Archives For Joshua Gans

Why I think the Apple e-books antitrust decision will (or at least should) be overturned

Geoffrey Manne —  22 July 2013

On July 10 a federal judge ruled that Apple violated antitrust law by conspiring to raise prices of e-books when it negotiated deals with five major publishers. I’ve written on the case and the issues involved in it several times, including here, here, here and here. The most recent of these was titled, “Why I think the government will have a tough time winning the Apple e-books antitrust case.” I’m hedging my bets with the title this time, but it’s fairly clear to me that the court got this case wrong.

The predominant sentiment among pundits following the decision seems to be approval (among authors, however, the response to the suit has been decidedly different). Supporters believe it will lower e-book prices and instigate a shift in the electronic publishing industry toward some more-preferred business model. This sort of reasoning is dangerous and inconsistent with principled, restrained antitrust. Neither the government nor its supporting commentators should use, or applaud the use, of antitrust to impose the government’s (or anyone else’s) preferred business model on industry. And lower prices in the short run, while often an indication of increased competition, are not, by themselves, sufficient to determine that a business model is efficient in the long run.

For example, in a recent article, Mark Lemley is quoted supporting the outcome, noting that it may spur a shift toward his preferred model of electronic publishing:

It also makes no sense that publishers, not authors, capture most of the revenue from e-books, when they do very little of the work. I understand why publishers are reluctant to give up their old business model, but if they want to survive in the digital world, it’s time to make some changes.

As noted, there is no basis for using antitrust enforcement to coerce an industry to shift to a particular distribution of profits simply because “it’s time to make some changes.” Lemley’s characterization of the market’s dynamics is also seriously lacking in economic grounding (and the Authors Guild response to the suit linked above suggests the same). The economics of entrepreneurship has an impressive intellectual pedigree that began with Frank Knight, was further developed by Joseph Schumpeter, Israel Kirzner and Harold Demsetz, among others, and continues to today with its inclusion as a factor of production. (On the development of this tradition and especially Harold Demsetz’s important contribution to it, see here). The implicit claim that publishers’ and authors’ interests (to say nothing of consumers’ interests) are simply at odds, and that the “right” distribution of profits would favor authors over publishers based on the amount of “work” they do is economically baseless. Although it is a common claim, reflecting either idiosyncratic preferences or ignorance about the role of content publishers and distributors in the e-book marketplace and the role of entrepreneurship more generally, it is nonetheless mistaken and has no place in a consumer-welfare-based assessment of the market or antitrust intervention in it.

It’s also utterly unclear how the antitrust suit would do anything to change the relative distribution of profits between publishers and authors. In fact, the availability of direct publishing (offered by both Amazon and Apple) is the most likely disruptor of that dynamic, and authors could only be helped by an increase in competition among platforms—in other words, by Apple’s successful entry into the market.

Apple entered the e-books market as a relatively small upstart battling a dominant incumbent. That it did so by offering publishers (suppliers) attractive terms to deal with its new iBookstore is no different than a new competitor in any industry offering novel products or loss-leader prices to attract customers and build market share. When new entry then induces an industry-wide shift toward the new entrants’ products, prices or business model it’s usually called “competition,” and lauded as the aim of properly functioning markets. The same should be true here.

Despite the court’s claim that

there is overwhelming evidence that the Publisher Defendants joined with each other in a horizontal price-fixing conspiracy,

that evidence is actually extremely weak. What is unclear is why the publishers would need a conspiracy when they rarely compete against each other directly.

The court states that

To protect their then-existing business model, the Publisher Defendants agreed to raise the prices of e-books by taking control of retail pricing.

But despite the use of the antitrust trigger-words, “agreed to raise prices,” this agreement is not remotely clear, and rests entirely on circumstantial evidence (more on this later). None of the evidence suggests actual agreement over price, and none of the evidence demonstrates conclusively any real incentive for the publishers to reach “agreement” at all. In actuality, publishers rarely compete against each other directly (least of all on price); instead, for each individual publisher (and really for each individual title), the most relevant competition for this case is between the e-book version of a particular title and its physical counterpart. In this situation it should matter little to any particular e-book’s sales whether every other e-book in the world is sold at the same price or even a lower price.

While the opinion asserts that each publisher

could also expect to lose substantial sales if they unilaterally raised the prices of their own e-books and none of their competitors followed suit,

it also states that

there is no evidence that the Publisher Defendants have ever competed with each other on price. To the contrary, several of the Publishers’ CEOs explained that they have not competed with each other on that basis.

These statements are difficult to reconcile, but the evidence supports the latter statement, not the former.

The only explanation offered by the court for the publishers’ alleged need for concerted action is an ambiguous claim that Amazon would capitulate in shifting to the agency model only if every publisher pressured it to do so simultaneously. The court claims that

if the Publisher Defendants were going to take control of e-book pricing and move the price point above $9.99, they needed to act collectively; any other course would leave an individual Publisher vulnerable to retaliation from Amazon.

But it’s not clear why this would be so.

On the one hand, if Apple really were the electronic publishing juggernaut implied by this antitrust action, this concern should be minimal: Publishers wouldn’t need Amazon and could simply sell their e-books through Apple’s iBookstore. In this case the threat of even any individual publisher’s “retaliation” against Amazon (decamping to Apple) would suffice to shift relative bargaining power between the publishers and Amazon, and concerted action wouldn’t be necessary. On this theory, the fact that it was only after Apple’s entry that Amazon agreed to shift to the agency model—a fact cited by the court many times to support its conclusions—is utterly unremarkable.

That prices may have shifted as well is equally unremarkable: The agency model puts pricing decisions in publishers’ hands (who, as I’ve previously discussed, have very different incentives than Amazon) where before Amazon had control over prices. Moreover, even when Apple presented evidence that average e-book prices actually fell after its entrance into the market, the court demanded that Apple prove a causal relationship between its entrance and lower overall prices. (Even the DOJ’s own evidence shows, at worst, little change in price, despite its heated claims to the contrary.) But the burden of proof in such cases rests with the government to prove that Apple caused prices to rise, not for Apple to explain why they fell.

On the other hand, if the loss of Amazon as a retail outlet were really so significant for publishers, Apple’s ability to function as the lynchpin of the alleged conspiracy is seriously questionable. While the agency model coupled with the persistence of $9.99 pricing by Amazon would seem to mean reduced revenue for publishers on each book sold through Apple’s store, the relatively trivial number of Apple sales compared with Amazon’s, particularly at the outset, would be of little concern to publishers, and thus to Amazon. In this case it is difficult to believe that publishers would threaten their relationships with Amazon for the sake of preserving the return on their newly negotiated contracts with Apple (and even more difficult to believe that Amazon would capitulate), and the claimed coordinating effects of the MFN provisions is difficult to sustain.

The story with respect to Amazon is questionable for another reason. While the court claims that the publishers’ concern with Amazon’s $9.99 pricing was its effect on physical book sales, it is extremely hard to believe that somehow $12.99 for the electronic version of a $30 (or, often, even more expensive) physical book would be significantly less damaging to physical book sales. Moreover, the evidence put forth by the DOJ and found persuasive by the court all pointed to e-book revenues alone, not physical book sales, as the issue of most concern to publishers (thus, for example, Steve Jobs wrote to HarperCollins’ CEO that it could “[k]eep going with Amazon at $9.99. You will make a bit more money in the short term, but in the medium term Amazon will tell you they will be paying you 70% of $9.99. They have shareholders too.”).

Moreover, as Joshua Gans points out, the agency model that Amazon may have entered into with the publishers would have been particularly unhelpful in ensuring monopoly returns for the publishers (we don’t know the exact terms of their contracts, however, and there are reports from trial that Amazon’s terms were “identical” to Apple’s):

While Apple gave publishers a 70 percent share of book sales and the ability to set their own price, Amazon offered a menu. If you price below $9.99 for a book, Amazon’s share will be 70 percent but if you price above $10, Amazon only returns 35 percent to the publisher. Amazon also charged publishers a delivery fee based on the book’s size (in kb).

Thus publishers could, of course, raise prices to $12.99 in both Apple’s and Amazon’s e-book stores, but, if this effective price cap applied, doing so would result in a significant loss of revenue from Amazon. In other words, the court’s claim—that, having entered into MFNs with Apple, the publishers then had to move Amazon to the agency model to ensure that they didn’t end up being forced by the MFNs to sell books via Apple (on the less-attractive agency terms) at Amazon’s $9.99—is far-fetched. To the extent that raising Amazon’s prices above $10 may have cut royalties almost in half, the MFNs with Apple would be extremely unlikely to have such a powerful effect. But, as noted above, because of the relative sales volumes involved the same dynamic would have applied even under identical terms.

It is true, of course, that Apple cares about price differences between books sold through its iBookstore and the same titles sold through other electronic retailers—and thus it imposed MFN clauses on the publishers. But this is not anticompetitive. In fact, by facilitating Apple’s entry, the MFN clauses plainly increased competition by introducing a new competitor to the industry. What’s more, the terms of Apple’s agreements with the publishers exactly mirrors the terms it uses for apps and music sold through the iTunes store, as well. And as Gordon Crovitz noted:

As this column reported when the case was brought last year, Apple executive Eddy Cue in 2011 turned down my effort to negotiate different terms for apps by news publishers by telling me: “I don’t think you understand. We can’t treat newspapers or magazines any differently than we treat FarmVille.” His point was clear: The 30% revenue-share model is how Apple does business with everyone. It is not, as the government alleges, a scheme Apple concocted to fix prices with book publishers.

Another important error in the case — and, unfortunately, it is one to which Apple’s lawyers acceded—is the treatment of “trade e-books” as the relevant market. For antitrust purposes, there is no generalized e-book (or physical book, for that matter) market. As noted above, the court itself acknowledged that the publishers “have [n]ever competed with each other on price.” The price of Stephen King’s latest novel likely has, at best, a trivial effect on sales of…nearly every other fiction book published, and probably zero effect on sales of non-fiction books.

This is important because the court’s opinion turns on mostly circumstantial evidence of an alleged conspiracy among publishers to raise prices and on the role of concerted action in protecting publishers from being “undercut” by their competitors. But in a world where publishers don’t compete on price (and where the alleged agreement would have reduced the publishers’ revenues in the short run and done little if anything to shore up physical book sales in the long run), it is far-fetched to interpret this evidence as the court does—to infer a conspiracy to raise prices.

Meanwhile, by restricting itself to consideration of competitive effects in the e-book market alone, the court also inappropriately and without commentary dispenses with Apple’s pro-competitive justifications for its conduct. Put simply, Apple contends that its entry into the e-book retail and reader markets was facilitated by its contract terms. But the court ignores these arguments.

On the one hand, it does so because it treats this as a per se case, in which procompetitive effects are irrelevant. But the court’s determination to treat this as a per se case—with its lengthy recitation of relevant legal precedent and only cursory application of precedent to the facts of the case—is suspect. As I have noted before:

What would [justify per se treatment] is if the publishers engaged in concerted action to negotiate these more-favorable terms with other publishers, and what would be problematic for Apple is if its agreement with each publisher facilitated that collusion.

But I don’t see any persuasive evidence that the terms of Apple’s deals with each publisher did any such thing. For MFNs to perform the function alleged by the DOJ it seems to me that the MFNs would have to contribute to the alleged agreement between the publishers, just as the actions of the vertical co-conspirators in Interstate Circuit and Toys-R-Us were alleged to facilitate coordination. But neither the agency agreement itself nor the MFN and price cap terms in the contracts in any way affected the publishers’ incentive to compete with each other. Nor, as noted above, did they require any individual publisher to cause its books to be sold at higher prices through other distributors.

Even if it is true that the publishers participated in a per se illegal horizontal price fixing scheme (and despite the court’s assertion that this is beyond dispute, the evidence is not nearly so clear as the court suggests), Apple’s unique role in that alleged scheme can’t be analyzed in the same fashion. As Leegin notes (and the court in this case quotes), for conduct to merit per se treatment it must “always or almost always tend to restrict competition and decrease output.” But the conduct at issue here—whether somehow coupled with a horizontal price fixing scheme or not—doesn’t meet this standard. The agency model, the MFN terms in the publishers’ contracts with Apple, and the efforts by Apple to secure broad participation by the largest publishers before entering the market are all potentially—if not likely—procompetitive. And output seems to have increased substantially following Apple’s entry into the e-book retail market.

In short, I continue to believe that the facts of this case do not merit per se treatment, and there is a good chance the court’s opinion could be overturned on this ground. For this reason, its rejection of Apple’s procompetitive arguments was inappropriate.

But even in its brief “even under the rule of reason…” analysis, the court improperly rejects Apple’s procompetitive arguments. The court’s consideration of these arguments is basically summed up here:

The pro-competitive effects to which Apple has pointed, including its launch of the iBookstore, the technical novelties of the iPad, and the evolution of digital publishing more generally, are phenomena that are independent of the Agreements and therefore do not demonstrate any pro-competitive effects flowing from the Agreements.

But this is factually inaccurate. Apple has claimed that its entry—and thus at minimum its development and marketing of the iPad as an e-reader and its creation of the iBookstore—were indeed functions of the contract terms and the simultaneous acceptance by the largest publishers of these terms.

The court goes on to assert that, even if the claimed pro-competitive effect was the introduction of competition into the e-book market,

Apple demanded, as a precondition of its entry into the market, that it would not have to compete with Amazon on price. Thus, from the consumer’s perspective — a not unimportant perspective in the field of antitrust — the arrival of the iBookstore brought less price competition and higher prices.

In making this claim the court effectively—and improperly—condemns MFNs to per se illegal status. In doing so the court claims that its opinion’s reach is not so broad:

this Court has not found that any of these [agency agreements, MFN clauses, etc.]…components of Apple’s entry into the market were wrongful, either alone or in combination. What was wrongful was the use of those components to facilitate a conspiracy with the Publisher Defendants”

But the claimed absence of retail price competition that accompanied Apple’s entry is entirely a function of the MFN clauses: Whether at $9.99 or $12.99, the MFN clauses were what ensured that Apple’s and Amazon’s prices would be the same, and disclaimer or not they are swept in to the court’s holding.

This effective condemnation of MFN clauses, while plainly sought by the DOJ, is simply inappropriate as a matter of law. In order to condemn Apple’s conduct under the per se rule, the court relies on the operation of the MFNs in allegedly reducing competition and raising prices to make its case. But that these do not “always or almost always tend to restrict competition and reduce output” is clear. While the DOJ may view such terms otherwise (more on this here and here), courts have not done so, and Leegin’s holding that such vertical restraints are to be assessed under the rule of reason still holds. The court’s use of the per se standard and its refusal to consider Apple’s claimed pro-competitive effects are improper.

Thus I (somewhat more cautiously this time…) suggest that the court’s decision may be overturned on appeal, and I most certainly think it should be. It seems plainly troubling as a matter of economics, and inappropriate as a matter of law.

In Amazon, Antitrust & Competition, Apple, Economic Theory, Justice Department, Law & Economics, Market Definition, Monopolization, Platforms, Resale Price Maintenance, Vertical Restraints , , , , , , , , , , , , , , , , , , , , , , , ,
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Welcome Digitopoly!

Josh Wright —  28 September 2011

This looks like a great new blog on economics and technology from a top notch group of economists:  Erik Brynjolfsson, Joshua Gans and Shane Greenstein.  Welcome Digitopoly.  Now added to the blogroll.  Here’s their description of the blog:

This blog was established by Professors Erik Brynjolfsson, Joshua Gans and Shane Greenstein. They noticed that there were many blogs devoted to digital developments and consumer products but the selection focussing on economic and business aspects of the digital world was very limited. Digitopoly’s mission is to provide an economic and strategic management perspective on digital opportunities, trends, limits, trade-offs and platforms; expanding commentary in this important space.

The blog’s name — Digitopoly — reflects our broad interests in the impact of digital technology on competition. While, in some cases, our concern is the preservation of competition in the face of pressures toward monopoly, in others we see opportunities for greater competition and welfare benefits.

Our logo is deliberately iconic. The heavy set line in the graph could represent Moore’s Law (for processing power as time progresses) or Metcalfe’s Law (for the value of networks as more join).  It overtakes the simple linear trend represented by thin, broken line. This reflects the idea that linear ways of thinking rarely serve us well in the digital economy.

Check it out.

In Economic Theory, Platforms ,
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Gans on Apple and Antitrust

Josh Wright —  3 March 2011

Joshua Gans has an interesting post examining potential antitrust issues involving Apple, an issue we’ve discussed here and here.  Gans focuses in on the two most relevant issues:

There are two aspects that might raise antitrust concern: (i) Apple’s exclusivity-like requirement that no external payment links be permitted in apps and (ii) Apple’s most-favored customer clause preventing discounting on other platforms. Let’s examine each in turn.

In my earlier post, I emphasized that a potential plaintiff would have a difficult time demonstrating that Apple has monopoly power in any relevant market for the purposes of antitrust analysis.  Both exclusivity arrangements and most-favored customer clauses can generate efficiencies and improve consumer outcomes; they pose little threat to competition and consumers in the absence of durable monopoly power.  I suggested that this was the largest obstacle to any antitrust analysis involving Apple’s subscription model:

The most often discussed bar to an antitrust action against Apple is the one many regulators simply assume into existence: Apple must have market power in an antitrust-relevant market.  While Apple’s share of the smartphone market is only 16% or so, its share of the tablet computing market is much larger.  The WSJ, for example, reports that Apple accounts for about three-fourths of tablet computer sales.  I’ve noted before in the smartphone context that this requirement should not be consider a bar to FTC suit, given the availability of Section 5; however, as the WSJ explains, market definition must be a critical issue in any Apple investigation or lawsuit:

Publishers, for example, might claim that Apple dominates the market for consumer tablet computers and that it has allegedly used that commanding position to restrict competition. Apple, in turn, might define the market to include all digital and print media, and counter that any publisher not happy with Apple’s terms is free to still reach its customers through many other print and digital outlets.

One must conduct a proper, empirically-grounded analysis of the relevant data to speak with confidence; however, it suffices to say that I am skeptical that tablet sales would constitute a relevant market.

Gans agrees, also suggesting that lack of monopoly power undercuts any potential antitrust case against Apple.

Exclusivity can be an issue as it might harm other platforms that might want to sell digital subscriptions. If Apple’s exclusivity means that those platforms cannot generate sales, then a monopoly platform may arise or be sustained. But that is the issue here: where is Apple’s monopoly? It is arguable that Apple has a monopoly over tablet devices and has had that monopoly now for almost 11 months since it first released its iPad. But if a publisher decided not to sell subscriptions for iPad users, it would have other options: particularly the options it had prior to April 2010; web based subscriptions and eReader subscriptions, not to mention physical subscriptions that fall outside of Apple’s terms. It would have to be demonstrated that the iPad was one of the few or the only way to access a particular customer class to believe that publishers were excluded by Apple’s terms. In any case, those terms are not strictly exclusionary as they do not prevent other digital subscription sales – even for iPad access. Instead, they at worst, raise the costs of those other sales. To be sure, raising costs can sometimes be an antitrust violation but the degree of market power a firm would have to possess to make that the case has to be proportionate. Right now, that case appears weak.

Most-favored customer clauses arise when the terms of one supply contract impose conditions on other contracts a party might enter into. Apple is effectively preventing discounting elsewhere. If it did not do this, then that discounting would occur and Apple may be unable to generate as much in sales. Worse than that, Apple may do the hard work of signing consumers up for initial subscriptions only to have those same consumers contacted outside of those arrangements with discounts.

But such clauses can have the effect of raising prices in the market and this is what might concern antitrust authorities. For this to be likely to occur here, Apple must have a requisite degree of power (so that publishers are forced to accept those terms) and it must be the case that prices actually rise. It is too early to tell but if Apple is right and iPad consumers really do purchase more, then it is possible that the price elasticity of demand from iPad consumers is relatively high; that is, charge $10 to an iPad consumer and you generate many more sales than $10 charged for other types of consumers. In this environment, it is not obvious that the iPad will lead to higher digital subscription prices.

My only quibble with Gans’ post is that he appears to describe the “monopoly power” requirement as a problem for antitrust, rather than a sensible requirement that protects consumers from overdeterrence.  For example, Gans writes that “antitrust law, as it currently stands, has difficulty in dealing with industries whereby the path is towards monopoly and how to act prospectively about it.”   Gans does not suggest that the antitrust authorities should bring a case against Apple on these grounds.   But he does seem to imply that antitrust would be more effective if it were more willing to reach business conduct that is not harming consumers, may well be providing significant efficiencies currently, but might generate future harm.   I’m not sure this is what he means or if I’m misinterpreting.  If I’m right, I would have characterized things quite differently, perhaps along the lines of “antitrust law is not willing to sacrifice current gains to consumers for the sake of prohibiting practices that are not currently harming competition and the basis for predicting future harm is speculative, at best.”

Potential minor quibble aside, its a very good post and well worth reading.

In Antitrust & Competition, Apple, Economic Theory, Federal Trade Commission, Google, Market Definition, Monopolization, Platforms, Section 5 ,
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On the ethical dimension of l’affair hiybbprqag

Geoffrey Manne —  9 February 2011

Former TOTM blog symposium participant Joshua Gans (visiting Microsoft Research) has a post at TAP on l’affair hiybbprqag, about which I blogged previously here.

Gans notes, as I did, that Microsoft is not engaged in wholesale copying of Google’s search results, even though doing so would be technologically feasible.  But Gans goes on to draw a normative conclusion:

Let’s start with “imitation,” “copying” and its stronger variants of “plagiarism” and “cheating.” Had Bing wanted to do this and directly map Google’s search results onto its own, it could have done it. It could have set up programs to enter terms in Google and skimmed off the results and then used them directly. And I think we can all agree that that is wrong. Why? Two reasons. First, if Google has invested to produce those results, if others can just hang off them and copy it, Google’s may not earn the return on its efforts it should do. Second, if Bing were doing this and representing itself as a different kind of search, then that misrepresentation would be misleading. Thus, imitation reduces Google’s reward for innovation while adding no value in terms of diversity.

His first reason why this would be wrong is . . . silly.  I mean, I don’t want to get into a moral debate, but since when is it wrong to engage in activity that “may” hamper another firm’s ability to earn the return on its effort that it “should” (whatever “should” means here)?  I always thought that was called “competition” and we encouraged it.  As I noted the other day, competition via imitation is an important part of Schumpeterian capitalism.  To claim that reducing another company’s profits via imitation is wrong, but doing so via innovation is good and noble, is to hang one’s hat on a distinction that does not really exist.

The second argument, that doing so would amount to misrepresentation, is possible, but I’m sure if Microsoft were actually just copying Google’s results their representations would look different than they do now and the problem would probably not exist, so this claim is speculative, at best.

Now, regardless, I doubt it would be profitable for Microsoft to copy Google wholesale, and this is basically just a red herring (as Gans understands–he goes on to discuss the more “innocuous” imitation at issue).  While I think Gans’ claims that it would be “wrong” are just hand waiving, I am confident it would be “wrong” from the point of view of Microsoft’s bottom line–or else they would already be doing it.  In this context, that would seem to be the only standard that matters, unless there were a legal basis for the claim.

On this score, Gans points us to Shane Greenstein (Kellogg).  Greenstein writes:

Let’s start with a weak standard, the law. Legally speaking, imitation is allowed so long as a firm does not violate laws governing patents, copyright, or trade secrets. Patents obviously do not apply to this situation, and neither does copyright  because Google does not get a copyright on a search result. It also does not appear as if Googles trade secrets were violated. So, generally speaking, it does not appear as if any law has been broken.

This is all well and good, but Greenstein goes on to engage in his own casual moralizing, and his comments are worth reproducing (imitating?) at some length:

The norms of rivalry

There is nothing wrong with one retailer walking through a rival’s shop and getting ideas for what to do. There is really nothing wrong with a designer of a piece of electronic equipment buying a rival’s product and studying it in order to get new ideas for a  better design. 

In the modern Internet, however, there is no longer any privacy for users. Providers want to know as much as they can, and generally the rich suppliers can learn quite a lot about user conduct and preferences.

That means that rivals can learn a great deal about how users conduct their business, even when they are at a rival’s site. It is as if one retailer had a camera in a rival’s store, or one designer could learn the names of the buyer’s of their rival’s products, and interview them right away.

In the offline world, such intimate familiarity with a rival’s users and their transactions would be uncomfortable. It would seem like an intrusion on the transaction between user and supplier. Why is it permissible in the online world? Why is there any confusion about this being an intrusion in the online world? Why isn’t Microsoft’s behavior seen — cut and dry — as an intrusion?

In other words, the transaction between supplier and user is between supplier and user, and nobody else should be able to observe it without permission of both supplier and user. The user alone does not have the right or ability to invite another party to observe all aspects of the transaction.

That is what bothers me about Bing’s behavior. There is nothing wrong with them observing users, but they are doing more than just that. They are observing their rival’s transaction with users. And learning from it. In other contexts that would not be allowed without explicit permission of both parties — both user and supplier.

Moreover, one party does not like it in this case, as they claim the transaction with users as something they have a right to govern and keep to themselves. There is some merit in that claim.

In most contexts it seems like the supplier’s wishes should be respected. Why not online? (emphasis mine)

Where on Earth do these moral standards come from?  In what way is it not “allowed” (whatever that means here) for a firm to observe and learn from a rival’s transactions with users?  I can see why the rival would prefer it to be otherwise, of course, but so what?  They would also prefer to eradicate their meddlesome rival entirely, if possible (hence Microsoft’s considerable engagement with antitrust authorities concerning Google’s business), but we hardly elevate such desires to the realm of the moral.

What I find most troublesome is the controlling, regulatory mindset implicit in these analyses.  Here’s Gans again:

Outright imitation of this type should be prohibited but what do we call some more innocuous types? Just look at how the look and feel of the iPhone has been adopted by some mobile software developers just as the consumer success of graphic based interfaces did in an earlier time. This certainly reduces Apple’s reward for its innovations but the hit on diversity is murkier because while some features are common, competitors have tried to differentiate themselves. So this is not imitation but it is something more common, leveraging without compensation and how you feel about it depends on just how much reward you think pioneers should receive.

It is usually politicians and not economists (other than politico-economists like Krugman) who think they have a handle on–and an obligation to do something about–things like “how much reward . . .pioneers should receive.”  I would have thought the obvious answer to the question would be either “the optimal amount, but good luck knowing what that is or expecting to find it in the real world,” or else, for the Second Best, “whatever the market gives them.”  The implication that there is some moral standard appreciable by human mortals, or even human economists, is a recipe for disaster.

In Apple, Copyright, Economic Theory, Google, Intellectual Property, Monopolization, Patent, Platforms , , , , , , ,
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The Microsoft-Google Antitrust Wars and Public Choice: There is Too An Argument Against Rival Involvement in Antitrust Enforcement

Josh Wright —  14 September 2010

How should an economist interpret the fact that Microsoft appears to be “behind” recent enforcement actions against Google in the United States and, especially, in Europe?

“With skepticism!”  Is the answer I suspect many readers will offer upon first glance.  There is a long public choice literature, and long history in antitrust itself, that suggests that one should be weary of private enforcement of the antitrust laws against rivals both in the form of litigation and attempts to delegate the enforcement effort (and costs) to the government.

In a recent post, economist (and blogger) Joshua Gans suggests that this conventional economic wisdom is wrong.  Gans discusses the Microsoft-Google Wars and claims that Microsoft’s involvement in the recent actions against Google in Europe, Texas and elsewhere are feature of an antitrust policy that is working, rather than a bug of an antitrust system that funnels competitive activity away on the margin from dimensions that benefit consumers, i.e. competition on the merits, and toward rent-seeking.

Gans characterizes Microsoft’s recent reported involvement in the antitrust activity launched against Google in Europe, and now Texas, as the result of some sort of epiphany at the company:

I think the narrative that is appropriate is that the antitrust action against Microsoft, while it didn’t end up breaking it up, actually worked. Microsoft has largely behaved itself since. It no longer aggressively bundles or bullies OEMs into exclusives. What is more, in its more competitive segments, it is actually a strong consumer performer. Think about video games, for one. And it is improving in its traditional monopoly areas too where it is forced to compete on products rather than with heavy handed contracting.

Lets hold aside the issue, for a moment, of whether Microsoft is as much of an antitrust enforcement success as Gans’ characterization suggests.  There remains significant debate on this issue, but I don’t want to re-hash that here, and do not need for the purposes of this post. There is also a lot of normative judgment in Gans’ post, e.g. “no longer aggressively bundles or bullies,” could be a good or bad thing from a consumer welfare perspective depending on whether the bundling or exclusive dealing with OEMs or IAPs provided consumer benefits.  But it is at least worth noting that the possibility that Microsoft has been chilled from plausibly pro-competitive conduct ought to be recognized.  But that is not the point.

The real question is what, if anything, Microsoft’s involvement tells us about how an economist should think about modern antitrust enforcement actions against Google?

Here is Gans’ answer:

Google’s new narrative in these actions is that this is a dynamic industry and they face lots of competition and potential competition — just look to Microsoft’s example! But if the correct story is that Microsoft faced real competition only because antitrust action tied its hands on anticompetitive acts, then Google’s line is incorrect and, what is worse, may lead to bad policy outcomes. Think to Google’s recent acquisitions in search in Japan that took it from a 70:30 duopoly to monopoly. This is not what we want.

In this regard, I can think of no better advocate for this narrative than Microsoft. Who better to tell the world that antitrust policy in high tech environments actually works. Yes, they are interested but it is not an argument against antitrust action to simply point to Microsoft involvement.

This answer did not move me from my initial skepticism.  At least, not in the direction of less skepticism.  There are some odd assumptions being made here.  First, I’m tempted to ask about who we know that a 70:30 market structure is “not what we want”?  Second, who is this “we” anyway?  Perhaps it is consumers.  Its unclear.  But it sounds essentially like a classic structure-conduct-performance argument.  The problems with such arguments in high-tech markets with rapid technological change (and even in more stable “brick and mortar” settings) are well known.  Is there any evidence that Google’s recent transactions in Japan generated consumer harms?  Did it generate benefits?  If it didn’t harm consumers — what is the problem?

From an economic perspective, assuming that Microsoft’s underlying conduct was clearly anticompetitive, that the costs of enforcement are less than the benefits created for consumers, and that anything around a 70-30 market share structure in search harms competition and reduces consumer welfare assumes away all of the interesting economic questions in order to reach a policy conclusion: Microsoft’s involvement tells us to favor antitrust enforcement against Google — or at the very least, is neutral.

But what about that policy argument?  It is the bolded sentence that got my attention.  Gans claims that Microsoft is the best advocate for antitrust enforcement in high-sectors because they know that enforcement “actually works.”  Somewhat more provocatively, Gans claims that the fact that Microsoft is self-interested is not an argument against antitrust action. Au contraire.

That investment in private antitrust enforcement against one’s rivals is, ceteris paribus, a negative signal about the economic merits of an antitrust action is indeed an argument.  And its a good one.  And one that has been around a long time.

Posner (Antitrust Law, 2d at 281) writes about influence of rivals on state enforcement:

I would like to see the states, which have been growing increasingly active in antitrust enforcement since the 1980s, stripped of their authority to bring antitrust suits, federal or state, except under circumstances in which a private firm would be able to sue … .  States are unwilling to devote the resources necessary to do more than free ride on federal antitrust litigation, complicating its resolution.  In addition, they are excessively influenced by interest groups that may represent a potential antitrust defendant’s competitors.  This is a particular concern when the defendant is located in one state and one of its competitors is located in another and that competitor, who is pressing his state’s attorney general to bring suit, is a major political force in that state.

Posner is not alone here in expressing concerns about the influence of rival firms on state and federal enforcement, as well as the use of private enforcement and the threat of treble damages to subvert competition.   Indeed, a classic in the antitrust economics literature is Baumol & Ordover, Use of Antitrust to Subvert Competition, in which the authors argue that courts should presumptively deny standing to competitors seeking to block mergers.  The idea that rivals can use the government agencies to do things to hinder rather than help competition is not new, and has deep roots in the public choice literature.

The argument appears in the Gavil, Kovacic and Baker Antitrust Law textbook (page 1088):

Despite their potential benefits, private enforcement schemes (including private antitrust enforcement) can have adverse consequences.  Private enforcement can generate questionable claims, and can enable firms to use the courts to impede efficient behavior by their rivals.  Although private enforcement reduces the need to enlarge public enforcement bodies, private suits can consume substantial social resources in the form of costs incurred to prosecute and defend such cases.  Perhaps recognizing these adverse possibilities, courts have established limits on the ability of private plaintiffs to obtain relief under the Clayton Act.

Of course, those limits apply to litigation in court.  No such limits apply when the rival knocks on the door at the FTC or DOJ or State AG’s office.

Fred McChesney writes, citing the Baumol & Ordover analysis and Salop & White (1986) on private antitrust litigation, that:

One of the most worrisome statistics in antitrust is that for every case brought by government, private plaintiffs bring ten. The majority of cases are filed to hinder, not help, competition. According to Steven Salop, formerly an antitrust official in the Carter administration, and Lawrence J. White, an economist at New York University, most private antitrust actions are filed by members of one of two groups. The most numerous private actions are brought by parties who are in a vertical arrangement with the defendant (e.g., dealers or franchisees) and who therefore are unlikely to have suffered from any truly anticompetitive offense. Usually, such cases are attempts to convert simple contract disputes (compensable by ordinary damages) into triple-damage payoffs under the Clayton Act.

The second most frequent private case is that brought by competitors. Because competitors are hurt only when a rival is acting procompetitively by increasing its sales and decreasing its price, the desire to hobble the defendant’s efficient practices must motivate at least some antitrust suits by competitors. Thus, case statistics suggest that the anticompetitive costs from “abuse of antitrust,” as New York University economists William Baumol and Janusz Ordover (1985) referred to it, may actually exceed any procompetitive benefits of antitrust laws.

Separately, McChesney provides an example:

Consider a case like that against Salton, Inc., for resale price maintenance of its George Foreman grills, provisionally settled in September 2002. The case is one in which the federal antitrust authorities would have no interest. Resale price maintenance is now understood to be an intrabrand practice that enhances interbrand competition. Economists almost unanimously applaud resale price maintenance as a way to enhance distributor efforts to market the product vis-à-vis competing brands in ways that almost never have any anticompetitive aspects. Resale price maintenance simply has no place in the modern, economics-based enforcement agenda.

However, resale price maintenance cases like that against Salton are a natural for the state attorneys general. First, anomalously, resale price maintenance remains per se illegal under the Sherman Act and thus is illegal under states’ antitrust acts. Therefore, victory is automatic — and cheap. All that need be shown is a contract to set resale prices, or something that a jury might so construe as such a contract.
Victory is even easier when the states sue for hundreds of millions of dollars (as in the Salton case) and then offer a settlement for cents on the dollar ($8 million in the Salton case).  No company, particularly one with public shareholders, could refuse an offer to settle for so little. To do so would invite a shareholder suit. Salton’s George Foreman grill is one of the great success stories in kitchen appliance sales. With unit sales in the millions, its high profile is guaranteed by George Foreman’s name and
ability to promote it. Hanging the scalp of a brand-name retailer and a phenomenally successful product on an attorney general’s wall was not likely to discourage the two lead attorneys general in the Salton case, New York’s Eliot Spitzer and Illinois’s
James Ryan. The former has shown himself not averse to publicity; the latter was running for governor at the time the suit’s settlement was announced.

The suit certainly was valuable to the attorneys general. But what was in it for consumers, the supposed beneficiaries of antitrust? Nothing, apparently. Not only is resale price maintenance generally a beneficial practice socially, but the settlement
amount was laughable in terms of redressing any supposed consumer injury. The settlement amounted to just pennies per grill sold. The attorneys general did not even try to get the money to the actual sufferers of any higher prices. Instead — attorneys general are politicians and 2002 was an election year — the money was destined elsewhere, as the attorneys general announced:

“In view of the difficulty in identifying the millions of purchasers of the Salton grills covered by the settlement and relatively small alleged overcharge per grill purchased, the states propose to use the $8 million settlement
in the following manner: Each state shall direct that its share of the $8 million be distributed to the state, its political subdivisions, municipalities, not-for-profit
corporations, and/or charitable organizations for health or nutrition-related causes. In this manner, the purchasers covered by the lawsuits (persons who bought Salton George Foreman Grills) will benefit from the settlement.”

This statement is commendably candid. Not only will supposedly wronged consumers not get any money, but the supposed overcharge was “relatively small” to begin with. If the overcharge was “relatively small,” Salton could not have had
much market power. Thus, the case flunks one of the principal filter tests that Judge Easterbrook rightly would impose to evaluate the worth of a standard antitrust case.

Judge Easterbrook himself, as McChesney notes, was one of the earliest to note the potential for consumer welfare-reducing abuse of the antitrust laws, arguing in the Limits of Antitrust that rival enforcement actions:

Antitrust litigation is attractive as a method of raising rivals’ costs because of the asymmetrical structure of incentives. The plaintiffs costs of litigation will be smaller than the defendant’s. The plaintiff need only file the complaint and serve demands for discovery. If the plaintiff wins, the defendant will bear these legal costs. The defendant, on the other hand, faces treble damages and injunction, as well as its own (and even its rival’s) costs of litigation. The principal burden of discovery falls on the defendant. The defendant is apt to be larger, with more files to search, and to have control of more pertinent documents than the plaintiff. … The books are full of suits by rivals for the purpose, or with the effect, of reducing competition and increasing
price.

Of course, these points apply just as well (and sometimes doubly) to the actions of rivals that do not even require them to go to court, and instead knock on the door of the government enforcement agency.  Easterbrook proposed significant restrictions on such suits.

The idea that Microsoft is an especially qualified party to “tell the world that antitrust policy in high tech environments actually works” is dubious even holding aside the debate over whether one can identify palpable consumer benefits from the enforcement action and demonstrate that they outweigh the costs.  Given the long history in antitrust of abuse of the private action to impose costs on rivals engaging in efficient business practices — a piece of history that is central to any narrative of the history of modern antitrust — and the longstanding concern about this idea in the economics literature, the argument that identity of the plaintiff or interloper is irrelevant to the economic merits of the underlying claim in the Microsoft-Google context seems especially wrongheaded.   If anything, the proliferation of national antitrust laws and availability of EU enforcement make the problems emphasized in that literature more important, not less.

In Antitrust & Competition, Economic Theory, Exclusive Dealing, Google, Justice Department, Monopolization, Platforms, Resale Price Maintenance , , , ,
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Amazon vs. Macmillan: It's all about control

Geoffrey Manne —  7 February 2010

The Amazon vs. Macmillan controversy has been beaten to a pulp in the blogosphere.  See Megan McArdle, John Scalzi, Joshua Gans, Virginia Postrel, Lynne Kiesling, Lynne Kielsing and Lynne Kiesling, among others.  Pulp or no (get it? It’s a book/e-book pun), I haven’t seen anyone hit squarely on what I think is the crux of the issue: control rights.

Amazon is an interesting hybrid, sometimes acting as a platform, sometimes acting as a direct merchant.  In its capacity as a platform, Amazon facilitates sales of goods from other merchants to Amazon’s customers through its website.  Amazon itself doesn’t actually sell these goods (because it never actually owns them), although it operates the system that enables these sales and takes a cut.  In its capacity as a merchant, Amazon purchases goods from suppliers and sells them directly to its customers.

The Kindle makes the merchant/platform distinction even more muddled for Amazon, and the distinction is at the core of the issue.

Basically, the difference between a merchant and a platform, as suggested above, is in the degree of control an intermediary exerts over pricing and other terms of sale, and the extent to which it bears risk.  The more control, the more merchant-like; the less control, the more platform-like (Thus the Gap is a merchant; eBay is a platform).  Background economic conditions determine which model (or where on the continuum between them) is more efficient for a given intermediary or market.  As these conditions change, the optimal degree of control may change, as well.  At the same time, suppliers or intermediaries may choose to assert or deny control in response to changing economic conditions–and this choice may not be optimal.  To my thinking, this is what is going on in the book/e-book market.

Steven Pearlstein in the WaPo hints at the issue:

While markets have their flaws, over the long run they are good at executing these technological transformations. My guess is that in the not-so-distant future, best-selling authors such as John Grisham and Malcolm Gladwell — along with unknown authors peddling their first books — will publish their own works, contracting with independent editors and marketers and selling directly to consumers as much as possible. Other authors will turn to smaller, more specialized publishing houses that will offer smaller advances but bigger royalties and will be built, as they once were, around great editors. Publishers will sell their books through competing online distributors and traditional hard-copy bookstores, the latter of which will continue to exist not only as places to browse and socialize, but also as places to have printed on demand. Backlists will be infinite, pricing will be dynamic, and more copies of more books will be read and sold.

From Amazon’s point of view, this possible future is probably a quite likely one (in part because it can help to hasten its arrival), and one which does not necessarily bode well for its merchant-like business model (on which see, e.g., Charlie Martin).  But this future is a goldmine for its platform model, particularly to the extent that Amazon’s Kindle offers a widespread and attractive platform to readers and authors alike.

When it comes to selling physical books directly, Amazon has, and is used to, full control over the terms of sale.  When it comes to selling e-books, however, Amazon is not really a merchant–but it’s not (yet) exactly a platform, either.  Most obviously, there is no physical inventory for Amazon to purchase with e-books, and whether it actually purchases e-books at the time of sale to resell in each transaction (even at a predetermined price) or simply facilitates a transaction between publisher and purchaser at the time of sale, Amazon bears the same extent of inventory risk: zero. Very platform-like.  But the terms of contracts with publishers complicate matters.  Under the Amazon-negotiated pricing scheme, Amazon does, indeed, buy the e-book and re-sell it.  Although this entails no inventory risk, it does mean that Amazon bears “pricing risk” (if that’s a term) just as a merchant does, and it is stuck with the price it negotiated with publishers, no matter the price at which it actually sells its e-books.

There are other nuances.  Important among these, use of e-books purchased through Amazon requires that buyers own a Kindle (just as use of Xbox video games generally requires owners to have purchased an Xbox).  If not enough buyers own Kindles, there is little value (and some cost) to publishers in participating in the e-book market through Amazon; likewise, if not enough publishers sell e-books through Amazon, there is little value to consumers in buying a Kindle.  Again, very platform-like.  But books will be written, published and marketed regardless (or maybe almost regardless) of the number of Kindle owners, and book buyers will buy the same books (or maybe almost the same books) whether they own Kindles or not–and some Kindle owners will buy physical books even though they own Kindles.  The point is that the indirect network effects (or economies of scale–a debate for another day) that one expects in platform markets and that one sees in, say, the video game market (the more Xbox owners, the more Xbox game developers there will be and thus the more Xbox owners there will be) are severely attenuated in the e-book market currently because of the overwhelming demand for physical versions of the same books.

Now, both of these points are discussed in different ways by many of the commentators I pointed to on this issue.  Obviously the nature of the contracts between Amazon and publishers is central to the story (in fact, it is the story), and everyone has discussed the issue.  Several folks have also pointed out that e-books compete with physical books, usually to mention that publishers are interested in price discrimination (on which Kiesling and Postrel are particularly good).

But I think viewed in the light of the choice of business model it is clear that the issue is control.  The question is the extent to which Amazon should act more like a platform or more like a merchant, and this distinction is determined by the amount of control it has.  As a merchant, Amazon expects–and everyone benefits from it having–a lot of control, with both its attendant costs and benefits, over the terms of sale of its products.  As a platform, Amazon is willing to cede control over the terms of sale and just manage the platform.

When publishers assert that they want more control over e-book prices they are pushing Amazon toward a platform model for e-books.  The problem is that because book publishers do not internalize the benefits conferred on other publishers from a wider use of Amazon’s platform, their pricing incentives may be inefficient.  As others have noted, publishers probably want to engage in pricing and price discrimination that will maximize their revenue.  But this control may not be optimal for the platform at this nascent stage.

And that’s really the twist.  Amazon is not ready to be a platform in this business.  The economic conditions are not yet right and it is clearly making a lot of money selling physical books directly to its users.  The Kindle is not ubiquitous and demand for electronic versions of books is not very significant–and thus Amazon does not want to take on the full platform development and distribution risk.  Where seller control over price usually entails a distribution of inventory risk away from suppliers and toward sellers, supplier control over price correspondingly distributes platform development risk toward sellers.  Under the old system Amazon was able to encourage the distribution of the platform (the Kindle) through loss-leader pricing on e-books, ensuring that publishers shared somewhat in the costs of platform distribution (from selling correspondingly fewer physical books) and allowing Amazon to subsidize Kindle sales in a way that helped to encourage consumer familiarity with e-books.  Under the new system it does not have that ability and can only subsidize Kindle use by reducing the price of Kindles–which impedes Amazon from engaging in effective price discrimination for the Kindle, does not tie the subsidy to increased use, and will make widespread distribution of the device more expensive and more risky for Amazon.

Many of the commentators (see especially Scalzi and Kiesling) are angered by Amazon’s conduct in the affair, and see in it reason to shift their loyalty from Amazon to its competitors (or at least they did before Amazon capitulated).  I see it quite differently.  To me the affair was a dispute over control rights allocated by contract.  Amazon is willing to pay more for control–to act, in other words, like a merchant re-selling publishers’ books.  It wants this control because it wants to sell e-books at a lower price than publishers want in an effort to sell more Kindles and encourage e-book use (and, incidentally, sell fewer physical books).  At this stage in this market what is needed is not more incentive for publishers to develop more inventory, but more incentive for Amazon to develop its platform.  To the extent that Amazon must now bear more of the risk and cost associated with the transition to e-books, the transition will likely occur more slowly.  Amazon’s effort to maintain pricing control by playing hardball with Macmillan in the physical book market was appropriate and gutsy.  And we would have been better off if it had succeeded.

I don’t think there’s anything to be “done” about the state of affairs other than for Amazon and publishers including Macmillan to continue negotiating.  But I will note one thing (seconding Joshua Gans):  It is almost certainly the case that Amazon capitulated in its dispute with Macmillan because of fear of drawing antitrust litigation.  If so, I think this would be most unfortunate, and it would represent antitrust enforcement placing an inefficient thumb on the bargaining power scale.  Perhaps we shouldn’t be so quick to reject the idea of false positives . . . .

Important Hat Tip.  When I started writing this post I hadn’t yet seen this article by Andrei Hagiu (Hagiu, Andrei (2007) “Merchant or Two-Sided Platform?,” Review of Network Economics: Vol. 6: Iss. 2, Article 3) (embarrassingly enough, as it was published in 2007).  But my thinking here maps significantly onto Andrei’s and I re-wrote some of the post, particularly reflecting some of his terminology, once I did read it in the middle of drafting the post.  It strikes me as an extremely important article in the two-sided markets literature, and I highly recommend it to everyone interested in the topic.  To the extent that I say what he says, he says it better; and to the extent that we diverge, he is probably correct and I am probably wrong.

In Amazon, Antitrust & Competition, Apple, Economic Theory, Google, Justice Department, Law & Economics, Monopolization, Platforms, Price Discrimination, Resale Price Maintenance, Vertical Restraints , , , , , , , , , , , , , , , , , , ,
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The Fee Neutrality Claim

Omri Ben-Shahar —  9 December 2009

Will reduction in interchange fees help or hurt consumers? Two posts yesterday made the conjecture that a reduction in one category of fees would only increase other fees, and that the overall sum of fees will not change. This is the fee-neutrality claim. Todd Zywicki writes:

The mathematics of the situation is inescapable: card issuers would have to increase the revenue generated from consumers from either interest payments or higher penalty fees.

And Josh Wright agrees:

It would be unwise from a consumer protection policy standpoint to assume that [reduction in interchange fees] represent the free lunch legislators have been looking for after all these years – or that those fees will not simply be reinstated in other guises elsewhere.

As a logical claim, I tend to agree with this “neutrality” conjecture. Indeed, the Australian experience can be explained in a way that is consistent with this dynamic, as Joshua Gans noted:

The interchange fee reduction causes merchant fees to fall but issuer fees to rise (or loyalty schemes to be curtailed) but otherwise does not impact on the consumer’s choice of payment instrument.

The question, though, is what are the implications of fee neutrality. Zywicki and Wright conclude, I believe, that in light of fee neutrality, it is pointless to try to help consumers by capping one component of the overall fee. It will not help, and might introduce an inefficiency.

My claim in this post is that the normative implications are not necessarily as Zywicki and Wright suggest. Fee neutrality, as I understand, applies only to the average cost of using credit cards. That is, consumers who use credit cards end up paying on average the same economic cost, regardless of the division of fees.  But when we consider other measures of consumer welfare, the neutrality claim no longer holds.

First, consumers who use credit cards as payment device and not for borrowing would benefit from the fee substitution. For them, the lower product prices when interchange fees decline are not offset by higher finance charges, because they don’t pay finance charges. So even if the neutrality proposition is correct on average, limits on fees have a distributive effect. This effect could also change the relative uses consumers make. Buying things becomes cheaper, borrowing becomes more expensive, and so we can predict some shift in primary conduct, which, again, violates the neutrality conjecture.

Second, even if for a given consumer the increase in finance and other charges exactly offsets the reduction in interchange fees, it is plausible to expect that a reduction in fees would lead to a reduction in prices of products and change the consumer’s purchasing decisions. Imagine that the interchange fee were to drop, in a hypothetical economy, from 5% to 0.5%. Do we think that product prices will drop accordingly? In response to a comment I posted yesterday, suggesting that such a price decline would occur, Todd Zywicki correctly responds that not all the saving will be rolled over to consumers. It depends on cross-elasticities of demand and supply. But at least in competitive markets, where prices equal marginal cost, the bulk of the savings in interchange fees would be enjoyed by consumers. It may be that nominal prices would display some stickiness, but it’s hard to imagine that in the long run consumers will be deprived of this benefit. One has to have very little faith in markets to imagine that the cost reduction will be enjoyed in its entirety by merchants, through higher profits.

If caps on interchange fees cause a non-trivial effect on prices, this regulation has the potential to reach far beyond the credit card market. It now affects primary decisions regarding the composition of consumption.

It is true that some of the increased demand due to lower prices is offset by the higher cost of credit. To buy these cheaper products with borrowed money would be just as costly, according to the neutrality claim. But it is important to unbundle the overall price into its two pure costs—the cost of the product and the cost of the credit. The potential efficiency of fee limits is in achieving an unbundled price, where the product component and the price component are priced separately.

In Credit Cards, Economic Theory, Financial Regulation, Law & Economics, The Law & Economics of Interchange Fees Symposium
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Welcome to Day Two

Geoffrey Manne —  9 December 2009

The Law and Economics of Interchange Fees and Credit Card Markets

Welcome to day two of of our two-day symposium on the law and economics of interchange fees and credit cards.

Our symposium brings together several of the world’s leading experts on interchange fees and the law and economics of credit card markets.  Our participants will discuss a range of issues surrounding the regulation of interchange and credit card markets.

Today’s posts will cover the following topics:

  • Assessing Cross-Subsidies.  Posts from Tom Brown & Tim Muris and Todd Zywicki
  • Assessing the Network Rules.  Posts from Bob Chakravorti and Joshua Gans
  • Considering the Costs: Fraud.  Posts from Jim Van Dyke, Allan Shampine and Geoffrey Manne
  • Additional Responses and Closing Thoughts.  Posts from Omri Ben-Shahar and Joshua Wright and TBD

The posts will appear regularly throughout the day to allow time between posts for discussion: Check back for updates and comments.  Expect free-ranging discussion in the comments–most of these issues are inter-related and we will return to several themes throughout the symposium.

You can find all of the symposium posts under the “credit card symposium” link on the right side of the page.

Thank you for joining us!

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In Antitrust & Competition, Credit Cards, Economic Theory, Financial Regulation, International Center for Law & Economics, Law & Economics, The Law & Economics of Interchange Fees Symposium
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What happened in Australia?

Joshua Gans —  8 December 2009

Joshua Gans is the foundation Professor of Management (Information Economics) at the Melbourne Business School, University of Melbourne.

What happens when you take a key price in an industry and cut it in half? For normal markets economists would expect that this would have a dramatic effect on quantity. That, however, was not the experience in Australia when the Reserve Bank of Australian (RBA) used new powers in 2003 to move Visa and MasterCard interchange fees from around 0.95 percent of the value of a transaction to just 0.5 percent. The evidence demonstrates that this change was virtually undetectable in any real variable to do with that industry.

To begin, let’s review the RBA reforms. First, in January 2003, it moved to eliminate the card association’s ‘no surcharge’ rule. Then in October 2003, the new interchange fee came into effect. As this submission outlined, that latter move had an immediate impact on merchants service charges with acquirers passing on the full extent of the interchange fee reduction to retailers. However, there was no impact on the value of credit card purchases, the level of credit card debt or the share of credit versus debit card transactions. Econometric analysis by Melbourne Business School’s Richard Hayes (also appended to that submission) confirmed this. Moreover, that analysis demonstrated that credit card usage did vary with other economic factors including underlying interest rates in the expected direction. Put simply, if we did not know the reforms were actually taking place, you would not be able to observe it in the data.

What was there no impact? There are a couple of possible explanations. First, it may be that the interchange fee was only one of a number of payments between acquirers and issuers and that, unobserved to analysts and the regulator, those payments adjusted to net out the regulated cap. Second, consistent with economic theory, when surcharging is permitted (and it did occur in Australia most notably for online air ticket purchases and phone payments), the interchange fee is neutral (as I will discuss in my next post). That is, the interchange fee reduction causes merchant fees to fall but issuer fees to rise (or loyalty schemes to be curtailed) but otherwise does not impact on the consumer’s choice of payment instrument. However, even if that were the case, it is surprising that there was not some period of adjustment.

The RBA continues to regulate interchange fees but has signaled that it is unlikely to adjust them further. When it comes down to it, by capping the fee the industry has survived without disruption and the RBA has ensured that rising interchange fees and associated problems as has occurred in the US will be avoided. That said, it may interest non-Australians to learn that the previous interchange fee was set in the late 1970s and was never changed despite that dramatic changes in the industry over the next two and a half decades. If there was any country without a credit card anti-trust problem it was probably Australia.

The Australian experience tells us that interventions to regulate interchange fees are probably not as important as ones that might deal with other card association rules or generic competition. But it also tells us that such interventions are unlikely to have dramatic consequences for the industry on the choice of payment instruments.

In Credit Cards, Economic Theory, Financial Regulation, Law & Economics, The Law & Economics of Interchange Fees Symposium
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Welcome: The Law and Economics of Interchange Fees and Credit Card Markets

Geoffrey Manne —  8 December 2009

The Law and Economics of Interchange Fees and Credit Card Markets

3274955487_766014dab1Today marks the start of our two-day symposium on the law and economics of interchange fees and credit cards.  As I noted in my announcement, the scholarly and policy debates over interchange fees and credit card markets more generally are raging, with several bills pending in Congress and a recent report by the GAO on the topic.  Meanwhile, the financial crisis has brought increased scrutiny to financial institutions and credit markets, and consumer credit in particular is in the regulatory cross hairs.  Litigation continues in the Eastern District of New York, and outside the US other countries continue to scrutinize (and regulate) interchange fees.

As the GAO notes:

Proposals for reducing interchange fees in the United States or other countries have included (1) setting or limiting interchange fees, (2) requiring their disclosure to consumers, (3) prohibiting card networks from imposing rules on merchants that limit their ability to steer customers away from higher-cost cards, and (4) granting antitrust waivers to allow merchants and issuers to voluntarily negotiate rates. If these measures were adopted here, merchants would benefit from lower interchange fees. Consumers would also benefit if merchants reduced prices for goods and services, but identifying such savings would be difficult. Consumers also might face higher card use costs if issuers raised other fees or interest rates to compensate for lost interchange fee income. Each of these options also presents challenges for implementation, such as determining at which rate to set, providing more information to consumers, or addressing the interests of both large and small issuers and merchants in bargaining efforts.

Our symposium will bring together several of the world’s leading experts on interchange fees and the law and economics of credit card markets.  Our participants will discuss a range of issues surrounding the regulation of interchange and credit card markets.

The Symposium will proceed in the following order:

December 8:

  • Introductory Statements.  Posts from Richard Epstein and Ronald Mann
  • Framing the Discussion.  Posts from Bob Stillman, Allan Shampine, Tom Brown & Tim Muris, and Bob Chakravorti
  • The Consequences of Regulation and the View from Australia. Posts from Joshua Gans and Todd Zywicki
  • Looking at the Proposed US Legislation.  Posts from Omri Ben-Shahar and Joshua Wright

December 9:

  • Assessing Cross-Subsidies.  Posts from Tom Brown & Tim Muris and Todd Zywicki
  • Assessing the Network Rules.  Posts from Bob Chakravorti and Joshua Gans
  • Considering the Costs: Fraud.  Posts from Jim Van Dyke, Allan Shampine and Geoffrey Manne
  • Antitrust Issues.  Posts from Joshua Wright and Geoffrey Manne
  • Additional Responses and Closing Thoughts.  Posts from TBD

The posts will appear regularly throughout the day to allow time between posts for discussion: Check back for updates and comments.  Expect free-ranging discussion in the comments–most of these issues are inter-related and we will return to several themes throughout the symposium.

We look forward to an engaged discussion in the comments to the symposium posts, and we hope all of our readers will check in frequently during the symposium and will contribute to the debate.

Finally, I am delighted to announce that this symposium is being hosted by the International Center for Law and Economics.

iclelogo

The International Center for Law and Economics (ICLE) is a new entity—a global think tank aimed at building a strong, managed, international network of meaningful (and self-sustaining) institutions and academics devoted to methodologies and research agendas that will inject rigorous, evidence-based thinking into important policy debates. Pursuing the most successful and rigorous aspects of law and economics, dynamic competition analysis, New Institutional Economics and similar approaches to law, economics and policy, the ICLE aims to become an essential part of the policy landscape in the most important policy debates around the globe. The goals of the ICLE are both to create important scholarship as well as to ensure that it has policy relevance. The ICLE develops intellectual work itself as well as drawing on its global intellectual network.  The ultimate goal is the reinvigoration of a law and economics movement in the spirit of intellectual forebears like Armen Alchian, Ronald Coase, Harold Demsetz, Frank Easterbrook, Benjamin Klein, Henry Manne and Oliver Williamson.  The ICLE is founded in honor of Armen Alchian.

The center’s work is built around the following principles:

  • A commitment to the application of economic theory, particularly price theory and new institutional economics, to antitrust and regulatory problems
  • A commitment to empirical scholarship and applications of economic theory with real world relevance
  • The use of formal mathematical modeling exclusively as a means to furthering our knowledge about the world, rather than an ends in its own right
  • A dedication to understanding both the role of the law and institutions in facilitating competition as well as the consequences of legal rules
  • A commitment to promoting an international discourse on issues of antitrust and regulatory policy in the increasingly-global regulatory environment

And so without further ado . . .

(credit card photo credit: http://www.flickr.com/photos/andresrueda/ / CC BY 2.0)
In Credit Cards, Economic Theory, Financial Regulation, Google, International Center for Law & Economics, Law & Economics, Platforms, Securities, The Law & Economics of Interchange Fees Symposium , , , ,
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Reminder: The Law and Economics of Interchange Fees and Credit Cards Symposium Starts Tuesday

Geoffrey Manne —  6 December 2009

Just a reminder that our blog symposium begins tomorrow,  Tuesday, December 8.

The Law and Economics of Interchange Fees and Credit Card Markets

For the uninitiated, the interchange fee is the fee charged (usually) by the credit card issuing bank (the cardholder’s bank) to the credit card acquiring bank (the merchant’s bank) to settle a credit card transaction between the cardholder and the merchant.  Interchange fees, as well as various rules set by credit card networks governing credit card transactions and the structure of the industry more generally have long been the subject of debate, litigation and regulation.  Credit cards have been among the most successful financial innovations ever, and credit card markets are fascinatingly complex–two features leading inexorably not only to commercial disputes but also to academic dispute and scholarly attention.

As regular readers may recall, we have had a few posts on the topic, including a spirited exchange when Steve Salop was visiting a few weeks ago.  I noted at the time that the topic of the regulation of interchange was interesting and timely–in fact, since then, while the then-pending bills are still pending in Congress, the GAO has issued its report on the effects of interchange fees on consumers and merchants.  The GAO report notes that interchange fees have been increasing, but questions whether this leads to any viable policy responses.  As the GAO notes:

Proposals for reducing interchange fees in the United States or other countries have included (1) setting or limiting interchange fees, (2) requiring their disclosure to consumers, (3) prohibiting card networks from imposing rules on merchants that limit their ability to steer customers away from higher-cost cards, and (4) granting antitrust waivers to allow merchants and issuers to voluntarily negotiate rates. If these measures were adopted here, merchants would benefit from lower interchange fees. Consumers would also benefit if merchants reduced prices for goods and services, but identifying such savings would be difficult. Consumers also might face higher card use costs if issuers raised other fees or interest rates to compensate for lost interchange fee income. Each of these options also presents challenges for implementation, such as determining at which rate to set, providing more information to consumers, or addressing the interests of both large and small issuers and merchants in bargaining efforts.

Our symposium will bring together several of the world’s leading experts on interchange fees and the law and economics of credit card markets.  Our participants will discuss a range of issues surrounding the regulation of interchange and credit card markets.

The symposium will take place on Tuesday and Wednesday, December 8 and 9.

  • Omri Ben-Shahar (University of Chicago Law School)
  • Tom Brown (O’Melveney & Myers)
  • Bob Chakravorti (Federal Reserve Bank of Chicago)
  • Richard Epstein (University of Chicago and NYU Law Schools)
  • Joshua Gans (University of Melbourne Business School)
  • Ron Mann (Columbia University Law School)
  • Geoffrey Manne (International Center for Law & Economics and Lewis & Clark Law School)
  • Tim Muris (George Mason University School of Law and O’Melveney & Myers)
  • Allan Shampine (Compass/Lexecon)
  • Bob Stillman (CRA International)
  • James Van Dyke (Javelin Strategy & Research)
  • Joshua Wright (George Mason University School of Law)
  • Todd Zywicki (George Mason University School of Law)

We look forward to an engaged discussion in the comments to the symposium posts, and we hope all of our readers will check in frequently during the symposium and will contribute to the debate.

In Credit Cards, Economic Theory, Financial Regulation, Google, International Center for Law & Economics, Law & Economics, Platforms, The Law & Economics of Interchange Fees Symposium
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Announcement: TOTM Blog Symposium on the Law and Economics of Credit Cards

Geoffrey Manne —  29 November 2009

Truth on the Market is pleased to announce its fourth blog symposium:

The Law and Economics of Interchange Fees and Credit Card Markets

For the uninitiated, the interchange fee is the fee charged (usually) by the credit card issuing bank (the cardholder’s bank) to the credit card acquiring bank (the merchant’s bank) to settle a credit card transaction between the cardholder and the merchant.  Interchange fees, as well as various rules set by credit card networks governing credit card transactions and the structure of the industry more generally have long been the subject of debate, litigation and regulation.  Credit cards have been among the most successful financial innovations ever, and credit card markets are fascinatingly complex–two features leading inexorably not only to commercial disputes but also to academic dispute and scholarly attention.

As regular readers may recall, we have had a few posts on the topic, including a spirited exchange when Steve Salop was visiting a few weeks ago.  I noted at the time that the topic of the regulation of interchange was interesting and timely–in fact, since then, while the then-pending bills are still pending in Congress, the GAO has issued its report on the effects of interchange fees on consumers and merchants.  The GAO report notes that interchange fees have been increasing, but questions whether this leads to any viable policy responses.  As the GAO notes:

Proposals for reducing interchange fees in the United States or other countries have included (1) setting or limiting interchange fees, (2) requiring their disclosure to consumers, (3) prohibiting card networks from imposing rules on merchants that limit their ability to steer customers away from higher-cost cards, and (4) granting antitrust waivers to allow merchants and issuers to voluntarily negotiate rates. If these measures were adopted here, merchants would benefit from lower interchange fees. Consumers would also benefit if merchants reduced prices for goods and services, but identifying such savings would be difficult. Consumers also might face higher card use costs if issuers raised other fees or interest rates to compensate for lost interchange fee income. Each of these options also presents challenges for implementation, such as determining at which rate to set, providing more information to consumers, or addressing the interests of both large and small issuers and merchants in bargaining efforts.

Our symposium will bring together several of the world’s leading experts on interchange fees and the law and economics of credit card markets.  Our participants will discuss a range of issues surrounding the regulation of interchange and credit card markets.

The symposium will take place on Tuesday and Wednesday, December 8 and 9.  We have not yet set the precise agenda for the symposium, but our participants include:

  • Omri Ben-Shahar (University of Chicago Law School)
  • Tom Brown (O’Melveney & Myers)
  • Bob Chakravorti (Federal Reserve Bank of Chicago)
  • Richard Epstein (University of Chicago and NYU Law Schools)
  • Joshua Gans (University of Melbourne Business School)
  • Ron Mann (Columbia University Law School)
  • Geoffrey Manne (International Center for Law & Economics and Lewis & Clark Law School)
  • Tim Muris (George Mason University School of Law and O’Melveney & Myers)
  • Allan Shampine (Compass/Lexecon)
  • Bob Stillman (CRA International)
  • Joshua Wright (George Mason University School of Law)
  • Todd Zywicki (George Mason University School of Law)

We look forward to an engaged discussion in the comments to the symposium posts, and we hope all of our readers will check in frequently during the symposium and will contribute to the debate.

We’ll announce the agenda and schedule no later than Monday, December 7.

In Credit Cards, Economic Theory, Financial Regulation, Google, International Center for Law & Economics, Law & Economics, Platforms, Securities, The Law & Economics of Interchange Fees Symposium , ,
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