One of the key recommendations of the House Judiciary Committee’s antitrust report which seems to have bipartisan support (see Rep. Buck’s report) is shifting evidentiary burdens of proof to defendants with “monopoly power.” These recommended changes are aimed at helping antitrust enforcers and private plaintiffs “win” more. The result may well be more convictions, more jury verdicts, more consent decrees, and more settlements, but there is a cost.
Presumption of illegality for certain classes of defendants unless they can prove otherwise is inconsistent with the American traditions of the presumption of innocence and allowing persons to dispose of their property as they wish. Forcing antitrust defendants to defend themselves from what is effectively a presumption of guilt will create an enormous burden upon them. But this will be felt far beyond just antitrust defendants. Consumers who would have benefited from mergers that are deterred or business conduct that is prevented will have those benefits foregone.
The Presumption of Liberty in American Law
The Presumption of Innocence
There is nothing wrong with presumptions in law as a general matter. For instance, one of the most important presumptions in American law is that criminal defendants are presumed innocent until proven guilty. Prosecutors bear the burden of proof, and must prove guilt beyond a reasonable doubt. Even in the civil context, plaintiffs, whether public or private, have the burden of proving a violation of the law, by the preponderance of the evidence. In either case, the defendant is not required to prove they didn’t violate the law.
Fundamentally, the presumption of innocence is about liberty. As William Blackstone put it in his Commentaries on the Law of England centuries ago: “the law holds that it is better that ten guilty persons escape than that one innocent suffer.”
In economic terms, society must balance the need to deter bad conduct, however defined, with not deterring good conduct. In a world of uncertainty, this includes the possibility that decision-makers will get it wrong. For instance, if a mere allegation of wrongdoing places the burden upon a defendant to prove his or her innocence, much good conduct would be deterred out of fear of false allegations. In this sense, the presumption of innocence is important: it protects the innocent from allegations of wrongdoing, even if that means in some cases the guilty escape judgment.
Presumptions in Property, Contract, and Corporate Law
Similarly, presumptions in other areas of law protect liberty and are against deterring the good in the name of preventing the bad. For instance, the presumption when it comes to how people dispose of their property is that unless a law says otherwise, they may do as they wish. In other words, there is no presumption that a person may not use their property in a manner they wish to do so. The presumption is liberty, unless a valid law proscribes behavior. The exceptions to this rule typically deal with situations where a use of property could harm someone else.
In contracts, the right of persons to come to a mutual agreement is the general rule, with rare exceptions. The presumption is in favor of enforcing voluntary agreements. Default rules in the absence of complete contracting supplement these agreements, but even the default rules can be contracted around in most cases.
Bringing the two together, corporate law—essentially the nexus of contract law and property law— allows persons to come together to dispose of property and make contracts, supplying default rules which can be contracted around. The presumption again is that people are free to do as they choose with their own property. The default is never that people can’t create firms to buy or sell or make agreements.
A corollary right of the above is that people may start businesses and deal with others on whatever basis they choose, unless a generally applicable law says otherwise. In fact, they can even buy other businesses. Mergers and acquisitions are generally allowed by the law.
Presumptions in Antitrust Law
Antitrust is a generally applicable set of laws which proscribe how people can use their property. But even there, the presumption is not that every merger or act by a large company is harmful.
On the contrary, antitrust laws allow groups of people to dispose of property as they wish unless it can be shown that a firm has “market power” that is likely to be exercised to the detriment of competition or consumers. Plaintiffs, whether public or private, bear the burden of proving all the elements of the antitrust violation alleged.
In particular, antitrust law has incorporated the error cost framework. This framework considers the cost of getting decisions wrong. Much like the presumption of innocence is based on the tradeoff of allowing some guilty persons to go unpunished in order to protect the innocent, the error cost framework notes there is tradeoff between allowing some anticompetitive conduct to go unpunished in order to protect procompetitive conduct. American antitrust law seeks to avoid the condemnation of procompetitive conduct more than it avoids allowing the guilty to escape condemnation.
For instance, to prove a merger or acquisition would violate the antitrust laws, a plaintiff must show the transaction will substantially lessen competition. This involves defining the market, that the defendant has power over that market, and that the transaction would lessen competition. While concentration of the market is an important part of the analysis, antitrust law must consider the effect on consumer welfare as a whole. The law doesn’t simply condemn mergers or acquisitions by large companies just because they are large.
Similarly, to prove a monopolization claim, a plaintiff must establish the defendant has “monopoly power” in the relevant market. But monopoly power isn’t enough. As stated by the Supreme Court in Trinko:
The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period— is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. 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.
The plaintiff must also prove the defendant has engaged in the “willful acquisition or maintenance of [market] power, as distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident.” Antitrust law is careful to avoid mistaken inferences and false condemnations, which are especially costly because they “chill the very conduct antitrust laws are designed to protect.”
The presumption isn’t against mergers or business conduct even when those businesses are large. Antitrust law only condemns mergers or business conduct when it is likely to harm consumers.
How Changing Antitrust Presumptions will Harm Society
In light of all of this, the House Judiciary Committee’s Investigation of Competition in Digital Markets proposes some pretty radical departures from the law’s normal presumption in favor of people disposing property how they choose. Unfortunately, the minority report issued by Representative Buck agrees with the recommendations to shift burdens onto antitrust defendants in certain cases.
One of the recommendations from the Subcommittee is that Congress:
“codify bright-line rules for merger enforcement, including structural presumptions. Under a structural presumption, mergers resulting in a single firm controlling an outsized market share, or resulting in a significant increase in concentration, would be presumptively prohibited under Section 7 of the Clayton Act. This structural presumption would place the burden of proof upon the merging parties to show that the merger would not reduce competition. A showing that the merger would result in efficiencies should not be sufficient to overcome the presumption that it is anticompetitive. It is the view of Subcommittee staff that the 30% threshold established by the Supreme Court in Philadelphia National Bank is appropriate, although a lower standard for monopsony or buyer power claims may deserve consideration by the Subcommittee. By shifting the burden of proof to the merging parties in cases involving concentrated markets and high market shares, codifying the structural presumption would help promote the efficient allocation of agency resources and increase the likelihood that anticompetitive mergers are blocked. (emphasis added)
Under this proposal, in cases where concentration meets an arbitrary benchmark based upon the market definition, the presumption will be that the merger is illegal. Defendants will now bear the burden of proof to show the merger won’t reduce competition, without even getting to refer to efficiencies that could benefit consumers.
Changing the burden of proof to be against criminal defendants would lead to more convictions of guilty people, but it would also lead to a lot more false convictions of innocent defendants. Similarly, changing the burden of proof to be against antitrust defendants would certainly lead to more condemnations of anticompetitive mergers, but it would also lead to the deterrence of a significant portion of procompetitive mergers.
So yes, if adopted, plaintiffs would likely win more as a result of these proposed changes, including in cases where mergers are anticompetitive. But this does not necessarily mean it would be to the benefit of larger society.
Antitrust has evolved over time to recognize that concentration alone is not predictive of likely competitive harm in merger analysis. Both the horizontal merger guidelines and the vertical merger guidelines issued by the FTC and DOJ emphasize the importance of fact-specific inquiries into competitive effects, and not just a reliance on concentration statistics. This reflected a long-standing bipartisan consensus. The HJC’s majority report overturns this consensus by suggesting a return to the structural presumptions which have largely been rejected in antitrust law.
The HJC majority report also calls for changes in presumptions when it comes to monopolization claims. For instance, the report calls on Congress to consider creating a statutory presumption of dominance by a seller with a market share of 30% or more and a presumption of dominance by a buyer with a market share of 25% or more. The report then goes on to suggest overturning a number of precedents dealing with monopolization claims which in their view restricted claims of tying, predatory pricing, refusals to deal, leveraging, and self-preferencing. In particular, they call on Congress to “[c]larify that ‘false positives’ (or erroneous enforcement) are not more costly than ‘false negatives’ (erroneous non-enforcement), and that, when relating to conduct or mergers involving dominant firms, ‘false negatives’ are costlier.”
This again completely turns the ordinary presumptions about innocence and allowing people to dispose of the property as they see fit on their head. If adopted, defendants would largely have to prove their innocence in monopolization cases if their shares of the market are above a certain threshold.
Moreover, the report calls for Congress to consider making conduct illegal even if it “can be justified as an improvement for consumers.” It is highly likely that the changes proposed will harm consumer welfare in many cases, as the focus changes from economic efficiency to concentration.
The HJC report’s recommendations on changing antitrust presumptions should be rejected. The harms will be felt not only by antitrust defendants, who will be much more likely to lose regardless of whether they have violated the law, but by consumers whose welfare is no longer the focus. The result is inconsistent with the American tradition that presumes innocence and the ability of people to dispose of their property as they see fit.
The writing is on the wall for Big Tech: regulation is coming. At least, that is what the House Judiciary Committee’s report into competition in digital markets would like us to believe.
The Subcommittee’s Majority members, led by Rhode Island’s Rep. David Cicilline, are calling for a complete overhaul of America’s antitrust and regulatory apparatus. This would notably entail a break up of America’s largest tech firms, by prohibiting them from operating digital platforms and competing on them at the same time. Unfortunately, the report ignores the tremendous costs that such proposals would impose upon consumers and companies alike.
For several years now, there has been growing pushback against the perceived“unfairness” of America’s tech industry: of large tech platforms favoring their own products at the expense of entrepreneurs who use their platforms; of incumbents acquiring startups to quash competition; of platforms overcharging companies like Epic Games, Spotify, and the media, just because they can; and of tech companies that spy on their users and use that data to sell them things they don’t need.
But this portrayal of America’s tech industry obscures an inconvenient possibility: supposing that these perceived ills even occur, there is every chance that the House’s reforms would merely exacerbate the status quo. The House report gives short shrift to this eventuality, but it should not.
Over the last decade, the tech sector has been the crown jewel of America’s economy. And while firms like Amazon, Google, Facebook, and Apple, may have grown at a blistering pace, countless others have flourished in their wake.
Google and Apple’s app stores have given rise to a booming mobile software industry. Platforms like Youtube and Instagram have created new venues for advertisers and ushered in a new generation of entrepreneurs including influencers, podcasters, and marketing experts. Social media platforms like Facebook and Twitter have disintermediated the production of news media, allowing ever more people to share their ideas with the rest of the world (mostly for better, and sometimes for worse). Amazon has opened up new markets for thousands of retailers, some of which are now going public. The recent $3.4 billion Snowflake IPO may have been the biggest public offering of a tech firm no one has heard of.
The trillion dollar question is whether it is possible to regulate this thriving industry without stifling its unparalleled dynamism. If Rep. Cicilline’s House report is anything to go by, the answer is a resounding no.
Acquisition by a Big Tech firm is one way for startups to rapidly scale and reach a wider audience, while allowing early investors to make a quick exit. Self-preferencing can enable platforms to tailor their services to the needs and desires of users (Apple and Google’s pre-installed app suites are arguably what drive users to opt for their devices). Excluding bad apples from a platform is essential to gain users’ trust and build a strong reputation. Finally, in the online retail space, copying rival products via house brands provides consumers with competitively priced goods and helps new distributors enter the market.
All of these practices would either be heavily scrutinized or outright banned under the Subcommittee ’s proposed reforms. Beyond its direct impact on the quality of online goods and services, this huge shift would threaten the climate of permissionless innovation that has arguably been key to Silicon Valley’s success.
More fundamentally, these reforms would mostly protect certain privileged rivals at the expense of the wider industry. Take Apple’s App Store: Epic Games and others have complained about the 30% Commission charged by Apple for in-app purchases (as is standard throughout the industry). Yet, as things stand, roughly 80% of apps pay no commission at all. Tackling this 30% commission — for instance by allowing developers to bypass Apple’s in-app payment processing — would almost certainly result in larger fees for small developers. In short, regulation could significantly impede smaller firms.
Fortunately, there is another way. For decades, antitrust law — guided by the judge-made consumer welfare standard — has been the cornerstone of economic policy in the US. During that time, America built a tech industry that is the envy of the world. This should give pause to would-be reformers. There is a real chance overbearing regulation will permanently hamper America’s tech industry. With competition from China more intense than ever, it is a risk that the US cannot afford to take.
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.
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:
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.
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.
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.
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.
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.
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.
[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 Geoffrey A. Manne, (President, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics); and Dirk Auer, (Senior Fellow of Law & Economics, ICLE)]
Back in 2012, Covidien, a large health care products company and medical device manufacturer, purchased Newport Medical Instruments, a small ventilator developer and manufacturer. (Covidien itself was subsequently purchased by Medtronic in 2015).
Eight years later, in the midst of the coronavirus pandemic, the New York Times has just published an article revisiting the Covidien/Newport transaction, and questioning whether it might have contributed to the current shortage of ventilators.
The article speculates that Covidien’s purchase of Newport, and the subsequent discontinuation of Newport’s “Aura” ventilator — which was then being developed by Newport under a government contract — delayed US government efforts to procure mechanical ventilators until the second half of 2020 — too late to treat the first wave of COVID-19 patients:
And then things suddenly veered off course. A multibillion-dollar maker of medical devices bought the small California company that had been hired to design the new machines. The project ultimately produced zero ventilators.
That failure delayed the development of an affordable ventilator by at least half a decade, depriving hospitals, states and the federal government of the ability to stock up.
* * *
Today, with the coronavirus ravaging America’s health care system, the nation’s emergency-response stockpile is still waiting on its first shipment.
The article has generated considerable interest not so much for what it suggests about government procurement policies or for its relevance to the ventilator shortages associated with the current pandemic, but rather for its purported relevance to ongoing antitrust debates and the arguments put forward by “antitrust populists” and others that merger enforcement in the US is dramatically insufficient.
Only a single sentence in the article itself points to a possible antitrust story — and it does nothing more than report unsubstantiated speculation from unnamed “government officials” and rival companies:
Government officials and executives at rival ventilator companies said they suspected that Covidien had acquired Newport to prevent it from building a cheaper product that would undermine Covidien’s profits from its existing ventilator business.
Nevertheless, and right on cue, various antitrust scholars quickly framed the deal as a so-called “killer acquisition” (see also here and here):
Unsurprisingly, politicians were also quick to jump on the bandwagon. David Cicilline, the powerful chairman of the House Antitrust Subcommittee, opined that:
The public reporting on this acquisition raises important questions about the review of this deal. We should absolutely be looking back to figure out what happened.
These “hot takes” raise a crucial issue. The New York Times story opened the door to a welter of hasty conclusions offered to support the ongoing narrative that antitrust enforcement has failed us — in this case quite literally at the cost of human lives. But are any of these claims actually supportable?
Unfortunately, the competitive realities of the mechanical ventilator industry, as well as a more clear-eyed view of what was likely going on with the failed government contract at the heart of the story, simply do not support the “killer acquisition” story.
What is a “killer acquisition”…?
Let’s take a step back. Because monopoly profits are, by definition, higher than joint duopoly profits (all else equal), economists have long argued that incumbents may find it profitable to acquire smaller rivals in order to reduce competition and increase their profits. More specifically, incumbents may be tempted to acquire would-be entrants in order to prevent them from introducing innovations that might hurt the incumbent’s profits.
For this theory to have any purchase, however, a number of conditions must hold. Most importantly, as Colleen Cunningham, Florian Ederer, and Song Ma put it in an influential paper:
“killer acquisitions” can only occur when the entrepreneur’s project overlaps with the acquirer’s existing product…. [W]ithout any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur… because, without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.
Moreover, the authors add that:
Successfully developing a new product draws consumer demand and profits away equally from all existing products. An acquiring incumbent is hurt more by such cannibalization when he is a monopolist (i.e., the new product draws demand away only from his own existing product) than when he already faces many other existing competitors (i.e., cannibalization losses are spread over many firms). As a result, as the number of existing competitors increases, the replacement effect decreases and the acquirer’s development decisions become more similar to those of the entrepreneur.
Finally, the “killer acquisition” terminology is appropriate only when the incumbent chooses to discontinue its rival’s R&D project:
If incumbents face significant existing competition, acquired projects are not significantly more frequently discontinued than independent projects. Thus, more competition deters incumbents from acquiring and terminating the projects of potential future competitors, which leads to more competition in the future.
…And what isn’t a killer acquisition?
What is left out of this account of killer acquisitions is the age-old possibility that an acquirer purchases a rival precisely because it has superior know-how or a superior governance structure that enables it to realize greater return and more productivity than its target. In the case of a so-called killer acquisition, this means shutting down a negative ROI project and redeploying resources to other projects or other uses — including those that may not have any direct relation to the discontinued project.
Such “synergistic” mergers are also — like allegedly “killer” mergers — likely to involve acquirers and targets in the same industry and with technological overlap between their R&D projects; it is in precisely these situations that the acquirer is likely to have better knowledge than the target’s shareholders that the target is undervalued because of poor governance rather than exogenous, environmental factors.
In other words, whether an acquisition is harmful or not — as the epithet “killer” implies it is — depends on whether it is about reducing competition from a rival, on the one hand, or about increasing the acquirer’s competitiveness by putting resources to more productive use, on the other.
As argued below, it is highly unlikely that Covidien’s acquisition of Newport could be classified as a “killer acquisition.” There is thus nothing to suggest that the merger materially impaired competition in the mechanical ventilator market, or that it measurably affected the US’s efforts to fight COVID-19.
The market realities of the ventilator market and its implications for the “killer acquisition” story
1. The mechanical ventilator market is highly competitive
As explained above, “killer acquisitions” are less likely to occur in competitive markets. Yet the mechanical ventilator industry is extremely competitive.
Medical ventilators market competition is intense.
The conclusion that the mechanical ventilator industry is highly competitive is further supported by the fact that the five largest producers combined reportedly hold only 50% of the market. In other words, available evidence suggests that none of these firms has anything close to a monopoly position.
Similarly, following preliminary investigations, neither the FTC nor the European Commission saw the need for an in-depth look at the ventilator market when they reviewed Medtronic’s subsequent acquisition of Covidien (which closed in 2015). Although Medtronic did not produce any mechanical ventilators before the acquisition, authorities (particularly the European Commission) could nevertheless have analyzed that market if Covidien’s presumptive market share was particularly high. The fact that they declined to do so tends to suggest that the ventilator market was relatively unconcentrated.
2. The value of the merger was too small
A second strong reason to believe that Covidien’s purchase of Newport wasn’t a killer acquisition is the acquisition’s value of $103 million.
Indeed, if it was clear that Newport was about to revolutionize the ventilator market, then Covidien would likely have been made to pay significantly more than $103 million to acquire it.
As noted above, the crux of the “killer acquisition” theory is that incumbents can induce welfare-reducing acquisitions by offering to acquire their rivals for significantly more than the present value of their rivals’ expected profits. Because an incumbent undertaking a “killer” takeover expects to earn monopoly profits as a result of the transaction, it can offer a substantial premium and still profit from its investment. It is this basic asymmetry that drives the theory.
[Where] a court may lack the expertise to [assess the commercial significance of acquired technology]…, the transaction value… may provide a reasonable proxy. Intuitively, if the startup is a relatively small company with relatively few sales to its name, then a very high acquisition price may reasonably suggest that the startup technology has significant promise.
The strategy only works, however, if the target firm’s shareholders agree that share value properly reflects only “normal” expected profits, and not that the target is poised to revolutionize its market with a uniquely low-cost or high-quality product. Relatively low acquisition prices relative to market size, therefore, tend to reflect low (or normal) expected profits, and a low perceived likelihood of radical innovations occurring.
We can apply this reasoning to Covidien’s acquisition of Newport:
Precise and publicly available figures concerning the mechanical ventilator market are hard to come by. Nevertheless, one estimate finds that the global ventilator market was worth $2.715 billion in 2012. Another report suggests that the global market was worth $4.30 billion in 2018; still another that it was worth $4.58 billion in 2019.
As noted above, Covidien reported to the SEC that it paid $103 million to purchase Newport (a firm that produced only ventilators and apparently had no plans to branch out).
For context, at the time of the acquisition Covidien had annual sales of $11.8 billion overall, and $743 million in sales of its existing “Airways and Ventilation Products.”
If the ventilator market was indeed worth billions of dollars per year, then the comparatively small $108 million paid by Covidien — small even relative to Covidien’s own share of the market — suggests that, at the time of the acquisition, it was unlikely that Newport was poised to revolutionize the market for mechanical ventilators (for instance, by successfully bringing its Aura ventilator to market).
The New York Times article claimed that Newport’s ventilators would be sold (at least to the US government) for $3,000 — a substantial discount from the reportedly then-going rate of $10,000. If selling ventilators at this price seemed credible at the time, then Covidien — as well as Newport’s shareholders — knew that Newport was about to achieve tremendous cost savings, enabling it to offer ventilators not only to the the US government, but to purchasers around the world, at an irresistibly attractive — and profitable — price.
Ventilators at the time typically went for about $10,000 each, and getting the price down to $3,000 would be tough. But Newport’s executives bet they would be able to make up for any losses by selling the ventilators around the world.
“It would be very prestigious to be recognized as a supplier to the federal government,” said Richard Crawford, who was Newport’s head of research and development at the time. “We thought the international market would be strong, and there is where Newport would have a good profit on the product.”
If achievable, Newport thus stood to earn a substantial share of the profits in a multi-billion dollar industry.
Of course, it is necessary to apply a probability to these numbers: Newport’s ventilator was not yet on the market, and had not yet received FDA approval. Nevertheless, if the Times’ numbers seemed credible at the time, then Covidien would surely have had to offer significantly more than $108 million in order to induce Newport’s shareholders to part with their shares.
Given the low valuation, however, as well as the fact that Newport produced other ventilators — and continues to do so to this day, there is no escaping the fact that everyone involved seemed to view Newport’s Aura ventilator as nothing more than a moonshot with, at best, a low likelihood of success.
Curically, this same reasoning explains why it shouldn’t surprise anyone that the project was ultimately discontinued; recourse to a “killer acquisition” theory is hardly necessary.
3. Lessons from Covidien’s ventilator product decisions
The killer acquisition claims are further weakened by at least four other important pieces of information:
Covidien initially continued to develop Newport’s Aura ventilator, and continued to develop and sell Newport’s other ventilators.
There was little overlap between Covidien and Newport’s ventilators — or, at the very least, they were highly differentiated
Covidien appears to have discontinued production of its own portable ventilator in 2014
The Newport purchase was part of a billion dollar series of acquisitions seemingly aimed at expanding Covidien’s in-hospital (i.e., not-portable) device portfolio
Covidien continued to develop and sell Newport’s ventilators
For a start, while the Aura line was indeed discontinued by Covidien, the timeline is important. The acquisition of Newport by Covidien was announced in March 2012, approved by the FTC in April of the same year, and the deal was closed on May 1, 2012.
However, as the FDA’s 510(k) database makes clear, Newport submitted documents for FDA clearance of the Aura ventilator months after its acquisition by Covidien (June 29, 2012, to be precise). And the Aura received FDA 510(k) clearance on November 9, 2012 — many months after the merger.
It would have made little sense for Covidien to invest significant sums in order to obtain FDA clearance for a project that it planned to discontinue (the FDA routinely requires parties to actively cooperate with it, even after 510(k) applications are submitted).
Moreover, if Covidien really did plan to discreetly kill off the Aura ventilator, bungling the FDA clearance procedure would have been the perfect cover under which to do so. Yet that is not what it did.
Covidien continued to develop and sell Newport’s other ventilators
Second, and just as importantly, Covidien (and subsequently Medtronic) continued to sell Newport’s other ventilators. The Newport e360 and HT70 are still sold today. Covidien also continued to improve these products: it appears to have introduced an improved version of the Newport HT70 Plus ventilator in 2013.
If eliminating its competitor’s superior ventilators was the only goal of the merger, then why didn’t Covidien also eliminate these two products from its lineup, rather than continue to improve and sell them?
At least part of the answer, as will be seen below, is that there was almost no overlap between Covidien and Newport’s product lines.
There was little overlap between Covidien’s and Newport’s ventilators
Third — and perhaps the biggest flaw in the killer acquisition story — is that there appears to have been very little overlap between Covidien and Newport’s ventilators.
This decreases the likelihood that the merger was a killer acquisition. When two products are highly differentiated (or not substitutes at all), sales of the first are less likely to cannibalize sales of the other. As Florian Ederer and his co-authors put it:
Importantly, without any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur, neither to “Acquire to Kill” nor to “Acquire to Continue.” This is because without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.
A quick search of the FDA’s 510(k) database reveals that Covidien has three approved lines of ventilators: the Puritan Bennett 980, 840, and 540 (apparently essentially the same as the PB560, the plans to which Medtronic recently made freely available in order to facilitate production during the current crisis). The same database shows that these ventilators differ markedly from Newport’s ventilators (particularly the Aura).
In particular, Covidien manufactured primarily traditional, invasive ICU ventilators (except for the PB540, which is potentially a substitute for the Newport HT70), while Newport made much-more-portable ventilators, suitable for home use (notably the Aura, HT50 and HT70 lines).
Under normal circumstances, critical care and portable ventilators are not substitutes. As the WHO website explains, portable ventilators are:
[D]esigned to provide support to patients who do not require complex critical care ventilators.
A quick glance at Medtronic’s website neatly illustrates the stark differences between these two types of devices:
This is not to say that these devices do not have similar functionalities, or that they cannot become substitutes in the midst of a coronavirus pandemic. However, in normal times (as was the case when Covidien acquired Newport), hospitals likely did not view these devices as substitutes.
The conclusion that Covidien and Newport’s ventilator were not substitutes finds further support in documents and statements released at the time of the merger. For instance, Covidien’s CEO explained that:
This acquisition is consistent with Covidien’s strategy to expand into adjacencies and invest in product categories where it can develop a global competitive advantage.
Newport’s products and technology complement our current portfolio of respiratory solutions and will broaden our ventilation platform for patients around the world, particularly in emerging markets.
In short, the fact that almost all of Covidien and Newport’s products were not substitutes further undermines the killer acquisition story. It also tends to vindicate the FTC’s decision to rapidly terminate its investigation of the merger.
Covidien appears to have discontinued production of its own portable ventilator in 2014
Perhaps most tellingly: It appears that Covidien discontinued production of its own competing, portable ventilator, the Puritan Bennett 560, in 2014.
The product is reported on the company’s 2011, 2012 and 2013 annual reports:
Airway and Ventilation Products — airway, ventilator, breathing systems and inhalation therapy products. Key products include: the Puritan Bennett™ 840 line of ventilators; the Puritan Bennett™ 520 and 560 portable ventilator….
Surely if Covidien had intended to capture the portable ventilator market by killing off its competition it would have continued to actually sell its own, competing device. The fact that the only portable ventilators produced by Covidien by 2014 were those it acquired in the Newport deal strongly suggests that its objective in that deal was the acquisition and deployment of Newport’s viable and profitable technologies — not the abandonment of them. This, in turn, suggests that the Aura was not a viable and profitable technology.
(Admittedly we are unable to determine conclusively that either Covidien or Medtronic stopped producing the PB520/540/560 series of ventilators. But our research seems to indicate strongly that this is indeed the case).
Putting the Newport deal in context
Finally, although not dispositive, it seems important to put the Newport purchase into context. In the same year as it purchased Newport, Covidien paid more than a billion dollars to acquire five other companies, as well — all of them primarily producing in-hospital medical devices.
That 2012 spending spree came on the heels of a series of previous medical device company acquisitions, apparently totally some four billion dollars. Although not exclusively so, the acquisitions undertaken by Covidien seem to have been primarily targeted at operating room and in-hospital monitoring and treatment — making the putative focus on cornering the portable (home and emergency) ventilator market an extremely unlikely one.
By the time Covidien was purchased by Medtronic the deal easily cleared antitrust review because of the lack of overlap between the company’s products, with Covidien’s focusing predominantly on in-hospital, “diagnostic, surgical, and critical care” and Medtronic’s on post-acute care.
Newport misjudged the costs associated with its Aura project; Covidien was left to pick up the pieces
So why was the Aura ventilator discontinued?
Although it is almost impossible to know what motivated Covidien’s executives, the Aura ventilator project clearly suffered from many problems.
The Aura project was intended to meet the requirements of the US government’s BARDA program (under the auspices of the U.S. Department of Health and Human Services’ Biomedical Advanced Research and Development Authority). In short, the program sought to create a stockpile of next generation ventilators for emergency situations — including, notably, pandemics. The ventilator would thus have to be designed for events where
mass casualties may be expected, and when shortages of experienced health care providers with respiratory support training, and shortages of ventilators and accessory components may be expected.
The Aura ventilator would thus sit somewhere between Newport’s two other ventilators: the e360 which could be used in pediatric care (for newborns smaller than 5kg) but was not intended for home care use (or the extreme scenarios envisioned by the US government); and the more portable HT70 which could be used in home care environments, but not for newborns.
Unfortunately, the Aura failed to achieve this goal. The FDA’s 510(k) clearance decision clearly states that the Aura was not intended for newborns:
The AURA family of ventilators is applicable for infant, pediatric and adult patients greater than or equal to 5 kg (11 lbs.).
the company was unable to secure FDA approval for use in neonatal populations — a contract requirement.
And the US Government RFP confirms that this was indeed an important requirement:
The device must be able to provide the same standard of performance as current FDA pre-market cleared portable ventilators and shall have the following additional characteristics or features:
• Flexibility to accommodate a wide patient population range from neonate to adult.
Newport also seems to have been unable to deliver the ventilator at the low price it had initially forecasted — a common problem for small companies and/or companies that undertake large R&D programs. It also struggled to complete the project within the agreed-upon deadlines. As the Medtronic press release explains:
Covidien learned that Newport’s work on the ventilator design for the Government had significant gaps between what it had promised the Government and what it could deliver — both in terms of being able to achieve the cost of production specified in the contract and product features and performance. Covidien management questioned whether Newport’s ability to complete the project as agreed to in the contract was realistic.
As Jason Crawford, an engineer and tech industry commentator, put it:
Projects fail all the time. “Supplier risk” should be a standard checkbox on anyone’s contingency planning efforts. This is even more so when you deliberately push the price down to 30% of the market rate. Newport did not even necessarily expect to be profitable on the contract.
The above is mostly Covidien’s “side” of the story, of course. But other pieces of evidence lend some credibility to these claims:
Newport agreed to deliver its Aura ventilator at a per unit cost of less than $3000. But, even today, this seems extremely ambitious. For instance, the WHO has estimated that portable ventilators cost between $3,300 and $13,500. If Newport could profitably sell the Aura at such a low price, then there was little reason to discontinue it (readers will recall the development of the ventilator was mostly complete when Covidien put a halt to the project).
Covidien/Newport is not the only firm to have struggled to offer suitable ventilators at such a low price. Philips (which took Newport’s place after the government contract fell through) also failed to achieve this low price. Rather than the $2,000 price sought in the initial RFP, Philips ultimately agreed to produce the ventilators for $3,280. But it has not yet been able to produce a single ventilator under the government contract at that price.
Covidien has repeatedly been forced to recall some of its other ventilators ( here, here and here) — including the Newport HT70. And rival manufacturers have also faced these types of issues (for example, here and here).
Accordingly, Covidien may well have preferred to cut its losses on the already problem-prone Aura project, before similar issues rendered it even more costly.
In short, while it is impossible to prove that these development issues caused Covidien to pull the plug on the Aura project, it is certainly plausible that they did. This further supports the hypothesis that Covidien’s acquisition of Newport was not a killer acquisition.
Ending the Aura project might have been an efficient outcome
As suggested above, moreover, it is entirely possible that Covidien was better able to realize the poor prospects of Newport’s Aura project and also better organized to enable it to make the requisite decision to abandon the project.
Moreover, the relatively large share of revue and reputation that Newport — worth $103 million in 2012, versus Covidien’s $11.8 billion — would have realized from fulfilling a substantial US government project could well have induced it to overestimate the project’s viability and to undertake excessive risk in the (vain) hope of bringing the project to fruition.
While there is a tendency among antitrust scholars, enforcers, and practitioners to look for (and find…) antitrust-related rationales for mergers and other corporate conduct, it remains the case that most corporate control transactions (such as mergers) are driven by the acquiring firm’s expectation that it can manage more efficiently. As Henry G. Manne put it in his seminal article, Mergers and the Market for Corporate Control (1965):
Since, in a world of uncertainty, profitable transactions will be entered into more often by those whose information is relatively more reliable, it should not surprise us that mergers within the same industry have been a principal form of changing corporate control. Reliable information is often available to suppliers and customers as well. Thus many vertical mergers may be of the control takeover variety rather than of the “foreclosure of competitors” or scale-economies type.
Of course, the same information that renders an acquiring firm in the same line of business knowledgeable enough to operate a target more efficiently could also enable it to effect a “killer acquisition” strategy. But the important point is that a takeover by a firm with a competing product line, after which the purchased company’s product line is abandoned, is at least as consistent with a “market for corporate control” story as with a “killer acquisition” story.
“Killer acquisitions” can have a nefarious image, but killing off a rival’s product was probably not the main purpose of the transaction, Ederer said. He raised the possibility that Covidien decided to kill Newport’s innovation upon realising that the development of the devices would be expensive and unlikely to result in profits.
In conclusion, Covidien’s acquisition of Newport offers a cautionary tale about reckless journalism, “blackboard economics,” and government failure.
Reckless journalism because the New York Times clearly failed to do the appropriate due diligence for its story. Its journalists notably missed (or deliberately failed to mention) a number of critical pieces of information — such as the hugely important fact that most of Covidien’s and Newport’s products did not overlap, or the fact that there were numerous competitors in the highly competitive mechanical ventilator industry.
And yet, that did not stop the authors from publishing their extremely alarming story, effectively suggesting that a small medical device merger materially contributed to the loss of many American lives.
What is studied is a system which lives in the minds of economists but not on earth.
Numerouscommentators rushed to fit the story to their preconceived narratives, failing to undertake even a rudimentary examination of the underlying market conditions before they voiced their recriminations.
The only thing that Covidien and Newport’s merger ostensibly had in common with the killer acquisition theory was the fact that a large firm purchased a small rival, and that the one of the small firm’s products was discontinued. But this does not even begin to meet the stringent conditions that must be fulfilled for the theory to hold water. Unfortunately, critics appear to have completely ignored all contradicting evidence.
Finally, what the New York Times piece does offer is a chilling tale of government failure.
The inception of the US government’s BARDA program dates back to 2008 — twelve years before the COVID-19 pandemic hit the US.
The collapse of the Aura project is no excuse for the fact that, more than six years after the Newport contract fell through, the US government still has not obtained the necessary ventilators. Questions should also be raised about the government’s decision to effectively put all of its eggs in the same basket — twice. If anything, it is thus government failure that was the real culprit.
And yet the New York Times piece and the critics shouting “killer acquisition!” effectively give the US government’s abject failure here a free pass — all in the service of pursuing their preferred “killer story.”
Antitrust populists have a long list of complaints about competition policy, including: laws aren’t broad enough or tough enough, enforcers are lax, and judges tend to favor defendants over plaintiffs or government agencies. The populist push got a bump with the New York Times coverage of Lina Khan’s “Amazon’s Antitrust Paradox” in which she advocated breaking up Amazon and applying public utility regulation to platforms. Khan’s ideas were picked up by Sen. Elizabeth Warren, who has a plan for similar public utility regulation and promised to unwind earlier acquisitions by Amazon (Whole Foods and Zappos), Facebook (WhatsApp and Instagram), and Google (Waze, Nest, and DoubleClick).
Khan, Warren, and the other Break Up Big Tech populists don’t clearly articulate how consumers, suppliers — or anyone for that matter — would be better off with their mandated spinoffs. The Khan/Warren plan, however, requires a unique alignment of many factors: Warren must win the White House, Democrats must control both houses of Congress, and judges must substantially shift their thinking. It’s like turning a supertanker on a dime in the middle of a storm. Instead of publishing manifestos and engaging in antitrust hashtag hipsterism, maybe — just maybe — the populists can do something.
The populists seem to have three main grievances:
Small firms cannot enter the market or cannot thrive once they enter;
Suppliers, including workers, are getting squeezed; and
Speculation that someday firms will wake up, realize they have a monopoly, and begin charging noncompetitive prices to consumers.
Each of these grievances can be, and has been, already addressed by antitrust and competition litigation. And, in many cases these grievances were addressed in private antitrust litigation. For example:
The European Commission’s Google Search investigation was prompted by complaints filed by a private party, Foundem.
In the US, private actions are available for a wide range of alleged anticompetitive conduct, including coordinated conduct (e.g., price-fixing), single-firm conduct (e.g., predatory pricing), and mergers that would substantially lessen competition.
If the antitrust populists are so confident that concentration is rising and firms are behaving anticompetitively and consumers/suppliers/workers are being harmed, then why don’t they organize an antitrust lawsuit against the worst of the worst violators? If anticompetitive activity is so obvious and so pervasive, finding compelling cases should be easy.
While predatory pricing technically remains illegal, it is extremely difficult to win predatory pricing claims because courts now require proof that the alleged predator would be able to raise prices and recoup its losses.
However, in her criticism of the court in the Apple e-books litigation, she lays out a clear rationale for courts to revise their thinking on predatory pricing [emphasis added]:
Judge Cote, who presided over the district court trial, refrained from affirming the government’s conclusion. Still, the government’s argument illustrates the dominant framework that courts and enforcers use to analyze predation—and how it falls short. Specifically, the government erred by analyzing the profitability of Amazon’s e-book business in the aggregate and by characterizing the conduct as “loss leading” rather than potentially predatory pricing. These missteps suggest a failure to appreciate two critical aspects of Amazon’s practices: (1) how steep discounting by a firm on a platform-based product creates a higher risk that the firm will generate monopoly power than discounting on non-platform goods and (2) the multiple ways Amazon could recoup losses in ways other than raising the price of the same e-books that it discounted.
Why not put Khan’s cross-subsidy theory to the test by building an antitrust case around it? Surely there’d be a document explaining how the firm expects to recoup its losses. Or, maybe not. Maybe by the firm’s accounting, it’s not losing money on the discounted products. Without evidence, it’s just speculation.
In fairness, one can argue that recent court decisions have made pursuing private antitrust litigation more difficult. For example, the Supreme Court’s decision in Twombly requires an antitrust plaintiff to show more than mere speculation based on circumstantial evidence in order to move forward to discovery. Decisions in matters such as Ashcroft v. Iqbal have made it more difficult for plaintiffs to maintain antitrust claims. Wal-Mart v. Dukes and Comcast Corp v Behrend subject antitrust class actions to more rigorous analysis. In Ohio v. Amex the court ruled antitrust plaintiffs can’t meet the burden of proof by showing only some effect on some part of a two-sided market.
At the same time Jeld-Wen indicates third party plaintiffs can be awarded damages and obtain divestitures, even after mergers clear. In Jeld-Wen, a competitor filed suit to challenge the consummated Jeld-Wen/Craftmaster merger four years after the DOJ approved the merger without conditions. The challenge was lengthy, but successful, and a district court ordered damages and the divestiture of one of the combined firm’s manufacturing facilities six years after the merger was closed.
Despite the possible challenges of pursuing a private antitrust suit, Daniel Crane’s review of US federal court workload statistics concludes the incidence of private antitrust enforcement in the United States has been relatively stable since the mid-1980s — in the range of 600 to 900 new private antitrust filings a year. He also finds resolution by trial has been relatively stable at an average of less than 1 percent a year. Thus, it’s not clear that recent decisions have erected insurmountable barriers to antitrust plaintiffs.
In the US, third parties may fund private antitrust litigation and plaintiffs’ attorneys are allowed to work under a contingency fee arrangement, subject to court approval. A compelling case could be funded by deep-pocketed supporters of the populists’ agenda, big tech haters, or even investors. Perhaps the most well-known example is Peter Thiel’s bankrolling of Hulk Hogan’s takedown of Gawker. Before that, the savings and loan crisis led to a number of forced mergers which were later challenged in court, with the costs partially funded by the issuance of litigation tracking warrants.
The antitrust populist ranks are chock-a-block with economists, policy wonks, and go-getter attorneys. If they are so confident in their claims of rising concentration, bad behavior, and harm to consumers, suppliers, and workers, then they should put those ideas to the test with some slam dunk litigation. The fact that they haven’t suggests they may not have a case.
These days, lacking a coherent legal theory presents no challenge to the would-be antitrust crusader. In a previous post, we noted how Shaoul Sussman’s predatory pricing claims against Amazon lacked a serious legal foundation. Sussman has returned with a new post, trying to build out his fledgling theory, but fares little better under even casual scrutiny.
According to Sussman, Amazon’s allegedly anticompetitive
conduct not only cemented its role as the primary destination for consumers that shop online but also helped it solidify its power over brands.
Further, the company
was willing to go to great lengths to ensure brand availability and inventory, including turning to the grey market, recruiting unauthorized sellers, and even selling diverted goods and counterfeits to its customers.
Sussman is trying to make out a fairly convoluted predatory pricing case, but once again without ever truly connecting the dots in a way that develops a cognizable antitrust claim. According to Sussman:
Amazon sold products as a first-party to consumers on its platform at below average variable cost and  Amazon recently began to recoup its losses by shifting the bulk of the transactions that occur on the website to its marketplace, where millions of third-party sellers pay hefty fees that enable Amazon to take a deep cut of every transaction.
Sussman now bases this claim on an allegation that Amazon relied on “grey market” sellers on its platform, the presence of which forces legitimate brands onto the Amazon Marketplace. Moreover, Sussman claims that — somehow — these brands coming on board on Amazon’s terms forces those brands raise prices elsewhere, and the net effect of this process at scale is that prices across the economy have risen.
As we detail below, Sussman’s chimerical argument depends on conflating unrelated concepts and relies on non-public anecdotal accounts to piece together an argument that, even if you squint at it, doesn’t make out a viable theory of harm.
Conflating legal reselling and illegal counterfeit selling as the “grey market”
The biggest problem with Sussman’s new theory is that he conflates pro-consumer unauthorized reselling and anti-consumer illegal counterfeiting, erroneously labeling both the “grey market”:
Amazon had an ace up its sleeve. My sources indicate that the company deliberately turned to and empowered the “grey market“ — where both genuine, authentic goods and knockoffs are purchased and resold outside of brands’ intended distribution pipes — to dominate certain brands.
By definition, grey market goods are — as the link provided by Sussman states — “goods sold outside the authorized distribution channels by entities which may have no relationship with the producer of the goods.” Yet Sussman suggests this also encompasses counterfeit goods. This conflation is no minor problem for his argument. In general, the grey market is legal and beneficial for consumers. Brands such as Nike may try to limit the distribution of their products to channels the company controls, but they cannot legally prevent third parties from purchasing Nike products and reselling them on Amazon (or anywhere else).
This legal activity can increase consumer choice and can lead to lower prices, even though Sussman’s framing omits these key possibilities:
In the course of my conversations with former Amazon employees, some reported that Amazon actively sought out and recruited unauthorized sellers as both third-party sellers and first-party suppliers. Being unauthorized, these sellers were not bound by the brands’ policies and therefore outside the scope of their supervision.
In other words, Amazon actively courted third-party sellers who could bring legitimate goods, priced competitively, onto its platform. Perhaps this gives Amazon “leverage” over brands that would otherwise like to control the activities of legal resellers, but it’s exceedingly strange to try to frame this as nefarious or anticompetitive behavior.
Of course, we shouldn’t ignore the fact that there are also potential consumer gains when Amazon tries to restrict grey market activity by partnering with brands. But it is up to Amazon and the brands to determine through a contracting process when it makes the most sense to partner and control the grey market, or when consumers are better served by allowing unauthorized resellers. The point is: there is simply no reason to assume that either of these approaches is inherently problematic.
Yet, even when Amazon tries to restrict its platform to authorized resellers, it exposes itself to a whole different set of complaints. In 2018, the company made a deal with Apple to bring the iPhone maker onto its marketplace platform. In exchange for Apple selling its products directly on Amazon, the latter agreed to remove unauthorized Apple resellers from the platform. Sussman portrays this as a welcome development in line with the policy changes he recommends.
But news reports last month indicate the FTC is reviewing this deal for potential antitrust violations. One is reminded of Ronald Coase’s famous lament that he “had gotten tired of antitrust because when the prices went up the judges said it was monopoly, when the prices went down they said it was predatory pricing, and when they stayed the same they said it was tacit collusion.” It seems the same is true for Amazon and its relationship with the grey market.
Amazon’s incentive to remove counterfeits
What is illegal — and explicitly against Amazon’s marketplace rules — is selling counterfeit goods. Counterfeit goods destroy consumer trust in the Amazon ecosystem, which is why the company actively polices its listings for abuses. And as Sussman himself notes, when there is an illegal counterfeit listing, “Brands can then file a trademark infringement lawsuit against the unauthorized seller in order to force Amazon to suspend it.”
Sussman’s attempt to hang counterfeiting problems around Amazon’s neck belies the actual truth about counterfeiting: probably the most cost-effective way to stop counterfeiting is simply to prohibit all third-party sellers. Yet, a serious cost-benefit analysis of Amazon’s platforms could hardly support such an action (and would harm the small sellers that antitrust activists seem most concerned about).
But, more to the point, if Amazon’s strategy is to encourage piracy, it’s doing a terrible job. It engages in litigation against known pirates, and earlier this year it rolled out a suite of tools (called Project Zero) meant to help brand owners report and remove known counterfeits. As part of this program, according to Amazon, “brands provide key data points about themselves (e.g., trademarks, logos, etc.) and we scan over 5 billion daily listing update attempts, looking for suspected counterfeits.” And when a brand identifies a counterfeit listing, they can remove it using a self-service tool (without needing approval from Amazon).
Any large platform that tries to make it easy for independent retailers to reach customers is going to run into a counterfeit problem eventually. In his rush to discover some theory of predatory pricing to stick on Amazon, Sussman ignores the tradeoffs implicit in running a large platform that essentially democratizes retail:
Indeed, the democratizing effect of online platforms (and of technology writ large) should not be underestimated. While many are quick to disparage Amazon’s effect on local communities, these arguments fail to recognize that by reducing the costs associated with physical distance between sellers and consumers, e-commerce enables even the smallest merchant on Main Street, and the entrepreneur in her garage, to compete in the global marketplace.
In short, Amazon Marketplace is designed to make it as easy as possible for anyone to sell their products to Amazon customers. As the WSJ reported:
Counterfeiters, though, have been able to exploit Amazon’s drive to increase the site’s selection and offer lower prices. The company has made the process to list products on its website simple—sellers can register with little more than a business name, email and address, phone number, credit card, ID and bank account—but that also has allowed impostors to create ersatz versions of hot-selling items, according to small brands and seller consultants.
The existence of counterfeits is a direct result of policies designed to lower prices and increase consumer choice. Thus, we would expect some number of counterfeits to exist as a result of running a relatively open platform. The question is not whether counterfeits exist, but — at least in terms of Sussman’s attempt to use antitrust law — whether there is any reason to think that Amazon’s conduct with respect to counterfeits is actually anticompetitive. But, even if we assume for the moment that there is some plausible way to draw a competition claim out of the existence of counterfeit goods on the platform, his theory still falls apart.
There is both theoretical and empiricalevidence for why Amazon is likely not engaged in the conduct Sussman describes. As a platform owner involved in a repeated game with customers, sellers, and developers, Amazon has an incentive to increase trust within the ecosystem. Counterfeit goods directly destroy that trust and likely decrease sales in the long run. If individuals can’t depend on the quality of goods on Amazon, they can easily defect to Walmart, eBay, or any number of smaller independent sellers. That’s why Amazon enters into agreements with companies like Apple to ensure there are only legitimate products offered. That’s also why Amazon actively sues counterfeiters in partnership with its sellers and brands, and also why Project Zero is a priority for the company.
Sussman relies on private, anecdotal claims while engaging in speculation that is entirely unsupported by public data
Much of Sussman’s evidence is “[b]ased on conversations [he] held with former employees, sellers, and brands following the publication of [his] paper”, which — to put it mildly — makes it difficult for anyone to take seriously, let alone address head on. Here’s one example:
One third-party seller, who asked to remain anonymous, was willing to turn over his books for inspection in order to illustrate the magnitude of the increase in consumer prices. Together, we analyzed a single product, of which tens of thousands of units have been sold since 2015. The minimum advertised price for this single product, at any and all outlets, has increased more than 30 percent in the past four years. Despite this fact, this seller’s margins on this product are tighter than ever due to Amazon’s fee increases.
Needless to say, sales data showing the minimum advertised price for a single product “has increased more than 30 percent in the past four years” is not sufficient to prove, well, anything. At minimum, showing an increase in prices above costs would require data from a large and representative sample of sellers. All we have to go on from the article is a vague anecdote representing — maybe — one data point.
Not only is Sussman’s own data impossible to evaluate, but he bases his allegations on speculation that is demonstrably false. For instance, he asserts that Amazon used its leverage over brands in a way that caused retail prices to rise throughout the economy. But his starting point assumption is flatly contradicted by reality:
To remedy this, Amazon once again exploited brands’ MAP policies. As mentioned, MAP policies effectively dictate the minimum advertised price of a given product across the entire retail industry. Traditionally, this meant that the price of a typical product in a brick and mortar store would be lower than the price online, where consumers are charged an additional shipping fee at checkout.
Sussman presents no evidence for the claim that “the price of a typical product in a brick and mortar store would be lower than the price online.” The widespread phenomenon of showrooming — when a customer examines a product at a brick-and-mortar store but then buys it for a lower price online — belies the notion that prices are higher online. One recent study by Nielsen found that “nearly 75% of grocery shoppers have used a physical store to ‘showroom’ before purchasing online.”
In fact, the company’s downward pressure on prices is so large that researchers now speculate that Amazon and other internet retailers are partially responsible for the low and stagnant inflation in the US over the last decade (dubbing this the “Amazon effect”). It is also curious that Sussman cites shipping fees as the reason prices are higher online while ignoring all the overhead costs of running a brick-and-mortar store which online retailers don’t incur. The assumption that prices are lower in brick-and-mortar stores doesn’t pass the laugh test.
Sussman can keep trying to tell a predatory pricing story about Amazon, but the more convoluted his theories get — and the less based in empirical reality they are — the less convincing they become. There is a predatory pricing law on the books, but it’s hard to bring a case because, as it turns out, it’s actually really hard to profitably operate as a predatory pricer. Speculating over complicated new theories might be entertaining, but it would be dangerous and irresponsible if these sorts of poorly supported theories were incorporated into public policy.
[This post is the seventh in an ongoing symposium on “Should We Break Up Big Tech?” that features analysis and opinion from various perspectives.]
[This post is authored by Alec Stapp, Research Fellow at the International Center for Law & Economics]
Should we break up Microsoft?
In all the talk of breaking up “Big Tech,” no one seems to mention the biggest tech company of them all. Microsoft’s market cap is currently higher than those of Apple, Google, Amazon, and Facebook. If big is bad, then, at the moment, Microsoft is the worst.
Apart from size, antitrust activists also claim that the structure and behavior of the Big Four — Facebook, Google, Apple, and Amazon — is why they deserve to be broken up. But they never include Microsoft, which is curious given that most of their critiques also apply to the largest tech giant:
Microsoft is big (current market cap exceeds $1 trillion)
Microsoft is dominant in narrowly-defined markets (e.g., desktop operating systems)
Microsoft is simultaneously operating and competing on a platform (i.e., the Microsoft Store)
Microsoft is a conglomerate capable of leveraging dominance from one market into another (e.g., Windows, Office 365, Azure)
Microsoft has its own “kill zone” for startups (196 acquisitions since 1994)
Microsoft operates a search engine that preferences its own content over third-party content (i.e., Bing)
Microsoft operates a platform that moderates user-generated content (i.e., LinkedIn)
To be clear, this is not to say that an antitrust case against Microsoft is as strong as the case against the others. Rather, it is to say that the cases against the Big Four on these dimensions are as weak as the case against Microsoft, as I will show below.
Big is bad
Tim Wu published a book last year arguing for more vigorous antitrust enforcement — including against Big Tech — called “The Curse of Bigness.” As you can tell by the title, he argues, in essence, for a return to the bygone era of “big is bad” presumptions. In his book, Wu mentions “Microsoft” 29 times, but only in the context of its 1990s antitrust case. On the other hand, Wu has explicitly called for antitrust investigations of Amazon, Facebook, and Google. It’s unclear why big should be considered bad when it comes to the latter group but not when it comes to Microsoft. Maybe bigness isn’t actually a curse, after all.
As the saying goes in antitrust, “Big is not bad; big behaving badly is bad.” This aphorism arose to counter erroneous reasoning during the era of structure-conduct-performance when big was presumed to mean bad. Thanks to an improved theoretical and empirical understanding of the nature of the competitive process, there is now a consensus that firms can grow large either via superior efficiency or by engaging in anticompetitive behavior. Size alone does not tell us how a firm grew big — so it is not a relevant metric.
Microsoft is also dominant in the “professional networking platform” market after its acquisition of LinkedIn in 2016. And the legacy tech giant is still the clear leader in the “paid productivity software” market. (Microsoft’s Office 365 revenue is roughly 10x Google’s G Suite revenue).
The problem here is obvious. These are overly-narrow market definitions for conducting an antitrust analysis. Is it true that Facebook’s platforms are the only service that can connect you with your friends? Should we really restrict the productivity market to “paid”-only options (as the EU similarly did in its Android decision) when there are so many free options available? These questions are laughable. Proper market definition requires considering whether a hypothetical monopolist could profitably impose a small but significant and non-transitory increase in price (SSNIP). If not (which is likely the case in the narrow markets above), then we should employ a broader market definition in each case.
Simultaneously operating and competing on a platform
Elizabeth Warren likes to say that if you own a platform, then you shouldn’t both be an umpire and have a team in the game. Let’s put aside the problems with that flawed analogy for now. What she means is that you shouldn’t both run the platform and sell products, services, or apps on that platform (because it’s inherently unfair to the other sellers).
Warren’s solution to this “problem” would be to create a regulated class of businesses called “platform utilities” which are “companies with an annual global revenue of $25 billion or more and that offer to the public an online marketplace, an exchange, or a platform for connecting third parties.” Microsoft’s revenue last quarter was $32.5 billion, so it easily meets the first threshold. And Windows obviously qualifies as “a platform for connecting third parties.”
Just as in mobile operating systems, desktop operating systems are compatible with third-party applications. These third-party apps can be free (e.g., iTunes) or paid (e.g., Adobe Photoshop). Of course, Microsoft also makes apps for Windows (e.g., Word, PowerPoint, Excel, etc.). But the more you think about the technical details, the blurrier the line between the operating system and applications becomes. Is the browser an add-on to the OS or a part of it (as Microsoft Edge appears to be)? The most deeply-embedded applications in an OS are simply called “features.”
Even though Warren hasn’t explicitly mentioned that her plan would cover Microsoft, it almost certainly would. Previously, she left Apple out of the Medium post announcing her policy, only to later tell a journalist that the iPhone maker would also be prohibited from producing its own apps. But what Warren fails to include in her announcement that she would break up Apple is that trying to police the line between a first-party platform and third-party applications would be a nightmare for companies and regulators, likely leading to less innovation and higher prices for consumers (as they attempt to rebuild their previous bundles).
Leveraging dominance from one market into another
The core critique in Lina Khan’s “Amazon’s Antitrust Paradox” is that the very structure of Amazon itself is what leads to its anticompetitive behavior. Khan argues (in spite of the data) that Amazon uses profits in some lines of business to subsidize predatory pricing in other lines of businesses. Furthermore, she claims that Amazon uses data from its Amazon Web Services unit to spy on competitors and snuff them out before they become a threat.
Of course, this is similar to the theory of harm in Microsoft’s 1990s antitrust case, that the desktop giant was leveraging its monopoly from the operating system market into the browser market. Why don’t we hear the same concern today about Microsoft? Like both Amazon and Google, you could uncharitably describe Microsoft as extending its tentacles into as many sectors of the economy as possible. Here are some of the markets in which Microsoft competes (and note how the Big Four also compete in many of these same markets):
What these potential antitrust harms leave out are the clear consumer benefits from bundling and vertical integration. Microsoft’s relationships with customers in one market might make it the most efficient vendor in related — but separate — markets. It is unsurprising, for example, that Windows customers would also frequently be Office customers. Furthermore, the zero marginal cost nature of software makes it an ideal product for bundling, which redounds to the benefit of consumers.
The “kill zone” for startups
In a recent article for The New York Times, Tim Wu and Stuart A. Thompson criticize Facebook and Google for the number of acquisitions they have made. They point out that “Google has acquired at least 270 companies over nearly two decades” and “Facebook has acquired at least 92 companies since 2007”, arguing that allowing such a large number of acquisitions to occur is conclusive evidence of regulatory failure.
Microsoft has made 196 acquisitions since 1994, but they receive no mention in the NYT article (or in most of the discussion around supposed “kill zones”). But the acquisitions by Microsoft or Facebook or Google are, in general, not problematic. They provide a crucial channel for liquidity in the venture capital and startup communities (the other channel being IPOs). According to the latest data from Orrick and Crunchbase, between 2010 and 2018, there were 21,844 acquisitions of tech startups for a total deal value of $1.193 trillion.
By comparison, according to data compiled by Jay R. Ritter, a professor at the University of Florida, there were 331 tech IPOs for a total market capitalization of $649.6 billion over the same period. Making it harder for a startup to be acquired would not result in more venture capital investment (and therefore not in more IPOs), according to recent research by Gordon M. Phillips and Alexei Zhdanov. The researchers show that “the passage of a pro-takeover law in a country is associated with more subsequent VC deals in that country, while the enactment of a business combination antitakeover law in the U.S. has a negative effect on subsequent VC investment.”
As investor and serial entrepreneur Leonard Speiser said recently, “If the DOJ starts going after tech companies for making acquisitions, venture investors will be much less likely to invest in new startups, thereby reducing competition in a far more harmful way.”
Search engine bias
Google is often accused of biasing its search results to favor its own products and services. The argument goes that if we broke them up, a thousand search engines would bloom and competition among them would lead to less-biased search results. While it is a very difficult — if not impossible — empirical question to determine what a “neutral” search engine would return, one attempt by Josh Wright found that “own-content bias is actually an infrequent phenomenon, and Google references its own content more favorably than other search engines far less frequently than does Bing.”
The report goes on to note that “Google references own content in its first results position when no other engine does in just 6.7% of queries; Bing does so over twice as often (14.3%).” Arguably, users of a particular search engine might be more interested in seeing content from that company because they have a preexisting relationship. But regardless of how we interpret these results, it’s clear this not a frequent phenomenon.
So why is Microsoft being left out of the antitrust debate now?
One potential reason why Google, Facebook, and Amazon have been singled out for criticism of practices that seem common in the tech industry (and are often pro-consumer) may be due to the prevailing business model in the journalism industry. Google and Facebook are by far the largest competitors in the digital advertising market, and Amazon is expected to be the third-largest player by next year, according to eMarketer. As Ramsi Woodcock pointed out, news publications are also competing for advertising dollars, the type of conflict of interest that usually would warrant disclosure if, say, a journalist held stock in a company they were covering.
Or perhaps Microsoft has successfully avoided receiving the same level of antitrust scrutiny as the Big Four because it is neither primarily consumer-facing like Apple or Amazon nor does it operate a platform with a significant amount of political speech via user-generated content (UGC) like Facebook or Google (YouTube). Yes, Microsoft moderates content on LinkedIn, but the public does not get outraged when deplatforming merely prevents someone from spamming their colleagues with requests “to add you to my professional network.”
Microsoft’s core areas are in the enterprise market, which allows it to sidestep the current debates about the supposed censorship of conservatives or unfair platform competition. To be clear, consumer-facing companies or platforms with user-generated content do not uniquely merit antitrust scrutiny. On the contrary, the benefits to consumers from these platforms are manifest. If this theory about why Microsoft has escaped scrutiny is correct, it means the public discussion thus far about Big Tech and antitrust has been driven by perception, not substance.
[This post is the sixth in an ongoing symposium on “Should We Break Up Big Tech?” that features analysis and opinion from various perspectives.]
[This post is authored by Thibault Schrepel, Faculty Associate at the Berkman Center at Harvard University and Assistant Professor in European Economic Law at Utrecht University School of Law.]
The pretense of ignorance
Over the last few years, I have published a series of antitrust conversations with Nobel laureates in economics. I have discussed big tech dominance with most of them, and although they have different perspectives, all of them agreed on one thing: they do not know what the effect of breaking up big tech would be. In fact, I have never spoken with any economist who was able to show me convincing empirical evidence that breaking up big tech would on net be good for consumers. The same goes for political scientists; I have never read any article that, taking everything into consideration, proves empirically that breaking up tech companies would be good for protecting democracies, if that is the objective (please note that I am not even discussing the fact that using antitrust law to do that would violate the rule of law, for more on the subject, click here).
This reminds me of Friedrich Hayek’s Nobel memorial lecture, in which he discussed the “pretense of knowledge.” He argued that some issues will always remain too complex for humans (even helped by quantum computers and the most advanced AI; that’s right!). Breaking up big tech is one such issue; it is simply impossible simultaneously to consider the micro and macro-economic impacts of such an enormous undertaking, which would affect, literally, billions of people. Not to mention the political, sociological and legal issues, all of which combined are beyond human understanding.
Ignorance + fear = fame
In the absence of clear-cut conclusions, here is why (I think), some officials are arguing for breaking up big tech. First, it may be possible that some of them actually believe that it would be great. But I am sure we agree that beliefs should not be a valid basis for such actions. More realistically, the answer can be found in the work of another Nobel laureate, James Buchanan, and in particular his 1978 lecture in Vienna entitled “Politics Without Romance.”
In his lecture and the paper that emerged from it, Buchanan argued that while markets fail, so do governments. The latter is especially relevant insofar as top officials entrusted with public power may, occasionally at least, use that power to benefit their personal interests rather than the public interest. Thus, the presumption that government-imposed corrections for market failures always accomplish the desired objectives must be rejected. Taking that into consideration, it follows that the expected effectiveness of public action should always be established as precisely and scientifically as possible before taking action. Integrating these insights from Hayek and Buchanan, we must conclude that it is not possible to know whether the effects of breaking up big tech would on net be positive.
The question then is why, in the absence of positive empirical evidence, are some officials arguing for breaking up tech giants then? Well, because defending such actions may help them achieve their personal goals. Often, it is more important for public officials to show their muscle and take action, rather showing great care about reaching a positive net result for society. This is especially true when it is practically impossible to evaluate the outcome due to the scale and complexity of the changes that ensue. That enables these officials to take credit for being bold while avoiding blame for the harms.
But for such a call to be profitable for the public officials, they first must legitimize the potential action in the eyes of the majority of the public. Until now, most consumers evidently like the services of tech giants, which is why it is crucial for the top officials engaged in such a strategy to demonize those companies and further explain to consumers why they are wrong to enjoy them. Only then does defending the breakup of tech giants becomes politically valuable.
Some data, one trend
In a recent paper entitled “Antitrust Without Romance,” I have analyzed the speeches of the five current FTC commissioners, as well as the speeches of the current and three previous EU Competition Commissioners. What I found is an increasing trend to demonize big tech companies. In other words, public officials increasingly seek to prepare the general public for the idea that breaking up tech giants would be great.
In Europe, current Competition Commissioner Margrethe Vestager has sought to establish an opposition between the people (referred under the pronoun “us”) and tech companies (referred under the pronoun “them”) in more than 80% of her speeches. She further describes these companies as engaging in manipulation of the public and unleashing violence. She says they, “distort or fabricate information, manipulate people’s views and degrade public debate” and help “harmful, untrue information spread faster than ever, unleashing violence and undermining democracy.” Furthermore, she says they cause, “danger of death.” On this basis, she mentions the possibility of breaking them up (for more data about her speeches, see this link).
In the US, we did not observe a similar trend. Assistant Attorney General Makan Delrahim, who has responsibility for antitrust enforcement at the Department of Justice, describes the relationship between people and companies as being in opposition in fewer than 10% of his speeches. The same goes for most of the FTC commissioners (to see all the data about their speeches, see this link). The exceptions are FTC Chairman Joseph J. Simons, who describes companies’ behavior as “bad” from time to time (and underlines that consumers “deserve” better) and Commissioner Rohit Chopra, who describes the relationship between companies and the people as being in opposition to one another in 30% of his speeches. Chopra also frequently labels companies as “bad.” These are minor signs of big tech demonization compared to what is currently done by European officials. But, unfortunately, part of the US doctrine (which does not hide political objectives) pushes for demonizing big tech companies. One may have reason to fear that such a trend will grow in the US as it has in Europe, especially considering the upcoming presidential campaign in which far-right and far-left politicians seem to agree about the need to break up big tech.
And yet, let’s remember that no-one has any documented, tangible, and reproducible evidence that breaking up tech giants would be good for consumers, or societies at large, or, in fact, for anyone (even dolphins, okay). It might be a good idea; it might be a bad idea. Who knows? But the lack of evidence either way militates against taking such action. Meanwhile, there is strong evidence that these discussions are fueled by a handful of individuals wishing to benefit from such a call for action. They do so, first, by depicting tech giants as representing the new elite in opposition to the people and they then portray themselves as the only saviors capable of taking action.
Epilogue: who knows, life is not a Tarantino movie
For the last 30 years, antitrust law has been largely immune to strategic takeover by political interests. It may now be returning to a previous era in which it was the instrument of a few. This transformation is already happening in Europe (it is expected to hit case law there quite soon) and is getting real in the US, where groups display political goals and make antitrust law a Trojan horse for their personal interests.The only semblance of evidence they bring is a few allegedly harmful micro-practices (see Amazon’s Antitrust Paradox), which they use as a basis for defending the urgent need of macro, structural measures, such as breaking up tech companies. This is disproportionate, but most of all and in the absence of better knowledge, purely opportunistic and potentially foolish. Who knows at this point whether antitrust law will come out intact of this populist and moralist episode? And who knows what the next idea of those who want to use antitrust law for purely political purposes will be. Life is not a Tarantino movie; it may end up badly.
[This post is the third in an ongoing symposium on “Should We Break Up Big Tech?” that will feature analysis and opinion from various perspectives.]
[This post is authored by John E. Lopatka, Robert Noll Distinguished Professor of Law, School of Law, The Pennsylvania State University]
Big Tech firms stand accused of many evils, and the clamor to break them up is loud. Should we fetch our pitchforks? The antitrust laws are designed to address a range of wrongs and authorize a set of remedies, which include but do not emphasize divestiture. When the harm caused by a Big Tech company is of a kind the antitrust laws are intended to prevent, an appropriate antitrust remedy can be devised. In such a case, it makes sense to use antitrust: If antitrust and its remedies are adequate to do the job fully, no legislative changes are required. When the harm falls outside the ambit of antitrust and any other pertinent statute, a choice must be made. Antitrust can be expanded; other statutes can be amended or enacted; or any harms that are not perfectly addressed by existing statutory and common law can be left alone, for legal institutions are never perfect, and a disease can be less harmful than a cure.
A comprehensive list of the myriad and changing attacks on Big Tech firms would be difficult to compile. Indeed, the identity of the offenders is not self-evident, though Google (Alphabet), Facebook, Amazon, and Apple have lately attracted the most attention. The principal charges against Big Tech firms seem to be these: 1) compromising consumer privacy; 2) manipulating the news; 3) accumulating undue social and political influence; 4) stifling innovation by acquiring creative upstarts; 5) using market power in one market to injure competitors in adjacent markets; 6) exploiting input suppliers; 7) exploiting their own employees; and 8) damaging communities by location choices.
These charges are not uniform across the Big Tech targets. Some charges have been directed more forcefully against some firms than others. For instance, infringement of consumer privacy has been a focus of attacks on Facebook. Both Facebook and Google have been accused of manipulating the news. And claims about the exploitation of input suppliers and employees and the destruction of communities have largely been directed at Amazon.
What is “Big Tech”?
Despite the variance among firms, the attacks against all of them proceed from the same syllogism: Some tech firms are big; big tech firms do social harm; therefore, big tech firms should be broken up. From an antitrust perspective, something is missing. Start with the definition of a “tech” firm. In the modern economy, every firm relies on sophisticated technology – from an auto repair shop to an airplane manufacturer to a social media website operator. Every firm is a tech firm. But critics have a more limited concept in mind. They are concerned about platforms, or intermediaries, in multi-sided markets. These markets exhibit indirect network effects. In a two-sided market, for instance, each side of the market benefits as the size of the other side grows. Platforms provide value by coordinating the demand and supply of different groups of economic actors where the actors could not efficiently interact by themselves. In short, platforms reduce transaction costs. They have been around for centuries, but their importance has been magnified in recent years by rapid advances in technology. Rational observers can sensibly ask whether platforms are peculiarly capable of causing harm. But critics tend to ignore or at least to discount the value that platforms provide, and doing so presents a distorted image that breeds bad policy.
Assuming we know what a tech firm is, what is “big”? One could measure size by many standards. Most critics do not bother to define “big,” though at least Senator Elizabeth Warren has proposed defining one category of bigness as firms with annual global revenue of $25 billion or more and a second category as those with annual global revenue of between $90 million and $25 billion. The proper standard for determining whether tech firms are objectionably large is not self-evident. Indeed, a size threshold embodied in any legal policy will almost always be somewhat arbitrary. That by itself is not a failing of a policy prescription. But why use a size screen at all? A few answers are possible. Large firms may do more harm than small firms when harm is proportionate to size. Size may matter because government intervention is costly and less sensitive to firm size than is harm, implying that only harm caused by large firms is large enough to outweigh the costs of enforcement. And most important, the size of a firm may be related to the kind of harm the firm is accused of doing. Perhaps only a firm of a certain size can inflict a particular kind of injury. A clear standard of size and its justification ought to precede any policy prescription.
What’s the (antitrust) beef?
The social harms that Big Tech firms are accused of doing are a hodgepodge. Some are familiar to antitrust scholars as either current or past objects of antitrust concern; others are not. Antitrust protects against a certain kind of economic harm: The loss of economic welfare caused by a restriction on competition. Though the terms are sometimes used in different ways, the core concept is reasonably clear and well accepted. In most cases, economic welfare is synonymous with consumer welfare. Economic welfare, though, is a broader concept. For example, economic welfare is reduced when buyers exercise market power to the detriment of sellers and by productive inefficiencies. But despite the claim of some Big Tech critics, when consumer welfare is at stake, it is not measured exclusively by the price consumers pay. Economists often explicitly refer to quality-adjusted prices and implicitly have the qualification in mind in any analysis of price. Holding quality constant makes quantitative models easier to construct, but a loss of quality is a matter of conventional antitrust concern. The federal antitrust agencies’ horizontal merger guidelines recognize that “reduced product quality, reduced product variety, reduced service, [and] diminished innovation” are all cognizable adverse effects. The scope of antitrust is not as constricted as some critics assert. Still, it has limits.
Leveraging market power is standard antitrust fare, though it is not nearly as prevalent as once thought. Horizontal mergers that reduce economic welfare are an antitrust staple. The acquisition and use of monopsony power to the detriment of input suppliers is familiar antitrust ground. If Big Tech firms have committed antitrust violations of this ilk, the offenses can be remedied under the antitrust laws.
Other complaints against the Big Tech firms do not fit comfortably or at all within the ambit of antitrust. Antitrust does not concern itself with political or social influence. Influence is a function of size, but not relative to any antitrust market. Firms that have more resources than other firms may have more influence, but the deployment of those resources across the economy is irrelevant. The use of antitrust to attack conglomerate mergers was an inglorious period in antitrust history. Injuries to communities or to employees are not a proper antitrust concern when they result from increased efficiency. Acquisitions might stifle innovation, which is a proper antitrust concern, but they might spur innovation by inducing firms to create value and thereby become attractive acquisition targets or by facilitating integration. Whether the consumer interest in informational privacy has much to do with competition is difficult to say. Privacy in this context means the collection and use of data. In a multi-sided market, one group of participants may value not only the size but also the composition and information about another group. Competition among platforms might or might not occur on the dimension of privacy. For any platform, however, a reduction in the amount of valuable data it can collect from one side and provide to another side will reduce the price it can charge the second side, which can flow back and injure the first side. In all, antitrust falters when it is asked to do what it cannot do well, and whether other laws should be brought to bear depends on a cost/benefit calculus.
Does Big Tech’s conduct merit antitrust action?
When antitrust is used, it unquestionably requires a causal connection between conduct and harm. Conduct must restrain competition, and the restraint must cause cognizable harm. Most of the attacks against Big Tech firms if pursued under the antitrust laws would proceed as monopolization claims. A firm must have monopoly power in a relevant market; the firm must engage in anticompetitive conduct, typically conduct that excludes rivals without increasing efficiency; and the firm must have or retain its monopoly power because of the anticompetitive conduct.
Put aside the flaccid assumption that all the targeted Big Tech platforms have monopoly power in relevant markets. Maybe they do, maybe they don’t, but an assumption is unwarranted. Focus instead on the conduct element of monopolization. Most of the complaints about Big Tech firms concern their use of whatever power they have. Use isn’t enough. Each of the firms named above has achieved its prominence by extraordinary innovation, shrewd planning, and effective execution in an unforgiving business climate, one in which more platforms have failed than have succeeded. This does not look like promising ground for antitrust.
Of course, even firms that generally compete lawfully can stray. But to repeat, monopolists do not monopolize unless their unlawful conduct is causally connected to their market power. The complaints against the Big Tech firms are notably weak on allegations of anticompetitive conduct that resulted in the acquisition or maintenance of their market positions. Some critics have assailed Facebook’s acquisitions of WhatsApp and Instagram. Even assuming these firms competed with Facebook in well-defined antitrust markets, the claim that Facebook’s dominance in its core business was created or maintained by these acquisitions is a stretch.
The difficulty fashioning remedies
The causal connection between conduct and monopoly power becomes particularly important when remedies are fashioned for monopolization. Microsoft, the first major monopolization case against a high tech platform, is instructive. DOJ in its complaint sought only conduct remedies for Microsoft’s alleged unlawful maintenance of a monopoly in personal computer operating systems. The trial court found that Microsoft had illegally maintained its monopoly by squelching Netscape’s Navigator and Sun’s Java technologies, and by the end of trial DOJ sought and the court ordered structural relief in the form of “vertical” divestiture, separating Microsoft’s operating system business from its applications business. Some commentators at the time argued for various kinds of “horizontal” divestiture, which would have created competing operating system platforms. The appellate court set aside the order, emphasizing that an antitrust remedy must bear a close causal connection to proven anticompetitive conduct. Structural remedies are drastic, and a plaintiff must meet a heightened standard of proof of causation to justify any kind of divestiture in a monopolization case. On remand, DOJ abandoned its request for divestiture. The evidence that Microsoft maintained its market position by inhibiting the growth of middleware was sufficient to support liability, but not structural relief.
The court’s trepidation was well-founded. Divestiture makes sense when monopoly power results from acquisitions, because the mergers expose joints at which the firm might be separated without rending fully integrated operations. But imposing divestiture on a monopolist for engaging in single-firm exclusionary conduct threatens to destroy the integration that is the essence of any firm and is almost always disproportional to the offense. Even if conduct remedies can be more costly to enforce than structural relief, the additional cost is usually less than the cost to the economy of forgone efficiency.
The proposals to break up the Big Tech firms are ill-defined. Based on what has been reported, no structural relief could be justified as antitrust relief. Whatever conduct might have been unlawful was overwhelmingly unilateral. The few acquisitions that have occurred didn’t appreciably create or preserve monopoly power, and divestiture wouldn’t do much to correct the misbehavior critics see anyway. Big Tech firms could be restructured through new legislation, but that would be a mistake. High tech platform markets typically yield dominant firms, though heterogeneous demand often creates space for competitors. Markets are better at achieving efficient structures than are government planners. Legislative efforts at restructuring are likely to invite circumvention or lock in inefficiency.
Regulate “Big Tech” instead?
In truth, many critics are willing to put up with dominant tech platforms but want them regulated. If we learned any lesson from the era of pervasive economic regulation of public utilities, it is that regulation is costly and often yields minimal benefits. George Stigler and Claire Friedland demonstrated 57 years ago that electric utility regulation had little impact. The era of regulation was followed by an era of deregulation. Yet the desire to regulate remains strong, and as Stigler and Friedland observed, “if wishes were horses, one would buy stock in a harness factory.” And just how would Big Tech platform regulators regulate? Senator Warren offers a glimpse of the kind of regulation that critics might impose: “Platform utilities would be required to meet a standard of fair, reasonable, and nondiscriminatory dealing with users.” This kind of standard has some meaning in the context of a standard-setting organization dealing with patent holders. What it would mean in the context of a social media platform, for example, is anyone’s guess. Would it prevent biasing of information for political purposes, and what government official should be entrusted with that determination? What is certain is that it would invite government intervention into markets that are working well, if not perfectly. It would invite public officials to tradeoff economic welfare for a host of values embedded in the concept of fairness. Federal agencies charged with promoting the “public interest” have a difficult enough time reaching conclusions where competition is one of several specific values to be considered. Regulation designed to address all the evils high tech platforms are thought to perpetrate would make traditional economic or public-interest regulation look like child’s play.
Big Tech firms have generated immense value. They may do real harm. From all that can now be gleaned, any harm has had little to do with antitrust, and it certainly doesn’t justify breaking them up. Nor should they be broken up as an exercise in central economic planning. If abuses can be identified, such as undesirable invasions of privacy, focused legislation may be in order, but even then only if the government action is predictably less costly than the abuses.
This guest post is by Corbin K. Barthold, Litigation Counsel at Washington Legal Foundation.
Complexity need not follow size. A star is huge but mostly homogenous. “It’s core is so hot,” explains Martin Rees, “that no chemicals can exist (complex molecules get torn apart); it is basically an amorphous gas of atomic nuclei and electrons.”
Nor does complexity always arise from remoteness of space or time. Celestial gyrations can be readily grasped. Thales of Miletus probably predicted a solar eclipse. Newton certainly could have done so. And we’re confident that in 4.5 billion years the Andromeda galaxy will collide with our own.
If the simple can be seen in the large and the distant, equally can the complex be found in the small and the immediate. A double pendulum is chaotic. Likewise the local weather, the fluctuations of a wildlife population, or the dispersion of the milk you pour into your coffee.
Our economy is not like a planetary orbit. It’s more like the weather or the milk. No one knows which companies will become dominant, which products will become popular, or which industries will become defunct. No one can see far ahead. Investing is inherently risky because the future of the economy, or even a single segment of it, is intractably uncertain. Do not hand your savings to any expert who says otherwise. Experts, in fact, often see the least of all.
But if a broker with a “sure thing” stock is a mountebank, what does that make an antitrust scholar with an “optimum structure” for a market?
Not a prophet.
There is so much that we don’t know. Consider, for example, the notion that market concentration is a good measure of market competitiveness. The idea seems intuitive enough, and in many corners it remains an article of faith.
But the markets where this assumption is most plausible—hospital care and air travel come to mind—are heavily shaped by that grand monopolist we call government. Only a large institution can cope with the regulatory burden placed on the healthcare industry. As Tyler Cowen writes, “We get the level of hospital concentration that we have in essence chosen through politics and the law.”
As for air travel: the government promotes concentration by barring foreign airlines from the domestic market. In any case, the state of air travel does not support a straightforward conclusion that concentration equals power. The price of flying has fallen almost continuously since passage of the Airline Deregulation Act in 1978. The major airlines are disciplined by fringe carriers such as JetBlue and Southwest.
It is by no means clear that, aside from cases of government-imposed concentration, a consolidated market is something to fear. Technology lowers costs, lower costs enable scale, and scale tends to promote efficiency. Scale can arise naturally, therefore, from the process of creating better and cheaper products.
Say you’re a nineteenth-century cow farmer, and the railroad reaches you. Your shipping costs go down, and you start to sell to a wider market. As your farm grows, you start to spread your capital expenses over more sales. Your prices drop. Then refrigerated rail cars come along, you start slaughtering your cows on site, and your shipping costs go down again. Your prices drop further. Farms that fail to keep pace with your cost-cutting go bust. The cycle continues until beef is cheap and yours is one of the few cow farms in the area. The market improves as it consolidates.
As the decades pass, this story repeats itself on successively larger stages. The relentless march of technology has enabled the best companies to compete for regional, then national, and now global market share. We should not be surprised to see ever fewer firms offering ever better products and services.
Bear in mind, moreover, that it’s rarely the same company driving each leap forward. As Geoffrey Manne and Alec Stapp recently noted in this space, markets are not linear. Just after you adopt the next big advance in the logistics of beef production, drone delivery will disrupt your delivery network, cultured meat will displace your product, or virtual-reality flavoring will destroy your industry. Or—most likely of all—you’ll be ambushed by something you can’t imagine.
Does market concentration inhibit innovation? It’s possible. “To this day,” write Joshua Wright and Judge Douglas Ginsburg, “the complex relationship between static product market competition and the incentive to innovate is not well understood.”
There’s that word again: complex. When will thumping company A in an antitrust lawsuit increase the net amount of innovation coming from companies A, B, C, and D? Antitrust officials have no clue. They’re as benighted as anyone. These are the people who will squash Blockbuster’s bid to purchase a rival video-rental shop less than two years before Netflix launches a streaming service.
And it’s not as if our most innovative companies are using market concentration as an excuse to relax. If its only concern were maintaining Google’s grip on the market for internet-search advertising, Alphabet would not have spent $16 billion on research and development last year. It spent that much because its long-term survival depends on building the next big market—the one that does not exist yet.
No expert can reliably make the predictions necessary to say when or how a market should look different. And if we empowered some experts to make such predictions anyway, no other experts would be any good at predicting what the empowered experts would predict. Experts trying to give us “well structured” markets will instead give us a costly, politicized, and stochastic antitrust enforcement process.
Here’s a modest proposal. Instead of using the antitrust laws to address the curse of bigness, let’s create the Office of the Double Pendulum. We can place the whole section in a single room at the Justice Department.
All we’ll need is some ping-pong balls, a double pendulum, and a monkey. On each ball will be the name of a major corporation. Once a quarter—or a month; reasonable minds can differ—a ball will be drawn, and the monkey prodded into throwing the pendulum. An even number of twirls saves the company on the ball. An odd number dooms it to being broken up.
This system will punish success just as haphazardly as anything our brightest neo-Brandeisian scholars can devise, while avoiding the ruinously expensive lobbying, rent-seeking, and litigation that arise when scholars succeed in replacing the rule of law with the rule of experts.
All hail the chaos monkey. Unutterably complex. Ineffably simple.
In 2014, Benedict Evans, a venture capitalist at Andreessen Horowitz, wrote “Why Amazon Has No Profits (And Why It Works),” a blog post in which he tried to explain Amazon’s business model. He began with a chart of Amazon’s revenue and net income that has now become (in)famous:
A question inevitably followed in antitrust circles: How can a company that makes so little profit on so much revenue be worth so much money? It must be predatory pricing!
Predatory pricing is a rather rare anticompetitive practice because the “predator” runs the risk of bankrupting itself in the process of trying to drive rivals out of business with below-cost pricing. Furthermore, even if a predator successfully clears the field of competition, in developed markets with deep capital markets, keeping out new entrants is extremely unlikely.
Nonetheless, in those rare cases where plaintiffs can demonstrate that a firm actually has a viable scheme to drive competitors from the market with prices that are “too low” and has the ability to recoup its losses once it has cleared the market of those competitors, plaintiffs (including the DOJ) can prevail in court.
In other words, whoa if true.
Khan’s Predatory Pricing Accusation
In 2017, Lina Khan, then a law student at Yale, published “Amazon’s Antitrust Paradox” in a note for the Yale Law Journal and used Evans’ chart as supporting evidence that Amazon was guilty of predatory pricing. In the abstract she says, “Although Amazon has clocked staggering growth, it generates meager profits, choosing to price below-cost and expand widely instead.”
But if Amazon is selling below-cost, where does the money come from to finance those losses?
In her article, Khan hinted at two potential explanations: (1) Amazon is using profits from the cloud computing division (AWS) to cross-subsidize losses in the retail division or (2) Amazon is using money from investors to subsidize short-term losses:
Recently, Amazon has started reporting consistent profits, largely due to the success of Amazon Web Services, its cloud computing business. Its North America retail business runs on much thinner margins, and its international retail business still runs at a loss. But for the vast majority of its twenty years in business, losses—not profits—were the norm. Through 2013, Amazon had generated a positive net income in just over half of its financial reporting quarters. Even in quarters in which it did enter the black, its margins were razor-thin, despite astounding growth.
Just as striking as Amazon’s lack of interest in generating profit has been investors’ willingness to back the company. With the exception of a few quarters in 2014, Amazon’s shareholders have poured money in despite the company’s penchant for losses.
Revising predatory pricing doctrine to reflect the economics of platform markets, where firms can sink money for years given unlimited investor backing, would require abandoning the recoupment requirement in cases of below-cost pricing by dominant platforms.
Below-Cost Pricing Not Subsidized by Investors
But neither explanation withstands scrutiny. First, the money is not from investors. Amazon has not raised equity financing since 2003. Nor is it debt financing: The company’s net debt position has been near-zero or negative for its entire history (excluding the Whole Foods acquisition):
As Priya Anand observed in a recent piece for The Information, since Amazon started breaking out AWS in its financials, operating income for the North America retail business has been significantly positive:
But [Khan] underplays its retail profits in the U.S., where the antitrust debate is focused. As the above chart shows, its North America operation has been profitable for years, and its operating income has been on the rise in recent quarters. While its North America retail operation has thinner margins than AWS, it still generated $2.84 billion in operating income last year, which isn’t exactly a rounding error compared to its $4.33 billion in AWS operating income.
Below-Cost Pricing in Retail Also Known as “Loss Leader” Pricing
Okay, so maybe Amazon isn’t using below-cost pricing in aggregate in its retail division. But it still could be using profits from some retail products to cross-subsidize below-cost pricing for other retail products (e.g., diapers), with the intention of driving competitors out of business to capture monopoly profits. This is essentially what Khan claims happened in the Diapers.com (Quidsi) case. But in the retail industry, diapers are explicitly cited as a loss leader that help retailers to develop a customer relationship with mothers in the hopes of selling them a higher volume of products over time. This is exactly what the founders of Diapers.com told Inc Magazine in a 2012 interview (emphasis added):
We saw brick-and-mortar stores, the Wal-Marts and Targets of the world, using these products to build relationships with mom and the end consumer, bringing them into the store and selling them everything else. So we thought that was an interesting model and maybe we could replicate that online. And so we started with selling the loss leader product to basically build a relationship with mom. And once they had the passion for the brand and they were shopping with us on a weekly or a monthly basis that they’d start to fall in love with that brand. We were losing money on every box of diapers that we sold. We weren’t able to buy direct from the manufacturers.
An anticompetitive scheme could be built into such bundling, but in many if not the overwhelming majority of these cases, consumers are the beneficiaries of lower prices and expanded output produced by these arrangements. It’s hard to definitively say whether any given firm that discounts its products is actually pricing below average variable cost (“AVC”) without far more granular accounting ledgers than are typically maintained. This is part of the reason why these cases can be so hard to prove.
A successful predatory pricing strategy also requires blocking market entry when the predator eventually raises prices. But the Diapers.com case is an explicit example of repeated entry that would defeat recoupment. In an article for the American Enterprise Institute, Jeffrey Eisenach shares the rest of the story following Amazon’s acquisition of Diapers.com:
Amazon’s conduct did not result in a diaper-retailing monopoly. Far from it. According to Khan, Amazon had about 43 percent of online sales in 2016 — compared with Walmart at 23 percent and Target with 18 percent — and since many people still buy diapers at the grocery store, real shares are far lower.
In the end, Quidsi proved to be a bad investment for Amazon: After spending $545 million to buy the firm and operating it as a stand-alone business for more than six years, it announced in April 2017 it was shutting down all of Quidsi’s operations, Diapers.com included. In the meantime, Quidsi’s founders poured the proceeds of the Amazon sale into a new online retailer — Jet.com — which was purchased by Walmart in 2016 for $3.3 billion. Jet.com cofounder Marc Lore now runs Walmart’s e-commerce operations and has said publicly that his goal is to surpass Amazon as the top online retailer.
Sussman argues that the company has been inflating its free cash flow numbers by excluding “capital leases.” According to Sussman, “If all of those expenses as detailed in its statements are accounted for, Amazon experienced a negative cash outflow of $1.461 billion in 2017.” Even though it’s not dispositive of predatory pricing on its own, Sussman believes that a negative free cash flow implies the company has been selling below-cost to gain market share.
2. Amazon Recoups Losses By Lowering AVC, Not By Raising Prices
Instead of raising prices to recoup losses from pricing below-cost, Sussman argues that Amazon flies under the antitrust radar by keeping consumer prices low and progressively decreasing AVC, ostensibly through using its monopsony power to offload costs on suppliers and partners (although this point is not fully explored in his piece).
But Sussman’s argument contains errors in both legal reasoning as well as its underlying empirical assumptions.
While there are many different ways to calculate the “cost” of a product or service, generally speaking, “below-cost pricing” means the price is less than marginal cost or AVC. Typically, courts tend to rely on AVC when dealing with predatory pricing cases. And as Herbert Hovenkamp has noted, proving that a price falls below the AVC is exceedingly difficult, particularly when dealing with firms in dynamic markets that sell a number of differentiated but complementary goods or services. Amazon, the focus of Sussman’s article, is a useful example here.
When products are complements, or can otherwise be bundled, firms may also be able to offer discounts that are unprofitable when selling single items. In business this is known as the “razor and blades model” (i.e., sell the razor handle below-cost one time and recoup losses on future sales of blades — although it’s not clear if this ever actually happens). Printer manufacturers are also an oft-cited example here, where printers are often sold below AVC in the expectation that the profits will be realized on the ongoing sale of ink. Amazon’s Kindle functions similarly: Amazon sells the Kindle around its AVC, ostensibly on the belief that it will realize a profit on selling e-books in the Kindle store.
Yet, even ignoring this common and broadly inoffensive practice, Sussman’s argument is odd. In essence, he claims that Amazon is concealing some of its costs in the form of capital leases in an effort to conceal its below-AVC pricing while it works to simultaneously lower its real AVC below the prices it charges consumers. At the end of this process, once its real AVC is actually sufficiently below consumers prices, it will (so the argument goes) be in the position of a monopolist reaping monopoly profits.
The problem with this argument should be immediately apparent. For the moment, let’s ignore the classic recoupment problem where new entrants will be drawn into the market to win some of those monopoly prices based on the new AVC that is possible. The real problem with his logic is that Sussman basically suggests that if Amazon sharply lowers AVC — that is it makes production massively more efficient — and then does not drop prices, they are a “predator.” But by pricing below its AVC in the first place, consumers in essence were given a loan by Amazon — they were able to enjoy what Sussman believes are radically low prices while Amazon works to actually make those prices possible through creating production efficiencies. It seems rather strange to punish a firm for loaning consumers a large measure of wealth. Its doubly odd when you then re-factor the recoupment problem back in: as soon as other firms figure out that a lower AVC is possible, they will enter the market and bid away any monopoly profits from Amazon.
Sussman’s Technical Analysis Is Flawed
While there are issues with Sussman’s general theory of harm, there are also some specific problems with his technical analysis of Amazon’s financial statements.
Capital Leases Are a Fixed Cost
First, capital leases should be not be included in cost calculations for a predatory pricing case because they are fixed — not variable — costs. Again, “below-cost” claims in predatory pricing cases generally use AVC (and sometimes marginal cost) as relevant cost measures.
Capital Leases Are Mostly for Server Farms
Second, the usual story is that Amazon uses its wildly-profitable Amazon Web Services (AWS) division to subsidize predatory pricing in its retail division. But Amazon’s “capital leases” — Sussman’s hidden costs in the free cash flow calculations — are mostly for AWS capital expenditures (i.e., server farms).
According to the most recent annual report: “Property and equipment acquired under capital leases was $5.7 billion, $9.6 billion, and $10.6 billion in 2016, 2017, and 2018, with the increase reflecting investments in support of continued business growth primarily due to investments in technology infrastructure for AWS, which investments we expect to continue over time.”
In other words, any adjustments to the free cash flow numbers for capital leases would make Amazon Web Services appear less profitable, and would not have a large effect on the accounting for Amazon’s retail operation (the only division thus far accused of predatory pricing).
Look at Operating Cash Flow Instead of Free Cash Flow
Again, while cash flow measures cannot prove or disprove the existence of predatory pricing, a positive cash flow measure should make us more skeptical of such accusations. In the retail sector, operating cash flow is the appropriate metric to consider. As shown above, Amazon has had positive (and increasing) operating cash flow since 2002.
Your Theory of Harm Is Also Known as “Investment”
Third, in general, Sussman’s novel predatory pricing theory is indistinguishable from pro-competitive behavior in an industry with high fixed costs. From the abstract (emphasis added):
[N]egative cash flow firm[s] … can achieve greater market share through predatory pricing strategies that involve long-term below average variable cost prices … By charging prices in the present reflecting future lower costs based on prospective technological and scale efficiencies, these firms are able to rationalize their predatory pricing practices to investors and shareholders.
“’Charging prices in the present reflecting future lower costs based on prospective technological and scale efficiencies” is literally what it means to invest in capex and R&D.
Sussman’s paper presents a clever attempt to work around the doctrinal limitations on predatory pricing. But, if courts seriously adopt an approach like this, they will be putting in place a legal apparatus that quite explicitly focuses on discouraging investment. This is one of the last things we should want antitrust law to be doing.