldt and Rainer Nitsche called these measures “meaningless”:
Such approaches are taken by Rewheel (2013) and also the Austrian regulator rtr … Such studies face the following problems: They may pick tariffs that are relatively meaningless in the country. They will have to assume one or more consumption baskets (voice minutes, data volume etc.) in order to compare tariffs. This may drive results. Apart from these difficulties such comparisons require very careful tracking of tariffs and their changes. Even if one assumes studying a sample of tariffs is potentially meaningful, a comparison across countries (or over time) would still require taking into account key differences across countries (or over time) like differences in demand, costs, network quality etc.
For example, reporting that the average price of a certain T-Mobile USA smartphone, tablet and home Internet plan is $125 is about as useless as knowing that the average price of a Kroger shopping cart containing a six-pack of Budweiser, a dozen eggs, and a pound of oranges is $10. Is Safeway less “competitive” if the price of the same cart of goods is $12? What could you say about pricing at a store that doesn’t sell Budweiser (e.g., Trader Joe’s)?
Rewheel solves that last problem by doing something bonkers. If a carrier doesn’t offer a plan in one of Rewheel’s baskets, they “assign” the HIGHEST monthly price in the world.
For example, Rewheel notes that Vodafone India does not offer a fixed wireless broadband plan with at least 1,000GB of data and download speeds of 100 Mbps or faster. So, Rewheel “assigns” Vodafone India the highest price in its dataset. That price belongs to a plan that’s sold in the United Kingdom. It simply makes no sense.
To return to the supermarket analogy, it would be akin to saying that, if a Trader Joe’s in the United States doesn’t sell six-packs of Budweiser, we should assume the price of Budweiser at Trader Joe’s is equal to the world’s most expensive six-pack of the beer. In reality, Trader Joe’s is known for having relatively low prices. But using the Rewheel approach, the store would be assessed to have some of the highest prices.
Because of Rewheel’s “assignment” of highest monthly prices to many plans, it’s irrelevant whether their analysis is based on a country’s median price or lowest price. The median is skewed and the lowest actual may be missing from the dataset.
Rewheel publishes these reports to support its argument that mobile prices are lower in markets with four carriers than in those with three carriers. But even if we accept Rewheel’s price data as reliable, which it isn’t, their own data show no relationship between the number of carriers and average price.
Notice the huge overlap of observations among markets with three and four carriers.
Rewheel’s latest report provides a redacted dataset, reporting only data usage and weighted average price for each provider. So, we have to work with what we have.
A simple regression analysis shows there is no statistically significant difference in the intercept or the slopes for markets with three, four or five carriers (the default is three carriers in the regression). Based on the data Rewheel provides to the public, the number of carriers in a country has no relationship to wireless prices.
Rewheel seems to have a rich dataset of pricing information that could be useful to inform policy. It’s a shame that their topline summaries seem designed to support a predetermined conclusion.
The Federal Trade Commission and 46 state attorneys general (along with the District of Columbia and the Territory of Guam) filed their long-awaited complaints against Facebook Dec. 9. The crux of the arguments in both lawsuits is that Facebook pursued a series of acquisitions over the past decade that aimed to cement its prominent position in the “personal social media networking” market.
Make no mistake, if successfully prosecuted, these cases would represent one of the most fundamental shifts in antitrust law since passage of the Hart-Scott-Rodino Act in 1976. That law required antitrust authorities to be notified of proposed mergers and acquisitions that exceed certain value thresholds, essentially shifting the paradigm for merger enforcement from ex-post to ex-ante review.
While the prevailing paradigm does not explicitly preclude antitrust enforcers from taking a second bite of the apple via ex-post enforcement, it has created an assumption among that regulatory clearance of a merger makes subsequent antitrust proceedings extremely unlikely.
Indeed, the very point of ex-ante merger regulations is that ex-post enforcement, notably in the form of breakups, has tremendous social costs. It can scupper economies of scale and network effects on which both consumers and firms have come to rely. Moreover, the threat of costly subsequent legal proceedings will hang over firms’ pre- and post-merger investment decisions, and may thus reduce incentives to invest.
With their complaints, the FTC and state AGs threaten to undo this status quo. Even if current antitrust law allows it, pursuing this course of action threatens to quash the implicit assumption that regulatory clearance generally shields a merger from future antitrust scrutiny. Ex-post review of mergers and acquisitions does also entail some positive features, but the Facebook complaints fail to consider these complicated trade-offs. This oversight could hamper tech and other U.S. industries.
Mergers and uncertainty
Merger decisions are probabilistic. Of the thousands of corporate acquisitions each year, only a handful end up deemed “successful.” These relatively few success stories have to pay for the duds in order to preserve the incentive to invest.
Switching from ex-ante to ex-post review enables authorities to focus their attention on the most lucrative deals. It stands to reason that they will not want to launch ex-post antitrust proceedings against bankrupt firms whose assets have already been stripped. Instead, as with the Facebook complaint, authorities are far more likely to pursue high-profile cases that boost their political capital.
This would be unproblematic if:
Authorities would commit to ex-post prosecution only of anticompetitive mergers;and
If parties could reasonably anticipate whether their deals would be deemed anticompetitive in the future.
If those were the conditions, ex-post enforcement would merely reduce the incentive to partake in problematic mergers. It would leave welfare-enhancing deals unscathed. But where firms could not have ex-ante knowledge that a given deal would be deemed anticompetitive, the associated error-costs should weigh against prosecuting such mergers ex post, even if such enforcement might appear desirable. The deterrent effect that would arise from such prosecutions would be applied by the market to all mergers, including efficient ones. Put differently, authorities might get the ex-post assessment right in one case, such as the Facebook proceedings, but the bigger picture remains that they could be wrong in many other cases. Firms will perceive this threat and it may hinder their investments.
There is also reason to doubt that either of the ideal conditions for ex-post enforcement could realistically be met in practice.Ex-ante merger proceedings involve significant uncertainty. Indeed, antitrust-merger clearance decisions routinely have an impact on the merging parties’ stock prices. If management and investors knew whether their transactions would be cleared, those effects would be priced-in when a deal is announced, not when it is cleared or blocked. Indeed, if firms knew a given merger would be blocked, they would not waste their resources pursuing it. This demonstrates that ex-ante merger proceedings involve uncertainty for the merging parties.
Unless the answer is markedly different for ex-post merger reviews, authorities should proceed with caution. If parties cannot properly self-assess their deals, the threat of ex-post proceedings will weigh on pre- and post-merger investments (a breakup effectively amounts to expropriating investments that are dependent upon the divested assets).
Furthermore, because authorities will likely focus ex-post reviews on the most lucrative deals, their incentive effects can be particularly pronounced. Parties may fear that the most successful mergers will be broken up. This could have wide-reaching effects for all merging firms that do not know whether they might become “the next Facebook.”
Accordingly, for ex-post merger reviews to be justified, it is essential that:
Their outcomes be predictable for the parties; and that
Analyzing the deals after the fact leads to better decision-making (fewer false acquittals and convictions) than ex-ante reviews would yield.
If these conditions are not in place, ex-post assessments will needlessly weigh down innovation, investment and procompetitive merger activity in the economy.
Hindsight does not disentangle efficiency from market power
So, could ex-post merger reviews be so predictable and effective as to alleviate the uncertainties described above, along with the costs they entail?
Based on the recently filed Facebook complaints, the answer appears to be no. We simply do not know what the counterfactual to Facebook’s acquisitions of Instagram and WhatsApp would look like. Hindsight does not tell us whether Facebook’s acquisitions led to efficiencies that allowed it to thrive (a pro-competitive scenario), or whether Facebook merely used these deals to kill off competitors and maintain its monopoly (an anticompetitive scenario).
These email exchanges may not paint a particularly positive picture of Zuckerberg’s intent in doing the merger, and it is possible that at the time they may have caused antitrust agencies to scrutinise the merger more carefully. But they do not tell us that the acquisition was ultimately harmful to consumers, or about the counterfactual of the merger being blocked. While we know that Instagram became enormously popular in the years following the merger, it is not clear that it would have been just as successful without the deal, or that Facebook and its other products would be less popular today.
Moreover, it fails to account for the fact that Facebook had the resources to quickly scale Instagram up to a level that provided immediate benefits to an enormous number of users, instead of waiting for the app to potentially grow to such scale organically.
In fact, contrary to what some have argued, hindsight might even complicate matters (again from Sam and me):
Today’s commentators have the benefit of hindsight. This inherently biases contemporary takes on the Facebook/Instagram merger. For instance, it seems almost self-evident with hindsight that Facebook would succeed and that entry in the social media space would only occur at the fringes of existing platforms (the combined Facebook/Instagram platform) – think of the emergence of TikTok. However, at the time of the merger, such an outcome was anything but a foregone conclusion.
In other words, ex-post reviews will, by definition, focus on mergers where today’s outcomes seem preordained — when, in fact, they were probabilistic. This will skew decisions toward finding anticompetitive conduct. If authorities think that Instagram was destined to become great, they are more likely to find that Facebook’s acquisition was anticompetitive because they implicitly dismiss the idea that it was the merger itself that made Instagram great.
Authorities might also confuse correlation for causality. For instance, the state AGs’ complaint ties Facebook’s acquisitions of Instagram and WhatsApp to the degradation of these services, notably in terms of privacy and advertising loads. As the complaint lays out:
127. Following the acquisition, Facebook also degraded Instagram users’ privacy by matching Instagram and Facebook Blue accounts so that Facebook could use information that users had shared with Facebook Blue to serve ads to those users on Instagram.
180. Facebook’s acquisition of WhatsApp thus substantially lessened competition […]. Moreover, Facebook’s subsequent degradation of the acquired firm’s privacy features reduced consumer choice by eliminating a viable, competitive, privacy-focused option
But these changes may have nothing to do with Facebook’s acquisition of these services. At the time, nearly all tech startups focused on growth over profits in their formative years. It should be no surprise that the platforms imposed higher “prices” to users after their acquisition by Facebook; they were maturing. Further monetizing their platform would have been the logical next step, even absent the mergers.
It is just as hard to determine whether post-merger developments actually harmed consumers. For example, the FTC complaint argues that Facebook stopped developing its own photo-sharing capabilities after the Instagram acquisition,which the commission cites as evidence that the deal neutralized a competitor:
98. Less than two weeks after the acquisition was announced, Mr. Zuckerberg suggested canceling or scaling back investment in Facebook’s own mobile photo app as a direct result of the Instagram deal.
But it is not obvious that Facebook or consumers would have gained anything from the duplication of R&D efforts if Facebook continued to develop its own photo-sharing app. More importantly, this discontinuation is not evidence that Instagram could have overthrown Facebook. In other words, the fact that Instagram provided better photo-sharing capabilities does necessarily imply that it could also provide a versatile platform that posed a threat to Facebook.
Finally, if Instagram’s stellar growth and photo-sharing capabilities were certain to overthrow Facebook’s monopoly, why do the plaintiffs ignore the competitive threat posed by the likes of TikTok today? Neither of the complaints makes any mention of TikTok,even though it currently has well over 1 billion monthly active users. The FTC and state AGs would have us believe that Instagram posed an existential threat to Facebook in 2012 but that Facebook faces no such threat from TikTok today. It is exceedingly unlikely that both these statements could be true, yet both are essential to the plaintiffs’ case.
Some appropriate responses
None of this is to say that ex-post review of mergers and acquisitions should be categorically out of the question. Rather, such proceedings should be initiated only with appropriate caution and consideration for their broader consequences.
When undertaking reviews of past mergers, authorities do not necessarily need to impose remedies every time they find a merger was wrongly cleared. The findings of these ex-post reviews could simply be used to adjust existing merger thresholds and presumptions. This would effectively create a feedback loop where false acquittals lead to meaningful policy reforms in the future.
At the very least, it may be appropriate for policymakers to set a higher bar for findings of anticompetitive harm and imposition of remedies in such cases. This would reduce the undesirable deterrent effects that such reviews may otherwise entail, while reserving ex-post remedies for the most problematic cases.
Finally, a tougher system of ex-post review could be used to allow authorities to take more risks during ex-ante proceedings. Indeed, when in doubt, they could effectively experiment by allowing marginal mergers to proceed, with the understanding that bad decisions could be clawed back afterwards. In that regard, it might also be useful to set precise deadlines for such reviews and to outline the types of concerns that might prompt scrutiny or warrant divestitures.
In short, some form of ex-post review may well be desirable. It could help antitrust authorities to learn what works and subsequently to make useful changes to ex-ante merger-review systems. But this would necessitate deep reflection on the many ramifications of ex-post reassessments. Legislative reform or, at the least, publication of guidance documents by authorities, seem like essential first steps.
Unfortunately, this is the exact opposite of what the Facebook proceedings would achieve. Plaintiffs have chosen to ignore these complex trade-offs in pursuit of a case with extremely dubious underlying merits. Success for the plaintiffs would thus prove a pyrrhic victory, destroying far more than it intends to achieve.
The European Court of Justice issued its long-awaited ruling Dec. 9 in the Groupe Canal+ case. The case centered on licensing agreements in which Paramount Pictures granted absoluteterritorial exclusivity to several European broadcasters, including Canal+.
Back in 2015, the European Commission charged six U.S. film studios, including Paramount, as well as British broadcaster Sky UK Ltd., with illegally limiting access to content. The crux of the EC’s complaint was that the contractual agreements to limit cross-border competition for content distribution ran afoul of European Union competition law. Paramount ultimately settled its case with the commission and agreed to remove the problematic clauses from its contracts. This affected third parties like Canal+, who lost valuable contractual protections.
While the ECJ ultimately upheld the agreements on what amounts to procedural grounds (Canal+ was unduly affected by a decision to which it was not a party), the case provides yet another example of the European Commission’s misguided stance on absoluteterritorial licensing, sometimes referred to as “geo-blocking.”
The EC’s long-running efforts to restrict geo-blocking emerge from its attempts to harmonize trade across the EU. Notably, in its Digital Single Market initiative, the Commission envisioned:
[A] Digital Single Market is one in which the free movement of goods, persons, services and capital is ensured and where individuals and businesses can seamlessly access and exercise online activities under conditions of fair competition, and a high level of consumer and personal data protection, irrespective of their nationality or place of residence.
This policy stance has been endorsed consistently by the European Court of Justice. In the 2011 Murphy decision, for example, the court held that agreements between rights holders and broadcasters infringe European competition when they categorically prevent the latter from supplying “decoding devices” to consumers located in other member states. More precisely, while rights holders can license their content on a territorial basis, they cannot restrict so-called “passive sales”; broadcasters can be prevented from actively chasing consumers in other member states, but not from serving them altogether. If this sounds Kafkaesque, it’s because it is.
The problem with the ECJ’s vision is that it elides the complex factors that underlie a healthy free-trade zone. Geo-blocking frequently is misunderstood or derided by consumers as an unwarranted restriction on their consumption preferences. It doesn’t feel “fair” or “seamless” when a rights holder can decide who can access their content and on what terms. But that doesn’t mean geo-blocking is a nefarious or socially harmful practice. Quite the contrary: allowing creators to create different sets of distribution options offers both a return to the creators as well as more choice in general to consumers.
In economic terms, geo-blocking allows rights holders to engage in third-degree price discrimination; that is, they have the ability to charge different prices for different sets of consumers. This type of pricing will increase total welfare so long as it increases output. As Hal Varian puts it:
If a new market is opened up because of price discrimination—a market that was not previously being served under the ordinary monopoly—then we will typically have a Pareto improving welfare enhancement.
Another benefit of third-degree price discrimination is that, by shifting some economic surplus from consumers to firms, it can stimulate investment in much the same way copyright and patents do. Put simply, the prospect of greater economic rents increases the maximum investment firms will be willing to make in content creation and distribution.
For these reasons, respecting parties’ freedom to license content as they see fit is likely to produce much more efficient outcomes than annulling those agreements through government-imposed “seamless access” and “fair competition” rules. Part of the value of copyright law is in creating space to contract by protecting creators’ property rights. Without geo-blocking, the enforcement of licensing agreements would become much more difficult. Laws restricting copyright owners’ ability to contract freely reduce allocational efficiency, as well as the incentives to create in the first place. Further, when individual creators have commercial and creative autonomy, they gain a degree of predictability that can ensure they will continue to produce content in the future.
The European Union would do well to adopt a more nuanced understanding of the contractual relationships between producers and distributors.