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Assessing Less Restrictive Alternatives and Interbrand Competition in Epic v Apple

Geoff Manne, Dirk Auer & Lazar Radic —  1 April 2022

The International Center for Law & Economics (ICLE) filed an amicus brief on behalf of itself and 26 distinguished law & economics scholars with the 9th U.S. Circuit Court of Appeals in the hotly anticipated and intensely important Epic Games v Apple case.

A fantastic group of attorneys from White & Case generously assisted us with the writing and filing of the brief, including George Paul, Jack Pace, Gina Chiapetta, and Nicholas McGuire. The scholars who signed the brief are listed at the end of this post. A summary of the brief’s arguments follows. For some of our previous writings on the case, see here, here, here, and here.

Introduction

In Epic Games v. Apple, Epic challenged Apple’s prohibition of third-party app stores and in-app payments (IAP) systems from operating on its proprietary iOS platform as a violation of antitrust law. The U.S. District Court for the Northern District of California ruled against Epic, finding that Epic’s real concern is its own business interests in the face of Apple’s business model—in particular, the commission Apple charges for use of its IAP system—rather than harm to consumers and to competition more broadly.

Epic appealed to the 9th Circuit on several grounds. Our brief primarily addresses two of Epic’s arguments:

  • First, Epic takes issue with the district court’s proper finding that Apple’s procompetitive justifications outweigh the anticompetitive effects of Apple’s business model. But Epic’s case fails at step one of the rule-of-reason analysis, as it didn’t demonstrate that Apple’s app distribution and IAP practices caused the significant, market-wide, anticompetitive effects that the Supreme Court, in 2018’s Ohio v. American Express (“Amex”), deemed necessary to show anticompetitive harm in cases involving two-sided transaction markets (like Apple’s App Store).
  • Second, Epic argues that the theoretical existence of less restrictive alternatives (“LRA”) to Apple’s business model is sufficient to meet its burden under the rule of reason. But the reliance on LRA in this case is misplaced. Forcing Apple to adopt the “open” platform that Epic champions would reduce interbrand competition and improperly permit antitrust plaintiffs to commandeer the judiciary to modify routine business conduct any time a plaintiff’s attorney or district court can imagine a less restrictive version of a challenged practice—irrespective of whether the practice promotes consumer welfare. This is especially true in the context of two-sided platform businesses, where such an approach would sacrifice interbrand, systems-level competition for the sake of a superficial increase in competition among a small subset of platform users.

Competitive Effects in Two-Sided Markets

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 conversely, product developers’ demand for a platform increases as additional consumers use the platform, increasing 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.

That’s why the Supreme Court recognized in Amex that it was improper to focus on only one side of a two-sided platform. And this holding doesn’t require adherence to the Court’s contentious finding of a two-sided relevant market in Amex. Indeed, even scholars highly critical of the Amex decision recognize the importance of considering effects on both sides of a two-sided platform.

While the district court did find that Epic demonstrated some anticompetitive effects, Epic’s evidence focused only on the effects that Apple’s conduct had on certain app developers; it failed to appropriately examine whether consumers were harmed overall. As Geoffrey Manne has observed, in two-sided markets, “some harm” is not the same thing as “competitively relevant harm.” Supracompetitive prices on one side do not tell us much about the existence or exercise of (harmful) market power in two-sided markets. As the Supreme Court held in Amex:

The fact that two-sided platforms charge one side a price that is below or above cost reflects differences in the two sides’ demand elasticity, not market power or anticompetitive pricing. Price increases on one side of the platform likewise do not suggest anticompetitive effects without some evidence that they have increased the overall cost of the platform’s services.

Without further evidence of the effect of Apple’s practices on consumers, no conclusions can be drawn about the competitive effects of Apple’s conduct. 

Nor can an appropriate examination of anticompetitive effects ignore output. The ability to restrict output, after all, is what allows a monopolist to increase prices. Whereas price effects alone might appear predatory on one side of the market and supra-competitive on the other, output reflects what is happening in the market as a whole. It is therefore the most appropriate measure for antitrust law generally, and it is especially useful in two-sided markets, where asymmetrical price changes are of little use in determining anticompetitive effects.

Ultimately, the question before the court must be whether Apple’s overall pricing structure and business model reduces output, either by deterring app developers from participating in the market or by deterring users from purchasing apps (or iOS devices) as a consequence of the app-developer commission. The district court here noted that it could not ascertain whether Apple’s alleged restrictions had a “positive or negative impact on game transaction volume.”

Thus, Epic’s case fails at step one of the rule of reason analysis because it simply hasn’t demonstrated the requisite harm to competition.

Less Restrictive Alternatives and the Rule of Reason

But even if that weren’t the case, Epic’s claims also don’t make it past step three of the rule of reason analysis.

Epic’s appeal relies on theoretical “less restrictive alternatives” (LRA) to Apple’s business model, which highlights longstanding questions about the role and limits of LRA analysis under the rule of reason. 

According to Epic, because the district court 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 at step three. 

There are several problems with this.

First, the existence of an LRA is irrelevant if anticompetitive harm has not been established, of course (as is the case here).

Nor does the fact that some hypothetically less restrictive alternative exists automatically render the conduct under consideration anticompetitive. As the Court held in Trinko, antitrust laws do not “give judges carte blanche to insist that a monopolist alter its way of doing business whenever some other approach might yield greater competition.” 

While, 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, 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, but because that case was resolved at step one, it must be viewed as mere dictum).And for good reason. In the context 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. As Tom Nachbar writes:

Platform defendants, even if they are able to establish the general procompetitive justifications for charging above and below cost prices on the two sides of their platforms, will have to defend the precise combination of prices they have chosen [under an LRA approach] . . . . The relative difficulty of defending any particular allocation of costs will present considerable risk of destabilizing platform markets.

Moreover, LRAs—like the ones proposed by Epic—that 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. As Alan Devlin deftly puts it:

This construction of antitrust law—that dominant companies must affirmatively support their fringe rivals’ ability to compete effectively—adopts a perspective of antitrust that is regulatory in nature. . . . [I]f one adopts the increasingly prevalent view that antitrust must facilitate unfettered access to markets, thus spurring free entry and expansion by incumbent rivals, the Sherman Act goes from being a prophylactic device aimed at protecting consumers against welfare-reducing acts to being a misplaced regulatory tool that potentially sacrifices both consumer welfare and efficiency in a misguided pursuit of more of both.

Open Platforms Are not Necessarily Less Restrictive Platforms

It is also important to note that Epic’s claimed LRAs are neither viable alternatives nor actually “less restrictive.” Epic’s proposal would essentially turn Apple’s iOS into an open platform more similar to Google’s Android, its largest market competitor.

“Open” and “closed” platforms both have distinct benefits and drawbacks; one is not inherently superior to the other. Closed proprietary platforms like Apple’s iOS create incentives for companies to internalize positive indirect network effects, which can lead to higher levels of product variety, user adoption, and total social welfare. As Andrei Hagiu has written:

A proprietary platform may in fact induce more developer entry (i.e., product variety), user adoption and higher total social welfare than an open platform.

For example, by filtering which apps can access the App Store and precluding some transactions from taking place on it, a closed or semi-closed platform like Apple’s may ultimately increase the number of apps and transactions on its platform, where doing so makes the iOS ecosystem more attractive to both consumers and developers. 

Any analysis of a supposedly less restrictive alternative to Apple’s “walled garden” model thus needs to account for the tradeoffs between open and closed platforms, and not merely assume that “open” equates to “good,” and “closed” to “bad.” 

Further, such analysis also must consider tradeoffs among consumers and among developers. More vigilant users might be better served by an “open” platform because they find it easier to avoid harmful content; less vigilant ones may want more active assistance in screening for malware, spyware, or software that simply isn’t optimized for the user’s device. There are similar tradeoffs on the developer side: Apple’s model lowers the cost to join the App store, which particularly benefits smaller developers and those whose apps fall outside the popular gaming sector. In a nutshell, the IAP fee cross-subsidizes the delivery of services to the approximately 80% of apps on the App Store that are free and pay no IAP fees.

In fact, the overwhelming irony of Epic’s proposed approach is that Apple could avoid condemnation if it made its overall platform more restrictive. If, for example, Apple had not adopted an App Store model and offered a completely closed and fully integrated device, there would be no question of relative costs and benefits imposed on independent app developers; there would be no independent developers on the iOS platform at all. 

Thus, Epic’s proposed LRA approach, which amounts to converting iOS to an open platform, proves too much. It would enable any contractual or employment relationship for a complementary product or service to be challenged because it could be offered through a “less restrictive” open market mechanism—in other words, that any integrated firm should be converted into an open platform. 

At least since the Supreme Court’s seminal 1977 Sylvania ruling, U.S. antitrust law has been unequivocal in its preference for interbrand over intrabrand competition. Paradoxically, turning a closed platform into an open one (as Epic intends) would, under the guise of protecting competition, actually destroy competition where it matters most: at the interbrand, systems level.

Conclusion

Forcing Apple to adopt the “open” platform that Epic champions would reduce interbrand competition among platform providers. It would also more broadly allow antitrust plaintiffs to insist the courts modify routine business conduct any time a plaintiff’s attorney or district court can imagine a less restrictive version of a challenged practice, regardless of whether that practice nevertheless promotes consumer welfare. In the context of two-sided platform businesses, this would mean sacrificing systems-level competition for the sake of a superficial increase in competition among a small subset of platform users.

The bottom line is that an order compelling Apple to allow competing app stores would require the company to change the way in which it monetizes the App Store. This might have far-reaching distributional consequences for both groups— consumers and distributors. Courts (and, obviously, competitors) are ill-suited to act as social planners and to balance out such complex tradeoffs, especially in the absence of clear anticompetitive harm and the presence of plausible procompetitive benefits.

Amici Scholars Signing on to the Brief


(The ICLE brief presents the views of the individual signers listed below. Institutions are listed for identification purposes only.)

Alden Abbott
Senior Research Fellow, Mercatus Center, George Mason University
Former General Counsel, U.S. Federal Trade Commission		Ben Klein
Professor of Economics Emeritus, University of California Los Angeles
Thomas C. Arthur
L. Q. C. Lamar Professor of Law, Emory University School of Law		Peter Klein
Professor of Entrepreneurship and Corporate Innovation, Baylor University, Hankamer School of Business
Dirk Auer
Director of Competition Policy, International Center for Law & Economics
Adjunct Professor, University of Liège (Belgium)		Jonathan Klick
Charles A. Heimbold, Jr. Professor of Law, University of Pennsylvania Carey Law School
Jonathan M. Barnett
Torrey H. Webb Professor of Law, University of Southern California, Gould School of Law		Daniel Lyons
Professor of Law, Boston College Law School
Donald J. Boudreaux
Professor of Economics, former Economics Department Chair, George Mason University		Geoffrey A. Manne
President and Founder, International Center for Law & Economics
Distinguished Fellow, Northwestern University Center on Law, Business & Economics
Giuseppe Colangelo
Jean Monnet Chair in European Innovation Policy and Associate Professor of Competition Law and Economics, University of Basilicata and Libera Università Internazionale degli Studi Sociali		Francisco Marcos
Associate Professor of Law, IE University Law School (Spain)
Anthony Dukes
Chair and Professor of Marketing, University of Southern California, Marshall School of Business		Scott E. Masten
Professor of Business Economics and Public Policy, University of Michigan, Ross Business School
Richard A. Epstein
Laurence A. Tisch Professor of Law, New York University, School of Law James Parker Hall Distinguished Service Professor of Law Emeritus, University of Chicago Law School		Alan J. Meese
Ball Professor of Law, College of William & Mary Law School
Vivek Ghosal
Economics Department Chair and Virginia and Lloyd W. Rittenhouse Professor of Economics, Rensselaer Polytechnic Institute		Igor Nikolic
Research Fellow, Robert Schuman Centre for Advanced Studies, European University Institute (Italy)
Janice Hauge
Professor of Economics, University of North Texas		Paul H. Rubin
Samuel Candler Dobbs Professor of Economics Emeritus, Emory University
Justin (Gus) Hurwitz
Professor of Law, University of Nebraska College of Law		Vernon L. Smith
George L. Argyros Endowed Chair in Finance and Economics and Professor of Economics and Law, Chapman University Nobel Laureate in Economics (2002)
Michael S. Jacobs
Distinguished Research Professor of Law Emeritus, DePaul University College of Law		Michael Sykuta
Associate Professor of Economics, University of Missouri
Mark A. Jamison
Gerald Gunter Professor of the Public Utility Research Center, University of Florida, Warrington College of Business		Alexander “Sasha” Volokh
Associate Professor of Law, Emory University School of Law
In Antitrust & Competition, Apple, Exclusionary Conduct, Exclusive Dealing, Platforms, Supreme Court, Truth on the Market, Tying, Vertical Restraints , , , , , , ,
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Breaking Down the American Choice and Innovation Online Act

Sam Bowman —  1 September 2021

The American Choice and Innovation Online Act (previously called the Platform Anti-Monopoly Act), introduced earlier this summer by U.S. Rep. David Cicilline (D-R.I.), would significantly change the nature of digital platforms and, with them, the internet itself. Taken together, the bill’s provisions would turn platforms into passive intermediaries, undermining many of the features that make them valuable to consumers. This seems likely to remain the case even after potential revisions intended to minimize the bill’s unintended consequences.

In its current form, the bill is split into two parts that each is dangerous in its own right. The first, Section 2(a), would prohibit almost any kind of “discrimination” by platforms. Because it is so open-ended, lawmakers might end up removing it in favor of the nominally more focused provisions of Section 2(b), which prohibit certain named conduct. But despite being more specific, this section of the bill is incredibly far-reaching and would effectively ban swaths of essential services.

I will address the potential effects of these sections point-by-point, but both elements of the bill suffer from the same problem: a misguided assumption that “discrimination” by platforms is necessarily bad from a competition and consumer welfare point of view. On the contrary, this conduct is often exactly what consumers want from platforms, since it helps to bring order and legibility to otherwise-unwieldy parts of the Internet. Prohibiting it, as both main parts of the bill do, would make the Internet harder to use and less competitive.

Section 2(a)

Section 2(a) essentially prohibits any behavior by a covered platform that would advantage that platform’s services over any others that also uses that platform; it characterizes this preferencing as “discrimination.”

As we wrote when the House Judiciary Committee’s antitrust bills were first announced, this prohibition on “discrimination” is so broad that, if it made it into law, it would prevent platforms from excluding or disadvantaging any product of another business that uses the platform or advantaging their own products over those of their competitors.

The underlying assumption here is that platforms should be like telephone networks: providing a way for different sides of a market to communicate with each other, but doing little more than that. When platforms do do more—for example, manipulating search results to favor certain businesses or to give their own products prominence —it is seen as exploitative “leveraging.”

But consumers often want platforms to be more than just a telephone network or directory, because digital markets would be very difficult to navigate without some degree of “discrimination” between sellers. The Internet is so vast and sellers are often so anonymous that any assistance which helps you choose among options can serve to make it more navigable. As John Gruber put it:

From what I’ve seen over the last few decades, the quality of the user experience of every computing platform is directly correlated to the amount of control exerted by its platform owner. The current state of the ownerless world wide web speaks for itself.

Sometimes, this manifests itself as “self-preferencing” of another service, to reduce additional time spent searching for the information you want. When you search for a restaurant on Google, it can be very useful to get information like user reviews, the restaurant’s phone number, a button on mobile to phone them directly, estimates of how busy it is, and a link to a Maps page to see how to actually get there.

This is, undoubtedly, frustrating for competitors like Yelp, who would like this information not to be there and for users to have to click on either a link to Yelp or a link to Google Maps. But whether it is good or bad for Yelp isn’t relevant to whether it is good for users—and it is at least arguable that it is, which makes a blanket prohibition on this kind of behavior almost inevitably harmful.

If it isn’t obvious why removing this kind of feature would be harmful for users, ask yourself why some users search in Yelp’s app directly for this kind of result. The answer, I think, is that Yelp gives you all the information above that Google does (and sometimes is better, although I tend to trust Google Maps’ reviews over Yelp’s), and it’s really convenient to have all that on the same page. If Google could not provide this kind of “rich” result, many users would probably stop using Google Search to look for restaurant information in the first place, because a new friction would have been added that made the experience meaningfully worse. Removing that option would be good for Yelp, but mainly because it removes a competitor.

If all this feels like stating the obvious, then it should highlight a significant problem with Section 2(a) in the Cicilline bill: it prohibits conduct that is directly value-adding for consumers, and that creates competition for dedicated services like Yelp that object to having to compete with this kind of conduct.

This is true across all the platforms the legislation proposes to regulate. Amazon prioritizes some third-party products over others on the basis of user reviews, rates of returns and complaints, and so on; Amazon provides private label products to fill gaps in certain product lines where existing offerings are expensive or unreliable; Apple pre-installs a Camera app on the iPhone that, obviously, enjoys an advantage over rival apps like Halide.

Some or all of this behavior would be prohibited under Section 2(a) of the Cicilline bill. Combined with the bill’s presumption that conduct must be defended affirmatively—that is, the platform is presumed guilty unless it can prove that the challenged conduct is pro-competitive, which may be very difficult to do—and the bill could prospectively eliminate a huge range of socially valuable behavior.

Supporters of the bill have already been left arguing that the law simply wouldn’t be enforced in these cases of benign discrimination. But this would hardly be an improvement. It would mean the Federal Trade Commission (FTC) and U.S. Justice Department (DOJ) have tremendous control over how these platforms are built, since they could challenge conduct in virtually any case. The regulatory uncertainty alone would complicate the calculus for these firms as they refine, develop, and deploy new products and capabilities. 

So one potential compromise might be to do away with this broad-based rule and proscribe specific kinds of “discriminatory” conduct instead. This approach would involve removing Section 2(a) from the bill but retaining Section 2(b), which enumerates 10 practices it deems to be “other discriminatory conduct.” This may seem appealing, as it would potentially avoid the worst abuses of the broad-based prohibition. In practice, however, it would carry many of the same problems. In fact, many of 2(b)’s provisions appear to go even further than 2(a), and would proscribe even more procompetitive conduct that consumers want.

Sections 2(b)(1) and 2(b)(9)

The wording of these provisions is extremely broad and, as drafted, would seem to challenge even the existence of vertically integrated products. As such, these prohibitions are potentially even more extensive and invasive than Section 2(a) would have been. Even a narrower reading here would seem to preclude safety and privacy features that are valuable to many users. iOS’s sandboxing of apps, for example, serves to limit the damage that a malware app can do on a user’s device precisely because of the limitations it imposes on what other features and hardware the app can access.

Section 2(b)(2)

This provision would preclude a firm from conditioning preferred status on use of another service from that firm. This would likely undermine the purpose of platforms, which is to absorb and counter some of the risks involved in doing business online. An example of this is Amazon’s tying eligibility for its Prime program to sellers that use Amazon’s delivery service (FBA – Fulfilled By Amazon). The bill seems to presume in an example like this that Amazon is leveraging its power in the market—in the form of the value of the Prime label—to profit from delivery. But Amazon could, and already does, charge directly for listing positions; it’s unclear why it would benefit from charging via FBA when it could just charge for the Prime label.

An alternate, simpler explanation is that FBA improves the quality of the service, by granting customers greater assurance that a Prime product will arrive when Amazon says it will. Platforms add value by setting out rules and providing services that reduce the uncertainties between buyers and sellers they’d otherwise experience if they transacted directly with each other. This section’s prohibition—which, as written, would seem to prevent any kind of quality assurance—likely would bar labelling by a platform, even where customers explicitly want it.

Section 2(b)(3)

As written, this would prohibit platforms from using aggregated data to improve their services at all. If Apple found that 99% of its users uninstalled an app immediately after it was installed, it would be reasonable to conclude that the app may be harmful or broken in some way, and that Apple should investigate. This provision would ban that.

Sections 2(b)(4) and 2(b)(6)

These two provisions effectively prohibit a platform from using information it does not also provide to sellers. Such prohibitions ignore the fact that it is often good for sellers to lack certain information, since withholding information can prevent abuse by malicious users. For example, a seller may sometimes try to bribe their customers to post positive reviews of their products, or even threaten customers who have posted negative ones. Part of the role of a platform is to combat that kind of behavior by acting as a middleman and forcing both consumer users and business users to comply with the platform’s own mechanisms to control that kind of behavior.

If this seems overly generous to platforms—since, obviously, it gives them a lot of leverage over business users—ask yourself why people use platforms at all. It is not a coincidence that people often prefer Amazon to dealing with third-party merchants and having to navigate those merchants’ sites themselves. The assurance that Amazon provides is extremely valuable for users. Much of it comes from the company’s ability to act as a middleman in this way, lowering the transaction costs between buyers and sellers.

Section 2(b)(5)

This provision restricts the treatment of defaults. It is, however, relatively restrained when compared to, for example, the DOJ’s lawsuit against Google, which treats as anticompetitive even payment for defaults that can be changed. Still, many of the arguments that apply in that case also apply here: default status for apps can be a way to recoup income foregone elsewhere (e.g., a browser provided for free that makes its money by selling the right to be the default search engine).

Section 2(b)(7)

This section gets to the heart of why “discrimination” can often be procompetitive: that it facilitates competition between platforms. The kind of self-preferencing that this provision would prohibit can allow firms that have a presence in one market to extend that position into another, increasing competition in the process. Both Apple and Amazon have used their customer bases in smartphones and e-commerce, respectively, to grow their customer bases for video streaming, in competition with Netflix, Google’s YouTube, cable television, and each other. If Apple designed a search engine to compete with Google, it would do exactly the same thing, and we would be better off because of it. Restricting this kind of behavior is, perversely, exactly what you would do if you wanted to shield these incumbents from competition.

Section 2(b)(8)

As with other provisions, this one would preclude one of the mechanisms by which platforms add value: creating assurance for customers about the products they can expect if they visit the platform. Some of this relates to child protection; some of the most frustrating stories involve children being overcharged when they use an iPhone or Android app, and effectively being ripped off because of poor policing of the app (or insufficiently strict pricing rules by Apple or Google). This may also relate to rules that state that the seller cannot offer a cheaper product elsewhere (Amazon’s “General Pricing Rule” does this, for example). Prohibiting this would simply impose a tax on customers who cannot shop around and would prefer to use a platform that they trust has the lowest prices for the item they want.

Section 2(b)(10)

Ostensibly a “whistleblower” provision, this section could leave platforms with no recourse, not even removing a user from its platform, in response to spurious complaints intended purely to extract value for the complaining business rather than to promote competition. On its own, this sort of provision may be fairly harmless, but combined with the provisions above, it allows the bill to add up to a rent-seekers’ charter.

Conclusion

In each case above, it’s vital to remember that a reversed burden of proof applies. So, there is a high chance that the law will side against the defendant business, and a large downside for conduct that ends up being found to violate these provisions. That means that platforms will likely err on the side of caution in many cases, avoiding conduct that is ambiguous, and society will probably lose a lot of beneficial behavior in the process.

Put together, the provisions undermine much of what has become an Internet platform’s role: to act as an intermediary, de-risk transactions between customers and merchants who don’t know each other, and tweak the rules of the market to maximize its attractiveness as a place to do business. The “discrimination” that the bill would outlaw is, in practice, behavior that makes it easier for consumers to navigate marketplaces of extreme complexity and uncertainty, in which they often know little or nothing about the firms with whom they are trying to transact business.

Customers do not want platforms to be neutral, open utilities. They can choose platforms that are like that already, such as eBay. They generally tend to prefer ones like Amazon, which are not neutral and which carefully cultivate their service to be as streamlined, managed, and “discriminatory” as possible. Indeed, many of people’s biggest complaints with digital platforms relate to their openness: the fake reviews, counterfeit products, malware, and spam that come with letting more unknown businesses use your service. While these may be unavoidable by-products of running a platform, platforms compete on their ability to ferret them out. Customers are unlikely to thank legislators for regulating Amazon into being another eBay.

In Amazon, Antitrust & Competition, Antitrust Division, Apple, Exclusive Dealing, Federal Trade Commission, Google, Justice Department, Monopolization, Platforms, Price Discrimination, Truth on the Market, Tying , , , , , , , , , , , , , , ,
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European Commission Objection to App Store Rules Lack Empirical Support

Paula Pernas Castrillo —  27 May 2021

The European Commission recently issued a formal Statement of Objections (SO) in which it charges Apple with antitrust breach. In a nutshell, the commission argues that Apple prevents app developers—in this case, Spotify—from using alternative in-app purchase systems (IAPs) other than Apple’s own, or steering them towards other, cheaper payment methods on another site. This, the commission says, results in higher prices for consumers in the audio streaming and ebook/audiobook markets.

More broadly, the commission claims that Apple’s App Store rules may distort competition in markets where Apple competes with rival developers (such as how Apple Music competes with Spotify). This explains why the anticompetitive concerns raised by Spotify regarding the Apple App Store rules have now expanded to Apple’s e-books, audiobooks and mobile payments platforms.

However, underlying market realities cast doubt on the commission’s assessment. Indeed, competition from Google Play and other distribution mediums makes it difficult to state unequivocally that the relevant market should be limited to Apple products. Likewise, the conduct under investigation arguably solves several problems relating to platform dynamics, and consumers’ privacy and security.

Should the relevant market be narrowed to iOS?

An important first question is whether there is a distinct, antitrust-relevant market for “music streaming apps distributed through the Apple App Store,” as the EC posits.

This market definition is surprising, given that it is considerably narrower than the one suggested by even the most enforcement-minded scholars. For instance, Damien Geradin and Dimitrias Katsifis—lawyers for app developers opposed to Apple—define the market as “that of app distribution on iOS devices, a two-sided transaction market on which Apple has a de facto monopoly.” Similarly, a report by the Dutch competition authority declared that the relevant market was limited to the iOS App Store, due to the lack of interoperability with other systems.

The commission’s decisional practice has been anything but constant in this space. In the Apple/Shazam and Apple/Beats cases, it did not place competing mobile operating systems and app stores in separate relevant markets. Conversely, in the Google Android decision, the commission found that the Android OS and Apple’s iOS, including Google Play and Apple’s App Store, did not compete in the same relevant market. The Spotify SO seems to advocate for this definition, narrowing it even further to music streaming services.

However, this narrow definition raises several questions. Market definition is ultimately about identifying the competitive constraints that the firm under investigation faces. As Gregory Werden puts it: “the relevant market in an antitrust case […] identifies the competitive process alleged to be harmed.”

In that regard, there is clearly some competition between Apple’s App Store, Google Play and other app stores (whether this is sufficient to place them in the same relevant market is an empirical question).

This view is supported by the vast number of online posts comparing Android and Apple and advising consumers on their purchasing options. Moreover, the growth of high-end Android devices that compete more directly with the iPhone has reinforced competition between the two firms. Likewise, Apple has moved down the value chain; the iPhone SE, priced at $399, competes with other medium-range Android devices.

App developers have also suggested they view Apple and Android as alternatives. They take into account technical differences to decide between the two, meaning that these two platforms compete with each other for developers.

All of this suggests that the App Store may be part of a wider market for the distribution of apps and services, where Google Play and other app stores are included—though this is ultimately an empirical question (i.e., it depends on the degree of competition between both platforms)

If the market were defined this way, Apple would not even be close to holding a dominant position—a prerequisite for European competition intervention. Indeed, Apple only sold 27.43% of smartphones in March 2021. Similarly, only 30.41% of smartphones in use run iOS, as of March 2021. This is well below the lowest market share in a European abuse of dominance—39.7% in the British Airways decision.

The sense that Apple and Android compete for users and developers is reinforced by recent price movements. Apple dropped its App Store commission fees from 30% to 15% in November 2020 and Google followed suit in March 2021. This conduct is consistent with at least some degree of competition between the platforms. It is worth noting that other firms, notably Microsoft, have so far declined to follow suit (except for gaming apps).

Barring further evidence, neither Apple’s market share nor its behavior appear consistent with the commission’s narrow market definition.

Are Apple’s IAP system rules and anti-steering provisions abusive?

The commission’s case rests on the idea that Apple leverages its IAP system to raise the costs of rival app developers:

 “Apple’s rules distort competition in the market for music streaming services by raising the costs of competing music streaming app developers. This in turn leads to higher prices for consumers for their in-app music subscriptions on iOS devices. In addition, Apple becomes the intermediary for all IAP transactions and takes over the billing relationship, as well as related communications for competitors.”

However, expropriating rents from these developers is not nearly as attractive as it might seem. The report of the Dutch competition notes that “attracting and maintaining third-party developers that increase the value of the ecosystem” is essential for Apple. Indeed, users join a specific platform because it provides them with a wide number of applications they can use on their devices. And the opposite applies to developers. Hence, the loss of users on either or both sides reduces the value provided by the Apple App Store. Following this logic, it would make no sense for Apple to systematically expropriate developers. This might partly explain why Apple’s fees are only 30%-15%, since in principle they could be much higher.

It is also worth noting that Apple’s curated App Store and IAP have several redeeming virtues. Apple offers “a highly curated App Store where every app is reviewed by experts and an editorial team helps users discover new apps every day.”  While this has arguably turned the App Store into a relatively closed platform, it provides users with the assurance that the apps they find there will meet a standard of security and trustworthiness.

As noted by the Dutch competition authority, “one of the reasons why the App Store is highly valued is because of the strict review process. Complaints about malware spread via an app downloaded in the App Store are rare.” Apple provides users with a special degree of privacy and security. Indeed, Apple stopped more than $1.5 billion in potentially fraudulent transactions in 2020, proving that the security protocols are not only necessary, but also effective. In this sense, the App Store Review Guidelines are considered the first line of defense against fraud and privacy breaches.

It is also worth noting that Apple only charges a nominal fee for iOS developer kits and no fees for in-app advertising. The IAP is thus essential for Apple to monetize the platform and to cover the costs associated with running the platform (note that Apple does make money on device sales, but that revenue is likely constrained by competition between itself and Android). When someone downloads Spotify from the App Store, Apple does not get paid, but Spotify does get a new client. Thus, while independent developers bear the costs of the app fees, Apple bears the costs and risks of running the platform itself.

For instance, Apple’s App Store Team is divided into smaller teams: the Editorial Design team, the Business Operations team, and the Engineering R&D team. These teams each have employees, budgets, and resources for which Apple needs to pay. If the revenues stopped, one can assume that Apple would have less incentive to sustain all these teams that preserve the App Store’s quality, security, and privacy parameters.

Indeed, the IAP system itself provides value to the Apple App Store. Instead of charging all of the apps it provides, it takes a share of the income from some of them. As a result, large developers that own in-app sales contribute to the maintenance of the platform, while smaller ones are still offered to consumers without having to contribute economically. This boosts Apple’s App Store diversity and supply of digital goods and services.

If Apple was forced to adopt another system, it could start charging higher prices for access to its interface and tools, leading to potential discrimination against the smaller developers. Or, Apple could increase the prices of handset devices, thus incurring higher costs for consumers who do not purchase digital goods. Therefore, there are no apparent alternatives to the current IAP that satisfy the App Store’s goals in the same way.

As the Apple Review Guidelines emphasize, “for everything else there is always the open Internet.” Netflix and Spotify have ditched the subscription options from their app, and they are still among the top downloaded apps in iOS. The IAP system is therefore not compulsory to be successful in Apple’s ecosystem, and developers are free to drop Apple Review Guidelines.

Conclusion

The commission’s case against Apple is based on shaky foundations. Not only is the market definition extremely narrow—ignoring competition from Android, among others—but the behavior challenged by the commission has a clear efficiency-enhancing rationale. Of course, both of these critiques ultimately boil down to empirical questions that the commission will have overcome before it reaches a final decision. In the meantime, the jury is out.

In Antitrust & Competition, Apple, European Union, Google, International, Market Definition, Monopolization, Platforms, Truth on the Market , , , , , , , , , , , , , , , , , ,
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Why the Federal Government’s Antitrust Case Against Google Should—and Likely Will—Fail

Thom Lambert —  18 December 2020

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]

On October 20, 2020, the U.S. Department of Justice (DOJ) and eleven states with Republican attorneys general sued Google for monopolizing and attempting to monopolize the markets for general internet search services, search advertising, and “general search text” advertising (i.e., ads that resemble search results).  Last week, California joined the lawsuit, making it a bipartisan affair.

DOJ and the states (collectively, “the government”) allege that Google has used contractual arrangements to expand and cement its dominance in the relevant markets.  In particular, the government complains that Google has agreed to share search ad revenues in exchange for making Google Search the default search engine on various “search access points.” 

Google has entered such agreements with Apple (for search on iPhones and iPads), manufacturers of Android devices and the mobile service carriers that support them, and producers of web browsers.  Google is also pursuing default status on new internet-enabled consumer products, such as voice assistants and “smart” TVs, appliances, and wearables.  In the government’s telling, this all amounts to Google’s sharing of monopoly profits with firms that can ensure its continued monopoly by imposing search defaults that users are unlikely to alter.

There are several obvious weaknesses with the government’s case.  One is that preset internet defaults are super easy to change and, in other contexts, are regularly altered.  For example, while 88% of desktop and laptop computers use the Windows operating system, which defaults to a Microsoft browser (Internet Explorer or Edge), Google’s Chrome browser commands a 69% market share on desktops and laptops, compared to around 13% for Internet Explorer and Edge combined.  Changing a default search engine is as easy as changing a browser default—three simple steps on an iPhone!—and it seems consumers will change defaults they don’t actually prefer.

A second obvious weakness, related to the first, is that the government has alleged no facts suggesting that Google’s search rivals—primarily Bing, Yahoo, and DuckDuckGo—would have enjoyed more success but for Google’s purportedly exclusionary agreements.  Even absent default status, people likely would have selected Google Search because it’s the better search engine.  It doesn’t seem the challenged arrangements caused Google’s search dominance.

Admittedly, the standard of causation in monopolization cases (at least those seeking only injunctive relief) is low.  The D.C. Circuit’s Microsoft decision described it as “edentulous” or, less pretentiously, toothless.  Nevertheless, the government is unlikely to prevail in its action against Google—and that’s a good thing.  Below, I highlight the central deficiency in the government’s Google case and point out problems with the government’s challenges to each of Google’s purportedly exclusionary arrangements.   

The Lawsuit’s Overarching Deficiency

We’ve all had the experience of typing a query only to have Google, within a few key strokes, accurately predict what we were going to ask and provide us with exactly the answer we were looking for.  It’s both eerie and awesome, and it keeps us returning to Google time and again.

But it’s not magic.  Nor has Google hacked our brains.  Google is so good at predicting our questions and providing responsive search results because its top-notch algorithms process gazillions of searches and can “learn” from users’ engagement.  Scale is thus essential to Google’s quality. 

The government’s complaint concedes as much.  It acknowledges that “[g]reater scale improves the quality of a general search engine’s algorithms” (¶35) and that “[t]he additional data from scale allows improved automated learning for algorithms to deliver more relevant results, particularly on ‘fresh’ queries (queries seeking recent information), location-based queries (queries asking about something in the searcher’s vicinity), and ‘long-tail’ queries (queries used infrequently)” (¶36). The complaint also asserts that “[t]he most effective way to achieve scale is for the general search engine to be the preset default on mobile devices, computers, and other devices…” (¶38).

Oddly, though, the government chides Google for pursuing “[t]he most effective way” of securing the scale that concededly “improves the quality of a general search engine’s algorithms.”  Google’s efforts to ensure and enhance its own product quality are improper, the government says, because “they deny rivals scale to compete effectively” (¶8).  In the government’s view, Google is legally obligated to forego opportunities to make its own product better so as to give its rivals a chance to improve their own offerings.

This is inconsistent with U.S. antitrust law.  Just as firms are not required to hold their prices high to create a price umbrella for their less efficient rivals, they need not refrain from efforts to improve the quality of their own offerings so as to give their rivals a foothold. 

Antitrust does forbid anticompetitive foreclosure of rivals—i.e., business-usurping arrangements that are not the result of efforts to compete on the merits by reducing cost or enhancing quality.  But firms are, and should be, free to make their products better, even if doing so makes things more difficult for their rivals.  Antitrust, after all, protects competition, not competitors.    

The central deficiency in the government’s case is that it concedes that scale is crucial to search engine quality, but it does not assert that there is a “minimum efficient scale”—i.e., a point at which scale economies are exhausted.  If a firm takes actions to enhance its own scale beyond minimum efficient scale, and if its efforts may hold its rivals below such scale, then it may have engaged in anticompetitive foreclosure.  But a firm that pursues scale that makes its products better is simply competing on the merits.

The government likely did not allege that there is a minimum efficient scale in general internet search services because returns to scale go on indefinitely, or at least for a very long time.  But the absence of such an allegation damns the government’s case against Google, for it implies that Google’s efforts to secure the distribution, and thus the greater use, of its services make those services better.

In this regard, the Microsoft case, which the government points to as a model for its action against Google (¶10), is inapposite.  Inthat case, the government alleged that Microsoft had entered license agreements that foreclosed Netscape, a potential rival, from the best avenues of browser distribution: original equipment manufacturers (OEMs) and internet access providers.  The government here similarly alleges that Google has foreclosed rival search engines from the best avenues of search distribution: default settings on mobile devices and web browsers.  But a key difference (in addition to the fact that search defaults are quite easy to change) is that Microsoft’s license restrictions foreclosed Netscape without enhancing the quality of Microsoft’s offerings.  Indeed, the court emphasized that the challenged Microsoft agreements were anticompetitive because they “reduced rival browsers’ usage share not by improving [Microsoft’s] own product but, rather, by preventing OEMs from taking actions that could increase rivals’ share of usage” (emphasis added).  Here, any foreclosure of Google’s search rivals is incidental to Google’s efforts to improve its product by enhancing its scale.

Now, the government might contend that the anticompetitive harms from raising rivals’ distribution costs exceed the procompetitive benefits of enhancing the quality of Google’s search services.  Courts, though, have generally been skeptical of claims that exclusion-causing product enhancements are anticompetitive because they do more harm than good.  There’s a sound reason for this: courts are ill-equipped to weigh the benefits of product enhancements against the costs of competition reductions resulting from product-enhancement efforts.  For that reason, they should—and likely will—stick with the rule that this sort of product-enhancing conduct is competition on the merits, even if it has the incidental effect of raising rivals’ costs.  And if they do so, the government will lose this case.     

Problems with the Government’s Specific Challenges

Agreements with Android OEMs and Wireless Carriers

The government alleges that Google has foreclosed its search rivals from distribution opportunities on the Android platform.  It has done so, the government says, by entering into exclusion-causing agreements with OEMs that produce Android products (Samsung, Motorola, etc.) and with carriers that provide wireless service for Android devices (AT&T, Verizon, etc.).

Android is an open source operating system that is owned by Google and licensed, for free, to producers of mobile internet devices.  Under the terms of the challenged agreements, Google’s counterparties promise not to produce Android “forks”—operating systems that are Android-based but significantly alter or “fragment” the basic platform—in order to get access to proprietary Google apps that Android users typically desire and to certain application protocol interfaces (APIs) that enable various functionalities.  In addition to these “anti-forking agreements,” counterparties enter various “pre-installation agreements” obligating them to install a suite of Google apps that use Google Search as a default.  Installing that suite is a condition for obtaining the right to pre-install Google’s app store (Google Play) and other must-have apps.  Finally, OEMs and carriers enter “revenue sharing agreements” that require the use of Google Search as the sole preset default on a number of search access points in exchange for a percentage of search ad revenue derived from covered devices.  Taken together, the government says, these anti-forking, pre-installation, and revenue-sharing agreements preclude the emergence of Android rivals (from forks) and ensure the continued dominance of Google Search on Android devices.

Eliminating these agreements, though, would likely harm consumers by reducing competition in the market for mobile operating systems.  Within that market, there are two dominant players: Apple’s iOS and Google’s Android.  Apple earns money off iOS by selling hardware—iPhones and iPads that are pre-installed with iOS.  Google licenses Android to OEMs for free but then earns advertising revenue off users’ searches (which provide an avenue for search ads) and other activities (which generate user data for better targeted display ads).  Apple and Google thus compete on revenue models.  As Randy Picker has explained, Microsoft tried a third revenue model—licensing a Windows mobile operating system to OEMs for a fee—but it failed.  The continued competition between Apple and Google, though, allows for satisfaction of heterogenous consumer preferences: Apple products are more expensive but more secure (due to Apple’s tight control over software and hardware); Android devices are cheaper (as the operating system is ad-supported) and offer more innovations (as OEMs have more flexibility), but tend to be less secure.  Such variety—a result of business model competition—is good for consumers. 

If the government were to prevail and force Google to end the agreements described above, thereby reducing the advertising revenue Google derives from Android, Google would have to either copy Apple’s vertically integrated model so as to recoup its Android investments through hardware sales, charge OEMs for Android (a la Microsoft), or cut back on its investments in Android.  In each case, consumers would suffer.  The first option would take away an offering preferred by many consumers—indeed most globally, as Android dominates iOS on a worldwide basis.  The second option would replace Google’s business model with one that failed, suggesting that consumers value it less.  The third option would reduce product quality in the market for mobile operating systems. 

In the end, then, the government’s challenge to Google’s Android agreements is myopic and misguided.  Competition among business models, like competition along any dimension, inures to the benefit of consumers.  Precluding it as the government is demanding would be silly.       

Agreements with Browser Producers

Web browsers like Apple’s Safari and Mozilla’s Firefox are a primary distribution channel for search engines.  The government claims that Google has illicitly foreclosed rival search engines from this avenue of distribution by entering revenue-sharing agreements with the major non-Microsoft browsers (i.e., all but Microsoft’s Edge and Internet Explorer).  Under those agreements, Google shares up to 40% of ad revenues generated from a browser in exchange for being the preset default on both computer and mobile versions of the browser.

Surely there is no problem, though, with search engines paying royalties to web browsers.  That’s how independent browsers like Opera and Firefox make money!  Indeed, 95% of Firefox’s revenue comes from search royalties.  If browsers were precluded from sharing in search engines’ ad revenues, they would have to find an alternative source of financing.  Producers of independent browsers would likely charge license fees, which consumers would probably avoid.  That means the only available browsers would be those affiliated with an operating system (Microsoft’s Edge, Apple’s Safari) or a search engine (Google’s Chrome).  It seems doubtful that reducing the number of viable browsers would benefit consumers.  The law should therefore allow payment of search royalties to browsers.  And if such payments are permitted, a browser will naturally set its default search engine so as to maximize its payout.  

Google’s search rivals can easily compete for default status on a browser by offering a better deal to the browser producer.  In 2014, for example, search engine Yahoo managed to wrest default status on Mozilla’s Firefox away from Google.  The arrangement was to last five years, but in 2017, Mozilla terminated the agreement and returned Google to default status because so many Firefox users were changing the browser’s default search engine from Yahoo to Google.  This historical example undermines the government’s challenges to Google’s browser agreements by showing (1) that other search engines can attain default status by competing, and (2) that defaults aren’t as “sticky” as the government claims—at least, not when the default is set to a search engine other than the one most people prefer.

In short, there’s nothing anticompetitive about Google’s browser agreements, and enjoining such deals would likely injure consumers by reducing competition among browsers.

Agreements with Apple

That brings us to the allegations that have gotten the most attention in the popular press: those concerning Google’s arrangements with Apple.  The complaint alleges that Google pays Apple $8-12 billion a year—a whopping 15-20% of Apple’s net income—for granting Google default search status on iOS devices.  In the government’s telling, Google is agreeing to share a significant portion of its monopoly profits with Apple in exchange for Apple’s assistance in maintaining Google’s search monopoly.

An alternative view, of course, is that Google is just responding to Apple’s power: Apple has assembled a giant installed base of loyal customers and can demand huge payments to favor one search engine over another on its popular mobile devices.  In that telling, Google may be paying Apple to prevent it from making Bing or another search engine the default on Apple’s search access points.

If that’s the case, what Google is doing is both procompetitive and a boon to consumers.  Microsoft could easily outbid Google to have Bing set as the default search engine on Apple’s devices. Microsoft’s market capitalization exceeds that of Google parent Alphabet by about $420 billion ($1.62 trillion versus $1.2 trillion), which is roughly the value of Walmart.  Despite its ability to outbid Google for default status, Microsoft hasn’t done so, perhaps because it realizes that defaults aren’t that sticky when the default service isn’t the one most people prefer.  Microsoft knows that from its experience with Internet Explorer and Edge (which collectively command only around 13% of the desktop browser market even though they’re the defaults on Windows, which has a 88% market share on desktops and laptops), and from its experience with Bing (where “Google” is the number one search term).  Nevertheless, the possibility remains that Microsoft could outbid Google for default status, improve its quality to prevent users from changing the default (or perhaps pay users for sticking with Bing), and thereby take valuable scale from Google, impairing the quality of Google Search.  To prevent that from happening, Google shares with Apple a generous portion of its search ad revenues, which, given the intense competition for mobile device sales, Apple likely passes along to consumers in the form of lower phone and tablet prices.

If the government succeeds in enjoining Google’s payments to Apple for default status, other search engines will presumably be precluded from such arrangements as well.  After all, the “foreclosure” effect of paying for default search status on Apple products is the same regardless of which search engine does the paying, and U.S. antitrust law does not “punish” successful firms by forbidding them from engaging in competitive activities that are open to their rivals. 

Ironically, then, the government’s success in its challenge to Google’s Apple payments would benefit Google at the expense of consumers:  Google would almost certainly remain the default search engine on Apple products, as it is most preferred by consumers and no rival could pay to dislodge it; Google would not have to pay a penny to retain its default status; and Apple would lose revenues that it likely passes along to consumers in the form of lower prices.  The courts are unlikely to countenance this perverse result by ruling that Google’s arrangements with Apple violate the antitrust laws.

Arrangements with Producers of Internet-Enabled “Smart” Devices

The final part of the government’s case against Google starkly highlights a problem that is endemic to the entire lawsuit.  The government claims that Google, having locked up all the traditional avenues of search distribution with the arrangements described above, is now seeking to foreclose search distribution in the new avenues being created by internet-enabled consumer products like wearables (e.g., smart watches), voice assistants, smart TVs, etc.  The alleged monopolistic strategy is similar to those described above: Google will share some of its monopoly profits in exchange for search default status on these smart devices, thereby preventing rival search engines from attaining valuable scale.

It’s easy to see in this context, though, why Google’s arrangements are likely procompetitive.  Unlike web browsers, mobile phones, and tablets, internet-enabled smart devices are novel.  Innovators are just now discovering new ways to embed internet functionality into everyday devices. 

Putting oneself in the position of these innovators helps illuminate a key beneficial aspect of Google’s arrangements:  They create an incentive to develop new and attractive means of distributing search.  Innovators currently at work on internet-enabled devices are no doubt spurred on by the possibility of landing a lucrative distribution agreement with Google or another search engine.  Banning these sorts of arrangements—the consequence of governmental success in this lawsuit—would diminish the incentive to innovate.

But that can be said of every single one of the arrangements the government is challenging. Because of Google’s revenue-sharing with search distributors, each of them has an added incentive to make their distribution channels desirable to consumers.  Android OEMs and Apple will work harder to produce mobile devices that people will want to use for internet searches; browser producers will endeavor to improve their offerings.  By paying producers of search access points a portion of the search ad revenues generated on their platforms, Google motivates them to generate more searches, which they can best do by making their products as attractive as possible. 

At the end of the day, then, the government’s action against Google seeks to condemn conduct that benefits consumers.  Because of the challenged arrangements, Google makes its own search services better, is able to license Android for free, ensures the continued existence of independent web browsers like Firefox and Opera, helps lower the price of iPhones and iPads, and spurs innovators to develop new “Internet of Things” devices that can harness the power of the web. 

The Biden administration would do well to recognize this lawsuit for what it is: a poorly conceived effort to appear to be “doing something” about a Big Tech company that has drawn the ire (for different reasons) of both progressives and conservatives.  DOJ and its state co-plaintiffs should seek dismissal of this action.  

In Apple, Google, Justice Department, Platforms, Symposia, Symposium on the Future of American Antitrust: The Google Lawsuits, Telecommunications, Truth on the Market, Wireless , , , , , , , , , ,
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The Epic Flaws of Epic’s Antitrust Gambit

Dirk Auer —  27 August 2020

Much has already been said about the twin antitrust suits filed by Epic Games against Apple and Google. For those who are not familiar with the cases, the game developer – most famous for its hit title Fortnite and the “Unreal Engine” that underpins much of the game (and movie) industry – is complaining that Apple and Google are thwarting competition from rival app stores and in-app payment processors. 

Supporters have been quick to see in these suits a long-overdue challenge against the 30% commissions that Apple and Google charge. Some have even portrayed Epic as a modern-day Robin Hood, leading the fight against Big Tech to the benefit of small app developers and consumers alike. Epic itself has been keen to stoke this image, comparing its litigation to a fight for basic freedoms in the face of Big Brother:

However, upon closer inspection, cracks rapidly appear in this rosy picture. What is left is a company partaking in blatant rent-seeking that threatens to harm the sprawling ecosystems that have emerged around both Apple and Google’s app stores.

Two issues are particularly salient. First, Epic is trying to protect its own interests at the expense of the broader industry. If successful, its suit would merely lead to alternative revenue schemes that – although more beneficial to itself – would leave smaller developers to shoulder higher fees. Second, the fees that Epic portrays as extortionate were in fact key to the emergence of mobile gaming.

Epic’s utopia is not an equilibrium

Central to Epic’s claims is the idea that both Apple and Google: (i) thwart competition from rival app stores, and implement a series of measures that prevent developers from reaching gamers through alternative means (such as pre-installing apps, or sideloading them in the case of Apple’s platforms); and (ii) tie their proprietary payment processing services to their app stores. According to Epic, this ultimately enables both Apple and Google to extract “extortionate” commissions (30%) from app developers.

But Epic’s whole case is based on the unrealistic assumption that both Apple and Google will sit idly by while rival play stores and payment systems take a free-ride on the vast investments they have ploughed into their respective smartphone platforms. In other words, removing Apple and Google’s ability to charge commissions on in-app purchases does not prevent them from monetizing their platforms elsewhere.

Indeed, economic and strategic management theory tells us that so long as Apple and Google single-handedly control one of the necessary points of access to their respective ecosystems, they should be able to extract a sizable share of the revenue generated on their platforms. One can only speculate, but it is easy to imagine Apple and Google charging rival app stores for access to their respective platforms, or charging developers for access to critical APIs.

Epic itself seems to concede this point. In a recent Verge article, it argued that Apple was threatening to cut off its access to iOS and Mac developer tools, which Apple currently offers at little to no cost:

Apple will terminate Epic’s inclusion in the Apple Developer Program, a membership that’s necessary to distribute apps on iOS devices or use Apple developer tools, if the company does not “cure your breaches” to the agreement within two weeks, according to a letter from Apple that was shared by Epic. Epic won’t be able to notarize Mac apps either, a process that could make installing Epic’s software more difficult or block it altogether. Apple requires that all apps are notarized before they can be run on newer versions of macOS, even if they’re distributed outside the App Store.

There is little to prevent Apple from more heavily monetizing these tools – should Epic’s antitrust case successfully prevent it from charging commissions via its app store.

All of this raises the question: why is Epic bringing a suit that, if successful, would merely result in the emergence of alternative fee schedules (as opposed to a significant reduction of the overall fees paid by developers).

One potential answer is that the current system is highly favorable to small apps that earn little to no revenue from purchases and who benefit most from the trust created by Apple and Google’s curation of their stores. It is, however, much less favorable to developers like Epic who no longer require any curation to garner the necessary trust from consumers and who earn a large share of their revenue from in-app purchases.

In more technical terms, the fact that all in-game payments are made through Apple and Google’s payment processing enables both platforms to more easily price-discriminate. Unlike fixed fees (but just like royalties), percentage commissions are necessarily state-contingent (i.e. the same commission will lead to vastly different revenue depending on an underlying app’s success). The most successful apps thus contribute far more to a platform’s fixed costs. For instance, it is estimated that mobile games account for 72% of all app store spend. Likewise, more than 80% of the apps on Apple’s store pay no commission at all.

This likely expands app store output by getting lower value developers on board. In that sense, it is akin to Ramsey pricing (where a firm/utility expands social welfare by allocating a higher share of fixed costs to the most inelastic consumers). Unfortunately, this would be much harder to accomplish if high value developers could easily bypass Apple or Google’s payment systems.

The bottom line is that Epic appears to be fighting to change Apple and Google’s app store business models in order to obtain fee schedules that are better aligned with its own interests. This is all the more important for Epic Games, given that mobile gaming is becoming increasingly popular relative to other gaming mediums (also here).

The emergence of new gaming platforms

Up to this point, I have mostly presented a zero-sum view of Epic’s lawsuit – i.e. developers and platforms are fighting over the distribution app store profits (though some smaller developers may lose out). But this ignores what is likely the chief virtue of Apple and Google’s “closed” distribution model. Namely, that it has greatly expanded the market for mobile gaming (and other mobile software), and will likely continue to do so in the future.

Much has already been said about the significant security and trust benefits that Apple and Google’s curation of their app stores (including their control of in-app payments) provide to users. Benedict Evans and Ben Thompson have both written excellent pieces on this very topic. 

In a nutshell, the closed model allows previously unknown developers to rapidly expand because (i) users do not have to fear their apps contain some form of malware, and (ii) they greatly reduce payments frictions, most notably security related ones. But while these are indeed tremendous benefits, another important upside seems to have gone relatively unnoticed. 

The “closed” business model also gives Apple and Google (as well as other platforms) significant incentives to develop new distribution mediums (smart TVs spring to mind) and improve existing ones. In turn, this greatly expands the audience that software developers can reach. In short, developers get a smaller share of a much larger pie.

The economics of two-sided markets are enlightening in this respect. Apple and Google’s stores are what Armstrong and Wright (here and here) refer to as “competitive bottlenecks”. That is, they compete aggressively (amongst themselves, and with other gaming platforms) to attract exclusive users. They can then charge developers a premium to access those users (note, however, that in the case at hand the incidence of those platform fees is unclear).

This gives platforms significant incentives to continuously attract and retain new users. For instance, if Steve Jobs is to be believed, giving consumers better access to media such as eBooks, video and games was one of the driving forces behind the launch of the iPad. 

This model of innovation would be seriously undermined if developers and consumers could easily bypass platforms (as Epic games is seeking to do).

In response, some commentators have countered that platforms may use their strong market positions to squeeze developers, thereby undermining software investments. But such a course of action may ultimately be self-defeating. For instance, writing about retail platforms imitating third-party sellers, Anfrei Hagiu, Tat-How Teh and Julian Wright have argued that:

[T]he platform has an incentive to commit itself not to imitate highly innovative third-party products in order to preserve their incentives to innovate.

Seen in this light, Apple and Google’s 30% commissions can be seen as a soft commitment not to expropriate developers, thus leaving them with a sizable share of the revenue generated on each platform. This may explain why the 30% commission has become a standard in the games industry (and beyond). 

Furthermore, from an evolutionary perspective, it is hard to argue that the 30% commission is somehow extortionate. If game developers were systematically expropriated, then the gaming industry – in particular its mobile segment – would not have grown so drastically over the past years:

All of this this likely explains why a recent survey found that 81% of app developers believed regulatory intervention would be misguided:

81% of developers and publishers believe that the relationship between them and platforms is best handled within the industry, rather than through government intervention. Competition and choice mean that developers will use platforms that they work with best.

The upshot is that the “closed” model employed by Apple and Google has served the gaming industry well. There is little compelling reason to overhaul that model today.

Final thoughts

When all is said and done, there is no escaping the fact that Epic games is currently playing a high-stakes rent-seeking game. As Apple noted in its opposition to Epic’s motion for a temporary restraining order:

Epic did not, and has not, contested that it is in breach of the App Store Guidelines and the License Agreement. Epic’s plan was to violate the agreements intentionally in order to manufacture an emergency. The moment Fortnite was removed from the App Store, Epic launched an extensive PR smear campaign against Apple and a litigation plan was orchestrated to the minute; within hours, Epic had filed a 56-page complaint, and within a few days, filed nearly 200 pages with this Court in a pre-packaged “emergency” motion. And just yesterday, it even sought to leverage its request to this Court for a sales promotion, announcing a “#FreeFortniteCup” to take place on August 23, inviting players for one last “Battle Royale” across “all platforms” this Sunday, with prizes targeting Apple.

Epic is ultimately seeking to introduce its own app store on both Apple and Google’s platforms, or at least bypass their payment processing services (as Spotify is seeking to do in the EU).

Unfortunately, as this post has argued, condoning this type of free-riding could prove highly detrimental to the entire mobile software industry. Smaller companies would almost inevitably be left to foot a larger share of the bill, existing platforms would become less secure, and the development of new ones could be hindered. At the end of the day, 30% might actually be a small price to pay.

In Antitrust & Competition, Apple, European Union, Google, International, Platforms, Truth on the Market , , , , , , ,
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Will the European Commission’s Google Android Decision Benefit Consumers?

Professor Pinar Akman —  19 July 2018

By Pinar Akman, Professor of Law, University of Leeds*

The European Commission’s decision in Google Android cuts a fine line between punishing a company for its success and punishing a company for falling afoul of the rules of the game. Which side of the line it actually falls on cannot be fully understood until the Commission publishes its full decision. Much depends on the intricate facts of the case. As the full decision may take months to come, this post offers merely the author’s initial thoughts on the decision on the basis of the publicly available information.

The eye-watering fine of $5.1 billion — which together with the fine of $2.7 billion in the Google Shopping decision from last year would (according to one estimate) suffice to fund for almost one year the additional yearly public spending necessary to eradicate world hunger by 2030 — will not be further discussed in this post. This is because the fine is assumed to have been duly calculated on the basis of the Commission’s relevant Guidelines, and, from a legal and commercial point of view, the absolute size of the fine is not as important as the infringing conduct and the remedy Google will need to adopt to comply with the decision.

First things first. This post proceeds on the premise that the aim of competition law is to prevent the exclusion of competitors that are (at least) as efficient as the dominant incumbent, whose exclusion would ultimately harm consumers.

Next, it needs to be noted that the Google Android case is a more conventional antitrust case than Google Shopping in the sense that one can at least envisage a potentially robust antitrust theory of harm in the former case. If a dominant undertaking ties its products together to exclude effective competition in some of these markets or if it pays off customers to exclude access by its efficient competitors to consumers, competition law intervention may be justified.

The central question in Google Android is whether on the available facts this appears to have happened.

What we know and market definition

The premise of the case is that Google used its dominance in the Google Play Store (which enables users to download apps onto their Android phones) to “cement Google’s dominant position in general internet search.”

It is interesting that the case appears to concern a dominant undertaking leveraging its dominance from a market in which it is dominant (Google Play Store) into another market in which it is also dominant (internet search). As far as this author is aware, most (if not all?) cases of tying in the EU to date concerned tying where the dominant undertaking leveraged its dominance in one market to distort or eliminate competition in an otherwise competitive market.

Thus, for example, in Microsoft (Windows Operating System —> media players), Hilti (patented cartridge strips —> nails), and Tetra Pak II (packaging machines —> non-aseptic cartons), the tied market was actually or potentially competitive, and this was why the tying was alleged to have eliminated competition. It will be interesting to see which case the Commission uses as precedent in its decision — more on that later.

Also noteworthy is that the Commission does not appear to have defined a separate mobile search market that would have been competitive but for Google’s alleged leveraging. The market has been defined as the general internet search market. So, according to the Commission, the Google Search App and Google Search engine appear to be one and the same thing, and desktop and mobile devices are equivalent (or substitutable).

Finding mobile and desktop devices to be equivalent to one another may have implications for other cases including the ongoing appeal in Google Shopping where, for example, the Commission found that “[m]obile [apps] are not a viable alternative for replacing generic search traffic from Google’s general search results pages” for comparison shopping services. The argument that mobile apps and mobile traffic are fundamental in Google Android but trivial in Google Shopping may not play out favourably for the Commission before the Court of Justice of the EU.

Another interesting market definition point is that the Commission has found Apple not to be a competitor to Google in the relevant market defined by the Commission: the market for “licensable smart mobile operating systems.” Apple does not fall within that market because Apple does not license its mobile operating system to anyone: Apple’s model eliminates all possibility of competition from the start and is by definition exclusive.

Although there is some internal logic in the Commission’s exclusion of Apple from the upstream market that it has defined, is this not a bit of a definitional stop? How can Apple compete with Google in the market as defined by the Commission when Apple allows only itself to use its operating system only on devices that Apple itself manufactures?

To be fair, the Commission does consider there to be some competition between Apple and Android devices at the level of consumers — just not sufficient to constrain Google at the upstream, manufacturer level.

Nevertheless, the implication of the Commission’s assessment that separates the upstream and downstream in this way is akin to saying that the world’s two largest corn producers that produce the corn used to make corn flakes do not compete with one another in the market for corn flakes because one of them uses its corn exclusively in its own-brand cereal.

Although the Commission cabins the use of supply-side substitutability in market definition, its own guidance on the topic notes that

Supply-side substitutability may also be taken into account when defining markets in those situations in which its effects are equivalent to those of demand substitution in terms of effectiveness and immediacy. This means that suppliers are able to switch production to the relevant products and market them in the short term….

Apple could — presumably — rather immediately and at minimal cost produce and market a version of iOS for use on third-party device makers’ devices. By the Commission’s own definition, it would seem to make sense to include Apple in the relevant market. Nevertheless, it has apparently not done so here.

The message that the Commission sends with the finding is that if Android had not been open source and freely available, and if Google competed with Apple with its own version of a walled-garden built around exclusivity, it is possible that none of its practices would have raised any concerns. Or, should Apple be expecting a Statement of Objections next from the EU Commission?

Is Microsoft really the relevant precedent?

Given that Google Android appears to revolve around the idea of tying and leveraging, the EU Commission’s infringement decision against Microsoft, which found an abusive tie in Microsoft’s tying of Windows Operating System with Windows Media Player, appears to be the most obvious precedent, at least for the tying part of the case.

There are, however, potentially important factual differences between the two cases. To take just a few examples:

  • Microsoft charged for the Windows Operating System, whereas Google does not;
  • Microsoft tied the setting of Windows Media Player as the default to OEMs’ licensing of the operating system (Windows), whereas Google ties the setting of Search as the default to device makers’ use of other Google apps, while allowing them to use the operating system (Android) without any Google apps; and
  • Downloading competing media players was difficult due to download speeds and lack of user familiarity, whereas it is trivial and commonplace for users to download apps that compete with Google’s.

Moreover, there are also some conceptual hurdles in finding the conduct to be that of tying.

First, the difference between “pre-installed,” “default,” and “exclusive” matters a lot in establishing whether effective competition has been foreclosed. The Commission’s Press Release notes that to pre-install Google Play, manufacturers have to also pre-install Google Search App and Google Chrome. It also states that Google Search is the default search engine on Google Chrome. The Press Release does not indicate that Google Search App has to be the exclusive or default search app. (It is worth noting, however, that the Statement of Objections in Google Android did allege that Google violated EU competition rules by requiring Search to be installed as the default. We will have to await the decision itself to see if this was dropped from the case or simply not mentioned in the Press Release).

In fact, the fact that the other infringement found is that of Google’s making payments to manufacturers in return for exclusively pre-installing the Google Search App indirectly suggests that not every manufacturer pre-installs Google Search App as the exclusive, pre-installed search app. This means that any other search app (provider) can also (request to) be pre-installed on these devices. The same goes for the browser app.

Of course, regardless, even if the manufacturer does not pre-install competing apps, the consumer is free to download any other app — for search or browsing — as they wish, and can do so in seconds.

In short, pre-installation on its own does not necessarily foreclose competition, and thus may not constitute an illegal tie under EU competition law. This is particularly so when download speeds are fast (unlike the case at the time of Microsoft) and consumers regularly do download numerous apps.

What may, however, potentially foreclose effective competition is where a dominant undertaking makes payments to stop its customers, as a practical matter, from selling its rivals’ products. Intel, for example, was found to have abused its dominant position through payments to a computer retailer in return for its not selling computers with its competitor AMD’s chips, and to computer manufacturers in return for delaying the launch of computers with AMD chips.

In Google Android, the exclusivity provision that would require manufacturers to pre-install Google Search App exclusively in return for financial incentives may be deemed to be similar to this.

Having said that, unlike in Intel where a given computer can have a CPU from only one given manufacturer, even the exclusive pre-installation of the Google Search App would not have prevented consumers from downloading competing apps. So, again, in theory effective competition from other search apps need not have been foreclosed.

It must also be noted that just because a Google app is pre-installed does not mean that it generates any revenue to Google — consumers have to actually choose to use that app as opposed to another one that they might prefer in order for Google to earn any revenue from it. The Commission seems to place substantial weight on pre-installation which it alleges to create “a status quo bias.”

The concern with this approach is that it is not possible to know whether those consumers who do not download competing apps do so out of a preference for Google’s apps or, instead, for other reasons that might indicate competition not to be working. Indeed, one hurdle as regards conceptualising the infringement as tying is that it would require establishing that a significant number of phone users would actually prefer to use Google Play Store (the tying product) without Google Search App (the tied product).

This is because, according to the Commission’s Guidance Paper, establishing tying starts with identifying two distinct products, and

[t]wo products are distinct if, in the absence of tying or bundling, a substantial number of customers would purchase or would have purchased the tying product without also buying the tied product from the same supplier.

Thus, if a substantial number of customers would not want to use Google Play Store without also preferring to use Google Search App, this would cause a conceptual problem for making out a tying claim.

In fact, the conduct at issue in Google Android may be closer to a refusal to supply type of abuse.

Refusal to supply also seems to make more sense regarding the prevention of the development of Android forks being found to be an abuse. In this context, it will be interesting to see how the Commission overcomes the argument that Android forks can be developed freely and Google may have legitimate business reasons in wanting to associate its own, proprietary apps only with a certain, standardised-quality version of the operating system.

More importantly, the possible underlying theory in this part of the case is that the Google apps — and perhaps even the licensed version of Android — are a “must-have,” which is close to an argument that they are an essential facility in the context of Android phones. But that would indeed require a refusal to supply type of abuse to be established, which does not appear to be the case.

What will happen next?

To answer the question raised in the title of this post — whether the Google Android decision will benefit consumers — one needs to consider what Google may do in order to terminate the infringing conduct as required by the Commission, whilst also still generating revenue from Android.

This is because unbundling Google Play Store, Google Search App and Google Chrome (to allow manufacturers to pre-install Google Play Store without the latter two) will disrupt Google’s main revenue stream (i.e., ad revenue generated through the use of Google Search App or Google Search within the Chrome app) which funds the free operating system. This could lead Google to start charging for the operating system, and limiting to whom it licenses the operating system under the Commission’s required, less-restrictive terms.

As the Commission does not seem to think that Apple constrains Google when it comes to dealings with device manufacturers, in theory, Google should be able to charge up to the monopoly level licensing fee to device manufacturers. If that happens, the price of Android smartphones may go up. It is possible that there is a new competitor lurking in the woods that will grow and constrain that exercise of market power, but how this will all play out for consumers — as well as app developers who may face increasing costs due to the forking of Android — really remains to be seen.

 

* Pinar Akman is Professor of Law, Director of Centre for Business Law and Practice, University of Leeds, UK. This piece has not been commissioned or funded by any entity. The author has not been involved in the Google Android case in any capacity. In the past, the author wrote a piece on the Commission’s Google Shopping case, ‘The Theory of Abuse in Google Search: A Positive and Normative Assessment under EU Competition Law,’ supported by a research grant from Google. The author would like to thank Peter Whelan, Konstantinos Stylianou, and Geoffrey Manne for helpful comments. All errors remain her own. The author can be contacted here.

In Antitrust & Competition, Apple, European Union, Exclusive Dealing, Google, Intellectual Property, International, Market Definition, Monopolization, Patent, Platforms, Tying, Vertical Restraints , , , , , , , , , , , , , , ,
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The EU’s Google Android antitrust decision falls prey to the nirvana fallacy

Geoffrey Manne —  18 July 2018

Today the European Commission launched its latest salvo against Google, issuing a decision in its three-year antitrust investigation into the company’s agreements for distribution of the Android mobile operating system. The massive fine levied by the Commission will dominate the headlines, but the underlying legal theory and proposed remedies are just as notable — and just as problematic.

The nirvana fallacy

It is sometimes said that the most important question in all of economics is “compared to what?” UCLA economist Harold Demsetz — one of the most important regulatory economists of the past century — coined the term “nirvana fallacy” to critique would-be regulators’ tendency to compare messy, real-world economic circumstances to idealized alternatives, and to justify policies on the basis of the discrepancy between them. Wishful thinking, in other words.

The Commission’s Android decision falls prey to the nirvana fallacy. It conjures a world in which Google offers its Android operating system on unrealistic terms, prohibits it from doing otherwise, and neglects the actual consequences of such a demand.

The idea at the core of the Commission’s decision is that by making its own services (especially Google Search and Google Play Store) easier to access than competing services on Android devices, Google has effectively foreclosed rivals from effective competition. In order to correct that claimed defect, the Commission demands that Google refrain from engaging in practices that favor its own products in its Android licensing agreements:

At a minimum, Google has to stop and to not re-engage in any of the three types of practices. The decision also requires Google to refrain from any measure that has the same or an equivalent object or effect as these practices.

The basic theory is straightforward enough, but its application here reflects a troubling departure from the underlying economics and a romanticized embrace of industrial policy that is unsupported by the realities of the market.

In a recent interview, European Commission competition chief, Margrethe Vestager, offered a revealing insight into her thinking about her oversight of digital platforms, and perhaps the economy in general: “My concern is more about whether we get the right choices,” she said. Asked about Facebook, for example, she specified exactly what she thinks the “right” choice looks like: “I would like to have a Facebook in which I pay a fee each month, but I would have no tracking and advertising and the full benefits of privacy.”

Some consumers may well be sympathetic with her preference (and even share her specific vision of what Facebook should offer them). But what if competition doesn’t result in our — or, more to the point, Margrethe Vestager’s — prefered outcomes? Should competition policy nevertheless enact the idiosyncratic consumer preferences of a particular regulator? What if offering consumers the “right” choices comes at the expense of other things they value, like innovation, product quality, or price? And, if so, can antitrust enforcers actually engineer a better world built around these preferences?

Android’s alleged foreclosure… that doesn’t really foreclose anything

The Commission’s primary concern is with the terms of Google’s deal: In exchange for royalty-free access to Android and a set of core, Android-specific applications and services (like Google Search and Google Maps) Google imposes a few contractual conditions.

Google allows manufacturers to use the Android platform — in which the company has invested (and continues to invest) billions of dollars — for free. It does not require device makers to include any of its core, Google-branded features. But if a manufacturer does decide to use any of them, it must include all of them, and make Google Search the device default. In another (much smaller) set of agreements, Google also offers device makers a small share of its revenue from Search if they agree to pre-install only Google Search on their devices (although users remain free to download and install any competing services they wish).

Essentially, that’s it. Google doesn’t allow device makers to pick and choose between parts of the ecosystem of Google products, free-riding on Google’s brand and investments. But manufacturers are free to use the Android platform and to develop their own competing brand built upon Google’s technology.

Other apps may be installed in addition to Google’s core apps. Google Search need not be the exclusive search service, but it must be offered out of the box as the default. Google Play and Chrome must be made available to users, but other app stores and browsers may be pre-installed and even offered as the default. And device makers who choose to do so may share in Search revenue by pre-installing Google Search exclusively — but users can and do install a different search service.

Alternatives to all of Google’s services (including Search) abound on the Android platform. It’s trivial both to install them and to set them as the default. Meanwhile, device makers regularly choose to offer these apps alongside Google’s services, and some, like Samsung, have developed entire customized app suites of their own. Still others, like Amazon, pre-install no Google apps and use Android without any of these constraints (and whose Google-free tablets are regularly ranked as the best-rated and most popular in Europe).

By contrast, Apple bundles its operating system with its devices, bypasses third-party device makers entirely, and offers consumers access to its operating system only if they pay (lavishly) for one of the very limited number of devices the company offers, as well. It is perhaps not surprising — although it is enlightening — that Apple earns more revenue in an average quarter from iPhone sales than Google is reported to have earned in total from Android since it began offering it in 2008.

Reality — and the limits it imposes on efforts to manufacture nirvana

The logic behind Google’s approach to Android is obvious: It is the extension of Google’s “advertisers pay” platform strategy to mobile. Rather than charging device makers (and thus consumers) directly for its services, Google earns its revenue by charging advertisers for targeted access to users via Search. Remove Search from mobile devices and you remove the mechanism by which Google gets paid.

It’s true that most device makers opt to offer Google’s suite of services to European users, and that most users opt to keep Google Search as the default on their devices — that is, indeed, the hoped-for effect, and necessary to ensure that Google earns a return on its investment.

That users often choose to keep using Google services instead of installing alternatives, and that device makers typically choose to engineer their products around the Google ecosystem, isn’t primarily the result of a Google-imposed mandate; it’s the result of consumer preferences for Google’s offerings in lieu of readily available alternatives.

The EU decision against Google appears to imagine a world in which Google will continue to develop Android and allow device makers to use the platform and Google’s services for free, even if the likelihood of recouping its investment is diminished.

The Commission also assessed in detail Google’s arguments that the tying of the Google Search app and Chrome browser were necessary, in particular to allow Google to monetise its investment in Android, and concluded that these arguments were not well founded. Google achieves billions of dollars in annual revenues with the Google Play Store alone, it collects a lot of data that is valuable to Google’s search and advertising business from Android devices, and it would still have benefitted from a significant stream of revenue from search advertising without the restrictions.

For the Commission, Google’s earned enough [trust me: you should follow the link. It’s my favorite joke…].

But that world in which Google won’t alter its investment decisions based on a government-mandated reduction in its allowable return on investment doesn’t exist; it’s a fanciful Nirvana.

Google’s real alternatives to the status quo are charging for the use of Android, closing the Android platform and distributing it (like Apple) only on a fully integrated basis, or discontinuing Android.

In reality, and compared to these actual alternatives, Google’s restrictions are trivial. Remember, Google doesn’t insist that Google Search be exclusive, only that it benefit from a “leg up” by being pre-installed as the default. And on this thin reed Google finances the development and maintenance of the (free) Android operating system and all of the other (free) apps from which Google otherwise earns little or no revenue.

It’s hard to see how consumers, device makers, or app developers would be made better off without Google’s restrictions, but in the real world in which the alternative is one of the three manifestly less desirable options mentioned above.

Missing the real competition for the trees

What’s more, while ostensibly aimed at increasing competition, the Commission’s proposed remedy — like the conduct it addresses — doesn’t relate to Google’s most significant competitors at all.

Facebook, Instagram, Firefox, Amazon, Spotify, Yelp, and Yahoo, among many others, are some of the most popular apps on Android phones, including in Europe. They aren’t foreclosed by Google’s Android distribution terms, and it’s even hard to imagine that they would be more popular if only Android phones didn’t come with, say, Google Search pre-installed.

It’s a strange anticompetitive story that has Google allegedly foreclosing insignificant competitors while apparently ignoring its most substantial threats.

The primary challenges Google now faces are from Facebook drawing away the most valuable advertising and Amazon drawing away the most valuable product searches (and increasingly advertising, as well). The fact that Google’s challenged conduct has never shifted in order to target these competitors as their threat emerged, and has had no apparent effect on these competitive dynamics, says all one needs to know about the merits of the Commission’s decision and the value of its proposed remedy.

In reality, as Demsetz suggested, Nirvana cannot be designed by politicians, especially in complex, modern technology markets. Consumers’ best hope for something close — continued innovation, low prices, and voluminous choice — lies in the evolution of markets spurred by consumer demand, not regulators’ efforts to engineer them.

In Amazon, Antitrust & Competition, Apple, European Union, Facebook, Google, International, International Trade, Law & Economics, Market Definition, Platforms, Tying, Vertical Restraints , , , , , , , , , , , , , , , , , ,
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Why the Commission’s Google Android decision harms competition and stifles innovation

Dirk Auer —  18 July 2018

Our story begins on the morning of January 9, 2007. Few people knew it at the time, but the world of wireless communications was about to change forever. Steve Jobs walked on stage wearing his usual turtleneck, and proceeded to reveal the iPhone. The rest, as they say, is history. The iPhone moved the wireless communications industry towards a new paradigm. No more physical keyboards, clamshell bodies, and protruding antennae. All of these were replaced by a beautiful black design, a huge touchscreen (3.5” was big for that time), a rear-facing camera, and (a little bit later) a revolutionary new way to consume applications: the App Store. Sales soared and Apple’s stock started an upward trajectory that would see it become one of the world’s most valuable companies.

The story could very well have ended there. If it had, we might all be using iPhones today. However, years before, Google had commenced its own march into the wireless communications space by purchasing a small startup called Android. A first phone had initially been slated for release in late 2007. But Apple’s iPhone announcement sent Google back to the drawing board. It took Google and its partners until 2010 to come up with a competitive answer – the Google Nexus One produced by HTC.

Understanding the strategy that Google put in place during this three year timespan is essential to understanding the European Commission’s Google Android decision.

How to beat one of the great innovations?

In order to overthrow — or even merely just compete with — the iPhone, Google faced the same dilemma that most second-movers have to contend with: imitate or differentiate. Its solution was a mix of both. It took the touchscreen, camera, and applications, but departed on one key aspect. Whereas Apple controls the iPhone from end-to-end, Google opted for a licensed, open-source operating system that substitutes a more-decentralized approach for Apple’s so-called “walled garden.”

Google and a number of partners founded the Open Handset Alliance (“OHA”) in November 2007. This loose association of network operators, software companies and handset manufacturers became the driving force behind the Android OS. Through the OHA, Google and its partners have worked to develop minimal specifications for OHA-compliant Android devices in order to ensure that all levels of the device ecosystem — from device makers to app developers — function well together. As its initial press release boasts, through the OHA:

Handset manufacturers and wireless operators will be free to customize Android in order to bring to market innovative new products faster and at a much lower cost. Developers will have complete access to handset capabilities and tools that will enable them to build more compelling and user-friendly services, bringing the Internet developer model to the mobile space. And consumers worldwide will have access to less expensive mobile devices that feature more compelling services, rich Internet applications and easier-to-use interfaces — ultimately creating a superior mobile experience.

The open source route has a number of advantages — notably the improved division of labor — but it is not without challenges. One key difficulty lies in coordinating and incentivizing the dozens of firms that make up the alliance. Google must not only keep the diverse Android ecosystem directed toward a common, compatible goal, it also has to monetize a product that, by its very nature, is given away free of charge. It is Google’s answers to these two problems that set off the Commission’s investigation.

The first problem is a direct consequence of Android’s decentralization. Whereas there are only a small number of iPhones (the couple of models which Apple markets at any given time) running the same operating system, Android comes in a jaw-dropping array of flavors. Some devices are produced by Google itself, others are the fruit of high-end manufacturers such as Samsung and LG, there are also so-called “flagship killers” like OnePlus, and budget phones from the likes of Motorola and Honor (one of Huawei’s brands). The differences don’t stop there. Manufacturers, like Samsung, Xiaomi and LG (to name but a few) have tinkered with the basic Android setup. Samsung phones heavily incorporate its Bixby virtual assistant, while Xiaomi packs in a novel user interface. The upshot is that the Android marketplace is tremendously diverse.

Managing this variety is challenging, to say the least (preventing projects from unravelling into a myriad of forks is always an issue for open source projects). Google and the OHA have come up with an elegant solution. The alliance penalizes so-called “incompatible” devices — that is, handsets whose software or hardware stray too far from a predetermined series of specifications. When this is the case, Google may refuse to license its proprietary applications (most notably the Play Store). This minimum level of uniformity ensures that apps will run smoothly on all devices. It also provides users with a consistent experience (thereby protecting the Android brand) and reduces the cost of developing applications for Android. Unsurprisingly, Android developers have lauded these “anti-fragmentation” measures, branding the Commission’s case a disaster.

A second important problem stems from the fact that the Android OS is an open source project. Device manufacturers can thus license the software free of charge. This is no small advantage. It shaves precious dollars from the price of Android smartphones, thus opening-up the budget end of the market. Although there are numerous factors at play, it should be noted that a top of the range Samsung Galaxy S9+ is roughly 30% cheaper ($819) than its Apple counterpart, the iPhone X ($1165).

Offering a competitive operating system free of charge might provide a fantastic deal for consumers, but it poses obvious business challenges. How can Google and other members of the OHA earn a return on the significant amounts of money poured into developing, improving, and marketing and Android devices? As is often the case with open source projects, they essentially rely on complementarities. Google produces the Android OS in the hope that it will boost users’ consumption of its profitable, ad-supported services (Google Search in particular). This is sometimes referred to as a loss leader or complementary goods strategy.

Google uses two important sets of contractual provisions to cement this loss leader strategy. First, it seemingly bundles a number of proprietary applications together. Manufacturers must pre-load the Google Search and Chrome apps in order to obtain the Play Store app (the lynchpin on which the Android ecosystem sits). Second, Google has concluded a number of “revenue sharing” deals with manufacturers and network operators. These companies receive monetary compensation when the Google Search is displayed prominently on a user’s home screen. In effect, they are receiving a cut of the marginal revenue that the use of this search bar generates for Google. Both of these measures ultimately nudge users — but do not force them, as neither prevents users from installing competing apps — into using Google’s most profitable services.

Readers would be forgiven for thinking that this is a win-win situation. Users get a competitive product free of charge, while Google and other members of the OHA earn enough money to compete against Apple.

The Commission is of another mind, however.

Commission’s hubris

The European Commission believes that Google is hurting competition. Though the text of the decision is not yet available, the thrust of its argument is that Google’s anti-fragmentation measures prevent software developers from launching competing OSs, while the bundling and revenue sharing both thwart rival search engines.

This analysis runs counter to some rather obvious facts:

  • For a start, the Android ecosystem is vibrant. Numerous firms have launched forked versions of Android, both with and without Google’s apps. Amazon’s Fire line of devices is a notable example.
  • Second, although Google’s behavior does have an effect on the search engine market, there is nothing anticompetitive about it. Yahoo could very well have avoided its high-profile failure if, way back in 2005, it had understood the importance of the mobile internet. At the time, it still had a 30% market share, compared to Google’s 36%. Firms that fail to seize upon business opportunities will fall out of the market. This is not a bug; it is possibly the most important feature of market economies. It reveals the products that consumers prefer and stops resources from being allocated to less valuable propositions.
  • Last but not least, Google’s behavior does not prevent other search engines from placing their own search bars or virtual assistants on smartphones. This is essentially what Samsung has done by ditching Google’s assistant in favor of its Bixby service. In other words, Google is merely competing with other firms to place key apps on or near the home screen of devices.

Even if the Commission’s reasoning where somehow correct, the competition watchdog is using a sledgehammer to crack a nut. The potential repercussions for Android, the software industry, and European competition law are great:

  • For a start, the Commission risks significantly weakening Android’s competitive position relative to Apple. Android is a complex ecosystem. The idea that it is possible to bring incremental changes to its strategy without threatening the viability of the whole is a sign of the Commission’s hubris.
  • More broadly, the harsh treatment of Google could have significant incentive effects for other tech platforms. As others have already pointed out, the Commission’s decision rests on the idea that dominant firms should not be allowed to favor their own services compared to those of rivals. Taken a face value, this anti-discrimination policy will push firms to design closed platforms. If rivals are excluded from the very start, there is no one against whom to discriminate. Antitrust watchdogs are thus kept at bay (and thus the Commission is acting against Google’s marginal preference for its own services, rather than Apple’s far-more-substantial preferencing of its own services). Moving to a world of only walled gardens might harm users and innovators alike.

Over the next couple of days and weeks, many will jump to the Commission’s defense. They will see its action as a necessary step against the abstract “power” of Silicon Valley’s tech giants. Rivals will feel vindicated. But when all is done and dusted, there seems to be little doubt that the decision is misguided. The Commission will have struck a blow to the heart of the most competitive offering in the smartphone space. And consumers will be the biggest losers.

This is not what the competition laws were intended to achieve.

In Amazon, Antitrust & Competition, Apple, European Union, Google, International, Law & Economics, Market Definition, Monopolization, Platforms, Telecommunications, Tying, Vertical Restraints, Wireless , , , , , , , , , , , , ,
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Microsoft’s Android Anathema

Geoffrey Manne —  15 August 2014

Microsoft wants you to believe that Google’s business practices stifle competition and harm consumers. Again.

The latest volley in its tiresome and ironic campaign to bludgeon Google with the same regulatory club once used against Microsoft itself is the company’s effort to foment an Android-related antitrust case in Europe.

In a recent polemic, Microsoft consultant (and business school professor) Ben Edelman denounces Google for requiring that, if device manufacturers want to pre-install key Google apps on Android devices, they “must install all the apps Google specifies, with the prominence Google requires, including setting these apps as defaults where Google instructs.” Edelman trots out gasp-worthy “secret” licensing agreements that he claims support his allegation (more on this later).

Similarly, a recent Wall Street Journal article, “Android’s ‘Open’ System Has Limits,” cites Edelman’s claim that limits on the licensing of Google’s proprietary apps mean that the Android operating system isn’t truly open source and comes with “strings attached.”

In fact, along with the Microsoft-funded trade organization FairSearch, Edelman has gone so far as to charge that this “tying” constitutes an antitrust violation. It is this claim that Microsoft and a network of proxies brought to the Commission when their efforts to manufacture a search-neutrality-based competition case against Google failed.

But before getting too caught up in the latest round of anti-Google hysteria, it’s worth noting that the Federal Trade Commission has already reviewed these claims. After a thorough, two-year inquiry, the FTC found the antitrust arguments against Google to be without merit. The South Korea Fair Trade Commission conducted its own two year investigation into Google’s Android business practices and dismissed the claims before it as meritless, as well.

Taking on Edelman and FairSearch with an exhaustive scholarly analysis, German law professor Torsten Koerber recently assessed the nature of competition among mobile operating systems and concluded that:

(T)he (EU) Fairsearch complaint ultimately does not aim to protect competition or consumers, as it pretends to. It rather strives to shelter Microsoft from competition by abusing competition law to attack Google’s business model and subvert competition.

It’s time to take a step back and consider the real issues at play.

In order to argue that Google has an iron grip on Android, Edelman’s analysis relies heavily on ”secret” Google licensing agreements — “MADAs” (Mobile Application Distribution Agreements) — trotted out with such fanfare one might think it was the first time two companies ever had a written contract (or tried to keep it confidential).

For Edelman, these agreements “suppress competition” with “no plausible pro-consumer benefits.” He writes, “I see no way to reconcile the MADA restrictions with [Android openness].”

Conveniently, however, Edelman neglects to cite to Section 2.6 of the MADA:

The parties will create an open environment for the Devices by making all Android Products and Android Application Programming Interfaces available and open on the Devices and will take no action to limit or restrict the Android platform.

Professor Korber’s analysis provides a straight-forward explanation of the relationship between Android and its OEM licensees:

Google offers Android to OEMs on a royalty-free basis. The licensees are free to download, distribute and even modify the Android code as they like. OEMs can create mobile devices that run “pure” Android…or they can apply their own user interfaces (IO) and thereby hide most of the underlying Android system (e.g. Samsung’s “TouchWiz” or HTC’s “Sense”). OEMs make ample use of this option.

The truth is that the Android operating system remains, as ever, definitively open source — but Android’s openness isn’t really what the fuss is about. In this case, the confusion (or obfuscation) stems from the casual confounding of Google Apps with the Android Operating System. As we’ll see, they aren’t the same thing.

Consider Amazon, which pre-loads no Google applications at all on its Kindle Fire and Fire Phone. Amazon’s version of Android uses Microsoft’s Bing as the default search engine; Nokia provides mapping services, and the app store is Amazon’s own.

Still, Microsoft’s apologists continue to claim that Android licensees can’t choose to opt out of Google’s applications suite — even though, according to a new report from ABI Research, 20 percent of smartphones shipped between May and July 2014 were based on a “Google-less” version of the Android OS. And that number is consistently increasing: Analysts predict that by 2015, 30 percent of Android phones won’t access Google Services.

It’s true that equipment manufacturers who choose the Android operating system have the option to include the suite of integrated, proprietary Google apps and services licensed (royalty-free) under the name Google Mobile Services (GMS). GMS includes Google Search, Maps, Calendar, YouTube and other apps that together define the “Google Android experience” that users know and love.

But Google Android is far from the only Android experience.

Even if a manufacturer chooses to license Google’s apps suite, Google’s terms are not exclusive. Handset makers are free to install competing applications, including other search engines, map applications or app stores.

Although Google requires that Google Search be made easily accessible (hardly a bad thing for consumers, as it is Google Search that finances the development and maintenance of all of the other (free) apps from which Google otherwise earns little to no revenue), OEMs and users alike can (and do) easily install and access other search engines in numerous ways. As Professor Korber notes:

The standard MADA does not entail any exclusivity for Google Search nor does it mandate a search default for the web browser.

Regardless, integrating key Google apps (like Google Search and YouTube) with other apps the company offers (like Gmail and Google+) is an antitrust problem only if it significantly forecloses competitors from these apps’ markets compared to a world without integrated Google apps, and without pro-competitive justification. Neither is true, despite the unsubstantiated claims to the contrary from Edelman, FairSearch and others.

Consumers and developers expect and demand consistency across devices so they know what they’re getting and don’t have to re-learn basic functions or program multiple versions of the same application. Indeed, Apple’s devices are popular in part because Apple’s closed iOS provides a predictable, seamless experience for users and developers.

But making Android competitive with its tightly controlled competitors requires special efforts from Google to maintain a uniform and consistent experience for users. Google has tried to achieve this uniformity by increasingly disentangling its apps from the operating system (the opposite of tying) and giving OEMs the option (but not the requirement) of licensing GMS — a “suite” of technically integrated Google applications (integrated with each other, not the OS).  Devices with these proprietary apps thus ensure that both consumers and developers know what they’re getting.

Unlike Android, Apple prohibits modifications of its operating system by downstream partners and users, and completely controls the pre-installation of apps on iOS devices. It deeply integrates applications into iOS, including Apple Maps, iTunes, Siri, Safari, its App Store and others. Microsoft has copied Apple’s model to a large degree, hard-coding its own applications (including Bing, Windows Store, Skype, Internet Explorer, Bing Maps and Office) into the Windows Phone operating system.

In the service of creating and maintaining a competitive platform, each of these closed OS’s bakes into its operating system significant limitations on which third-party apps can be installed and what they can (and can’t) do. For example, neither platform permits installation of a third-party app store, and neither can be significantly customized. Apple’s iOS also prohibits users from changing default applications — although the soon-to-be released iOS 8 appears to be somewhat more flexible than previous versions.

In addition to pre-installing a raft of their own apps and limiting installation of other apps, both Apple and Microsoft enable greater functionality for their own apps than they do the third-party apps they allow.

For example, Apple doesn’t make available for other browsers (like Google’s Chrome) all the JavaScript functionality that it does for Safari, and it requires other browsers to use iOS Webkit instead of their own web engines. As a result there are things that Chrome can’t do on iOS that Safari and only Safari can do, and Chrome itself is hamstrung in implementing its own software on iOS. This approach has led Mozilla to refuse to offer its popular Firefox browser for iOS devices (while it has no such reluctance about offering it on Android).

On Windows Phone, meanwhile, Bing is integrated into the OS and can’t be removed. Only in markets where Bing is not supported (and with Microsoft’s prior approval) can OEMs change the default search app from Bing. While it was once possible to change the default search engine that opens in Internet Explorer (although never from the hardware search button), the Windows 8.1 Hardware Development Notes, updated July 22, 2014, state:

By default, the only search provider included on the phone is Bing. The search provider used in the browser is always the same as the one launched by the hardware search button.

Both Apple iOS and Windows Phone tightly control the ability to use non-default apps to open intents sent from other apps and, in Windows especially, often these linkages can’t be changed.

As a result of these sorts of policies, maintaining the integrity — and thus the brand — of the platform is (relatively) easy for closed systems. While plenty of browsers are perfectly capable of answering an intent to open a web page, Windows Phone can better ensure a consistent and reliable experience by forcing Internet Explorer to handle the operation.

By comparison, Android, with or without Google Mobile Services, is dramatically more open, more flexible and customizable, and more amenable to third-party competition. Even the APIs that it uses to integrate its apps are open to all developers, ensuring that there is nothing that Google apps are able to do that non-Google apps with the same functionality are prevented from doing.

In other words, not just Gmail, but any email app is permitted to handle requests from any other app to send emails; not just Google Calendar but any calendar app is permitted to handle requests from any other app to accept invitations.

In no small part because of this openness and flexibility, current reports indicate that Android OS runs 85 percent of mobile devices worldwide. But it is OEM giant Samsung, not Google, that dominates the market, with a 65 percent share of all Android devices. Competition is rife, however, especially in emerging markets. In fact, according to one report, “Chinese and Indian vendors accounted for the majority of smartphone shipments for the first time with a 51% share” in 2Q 2014.

As he has not been in the past, Edelman is at least nominally circumspect in his unsubstantiated legal conclusions about Android’s anticompetitive effect:

Applicable antitrust law can be complicated: Some ties yield useful efficiencies, and not all ties reduce welfare.

Given Edelman’s connections to Microsoft and the realities of the market he is discussing, it could hardly be otherwise. If every integration were an antitrust violation, every element of every operating system — including Apple’s iOS as well as every variant of Microsoft’s Windows — should arguably be the subject of a government investigation.

In truth, Google has done nothing more than ensure that its own suite of apps functions on top of Android to maintain what Google sees as seamless interconnectivity, a high-quality experience for users, and consistency for application developers — while still allowing handset manufacturers room to innovate in a way that is impossible on other platforms. This is the very definition of pro-competitive, and ultimately this is what allows the platform as a whole to compete against its far more vertically integrated alternatives.

Which brings us back to Microsoft. On the conclusion of the FTC investigation in January 2013, a GigaOm exposé on the case had this to say:

Critics who say Google is too powerful have nagged the government for years to regulate the company’s search listings. But today the critics came up dry….

The biggest loser is Microsoft, which funded a long-running cloak-and-dagger lobbying campaign to convince the public and government that its arch-enemy had to be regulated….

The FTC is also a loser because it ran a high profile two-year investigation but came up dry.

EU regulators, take note.

In Amazon, Antitrust & Competition, Apple, Federal Trade Commission, Google, Law & Economics, Monopolization, Platforms, Telecommunications, Tying, Wireless , , , , , , , , , , , , , , ,
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