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[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Julian Morris, (Director of Innovation Policy, ICLE).]

Governments are beginning to lift the lockdowns they imposed to slow the spread of COVID-19. That is a good thing. But simply lifting the restrictions won’t immediately take us back to normality. For that to happen requires a massive investment in mechanisms that will rebuild trust.

Prior to COVID-19, people implicitly trusted that travelling on public transit, working in an office, attending a ball game, or going to a shopping mall would not subject them to the risk of infection by a potentially deadly virus (or any other terrible eventuality). In the wake of the pandemic, this implicit trust is gone. Many people are afraid of COVID-19 and will require reassurance. While governments likely contributed significantly to the loss of trust, they are likely not in the best position to rebuild that trust. The onus is thus on businesses and civic organizations to provide reassurance and rebuild trust. This post outlines two ways businesses can contribute to this effort.

Lockdowns and the Trust Deficit

As the incidence of COVID-19 began to rise dramatically in March, governments across the world imposed “lockdowns.” These curfew-like arrangements have gone well beyond the limits on public gatherings and other “social distancing” strategies deployed during previous major pandemics such as the Spanish ‘flu of 1918-19. Indeed, they are among the most far-reaching restrictions ever imposed on human activity during peacetime. Hundreds of millions of people have been cooped up at home for nearly two months, allowed out only briefly each day for exercise or to buy groceries. Millions of those now at home have also lost their main source of income.

Governments are now finally beginning to remove some of the most severe of these restrictions, allowing more businesses to operate. As they do so, businesses are trying to figure out what the post-lockdown economy is going to look like: Will employees come back to work in offices? Will customers shop in stores, eat at restaurants, visit movie theatres, and use rideshares, taxis, planes, and public transit?

Many people are fearful about the consequences of going back to work. A recent IPSOS-MORI poll for the Washington Post found that 74 percent of American adults want policymakers to, “keep trying to slow the spread of the coronavirus, even if that means keeping many businesses closed,” while just 25 percent prefer to, “open up businesses and get the economy going again, even if that means more people would get the coronavirus.” Meanwhile, in a recent survey in the UK, the TUC union found that 40% of workers were worried about the prospects of returning to crowded workplaces.  

The loss of trust is likely in part be due to conditioning: for the past two months we have been told by all and sundry to avoid other people (except over Zoom). Governments likely contributed to this through their promotion of scary predictions that millions could die if people didn’t “stay home, stay safe.” Partly, however, it is a natural reaction to the perceived threat posed by COVID-19.

For the elderly and those with underlying conditions more likely to be adversely affected by COVID-19, such anxiety is understandable. But even many people less likely to become seriously ill or die from COVID-19 are worried. This is also not surprising: They may have heard horror stories of young, otherwise healthy people who ended up on a ventilator and either died or suffered permanent lung damage. Or perhaps they read about the mysterious effects COVID-19 can have on other organs, ranging from the intestines to the brain. Or they may have a more vulnerable person in our household and are worried about the possibility that we might infect them. Or, as I am sure is the case with many, they just don’t know—and this is their reaction to uncertainty (fueled, in part by the now-discredited predictions of doom).

Regardless of why a person fears COVID-19, the fact is that many do. And one thing common to all of them is a trust deficit. Given widespread uncertainty regarding who has the virus, how can one trust that the business one works, shops, or dines at provides a safe environment free of COVID-19? This even extends to friends and colleagues: how can one individual trust another individual they might encounter while at work or at play? And it applies also to the use of taxis and rideshares; how can riders and drivers trust one another?

It might be argued that since governments were in no small part responsible for generating the trust deficit, through their well-intentioned but probably misguided efforts to lock down the economy and constant exhortations to avoid all human contact, they should now be trying to do what they can to rebuild trust. Unfortunately, however, they may not be in a very good position to do that. While governments are quite good at scaring people (“I’m from the government and I’m here to help”), they are less good at providing reassurance (“I’m from the government and I’m here to help”), or even data. In other words, governments aren’t much good at engaging in the kinds of “costly signalling” necessary to build trust between individuals and businesses. As a result, much of the responsibility for rebuilding trust will fall on businesses and civic organizations.

Businesses can do several things that would likely reduce this trust deficit and allay the fears of employees and customers. First, they can establish, communicate, and implement clear standards for employees and customers regarding the practices to be adopted to reduce infection risk. Second, and relatedly, where employees are likely to be working in close quarters with one another or with customers or suppliers, they can adopt mechanisms to establish the COVID-19 status of those employees, suppliers and customers (somewhat along the lines of the system implemented by Taiwan in February and subsequently elaborated by Hal Singer in his post in this series here). 

The following sections briefly consider how such systems might work.

CV19 Standards

Companies that have not been locked down are already implementing processes to limit the exposure of employees to potentially infected customers, suppliers, and other employees. For example, many supermarkets require staff to use masks and/or protective screens and gloves. Some stores also require customers to wear masks, limit how many people can be in the store, and impose distancing rules. Some have even built seemingly permanent screens in front of check-out clerks and imposed seemingly permanent rules for in-store movement.  Other stores and restaurants are currently limiting service to take-out and delivery.

At present, the approaches taken by businesses vary considerably. There is nothing inherently wrong with this; indeed, it is a healthy part of a market process in which companies develop different solutions to the same problem and allow consumers to pick and choose the ones that work best for them. Consumers can be aided in this process by reading reviews and ratings provided by other consumers; that model has worked well for goods and services purchased online. As Paul Seabright has noted, these systems are designed to enable users to build trusting relationships with suppliers. Survey data suggest that consumers find such systems more trustworthy than government regulations.

But when consumers are not well placed to evaluate the most effective solution, for example because it is difficult to observe the effectiveness of the solution directly, it can be helpful for third parties to evaluate the various solutions and either rank them or set out voluntary pass-fail standards. COVID-19 is just such a case: individual consumers and employees are unlikely to be in a good position to evaluate the relative effectiveness of different processes and technologies designed to limit the transmission of SARS-CoV-2. As such, pass-fail standards developed and/or validated by credible, independent third parties are likely to be the most effective way to help rebuild trust.

Standards will vary depending on the type of establishment and activity. For some businesses, such as theatres, gyms, and mass transit systems, the standards will likely be more onerous than others. Plausibly, such establishments could reduce transmission through such things as: mandatory masks, mandatory use of antiviral hand sanitizer on entry, regular cleaning, the use of HEPA filters (which remove the droplets on which the virus is spread), and other technologies. But given the very close proximity of people in such systems, often for extended periods (half an hour or more), the risk of significant viral load being transferred from one person to another, even if wearing basic masks, remains.

For standards to be effective as a means of regaining the trust of employees, suppliers, and consumers, it is important that they are communicated effectively through marketing campaigns, likely including advertising and signage. Standards will also likely change over time as understanding of the way the virus is transmitted, technologies that can prevent transmission, and hence best practices improve. The need for such standards will also likely change over time and once the virus is no longer a major threat there should be no need for such standards. For these reasons, standards should be both voluntary and developed privately. However, governments can play a role in encouraging the adoption of such standards by legislating that organizations that are compliant with a recognized standard will not be liable if an infection occurs on their property or through the actions of their employees.

In addition to other practices designed to reduce transmission of the SARS-CoV-2 virus, some businesses have begun testing employees for the virus, to determine who is and who is not currently infected, so that infected individuals can be isolated until they are no longer infectious (employees who are required to isolate continue to receive their salary). Some businesses are also considering testing for antibodies to the virus, to determine who has had the virus and likely has some immunity. By doing such testing, businesses are probably reducing transmission both among employees and between employees and customers to a greater extent than by merely implementing technologies, hygiene and distancing rules. But the tests are not perfect and given the potential for infection outside work, it is possible that an employee who tests negative on one day could then become infected and be infective a few days later. While daily testing might be an option for some firms, it is unrealistic for most—and will not solve the trust problem for most individuals.

CV19 Status Verification

This brings us to the second major thing that business can do to reduce the trust gap: status verification. The idea here is to enable parties to ascertain one another’s current COVID-19 status without the need to resort to constant testing. One possible approach is to use a smartphone-based app that combines various pieces of information (time stamped virus tests and antibody tests, anonymized information about contacts with people who subsequently tested positive, and self-reported health-relevant data) to offer the most accurate and up-to-date status of an individual.

In principle, such a status app could be used by employers to minimize the likelihood that their staff have COVID (and to require those that may be infected to self-isolate and obtain a test). But their potential application is far wider:

·       Universities, churches, theatres, restaurants, bars, and events might utilize the status app not only for employees but also to determine who may participate and/or what forms of PPE they should utilize and/or where participants may congregate.

·       Airlines might utilize status apps to determine who might fly and where passengers should be seated.

·       Jurisdictions might utilize status apps as a means of facilitating more rapid immigration – and to enable those who most likely do not have COVID-19 to avoid most quarantine requirements.

·       Public transit systems might utilize status apps to determine who can use the system.

·       Taxis and ridesharing services, such as Uber and Lyft, might utilize data from the status app to help match riders and drivers.

·       Personal services facilitators such as Thumbtack might utilize the app to help match service providers and customers.

·       Hotels, AirBnB and vacation rental facilitators such as vrbo might use status apps for both hosts (and their employees and contractors) and guests in order to minimize infection risk during a visit.

·       Online dating and matchmaking services such as Match and Tinder might utilize status apps to help facilitate virus-compatible matches. (While SARS-CoV-2/COVID-19 is not really comparable to HIV/AIDS, it is noteworthy that sites already exist that seek to match people who are HIV positive.)

How a CV19 Status App might Work

A basic schema for a CV19 status app would be:

·       Red = Has COVID-19 (e.g. recently tested positive for virus)

·       Red-Amber = May have COVID-19 (e.g. recently tested negative for virus but either has COVID-19 related symptoms or has been in contact with someone who tested positive).

·       Amber = Is susceptible: Has not had COVID-19 and likely does not have COVID-19 (e.g. recently tested negative for COVID-19, has no COVID-19 symptoms, and has had no recent known contact with someone who tested positive).

·       Green = Has had COVID-19 and is now presumed to be immune (either tested positive for CV19 and then tested negative for CV19, or tested negative for CV19 and also tested positive for Antibodies) (See below regarding immunity concerns.)

This schema is shown in the decision tree below

There are numerous technical issues relating to the operation of an app designed to establish a person’s CV19 status that must be addressed for it to function effectively. First, it will be necessary to ensure that the person using the app is the person whose status is being asserted. It should be possible to address this by storing the information from tests, contacts with infected people, and self-reported symptoms on an immutable digital ledger and use biometric identification both to record and to share status information. (Storing the status information on a person’s phone in this way also avoids the risk of hacking that plagues centralized databases.)

Next there is the question of authenticating test data recorded by the app. Ideally, this would be done by having a trusted third party—such as a doctor, nurse, or pharmacist—verify the data. If that is not feasible—for example because the test was carried out at home—then some other mechanism will be required to ensure the data is input correctly, such as rewards for accurate self-reports and/or penalties for inaccurate self-reports. (Self-reported data could also be treated within the system as less reliable, or simply as tentative—requiring verified test data to be added within a specified period.)

Beyond these verification issues, there remain problems with the specificity and sensitivity of tests—implying a likelihood of both false positive and false negatives. Although there are now both PCR and antibody tests that achieve very high levels of accuracy, even small numbers of false negative PCR tests and false positive antibody tests would clearly create problems for the effective functioning of the status app system. To address these problems, it may be necessary to undertake secondary testing for some portion of the tests.

The more challenging problem is that of infection after tests are conducted. As noted above, this can in principle be mitigated—but not eliminated—by incorporating contact tracing and/or self-reporting of symptoms. Related to this is the possibility that having COVID-19 confers only limited immunity (as has been suggested in relation to some people who have seemingly become reinfected). This obviously poses problems for the notion of a “Green” status; if reinfection is possible, then Green clearly would not be a permanent designation and would require regular testing. The evidence remains ambiguous, with news of five US sailors who had COVID then tested negative twice subsequently having new symptoms and testing positive again; on the other hand, a recent study suggests that people who test positive after recovery do not have a live (infectious) version of the virus.

Contact tracing apps have been used successfully in several locations as part of a strategy for containing COVID-19. However, the only really successful implementations so far have been those in China, South Korea and Hong Kong, which had a mandatory component and were highly centralized. By contrast, apps that required voluntary uptake have generally been less successful.

One reason for the lack of success of voluntary contact tracing apps is heightened concern regarding privacy (for example, the app used in Hong Kong enables anyone to find the gender, age, and precise locations of every person in the city who currently has COVID-19). Of course it is worth repeating Jane Bambauer’s observation in an earlier post that “Objections to surveillance lose their moral and logical bearings when the alternatives are out-of-control disease or mass lockdowns. Compared to those, mass surveillance is the most liberty-preserving option.” But assuming imprisonment is not the only alternative, concerns over privacy are not necessarily unmoored from logic or ethics (pace Christine Wilson’s earlier post). And to address these concerns, several groups have developed privacy-protecting systems. For example, the TCN coalition developed a system that shares anonymized tokens with other nearby phones over Bluetooth Low Energy. That system has now been adopted by Google and Apple in an API that is being made available to government health authorities (but not to other private app developers).

Another reason voluntary contact tracing apps have not been successful is the lack of incentives to adopt them. The main benefit of a contact tracing app is that it notifies the user when they have been in close contact with someone who subsequently tested positive. Logically, the people most likely voluntarily to adopt a contact tracing app are those who are most risk averse. But those people would also presumably be taking strong measures to avoid contracting COVID-19, so they would be less likely to become infected. By contrast, the people most likely to become infected are those who are least risk averse. But those people are least likely to be motivated to use the contact tracing app. In other words, even if there is relatively wide uptake of the app (say, 40% of the population, as in Iceland), it is likely to miss many of the people most likely to be spreading COVID-19 and so would not actually be very useful as a means of identifying and containing clusters.

Tying the contact tracing app to a CV19 Status App potentially overcomes this incentive compatibility problem, since anyone who wants to engage in an activity that requires use of the app would automatically participate in the contact tracing system. It could thus be quite effective at identifying instances of transmission that occur during activities that require the app to be used, which would also presumably be activities that put users at higher risk.

Nonetheless, for the app to be useful as a means of identifying clusters of COVID-19, either a significant proportion of common activities would have to require use of the app (e.g. public transit, rideshares, gyms, and shopping malls) or it would have to be used by at least some proportion of those not required to use it for access to activities.  

Adding a symptom monitoring component can help in two ways. First, by offering users a way to self-assess for early symptoms of COVID-19, it encourages more people to download and use the app.  More important, symptom monitoring can help identify additional potential COVID-19 infections, both among the individuals reporting symptoms and among their contacts. Thus, the combination of test data, symptom data and contact tracing become the information determining a person’s current status in a manner that is more reliable than relying on any one datum.

It should be noted that even combining these data will not make the status app 100% accurate. Some people with COVID-19 will likely slip through as Green or Orange and others will likely inadvertently be infected as a result. But the number of such instances is likely to be small and certainly much lower than would be the case without the use of the app. Moreover, widespread use of the app should dramatically reduce the infection rate throughout the population, with benefits to all.     

Conclusions

Both CV19 standards and CV19 status verification offer potential means by which to address the trust deficit that has emerged in the context of the continuing COVID-19 pandemic. A company that adopts both solutions would likely dramatically reduce the chances of their employees, suppliers and customers contracting the virus on their premises. That would also likely reduce the company’s liability, which could be rewarded by insurance providers offering discounts. Indeed, one could envisage a greater role for insurance companies in designing or certifying the standards and the status app.

However, the real benefits of these systems come not from one or a few companies adopting them but from widespread adoption, which has the potential dramatically to reduce the transmission of the virus both now and in the future (should there be a second wave). This leads to something of a paradox: Governments could mandate adoption, but such an approach may be counterproductive for two reasons. First, much knowledge is dispersed and tacit, so it is generally better to allow private actors to determine which standards to adopt (lest an inferior standard be the subject of a mandate). Second, if companies are genuinely concerned to address the trust deficit, then they will be willing to invest in standards and to limit access though status apps — both of which entail costs. By contrast, if governments mandate the use of standards and apps, they would effectively prevent firms from engaging in such costly signalling, so would undermine at least part of the effectiveness of such tools as trust-generative.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Kristian Stout, (Associate Director, International Center for Law & Economics]

The public policy community’s infatuation with digital privacy has grown by leaps and bounds since the enactment of GDPR and the CCPA, but COVID-19 may leave the most enduring mark on the actual direction that privacy policy takes. As the pandemic and associated lockdowns first began, there were interesting discussions cropping up about the inevitable conflict between strong privacy fundamentalism and the pragmatic steps necessary to adequately trace the spread of infection. 

Axiomatic of this controversy is the Apple/Google contact tracing system, software developed for smartphones to assist with the identification of individuals and populations that have likely been in contact with the virus. The debate sparked by the Apple/Google proposal highlights what we miss when we treat “privacy” (however defined) as an end in itself, an end that must necessarily  trump other concerns. 

The Apple/Google contact tracing efforts

Apple/Google are doing yeoman’s work attempting to produce a useful contact tracing API given the headwinds of privacy advocacy they face. Apple’s webpage describing its new contact tracing system is a testament to the extent to which strong privacy protections are central to its efforts. Indeed, those privacy protections are in the very name of the service: “Privacy-Preserving Contact Tracing” program. But, vitally, the utility of the Apple/Google API is ultimately a function of its efficacy as a tracing tool, not in how well it protects privacy.

Apple/Google — despite the complaints of some states — are rolling out their Covid-19-tracking services with notable limitations. Most prominently, the APIs will not allow collection of location data, and will only function when users explicitly opt-in. This last point is important because there is evidence that opt-in requirements, by their nature, tend to reduce the flow of information in a system, and when we are considering tracing solutions to an ongoing pandemic surely less information is not optimal. Further, all of the data collected through the API will be anonymized, preventing even healthcare authorities from identifying particular infected individuals.

These restrictions prevent the tool from being as effective as it could be, but it’s not clear how Apple/Google could do any better given the political climate. For years, the Big Tech firms have been villainized by privacy advocates that accuse them of spying on kids and cavalierly disregarding consumer privacy as they treat individuals’ data as just another business input. The problem with this approach is that, in the midst of a generational crisis, our best tools are being excluded from the fight. Which begs the question: perhaps we have privacy all wrong? 

Privacy is one value among many

The U.S. constitutional order explicitly protects our privacy as against state intrusion in order to guarantee, among other things, fair process and equal access to justice. But this strong presumption against state intrusion—far from establishing a fundamental or absolute right to privacy—only accounts for part of the privacy story. 

The Constitution’s limit is a recognition of the fact that we humans are highly social creatures and that privacy is one value among many. Properly conceived, privacy protections are themselves valuable only insofar as they protect other things we value. Jane Bambauer explored some of this in an earlier post where she characterized privacy as, at best, an “instrumental right” — that is a tool used to promote other desirable social goals such as “fairness, safety, and autonomy.”

Following from Jane’s insight, privacy — as an instrumental good — is something that can have both positive and negative externalities, and needs to be enlarged or attenuated as its ability to serve instrumental ends changes in different contexts. 

According to Jane:

There is a moral imperative to ignore even express lack of consent when withholding important information that puts others in danger. Just as many states affirmatively require doctors, therapists, teachers, and other fiduciaries to report certain risks even at the expense of their client’s and ward’s privacy …  this same logic applies at scale to the collection and analysis of data during a pandemic.

Indeed, dealing with externalities is one of the most common and powerful justifications for regulation, and an extreme form of “privacy libertarianism” —in the context of a pandemic — is likely to be, on net, harmful to society.

Which brings us back to efforts of Apple/Google. Even if those firms wanted to risk the ire of  privacy absolutists, it’s not clear that they could do so without incurring tremendous regulatory risk, uncertainty and a popular backlash. As statutory matters, the CCPA and the GDPR chill experimentation in the face of potentially crippling fines. While the FTC Act’s Section 5 prohibition on “unfair or deceptive” practices is open to interpretation in manners which could result in existentially damaging outcomes. Further, some polling suggests that the public appetite for contact tracing is not particularly high – though, as is often the case, such pro-privacy poll outcomes rarely give appropriate shrift to the tradeoff required.

As a general matter, it’s important to think about the value of individual privacy, and how best to optimally protect it. But privacy does not stand above all other values in all contexts. It is entirely reasonable to conclude that, in a time of emergency, if private firms can devise more effective solutions for mitigating the crisis, they should have more latitude to experiment. Knee-jerk preferences for an amorphous “right of privacy” should not be used to block those experiments.

Much as with the Cosmic Turtle, its tradeoffs all the way down. Most of the U.S. is in lockdown, and while we vigorously protect our privacy, we risk frustrating the creation of tools that could put a light at the end of the tunnel. We are, in effect, trading liberty and economic self-determination for privacy.

Once the worst of the Covid-19 crisis has passed — hastened possibly by the use of contact tracing programs — we can debate the proper use of private data in exigent circumstances. For the immediate future, we should instead be encouraging firms like Apple/Google to experiment with better ways to control the pandemic. 

What to make of Wednesday’s decision by the European Commission alleging that Google has engaged in anticompetitive behavior? In this post, I contrast the European Commission’s (EC) approach to competition policy with US antitrust, briefly explore the history of smartphones and then discuss the ruling.

Asked about the EC’s decision the day it was announced, FTC Chairman Joseph Simons noted that, while the market is concentrated, Apple and Google “compete pretty heavily against each other” with their mobile operating systems, in stark contrast to the way the EC defined the market. Simons also stressed that for the FTC what matters is not the structure of the market per se but whether or not there is harm to the consumer. This again contrasts with the European Commission’s approach, which does not require harm to consumers. As Simons put it:

Once they [the European Commission] find that a company is dominant… that imposes upon the company kind of like a fairness obligation irrespective of what the effect is on the consumer. Our regulatory… our antitrust regime requires that there be a harm to consumer welfare — so the consumer has to be injured — so the two tests are a little bit different.

Indeed, and as the history below shows, the popularity of Apple’s iOS and Google’s Android operating systems arose because they were superior products — not because of anticompetitive conduct on the part of either Apple or Google. On the face of it, the conduct of both Apple and Google has led to consumer benefits, not harms. So, from the perspective of U.S. antitrust authorities, there is no reason to take action.

Moreover, there is a danger that by taking action as the EU has done, competition and innovation will be undermined — which would be a perverse outcome indeed. These concerns were reflected in a statement by Senator Mike Lee (R-UT):

Today’s decision by the European Commission to fine Google over $5 billion and require significant changes to its business model to satisfy EC bureaucrats has the potential to undermine competition and innovation in the United States,” Sen. Lee said. “Moreover, the decision further demonstrates the different approaches to competition policy between U.S. and EC antitrust enforcers. As discussed at the hearing held last December before the Senate’s Subcommittee on Antitrust, Competition Policy & Consumer Rights, U.S. antitrust agencies analyze business practices based on the consumer welfare standard. This analytical framework seeks to protect consumers rather than competitors. A competitive marketplace requires strong antitrust enforcement. However, appropriate competition policy should serve the interests of consumers and not be used as a vehicle by competitors to punish their successful rivals.

Ironically, the fundamental basis for the Commission’s decision is an analytical framework developed by economists at Harvard in the 1950s, which presumes that the structure of a market determines the conduct of the participants, which in turn presumptively affects outcomes for consumers. This “structure-conduct-performance” paradigm has been challenged both theoretically and empirically (and by “challenged,” I mean “demolished”).

Maintaining, as EC Commissioner Vestager has, that “What would serve competition is to have more players,” is to adopt a presumption regarding competition rooted in the structure of the market, without sufficient attention to the facts on the ground. As French economist Jean Tirole noted in his Nobel Prize lecture:

Economists accordingly have advocated a case-by-case or “rule of reason” approach to antitrust, away from rigid “per se” rules (which mechanically either allow or prohibit certain behaviors, ranging from price-fixing agreements to resale price maintenance). The economists’ pragmatic message however comes with a double social responsibility. First, economists must offer a rigorous analysis of how markets work, taking into account both the specificities of particular industries and what regulators do and do not know….

Second, economists must participate in the policy debate…. But of course, the responsibility here goes both ways. Policymakers and the media must also be willing to listen to economists.

In good Tirolean fashion, we begin with an analysis of how the market for smartphones developed. What quickly emerges is that the structure of the market is a function of intense competition, not its absence. And, by extension, mandating a different structure will likely impede competition, or, at the very least, will not likely contribute to it.

A brief history of smartphone competition

In 2006, Nokia’s N70 became the first smartphone to sell more than a million units. It was a beautiful device, with a simple touch screen interface and real push buttons for numbers. The following year, Apple released its first iPhone. It sold 7 million units — about the same as Nokia’s N95 and slightly less than LG’s Shine. Not bad, but paltry compared to the sales of Nokia’s 1200 series phones, which had combined sales of over 250 million that year — about twice the total of all smartphone sales in 2007.

By 2017, smartphones had come to dominate the market, with total sales of over 1.5 billion. At the same time, the structure of the market has changed dramatically. In the first quarter of 2018, Apple’s iPhone X and iPhone 8 were the two best-selling smartphones in the world. In total, Apple shipped just over 52 million phones, accounting for 14.5% of the global market. Samsung, which has a wider range of devices, sold even more: 78 million phones, or 21.7% of the market. At third and fourth place were Huawei (11%) and Xiaomi (7.5%). Nokia and LG didn’t even make it into the top 10, with market shares of only 3% and 1% respectively.

Several factors have driven this highly dynamic market. Dramatic improvements in cellular data networks have played a role. But arguably of greater importance has been the development of software that offers consumers an intuitive and rewarding experience.

Apple’s iOS and Google’s Android operating systems have proven to be enormously popular among both users and app developers. This has generated synergies — or what economists call network externalities — as more apps have been developed, so more people are attracted to the ecosystem and vice versa, leading to a virtuous circle that benefits both users and app developers.

By contrast, Nokia’s early smartphones, including the N70 and N95, ran Symbian, the operating system developed for Psion’s handheld devices, which had a clunkier user interface and was more difficult to code — so it was less attractive to both users and developers. In addition, Symbian lacked an effective means of solving the problem of fragmentation of the operating system across different devices, which made it difficult for developers to create apps that ran across the ecosystem — something both Apple (through its closed system) and Google (through agreements with carriers) were able to address. Meanwhile, Java’s MIDP used in LG’s Shine, and its successor J2ME imposed restrictions on developers (such as prohibiting access to files, hardware, and network connections) that seem to have made it less attractive than Android.

The relative superiority of their operating systems enabled Apple and the manufacturers of Android-based phones to steal a march on the early leaders in the smartphone revolution.

The fact that Google allows smartphone manufacturers to install Android for free, distributes Google Play and other apps in a free bundle, and pays such manufacturers for preferential treatment for Google Search, has also kept the cost of Android-based smartphones down. As a result, Android phones are the cheapest on the market, providing a powerful experience for as little as $50. It is reasonable to conclude from this that innovation, driven by fierce competition, has led to devices, operating systems, and apps that provide enormous benefits to consumers.

The Commission decision would harm device manufacturers, app developers and consumers

The EC’s decision seems to disregard the history of smartphone innovation and competition and their ongoing consequences. As Dirk Auer explains, the Open Handset Alliance (OHA) was created specifically to offer an effective alternative to Apple’s iPhone — and it worked. Indeed, it worked so spectacularly that Android is installed on about 80% of all new phones. This success was the result of several factors that the Commission now seeks to undermine:

First, in order to maintain order within the Android universe, and thereby ensure that apps developed for Android would function on the vast majority of Android devices, Google and the OHA sought to limit the extent to which Android “forks” could be created. (Apple didn’t face this problem because its source code is proprietary, so cannot be modified by third-party developers.) One way Google does this is by imposing restrictions on the licensing of its proprietary apps, such as the Google Play store (a repository of apps, similar to Apple’s App Store).

Device manufacturers that don’t conform to these restrictions may still build devices with their forked version of Android — but without those Google apps. Indeed, Amazon chooses to develop a non-conforming version of Android and built its own app repository for its Fire devices (though it is still possible to add the Google Play Store). That strategy seems to be working for Amazon in the tablet market; in 2017 it rose past Samsung to become the second biggest manufacturer of tablets worldwide, after Apple.

Second, in order to be able to offer Android for free to smartphone manufacturers, Google sought to develop unique revenue streams (because, although the software is offered for free, it turns out that software developers generally don’t work for free). The main way Google did this was by requiring manufacturers that choose to install Google Play also to install its browser (Chrome) and search tools, which generate revenue from advertising. At the same time, Google kept its platform open by permitting preloads of rivals’ apps and creating a marketplace where rivals can also reach scale. Mozilla’s Firefox browser, for example, has been downloaded over 100 million times on Android.

The importance of these factors to the success of Android is acknowledged by the EC. But instead of treating them as legitimate business practices that enabled the development of high-quality, low-cost smartphones and a universe of apps that benefits billions of people, the Commission simply asserts that they are harmful, anticompetitive practices.

For example, the Commission asserts that

In order to be able to pre-install on their devices Google’s proprietary apps, including the Play Store and Google Search, manufacturers had to commit not to develop or sell even a single device running on an Android fork. The Commission found that this conduct was abusive as of 2011, which is the date Google became dominant in the market for app stores for the Android mobile operating system.

This is simply absurd, to say nothing of ahistorical. As noted, the restrictions on Android forks plays an important role in maintaining the coherency of the Android ecosystem. If device manufacturers were able to freely install Google apps (and other apps via the Play Store) on devices running problematic Android forks that were unable to run the apps properly, consumers — and app developers — would be frustrated, Google’s brand would suffer, and the value of the ecosystem would be diminished. Extending this restriction to all devices produced by a specific manufacturer, regardless of whether they come with Google apps preinstalled, reinforces the importance of the prohibition to maintaining the coherency of the ecosystem.

It is ridiculous to say that something (efforts to rein in Android forking) that made perfect sense until 2011 and that was central to the eventual success of Android suddenly becomes “abusive” precisely because of that success — particularly when the pre-2011 efforts were often viewed as insufficient and unsuccessful (a January 2012 Guardian Technology Blog post, “How Google has lost control of Android,” sums it up nicely).

Meanwhile, if Google is unable to tie pre-installation of its search and browser apps to the installation of its app store, then it will have less financial incentive to continue to maintain the Android ecosystem. Or, more likely, it will have to find other ways to generate revenue from the sale of devices in the EU — such as charging device manufacturers for Android or Google Play. The result is that consumers will be harmed, either because the ecosystem will be degraded, or because smartphones will become more expensive.

The troubling absence of Apple from the Commission’s decision

In addition, the EC’s decision is troublesome in other ways. First, for its definition of the market. The ruling asserts that “Through its control over Android, Google is dominant in the worldwide market (excluding China) for licensable smart mobile operating systems, with a market share of more than 95%.” But “licensable smart mobile operating systems” is a very narrow definition, as it necessarily precludes operating systems that are not licensable — such as Apple’s iOS and RIM’s Blackberry OS. Since Apple has nearly 25% of the market share of smartphones in Europe, the European Commission has — through its definition of the market — presumed away the primary source of effective competition. As Pinar Akman has noted:

How can Apple compete with Google in the market as defined by the Commission when Apple allows only itself to use its operating system only on devices that Apple itself manufactures?

The EU then invents a series of claims regarding the lack of competition with Apple:

  • end user purchasing decisions are influenced by a variety of factors (such as hardware features or device brand), which are independent from the mobile operating system;

It is not obvious that this is evidence of a lack of competition. A better explanation is that the EU’s narrow definition of the market is defective. In fact, one could easily draw the opposite conclusion of that drawn by the Commission: the fact that purchasing decisions are driven by various factors suggests that there is substantial competition, with phone manufacturers seeking to design phones that offer a range of features, on a number of dimensions, to best capture diverse consumer preferences. They are able to do this in large part precisely because consumers are able to rely upon a generally similar operating system and continued access to the apps that they have downloaded. As Tim Cook likes to remind his investors, Apple is quite successful at targeting “Android switchers” to switch to iOS.

 

  • Apple devices are typically priced higher than Android devices and may therefore not be accessible to a large part of the Android device user base;

 

And yet, in the first quarter of 2018, Apple phones accounted for five of the top ten selling smartphones worldwide. Meanwhile, several competing phones, including the fifth and sixth best-sellers, Samsung’s Galaxy S9 and S9+, sell for similar prices to the most expensive iPhones. And a refurbished iPhone 6 can be had for less than $150.

 

  • Android device users face switching costs when switching to Apple devices, such as losing their apps, data and contacts, and having to learn how to use a new operating system;

 

This is, of course, true for any system switch. And yet the growing market share of Apple phones suggests that some users are willing to part with those sunk costs. Moreover, the increasing predominance of cloud-based and cross-platform apps, as well as Apple’s own “Move to iOS” Android app (which facilitates the transfer of users’ data from Android to iOS), means that the costs of switching border on trivial. As mentioned above, Tim Cook certainly believes in “Android switchers.”

 

  • even if end users were to switch from Android to Apple devices, this would have limited impact on Google’s core business. That’s because Google Search is set as the default search engine on Apple devices and Apple users are therefore likely to continue using Google Search for their queries.

 

This is perhaps the most bizarre objection of them all. The fact that Apple chooses to install Google search as the default demonstrates that consumers prefer that system over others. Indeed, this highlights a fundamental problem with the Commission’s own rationale, As Akman notes:

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

Conclusion

As the foregoing demonstrates, the EC’s decision is based on a fundamental misunderstanding of the nature and evolution of the market for smartphones and associated applications. The statement by Commissioner Vestager quoted above — that “What would serve competition is to have more players” — belies this misunderstanding and highlights the erroneous assumptions underpinning the Commission’s analysis, which is wedded to a theory of market competition that was long ago thrown out by economists.

And, thankfully, it appears that the FTC Chairman is aware of at least some of the flaws in the EC’s conclusions.

Google will undoubtedly appeal the Commission’s decision. For the sakes of the millions of European consumers who rely on Android-based phones and the millions of software developers who provide Android apps, let’s hope that they succeed.

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

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

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

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

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

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

What we know and market definition

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

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

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

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

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

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

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

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

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

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

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

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

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

Is Microsoft really the relevant precedent?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What will happen next?

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

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

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

 

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

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

The nirvana fallacy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Missing the real competition for the trees

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

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

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

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

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

Regardless of which standard you want to apply to competition law – consumer welfare, total welfare, hipster, or redneck antitrust – it’s never good when competition/antitrust agencies are undermining innovation. Yet, this is precisely what the European Commission is doing.

Today, the agency announced a €4.34 billion fine against Alphabet (Google). It represents more than 30% of what the company invests annually in R&D (based on 2017 figures). This is more than likely to force Google to cut its R&D investments, or, at least, to slow them down.

In fact, the company says in a recent 10-K filing with the SEC that it is uncertain as to the impact of these sanctions on its financial stability. It follows that the European Commission necessarily is ignorant of such concerns, as well, which is thus clearly not reflected in the calculation of its fine.

One thing is for sure, however: In the end, consumers will suffer if the failure to account for the fine’s effect on innovation will lead to less of it from Google.

And Google is not alone in this situation. In a paper just posted by the International Center for Law & Economics, I conduct an empirical study comparing all the fines imposed by the European Commission on the basis of Article 102 TFEU over the period 2004 to 2018 (Android included) with the annual R&D investments by the targeted companies.

The results are indisputable: The European Commission’s fines are disproportionate in this regard and have the probable effect of slowing down the innovation of numerous sanctioned companies.

For this reason, an innovation protection mechanism should be incorporated into the calculation of the EU’s Article 102 fines. I propose doing so by introducing a new limit that caps Article 102 fines at a certain percentage of companies’ investment in R&D.

The full paper is available here.

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

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

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

How to beat one of the great innovations?

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

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

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

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

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

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

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

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

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

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

The Commission is of another mind, however.

Commission’s hubris

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

This analysis runs counter to some rather obvious facts:

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

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

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

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

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