Archives For Leegin

[This post adapts elements of “Should ASEAN Antitrust Laws Emulate European Competition Policy?”, published in the Singapore Economic Review (2021). Open access working paper here.]

U.S. and European competition laws diverge in numerous ways that have important real-world effects. Understanding these differences is vital, particularly as lawmakers in the United States, and the rest of the world, consider adopting a more “European” approach to competition.

In broad terms, the European approach is more centralized and political. The European Commission’s Directorate General for Competition (DG Comp) has significant de facto discretion over how the law is enforced. This contrasts with the common law approach of the United States, in which courts elaborate upon open-ended statutes through an iterative process of case law. In other words, the European system was built from the top down, while U.S. antitrust relies on a bottom-up approach, derived from arguments made by litigants (including the government antitrust agencies) and defendants (usually businesses).

This procedural divergence has significant ramifications for substantive law. European competition law includes more provisions akin to de facto regulation. This is notably the case for the “abuse of dominance” standard, in which a “dominant” business can be prosecuted for “abusing” its position by charging high prices or refusing to deal with competitors. By contrast, the U.S. system places more emphasis on actual consumer outcomes, rather than the nature or “fairness” of an underlying practice.

The American system thus affords firms more leeway to exclude their rivals, so long as this entails superior benefits for consumers. This may make the U.S. system more hospitable to innovation, since there is no built-in regulation of conduct for innovators who acquire a successful market position fairly and through normal competition.

In this post, we discuss some key differences between the two systems—including in areas like predatory pricing and refusals to deal—as well as the discretionary power the European Commission enjoys under the European model.

Exploitative Abuses

U.S. antitrust is, by and large, unconcerned with companies charging what some might consider “excessive” prices. The late Associate Justice Antonin Scalia, writing for the Supreme Court majority in the 2003 case Verizon v. Trinko, observed that:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period—is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth.

This contrasts with European competition-law cases, where firms may be found to have infringed competition law because they charged excessive prices. As the European Court of Justice (ECJ) held in 1978’s United Brands case: “In this case charging a price which is excessive because it has no reasonable relation to the economic value of the product supplied would be such an abuse.”

While United Brands was the EU’s foundational case for excessive pricing, and the European Commission reiterated that these allegedly exploitative abuses were possible when it published its guidance paper on abuse of dominance cases in 2009, the commission had for some time demonstrated apparent disinterest in bringing such cases. In recent years, however, both the European Commission and some national authorities have shown renewed interest in excessive-pricing cases, most notably in the pharmaceutical sector.

European competition law also penalizes so-called “margin squeeze” abuses, in which a dominant upstream supplier charges a price to distributors that is too high for them to compete effectively with that same dominant firm downstream:

[I]t is for the referring court to examine, in essence, whether the pricing practice introduced by TeliaSonera is unfair in so far as it squeezes the margins of its competitors on the retail market for broadband connection services to end users. (Konkurrensverket v TeliaSonera Sverige, 2011)

As Scalia observed in Trinko, forcing firms to charge prices that are below a market’s natural equilibrium affects firms’ incentives to enter markets, notably with innovative products and more efficient means of production. But the problem is not just one of market entry and innovation.  Also relevant is the degree to which competition authorities are competent to determine the “right” prices or margins.

As Friedrich Hayek demonstrated in his influential 1945 essay The Use of Knowledge in Society, economic agents use information gleaned from prices to guide their business decisions. It is this distributed activity of thousands or millions of economic actors that enables markets to put resources to their most valuable uses, thereby leading to more efficient societies. By comparison, the efforts of central regulators to set prices and margins is necessarily inferior; there is simply no reasonable way for competition regulators to make such judgments in a consistent and reliable manner.

Given the substantial risk that investigations into purportedly excessive prices will deter market entry, such investigations should be circumscribed. But the court’s precedents, with their myopic focus on ex post prices, do not impose such constraints on the commission. The temptation to “correct” high prices—especially in the politically contentious pharmaceutical industry—may thus induce economically unjustified and ultimately deleterious intervention.

Predatory Pricing

A second important area of divergence concerns predatory-pricing cases. U.S. antitrust law subjects allegations of predatory pricing to two strict conditions:

  1. Monopolists must charge prices that are below some measure of their incremental costs; and
  2. There must be a realistic prospect that they will able to recoup these initial losses.

In laying out its approach to predatory pricing, the U.S. Supreme Court has identified the risk of false positives and the clear cost of such errors to consumers. It thus has particularly stressed the importance of the recoupment requirement. As the court found in 1993’s Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., without recoupment, “predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced.”

Accordingly, U.S. authorities must prove that there are constraints that prevent rival firms from entering the market after the predation scheme, or that the scheme itself would effectively foreclose rivals from entering the market in the first place. Otherwise, the predator would be undercut by competitors as soon as it attempts to recoup its losses by charging supra-competitive prices.

Without the strong likelihood that a monopolist will be able to recoup lost revenue from underpricing, the overwhelming weight of economic evidence (to say nothing of simple logic) is that predatory pricing is not a rational business strategy. Thus, apparent cases of predatory pricing are most likely not, in fact, predatory; deterring or punishing them would actually harm consumers.

By contrast, the EU employs a more expansive legal standard to define predatory pricing, and almost certainly risks injuring consumers as a result. Authorities must prove only that a company has charged a price below its average variable cost, in which case its behavior is presumed to be predatory. Even when a firm charges prices that are between its average variable and average total cost, it can be found guilty of predatory pricing if authorities show that its behavior was part of a plan to eliminate a competitor. Most significantly, in neither case is it necessary for authorities to show that the scheme would allow the monopolist to recoup its losses.

[I]t does not follow from the case‑law of the Court that proof of the possibility of recoupment of losses suffered by the application, by an undertaking in a dominant position, of prices lower than a certain level of costs constitutes a necessary precondition to establishing that such a pricing policy is abusive. (France Télécom v Commission, 2009).

This aspect of the legal standard has no basis in economic theory or evidence—not even in the “strategic” economic theory that arguably challenges the dominant Chicago School understanding of predatory pricing. Indeed, strategic predatory pricing still requires some form of recoupment, and the refutation of any convincing business justification offered in response. For example, ​​in a 2017 piece for the Antitrust Law Journal, Steven Salop lays out the “raising rivals’ costs” analysis of predation and notes that recoupment still occurs, just at the same time as predation:

[T]he anticompetitive conditional pricing practice does not involve discrete predatory and recoupment periods, as in the case of classical predatory pricing. Instead, the recoupment occurs simultaneously with the conduct. This is because the monopolist is able to maintain its current monopoly power through the exclusionary conduct.

The case of predatory pricing illustrates a crucial distinction between European and American competition law. The recoupment requirement embodied in American antitrust law serves to differentiate aggressive pricing behavior that improves consumer welfare—because it leads to overall price decreases—from predatory pricing that reduces welfare with higher prices. It is, in other words, entirely focused on the welfare of consumers.

The European approach, by contrast, reflects structuralist considerations far removed from a concern for consumer welfare. Its underlying fear is that dominant companies could use aggressive pricing to engender more concentrated markets. It is simply presumed that these more concentrated markets are invariably detrimental to consumers. Both the Tetra Pak and France Télécom cases offer clear illustrations of the ECJ’s reasoning on this point:

[I]t would not be appropriate, in the circumstances of the present case, to require in addition proof that Tetra Pak had a realistic chance of recouping its losses. It must be possible to penalize predatory pricing whenever there is a risk that competitors will be eliminated… The aim pursued, which is to maintain undistorted competition, rules out waiting until such a strategy leads to the actual elimination of competitors. (Tetra Pak v Commission, 1996).

Similarly:

[T]he lack of any possibility of recoupment of losses is not sufficient to prevent the undertaking concerned reinforcing its dominant position, in particular, following the withdrawal from the market of one or a number of its competitors, so that the degree of competition existing on the market, already weakened precisely because of the presence of the undertaking concerned, is further reduced and customers suffer loss as a result of the limitation of the choices available to them.  (France Télécom v Commission, 2009).

In short, the European approach leaves less room to analyze the concrete effects of a given pricing scheme, leaving it more prone to false positives than the U.S. standard explicated in the Brooke Group decision. Worse still, the European approach ignores not only the benefits that consumers may derive from lower prices, but also the chilling effect that broad predatory pricing standards may exert on firms that would otherwise seek to use aggressive pricing schemes to attract consumers.

Refusals to Deal

U.S. and EU antitrust law also differ greatly when it comes to refusals to deal. While the United States has limited the ability of either enforcement authorities or rivals to bring such cases, EU competition law sets a far lower threshold for liability.

As Justice Scalia wrote in Trinko:

Aspen Skiing is at or near the outer boundary of §2 liability. The Court there found significance in the defendant’s decision to cease participation in a cooperative venture. The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggested a willingness to forsake short-term profits to achieve an anticompetitive end. (Verizon v Trinko, 2003.)

This highlights two key features of American antitrust law with regard to refusals to deal. To start, U.S. antitrust law generally does not apply the “essential facilities” doctrine. Accordingly, in the absence of exceptional facts, upstream monopolists are rarely required to supply their product to downstream rivals, even if that supply is “essential” for effective competition in the downstream market. Moreover, as Justice Scalia observed in Trinko, the Aspen Skiing case appears to concern only those limited instances where a firm’s refusal to deal stems from the termination of a preexisting and profitable business relationship.

While even this is not likely the economically appropriate limitation on liability, its impetus—ensuring that liability is found only in situations where procompetitive explanations for the challenged conduct are unlikely—is completely appropriate for a regime concerned with minimizing the cost to consumers of erroneous enforcement decisions.

As in most areas of antitrust policy, EU competition law is much more interventionist. Refusals to deal are a central theme of EU enforcement efforts, and there is a relatively low threshold for liability.

In theory, for a refusal to deal to infringe EU competition law, it must meet a set of fairly stringent conditions: the input must be indispensable, the refusal must eliminate all competition in the downstream market, and there must not be objective reasons that justify the refusal. Moreover, if the refusal to deal involves intellectual property, it must also prevent the appearance of a new good.

In practice, however, all of these conditions have been relaxed significantly by EU courts and the commission’s decisional practice. This is best evidenced by the lower court’s Microsoft ruling where, as John Vickers notes:

[T]he Court found easily in favor of the Commission on the IMS Health criteria, which it interpreted surprisingly elastically, and without relying on the special factors emphasized by the Commission. For example, to meet the “new product” condition it was unnecessary to identify a particular new product… thwarted by the refusal to supply but sufficient merely to show limitation of technical development in terms of less incentive for competitors to innovate.

EU competition law thus shows far less concern for its potential chilling effect on firms’ investments than does U.S. antitrust law.

Vertical Restraints

There are vast differences between U.S. and EU competition law relating to vertical restraints—that is, contractual restraints between firms that operate at different levels of the production process.

On the one hand, since the Supreme Court’s Leegin ruling in 2006, even price-related vertical restraints (such as resale price maintenance (RPM), under which a manufacturer can stipulate the prices at which retailers must sell its products) are assessed under the rule of reason in the United States. Some commentators have gone so far as to say that, in practice, U.S. case law on RPM almost amounts to per se legality.

Conversely, EU competition law treats RPM as severely as it treats cartels. Both RPM and cartels are considered to be restrictions of competition “by object”—the EU’s equivalent of a per se prohibition. This severe treatment also applies to non-price vertical restraints that tend to partition the European internal market.

Furthermore, in the Consten and Grundig ruling, the ECJ rejected the consequentialist, and economically grounded, principle that inter-brand competition is the appropriate framework to assess vertical restraints:

Although competition between producers is generally more noticeable than that between distributors of products of the same make, it does not thereby follow that an agreement tending to restrict the latter kind of competition should escape the prohibition of Article 85(1) merely because it might increase the former. (Consten SARL & Grundig-Verkaufs-GMBH v. Commission of the European Economic Community, 1966).

This treatment of vertical restrictions flies in the face of longstanding mainstream economic analysis of the subject. As Patrick Rey and Jean Tirole conclude:

Another major contribution of the earlier literature on vertical restraints is to have shown that per se illegality of such restraints has no economic foundations.

Unlike the EU, the U.S. Supreme Court in Leegin took account of the weight of the economic literature, and changed its approach to RPM to ensure that the law no longer simply precluded its arguable consumer benefits, writing: “Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” Further, the court found that the prior approach to resale price maintenance restraints “hinders competition and consumer welfare because manufacturers are forced to engage in second-best alternatives and because consumers are required to shoulder the increased expense of the inferior practices.”

The EU’s continued per se treatment of RPM, by contrast, strongly reflects its “precautionary principle” approach to antitrust. European regulators and courts readily condemn conduct that could conceivably injure consumers, even where such injury is, according to the best economic understanding, exceedingly unlikely. The U.S. approach, which rests on likelihood rather than mere possibility, is far less likely to condemn beneficial conduct erroneously.

Political Discretion in European Competition Law

EU competition law lacks a coherent analytical framework like that found in U.S. law’s reliance on the consumer welfare standard. The EU process is driven by a number of laterally equivalent—and sometimes mutually exclusive—goals, including industrial policy and the perceived need to counteract foreign state ownership and subsidies. Such a wide array of conflicting aims produces lack of clarity for firms seeking to conduct business. Moreover, the discretion that attends this fluid arrangement of goals yields an even larger problem.

The Microsoft case illustrates this problem well. In Microsoft, the commission could have chosen to base its decision on various potential objectives. It notably chose to base its findings on the fact that Microsoft’s behavior reduced “consumer choice.”

The commission, in fact, discounted arguments that economic efficiency may lead to consumer welfare gains, because it determined “consumer choice” among media players was more important:

Another argument relating to reduced transaction costs consists in saying that the economies made by a tied sale of two products saves resources otherwise spent for maintaining a separate distribution system for the second product. These economies would then be passed on to customers who could save costs related to a second purchasing act, including selection and installation of the product. Irrespective of the accuracy of the assumption that distributive efficiency gains are necessarily passed on to consumers, such savings cannot possibly outweigh the distortion of competition in this case. This is because distribution costs in software licensing are insignificant; a copy of a software programme can be duplicated and distributed at no substantial effort. In contrast, the importance of consumer choice and innovation regarding applications such as media players is high. (Commission Decision No. COMP. 37792 (Microsoft)).

It may be true that tying the products in question was unnecessary. But merely dismissing this decision because distribution costs are near-zero is hardly an analytically satisfactory response. There are many more costs involved in creating and distributing complementary software than those associated with hosting and downloading. The commission also simply asserts that consumer choice among some arbitrary number of competing products is necessarily a benefit. This, too, is not necessarily true, and the decision’s implication that any marginal increase in choice is more valuable than any gains from product design or innovation is analytically incoherent.

The Court of First Instance was only too happy to give the commission a pass in its breezy analysis; it saw no objection to these findings. With little substantive reasoning to support its findings, the court fully endorsed the commission’s assessment:

As the Commission correctly observes (see paragraph 1130 above), by such an argument Microsoft is in fact claiming that the integration of Windows Media Player in Windows and the marketing of Windows in that form alone lead to the de facto standardisation of the Windows Media Player platform, which has beneficial effects on the market. Although, generally, standardisation may effectively present certain advantages, it cannot be allowed to be imposed unilaterally by an undertaking in a dominant position by means of tying.

The Court further notes that it cannot be ruled out that third parties will not want the de facto standardisation advocated by Microsoft but will prefer it if different platforms continue to compete, on the ground that that will stimulate innovation between the various platforms. (Microsoft Corp. v Commission, 2007)

Pointing to these conflicting effects of Microsoft’s bundling decision, without weighing either, is a weak basis to uphold the commission’s decision that consumer choice outweighs the benefits of standardization. Moreover, actions undertaken by other firms to enhance consumer choice at the expense of standardization are, on these terms, potentially just as problematic. The dividing line becomes solely which theory the commission prefers to pursue.

What such a practice does is vest the commission with immense discretionary power. Any given case sets up a “heads, I win; tails, you lose” situation in which defendants are easily outflanked by a commission that can change the rules of its analysis as it sees fit. Defendants can play only the cards that they are dealt. Accordingly, Microsoft could not successfully challenge a conclusion that its behavior harmed consumers’ choice by arguing that it improved consumer welfare, on net.

By selecting, in this instance, “consumer choice” as the standard to be judged, the commission was able to evade the constraints that might have been imposed by a more robust welfare standard. Thus, the commission can essentially pick and choose the objectives that best serve its interests in each case. This vastly enlarges the scope of potential antitrust liability, while also substantially decreasing the ability of firms to predict when their behavior may be viewed as problematic. It leads to what, in U.S. courts, would be regarded as an untenable risk of false positives that chill innovative behavior and create nearly unwinnable battles for targeted firms.

By William Kolasky

Jon Jacobson in his initial posting claims that it would be “hard to find an easier case” than Apple e-Books, and David Balto and Chris Sagers seem to agree. I suppose that would be true if, as Richard Epstein claims, “the general view is that horizontal arrangements are per se unlawful.”

That, however, is not the law, and has not been since William Howard Taft’s 1898 opinion in Addyston Pipe. In his opinion, borrowing from an earlier dissenting opinion by Justice Edward Douglas White in Trans-Missouri Freight Ass’n, Taft surveyed the common law of restraints of trade. He showed that it was already well established in 1898 that even horizontal restraints of trade were not necessarily unlawful if they were ancillary to some legitimate business transaction or arrangement.

Building on that opinion, the Supreme Court, in what is now a long series of decisions beginning with BMI and continuing through Actavis, has made it perfectly clear that even a horizontal restraint cannot be condemned as per se unlawful unless it is a “naked” restraint that, on its face, could not serve any “plausible” procompetitive business purpose. That there are many horizontal arrangements that are not per se unlawful is shown by the DOJ’s own Competitor Collaboration Guidelines, which provide many examples, including joint sales agents.

As I suggested in my initial posting, Apple may have dug its own grave by devoting so much effort to denying the obvious—namely, that it had helped facilitate a horizontal agreement among the publishers, just as the lower courts found. Apple might have had more success had it instead spent more time explaining why it needed a horizontal agreement among the publishers as to the terms on which they would designate Apple as their common sales agent in order for it to successfully enter the e-book market, and why those terms did not amount to a naked horizontal price fixing agreement. Had it done so, Apple likely could have made a stronger case for why a rule of reason review was necessary than it did by trying to fit a square peg into a round hole by insisting that its agreements were purely vertical.

By Thomas Hazlett

The Apple e-books case is throwback to Dr. Miles, the 1911 Supreme Court decision that managed to misinterpret the economics of competition and so thwart productive activity for over a century. The active debate here at TOTM reveals why.

The District Court and Second Circuit have employed a per se rule to find that the Apple e-books agreement with five major publishers constituted a violation of Section 1 of the Sherman Act. Citing the active cooperation in contract negotiations involving multiple horizontal competitors (publishers) and the Apple offer, which appears to have raised prices paid for e-books, the conclusion that this is a case of horizontal collusion appears a slam dunk to some. “Try as one may,” writes Jonathan Jacobson, “it is hard to find an easier antitrust case than United States v. Apple.”

I’m guessing that that is what Charles Evans Hughes thought about the Dr. Miles case in 1911.

Upon scrutiny, the apparent simplicity in either instance evaporates. Dr. Miles has been revised as per GTE Sylvania, Leegin, and (thanks, Keith Hylton) Business Electronics v. Sharp Electronics. Let’s here look at the pending Apple dispute.

First, the Second Circuit verdict was not only a split decision on application of the per se rule, the dissent ably stated a case for why the Apple e-books deal should be regarded as pro-competitive and, thus, legal.

Second, the price increase cited as determinative occurred in a two-sided market; the fact asserted does not establish a monopolistic restriction of output. Further analysis, as called for under the rule of reason, is needed to flesh out the totality of the circumstances and the net impact of the Apple-publisher agreement on consumer welfare. That includes evidence regarding what happens to total revenues as market structure and prices change.

Third, a new entrant emerged as per the actions undertaken — the agreements pointedly did not “lack…. any redeeming virtue” (Northwest Wholesale Stationers, 1985), the justification for per se illegality. The fact that a new platform — Apple challenging Amazon’s e-book dominance — was both cause and effect of the alleged anti-competitive behavior is a textbook example of ancillarity. The “naked restraints” that publishers might have imposed had Apple not brought new products and alternative content distribution channels into the mix thus dressed up. It is argued by some that the clothes were skimpy. But that fashion statement is what a rule of reason analysis is needed to determine.

Fourth, the successful market foray that came about in the two-sided e-book market is a competitive victory not to be trifled. As the Supreme Court determined in Leegin: A “per se rule cannot be justified by the possibility of higher prices absent a further showing of anticompetitive conduct. The antitrust laws are designed to protect interbrand competition from which lower prices can later result.” The Supreme Court need here overturn U.S. v. Apple as decided by the Second Circuit in order that the “later result” be reasonably examined.

Fifth, lock-in is avoided with a rule of reason. As the Supreme Court said in Leegin:

As courts gain experience considering the effects of these restraints by applying the rule of reason… they can establish the litigation structure to ensure the rule operates to eliminate anticompetitive restraints….

The lock-in, conversely, comes with per se rules that nip the analysis in the bud, assuming simplicity where complexity obtains.

Sixth, Judge Denise Cote, who issued the District Court ruling against Apple, shows why the rule of reason is needed to counter her per se approach:

Here we have every necessary component: with Apple’s active encouragement and assistance, the Publisher Defendants agreed to work together to eliminate retail price competition and raise e-book prices, and again with Apple’s knowing and active participation, they brought their scheme to fruition.

But that cannot be “every necessary component.” It is not in Apple’s interest to raise prices, but to lower prices paid. Something more has to be going on. Indeed, in raising prices the judge unwittingly cites an unarguable pro-competitive aspect of Apple’s foray: It is competing with Amazon and bidding resources from a rival. Indeed, the rival is, arguably, an incumbent with market power. This cannot be the end of the analysis. That it is constitutes a throwback to the anti-competitive per se rule of Dr. Miles.

Seventh, in oral arguments at the Second Circuit, Judge Raymond J. Lohier, Jr. directed a question to Justice Department counsel, asking how Apple and the publishers “could have broken Amazon’s monopoly of the e-book market without violating antitrust laws.” The DOJ attorney responded, according to an article in The New Yorker, by advising that

Apple could have let the competition among companies play out naturally without pursuing explicit strategies to push prices higher—or it could have sued, or complained to the Justice Department and to federal regulatory authorities.

But the DOJ itself brought no complaint against Amazon — it, instead, sued Apple. And the admonition that an aggressive innovator should sit back and let things “play out naturally” is exactly what will kill efficiency enhancing “creative destruction.” Moreover, the government’s view that Apple “pursued an explicit strategy to push prices higher” fails to acknowledge that Apple was the buyer. Such as it was, Apple’s effort was to compete, luring content suppliers from a rival. The response of the government is to recommend, on the one hand, litigation it will not itself pursue and, on the other, passive acceptance that avoids market disruption. It displays the error, as Judge Jacobs’ Second Circuit dissent puts it, “That antitrust law is offended by gloves off competition.” Why might innovation not be well served by this policy?

Eighth, the choice of rule of reason does not let Apple escape scrutiny, but applies it to both sides of the argument. It adds important policy symmetry. Dr. Miles impeded efficient market activity for nearly a century. The creation of new platforms in Internet markets ought not to have such handicaps. It should be recalled that, in introducing its iTunes platform and its vertically linked iPod music players, circa 2002, the innovative Apple likewise faced attack from competition policy makers (more in Europe, indeed, than the U.S.). Happily, progress in the law had loosened barriers to business model innovation, and the revolutionary ecosystem was allowed to launch. Key to that progressive step was the bulk bargain struck with music labels. Richard Epstein thinks that such industry-wide dealing now endangers Apple’s more recent platform launch. Perhaps. But there is no reason to jump to that conclusion, and much to find out before we embrace it.

By Chris Sagers

United States v. Apple has fascinated me continually ever since the instantly-sensational complaint was made public, more than three years ago. Just one small, recent manifestation of the larger theme that makes it so interesting is the improbable range of folks who apparently consider certiorari rather likely—not least some commenters here, and even SCOTUSblog, which listed the case on their “Petitions We’re Watching.” It seems improbable, I say, not because reasonable people couldn’t differ on the policy issues. In this day and age somebody pops up to doubt every antitrust case brought against anybody no matter what. Rather, on the traditional criteria, the case just seems really ill-suited for cert.[*]

But it is in keeping with the larger story that people might expect the Court to take this basically hum-drum fact case in which there’s no circuit split. People have been savaging this case since its beginnings, despite the fact that to almost all antitrust lawyers it was such a legal slam dunk that so long as the government could prove its facts, it couldn’t lose.

And so I’m left with questions I’ve been asking since the case came out. Why, given the straightforward facts, nicely fitting a per se standard generally thought to be well-settled, involving conduct that on the elaborate trial record had no plausible effect except a substantial price increase,[**] do so many people hate this case? Why, more specifically, do so many people think there is something special about it, such that it shouldn’t be subject to the same rules that would apply to anybody else who did what these defendants did?

To be clear, I think the case is interesting. Big time. But what is interesting is not its facts or the underlying conduct or anything about book publishing or technological change or any of that. In other words, I don’t think the case is special. Like Jonathan Jacobson, I think it is simple.  What is remarkable is the reactions it has generated, across the political spectrum.

In the years of its pendency, on any number of panels and teleconferences and brown-bags and so on we’ve heard BigLaw corporate defense lawyers talking about the case like they’re Louis Brandeis. The problem, you see, is not a naked horizontal producer cartel coordinated by a retail entrant with a strong incentive to discipline its retail rival. No, no, no. The problem was actually Amazon, and the problem with Amazon was that it is big. Moreover, this case is about entry, they say, and entry is what antitrust is all about. Entry must be good, because numerosity in and of itself is competition. Consider too the number of BigLaw antitrust partners who’ve publicly argued that Amazon is in fact a monopolist, and that it engaged in predatory pricing, of all things.

When has anyone ever heard this group of people talk like that?

For another example, consider how nearly identical have been the views of left-wing critics like the New America Foundation’s Barry Lynn to those of the Second Circuit dissenter in Apple, the genteel, conservative Bush appointee, Judge Dennis Jacobs. They both claim, as essentially their only argument, that Amazon is a powerful firm, which can be tamed only if publishers can set their own retail prices (even if they do so collusively).

And there are so many other examples. The government’s case was condemned by no less than a Democrat and normally pro-enforcement member of the Senate antitrust committee, as it was by two papers as otherwise divergent as the Wall Street Journal and the New York Times. Meanwhile, the damnedest thing about the case, as I’ll show in a second, is that it frequently causes me to talk like Robert Bork.

So what the hell is going on?

I have a theory.  We in America have almost as our defining character, almost uniquely among developed nations, a commitment to markets, competition, and individual enterprise. But we tend to forget until a case like Apple reminds us that markets, when they work as they are supposed to, are machines for producing pain. Firms fail, people lose jobs, valuable institutions—like, perhaps, the paper book—are sometimes lost. And it can be hard to believe that such a free, decentralized mess will somehow magically optimize organization, distribution, and innovation. I think the reason people find a case like Apple hard to support is that, because we find all that loss and anarchy so hard to swallow, we as a people do not actually believe in competition at all.

I think it helps in making this point to work through the individual arguments that the Apple defendants and their supporters have made, in court and out. For my money, what we find is not only that most of the arguments are not really that strong, but that they are the same arguments that all defendants make, all the time. As it turns out, there has never been an antitrust defendant that didn’t think its market was special.

Taking the arguments I’ve heard, roughly in increasing order of plausibility:

  • Should it matter that discipline of Amazon’s aggressive pricing might help keep the publisher defendants in business? Hardly. While the lamentations of the publishers seem overblown—they may be forced to adapt, and it may not be painless, but that is much more likely at the moment than their insolvency—if they are forced out because they cannot compete on a price basis, then that is exactly what is supposed to happen. Econ 101.
  • Was Apple’s entry automatically good just because it was entry? Emphatically no. There is no rule in antitrust that entry is inherently good, and a number of strong rules to the contrary (consider, for example, the very foundation of the Brook Group predation standard, which is that we should provide no legal protection to less efficient competitors, including entrants). That is for a simple reason: entry is good when causes quality-adjusted price to go down. The opposite occurred in Apple[***]
  • Is Amazon the real villain, so obviously that we should allow its suppliers to regulate its power through horizontal cartel? I rather think not. While I have no doubt that Amazon is a dangerous entity, that probably will merit scrutiny on any number of grounds now or in the future, it seems implausible that it priced e-books predatorily, surely not on the legal standard that currently prevails in the United States. In fact, an illuminating theme in The Everything Store, Brad Stone’s comprehensive study of the company, was the ubiquity of supplier allegations of Amazon’s predation in all kinds of products, complaints that have gone on throughout the company’s two-decade existence. I don’t believe Amazon is any hero or that it poses no threats, but what it’s done in these cases is just charge lower prices. It’s been able to do so in a sustained manner mainly through innovation in distribution. And in any case, whether Amazon is big and bad or whatever, the right tool to constrain it is not a price fixing cartel. No regulator cares less about the public interest.
  • Does it make the case special in some way that a technological change drove the defendants to their conspiracy? No. The technological change afoot was in effect just a change in costs. It is much cheaper to deliver content electronically than in hard copy, not least because as things have unfolded, consumers have actually paid for and own most of the infrastructure. To that extent there’s nothing different about Apple than any case in which an innovation in production or distribution has given one player a cost advantage. In fact, the publishers’ primary need to defend against pricing of e-books at some measure of their actual cost is that the publishers’ whole structure is devoted to an expensive intermediating function that becomes largely irrelevant with digital distribution.
  • Is there reason to believe that a horizontal cartel orchestrated by a powerful distributor will achieve better quality-adjusted prices, which I take to be Geoff Manne’s overall theme? I mean, come on. This is essentially a species of destructive competition argument, that otherwise healthy markets can be so little trusted efficiently to supply products that customers want that we’ll put the government to a full rule of reason challenge to attack a horizontal cartel? Do we believe in competition at all?
  • Should it matter that valuable cultural institutions may be at risk, including the viability of paper books, independent bookstores, and perhaps the livelihoods of writers or even literature itself? This seems more troubling than the other points, but hardly is unique to the case or a particularly good argument for self-help by cartel. Consider, if you will, another, much older case. The sailing ship industry was thousands of years old and of great cultural and human significance when it met its demise in the 1870s at the hands of the emerging steamship industry. Ships that must await the fickle winds cannot compete with those that can offer the reliable, regular departures that shipper customers desire. There followed a period of desperate price war following which the sail industry was destroyed. That was sad, because tall-masted sailing ships are very swashbuckling and fun, and were entwined in our literature and culture. But should we have allowed the two industries to fix their prices, to preserve sailing ships as a living technology?

There are other arguments, and we could keep working through them one by one, but the end result is the same. The arguments mostly are weak, and even those with a bit more heft do nothing more than pose the problem inherent in that very last point. Healthy markets sometimes produce pain, with genuinely regrettable consequences.  But that just forces us to ask: do we believe in competition or don’t we?

___________

[*] Except possibly for one narrow issue, Apple is at this point emphatically a fact case, and the facts were resolved on an extensive record by an esteemed trial judge, in a long and elaborate opinion, and left undisturbed on appeal (even in the strongly worded dissent). The one narrow issue that is actually a legal one, and that Apple mainly stresses in its petition—whether in the wake of Leegin the hub in a hub-and-spoke arrangement can face per se liability—is one on which I guess people could plausibly disagree. But even when that is the case this Court virtually never grants cert. in the absence of a significant circuit split, and here there isn’t one.

Apple points only to one other Circuit decision, the Third Circuit’s Toledo Mack. It is true as Apple argues that a passage in Toledo Mack seemed to read language from Leegin fairly broadly, and to apply even when there is horizontal conspiracy at the retail level. But Toledo Mack was not a hub-and-spoke case. While plaintiff alleged a horizontal conspiracy among retailers of heavy trucks, and Mack Trucks later acquiescence in it, Mack played no role in coordinating the conspiracy. Separately, whether Toledo Mack really conflicts with Apple or not, the law supporting the old per se rule against hub-and-spoke conspiracies is pretty strong (take a look, for example, at pp. 17-18 of the Justice Department’s opposition brief.

So, I suppose one might think there is no distinction between a hub-and-spoke and a case like Toledo Mack, in which a manufacturer merely agreed after the fact to assist an existing retail conspiracy, and that there is therefore a circuit split, but that would be rather in contrast to a lot of Supreme Court authority. On the other hand, if there is some legal difference between a hub-and-spoke and the facts of Toledo Mack, then Toledo Mack is relevant only if it is understood to have read Leegin to apply to all “vertical” conduct, including true hub-and-spoke agreements. But that would be a broad reading indeed of both Leegin and Toledo Mack. It would require believing that Leegin reversed sub silentio a number of important decisions on an issue that was not before the Court in Leegin. It would also make a circuit split out of a point that would be only dicta in Toledo Mack. And yes, yes, yes, I know, Judge Jacobs in dissent below himself said that his panel’s decision created a circuit split with Toledo Mack. But I mean, come on. A circuit split means that two holdings are in conflict, not that one bit of dicta commented on some other bit of dicta.

A whole different reason cert. seems improbable is that the issue presented is whether per se treatment was appropriate. But the trial court specifically found the restraint to have been unreasonable under a rule of reason standard. Of course that wouldn’t preclude the Court from reversing the trial court’s holding that the per se rule applies, but it would render a reversal almost certainly academic in the case actually before the Court.

Don’t get me wrong. Nothing the courts do really surprises me anymore, and there are still four members of the Court, even in the wake of Justice Scalia’s passing, who harbor open animosity for antitrust and a strong fondness for Leegin. It is also plausible that those four will see the case Apple’s way, and favor reversing Interstate Circuit (though that seems unlikely to me; read a case like Ticor or North Carolina Dental Examiners if you want to know how Anthony Kennedy feels about naked cartel conduct). But the ideological affinities of the Justices, in and of themselves, just don’t usually turn an otherwise ordinary case into a cert-worthy one.

[**] Yes, yes, yes, Grasshopper, I know, Apple argued that in fact its entry increased quality and consumer choice, and also put on an argument that the output of e-books actually expanded during the period of the publishers’ conspiracy. But, a couple of things. First, as the government observed in some juicy briefing in the case, and Judge Cote found in specific findings, each of Apple’s purported quality enhancements turned out to involve either other firms’ innovations or technological enhancements that appeared in the iPad before Apple ever communicated with the publishers. As for the expanded output argument, it was fairly demolished by the government’s experts, a finding not disturbed even in Judge Jacobs’ dissent.

In any case, any benefit Apple did manage to supply came at the cost of a price increase of fifty freaking percent, across thousands of titles, that were sustained for the entire two years that the conspiracy survived.

[***] There have also been the usual squabbles over factual details that are said to be very important, but these points are especially uninteresting. E.g., the case involved “MFNs” and “agency contracts,” and there is supposed to be some magic in either their vertical nature or the great uncertainty of their consequences that count against per se treatment. There isn’t. Neither the government’s complaint, the district court, nor the Second Circuit attacked the bilateral agreements in and of themselves; on the contrary, both courts emphatically stressed that they only found illegal the horizontal price fixing conspiracy and Apple’s role in coordinating it.

Likewise, some stress that the publisher defendants in fact earned slightly less per price-fixed book under their agency agreements than they had with Apple. Why would they do that, if there weren’t some pro-competitive reason? Simple. The real money in trade publishing was not then or now in the puny e-book sector, but in hard-cover, new-release best sellers, which publishers have long sold at very significant mark-ups over cost. Those margins were threatened by Amazon’s very low e-book prices, and the loss on agency sales was worth it to preserve the real money makers.

The Apple E-Books Antitrust Case: Implications for Antitrust Law and for the Economy — Day 2

February 16, 2016

truthonthemarket.com

We will have a few more posts today to round out the Apple e-books case symposium started yesterday.

You can find all of the current posts, and eventually all of the symposium posts, here. Yesterdays’ posts, in order of posting:

Look for posts a little later today from:

  • Tom Hazlett
  • Morgan Reed
  • Chris Sagers

And possibly a follow-up post or two from some of yesterday’s participants.

The “magic” of Washington can only go so far. Whether it is political consultants trying to create controversy where there is basic consensus, such as in parts of the political campaign, or the earnest effort to create a controversy over the Apple decision, there may be lots of words exchanged and animated discussion by political and antitrust pundits, but at the end of the day it’s much ado about not much. For the Apple case, even though this blog has attracted some of the keenest creative antitrust thinkers, a simple truth remains – there was overwhelming evidence that there was a horizontal agreement among suppliers and that Apple participated or even led the agreement as a seller. This is, by definition, a hub-and-spoke conspiracy that resulted in horizontal price fixing among ebook suppliers – an activity worthy of per se treatment.

The simplicity of this case belies the controversy of the ruling and the calls for Supreme Court review. Those that support Apple’s petition for certiorari seem to think that the case is a good vehicle to address important questions of policy in the law. Indeed, ICLE submitted an excellent brief making just such a case. But, unfortunately, the facts of this case are not great for resolving these problems.

For example, some would like to look at this case not as a horizontal price fixing agreement among competitors facilitated by a vertical party, but instead as a series of vertical agreements. This is very tempting, because the antitrust revolution was built on the back of fixing harmful precedent of per se condemnation of vertical restraints. Starting with GTE Sylvania, the Supreme Court has repeatedly applied modern economic learning to vertical restraints and found that there are numerous potential procompetitive benefits that must be accounted for in any proper antitrust analysis of a vertical agreement.

This view of the Apple e-book case is especially tempting because the Supreme Court’s work in this area of the law is not done. For example, the Supreme Court needs to update the law on exclusive dealing and loyalty discounts to reflect post-GTE Sylvania thinking, something I have written extensively on (including here at TOTM: here, here and here) in the context of the McWane case. (Which is also up for cert review). However, the facts of this case simply make this a bad case to resolve any matter of vertical restraint law. Apple was not approaching publishers individually, but aggressively orchestrating a scheme that immediately raised e-book prices by 30% and ensured that Apple’s store could not be undercut by any competitor. Consumers were very obviously harmed and the horizontal price fixing conspiracy could not have taken place without Apple’s involvement.

Of course in the court of public opinion (which is not an antitrust court) Apple attempted to wear the garb of the Robin Hood for consumers suggesting it was just trying to respond to Amazon’s dominance over ebooks. But the Justice Department and the court quickly saw through that guise. The proper response to market dominance is to compete harder. And that’s what happened. Apple’s successful entry into the e-book market seems to provide a more effective response than any cartel. But this does not show that there were procompetitive benefits of Apple’s anticompetitive actions worthy of rule of reason treatment. To the contrary, prices rose and output fell during the conduct at issue – exactly what one would expect to see following anticompetitive activities.

This argument also presupposes that Amazon’s dominance was bad for consumers. This is refuted by Scalia in Trinko:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

The other problem with this line of thinking is that it suggests that it is OK to violate the antitrust laws to prevent a rival from charging too low of a price. This would obviously be bad policy. If Amazon was maintaining its dominant position through anticompetitive conduct, then there exists recourse in the law. As the old adage states, two wrongs do not make a right.

The main problem with the Apple e-book case is that it is a very simple case that lightly brushes against up against areas of law that and questions of policy that are attractive for Supreme Court review. There are important policy issues that still need to be addressed by the Supreme Court, but these facts don’t present them.

The Supreme Court does have an important job in helping antitrust law evolve in a sensible fashion. But this case is a soggy appetizer when there is a much more engaging main course about to be served. A cert petition has been filed in the FTC’s case against McWane, which provides a chance to update the law of exclusive dealing which the Court has not grappled with since the days of Sputnik (Only a slight exaggeration). And in McWane the most important business groups Including the Chamber of Commerce and the National Association of Manufacturers have explained that the confusion and obscurity in this area and the mischief of the lower court’s decisions create real impediments to procompetitive conduct. Professors of law and economics (including several TOTM authors) also wrote in support of the petition.

The Court should skip the appetizer and get to the main course.

For a few months I have thought that the Apple eBooks case would find an easy fit within the Supreme Court’s antitrust decisions. The case that seems closest to me is Business Electronics v. Sharp Electronics, an unfortunately under-appreciated piece of antitrust precedent. One sign of its under-appreciation is its absence in some recent editions of antitrust casebooks.

In Business Electronics, the Court looked at a vertical relationship in which a manufacturer agreed with one of its retailers to terminate another retailer for failing to comply with the manufacturer’s suggested minimum prices. The Court held that such an agreement could not be ruled per se illegal unless the plaintiff could prove that the non-terminated retailer had agreed with the manufacturer to set its resale price at some level. The Court was reluctant to apply the per se test to this sort of case because of the potential efficiencies that might justify the manufacturer’s minimum retail prices. To allow some leeway for these efficiencies to be realized, the Court erected a high burden of proof under the per se test. Now, of course, the Court no longer applies the per se test to vertical arrangements like that in Business Electronics because of its decision in Leegin to adopt rule of reason analysis for vertical restraints.

The Apple eBooks case falls under Business Electronics. Apple offered the book publishers a contract that left Amazon with a choice of complying with a pricing system closer to the publisher’s preferences or terminating its relationship with the publishers. In other words, the Apple contract, with its famous most-favored-nations clause, effectively presented Amazon with an ultimatum similar to the one observed in Business Electronics. The ultimatum worked: Amazon was forced to comply with the pricing scheme preferred by the publishers and Apple. It follows from Business Electronics, and from Leegin, that the burden of proof in this case should be set high – a bit higher than the trial court set it in this case. Further, Leegin suggests that rule of reason analysis should apply because the relationship at issue is vertical.

Justice Scalia’s passing may have affected the Apple eBooks case already. Scalia was the author of Business Electronics, and presumably the Supreme Court Justice most likely to have noticed the similarity between Business Electronics and Apple eBooks.

By Andrew Albanese

In October of last year, I had the chance to interview Hachette CEO Arnaud Nourry from the stage at the Frankfurt Book Fair, and I asked him whether his 2009 concerns that low e-book prices would devalue the book—the driving factor behind the alleged e-book price-fixing conspiracy—were in the the past. After all, much has changed over the last six years.

Nourry was resolute in his response.

When you lose control over your price point you are on the way to death. We have to be very careful and never think it is behind us. We are still concerned. And I am glad that there is a consensus among major publishers that we should keep control.

As the non-lawyer here, I’m necessarily going to take a slightly different approach to today’s symposium. But I want to be clear, right up front: However the Supreme Court dispatches with Apple’s appeal in it e-book price-fixing case, whether the court declines to take up the appeal, or ultimately reverses, it is going to have little effect on the e-book market.

Even though it triggered a high profile antitrust case, and two years of market sanctions, Apple’s 2010 scheme with publishers to eliminate retail price competition from the e-book market ultimately succeeded. Today, the Big Five publishers (Hachette, HarperCollins, Macmillan, Simon & Schuster and Penguin Random House) now control the consumer prices of their e-books. Apple does not have to worry about the iBookstore being undercut on price by Amazon. And Amazon’s main competitive advantage has been blunted—its $9.99 price on bestselling new release e-books—“that pitiful, paltry price,” as Daily Beast co-founder Tina Brown once called it—is history. Frontlist e-books now retail for as high as $14.99.

So, how is the e-book market faring, post-Apple? It’s been a mixed bag. On one hand, e-book sales from the Big Five publishers declined in 2015. For Nourry’s company, Hachette, digital sales (including digital audio) accounted for 22% of trade sales last year, down from 26% in 2014. So much for Steve Jobs’ 2010 prediction that Apple would usher in a “mainstream e-book revolution.”

On the other hand, print sales are up. Publishers say the dip in e-book sales and the rebound of print is a sign that the book market that is beginning to find its balance. And while they concede that higher e-book prices are clearly playing a role in the market’s re-balancing act, it is still too early to tell to what degree price or other factors are driving format choices in the publishing market.  

For me, the interesting question is where we go from here. In 2016, for the first time in the modern e-book market’s short history, there are no major disruptions on the horizon: no game-changing device like the iPad; no fundamental changes coming in the retail market (like the agency model); no looming negotiations with Amazon (for now); no court-imposed e-book discounting. With fewer thumbs on the scale, the next two years are poised to present the clearest picture yet of the demand for e-books, what prices work, or don’t, the viability of emerging new channels such as subscription access, where the competitive fault lines truly lie.

In that light, the narrow legal question before the Supreme Court in Apple’s appeal—whether a vertical firm that organizes a price-fixing conspiracy among its suppliers can be condemned as per se liable—feels anticlimactic, and largely academic. Sure, there is $400 million in consumer refunds at stake, per Apple’s settlement with the states and consumer class. But here’s what’s not at stake: the future of innovation.

Despite some outstanding work by Apple’s counsel, and some outraged editorials and amicus briefs, this case has never been about innovation, new technology, or novel business arrangements in emerging markets. When the publishers first agreed to Apple’s terms, they had yet to even see an iPad, or the iBookstore. And there is no dispute that the iPad was going to be used as an e-reading device regardless of whether or not Apple got into e-book retailing.

Rather, as Macmillan CEO John Sargent once suggested in an email, the benefit of the iPad was that its launch presented a singular opportunity to change the business model for e-books—to wrest pricing control from Amazon, and to raise e-book prices to levels they considered “rational.” 

While it is a compelling narrative, it seems highly unlikely to me that upholding per se liability in this case would discourage tech companies from innovating or striking novel new arrangements in emerging digital markets. Again, I am no lawyer. But isn’t the greater concern that, if vindicated, Apple’s scheme would essentially serve as a blueprint for large vertical players to work with major suppliers to eliminate retail price competition from nascent markets?

I keep going back to U.S. attorney Mark Ryan’s closing argument at Apple’s trial. Who knows, Ryan argued, how the market would have solved Amazon’s $9.99 problem? That, it seems to me, remains the key question.

Andrew Richard Albanese is Senior Writer for Publishers Weekly and the author of The Battle of $9.99: How Apple, Amazon, and the Big Six Publishers Changed the E-Book Business Overnight.

As ICLE argued in its amicus brief, the Second Circuit’s ruling in United States v. Apple Inc. is in direct conflict with the Supreme Court’s 2007 Leegin decision, and creates a circuit split with the Third Circuit based on that court’s Toledo Mack ruling. Moreover, the negative consequences of the court’s ruling will be particularly acute for modern, high-technology sectors of the economy, where entrepreneurs planning to deploy new business models will now face exactly the sort of artificial deterrents that the Court condemned in Trinko:

Mistaken inferences and the resulting false condemnations are especially costly, because they chill the very conduct the antitrust laws are designed to protect.

Absent review by the Supreme Court to correct the Second Circuit’s error, the result will be less-vigorous competition and a reduction in consumer welfare. The Court should grant certiorari.

The Second Circuit committed a number of important errors in its ruling.

First, as the Supreme Court held in Leegin, condemnation under the per se rule is appropriate

only for conduct that would always or almost always tend to restrict competition… [and] only after courts have had considerable experience with the type of restraint at issue.

Neither is true in this case. The use of MFNs in Apple’s contracts with the publishers and its adoption of the so-called “agency model” for e-book pricing have never been reviewed by the courts in a setting like this one, let alone found to “always or almost always tend to restrict competition.” There is no support in the case law or economic literature for the proposition that agency models or MFNs used to facilitate entry by new competitors in platform markets like this one are anticompetitive.

Second, the court of appeals emphasized that in some cases e-book prices increased after Apple’s entry, and it viewed that fact as strong support for application of the per se rule. But the Court in Leegin made clear that the per se rule is inappropriate where, as here, “prices can be increased in the course of promoting procompetitive effects.”  

What the Second Circuit missed is that competition occurs on many planes other than price; higher prices do not necessarily suggest decreased competition or anticompetitive effects. As Josh Wright points out:

[T]the multi-dimensional nature of competition implies that antitrust analysis seeking to maximize consumer or total welfare must inevitably calculate welfare tradeoffs when innovation and price effects run in opposite directions.

Higher prices may accompany welfare-enhancing “competition on the merits,” resulting in greater investment in product quality, reputation, innovation, or distribution mechanisms.

While the court acknowledged that “[n]o court can presume to know the proper price of an ebook,” its analysis nevertheless rested on the presumption that Amazon’s prices before Apple’s entry were competitive. The record, however, offered no support for that presumption, and thus no support for the inference that post-entry price increases were anticompetitive.

In fact, as Alan Meese has pointed out, a restraint might increase prices precisely because it overcomes a market failure:

[P]roof that a restraint alters price or output when compared to the status quo ante is at least equally consistent with an alternative explanation, namely, that the agreement under scrutiny corrects a market failure and does not involve the exercise or creation of market power. Because such failures can result in prices that are below the optimum, or output that is above it, contracts that correct or attenuate market failure will often increase prices or reduce output when compared to the status quo ante. As a result, proof that such a restraint alters price or other terms of trade is at least equally consistent with a procompetitive explanation, and thus cannot give rise to a prima facie case under settled antitrust doctrine.

Before Apple’s entry, Amazon controlled 90% of the e-books market, and the publishers had for years been unable to muster sufficient bargaining power to renegotiate the terms of their contracts with Amazon. At the same time, Amazon’s pricing strategies as a nascent platform developer in a burgeoning market (that it was, in practical effect, trying to create) likely did not always produce prices that would be optimal under evolving market conditions as the market matured. The fact that prices may have increased following the alleged anticompetitive conduct cannot support an inference that the conduct was anticompetitive.

Third, the Second Circuit also made a mistake in dismissing Apple’s defenses. The court asserted that

this defense — that higher prices enable more competitors to enter a market — is no justification for a horizontal price‐fixing conspiracy.

But the court is incorrect. As Bill Kolasky points out in his post, it is well-accepted that otherwise-illegal agreements that are ancillary to a procompetitive transaction should be evaluated under the rule of reason.

It was not that Apple couldn’t enter unless Amazon’s prices (and its own) were increased. Rather, the contention made by Apple was that it could not enter unless it was able to attract a critical mass of publishers to its platform – a task which required some sharing of information among the publishers – and unless it was able to ensure that Amazon would not artificially lower its prices to such an extent that it would prevent Apple from attracting a critical mass of readers to its platform. The MFN and the agency model were thus ancillary restraints that facilitated the transactions between Apple and the publishers and between Apple and iPad purchasers. In this regard they are appropriately judged under the rule of reason and, under the rule of reason, offer a valid procompetitive justification for the restraints.

And it was the fact of Apple’s entry, not the use of vertical restraints in its contracts, that enabled the publishers to wield the bargaining power sufficient to move Amazon to the agency model. The court itself noted that the introduction of the iPad and iBookstore “gave publishers more leverage to negotiate for alternative sales models or different pricing.” And as Ben Klein noted at trial,

Apple’s entry probably gave the publishers an increased ability to threaten [Amazon sufficiently that it accepted the agency model]…. The MFN [made] a trivial change in the publishers’ incentives…. The big change that occurs is the change on the other side of the bargaining situation after Apple comes in where Amazon now cannot just tell them no.

Fourth, the purpose of applying the per se rule is to root out activities that always or almost always harm competition. Although it’s possible that a horizontal agreement that facilitates entry and increases competition could be subject to the per se rule, in this case its application was inappropriate. The novelty of Apple’s arrangement with the publishers, coupled with the weakness of proof of any sort of actual price fixing fails to meet even a minimal threshold that would require application of the per se rule.

Not all horizontal arrangements are per se illegal. If an arrangement is relatively novel, facilitates entry, and is patently different from naked price fixing, it should be reviewed under the rule of reason. See BMI. All of those conditions are met here.

The conduct of the publishers – distinct from their agreements with Apple – to find some manner of changing their contracts with Amazon is not itself price fixing, either. The prices themselves would be set only subsequent to whatever new contracts were adopted. At worst, the conduct of the publishers in working toward new contracts with Amazon can be characterized as a facilitating practice.

But even then, the precedent of the Court counsels against applying the per se rule to facilitating practices such as the mere dissemination of price information or, as in this case, information regarding the parties’ preferred, bilateral, contractual relationships. As the Second Circuit itself once held, following the Supreme Court,  

[the] exchange of information is not illegal per se, but can be found unlawful under a rule of reason analysis.

In other words, even the behavior of the publishers should be analyzed under a rule of reason – and Apple’s conduct in facilitating that behavior cannot be imbued with complicity in a price-fixing scheme that may not have existed at all.

Fifth, in order for conduct to “eliminate price competition,” there must be price competition to begin with. But as the district court itself noted, the publishers do not compete on price. This point is oft-overlooked in discussions of the case. It is perhaps possible to say that the contract terms at issue and the publishers’ pressure on Amazon affected price competition between Apple and Amazon – but even then it cannot be said to have reduced competition, because, absent Apple’s entry, there was no competition at all between Apple and Amazon.

It’s true that, if all Apple’s entry did was to transfer identical e-book sales from Amazon to Apple, at higher prices and therefore lower output, it might be difficult to argue that Apple’s entry was procompetitive. But the myopic focus on e-book titles without consideration of product differentiation is mistaken, as well.

The relevant competition here is between Apple and Amazon at the platform level. As explained above, it is misleading to look solely at prices in evaluating the market’s competitiveness. Provided that switching costs are low enough and information about the platforms is available to consumers, consumer welfare may have been enhanced by competition between the platforms on a range of non-price dimensions, including, for example: the Apple iBookstore’s distinctive design, Apple’s proprietary file format, features on Apple’s iPad that were unavailable on Kindle Readers, Apple’s use of a range of marketing incentives unavailable to Amazon, and Apple’s algorithmic matching between its data and consumers’ e-book purchases.

While it’s difficult to disentangle Apple’s entry from other determinants of consumers’ demand for e-books, and even harder to establish with certainty the “but-for” world, it is nonetheless telling that the e-book market has expanded significantly since Apple’s entry, and that purchases of both iPads and Kindles have increased, as well.

There is, in other words, no clear evidence that consumers viewed the two products as perfect substitutes, and thus there is no evidence that Apple’s entry merely caused a non-welfare-enhancing substitution from Amazon to Apple. At minimum, there is no basis for treating the contract terms that facilitated Apple’s entry under a per se standard.

***

The point, in sum, is that there is in fact substantial evidence that Apple’ entry was pro-competitive, that there was no price-fixing scheme of which Apple was a part, and absolutely no evidence that the vertical restraints at issue in the case were the sort that should presumptively give rise to liability. Not only was application of the per se rule inappropriate, but, to answer Richard Epstein, there is strong evidence that Apple should win under a rule of reason analysis, as well.

by Jonathan Jacobson

Try as one may, it is hard to find an easier antitrust case than United States v. Apple.

Consider: The six leading publishers all wanted to prevent Amazon and others from offering best seller e-books at $9.99 (or other similar low prices). The problem, however, was that they had no mechanism for accomplishing that result. Then came Apple. Apple figured out that the “Amazon problem” could be fixed if the publishers changed their customer relationships from sale/resale to “agency,” all subject to an MFN with Apple that would prohibit any of the publishers – and, through the MFN, Amazon – from underselling the (higher) prices on Apple’s iBookstore. Loving this “aikido move” (in Steve Jobs’ words), all the publishers but Random House happily agreed. Prices for best seller e-books increased 30% almost overnight.

So what is this? The fact of a horizontal conspiracy among the five publishers is largely undisputed. Is it any less per se illegal because Apple was involved? Hardly; especially on these facts, where the participation by the “vertical” player was essential to make the whole scheme work. Apple’s role in no way made the conspiracy benign. It made it worse – and it couldn’t have been achieved without Apple’s active role.

Truly, all one needs to know about the case is in the attached video clip from the iPad launch event. Asked by the Wall Street Journal why anyone would pay $14.99 for a book from the iBookstore when it could be had for $9.99 on Amazon, Steve Jobs said: “Well, that won’t be the case.” Asked to explain, he added: “The prices will be the same.”

So we have a horizontal conspiracy to fix and raise e-book prices, made operational only through Apple’s aggressive involvement, that immediately raised prices by 30%. If that’s not an antitrust violation, we’re all in trouble.

As Judge (and Professor) Frank Easterbrook famously explained over three decades ago (in his seminal article The Limits of Antitrust), antitrust is an inherently limited body of law. In crafting and enforcing liability rules to combat market power and encourage competition, courts and regulators may err in two directions: they may wrongly forbid output-enhancing behavior or wrongly fail to condemn output-reducing conduct. The social losses from false convictions and false acquittals, taken together, comprise antitrust’s “error costs.” While it may be possible to reduce error costs by making liability rules more nuanced, added complexity raises the “decision costs” incurred by business planners (ex ante) and adjudicators (ex post). In light of all these costs, Easterbrook advocated an approach that would optimize antitrust’s effectiveness: interpret and enforce the antitrust laws so as to minimize the sum of error and decision costs.

Judge Easterbrook’s approach is consistent with the widely accepted proposition that antitrust enforcement should be viewed as an exercise in consumer welfare maximization. In order to maximize welfare, enforcers must have an understanding of – and seek to maximize the difference between – the aggregate costs and benefits that are likely to flow from their policies.  Specifically, antitrust enforcers first should ensure that the rules they propagate create net welfare benefits. Next, they should (to the extent possible) seek to calibrate those rules so as to maximize net welfare. This is achieved by employing an error cost (decision theoretic) framework, which seeks to minimize the sum of the costs attributable to false positives, false negatives, antitrust administrative costs, and disincentive costs imposed on third parties (the latter may also be viewed as a subset of false positives).

Perhaps the most glaring flaw of the Second Circuit’s 2015 decision in United States v. Apple Inc., is the failure to pay heed to error costs and the limits of antitrust as an administrative system.

In condemning Apple’s vertical contracts as illegal per se, because they allegedly were used to facilitate a horizontal price-fixing conspiracy among publishers, the Second Circuit ignored the vast literature on the efficiencies associated with vertical restraints. (They also failed to heed Supreme Court precedent, see here). Moreover, the vertical restraints employed by Apple in this case, such as most-favored nation (MFN) clauses, clearly had substantial efficiency potential – they were particularly well-suited to facilitate Apple’s competition with Amazon’s established e-book platform and thereby enhance competition in the emerging e-book market. (This theme is explained and developed here). Accordingly, the Second Circuit’s failure to examine the restraints in detail under the antitrust rule of reason created a strong potential for wrongly condemning procompetitive behavior (false positives). In contrast, the likelihood of wrongly failing to condemn anticompetitive practices (false negatives) under a rule of reason assessment in this case (involving a substantial record, an emerging dynamic market, and the use of typically efficient vertical contracts by a new entrant) would have been comparatively small. Furthermore, the Second Circuit’s per se condemnation of vertical restraints in Apple creates substantial disincentive costs, by discouraging other businesses from developing innovative distribution models employing vertical restraints in emerging markets.

In sum, the Second Circuit’s approach is plainly at odds with a welfare-enhancing, decision theoretic approach to antitrust. It also runs counter to the general thrust of the Supreme Court’s recent antitrust jurisprudence, which implicitly has adopted an error cost framework (see the article by Thom Lambert and me, here) with a focus on false positives. As the late Justice Scalia pithily explained, “[m]istaken inferences and the resulting false condemnations are ‘especially costly, because they chill the very conduct the antitrust laws are designed to protect.’” Verizon v. Trinko (citing Matsushita Elec. Indus. Co. v. Zenith Radio Corp.). It would be fitting tribute to the great Justice for the Supreme Court to heed this teaching and grant certiorari in the Apple case.

On balance the Second Circuit was right to apply the antitrust laws to Apple.

Right now the Supreme Court has before it a petition for Certiorari, brought by Apple, Inc., which asks the Court to reverse the decision of the Second Circuit. That decision found per se illegality under the Sherman Act, for Apple’s efforts to promote cooperation among a group of six major publishers, who desperately sought to break Amazon’s dominant position in the ebook market. At that time, Amazon employed a wholesale model for ebooks under which it bought them for a fixed price, but could sell them for whatever price it wanted, including sales at below cost of popular books treated as loss leaders. These sales particularly frustrated publishers because of the extra pressure they placed on the sale of hard cover and paper back books. That problem disappeared under the agency relationship model that Apple pioneered. Now the publishers would set the prices for the sale of their own volumes, and then pay Apple a fixed commission for its services in selling the ebooks.

This agency model gives the publishers a price freedom, but it would fall apart at the seams if Amazon could continue to sell ebooks under the wholesale model at prices below those that were set by publishers for ebook sales by Apple. To deal with this complication, Apple insisted that all publishers that sold to it through the agency model require Amazon to purchase the ebooks on the same terms. Apple also insisted that it receive a most-favored-nation clause so that it would not find itself undercut either by Amazon or by a new entrant that also used the agency model.

There is little question that Apple would be in fine shape if it had proposed this model to each of the publishers separately, for then its action would be a form of ordinary competition of the sort permitted to every new entrant. Competition often takes place in terms of price, where the terms of the contracts are standard between competitors. That common state of affairs makes it easier for customers to compare prices with each other, and—sigh—for competitors to collude with each other. But without some evidence of collusion, the price parallelism should be regarded as per se legal, as it is routinely today. The decision to adopt a new form of pricing makes cross-product comparisons more difficult, but, by the same token, it offers a wider range of choice to customers. Again there is nothing in the antitrust laws that does, or should, prevent nonprice competition, including a radical shift in business model.

As it happened, once Apple imposed its model, the older wholesale model gave way, because it could not survive anywhere once the agency model was introduced. In the short run, this tectonic market shift has resulted in an increase in the price of ebooks and a corresponding decline in revenue, which is just what one would expect when prices are raised. It is therefore difficult to defend the case on the ground that it produces, in either the long or the short run, lower prices that benefit consumers. But it is difficult in the abstract to find that higher prices themselves are the hallmark of an antitrust violation.

At root the main considerations should be structural. What makes the ebooks case so hard is that it arises at the cross-currents of two different antitrust approaches. The general view is that horizontal arrangements are per se illegal, which means that it is necessary to show some very specific justifications to defeat a charge under Section 1 of the Sherman Act. No such arguments — like the need to share information in order to operate in a network industry — present themselves here. Yet by the same token, the general view on vertical arrangements is that they offer efficiencies by reducing the bottlenecks that could be created if players at different levels of the distribution system seek to hold out for a larger share of the gain, thereby creating a serious double marginalization problem. In these cases, the modern view is that vertical arrangements are in general governed by rule of reason considerations. The question now is what happens where there is an inevitable confluence of the vertical and horizontal arrangements.

In preparing for this short column, I read the petition for certiorari by Apple, and the two separate briefs prepared in support of Apple by a set of law professors and economists respectively. Both urge that this case be evaluated under a rule of reason, not the per se rule that applies to horizontal price-fixing. Both these briefs are excellently done. But I confess that my current view is that they miss the central difficulty in this case. Any argument for a rule of reason has to be able to identify in advance the gains and losses that justify some kind of balancing act. That standard can be met in merger cases, where under the standard Williamson model one is asked to compare the social gains from lower costs with the social losses from increased competition. These are not decisions that can be made well within the judicial context, so a separate administrative procedure is set up under the premerger notification program established under the 1976 Hart-Scott-Rodino Act. The administrative setting makes it possible to collect the needed information, and to decide whether to allow the merger to go through, and if so, subject to what conditions on matters such as partial divestiture to avoid excessive concentration in relevant submarkets. The task is always messy, but the rule-of-thumb that five-to-four is generally fine and three-to-two is not, shows that it is possible to hone in on an answer in most cases, but not all.

But what is troublesome in Apple is that, though the briefs are very persuasive in arguing that mixed vertical and horizontal arrangements might fit better into a rule of reason framework, they do not indicate what metric the parties should use to determine, once the case is remanded, how the rule of reason plays out. That is to say, there is no clear theory of what should be traded off against what. To put the point another way, none of these briefs argues that the transaction in question should be regarded as per se legal, so my fear is this: all the relevant information is already made available in the case, so that, on remand, the only task left to be done is to decide whether Apple should be protected because its own conduct disrupts a near-monopoly position that is held by Amazon. But that argument is at least a little dicey given that no one could argue that Amazon has obtained its dominant position by any unlawful means, which undercuts (but does not destroy) the argument that cutting Amazon down to size is necessarily a good thing. It might not be if the willingness to allow a collusive collateral attack orchestrated by Apple would reduce ex ante the gains from innovation that Amazon surely created when it pioneered its own wholesale ebook model. Facilitation is often regarded as criminal and tortious conduct in other areas. So at the moment, and subject to revision, my view is that the Second Circuit got it right. The vertical assist to the horizontal arrangement increased the odds of the horizontal deal that was illegal, and probably shares in that taint.

In making this judgment I think of the decision in Fashion Originators’ Guild of America, Inc. v. FTC (FOGA) which did address the question of whether the defendants could resist a cease and desist order by the FTC, which had attacked as per se illegal a decision of the manufacturers whose comparative advantage was to act as sellers of original and distinctive designs that at the time received neither patent nor copyright protection. The defendants entered into a limited form of collusion whereby they agreed not to sell to any retailer who carried a knock-off of their creations. They did not extend their cooperative activity into any other area. In essence, they sought only to protect what they regarded as their intellectual property. Justice Black held that the case did not fall outside the per se Section 1 prohibition even though it could easily have been argued that these decisions were undertaken to protect the labor that these individuals had placed in their creations. In addition, the opinion concluded with this passage:

even if copying were an acknowledged tort under the law of every state, that situation would not justify petitioners in combining together to regulate and restrain interstate commerce in violation of federal law. And for these same reasons, the principles declared in International News Service v. Associated Press, 248 U.S. 215, [1918], cannot serve to legalize petitioners’ unlawful combination.

I think that the first sentence here is wrong if self-help is cheaper and more reliable in dealing with the threat. But Justice Black flatly rejected the INS decision, which in my view represents a highly sophisticated effort to develop a tort of unfair competition between direct competitors. It reaches the correct result by defining the protected right narrowly—publication for one news cycle only. That move guards against misappropriation when it matters most, but by design prevents the creation of any long-term monopoly on anything like the copyright model. The limited and proportionate response in FOGA, however, did not cut any ice.

In addition, the defendants in FOGA have a respectable case on the merits that some protection of these design elements should be provided under either the patent or copyright laws, precisely because the appropriation is so difficult to guard against by any other means. Probably, the statutory length of such protection should not be as long as that offered by standard patents and copyrights, but that matter could be settled by statute. Accordingly, if antitrust law turns a blind eye to these justifications, is the nonspecific concern raised, but not spelled out, by Apple any stronger?

Finally, what should be the bottom line? It is worth noting that in FOGA the government was seeking only an injunction against the conduct, without asking for any damages. In Apple, the co-plaintiff states are seeking damage awards. Perhaps the simplest solution is to allow the injunction and to deny the damages, in part because of the clear complexity of the underlying legal issues. In this case, King Solomon might be wise to split the baby.