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