Archives For antitrust enforcement

Apple’s legal team will be relieved that “you reap what you sow” is just a proverb. After a long-running antitrust battle against Qualcomm unsurprisingly ended in failure, Apple now faces antitrust accusations of its own (most notably from Epic Games). Somewhat paradoxically, this turn of events might cause Apple to see its previous defeat in a new light. Indeed, the well-established antitrust principles that scuppered Apple’s challenge against Qualcomm will now be the rock upon which it builds its legal defense.

But while Apple’s reversal of fortunes might seem anecdotal, it neatly illustrates a fundamental – and often overlooked – principle of antitrust policy: Antitrust law is about maximizing consumer welfare. Accordingly, the allocation of surplus between two companies is only incidentally relevant to antitrust proceedings, and it certainly is not a goal in and of itself. In other words, antitrust law is not about protecting David from Goliath.

Jockeying over the distribution of surplus

Or at least that is the theory. In practice, however, most antitrust cases are but small parts of much wider battles where corporations use courts and regulators in order to jockey for market position and/or tilt the distribution of surplus in their favor. The Microsoft competition suits brought by the DOJ and the European commission (in the EU and US) partly originated from complaints, and lobbying, by Sun Microsystems, Novell, and Netscape. Likewise, the European Commission’s case against Google was prompted by accusations from Microsoft and Oracle, among others. The European Intel case was initiated following a complaint by AMD. The list goes on.

The last couple of years have witnessed a proliferation of antitrust suits that are emblematic of this type of power tussle. For instance, Apple has been notoriously industrious in using the court system to lower the royalties that it pays to Qualcomm for LTE chips. One of the focal points of Apple’s discontent was Qualcomm’s policy of basing royalties on the end-price of devices (Qualcomm charged iPhone manufacturers a 5% royalty rate on their handset sales – and Apple received further rebates):

“The whole idea of a percentage of the cost of the phone didn’t make sense to us,” [Apple COO Jeff Williams] said. “It struck at our very core of fairness. At the time we were making something really really different.”

This pricing dispute not only gave rise to high-profile court cases, it also led Apple to lobby Standard Developing Organizations (“SDOs”) in a partly successful attempt to make them amend their patent policies, so as to prevent this type of pricing. 

However, in a highly ironic turn of events, Apple now finds itself on the receiving end of strikingly similar allegations. At issue is the 30% commission that Apple charges for in app purchases on the iPhone and iPad. These “high” commissions led several companies to lodge complaints with competition authorities (Spotify and Facebook, in the EU) and file antitrust suits against Apple (Epic Games, in the US).

Of course, these complaints are couched in more sophisticated, and antitrust-relevant, reasoning. But that doesn’t alter the fact that these disputes are ultimately driven by firms trying to tilt the allocation of surplus in their favor (for a more detailed explanation, see Apple and Qualcomm).

Pushback from courts: The Qualcomm case

Against this backdrop, a string of recent cases sends a clear message to would-be plaintiffs: antitrust courts will not be drawn into rent allocation disputes that have no bearing on consumer welfare. 

The best example of this judicial trend is Qualcomm’s victory before the United States Court of Appeal for the 9th Circuit. The case centered on the royalties that Qualcomm charged to OEMs for its Standard Essential Patents (SEPs). Both the district court and the FTC found that Qualcomm had deployed a series of tactics (rebates, refusals to deal, etc) that enabled it to circumvent its FRAND pledges. 

However, the Court of Appeal was not convinced. It failed to find any consumer harm, or recognizable antitrust infringement. Instead, it held that the dispute at hand was essentially a matter of contract law:

To the extent Qualcomm has breached any of its FRAND commitments, a conclusion we need not and do not reach, the remedy for such a breach lies in contract and patent law. 

This is not surprising. From the outset, numerous critics pointed that the case lied well beyond the narrow confines of antitrust law. The scathing dissenting statement written by Commissioner Maureen Olhaussen is revealing:

[I]n the Commission’s 2-1 decision to sue Qualcomm, I face an extraordinary situation: an enforcement action based on a flawed legal theory (including a standalone Section 5 count) that lacks economic and evidentiary support, that was brought on the eve of a new presidential administration, and that, by its mere issuance, will undermine U.S. intellectual property rights in Asia and worldwide. These extreme circumstances compel me to voice my objections. 

In reaching its conclusion, the Court notably rejected the notion that SEP royalties should be systematically based upon the “Smallest Saleable Patent Practicing Unit” (or SSPPU):

Even if we accept that the modem chip in a cellphone is the cellphone’s SSPPU, the district court’s analysis is still fundamentally flawed. No court has held that the SSPPU concept is a per se rule for “reasonable royalty” calculations; instead, the concept is used as a tool in jury cases to minimize potential jury confusion when the jury is weighing complex expert testimony about patent damages.

Similarly, it saw no objection to Qualcomm licensing its technology at the OEM level (rather than the component level):

Qualcomm’s rationale for “switching” to OEM-level licensing was not “to sacrifice short-term benefits in order to obtain higher profits in the long run from the exclusion of competition,” the second element of the Aspen Skiing exception. Aerotec Int’l, 836 F.3d at 1184 (internal quotation marks and citation omitted). Instead, Qualcomm responded to the change in patent-exhaustion law by choosing the path that was “far more lucrative,” both in the short term and the long term, regardless of any impacts on competition. 

Finally, the Court concluded that a firm breaching its FRAND pledges did not automatically amount to anticompetitive conduct: 

We decline to adopt a theory of antitrust liability that would presume anticompetitive conduct any time a company could not prove that the “fair value” of its SEP portfolios corresponds to the prices the market appears willing to pay for those SEPs in the form of licensing royalty rates.

Taken together, these findings paint a very clear picture. The Qualcomm Court repeatedly rejected the radical idea that US antitrust law should concern itself with the prices charged by monopolists — as opposed to practices that allow firms to illegally acquire or maintain a monopoly position. The words of Learned Hand and those of Antonin Scalia (respectively, below) loom large:

The successful competitor, having been urged to compete, must not be turned upon when he wins. 

And,

To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

Other courts (both in the US and abroad) have reached similar conclusions

For instance, a district court in Texas dismissed a suit brought by Continental Automotive Systems (which supplies electronic systems to the automotive industry) against a group of SEP holders. 

Continental challenged the patent holders’ decision to license their technology at the vehicle rather than component level (the allegation is very similar to the FTC’s complaint that Qualcomm licensed its SEPs at the OEM, rather than chipset level). However, following a forceful intervention by the DOJ, the Court ultimately held that the facts alleged by Continental were not indicative of antitrust injury. It thus dismissed the case.

Likewise, within weeks of the Qualcomm and Continental decisions, the UK Supreme court also ruled in favor of SEP holders. In its Unwired Planet ruling, the Court concluded that discriminatory licenses did not automatically infringe competition law (even though they might breach a firm’s contractual obligations):

[I]t cannot be said that there is any general presumption that differential pricing for licensees is problematic in terms of the public or private interests at stake.

In reaching this conclusion, the UK Supreme Court emphasized that the determination of whether licenses were FRAND, or not, was first and foremost a matter of contract law. In the case at hand, the most important guide to making this determination were the internal rules of the relevant SDO (as opposed to competition case law):

Since price discrimination is the norm as a matter of licensing practice and may promote objectives which the ETSI regime is intended to promote (such as innovation and consumer welfare), it would have required far clearer language in the ETSI FRAND undertaking to indicate an intention to impose the more strict, “hard-edged” non-discrimination obligation for which Huawei contends. Further, in view of the prevalence of competition laws in the major economies around the world, it is to be expected that any anti-competitive effects from differential pricing would be most appropriately addressed by those laws

All of this ultimately led the Court to rule in favor of Unwired Planet, thus dismissing Huawei’s claims that it had infringed competition law by breaching its FRAND pledges. 

In short, courts and antitrust authorities on both sides of the Atlantic have repeatedly, and unambiguously, concluded that pricing disputes (albeit in the specific context of technological standards) are generally a matter of contract law. Antitrust/competition law intercedes only when unfair/excessive/discriminatory prices are both caused by anticompetitive behavior and result in anticompetitive injury.

Apple’s Loss is… Apple’s gain.

Readers might wonder how the above cases relate to Apple’s app store. But, on closer inspection the parallels are numerous. As explained above, courts have repeatedly stressed that antitrust enforcement should not concern itself with the allocation of surplus between commercial partners. Yet that is precisely what Epic Game’s suit against Apple is all about.

Indeed, Epic’s central claim is not that it is somehow foreclosed from Apple’s App Store (for example, because Apple might have agreed to exclusively distribute the games of one of Epic’s rivals). Instead, all of its objections are down to the fact that it would like to access Apple’s store under more favorable terms:

Apple’s conduct denies developers the choice of how best to distribute their apps. Developers are barred from reaching over one billion iOS users unless they go through Apple’s App Store, and on Apple’s terms. […]

Thus, developers are dependent on Apple’s noblesse oblige, as Apple may deny access to the App Store, change the terms of access, or alter the tax it imposes on developers, all in its sole discretion and on the commercially devastating threat of the developer losing access to the entire iOS userbase. […]

By imposing its 30% tax, Apple necessarily forces developers to suffer lower profits, reduce the quantity or quality of their apps, raise prices to consumers, or some combination of the three.

And the parallels with the Qualcomm litigation do not stop there. Epic is effectively asking courts to make Apple monetize its platform at a different level than the one that it chose to maximize its profits (no more monetization at the app store level). Similarly, Epic Games omits any suggestion of profit sacrifice on the part of Apple — even though it is a critical element of most unilateral conduct theories of harm. Finally, Epic is challenging conduct that is both the industry norm and emerged in a highly competitive setting.

In short, all of Epic’s allegations are about monopoly prices, not monopoly maintenance or monopolization. Accordingly, just as the SEP cases discussed above were plainly beyond the outer bounds of antitrust enforcement (something that the DOJ repeatedly stressed with regard to the Qualcomm case), so too is the current wave of antitrust litigation against Apple. When all is said and done, Apple might thus be relieved that Qualcomm was victorious in their antitrust confrontation. Indeed, the legal principles that caused its demise against Qualcomm are precisely the ones that will, likely, enable it to prevail against Epic Games.

Speaking about his new book in a ProMarket interview, David Dayen inadvertently captures what is perhaps the essential disconnect between antitrust reformers (populists, neo-Brandeisians, hipsters, whatever you may call them) and those of us who are more comfortable with the antitrust status quo (whatever you may call us). He says: “The antitrust doctrine that we’ve seen over the last 40 years simply does not match the lived experience of people.”

Narratives of Consumer Experience of Markets

This emphasis on “lived experience” runs through Dayen’s antitrust perspective. Citing to Hal Singer’s review of the book, the interview notes that “the heart of Dayen’s book is the personal accounts of ordinary Americans—airline passengers, hospital patients, farmers, and small business owners—attempting to achieve a slice of the American dream and facing insurmountable barriers in the form of unaccountable private monopolies.” As Singer notes in his review, “Dayen’s personalized storytelling, free of any stodgy regression analysis, is more likely to move policymakers” than are traditional economic arguments.

Dayen’s focus on individual narratives — of the consumer’s lived experience — is fundamentally different than the traditional antitrust economist’s perspective on competition and the market. It is worth exploring the differences between the two. The basic argument that I make below is that Dayen is right but also that he misunderstands the purpose of competition in a capitalist economy. A robustly competitive market is a brutal rat race that places each individual on an accelerating treadmill. There is no satiation or satisfaction for the individual consumer in these markets. But it is this very lack of satisfaction, this endless thirst for more, that makes competitive markets so powerful, and ultimately beneficial, for consumers. 

This is the fundamental challenge and paradox of capitalism. Satisfaction requires perspective that most consumers often don’t feel, and that many consumers never will feel. It requires the ability to step off that treadmill occasionally and to look how far society and individual welfare has come, even if individually one feels like they have not moved at all. It requires recognizing that the alternative to an uncomfortable flight to visit family isn’t a comfortable one, but an unaffordable one; that the alternative to low cost, processed foods, isn’t abundant higher-quality food but greater poverty for those who already can least afford food; that the alternative to a startup being beholden to Google’s and Amazon’s terms of service isn’t a market in which they have boundless access to these platforms’ infrastructures, but one in which each startup needs to entirely engineer its own infrastructure. In all of these cases, the fundamental tradeoff is between having something that is less perfect than an imagined ideal of it, and not having it at all

What Dayen refers to as consumers’ “lived experience” is really their “perceived experience.” This is important to how markets work. Competition is driven by consumers’ perception that things could be better (and by entrepreneurs’ perception that they can make it so). This perception is what keeps us on the treadmill. Consumers don’t look to their past generations and say “wow, by nearly every measure my life can be better than theirs with less effort!” They focus on what they don’t have yet, on the seemingly better lives of their contemporaries.

This description of markets may sound grotesquely dehumanizing. To the extent that it really is, this is because we live in a world of scarcity. There will always be tradeoffs and in a literally real way no consumer will ever have everything that she needs, let alone that she wants. 

On the flip side, this is what drives markets to make consumers better off. Consumers’ wants drive producers’ factories and innovators’ minds. There is no supply curve without a demand curve. And consumers are able to satisfy their own needs by becoming producers who work to satisfy the wants and needs of others. 

A Fair Question: Are Markets Worth It?

Dayen’s perspective on this description of markets, shared with his fellow reform-minded anti-antitrust crusaders, is that the typical consumers’ perceived experience of the market demonstrates that markets don’t work — that they have been captured by monopolists seeking to extract every ounce of revenue from each individual consumer. But this is not a story of monopolies. It is more plainly the story of markets. What Dayen identifies as a problem with the markets really is just the markets working as they are supposed to.

If this is just how markets work, it is fair to ask whether they are worth it. Importantly, those of us who answer “yes” need not be blind to or dismissive of concerns such as Dayen’s — to the concerns of the typical consumer. Economists have long recognized that capitalist markets are about allocative efficiency, not distributive efficiency — about making society as a whole as wealthy as possible but not about making sure that that wealth is fairly distributed. 

The antitrust reform movement is driven by advocates who long for a world in which everyone is poorer but feels more equal, as opposed to what they perceive as a world in which a few monopolists are extremely wealthy and everyone else feels poor. Their perception of this as the but-for world is not unreasonable, but it is also not accurate. The better world is the one with thriving, prosperous, markets,in which consumers broadly feel that they share in this prosperity. It may be the case that such a world has some oligopolies and even monopolies — that is what economic efficiency sometimes looks like. 

But those firms’ prosperity need not be adverse to consumers’ experience of the market. The challenging question is how we achieve this outcome. But that is a question of politics and macroeconomic policy, and of corporate social policy. It is a question of national identity, whether consumers’ perception of the economic treadmill can pivot from one of perceived futility to one of recognizing their lived contributions to society. It is one that antitrust law as it exists today contributes to answering, but not one that antitrust law on its own can ever answer.

On the other hand, were we to follow the populists’ lead and turn antitrust into a remedy for the perceived maladies of the market, we would risk the engine that improves consumers’ actual lived experience. The alternative to an antitrust driven by economic analysis and that errs on the side of not disrupting markets in favor of perceived injuries is an antitrust in which markets are beholden to the whims of politicians and enforcement officials. This is a world in which litigation is used by politicians to make it appear they are delivering on impossible promises, in which litigation is used to displace blame for politicians’ policy failures, in which litigation is used to distract from socio-political events entirely unrelated to the market. 

Concerns such as Dayen’s are timeless and not unreasonable. But the reflexive action is not the answer to such concerns. Rather, the response always must be to ask “opposed to what?” What is the but-for world? Here, Dayen and his peers suffer both Type I and Type II errors. They misdiagnose antitrust and non-competitive markets as the cause of their perceived problems. And they are overly confident in their proposed solutions to those problems, not recognizing the real harms that their proposed politicization of antitrust and markets poses.

In an age of antitrust populism on both ends of the political spectrum, federal and state regulators face considerable pressure to deploy the antitrust laws against firms that have dominant market shares. Yet federal case law makes clear that merely winning the race for a market is an insufficient basis for antitrust liability. Rather, any plaintiff must show that the winner either secured or is maintaining its dominant position through practices that go beyond vigorous competition. Any other principle would inhibit the competitive process that the antitrust laws are designed to promote. Federal judges who enjoy life tenure are far more insulated from outside pressures and therefore more likely to demand evidence of anticompetitive practices as a predicate condition for any determination of antitrust liability.

This separation of powers between the executive branch, which prosecutes alleged infractions of the law, and the judicial branch, which polices the prosecutor, is the simple genius behind the divided system of government generally attributed to the eighteenth-century French thinker, Montesquieu. The practical wisdom of this fundamental principle of political design, which runs throughout the U.S. Constitution, can be observed in full force in the current antitrust landscape, in which the federal courts have acted as a bulwark against several contestable enforcement actions by antitrust regulators.

In three headline cases brought by the Department of Justice or the Federal Trade Commission since 2017, the prosecutorial bench has struck out in court. Under the exacting scrutiny of the judiciary, government litigators failed to present sufficient evidence that a dominant firm had engaged in practices that caused, or were likely to cause, significant anticompetitive effects. In each case, these enforcement actions, applauded by policymakers and commentators who tend to follow “big is bad” intuitions, foundered when assessed in light of judicial precedent, the factual record, and the economic principles embedded in modern antitrust law. An ongoing suit, filed by the FTC this year after more than 18 months since the closing of the targeted acquisition, exhibits similar factual and legal infirmities.

Strike 1: The AT&T/Time-Warner Transaction

In response to the announcement of AT&T’s $85.4 billion acquisition of Time Warner, the DOJ filed suit in 2017 to prevent the formation of a dominant provider in home-video distribution that would purportedly deny competitors access to “must-have” content. As I have observed previously, this theory of the case suffered from two fundamental difficulties. 

First, content is an abundant and renewable resource so it is hard to see how AT&T+TW could meaningfully foreclose competitors’ access to this necessary input. Even in the hypothetical case of potentially “must-have” content, it was unclear whether it would be economically rational for post-acquisition AT&T regularly to deny access to other distributors, given that doing so would imply an immediate and significant loss in licensing revenues without any clearly offsetting future gain in revenues from new subscribers.

Second, home-video distribution is a market lapsing rapidly into obsolescence as content monetization shifts from home-based viewing to a streaming environment in which consumers expect “anywhere, everywhere” access. The blockbuster acquisition was probably best understood as a necessary effort to adapt to this new environment (already populated by several major streaming platforms), rather than an otherwise puzzling strategy to spend billions to capture a market on the verge of commercial irrelevance. 

Strike 2: The Sabre/Farelogix Acquisition

In 2019, the DOJ filed suit to block the $360 million acquisition of Farelogix by Sabre, one of three leading airline booking platforms, on the ground that it would substantially lessen competition. The factual basis for this legal diagnosis was unclear. In 2018, Sabre earned approximately $3.9 billion in worldwide revenues, compared to $40 million for Farelogix. Given this drastic difference in market share, and the almost trivial share attributable to Farelogix, it is difficult to fathom how the DOJ could credibly assert that the acquisition “would extinguish a crucial constraint on Sabre’s market power.” 

To use a now much-discussed theory of antitrust liability, it might nonetheless be argued that Farelogix posed a “nascent” competitive threat to the Sabre platform. That is: while Farelogix is small today, it may become big enough tomorrow to pose a threat to Sabre’s market leadership. 

But that theory runs straight into a highly inconvenient fact. Farelogix was founded in 1998 and, during the ensuing two decades, had neither achieved broad adoption of its customized booking technology nor succeeded in offering airlines a viable pathway to bypass the three major intermediary platforms. The proposed acquisition therefore seems best understood as a mutually beneficial transaction in which a smaller (and not very nascent) firm elects to monetize its technology by embedding it in a leading platform that seeks to innovate by acquisition. Robust technology ecosystems do this all the time, efficiently exploiting the natural complementarities between a smaller firm’s “out of the box” innovation with the capital-intensive infrastructure of an incumbent. (Postscript: While the DOJ lost this case in federal court, Sabre elected in May 2020 not to close following similarly puzzling opposition by British competition regulators.) 

Strike 3: FTC v. Qualcomm

The divergence of theories of anticompetitive risk from market realities is vividly illustrated by the landmark suit filed by the FTC in 2017 against Qualcomm. 

The litigation pursued nothing less than a wholesale reengineering of the IP licensing relationships between innovators and implementers that underlie the global smartphone market. Those relationships principally consist of device-level licenses between IP innovators such as Qualcomm and device manufacturers and distributors such as Apple. This structure efficiently collects remuneration from the downstream segment of the supply chain for upstream firms that invest in pushing forward the technology frontier. The FTC thought otherwise and pursued a remedy that would have required Qualcomm to offer licenses to its direct competitors in the chip market and to rewrite its existing licenses with device producers and other intermediate users on a component, rather than device, level. 

Remarkably, these drastic forms of intervention into private-ordering arrangements rested on nothing more than what former FTC Commissioner Maureen Ohlhausen once appropriately called a “possibility theorem.” The FTC deployed a mostly theoretical argument that Qualcomm had extracted an “unreasonably high” royalty that had potentially discouraged innovation, impeded entry into the chip market, and inflated retail prices for consumers. Yet these claims run contrary to all available empirical evidence, which indicates that the mobile wireless device market has exhibited since its inception declining quality-adjusted prices, increasing output, robust entry into the production market, and continuous innovation. The mismatch between the government’s theory of market failure and the actual record of market success over more than two decades challenges the policy wisdom of disrupting hundreds of existing contractual arrangements between IP licensors and licensees in a thriving market. 

The FTC nonetheless secured from the district court a sweeping order that would have had precisely this disruptive effect, including imposing a “duty to deal” that would have required Qualcomm to license directly its competitors in the chip market. The Ninth Circuit stayed the order and, on August 11, 2020, issued an unqualified reversal, stating that the lower court had erroneously conflated “hypercompetitive” (good) with anticompetitive (bad) conduct and observing that “[t]hroughout its analysis, the district court conflated the desire to maximize profits with an intent to ‘destroy competition itself.’” In unusually direct language, the appellate court also observed (as even the FTC had acknowledged on appeal) that the district court’s ruling was incompatible with the Supreme Court’s ruling in Aspen Skiing Co. v. Aspen Highlands Skiing Corp., which strictly limits the circumstances in which a duty to deal can be imposed. In some cases, it appears that additional levels of judicial review are necessary to protect antitrust law against not only administrative but judicial overreach.

Axon v. FTC

For the most explicit illustration of the interface between Montesquieu’s principle of divided government and the risk posed to antitrust law by cases of prosecutorial excess, we can turn to an unusual and ongoing litigation, Axon v. FTC.

The HSR Act and Post-Consummation Merger Challenges

The HSR Act provides regulators with the opportunity to preemptively challenge acquisitions and related transactions on antitrust grounds prior to those transactions having been consummated. Since its enactment in 1976, this statutory innovation has laudably increased dealmakers’ ability to close transactions with a high level of certainty that regulators would not belatedly seek to “unscramble the egg.” While the HSR Act does not foreclose this contingency since regulatory failure to challenge a transaction only indicates current enforcement intentions, it is probably fair to say that M&A dealmakers generally assume that regulators would reverse course only in exceptional circumstances. In turn, the low prospect of after-the-fact regulatory intervention encourages the efficient use of M&A transactions for the purpose of shifting corporate assets to users that value those assets most highly.

The FTC’s Belated Attack on the Axon/Vievu Acquisition

Dealmakers may be revisiting that understanding in the wake of the FTC’s decision in January 2020 to challenge the acquisition of Vievu by Axon, each being a manufacturer of body-worn camera equipment and related data-management software for law enforcement agencies. The acquisition had closed in May 2018 but had not been reported through HSR since it fell well below the reportable deal threshold. Given a total transaction value of $7 million, the passage of more than 18 months since closing, and the insolvency or near-insolvency of the target company, it is far from obvious that the Axon acquisition posed a material competitive risk that merits unsettling expectations that regulators will typically not challenge a consummated transaction, especially in the case of what is a micro-sized nebula in the M&A universe. 

These concerns are heightened by the fact that the FTC suit relies on a debatably narrow definition of the relevant market (body-camera equipment and related “cloud-based” data management software for police departments in large metropolitan areas, rather than a market that encompassed more generally defined categories of body-worn camera equipment, law enforcement agencies, and data management services). Even within this circumscribed market, there are apparently several companies that offer related technologies and an even larger group that could plausibly enter in response to perceived profit opportunities. Despite this contestable legal position, Axon’s court filing states that the FTC offered to settle the suit on stiff terms: Axon must agree to divest itself of the Vievu assets and to license all of Axon’s pre-transaction intellectual property to the buyer of the Vievu assets. This effectively amounts to an opportunistic use of the antitrust merger laws to engage in post-transaction market reengineering, rather than merely blocking an acquisition to maintain the pre-transaction status quo.

Does the FTC Violate the Separation of Powers?

In a provocative strategy, Axon has gone on the offensive and filed suit in federal district court to challenge on constitutional grounds the long-standing internal administrative proceeding through which the FTC’s antitrust claims are initially adjudicated. Unlike the DOJ, the FTC’s first stop in the litigation process (absent settlement) is not a federal district court but an internal proceeding before an administrative law judge (“ALJ”), whose ruling can then be appealed to the Commission. Axon is effectively arguing that this administrative internalization of the judicial function violates the separation of powers principle as implemented in the U.S. Constitution. 

Writing on a clean slate, Axon’s claim is eminently reasonable. The fact that FTC-paid personnel sit on both sides of the internal adjudicative process as prosecutor (the FTC litigation team) and judge (the ALJ and the Commissioners) locates the executive and judicial functions in the hands of a single administrative entity. (To be clear, the Commission’s rulings are appealable to federal court, albeit at significant cost and delay.) In any event, a court presented with Axon’s claim—as of this writing, the Ninth Circuit (taking the case on appeal by Axon)—is not writing on a clean slate and is most likely reluctant to accept a claim that would trigger challenges to the legality of other similarly structured adjudicative processes at other agencies. Nonetheless, Axon’s argument does raise important concerns as to whether certain elements of the FTC’s adjudicative mechanism (as distinguished from the very existence of that mechanism) could be refined to mitigate the conflicts of interest that arise in its current form.

Conclusion

Antitrust vigilance certainly has its place, but it also has its limits. Given the aspirational language of the antitrust statutes and the largely unlimited structural remedies to which an antitrust litigation can lead, there is an inevitable risk of prosecutorial overreach that can betray the fundamental objective to protect consumer welfare. Applied to the antitrust context, the separation of powers principle mitigates this risk by subjecting enforcement actions to judicial examination, which is in turn disciplined by the constraints of appellate review and stare decisis. A rich body of federal case law implements this review function by anchoring antitrust in a decisionmaking framework that promotes the public’s interest in deterring business practices that endanger the competitive process behind a market-based economy. As illustrated by the recent string of failed antitrust suits, and the ongoing FTC litigation against Axon, that same decisionmaking framework can also protect the competitive process against regulatory practices that pose this same type of risk.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]

While much of the world of competition policy has focused on mergers in the COVID-19 era. Some observers see mergers as one way of saving distressed but valuable firms. Others have called for a merger moratorium out of fear that more mergers will lead to increased concentration and market power. In the meantime, there has been a growing push for increased nationalization of a wide range of businesses and industries.

In most cases, the call for a government takeover is not a reaction to the public health and economic crises associated with coronavirus. Instead, COVID-19 is a convenient excuse to pursue long sought after policies.

Last year, well before the pandemic, New York mayor Bill de Blasio called for a government takeover of electrical grid operator ConEd because he was upset over blackouts during a heatwave. Earlier that year, he threatened to confiscate housing units from private landlords, “we will seize their buildings, and we will put them in the hands of a community nonprofit that will treat tenants with the respect they deserve.”

With that sort of track record, it should come as no surprise the mayor proposed a government takeover of key industries to address COVID-19: “This is a case for a nationalization, literally a nationalization, of crucial factories and industries that could produce the medical supplies to prepare this country for what we need.” Dana Brown, director of The Next System Project at The Democracy Collaborative, agrees, “We should nationalize what remains of the American vaccine industry now, thereby assuring that any coronavirus vaccines produced can be made as widely available and as inexpensive soon as possible.” 

Dan Sullivan in the American Prospect suggests the U.S. should nationalize all the airlines. Some have gone so far as calling for nationalization of the U.S. oil industry.

On the one hand, it’s clear that de Blasio and Brown have no confidence in the price system to efficiently allocate resources. Alternatively, they may have overconfidence in the political/bureaucratic system to efficiently, and “equitably,” distribute resources. On the other hand, as Daniel Takash points out in an earlier post, both pharmaceuticals and oil are relatively unpopular industries with many Americans, in which case the threat of a government takeover has a big dose of populist score settling:

Yet last year a Gallup poll found that of 25 major industries, the pharmaceutical industry was the most unpopular–trailing behind fossil fuels, lawyers, and even the federal government. 

In the early days of the pandemic, France’s finance minister Bruno Le Maire promised to protect “big French companies.” The minister identified a range of actions under consideration: “That can be done by recapitalization, that can be done by taking a stake, I can even use the term nationalization if necessary.” While he did not mention any specific companies, it’s been speculated Air France KLM may be a target.

The Italian government is expected to nationalize Alitalia soon. The airline has been in state administration since May 2017, and the Italian government will have 100% control of the airline by June. Last week, the German government took a 20% stake in Lufthansa, in what has been characterized as a “temporary partial nationalization.” In Canada, Prime Minister Justin Trudeau has been coy about speculation that the government might nationalize Air Canada. 

Obviously, these takeovers have “bailout” written all over them, and bailouts have their own anticompetitive consequences that can be worse than those associated with mergers. For example, RyanAir announced it will contest the aid package for Lufthansa. RyanAir chief executive Michael O’Leary claims the aid will allow Lufthansa to “engage in below-cost selling” and make it harder for RyanAir and its rival low-cost carrier EasyJet to compete. 

There is also a bit of a “national champion” aspect to the takeovers. Each of the potential targets are (or were) considered their nation’s flagship airline. World Bank economists Tanja Goodwin and Georgiana Pop highlight the risk of nationalization harming competition: 

These [sic] should avoid rescuing firms that were already failing. …  But governments should also refrain from engaging in production or service delivery in industries that can be served by the private sector. The role of SOEs [state owned enterprises] should be assessed in order to ensure that bailout packages are not exclusively and unnecessarily favoring a dominant SOE.

To be sure, COVID-19 related mergers could raise the specter of increased market power post-pandemic. But, this risk must be balanced against the risks posed by a merger moratorium. These include the risk of widespread bankruptcies (that’s another post) and/or the possibility of nationalization of firms and industries. Either option can reduce competition which can bring harm to consumers, employees, and suppliers.

The goal of US antitrust law is to ensure that competition continues to produce positive results for consumers and the economy in general. We published a letter co-signed by twenty three of the U.S.’s leading economists, legal scholars and practitioners, including one winner of the Nobel Prize in economics (full list of signatories here), to exactly that effect urging the House Judiciary Committee on the State of Antitrust Law to reject calls for radical upheaval of antitrust law that would, among other things, undermine the independence and neutrality of US antitrust law. 

A critical part of maintaining independence and neutrality in the administration of antitrust is ensuring that it is insulated from politics. Unfortunately, this view is under attack from all sides. The President sees widespread misconduct among US tech firms that he believes are controlled by the “radical left” and is, apparently, happy to use whatever tools are at hand to chasten them. 

Meanwhile, Senator Klobuchar has claimed, without any real evidence, that the mooted Uber/Grubhub merger is simply about monopolisation of the market, and not, for example, related to the huge changes that businesses like this are facing because of the Covid shutdown.

Both of these statements challenge the principle that the rule of law depends on being politically neutral, including in antitrust. 

Our letter, contrary to the claims made by President Trump, Sen. Klobuchar and some of the claims made to the Committee, asserts that the evidence and economic theory is clear: existing antitrust law is doing a good job of promoting competition and consumer welfare in digital markets and the economy more broadly, and concludes that the Committee should focus on reforms that improve antitrust at the margin, not changes that throw out decades of practice and precedent.

The letter argues that:

  1. The American economy—including the digital sector—is competitive, innovative, and serves consumers well, contrary to how it is sometimes portrayed in the public debate. 
  2. Structural changes in the economy have resulted from increased competition, and increases in national concentration have generally happened because competition at the local level has intensified and local concentration has fallen.
  3. Lax antitrust enforcement has not allowed systematic increases in market power, and the evidence simply does not support out the idea that antitrust enforcement has weakened in recent decades.
  4. Existing antitrust law is adequate for protecting competition in the modern economy, and built up through years of careful case-by-case scrutiny. Calls to throw out decades of precedent to achieve an antitrust “Year Zero” would throw away a huge body of learning and deliberation.
  5. History teaches that discarding the modern approach to antitrust would harm consumers, and return to a situation where per se rules prohibited the use of economic analysis and fact-based defences of business practices.
  6. Common sense reforms should be pursued to improve antitrust enforcement, and the reforms proposed in the letter could help to improve competition and consumer outcomes in the United States without overturning the whole system.

The reforms suggested include measures to increase transparency of the DoJ and FTC, greater scope for antitrust challenges against state-sponsored monopolies, stronger penalties for criminal cartel conduct, and more agency resources being made available to protect workers from anti-competitive wage-fixing agreements between businesses. These are suggestions for the House Committee to consider and are not supported by all the letter’s signatories.

Some of the arguments in the letter are set out in greater detail in the ICLE’s own submission to the Committee, which goes into detail about the nature of competition in modern digital markets and in traditional markets that have been changed because of the adoption of digital technologies. 

The full letter is here.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Ramsi Woodcock, (Assistant Professor of Law, University of Kentucky; Assistant Professor of Management, Gatton College of Business and Economics).]

Specialists know that the antitrust courses taught in law schools and economics departments have an alter ego in business curricula: the course on business strategy. The two courses cover the same material, but from opposite perspectives. Antitrust courses teach how to end monopolies; strategy courses teach how to construct and maintain them.

Strategy students go off and run businesses, and antitrust students go off and make government policy. That is probably the proper arrangement if the policy the antimonopolists make is domestic. We want the domestic economy to run efficiently, and so we want domestic policymakers to think about monopoly—and its allocative inefficiencies—as something to be discouraged.

The coronavirus, and the shortages it has caused, have shown us that putting the antimonopolists in charge of international policy is, by contrast, a very big mistake.

Because we do not yet have a world government. America’s position, in relation to the rest of the world, is therefore more akin to that of a business navigating a free market than it is to a government seeking to promote efficient interactions among the firms that it governs. To flourish, America must engage in international trade with a view to creating and maintaining monopoly positions for itself, rather than eschewing them in the interest of realizing efficiencies in the global economy. Which is to say: we need strategists, not antimonopolists.

For the global economy is not America, and there is no guarantee that competitive efficiencies will redound to America’s benefit, rather than to those of her competitors. Absent a world government, other countries will pursue monopoly regardless what America does, and unless America acts strategically to build and maintain economic power, America will eventually occupy a position of commercial weakness, with all of the consequences for national security that implies.

When Antimonopolists Make Trade Policy

The free traders who have run American economic policy for more than a generation are antimonopolists playing on a bigger stage. Like their counterparts in domestic policy, they are loyal in the first instance only to the efficiency of the market, not to any particular trader. They are content to establish rules of competitive trading—the antitrust laws in the domestic context, the World Trade Organization in the international context—and then to let the chips fall where they may, even if that means allowing present or future adversaries to, through legitimate means, build up competitive advantages that the United States is unable to overcome.

Strategy is consistent with competition when markets are filled with traders of atomic size, for then no amount of strategy can deliver a competitive advantage to any trader. But global markets, more even than domestic markets, are filled with traders of macroscopic size. Strategy then requires that each trader seek to gain and maintain advantages, undermining competition. The only way antimonopolists could induce the trading behemoth that is America to behave competitively, and to let the chips fall where they may, was to convince America voluntarily to give up strategy, to sacrifice self-interest on the altar of efficient markets.

And so they did.

Thus when the question arose whether to permit American corporations to move their manufacturing operations overseas, or to permit foreign companies to leverage their efficiencies to dominate a domestic industry and ensure that 90% of domestic supply would be imported from overseas, the answer the antimonopolists gave was: “yes.” Because it is efficient. Labor abroad is cheaper than labor at home, and transportation costs low, so efficiency requires that production move overseas, and our own resources be reallocated to more competitive uses.

This is the impeccable logic of static efficiency, of general equilibrium models allocating resources optimally. But it is instructive to recall that the men who perfected this model were not trying to describe a free market, much less international trade. They were trying to create a model that a central planner could use to allocate resources to a state’s subjects. What mattered to them in building the model was the good of the whole, not any particular part. And yet it is to a particular part of the global whole that the United States government is dedicated.

The Strategic Trader

Students of strategy would have taken a very different approach to international trade. Strategy teaches that markets are dynamic, and that businesses must make decisions based not only on the market signals that exist today, but on those that can be made to exist in the future. For the successful strategist, unlike the antimonopolist, identifying a product for which consumers are willing to pay the costs of production is not alone enough to justify bringing the product to market. The strategist must be able to secure a source of supply, or a distribution channel, that competitors cannot easily duplicate, before the strategist will enter.

Why? Because without an advantage in supply, or distribution, competitors will duplicate the product, compete away any markups, and leave the strategist no better off than if he had never undertaken the project at all. Indeed, he may be left bankrupt, if he has sunk costs that competition prevents him from recovering. Unlike the economist, the strategist is interested in survival, because he is a partisan of a part of the market—himself—not the market entire. The strategist understands that survival requires power, and all power rests, to a greater or lesser degree, on monopoly.

The strategist is not therefore a free trader in the international arena, at least not as a matter of principle. The strategist understands that trading from a position of strength can enrich, and trading from a position of weakness can impoverish. And to occupy that position of strength, America must, like any monopolist, control supply. Moreover, in the constantly-innovating markets that characterize industrial economies, markets in which innovation emerges from learning by doing, control over physical supply translates into control over the supply of inventions itself.

The strategist does not permit domestic corporations to offshore manufacturing in any market in which the strategist wishes to participate, because that is unsafe: foreign countries could use control over that supply to extract rents from America, to drive domestic firms to bankruptcy, and to gain control over the supply of inventions.

And, as the new trade theorists belatedly discovered, offshoring prevents the development of the dense, geographically-contiguous, supply networks that confer power over whole product categories, such as the electronics hub in Zhengzhou, where iPhone-maker Foxconn is located.

Or the pharmaceutical hub in Hubei.

Coronavirus and the Failure of Free Trade

Today, America is unprepared for the coming wave of coronavirus cases because the antimonopolists running our trade policy do not understand the importance of controlling supply. There is a shortage of masks, because China makes half of the world’s masks, and the Chinese have cut off supply, the state having forbidden even non-Chinese companies that offshored mask production from shipping home masks for which American customers have paid. Not only that, but in January China bought up most of the world’s existing supply of masks, with free-trade-obsessed governments standing idly by as the clock ticked down to their own domestic outbreaks.  

New York State, which lies at the epicenter of the crisis, has agreed to pay five times the market price for foreign supply. That’s not because the cost of making masks has risen, but because sellers are rationing with price. Which is to say: using their control over supply to beggar the state. Moreover, domestic mask makers report that they cannot ramp up production because of a lack of supply of raw materials, some of which are actually made in Wuhan, China. That’s the kind of problem that does not arise when restrictions on offshoring allow manufacturing hubs to develop domestically.

But a shortage of masks is just the beginning. Once a vaccine is developed, the race will be on to manufacture it, and America controls less than 30% of the manufacturing facilities that supply pharmaceuticals to American markets. Indeed, just about the only virus-relevant industries in which we do not have a real capacity shortage today are food and toilet paper, panic buying notwithstanding. Because fortunately for us antimonopolists could not find a way to offshore California and Oregon. If they could have, they surely would have, since both agriculture and timber are labor-intensive industries.

President Trump’s failed attempt to buy a German drug company working on a coronavirus vaccine shows just how damaging free market ideology has been to national security: as Trump should have anticipated given his resistance to the antimonopolists’ approach to trade, the German government nipped the deal in the bud. When an economic agent has market power, the agent can pick its prices, or refuse to sell at all. Only in general equilibrium fantasy is everything for sale, and at a competitive price to boot.

The trouble is: American policymakers, perhaps more than those in any other part of the world, continue to act as though that fantasy were real.

Failures Left and Right

America’s coronavirus predicament is rich with intellectual irony.

Progressives resist free trade ideology, largely out of concern for the effects of trade on American workers. But they seem not to have realized that in doing so they are actually embracing strategy, at least for the benefit of labor.

As a result, progressives simultaneously reject the approach to industrial organization economics that underpins strategic thinking in business: Joseph Schumpeter’s theory of creative destruction, which holds that strategic behavior by firms seeking to achieve and maintain monopolies is ultimately good for society, because it leads to a technological arms race as firms strive to improve supply, distribution, and indeed product quality, in ways that competitors cannot reproduce.

Even if progressives choose to reject Schumpeter’s argument that strategy makes society better off—a proposition that is particularly suspect at the international level, where the availability of tanks ensures that the creative destruction is not always creative—they have much to learn from his focus on the economics of survival.

By the same token, conservatives embrace Schumpeter in arguing for less antitrust enforcement in domestic markets, all the while advocating free trade at the international level and savaging governments for using dumping and tariffs—which is to say, the tools of monopoly—to strengthen their trading positions. It is deeply peculiar to watch the coronavirus expose conservative economists as pie-in-the-sky internationalists. And yet as the global market for coronavirus necessities seizes up, the ideology that urged us to dispense with producing these goods ourselves, out of faith that we might always somehow rely on the support of the rest of the world, provided through the medium of markets, looks pathetically naive.

The cynic might say that inconsistency has snuck up on both progressives and conservatives because each remains too sympathetic to a different domestic constituency.

Dodging a Bullet

America is lucky that a mere virus exposed the bankruptcy of free trade ideology. Because war could have done that instead. It is difficult to imagine how a country that cannot make medical masks—much less a Macbook—would be able to respond effectively to a sustained military attack from one of the many nations that are closing the technological gap long enjoyed by the United States.

The lesson of the coronavirus is: strategy, not antitrust.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Steve Cernak, (Partner, Bona Law).]

The antitrust laws have not been suspended during the current COVID-19 crisis. But based on questions received from clients plus others discussed with other practitioners, the changed economic conditions have raised some new questions and put a new slant on some old ones. 

Under antitrust law’s flexible rule of reason standard, courts and enforcers consider the competitive effect of most actions under current and expected economic conditions. Because those conditions have changed drastically, at least temporarily, perhaps the antitrust assessments of certain actions will be different. Also, in a crisis, good businesses consider new options and reconsider others that had been rejected under the old conditions. So antitrust practitioners and enforcers need to be prepared for new questions and reconsiderations of others under new facts. Here are some that might cross their desks.

Benchmarking

Benchmarking had its antitrust moment a few years ago as practitioners discovered and began to worry about this form of communication with competitors. Both before and since then, the comparison of processes and metrics to industry bests to determine where improvement efforts should be concentrated has not raised serious antitrust issues – if done properly. Appropriate topic choice and implementation, often involving counsel review and third-party collection, should stay the same during this crisis. Companies implementing new processes might be tempted to reach out to competitors to learn best practices. Any of those companies unfamiliar with the right way to benchmark should get up to speed. Counsel must be prepared to help clients quickly, but properly, benchmark some suddenly important activities, like methods for deep-cleaning workplaces.

Joint ventures

Joint ventures where competitors work together to accomplish a task that neither could alone, or accomplish it more efficiently, have always received a receptive antitrust review. Often, those joint efforts have been temporary. Properly structured ones have always required the companies to remain competitors outside the joint venture. Joint efforts among competitors that did not make sense before the crisis might make perfect sense during it. For instance, a company whose distribution warehouse has been shut down by a shelter in place order might be able to use a competitor’s distribution assets to continue to get goods to the market. 

Some joint ventures of competitors have received special antitrust assurances for decades. The National Cooperative Research and Production Act of 1993 was originally passed in 1984 to protect research joint ventures of competitors. It was later extended to certain joint production efforts and standard development organizations. The law confirms that certain joint ventures of competitors will be judged under the rule of reason. If the parties file a very short notice with the DOJ Antitrust Division and FTC, they also will receive favorable treatment regarding damages and attorney’s fees in any antitrust lawsuit. For example, competitors cooperating on the development of new virus treatments might be able to use NCRPA to protect joint research and even production of the cure. 

Mergers

Horizontal mergers that permanently combine the assets of two competitors are unlikely to be justified under the antitrust laws by small transitory blips in the economic landscape. A huge crisis, however, might be so large and create such long-lasting effects that certain mergers suddenly might make sense, both on business and antitrust grounds. That rationale was used during the most recent economic crisis to justify several large mergers of banks although other large industrial mergers considered at the same time were abandoned for various reasons. It is not yet clear if that reasoning is present in any industry now. 

Remote communication among competitors

On a much smaller but more immediate scale, the new forms of communication being used while so many of us are physically separated have raised questions about the usual antitrust advice regarding communication with competitors. Antitrust practitioners have long advised clients about how to prepare and conduct an in-person meeting of competitors, say at a trade association convention. That same advice would seem to apply if, with the in-person convention cancelled, the meeting will be held via Teams or Zoom. And don’t forget: The reminders that the same rules apply to the cocktail party at the bar after the meeting should also be given for the virtual version conducted via Remo.co

Pricing and brand Management

Since at least the time when the Dr. Miles Medical Co. was selling its “restorative nervine,” manufacturers have been concerned about how their products were resold by retailers. Antitrust law has provided manufacturers considerable freedom for some time to impose non-price restraints on retailers to protect brand reputations; however, manufacturers must consider and impose those restraints before a crisis hits. For instance, a “no sale for resale” provision in place before the crisis would give a manufacturer of hand sanitizer another tool to use now to try to prevent bulk sales of the product that will be immediately resold on the street. 

Federal antitrust law has provided manufacturers considerable freedom to impose maximum price restraints. Even the states whose laws prevent minimum price restraints do not seem as concerned about maximum ones. But again, if a manufacturer is concerned that some consumer will blame it, not just the retailer, for a sudden skyrocketing price for a product in short supply, some sort of restraints must be in place before the crisis. Certain platforms are invoking their standard policies to prevent such actions by resellers on their platforms. 

Regulatory hurdles

While antitrust law is focused on actions by private parties that might prevent markets from properly working to serve consumers, the same rationales apply to unnecessary government interference in the market. The current health crisis has turned the spotlight back on certificate of need laws, a form of “brother may I?” government regulation that can allow current competitors to stifle entry by new competitors. Similarly, regulations that have slowed the use of telemedicine have been at least temporarily waived

Conclusion

Solving the current health crisis and rebuilding the economy will take the best efforts of both our public institutions and private companies. Antitrust law as currently written and enforced can and should continue to play a role in aligning incentives so we need not rely on “the benevolence of the butcher” for our dinner and other necessities. Instead, proper application of antitrust law can allow companies to do their part to (reviving a slogan helpful in a prior national crisis) keep America rolling.

This is the fourth, and last, in a series of TOTM blog posts discussing the Commission’s recently published Google Android decision (the first post can be found here, and the second here, and the third here). It draws on research from a soon-to-be published ICLE white paper.

The previous parts of this series have mostly focused on the Commission’s factual and legal conclusions. However, as this blog post points out, the case’s economic underpinnings also suffer from important weaknesses.

Two problems are particularly salient: First, the economic models cited by the Commission (discussed in an official paper, but not directly in the decision) poorly match the underlying facts. Second, the Commission’s conclusions on innovation harms are out of touch with the abundant economic literature regarding the potential link between market structure and innovation.

The wrong economic models

The Commission’s Chief Economist team outlined its economic reasoning in an article published shortly after the Android decision was published. The article reveals that the Commission relied upon three economic papers to support its conclusion that Google’s tying harmed consumer welfare.

Each of these three papers attempts to address the same basic problem. Ever since the rise of the Chicago-School, it is widely accepted that a monopolist cannot automatically raise its profits by entering an adjacent market (i.e. leveraging its monopoly position), for instance through tying. This has sometimes been called the single-monopoly-profit theory. In more recent years, various scholars have refined this Chicago-School intuition, and identified instances where the theory fails.

While the single monopoly profit theory has been criticized in academic circles, it is important to note that the three papers cited by the Commission accept its basic premise. They thus attempt to show why the theory fails in the context of the Google Android case. 

Unfortunately, the assumptions upon which they rely to reach this conclusion markedly differ from the case’s fact pattern. These papers thus offer little support to the Commission’s economic conclusions.

For a start, the authors of the first paper cited by the Commission concede that their own model does not apply to the Google case:

Actual antitrust cases are fact-intensive and our model does not perfectly fit with the current Google case in one important aspect.

The authors thus rely on important modifications, lifted from a paper by Frederico Etro and Cristina Caffara (the second paper cited by the Commission), to support their conclusion that Google’s tying was anticompetitive. 

The second paper cited by the Commission, however, is equally problematic

The authors’ underlying intuition is relatively straightforward: because Google bundles its suite of Google Apps (including Search) with the Play Store, a rival search engine would have to pay a premium in order to be pre-installed and placed on the home screen, because OEMs would have to entirely forgo Google’s suite of applications. The key assumption here is that OEMs cannot obtain the Google Play app and pre-install and place favorably a rival search app

But this is simply not true of Google’s contractual terms. The best evidence is that rivals search apps have indeed concluded deals with OEMs to pre-install their search apps, without these OEMs losing access to Google’s suite of proprietary apps. Google’s contractual terms simply do not force OEMs to choose between the Google Play app and the pre-installation of a rival search app. Etro and Caffara’s model thus falls flat.

More fundamentally, even if Google’s contractual terms did prevent OEMs from pre-loading rival apps, the paper’s conclusions would still be deeply flawed. The authors essentially assume that the only way for consumers to obtain a rival app is through pre-installation. But this is a severe misreading of the prevailing market conditions. 

Users remain free to independently download rival search apps. If Google did indeed purchase exclusive pre-installation, users would not have to choose between a “full Android” device and one with a rival search app but none of Google’s apps. Instead, they could download the rival app and place it alongside Google’s applications. 

A more efficient rival could even provide side payments, of some sort, to encourage consumers to download its app. Exclusive pre-installation thus generates a much smaller advantage than Etro and Caffara assume, and their model fails to reflect this.

Finally, the third paper by Alexandre de Cornière and Greg Taylor, suffers from the exact same problem. The authors clearly acknowledge that their findings only hold if OEMs (and consumers) are effectively prevented from (pre-)installing applications that compete with Google’s apps. In their own words:

Upstream firms offer contracts to the downstream firm, who chooses which component(s) to use and then sells to consumers. For our theory to apply, the following three conditions need to hold: (i) substitutability between the two versions of B leads the downstream firm to install at most one version.

The upshot is that all three of the economic models cited by the Commission cease to be relevant in the specific context of the Google Android decision. The Commission is thus left with little to no economic evidence to support its finding of anticompetitive effects.

Critics might argue that direct downloads by consumers are but a theoretical possibility. Yet nothing could be further from the truth. Take the web browser market: The Samsung Internet Browser has more than 1 Billion downloads on Google’s Play Store. The Opera, Opera Mini and Firefox browsers each have over a 100 million downloads. The Brave browser has more than 10 million downloads, but is growing rapidly.

In short the economic papers on which the Commission relies are based on a world that does not exist. They thus fail to support the Commission’s economic findings.

An incorrect view of innovation

In its decision, the Commission repeatedly claimed that Google’s behavior stifled innovation because it prevented rivals from entering the market. However, the Commission offered no evidence to support its assumption that reduced market entry on would lead to a decrease in innovation:

(858) For the reasons set out in this Section, the Commission concludes that the tying of the Play Store and the Google Search app helps Google to maintain and strengthen its dominant position in each national market for general search services, increases barriers to entry, deters innovation and tends to harm, directly or indirectly, consumers.

(859) First, Google’s conduct makes it harder for competing general search services to gain search queries and the respective revenues and data needed to improve their services.

(861) Second, Google’s conduct increases barriers to entry by shielding Google from competition from general search services that could challenge its dominant position in the national markets for general search services:

(862) Third, by making it harder for competing general search services to gain search queries including the respective revenues and data needed to improve their services, Google’s conduct reduces the incentives of competing general search services to invest in developing innovative features, such as innovation in algorithm and user experience design.

In a nutshell, the Commission’s findings rest on the assumption that barriers to entry and more concentrated market structures necessarily reduce innovation. But this assertion is not supported by the empirical economic literature on the topic.

For example, a 2006 paper published by Richard Gilbert surveys 24 empirical studies on the topic. These studies examine the link between market structure (or firm size) and innovation. Though earlier studies tended to identify a positive relationship between concentration, as well as firm size, and innovation, more recent empirical techniques found no significant relationship. Gilbert thus suggests that:

These econometric studies suggest that whatever relationship exists at a general economy-wide level between industry structure and R&D is masked by differences across industries in technological opportunities, demand, and the appropriability of inventions.

This intuition is confirmed by another high-profile empirical paper by Aghion, Bloom, Blundell, Griffith, and Howitt. The authors identify an inverted-U relationship between competition and innovation. Perhaps more importantly, they point out that this relationship is affected by a number of sector-specific factors.

Finally, reviewing fifty years of research on innovation and market structure, Wesley Cohen concludes that:

Even before one controls for industry effects, the variance in R&D intensity explained by market concentration is small. Moreover, whatever relationship that exists in cross sections becomes imperceptible with the inclusion of controls for industry characteristics, whether expressed as industry fixed effects or in the form of survey-based and other measures of industry characteristics such as technological opportunity, appropriability conditions, and demand. In parallel to a decades-long accumulation of mixed results, theorists have also spawned an almost equally voluminous and equivocal literature on the link between market structure and innovation.[16]

The Commission’s stance is further weakened by the fact that investments in the Android operating system are likely affected by a weak appropriability regime. In other words, because of its open source nature, it is hard for Google to earn a return on investments in the Android OS (anyone can copy, modify and offer their own version of the OS). 

Loosely tying Google’s proprietary applications to the OS is arguably one way to solve this appropriability problem. Unfortunately, the Commission brushed these considerations aside. It argued that Google could earn some revenue from the Google Play app, as well as other potential venues. However, the Commission did not question whether these sources of income were even comparable to the sums invested by Google in the Android OS. It is thus possible that the Commission’s decision will prevent Google from earning a positive return on some future investments in the Android OS, ultimately causing it to cut back its investments and slowing innovation.

The upshot is that the Commission was simply wrong to assume that barriers to entry and more concentrated market structures would necessarily reduce innovation. This is especially true, given that Google may struggle to earn a return on its investments, absent the contractual provisions challenged by the Commission.

Conclusion

In short, the Commission’s economic analysis was severely lacking. It relied on economic models that had little to say about the market it which Google and its rivals operated. Its decisions thus reveals the inherent risk of basing antitrust decisions upon overfitted economic models. 

As if that were not enough, the Android decision also misrepresents the economic literature concerning the link (or absence thereof) between market structure and innovation. As a result, there is no reason to believe that Google’s behavior reduced innovation.

The DOJ and 20 state AGs sued Microsoft on May 18, 1998 for unlawful maintenance of its monopoly position in the PC market. The government accused the desktop giant of tying its operating system (Windows) and its web browser (Internet Explorer). Microsoft had indeed become dominant in the PC market by the late 1980s:

Source: Asymco

But after the introduction of smartphones in the mid-2000s, Microsoft’s market share of personal computing units (including PCs, smartphones, and tablets) collapsed:

Source: Benedict Evans

Steven Sinofsy pointed out why this was a classic case of disruptive innovation rather than sustaining innovation: “Google and Microsoft were competitors but only by virtue of being tech companies hiring engineers. After that, almost nothing about what was being made or sold was similar even if things could ultimately be viewed as substitutes. That is literally the definition of innovation.”

Browsers

Microsoft grew to dominance during the PC era by bundling its desktop operating system (Windows) with its productivity software (Office) and modularizing the hardware providers. By 1995, Bill Gates had realized that the internet was the next big thing, calling it “The Internet Tidal Wave” in a famous internal memo. Gates feared that the browser would function as “middleware” and disintermediate Microsoft from its relationship with the end-user. At the time, Netscape Navigator was gaining market share from the first browser to popularize the internet, Mosaic (so-named because it supported a multitude of protocols).

Later that same year, Microsoft released its own browser, Internet Explorer, which would be bundled with its Windows operating system. Internet Explorer soon grew to dominate the market:

Source: Browser Wars

Steven Sinofsky described how the the browser threatened to undermine the Windows platform (emphasis added):

Microsoft saw browsers as a platform threat to Windows. Famously. Browsers though were an app — running everywhere, distributed everywhere. Microsoft chose to compete as though browsing was on par with Windows (i.e., substitutes).

That meant doing things like IBM did — finding holes in distribution where browsers could “sneak” in (e.g., OEM deals) and seeing how to make Microsoft browser work best and only with Windows. Sound familiar? It does to me.

Imagine (some of us did) a world instead where Microsoft would have built a browser that was an app distributed everywhere, running everywhere. That would have been a very different strategy. One that some imagined, but not when Windows was central.

Showing how much your own gravity as a big company can make even obvious steps strategically weak: Microsoft knew browsers had to be cross-platform so it built Internet Explorer for Mac and Unix. Neat. But wait, the main strategic differentiator for Internet Explorer was ActiveX which was clearly Windows only.

So even when trying to compete in a new market the strategy was not going to work technically and customers would immediately know. Either they would ignore the key part of Windows or the key part of x-platform. This is what a big company “master plan” looks like … Active Desktop.

Regulators claimed victory but the loss already happened. But for none of the reasons the writers of history say at least [in my humble opinion]. As a reminder, Microsoft stopped working on Internet Explorer 7 years before Chrome even existed — literally didn’t release a new version for 5+ years.

One of the most important pieces of context for this case is that other browsers were also free for personal use (even if they weren’t bundled with an operating system). At the time, Netscape was free for individuals. Mosaic was free for non-commercial use. Today, Chrome and Firefox are free for all users. Chrome makes money for Google by increasing the value of its ecosystem and serving as a complement for its other products (particularly search). Firefox is able to more than cover its costs by charging Google (and others) to be the default option in its browser. 

By bundling Internet Explorer with Windows for free, Microsoft was arguably charging the market rate. In highly competitive markets, economic theory tells us the price should approach marginal cost — which in software is roughly zero. As James Pethokoukis argued, there are many more reasons to be skeptical about the popular narrative surrounding the Microsoft case. The reasons for doubt range across features, products, and markets, including server operating systems, mobile devices, and search engines. Let’s examine a few of them.

Operating Systems

In a 2007 article for Wired titled “I Blew It on Microsoft,” Lawrence Lessig, a Harvard law professor, admits that his predictions about the future of competition in computer operating systems failed to account for the potential of open-source solutions:

We pro-regulators were making an assumption that history has shown to be completely false: That something as complex as an OS has to be built by a commercial entity. Only crazies imagined that volunteers outside the control of a corporation could successfully create a system over which no one had exclusive command. We knew those crazies. They worked on something called Linux.

According to Web Technology Surveys, as of April 2019, about 70 percent of servers use a Linux-based operating system while the remaining 30 percent use Windows.

Mobile

In 2007, Steve Ballmer believed that Microsoft would be the dominant company in smartphones, saying in an interview with USA Today (emphasis added):

There’s no chance that the iPhone is going to get any significant market share. No chance. It’s a $500 subsidized item. They may make a lot of money. But if you actually take a look at the 1.3 billion phones that get sold, I’d prefer to have our software in 60% or 70% or 80% of them, than I would to have 2% or 3%, which is what Apple might get.

But as Ballmer himself noted in 2013, Microsoft was too committed to the Windows platform to fully pivot its focus to mobile:

If there’s one thing I regret, there was a period in the early 2000s when we were so focused on what we had to do around Windows that we weren’t able to redeploy talent to the new device form factor called the phone.

This is another classic example of the innovator’s dilemma. Microsoft enjoyed high profit margins in its Windows business, which caused the company to underrate the significance of the shift from PCs to smartphones.

Search

To further drive home how dependent Microsoft was on its legacy products, this 2009 WSJ piece notes that the company had a search engine ad service in 2000 and shut it down to avoid cannibalizing its core business:

Nearly a decade ago, early in Mr. Ballmer’s tenure as CEO, Microsoft had its own inner Google and killed it. In 2000, before Google married Web search with advertising, Microsoft had a rudimentary system that did the same, called Keywords, running on the Web. Advertisers began signing up. But Microsoft executives, in part fearing the company would cannibalize other revenue streams, shut it down after two months.

Ben Thompson says we should wonder if the case against Microsoft was a complete waste of everyone’s time (and money): 

In short, to cite Microsoft as a reason for antitrust action against Google in particular is to get history completely wrong: Google would have emerged with or without antitrust action against Microsoft; if anything the real question is whether or not Google’s emergence shows that the Microsoft lawsuit was a waste of time and money.

The most obvious implications of the Microsoft case were negative: (1) PCs became bloated with “crapware” (2) competition in the browser market failed to materialize for many years (3) PCs were less safe because Microsoft couldn’t bundle security software, and (4) some PC users missed out on using first-party software from Microsoft because it couldn’t be bundled with Windows. When weighed against these large costs, the supposed benefits pale in comparison.

Conclusion

In all three cases I’ve discussed in this series — AT&T, IBM, and Microsoft — the real story was not that antitrust enforcers divined the perfect time to break up — or regulate — the dominant tech company. The real story was that slow and then sudden technological change outpaced the organizational inertia of incumbents, permanently displacing the former tech giants from their dominant position in the tech ecosystem. 

The next paradigm shift will be near-impossible to predict. Those who know which technology — and when — it will be would make a lot more money implementing their ideas than they would by playing pundit in the media. Regardless of whether the future winner will be Google, Facebook, Amazon, Apple, Microsoft, or some unknown startup company, antitrust enforcers should remember that the proper goal of public policy in this domain is to maximize total innovation — from firms both large and small. Fetishizing innovation by small companies — and using law enforcement to harass big companies in the hopes for an indirect benefit to competition — will make us all worse off in the long run.

The case against AT&T began in 1974. The government alleged that AT&T had monopolized the market for local and long-distance telephone service as well as telephone equipment. In 1982, the company entered into a consent decree to be broken up into eight pieces (the “Baby Bells” plus the parent company), which was completed in 1984. As a remedy, the government required the company to divest its local operating companies and guarantee equal access to all long-distance and information service providers (ISPs).

Source: Mohanram & Nanda

As the chart above shows, the divestiture broke up AT&T’s national monopoly into seven regional monopolies. In general, modern antitrust analysis focuses on the local product market (because that’s the relevant level for consumer decisions). In hindsight, how did breaking up a national monopoly into seven regional monopolies increase consumer choice? It’s also important to note that, prior to its structural breakup, AT&T was a government-granted monopoly regulated by the FCC. Any antitrust remedy should be analyzed in light of the company’s unique relationship with regulators.

Breaking up one national monopoly into seven regional monopolies is not an effective way to boost innovation. And there are economies of scale and network effects to be gained by owning a national network to serve a national market. In the case of AT&T, those economic incentives are why the Baby Bells forged themselves back together in the decades following the breakup.

Source: WSJ

As Clifford Winston and Robert Crandall noted

Appearing to put Ma Bell back together again may embarrass the trustbusters, but it should not concern American consumers who, in two decades since the breakup, are overwhelmed with competitive options to provide whatever communications services they desire.

Moreover, according to Crandall & Winston (2003), the lower prices following the breakup of AT&T weren’t due to the structural remedy at all (emphasis added):

But on closer examination, the rise in competition and lower long-distance prices are attributable to just one aspect of the 1982 decree; specifically, a requirement that the Bell companies modify their switching facilities to provide equal access to all long-distance carriers. The Federal Communications Commission (FCC) could have promulgated such a requirement without the intervention of the antitrust authorities. For example, the Canadian regulatory commission imposed equal access on its vertically integrated carriers, including Bell Canada, in 1993. As a result, long-distance competition developed much more rapidly in Canada than it had in the United States (Crandall and Hazlett, 2001). The FCC, however, was trying to block MCI from competing in ordinary long-distance services when the AT&T case was filed by the Department of Justice in 1974. In contrast to Canadian and more recent European experience, a lengthy antitrust battle and a disruptive vertical dissolution were required in the U.S. market to offset the FCC’s anti-competitive policies. Thus, antitrust policy did not triumph in this case over restrictive practices by a monopolist to block competition, but instead it overcame anticompetitive policies by a federal regulatory agency.

A quick look at the data on telephone service in the US, EU, and Canada show that the latter two were able to achieve similar reductions in price without breaking up their national providers.

Source: Crandall & Jackson (2011)

The paradigm shift from wireline to wireless

The technological revolution spurred by the transition from wireline telephone service to wireless telephone service shook up the telecommunications industry in the 1990s. The rapid change caught even some of the smartest players by surprise. In 1980, the management consulting firm McKinsey and Co. produced a report for AT&T predicting how large the cellular market might become by the year 2000. Their forecast said that 900,000 cell phones would be in use. The actual number was more than 109 million.

Along with the rise of broadband, the transition to wireless technology led to an explosion in investment. In contrast, the breakup of AT&T in 1984 had no discernible effect on the trend in industry investment:

The lesson for antitrust enforcers is clear: breaking up national monopolies into regional monopolies is no remedy. In certain cases, mandating equal access to critical networks may be warranted. Most of all, technology shocks will upend industries in ways that regulators — and dominant incumbents — fail to predict.

The Department of Justice began its antitrust case against IBM on January 17, 1969. The DOJ sued under the Sherman Antitrust Act, claiming IBM tried to monopolize the market for “general-purpose digital computers.” The case lasted almost thirteen years, ending on January 8, 1982 when Assistant Attorney General William Baxter declared the case to be “without merit” and dropped the charges. 

The case lasted so long, and expanded in scope so much, that by the time the trial began, “more than half of the practices the government raised as antitrust violations were related to products that did not exist in 1969.” Baltimore law professor Robert Lande said it was “the largest legal case of any kind ever filed.” Yale law professor Robert Bork called it “the antitrust division’s Vietnam.”

As the case dragged on, IBM was faced with increasingly perverse incentives. As NYU law professor Richard Epstein pointed out (emphasis added), 

Oddly, enough IBM was able to strengthen its antitrust-related legal position by reducing its market share, which it achieved through raising prices. When the suit was discontinued that share had fallen dramatically since 1969 from about 50 percent of the market to 37 percent in 1982. Only after the government suit ended did IBM lower its prices in order to increase market share.

Source: Levy & Welzer

In an interview with Vox, Tim Wu claimed that without the IBM case, Apple wouldn’t exist and we might still be using mainframe computers (emphasis added):

Vox: You said that Apple wouldn’t exist without the IBM case.

Wu: Yeah, I did say that. The case against IBM took 13 years and we didn’t get a verdict but in that time, there was the “policeman at the elbow” effect. IBM was once an all-powerful company. It’s not clear that we would have had an independent software industry, or that it would have developed that quickly, the idea of software as a product, [without this case]. That was one of the immediate benefits of that excavation.

And then the other big one is that it gave a lot of room for the personal computer to get started, and the software that surrounds the personal computer — two companies came in, Apple and Microsoft. They were sort of born in the wake of the IBM lawsuit. You know they were smart guys, but people did need the pressure off their backs.

Nobody is going to start in the shadow of Facebook and get anywhere. Snap’s been the best, but how are they doing? They’ve been halted. I think it’s a lot harder to imagine this revolutionary stuff that happened in the ’80s. If IBM had been completely unwatched by regulators, by enforcement, doing whatever they wanted, I think IBM would have held on and maybe we’d still be using mainframes, or something — a very different situation.

Steven Sinofsky, a former Microsoft executive and current Andreessen Horowitz board partner, had a different take on the matter, attributing IBM’s (belated) success in PCs to its utter failure in minicomputers (emphasis added):

IBM chose to prevent third parties from interoperating with mainframes sometimes at crazy levels (punch card formats). And then chose to defend until the end their business model of leasing … The minicomputer was a direct threat not because of technology but because of those attributes. I’ve heard people say IBM went into PCs because the antitrust loss caused them to look for growth or something. Ha. PCs were spun up because IBM was losing Minis. But everything about the PC was almost a fluke organizationally and strategically. The story of IBM regulation is told as though PCs exist because of the case.

The more likely story is that IBM got swamped by the paradigm shift from mainframes to PCs. IBM was dominant in mainframe computers which were sold to the government and large enterprises. Microsoft, Intel, and other leaders in the PC market sold to small businesses and consumers, which required an entirely different business model than IBM was structured to implement.

ABB – Always Be Bundling (Or Unbundling)

“There’s only two ways I know of to make money: bundling and unbundling.” – Jim Barksdale

In 1969, IBM unbundled its software and services from hardware sales. As many industry observers note, this action precipitated the rise of the independent software development industry. But would this have happened regardless of whether there was an ongoing antitrust case? Given that bundling and unbundling is ubiquitous in the history of the computer industry, the answer is likely yes.

As the following charts show, IBM first created an integrated solution in the mainframe market, controlling everything from raw materials and equipment to distribution and service. When PCs disrupted mainframes, the entire value chain was unbundled. Later, Microsoft bundled its operating system with applications software. 

Source: Clayton Christensen

The first smartphone to disrupt the PC market was the Apple iPhone — an integrated solution. And once the technology became “good enough” to meet the average consumer’s needs, Google modularized everything except the operating system (Android) and the app store (Google Play).

Source: SlashData
Source: Jake Nielson

Another key prong in Tim Wu’s argument that the government served as an effective “policeman at the elbow” in the IBM case is that the company adopted an open model when it entered the PC market and did not require an exclusive license from Microsoft to use its operating system. But exclusivity is only one term in a contract negotiation. In an interview with Playboy magazine in 1994, Bill Gates explained how he was able to secure favorable terms from IBM (emphasis added):

Our restricting IBM’s ability to compete with us in licensing MS-DOS to other computer makers was the key point of the negotiation. We wanted to make sure only we could license it. We did the deal with them at a fairly low price, hoping that would help popularize it. Then we could make our move because we insisted that all other business stay with us. We knew that good IBM products are usually cloned, so it didn’t take a rocket scientist to figure out that eventually we could license DOS to others. We knew that if we were ever going to make a lot of money on DOS it was going to come from the compatible guys, not from IBM. They paid us a fixed fee for DOS. We didn’t get a royalty, even though we did make some money on the deal. Other people paid a royalty. So it was always advantageous to us, the market grew and other hardware guys were able to sell units.

In this version of the story, IBM refrained from demanding an exclusive license from Microsoft not because it was fearful of antitrust enforcers but because Microsoft made significant concessions on price and capped its upside by agreeing to a fixed fee rather than a royalty. These economic and technical explanations for why IBM wasn’t able to leverage its dominant position in mainframes into the PC market are more consistent with the evidence than Wu’s “policeman at the elbow” theory.

In my next post, I will discuss the other major antitrust case that came to an end in 1982: AT&T.

Big Tech continues to be mired in “a very antitrust situation,” as President Trump put it in 2018. Antitrust advocates have zeroed in on Facebook, Google, Apple, and Amazon as their primary targets. These advocates justify their proposals by pointing to the trio of antitrust cases against IBM, AT&T, and Microsoft. Elizabeth Warren, in announcing her plan to break up the tech giants, highlighted the case against Microsoft:

The government’s antitrust case against Microsoft helped clear a path for Internet companies like Google and Facebook to emerge. The story demonstrates why promoting competition is so important: it allows new, groundbreaking companies to grow and thrive — which pushes everyone in the marketplace to offer better products and services.

Tim Wu, a law professor at Columbia University, summarized the overarching narrative recently (emphasis added):

If there is one thing I’d like the tech world to understand better, it is that the trilogy of antitrust suits against IBM, AT&T, and Microsoft played a major role in making the United States the world’s preeminent tech economy.

The IBM-AT&T-Microsoft trilogy of antitrust cases each helped prevent major monopolists from killing small firms and asserting control of the future (of the 80s, 90s, and 00s, respectively).

A list of products and firms that owe at least something to the IBM-AT&T-Microsoft trilogy.

(1) IBM: software as product, Apple, Microsoft, Intel, Seagate, Sun, Dell, Compaq

(2) AT&T: Modems, ISPs, AOL, the Internet and Web industries

(3) Microsoft: Google, Facebook, Amazon

Wu argues that by breaking up the current crop of dominant tech companies, we can sow the seeds for the next one. But this reasoning depends on an incorrect — albeit increasingly popular — reading of the history of the tech industry. Entrepreneurs take purposeful action to produce innovative products for an underserved segment of the market. They also respond to broader technological change by integrating or modularizing different products in their market. This bundling and unbundling is a never-ending process.

Whether the government distracts a dominant incumbent with a failed lawsuit (e.g., IBM), imposes an ineffective conduct remedy (e.g., Microsoft), or breaks up a government-granted national monopoly into regional monopolies (e.g., AT&T), the dynamic nature of competition between tech companies will far outweigh the effects of antitrust enforcers tilting at windmills.

In a series of posts for Truth on the Market, I will review the cases against IBM, AT&T, and Microsoft and discuss what we can learn from them. In this introductory article, I will explain the relevant concepts necessary for understanding the history of market competition in the tech industry.

Competition for the Market

In industries like tech that tend toward “winner takes most,” it’s important to distinguish between competition during the market maturation phase — when no clear winner has emerged and the technology has yet to be widely adopted — and competition after the technology has been diffused in the economy. Benedict Evans recently explained how this cycle works (emphasis added):

When a market is being created, people compete at doing the same thing better. Windows versus Mac. Office versus Lotus. MySpace versus Facebook. Eventually, someone wins, and no-one else can get in. The market opportunity has closed. Be, NeXT/Path were too late. Monopoly!

But then the winner is overtaken by something completely different that makes it irrelevant. PCs overtook mainframes. HTML/LAMP overtook Win32. iOS & Android overtook Windows. Google overtook Microsoft.

Tech antitrust too often wants to insert a competitor to the winning monopolist, when it’s too late. Meanwhile, the monopolist is made irrelevant by something that comes from totally outside the entire conversation and owes nothing to any antitrust interventions.

In antitrust parlance, this is known as competing for the market. By contrast, in more static industries where the playing field doesn’t shift so radically and the market doesn’t tip toward “winner take most,” firms compete within the market. What Benedict Evans refers to as “something completely different” is often a disruptive product.

Disruptive Innovation

As Clay Christensen explains in the Innovator’s Dilemma, a disruptive product is one that is low-quality (but fast-improving), low-margin, and targeted at an underserved segment of the market. Initially, it is rational for the incumbent firms to ignore the disruptive technology and focus on improving their legacy technology to serve high-margin customers. But once the disruptive technology improves to the point it can serve the whole market, it’s too late for the incumbent to switch technologies and catch up. This process looks like overlapping s-curves:

Source: Max Mayblum

We see these S-curves in the technology industry all the time:

Source: Benedict Evans

As Christensen explains in the Innovator’s Solution, consumer needs can be thought of as “jobs-to-be-done.” Early on, when a product is just good enough to get a job done, firms compete on product quality and pursue an integrated strategy — designing, manufacturing, and distributing the product in-house. As the underlying technology improves and the product overshoots the needs of the jobs-to-be-done, products become modular and the primary dimension of competition moves to cost and convenience. As this cycle repeats itself, companies are either bundling different modules together to create more integrated products or unbundling integrated products to create more modular products.

Moore’s Law

Source: Our World in Data

Moore’s Law is the gasoline that gets poured on the fire of technology cycles. Though this “law” is nothing more than the observation that “the number of transistors in a dense integrated circuit doubles about every two years,” the implications for dynamic competition are difficult to overstate. As Bill Gates explained in a 1994 interview with Playboy magazine, Moore’s Law means that computer power is essentially “free” from an engineering perspective:

When you have the microprocessor doubling in power every two years, in a sense you can think of computer power as almost free. So you ask, Why be in the business of making something that’s almost free? What is the scarce resource? What is it that limits being able to get value out of that infinite computing power? Software.

Exponentially smaller integrated circuits can be combined with new user interfaces and networks to create new computer classes, which themselves represent the opportunity for disruption.

Bell’s Law of Computer Classes

Source: Brad Campbell

A corollary to Moore’s Law, Bell’s law of computer classes predicts that “roughly every decade a new, lower priced computer class forms based on a new programming platform, network, and interface resulting in new usage and the establishment of a new industry.” Originally formulated in 1972, we have seen this prediction play out in the birth of mainframes, minicomputers, workstations, personal computers, laptops, smartphones, and the Internet of Things.

Understanding these concepts — competition for the market, disruptive innovation, Moore’s Law, and Bell’s Law of Computer Classes — will be crucial for understanding the true effects (or lack thereof) of the antitrust cases against IBM, AT&T, and Microsoft. In my next post, I will look at the DOJ’s (ultimately unsuccessful) 13-year antitrust battle with IBM.