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Untangling the 9th Circuit’s Ruling in Epic Games v Apple

Lazar Radic —  4 May 2023 — Leave a comment

The 9th U.S. Circuit Court of Appeals ruled late last month on Epic Games’ appeal of the decision rendered in 2021 by the U.S. District Court for the Northern District of California in Epic Games v Apple, affirming in part and reversing in part the district court’s judgment.

In the original case, Epic had challenged as a violation of antitrust law Apple’s prohibition of third-party app stores and in-app-payment (IAP) systems from operating on its proprietary iOS platform. The district court ruled against Epic, finding that the company’s real concern was its own business interests in the face of Apple’s business model—in particular, the commission that Apple charges for use of its IAP system—rather than harm to consumers and to competition more broadly.

We at the International Center for Law & Economics filed an amicus brief in the case last year on behalf of ourselves and 26 distinguished law & economics scholars in which we highlighted two important issues we thought the court got right:

  1. The assessment of competitive harm in two-sided markets (which, in turn, hinges on the correct definition of the relevant market); and
  2. The assessment of less-restrictive alternatives.

While the 9th Circuit reached the right conclusion on the whole, it didn’t always follow the right path. The court’s understanding of anticompetitive harm in two-sided markets and the role of less-restrictive alternatives, in particular, raise more questions than they answer. Whereas the immediate result is a victory for Apple, some of the more contentious aspects of the 9th Circuit’s ruling could complicate future cases for digital platforms.

Relevant and Irrelevant Mistakes in Antitrust Market Definition

The circuit court found that District Judge Yvonne Gonzalez Rogers erred in defining the relevant market, but that the error did not undermine her conclusion. The appellate panel was not unanimous on this issue, which became the subject of a partial dissent by Judge Sidney R. Thomas. After all, didn’t Epic Games v. Apple hinge largely on the correct definition of the relevant market (see, for example, here)? How can such a seemingly crucial mistake not reverberate down to the rule-of-reason analysis and, ultimately, the outcome of the case?

As the 9th Circuit explained, however, not all mistakes in market definition are terminal. The majority wrote:

We agree that the district court erred in certain aspects of its market-definition analysis but conclude that those errors were harmless.

The mistake stemmed from the district court’s imposition of “a categorical rule that an antitrust market can never relate to a product that is licensed or sold.” But this should be read as mere dicta, not as dispositive of the case. Indeed, what the appellate court had an issue with here is the blanket statement of principle; not with how it reflected on the specific case at hand.

While the notion that antitrust markets never relate to products that are licensed or sold can—and does—lead to the rejection of Epic’s proposed relevant market (if Apple does not license or sell its iOS, by the district court’s own reasoning, iOS can’t be the relevant market), the crucial point is that Epic had failed to show that consumers were unaware that purchasing iOS devices “locks” them in, as precedent requires.

Indeed, where the plaintiffs make a single-brand aftermarket claim, it is up to them to rebut the economic presumption that consumers make a knowing choice to restrict their aftermarket options when they enter into a contract on the competitive market (see Kodak and Newcal). For the record, however, it has been argued that even when consumers are totally uninformed about aftermarket conditions when they purchase equipment, they pay a competitive-package price because competition forces manufacturers to offset later aftermarket price increases with initial equipment-price decreases.

 As the 9th Circuit explains:

Moreover, the district court’s finding on Kodak/Newcal’s consumer-unawareness requirement renders harmless its rejection of Epic’s proposed aftermarkets on the legally erroneous basis that Apple does not license or sell iOS as a standalone product. […] To establish its single-brand aftermarkets, Epic bore the burden of “rebut[ting] the economic presumption that . . . consumers make a knowing choice to restrict their aftermarket options when they decide in the initial (competitive) market to enter a . . . contract.” […] Yet the district court found that there was “no evidence in the record” that could support such a showing. As a result, Epic cannot establish its proposed aftermarkets on the record before our court—even after the district court’s erroneous reasoning is corrected.

Because Epic’s proposed aftermarkets fail, and because Apple did not cross-appeal the district court’s rejection of its proposed market (the market for all game transactions, whether on consoles, smartphones, computers, or elsewhere), the district court’s middle-ground market of mobile-games transactions therefore stands on appeal. And it is that market in which the 9th Circuit turns to assessing whether Apple’s conduct is unlawful pursuant to the Sherman Act.

A broader point, and one that is easy to miss at first glance, is that operating systems (OS) could be a valid relevant market before the 9th Circuit. The practical consequences of this are ambiguous. For a platform with a relatively small share of the OS market, like Apple, this might be, on balance, a good thing. But to the extent that defining an OS as a relevant market may be used to undergird a narrow aftermarket (such as Epic attempted to do in this case), it could also be seen as a negative.

Anticompetitive Harm: One-Sided Logic in Two-Sided Markets

The 9th Circuit rightly underscored that a showing of harm in two-sided markets must be marketwide. Regrettably, however, it failed to apply this crucial insight correctly.

As we argued in our amicus brief, Epic didn’t demonstrate that Apple’s app-distribution and IAP practices caused the significant marketwide anticompetitive effects that the U.S. Supreme Court in Amex deemed necessary in cases involving two-sided transaction markets (like Apple’s App Store). Epic instead narrowly focused only on harms to developers.

Two-sided markets connect distinct sets of users whose demands for the platform are interdependent—i.e., consumers’ demand for a platform increases as more products are available and product developers’ demand for a platform increases as additional consumers use the platform. Together, the two sides’ demands increase the overall potential for transactions. As a result of these complex dynamics, conduct that may appear anticompetitive when considering the effects on only one set of customers may be entirely consistent with—and actually promote—healthy competition when examining the effects on both sides.

The 9th Circuit makes essentially the same mistake here. It notes a supracompetitive 30% commission fee for IAPs and, echoing the district court, finds “some evidence” of those costs being passed on to consumers as sufficient to establish anticompetitive harm.

But this is woefully insufficient to show marketwide harm. As we noted in our brief, the full effects on other sides of the market may include reduced prices for devices, a greater range of features, or various other benefits. All such factors need to be considered when assessing whether and to what extent “the market as a whole” is harmed by seemingly restrictive conduct on one side of the market.

Furthermore, just because some developers pay higher IAP fees to Apple doesn’t mean that the total number of mobile-game transactions is lower than the counterfactual. Developers that pay the 30% IAP fee may cross-subsidize those that distribute apps for free, thereby increasing the total number of game transactions.

The 9th Circuit therefore misapplied Amex and perpetuated a mistaken approach to the analysis of anticompetitive harm in two-sided markets. In other words: even if one applies “one-sided logic in two-sided markets” and looks at the two sides of the market separately, Epic failed to demonstrate anticompetitive harm. Of course, the mistake is even more glaring if one applies, as one should, two-sided logic in two-sided markets.

Procompetitive Benefits: Two-Sided Logic in Two-Sided Markets

Highlighting its error, the two-sided logic that the 9th Circuit should have applied in step one of the rule-of-reason analysis—i.e., identifying anticompetitive harm—is then applied in step two. The court asserts:

Contrary to Epic’s contention, Apple’s procompetitive justifications do relate to the app-transactions market. Because use of the App Store requires an iOS device, there are two ways of increasing App Store output: (1) increasing the total number of iOS device users, and (2) increasing the average number of downloads and in-app purchases made by iOS device users. Below, the district court found that a large portion of consumers factored security and privacy into their decision to purchase an iOS device—increasing total iOS device users. It also found that Apple’s security- and privacy-related restrictions “provide a safe and trusted user experience on iOS, which encourages both users and developers to transact freely”—increasing the per-user average number of app transactions.

If that same holistic approach had been taken in step one, the 9th Circuit wouldn’t need to assess procompetitive justifications, because it wouldn’t have found anticompetitive harm to begin with.

This ties into a longstanding debate in antitrust; namely, whether it is proper to put the burden on the defendant to show procompetitive benefits of its conduct, or whether those benefits need to be accounted for by the plaintiff at step one in making out its prima facie case. The Amex “market as a whole” approach goes some way toward suggesting that the benefits need to be incorporated into the prima facie case, at least insofar as they occur elsewhere in the (properly defined) relevant market and may serve to undermine the claim of net harm.

Arguably, however, the conflict can be avoided by focusing on output in the relevant market—i.e., on the number of transactions. To the extent that lower prices elsewhere increase the number of gaming transactions by increasing the number of users or cross-subsidizing transactions, it may not matter exactly where the benefit occurs.

In this case, the fact of a 30% fee should have been deemed insufficient to make out a prima facie case if it was accompanied by an increase in the total number of transactions.    

Steps Three and Four of Rule of Reason: Right Outcome, Wrong Reasoning

As we have written previously, there is a longstanding question about the role and limits of less-restrictive alternatives (LRAs) under the rule of reason.

Epic’s appeal relied on theoretical LRAs to Apple’s business model to satisfy step three of the rule of reason. According to Epic, because the district court had identified some anticompetitive effects on one side of the market, and because alternative business models could, in theory, be implemented to achieve the same procompetitive benefits as Apple’s current business model, the court should have ruled in Epic’s favor.

There were and are several problems with this reasoning. For starters, LRAs can clearly only be relevant if competitive harm has been established. As discussed above, Epic failed to demonstrate marketwide harm, as required in cases involving two-sided markets. In my view, the 9th Circuit’s findings don’t fundamentally alter this because there is still no convincing evidence of marketwide anticompetitive harm that would justify moving onto step three (or step two, for that matter) of rule-of-reason analysis.

Second, while it is true that, following the Supreme Court’s recent Alston decision, LRA analysis may well be appropriate in some contexts to identify anticompetitive conduct in the face of procompetitive justifications, contrary to the 9th Circuit’s assertions, there is no holding in either the 9th Circuit or the Supreme Court requiring it in the context of two-sided markets (Amex refers to LRA analysis as constituting step three of the rule of reason, but because that case was resolved at step one, it must be viewed as mere dictum).

And for good reason. In the case of two-sided platforms, an LRA approach would inevitably require courts to second guess the particular allocation of costs, prices, and product attributes across platform users (see here).

Moreover, LRAs like the ones proposed by Epic, which are based on maximizing competitor effectiveness by “opening” an incumbent’s platform, would convert the rule of reason into a regulatory tool that may not promote competition at all. This general approach is antithetical to the role of antitrust law. That role is to act as a prophylactic against anticompetitive conduct that harms consumers, not to be a makeshift regulatory tool for redrawing business models (here).

Unfortunately, the 9th Circuit failed to grasp this. It accepted Epic’s base argument and didn’t dispute that an LRA analysis should be conducted. It instead found that, on the facts, Epic failed to propose viable LRAs to Apple’s restrictions. Even further, the 9th Circuit posited (albeit reluctantly) that where the plaintiff fails to show a LRA as part of a “third step” in rule of reason, a fourth step is required to weigh the procompetitive against anticompetitive effects.

But as the 9th Circuit itself notes, the Supreme Court’s most recent rulings—i.e., Alston and Amex—did not require a fourth step. Why would it? Cost-benefit analysis is already baked into the rule of reason. As the 9th Circuit recognizes:

We are skeptical of the wisdom of superimposing a totality-of-the-circumstances balancing step onto a three-part test that is already intended to assess a restraint’s overall effect. 

Further:

Several amici suggest that balancing is needed to pick out restrictions that have significant anticompetitive effects but only minimal procompetitive benefits. But the three-step framework is already designed to identify such an imbalance: A court is likely to find the purported benefits pretextual at step two, or step-three review will likely reveal the existence of viable LRAs.

It is therefore unclear what benefits a fourth step would offer as, in most cases, this would only serve to “briefly [confirm] the result suggested by a step-three failure: that a business practice without a less restrictive alternative is not, on balance, anticompetitive.”

The 9th Circuit’s logic here appears circular. If the necessity of step four is practically precluded by failure at step three, how can it also be that failure to show LRAs in step three requires a fourth step? If step four is triggered after failure at step three, but step four is essentially an abridged version of step three, then what is the point of step four?

This entanglement leads the 9th Circuit to the inevitable conclusion that the failure to conduct a fourth step is immaterial where courts have hitherto diligently assessed anticompetitive harms and procompetitive benefits (under any procedural label):

Even though it did not expressly reference step four, it stated that it “carefully considered the evidence in the record and . . . determined, based on the rule of reason,” that the distribution and IAP restrictions “have procompetitive effects that offset their anticompetitive effects” (emphasis added). This analysis satisfied the court’s obligation pursuant to County of Tuolumne, and the court’s failure to expressly give this analysis a step-four label was harmless.

Conclusion

The 9th Circuit found in favor of Apple on nine out of 10 counts, but it is not entirely clear that the case is a “resounding victory” for Apple. The finding that Judge Rogers’ mistakes in market definition were relevant is, essentially, a red herring (except for the possibility of OS being a relevant market before the 9th Circuit). The important parts of this ruling—and the ones which should give Apple and other digital platforms some pause—are to be found in the rule-of-reason analysis.

First, the 9th Circuit found evidence of anticompetitive harm in a two-sided market without marketwide harm, all the while recognizing, in theory, that marketwide harm is the relevant question in antitrust analysis of two-sided markets. This kind of one-sided logic is bound to result in an overestimation of competitive harm in two-sided markets.

Second, the 9th Circuit’s flawed understanding of LRAs and the need for a fourth step in rule-of-reason analysis could grant plaintiffs not one, but two last-ditch (and unjustified) attempts to make their case, even after having failed previous steps. Ironically, the 9th Circuit found that a fourth step was needed because the rule of reason is not a “rotary list” and that substance, not form, should be dispositive of whether conduct passes muster. But if the rule of reason is not a “rotary list,” why was the district court’s failure to undertake a fourth step seen as a mistake (even if, by the circuit court’s own admission, it was a harmless one)? Shouldn’t it be enough that the district court weighed the procompettive and anticompetitive effects correctly?

The 9th Circuit appears to fall into the same kind of formalistic thinking that it claims to eschew; namely, that LRAs are necessary in all markets (including two-sided ones) and that a fourth step is always necessary where step three fails, even if skipping it is often inconsequential. We will have to see how this affects future antitrust cases involving digital platforms.

In Antitrust & Competition, Apple, Exclusionary Conduct, Monopolization, Platforms, Truth on the Market , , , , ,
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In Apple v Epic, 9th Circuit Should Remember that Antitrust Forbids Enhancing, not Exercising, Market Power

Thom Lambert —  1 April 2022

On March 31, I and several other law and economics scholars filed an amicus brief in Epic Games v. Apple, which is on appeal to the U.S. Court of Appeals for Ninth Circuit.  In this post, I summarize the central arguments of the brief, which was joined by Alden Abbott, Henry Butler, Alan Meese, Aurelien Portuese, and John Yun and prepared with the assistance of Don Falk of Schaerr Jaffe LLP.

First, some background for readers who haven’t followed the case.

Epic, maker of the popular Fortnite video game, brought antitrust challenges against two policies Apple enforces against developers of third-party apps that run on iOS, the mobile operating system for Apple’s popular iPhones and iPads.  One policy requires that all iOS apps be distributed through Apple’s own App Store.  The other requires that any purchases of digital goods made while using an iOS app utilize Apple’s In App Purchase system (IAP).  Apple collects a share of the revenue from sales made through its App Store and using IAP, so these two policies provide a way for it to monetize its innovative app platform.   

Epic maintains that Apple’s app policies violate the federal antitrust laws.  Following a trial, the district court disagreed, though it condemned another of Apple’s policies under California state law.  Epic has appealed the antitrust rulings against it. 

My fellow amici and I submitted our brief in support of Apple to draw the Ninth Circuit’s attention to a distinction that is crucial to ensuring that antitrust promotes long-term consumer welfare: the distinction between the mere extraction of surplus through the exercise of market power and the enhancement of market power via the weakening of competitive constraints.

The central claim of our brief is that Epic’s antitrust challenges to Apple’s app store policies should fail because Epic has not shown that the policies enhance Apple’s market power in any market.  Moreover, condemnation of the practices would likely induce Apple to use its legitimately obtained market power to extract surplus in a different way that would leave consumers worse off than they are under the status quo.   

Mere Surplus Extraction vs. Market Power Extension

As the Supreme Court has observed, “Congress designed the Sherman Act as a ‘consumer welfare prescription.’”  The Act endeavors to protect consumers from harm resulting from “market power,” which is the ability of a firm lacking competitive constraints to enhance its profits by reducing its output—either quantitively or qualitatively—from the level that would persist if the firm faced vigorous competition.  A monopolist, for example, might cut back on the quantity it produces (to drive up market price) or it might skimp on quality (to enhance its per-unit profit margin).  A firm facing vigorous competition, by contrast, couldn’t raise market price simply by reducing its own production, and it would lose significant sales to rivals if it raised its own price or unilaterally cut back on product quality.  Market power thus stems from deficient competition.

As Dennis Carlton and Ken Heyer have observed, two different types of market power-related business behavior may injure consumers and are thus candidates for antitrust prohibition.  One is an exercise of market power: an action whereby a firm lacking competitive constraints increases its returns by constricting its output so as to raise price or otherwise earn higher profit margins.  When a firm engages in this sort of conduct, it extracts a greater proportion of the wealth, or “surplus,” generated by its transactions with its customers.

Every voluntary transaction between a buyer and seller creates surplus, which is the difference between the subjective value the consumer attaches to an item produced and the cost of producing and distributing it.  Price and other contract terms determine how that surplus is allocated between the buyer and the seller.  When a firm lacking competitive constraints exercises its market power by, say, raising price, it extracts for itself a greater proportion of the surplus generated by its sale.

The other sort of market power-related business behavior involves an effort by a firm to enhance its market power by weakening competitive constraints.  For example, when a firm engages in unreasonably exclusionary conduct that drives its rivals from the market or increases their costs so as to render them less formidable competitors, its market power grows.

U.S. antitrust law treats these two types of market power-related conduct differently.  It forbids behavior that enhances market power and injures consumers, but it permits actions that merely exercise legitimately obtained market power without somehow enhancing it.  For example, while charging a monopoly price creates immediate consumer harm by extracting for the monopolist a greater share of the surplus created by the transaction, the Supreme Court observed in Trinko that “[t]he mere possession of monopoly power, and the concomitant charging of monopoly prices, is not . . . unlawful.”  (See also linkLine: “Simply possessing monopoly power and charging monopoly prices does not violate [Sherman Act] § 2….”)

Courts have similarly refused to condemn mere exercises of market power in cases involving surplus-extractive arrangements more complicated than simple monopoly pricing.  For example, in its Independent Ink decision, the U.S. Supreme Court expressly declined to adopt a rule that would have effectively banned “metering” tie-ins.

In a metering tie-in, a seller with market power on some unique product that is used with a competitively supplied complement that is consumed in varying amounts—say, a highly unique printer that uses standard ink—reduces the price of its unique product (the printer), requires buyers to also purchase from it their requirements of the complement (the ink), and then charges a supracompetitive price for the latter product.  This allows the seller to charge higher effective prices to high-volume users of its unique tying product (buyers who use lots of ink) and lower prices to lower-volume users. 

Assuming buyers’ use of the unique product correlates with the value they ascribe to it, a metering tie-in allows the seller to price discriminate, charging higher prices to buyers who value its unique product more.  This allows the seller to extract more of the surplus generated by sales of its product, but it in no way extends the seller’s market power.

In refusing to adopt a rule that would have condemned most metering tie-ins, the Independent Ink Court observed that “it is generally recognized that [price discrimination] . . . occurs in fully competitive markets” and that tying arrangements involving requirements ties may be “fully consistent with a free, competitive market.” The Court thus reasoned that mere price discrimination and surplus extraction, even when accomplished through some sort of contractual arrangement like a tie-in, are not by themselves anticompetitive harms warranting antitrust’s condemnation.    

The Ninth Circuit has similarly recognized that conduct that exercises market power to extract surplus but does not somehow enhance that power does not create antitrust liability.  In Qualcomm, the court refused to condemn the chipmaker’s “no license, no chips” policy, which enabled it to enhance its profits by earning royalties on original equipment manufacturers’ sales of their high-priced products.

In reversing the district court’s judgment in favor of the FTC, the Ninth Circuit conceded that Qualcomm’s policies were novel and that they allowed it to enhance its profits by extracting greater surplus.  The court refused to condemn the policies, however, because they did not injure competition by weakening competitive constraints:

This is not to say that Qualcomm’s “no license, no chips” policy is not “unique in the industry” (it is), or that the policy is not designed to maximize Qualcomm’s profits (Qualcomm has admitted as much). But profit-seeking behavior alone is insufficient to establish antitrust liability. As the Supreme Court stated in Trinko, the opportunity to charge monopoly prices “is an important element of the free-market system” and “is what attracts ‘business acumen’ in the first place; it induces risk taking that produces innovation and economic growth.”

The Qualcomm court’s reference to Trinko highlights one reason courts should not condemn exercises of market power that merely extract surplus without enhancing market power: allowing such surplus extraction furthers dynamic efficiency—welfare gain that accrues over time from the development of new and improved products and services.

Dynamic efficiency results from innovation, which entails costs and risks.  Firms are more willing to incur those costs and risks if their potential payoff is higher, and an innovative firm’s ability to earn supracompetitive profits off its “better mousetrap” enhances its payoff. 

Allowing innovators to extract such profits also helps address the fact most of the benefits of product innovation inure to people other than the innovator.  Private actors often engage in suboptimal levels of behaviors that produce such benefit spillovers, or “positive externalities,”  because they bear all the costs of those behaviors but capture just a fraction of the benefit produced.  By enhancing the benefits innovators capture from their innovative efforts, allowing non-power-enhancing surplus extraction helps generate a closer-to-optimal level of innovative activity.

Not only do supracompetitive profits extracted through the exercise of legitimately obtained market power motivate innovation, they also enable it by helping to fund innovative efforts.  Whereas businesses that are forced by competition to charge prices near their incremental cost must secure external funding for significant research and development (R&D) efforts, firms collecting supracompetitive returns can finance R&D internally.  Indeed, of the top fifteen global spenders on R&D in 2018, eleven were either technology firms accused of possessing monopoly power (#1 Apple, #2 Alphabet/Google, #5 Intel, #6 Microsoft, #7 Apple, and #14 Facebook) or pharmaceutical companies whose patent protections insulate their products from competition and enable supracompetitive pricing (#8 Roche, #9 Johnson & Johnson, #10 Merck, #12 Novartis, and #15 Pfizer).

In addition to fostering dynamic efficiency by motivating and enabling innovative efforts, a policy acquitting non-power-enhancing exercises of market power allows courts to avoid an intractable question: which instances of mere surplus extraction should be precluded?

Precluding all instances of surplus extraction by firms with market power would conflict with precedents like Trinko and linkLine (which say that legitimate monopolists may legally charge monopoly prices) and would be impracticable given the ubiquity of above-cost pricing in niche and brand-differentiated markets.

A rule precluding surplus extraction when accomplished by a practice more complicated that simple monopoly pricing—say, some practice that allows price discrimination against buyers who highly value a product—would be both arbitrary and backward.  The rule would be arbitrary because allowing supracompetitive profits from legitimately obtained market power motivates and enables innovation regardless of the means used to extract surplus. The rule would be backward because, while simple monopoly pricing always reduces overall market output (as output-reduction is the very means by which the producer causes price to rise), more complicated methods of extracting surplus, such as metering tie-ins, often enhance market output and overall social welfare.

A third possibility would be to preclude exercising market power to extract more surplus than is necessary to motivate and enable innovation.  That position, however, would require courts to determine how much surplus extraction is required to induce innovative efforts.  Courts are poorly positioned to perform such a task, and their inevitable mistakes could significantly chill entrepreneurial activity.

Consider, for example, a firm contemplating a $5 million investment that might return up to $50 million.  Suppose the managers of the firm weighed expected costs and benefits and decided the risky gamble was just worth taking.  If the gamble paid off but a court stepped in and capped the firm’s returns at $20 million—a seemingly generous quadrupling of the firm’s investment—future firms in the same position would not make similar investments.  After all, the firm here thought this gamble was just barely worth taking, given the high risk of failure, when available returns were $50 million.

In the end, then, the best policy is to draw the line as both the U.S. Supreme Court and the Ninth Circuit have done: Whereas enhancements of market power are forbidden, merely exercising legitimately obtained market power to extract surplus is permitted.

Apple’s Policies Do Not Enhance Its Market Power

Under the legal approach described above, the two Apple policies Epic has challenged do not give rise to antitrust liability.  While the policies may boost Apple’s profits by facilitating its extraction of surplus from app transactions on its mobile devices, they do not enhance Apple’s market power in any conceivable market.

As the creator and custodian of the iOS operating system, Apple has the ability to control which applications will run on its iPhones and iPads.  Developers cannot produce operable iOS apps unless Apple grants them access to the Application Programming Interfaces (APIs) required to enable the functionality of the operating system and hardware. In addition, Apple can require developers to obtain digital certificates that will enable their iOS apps to operate.  As the district court observed, “no certificate means the code will not run.”

Because Apple controls which apps will work on the operating system it created and maintains, Apple could collect the same proportion of surplus it currently extracts from iOS app sales and in-app purchases on iOS apps even without the policies Epic is challenging.  It could simply withhold access to the APIs or digital certificates needed to run iOS apps unless developers promised to pay it 30% of their revenues from app sales and in-app purchases of digital goods.

This means that the challenged policies do not give Apple any power it doesn’t already possess in the putative markets Epic identified: the markets for “iOS app distribution” and “iOS in-app payment processing.” 

The district court rejected those market definitions on the ground that Epic had not established cognizable aftermarkets for iOS-specific services.  It defined the relevant market instead as “mobile gaming transactions.”  But no matter.  The challenged policies would not enhance Apple’s market power in that broader market either.

In “mobile gaming transactions” involving non-iOS (e.g., Android) mobile apps, Apple’s policies give it no power at all.  Apple doesn’t distribute non-iOS apps or process in-app payments on such apps.  Moreover, even if Apple were to being doing so—say, by distributing Android apps in its App Store or allowing producers of Android apps to include IAP as their in-app payment system—it is implausible that Apple’s policies would allow it to gain new market power.  There are giant, formidable competitors in non-iOS app distribution (e.g., Google’s Play Store) and in payment processing for non-iOS in-app purchases (e.g., Google Play Billing).  It is inconceivable that Apple’s policies would allow it to usurp so much scale from those rivals that Apple could gain market power over non-iOS mobile gaming transactions.

That leaves only the iOS segment of the mobile gaming transactions market.  And, as we have just seen, Apple’s policies give it no new power to extract surplus from those transactions; because it controls access to iOS, it could do so using other means.

Nor do the challenged policies enable Apple to maintain its market power in any conceivable market.  This is not a situation like Microsoft where a firm in a market adjacent to a monopolist’s could somehow pose a challenge to that monopolist, and the monopolist nips the potential competition in the bud by reducing the potential rival’s scale.  There is no evidence in the record to support the (implausible) notion that rival iOS app stores or in-app payment processing systems could ever evolve in a manner that would pose a challenge to Apple’s position in mobile devices, mobile operating systems, or any other market in which it conceivably has market power. 

Epic might retort that but for the challenged policies, rivals could challenge Apple’s market share in iOS app distribution and in-app purchase processing.  Rivals could not, however, challenge Apple’s market power in such markets, as that power stems from its control of iOS.  The challenged policies therefore do not enable Apple to shore up any existing market power.

Alternative Means of Extracting Surplus Would Likely Reduce Consumer Welfare

Because the policies Epic has challenged are not the source of Apple’s ability to extract surplus from iOS app transactions, judicial condemnation of the policies would likely induce Apple to extract surplus using different means.  Changing how it earns profits off iOS app usage, however, would likely leave consumers worse off than they are under the status quo.

Apple could simply charge third-party app developers a flat fee for access to the APIs needed to produce operable iOS apps but then allow them to distribute their apps and process in-app payments however they choose.  Such an approach would allow Apple to monetize its innovative app platform while permitting competition among providers of iOS app distribution and in-app payment processing services.  Relative to the status quo, though, such a model would likely reduce consumer welfare by:

  • Reducing the number of free and niche apps,as app developers could no longer avoid a fee to Apple by adopting a free (likely ad-supported) business model, and producers of niche apps may not generate enough revenue to justify Apple’s flat fee;
  • Raising business risks for app developers, who, if Apple cannot earn incremental revenue off sales and use of their apps, may face a greater likelihood that the functionality of those apps will be incorporated into future versions of iOS;
  • Reducing Apple’s incentive to improve iOS and its mobile devices, as eliminating Apple’s incremental revenue from app usage reduces its motivation to make costly enhancements that keep users on their iPhones and iPads;
  • Raising the price of iPhones and iPads and generating deadweight loss, as Apple could no longer charge higher effective prices to people who use apps more heavily and would thus likely hike up its device prices, driving marginal consumers from the market; and
  • Reducing user privacy and security, as jettisoning a closed app distribution model (App Store only) would impair Apple’s ability to screen iOS apps for features and bugs that create security and privacy risks.

An alternative approach—one that would avoid many of the downsides just stated by allowing Apple to continue earning incremental revenue off iOS app usage—would be for Apple to charge app developers a revenue-based fee for access to the APIs and other amenities needed to produce operable iOS apps.  That approach, however, would create other costs that would likely leave consumers worse off than they are under the status quo.

The policies Epic has challenged allow Apple to collect a share of revenues from iOS app transactions immediately at the point of sale.  Replacing those policies with a revenue-based  API license system would require Apple to incur additional costs of collecting revenues and ensuring that app developers are accurately reporting them.  In order to extract the same surplus it currently collects—and to which it is entitled given its legitimately obtained market power—Apple would have to raise its revenue-sharing percentage above its current commission rate to cover its added collection and auditing costs.

The fact that Apple has elected not to adopt this alternative means of collecting the revenues to which it is entitled suggests that the added costs of moving to the alternative approach (extra collection and auditing costs) would exceed any additional consumer benefit such a move would produce.  Because Apple can collect the same revenue percentage from app transactions two different ways, it has an incentive to select the approach that maximizes iOS app transaction revenues.  That is the approach that creates the greatest value for consumers and also for Apple. 

If Apple believed that the benefits to app users of competition in app distribution and in-app payment processing would exceed the extra costs of collection and auditing, it would have every incentive to switch to a revenue-based licensing regime and increase its revenue share enough to cover its added collection and auditing costs.  As such an approach would enhance the net value consumers receive when buying apps and making in-app purchases, it would raise overall app revenues, boosting Apple’s bottom line.  The fact that Apple has not gone in this direction, then, suggests that it does not believe consumers would receive greater benefit under the alternative system.  Apple might be wrong, of course.  But it has a strong motivation to make the consumer welfare-enhancing decision here, as doing so maximizes its own profits.

The policies Epic has challenged do not enhance or shore up Apple’s market power, a salutary pre-requisite to antitrust liability.  Furthermore, condemning the policies would likely lead Apple to monetize its innovative app platform in a manner that would reduce consumer welfare relative to the status quo.  The Ninth Circuit should therefore affirm the district court’s rejection of Epic’s antitrust claims.  

In Antitrust & Competition, Apple, Economic Theory, Exclusionary Conduct, Exclusive Dealing, Law & Economics, Platforms, Supreme Court, Truth on the Market, Tying , , , , , , , ,
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Judge Ginsburg: On the Proposed Digital Markets Unit and the UK’s Competition and Markets Authority

Douglas Ginsburg —  8 November 2021

[Judge Douglas Ginsburg was invited to respond to the Beesley Lecture given by Andrea Coscelli, chief executive of the U.K. Competition and Markets Authority (CMA). Both the lecture and Judge Ginsburg’s response were broadcast by the BBC on Oct. 28, 2021. The text of Mr. Coscelli’s Beesley lecture is available on the CMA’s website. Judge Ginsburg’s response follows below.]

Thank you, Victoria, for the invitation to respond to Mr. Coscelli and his proposal for a legislatively founded Digital Markets Unit. Mr. Coscelli is one of the most talented, successful, and creative heads a competition agency has ever had. In the case of the DMU [ed., Digital Markets Unit], however, I think he has let hope triumph over experience and prudence. This is often the case with proposals for governmental reform: Indeed, it has a name, the Nirvana Fallacy, which comes from comparing the imperfectly functioning marketplace with the perfectly functioning government agency. Everything we know about the regulation of competition tells us the unintended consequences may dwarf the intended benefits and the result may be a less, not more, competitive economy. The precautionary principle counsels skepticism about such a major and inherently risky intervention.

Mr. Coscelli made a point in passing that highlights the difference in our perspectives: He said the SMS [ed., strategic market status] merger regime would entail “a more cautious standard of proof.” In our shared Anglo-American legal culture, a more cautious standard of proof means the government would intervene in fewer, not more, market activities; proof beyond a reasonable doubt in criminal cases is a more cautious standard than a mere preponderance of the evidence. I, too, urge caution, but of the traditional kind.

I will highlight five areas of concern with the DMU proposal.

I. Chilling Effects

The DMU’s ability to designate a firm as being of strategic market significance—or SMS—will place a potential cloud over innovative activity in far more sectors than Mr. Coscelli could mention in his lecture. He views the DMU’s reach as limited to a small number of SMS-designated firms; and that may prove true, but there is nothing in the proposal limiting DMU’s reach.

Indeed, the DMU’s authority to regulate digital markets is surely going to be difficult to confine. Almost every major retail activity or consumer-facing firm involves an increasingly significant digital component, particularly after the pandemic forced many more firms online. Deciding which firms the DMU should cover seems easy in theory, but will prove ever more difficult and cumbersome in practice as digital technology continues to evolve. For instance, now that money has gone digital, a bank is little more than a digital platform bringing together lenders (called depositors) and borrowers, much as Amazon brings together buyers and sellers; so, is every bank with market power and an entrenched position to be subject to rules and remedies laid down by the DMU as well as supervision by the bank regulators? Is Aldi in the crosshairs now that it has developed an online retail platform? Match.com, too? In short, the number of SMS firms will likely grow apace in the next few years.

II. SMS Designations Should Not Apply to the Whole Firm

The CMA’s proposal would apply each SMS designation firm-wide, even if the firm has market power in a single line of business. This will inhibit investment in further diversification and put an SMS firm at a competitive disadvantage across all its businesses.

Perhaps company-wide SMS designations could be justified if the unintended costs were balanced by expected benefits to consumers, but this will not likely be the case. First, there is little evidence linking consumer harm to lines of business in which large digital firms do not have market power. On the contrary, despite the discussion of Amazon’s supposed threat to competition, consumers enjoy lower prices from many more retailers because of the competitive pressure Amazon brings to bear upon them.

Second, the benefits Mr. Coscelli expects the economy to reap from faster government enforcement are, at best, a mixed blessing. The proposal, you see, reverses the usual legal norm, instead making interim relief the rule rather than the exception. If a firm appeals its SMS designation, then under the CMA’s proposal, the DMU’s SMS designations and pro-competition interventions, or PCIs, will not be stayed pending appeal, raising the prospect that a firm’s activities could be regulated for a significant period even though it was improperly designated. Even prevailing in the courts may be a Pyrrhic victory because opportunities will have slipped away. Making matters worse, the DMU’s designation of a firm as SMS will likely receive a high degree of judicial deference, so that errors may never be corrected.

III. The DMU Cannot Be Evidence-based Given its Goals and Objectives

The DMU’s stated goal is to “further the interests of consumers and citizens in digital markets by promoting competition and innovation.”[1] DMU’s objectives for developing codes of conduct are: fair trading, open choices, and trust and transparency.[2] Fairness, openness, trust, and transparency are all concepts that are difficult to define and probably impossible to quantify. Therefore, I fear Mr. Coscelli’s aspiration that the DMU will be an evidence-based, tailored, and predictable regime seem unrealistic. The CMA’s idea of “an evidence-based regime” seems destined to rely mostly upon qualitative conjecture about the potential for the code of conduct to set “rules of the game” that encourage fair trading, open choices, trust, and transparency. Even if the DMU commits to considering empirical evidence at every step of its process, these fuzzy, qualitative objectives will allow it to come to virtually any conclusion about how a firm should be regulated.

Implementing those broad goals also throws into relief the inevitable tensions among them. Some potential conflicts between DMU’s objectives for developing codes of conduct are clear from the EU’s experience. For example, one of the things DMU has considered already is stronger protection for personal data. The EU’s experience with the GDPR shows that data protection is costly and, like any costly requirement, tends to advantage incumbents and thereby discourage new entry. In other words, greater data protections may come at the expense of start-ups or other new entrants and the contribution they would otherwise have made to competition, undermining open choices in the name of data transparency.

Another example of tension is clear from the distinction between Apple’s iOS and Google’s Android ecosystems. They take different approaches to the trade-off between data privacy and flexibility in app development. Apple emphasizes consumer privacy at the expense of allowing developers flexibility in their design choices and offers its products at higher prices. Android devices have fewer consumer-data protections but allow app developers greater freedom to design their apps to satisfy users and are offered at lower prices. The case of Epic Games v. Apple put on display the purportedly pro-competitive arguments the DMU could use to justify shutting down Apple’s “walled garden,” whereas the EU’s GDPR would cut against Google’s open ecosystem with limited consumer protections. Apple’s model encourages consumer trust and adoption of a single, transparent model for app development, but Google’s model encourages app developers to choose from a broader array of design and payment options and allows consumers to choose between the options; no matter how the DMU designs its code of conduct, it will be creating winners and losers at the cost of either “open choices” or “trust and transparency.” As experience teaches is always the case, it is simply not possible for an agency with multiple goals to serve them all at the same time. The result is an unreviewable discretion to choose among them ad hoc.

Finally, notice that none of the DMU’s objectives—fair trading, open choices, and trust and transparency—revolves around quantitative evidence; at bottom, these goals are not amenable to the kind of rigor Mr. Coscelli hopes for.

IV. Speed of Proposals

Mr. Coscelli has emphasized the slow pace of competition law matters; while I empathize, surely forcing merging parties to prove a negative and truncating their due process rights is not the answer.

As I mentioned earlier, it seems a more cautious standard of proof to Mr. Coscelli is one in which an SMS firm’s proposal to acquire another firm is presumed, or all but presumed, to be anticompetitive and unlawful. That is, the DMU would block the transaction unless the firms can prove their deal would not be anticompetitive—an extremely difficult task. The most self-serving version of the CMA’s proposal would require it to prove only that the merger poses a “realistic prospect” of lessening competition, which is vague, but may in practice be well below a 50% chance. Proving that the merged entity does not harm competition will still require a predictive forward-looking assessment with inherent uncertainty, but the CMA wants the costs of uncertainty placed upon firms, rather than it. Given the inherent uncertainty in merger analysis, the CMA’s proposal would pose an unprecedented burden of proof on merging parties.

But it is not only merging parties the CMA would deprive of due process; the DMU’s so-called pro-competitive interventions, or PCI, SMS designations, and code-of-conduct requirements generally would not be stayed pending appeal. Further, an SMS firm could overturn the CMA’s designation only if it could overcome substantial deference to the DMU’s fact-finding. It is difficult to discern, then, the difference between agency decisions and final orders.

The DMU would not have to show or even assert an extraordinary need for immediate relief. This is the opposite of current practice in every jurisdiction with which I am familiar.  Interim orders should take immediate effect only in exceptional circumstances, when there would otherwise be significant and irreversible harm to consumers, not in the ordinary course of agency decision making.

V. Antitrust Is Not Always the Answer

Although one can hardly disagree with Mr. Coscelli’s premise that the digital economy raises new legal questions and practical challenges, it is far from clear that competition law is the answer to them all. Some commentators of late are proposing to use competition law to solve consumer protection and even labor market problems. Unfortunately, this theme also recurs in Mr. Coscelli’s lecture. He discusses concerns with data privacy and fair and reasonable contract terms, but those have long been the province of consumer protection and contract law; a government does not need to step in and regulate all realms of activity by digital firms and call it competition law. Nor is there reason to confine needed protections of data privacy or fair terms of use to SMS firms.

Competition law remedies are sometimes poorly matched to the problems a government is trying to correct. Mr. Coscelli discusses the possibility of strong interventions, such as forcing the separation of a platform from its participation in retail markets; for example, the DMU could order Amazon to spin off its online business selling and shipping its own brand of products. Such powerful remedies can be a sledgehammer; consider forced data sharing or interoperability to make it easier for new competitors to enter. For example, if Apple’s App Store is required to host all apps submitted to it in the interest of consumer choice, then Apple loses its ability to screen for security, privacy, and other consumer benefits, as its refusal   to deal is its only way to prevent participation in its store. Further, it is not clear consumers want Apple’s store to change; indeed, many prefer Apple products because of their enhanced security.

Forced data sharing would also be problematic; the hiQ v. LinkedIn case in the United States should serve as a cautionary tale. The trial court granted a preliminary injunction forcing LinkedIn to allow hiQ to scrape its users’ profiles while the suit was ongoing. LinkedIn ultimately won the suit because it did not have market power, much less a monopoly, in any relevant market. The court concluded each theory of anticompetitive conduct was implausible, but meanwhile LinkedIn had been forced to allow hiQ to scrape its data for an extended period before the final decision. There is no simple mechanism to “unshare” the data now that LinkedIn has prevailed. This type of case could be common under the CMA proposal because the DMU’s orders will go into immediate effect.

There is potentially much redeeming power in the Digital Regulation Co-operation Forum as Mr. Coscelli described it, but I take a different lesson from this admirable attempt to coordinate across agencies: Perhaps it is time to look beyond antitrust to solve problems that are not based upon market power. As the DRCF highlights, there are multiple agencies with overlapping authority in the digital market space. ICO and Ofcom each have authority to take action against a firm that disseminates fake news or false advertisements. Mr. Coscelli says it would be too cumbersome to take down individual bad actors, but, if so, then the solution is to adopt broader consumer protection rules, not apply an ill-fitting set of competition law rules. For example, the U.K. could change its notice-and-takedown rules to subject platforms to strict liability if they host fake news, even without knowledge that they are doing so, or perhaps only if they are negligent in discharging their obligation to police against it.

Alternatively, the government could shrink the amount of time platforms have to take down information; France gives platforms only about an hour to remove harmful information. That sort of solution does not raise the same prospect of broadly chilling market activity, but still addresses one of the concerns Mr. Coscelli raises with digital markets.

In sum, although Mr. Coscelli is of course correct that competition authorities and governments worldwide are considering whether to adopt broad reforms to their competition laws, the case against broadening remains strong. Instead of relying upon the self-corrective potential of markets, which is admittedly sometimes slower than anyone would like, the CMA assumes markets need regulation until firms prove otherwise. Although clearly well-intentioned, the DMU proposal is in too many respects not met to the task of protecting competition in digital markets; at worst, it will inhibit innovation in digital markets to the point of driving startups and other innovators out of the U.K.

[1] See Digital markets Taskforce, A new pro-competition regime for digital markets, at 22, Dec. 2020, available at: https://assets.publishing.service.gov.uk/media/5fce7567e90e07562f98286c/Digital_Taskforce_-_Advice.pdf; Oliver Dowden & Kwasi Kwarteng, A New Pro-competition Regime for Digital Markets, July 2021, available from: https://www.gov.uk/government/consultations/a-new-pro-competition-regime-for-digital-markets, at ¶ 27.

[2] Sam Bowman, Sam Dumitriu & Aria Babu, Conflicting Missions:The Risks of the Digital Markets Unit to Competition and Innovation, Int’l Center for L. & Econ., June 2021, at 13.

In Amazon, Antitrust & Competition, Apple, Banking, Barriers to Entry, COVID-19, Data Privacy & Security, European Union, Google, International, Merger Guidelines, Mergers & Acquisitions, Platforms, Truth on the Market, United Kingdom , , , , , , , , , , , , ,
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